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June
2003

THE MASTER SETTLEMENT AGREEMENT:
FIVE YEARS LATER, STILL ADJUSTING

The last five years in the cigarette world could more closely be compared to the average 20 years during most other eras. Having become the focus of intense public, legislative, and legal attention in recent years, the industry has been subjected to market changes and trends that would once have spanned decades, but have now been condensed into far shorter periods of time.

Next to soaring excise taxes, perhaps no single force can take as much credit in this department as the searingly complex Master Settlement Agreement (MSA), signed in 1998.

A truce between the Big Four domestic cigarette companies (Philip Morris USA, R.J. Reynolds, Brown & Williamson, and Liggett) and state attorneys general intended to settle legal claims by the states to recoup money spent treating illnesses of smokers, the settlement in the early days was considered a positive development for Big Tobacco: A clean break from the threat of endless, state-by-state litigation attempting to win settlements on these grounds.

But things didn't quite work out as anticipated... for anyone. Small cigarette companies and wholesale distributors felt the immediate burden, as their own best interests were not necessarily reflected in the settlement and the administrative burden of bureaucratic red tape became reality. Then, years of escalating cigarette excise taxes finally broke the "elastic demand" principal that had long governed premium cigarette pricing in the country, fueled by alternative retail channels like the internet, and alternatively priced discount brands. Small discount brands suddenly found themselves with a much larger chunk of the U.S. market than anyone ever anticipated, including the authors of the MSA.

In fact, the massive MSA payments to the 46 participating states - the cost of which was passed on to cigarette smokers - were from the very beginning seen as a significant threat to marketplace balance, so provisions were made, in part, to "level the playing field." Companies who chose not to voluntarily sign the MSA would be required to pay into escrow accounts, creating a financial fund in case the states should win legal settlements against those same companies at a later date.

Unfortunately, the loopholes in all of this madness proved to be a strong draw for companies who could enter the market, evade all escrow responsibilities, then disappear without contributing a dime, all the while enjoying a considerable pricing advantage in the marketplace. What in the world did the MSA authors expect? The gap between meeting one's "responsibilities" and being subject to timely legal enforcement of escrow payments was, in retrospect, way off base.

Now, a new wave of "complementary legislation" aims to fix many of those problems, linking a brand's legality to a manufacturer's MSA compliance status. Instead of a 16-month lag time in enforcement, new regulations being adopted by MSA states seek to prevent profiteering fly-by-night brands. But new rules mean new challenges, and the tighter regulation grip will introduce new problems for small, compliant companies.

The authors of the MSA unfairly overestimated the threat of existing, small distributors as potential scofflaws and grossly underestimated the vast opportunities the complex settlement afforded to opportunists. With little support in Congress to create a workable nationwide regulation system, the states took it upon themselves.

If you do a brisk cigarettes in cigarettes, pay attention, and scour Bob Ashley's lead story, "Fine-Tuning the MSA" on page 24 for a retailing perspective.

E. Edward "Ted" Hoyt III
Editor