Documents Suggest that Attorneys General are Scheming with Big Tobacco to Protect Financial Health of Major Tobacco Companies

Just one week after the Attorneys General stood before the media and boasted about how great they and the Master Settlement Agreement (MSA) have been for the public's health, an analysis of tobacco industy documents suggests that the Attorneys General, far from working to protect the public's health, are instead working with the tobacco companies to protect the financial well-being of the states and major tobacco companies.

A document from the Philip Morris document site demonstrates that the Attorneys General and participating manufacturers in the MSA met to discuss, share information, coordinate, and work together on legislative proposals throughout the nation to protect the market share of Big Tobacco by making it more difficult for non-participating companies to compete in the marketplace, and by doing so, to help protect the amount of MSA money coming into the states.

The January 25, 2004 memorandum recounts the events of a January 20, 2004 meeting between representatives of the National Association of Attorneys General (NAAG) and representatives of Philip Morris, R.J. Reynolds, Brown & Williamson, and Lorillard.

At the meeting, several types of legislative proposals to make it more difficult for non-participating manufacturers to compete in the marketplace were discussed, including allocable share legislation and equity fee legislation.

Allocable share legislation (to the best of my understanding) is legislation that requires non-participating manufacturers to pay additional money to the states, beyond that which would have been required under the language of the MSA, which provides for a "refund" of payments that are beyond those that would have been required of the non-participating manufacturers had they actually been participating manufacturers. This legislation appears to have been enacted in most of the states.

Equity fee legislation (to the best of my understanding) is legislation that imposes taxes or fees on the non-participating manufacturers in the form of a fee. This legislation appears to have been enacted in only a handful of states. For example, Minneosota and Michigan enacted laws that imposed a 35 cent per pack "equity fee" on non-participating manufacturers.

Not only were these legislative proposals discussed, but there appears to have been some give and take in terms of discussion of the actions that these two parties (the AGs and Big Tobacco) could take to enhance the prospects for passage of this type of legislation, which would protect Big Tobacco profits from the threat posed by non-participating manufacturers.

In fact, it appears that elements of a negotiation took place, where offers were made and discussed and the possibility of coordinating actions was considered. In other words, the document suggests that this was more than simply a neutral reporting of information. There was discussion about actions that the parties would or would not agree to take in an effort to enhance the chances of favorable legislation being enacted and "the entire MSA scheme" (NAAG's terminology, not mine) being preserved.

For example, a NAAG representative at the meeting was reported to have made the following points:

• "As a policy matter, the states are under attack for being too close to participating manufacturers;
• States are in favor of balancing but uncomfortable with legislation that would side them too closely with participating manufacturers;
• Potential for legal challenges - NAAG thinks substantial risk that Michigan will be challenged and is vulnerable to constitutional attack. More vulnerable than other types of proposed legislation;
• Freedom Holding - NAAG wants to avoid anything that directly involves states in marketplace. Entire scheme of MSA is currently under attack, and we do not want to increase that vulnerability and put that scheme at risk [...NY still up in the air on what to do next in Freedom Holding case];
• Think equity fee will make it harder to get allocable share enacted;
• Media is reporting that AGs and PMs are conspiring to hurt the little guy; and
• We want to concentrate on allocable share and think the best thing that could happen is to have that be the only thing pending in the states."

My impression is that the Attorneys General were suggesting to the tobacco companies that pursuing both the allocable share and equity fee legislative approaches to protect Big Tobacco's profits from competition from smaller (non-participating) manufacturers could backfire, because the equity fee legislation could be perceived as putting unfair burdens on the smaller manufacturers, could have constitutional problems, could create a public perception that the Attorneys General and Big Tobacco were conspiring to hurt the smaller manufacturers, and could threaten the entire "MSA scheme."

The R.J. Reynolds/Brown & Williamson representative apparently responded by noting:

• "We're not trying to enlist support of AGs - happy to have AGs remain neutral;
• "we ... think equity assessment will survive constitutional challenge; and
• "... equity fee legislation doesn't make the situation worse."

NAAG apparently responded by noting that the "purpose of allocable share was to create a level playing field. How do we now say we need so much more to achieve a level playing field."

To which the tobacco company representative apparently replied that "equity assessment makes it easier to pass allocable share."

In other words, what appears to be going on in this exchange is a discussion of strategy: What is the best strategy for enacting legislation in the states to protect the big tobacco companies profits' from competition from the smaller ones, and what can the parties at the table do to enhance the prospects of passing this legislation?

The discussion apparently then turned to the involvement or lack of involvement of the Attorneys General in the process of promoting this protective legislation.

A NAAG representative then apparently acknowledged (as I have been suggesting during the past week) that "states' exposure to bankruptcy is a serious concern." He also apparently emphasized that: "The states are concerned with potential for an OPM [original participating manufacturer] bankruptcy. Feel terribly exposed. Serious, unpredictable risk. States have had lengthy discussions of what happened in Price case."

There appears to have been a clear discussion of strategy and the roles that the two parties did or did not and would or would not play.

A tobacco company representative apparently noted that "during our November meeting, the AGs said nine states critical - RJR worked our buns off to accomplish this goal. We did so - so what's next?"

The question "What's next" suggests to me that on the table was a discussion by the parties of what steps to take. In other words, this was not just a reporting of actions that the sides took, but to some extent at least, a discussion of coordination of activity.

Then, in the most telling aspect of the document, it is apparent that the Brown & Williamson representative made an offer to the Attorneys General: "B&W Lobbyist offer - what if we back off in the 9 critical states you identified. 1. Not press equity assessment in nine states. 2. Not link equity assessment to allocable share in any state - Can we be assured of your neutrality?"

A representative of the Attorneys General apparently responded that "we prefer that nothing happen anywhere. Can't comment for every state and in states that already passed allocable share - the equity assessment is not welcome."

Clearly, by my reading of this, there was a negotiation taking place. An offer was made and the sides were apparently discussing an agreement. Would the Attorneys General agree to remain neutral, rather than oppose the equity assessment legislation if the tobacco companies agreed to back off from the equity assesssment legislation in 9 critical states in which the Attorneys General were apparently trying to get allocable share provisions passed?

In fact, it was clear that a decision had to be made during the meeting by the parties about what the Attorney General in Virginia would do about the filing of protective legislation (it's not clear exactly what type was on the table - presumably allocable share legislation) and that the Attorneys General were consistently referring to the promotion of state protective legislation as a "scheme."

A NAAG representative apparently asked: "what are we doing in Virginia? The wolf is at the door. We cannot leave this room without deciding what we're going to do. The AG wants an answer."

The Brown & Williamson lobbyist apparently asked: "if we cannot pass allocable share in Virginia, West Virginia and North Carolina, what does that do to the scheme?"

To which a NAAG representative apparently replied: "hurts it a lot."

In other words, this meeting clearly gives the impression that the Attorneys General and major tobacco companies were scheming together. In fact, one Attorney General representative actually used the term "coordinated strategy."

A tobacco company representative apparently asked for NAAG's assistance: "with respect to MSA specific bond cap efforts - we would appreciate NAAG's assistance."

Another deal was apparently thrown on the table: "Are the participating manufacturers in a position to say they will not push equity assessment anywhere in exchange for states taking the draft NAAG proposal off the table?"

I think this clearly indicates that the meeting involved more than simply an exchange of information, but that it involved negotiation and coordinated strategies and actions.

The Rest of the Story

It seems quite clear from this document that the Attorneys General and Big Tobacco were scheming to protect the profits of the major tobacco companies from competition from smaller companies. It appears that the Attorneys General were accomplices in the efforts of Big Tobacco to protect its market share, and that the Attorneys General were acting to protect Big Tobacco in order to protect their own financial status (i.e., that of the states whose budgets are dependent on the volume of MSA payments). Moreover, it appears that the Attorneys General were negotiating with, coordinating strategy with, and working together with the major tobacco companies to accomplish the enactment of Big Tobacco profit protection legislation.

Moreover, it is interesting to note that the Attorneys General themselves refer to the entire MSA as a "scheme." They also acknowledge that the "scheme" will be hurt a lot by the failure to enact Big Tobacco protective legislation (allocable share legislation) in just 3 critical states.

Furthermore, the Attorneys General acknowledge that states' exposure to bankruptcy is a critical concern. In other words, they appear to acknowledge that the states' financial health is dependent upon the financial health of the tobacco companies and that they therefore have a large incentive to protect the profits of Big Tobacco.

I think the document makes it clear, for the many reasons I highlighted above, that the Attorneys General were (and presumably are still) working and acting together with the major tobacco companies toward the same result or goal: namely, the enactment of state legislation that would protect Big Tobacco from competition from smaller companies not subject to the MSA's requirements and thus would protect both parties at the table: the participating manufacturers (by making it harder for non-participating manufacturers to compete) and the Attorneys General (by preserving and bolstering MSA and non-participating manufacturer payments to their states).

The Attorneys General acknowedged at the meeting that the legislation being discussed would hurt the non-participating manufacturers, and they even acknowledged that some tobacco distributors would no longer carry non-participating manufacturers' (NPM's) products ("NPM's have a huge advantage in the escrow loophole - once closed they will be disadvantaged by their lack of a release. Some distributors won't carry NPM product because they think it's risky").

The document appears, then, to put all the pieces of the puzzle together and to confirm what I have been arguing for some time: that the Attorneys General and the states have become partners of Big Tobacco and that they have a huge incentive to protect Big Tobacco's profits. But the document goes further than I would have been able to otherwise assert by demonstrating that the Attorneys General are actually working together with, and coordinating their actions with Big Tobacco.

I recognize that this is a complex issue and I'll try to explain it more clearly below for readers who may not be familiar with the details, but first, let me make 3 critical points:

1. I am not accusing the tobacco companies of any wrongdoing. In contrast, I praise them for being clever enough to be able to take the Attorneys General on the long ride that is the MSA, having taken advantage of the fact that they knew the Attorneys General would be motivated by the prospect of huge sums of money and would therefore agree to a deal that was advantageous for the tobacco companies' profits.

To even be able to have created this group of state officials who is doing their work for them - promoting legislation in almost every state to protect them against competition from smaller manufacturers - is a tremendously clever and brilliant accomplishment. Moreover, the tobacco companies are not in the business of protecting the public's health or looking out for the public's best interests. So taking advantage of the economic incentives of the MSA that encourage the states to protect Big Tobacco's interests is certainly something that they have the right to do.

The tobacco companies have every right to promote state legislation to protect their profits and to compete with smaller manufacturers. I don't think they are doing anything fraudulent, illegal, or otherwise wrong in doing so, with one possible exception. It is possible that what they are doing is unconstitutional, in the sense that the MSA could represent a compact between the states that violates the Compact Clause of the Constitution, as has been claimed in a lawsuit initiated by the Competitive Enterprise Institute. In that sense, the "scheme" that the tobacco companies and Attorneys Generals discussed at the meeting might be an unconstitutional scheme. That remains to be seen; it is not yet clear how the court will rule on this lawsuit.

2. On the other hand, I do not view the Attorneys General's actions in such a positive light. They, unlike the tobacco companies, do have the responsibility to protect the interests of the public, including the public's health. They, as the ones who brought these lawsuits in the first place, specifically put themselves in the position of protecting the public's health and of putting the health of the citizens above the profits of the tobacco companies. And they, as recently as last week, have been boasting to the public how concerned they are about the public's health and about how much they are doing to protect the public's health and to fight the tobacco companies.

But here we have what I see as pretty strong, if not conclusive evidence that the Attorneys General, rather than fighting against Big Tobacco to protect the public's health is actually scheming with Big Tobacco to protect the major tobacco companies' profits in order to protect the financial health and budget stability of their states.

What's clear to me is that the MSA is not about public health at all. What it's about, quite simply, is money. And to obtain and protect that money, the Attorneys General are apparently working with, coordinating with, and strategizing and scheming with Big Tobacco to protect the profits of companies which produce products that are the leading cause of death in their states.

This is hardly behavior that I would view as being appropriate for public officials who are putting themselves in front of microphones trying to cast themselves as being the protectors of the public's health. Far from it - they are the protectors of Big Tobacco's profits.

So in scheming and working together with Big Tobacco to protect their profits from competition from smaller tobacco companies, I do view the actions of the Attorney General as representing wrongdoing - not legal wrongdoing (notwithstanding the constitutional challenges to the MSA), but in a sense, ethical wrongdoing. It hardly seems ethical for state officials who are working under the pretense of protecting the public's health at the expense of Big Tobacco profits to be actually working in a coordinated fashion with those very companies to protect their profits.

3. Finally, I want to make it clear that I acknowledge that simply in meeting with the tobacco companies to discuss the MSA, I do not view the Attorneys General as doing anything wrong. In fact, the MSA requires them to meet with the tobacco companies no less than twice a year.

However, the expressed purpose of those meeting is specified as follows: "The purpose of the meetings and conference is to evaluate the success of this Agreement and coordinate efforts by the Attorneys General and the Participating Manufacturers tocontinue to reduce Youth smoking."

As I interpret this, the purpose of these meetings is to determine how successful the MSA has been in reducing youth smoking and to coordinate efforts to further reduce youth smoking.

Nothing in the memorandum of the January 20th meeting between the Attorneys General and participating manufacturers is about evaluating successes in reducing youth smoking prevalence or in discussing efforts to reduce youth smoking. Instead, the meeting is about how to protect the profits of the participating manufacturers from competition from the non-participating manufacturers. So the Attorneys General cannot successfully defend themselves by arguing that they are in fact contractually obliged to meet with the companies to discuss and work together for this purpose. They are not. They are obliged to meet with the companies and work together only to reduce youth smoking, something which was apparently not even a topic of discussion at the January 20th meeting.

For those who want to better understand the issues involved, here is an excerpt from an excellent summary that Bonnie Herzog of Smith Barney provided:

"Due to the lack of compliance by many new entrants into the cigarette industry, states have been losing money as the compliant manufacturers’ market share declines have led to lower MSA payments. Therefore, as more non-compliant manufacturers enter the market, states have started to enact more stringent laws and regulations to prevent these "illegal" manufacturers from slipping through the cracks of the MSA and thereby achieving a significant cost advantage.

Allocable Share Legislation: Currently the NPM (non-participating manufacturer) model statute (Exhibit T of the MSA) states that if a NPM pays more to a state on a per unit basis than the state would have received if that NPM were a signor on the MSA, then the state must refund the difference. This is often referred to as the "cap release."

Allocable Share legislation modifies the Model T statute of the MSA and eliminates the cap release, thus requiring a compliant NPM to absorb additional costs or pass them on in the form of higher prices. The current per carton escrow deposit required for the NPMs under the Model T statute is around $3.90 (which includes inflationary adjustments), which is close to the current national average MSA payment required for OPMs and SPMs.

Eighteen states passed this type of legislation in 2003, and an additional 13 (Colorado, Connecticut, Georgia, Kentucky, Maryland, Massachusetts, Michigan, Nebraska, New Mexico, South Dakota, Tennessee, Utah, Wyoming) have passed it so far this year. Eight additional states have proposed this legislation.

Quarterly Escrow Payments: Currently, non-participating manufacturers (NPMs) are required to make annual escrow payments. However, under the Quarterly Escrow Payment legislation, states have now begun to require NPMs to make quarterly payments to further ensure compliance. Requiring more frequent payments from a free cash flow standpoint, puts pressure on NPMs to increase their cigarette prices. Over the past two years, 29 states have passed this legislation; six states have proposed this legislation this year, (So far, Kentucky is the only state that has passed quarterly escrow payment.) ...

Other Legislation: In addition to the proposals mentioned above, there is also the threat of additional taxes or fees being placed on the non-Big Four manufacturers in the form of a fee. So far, Michigan and Minnesota are the only two states that have passed this type of legislation. On May 27, 2003, the governor of Minnesota signed into law a bill stating that NPMs would have to pay a $0.35 per pack fee to Minnesota. Minnesota was the first state to levy a fee against nonparticipating manufacturers. (Minnesota was one of the four states that independently settled with large cigarette companies and did not participate in the MSA.) On January 8, 2004, the governor of Michigan signed into law a bill requiring all nonparticipating manufacturers (NPMs) of the MSA to pay an "equity assessment" at a rate of $0.35 per pack of 20 cigarettes. The "equity assessment" is in addition to all other fees, assessments, and taxes levied by law and will be collected on April 15 of each year based on cigarettes sold in the previous calendar year."

The rest of the story is that the Attorneys General appear to be acting and working with the major tobacco companies to protect Big Tobacco from competition from smaller manufacturers in order to preserve and enhance both Big Tobacco profits and the financial health of the states. In contrast to what they would have us believe (that they are fighting the tobacco industry in order to protect our health), I believe that the Attorneys General are working together with the big tobacco companies to protect their profits, and that the end result has been a scheme that has substantially harmed the public's health to the benefit of large financial and political rewards for the Attorneys General and plaintiffs' lawyers.