The Wall Street Journal Interactive Edition -- September 23, 1997 FTC Sharply Criticizes Proposed Tobacco Deal Agency Says Profits Would Exceed Penalties Included in Settlement By JOHN R. WILKE and JEFFREY TAYLOR Staff Reporters of THE WALL STREET JOURNAL WASHINGTON -- The Federal Trade Commission sharply criticized the proposed national tobacco settlement, concluding that cigarette makers could reap big profits that would far exceed the penalties the pact would impose. The FTC's reaction strengthens the hand of President Clinton and those on Capitol Hill who are demanding a tougher settlement. The original deal, struck between tobacco companies, state attorneys general and public-health advocates on June 20, calls for the industry to pay $368.5 billion over 25 years to offset states' costs of caring for sick smokers. "Cigarette prices are likely to rise more than the amount of the annual payments, and as things now stand, vast additional revenues will go to the tobacco companies," FTC Chairman Robert Pitofsky said Monday. He found the proposed deal's broad antitrust exemption especially troublesome, saying it would give tobacco companies immunity from price fixing and let the largest grow stronger while squeezing out smaller players. The FTC found that the plan could boost industry profits from $36 billion to as much as $123 billion over the life of the settlement, depending in part on whether industry tax exemptions are enacted. Rep. Waxman Sought Study "This study shows that the tobacco settlement is an even better deal for the industry than anyone had imagined," said Rep. Henry Waxman, a California Democrat who asked the FTC to study the proposed settlement. He said the antitrust exemption is among many provisions that will have to be changed as Congress drafts tobacco legislation. A tobacco-industry spokesman, Scott Williams, rejected the FTC's report, saying it is "highly speculative and misses the point, which is that the price increases in the settlement are designed to maximize the reduction in underage tobacco use." He said the report "is based on assumptions that are at best inaccurate," such as the FTC's calculation that cigarette makers routinely pass on more than 100% of the cost of tax increases. The settlement calls for reductions in youth smoking of 30% in five years and 60% in 10 years. If the industry fails to meet the targets, the pact would impose penalties of as much as $2 billion a year, which would probably be passed along to customers in the form of further price increases. The payments would also be tax-deductible, and the industry could apply for refunds. President Clinton has said he wants to toughen these penalties. The pact also includes an exemption from antitrust laws that would allow cigarette companies to cooperate on raising prices. The FTC also said cigarette makers could end up paying significantly less than the $368.5 billion envisioned under the proposed settlement because the payments are linked in part to annual sales, which are expected to decline as consumer prices rise. Richard Lugar, the Indiana Republican who is chairman of the Senate Agriculture Committee, one of the panels likely to shape tobacco legislation, said Congress "will want sufficient funding of state and federal public-health costs caused by smoking." President Seeks FDA Role Last week, President Clinton called for changes in the proposed settlement, demanding that the Food and Drug Administration be authorized to control nicotine levels in tobacco products and calling for price increases of as much as $1.50 a pack to attack smoking among youths. The proposed settlement is being reviewed on Capitol Hill, which must come to terms with the president and pass legislation for its provisions to take effect. Congress isn't expected to begin the process in earnest until next year. But the FTC's Mr. Pitofsky said price increases could give tobacco companies too much leeway to boost profits. "Prices per pack ought to go up, but the question is how much and where is the money going to go?" he said. "Even without the antitrust exemption, if prices rise $1.50 a pack, that produces vast revenues that are not yet accounted for." Richard Scruggs, a plaintiffs attorney representing several states that sued the industry, said, "The intent of the settlement was to give the industry an exemption only to the extent necessary to fund the settlement. If the provision is too broad, we'll work to narrow it." He added that the settlement agreement was a "term sheet" rather than a detailed piece of legislation. Moore Rejects 'Collusion' Added Michael Moore of Mississippi, the lead negotiator for the state attorneys general, said, "We're certainly not for any collusion." Mr. Moore said, however, "We always thought tobacco companies would raise prices higher than what they had to for the settlement, but truthfully we thought that was a good thing from a public-health perspective." Industry lawyers say the tobacco companies are willing to work with the FTC to narrow the antitrust exemption. As drafted, it would permit tobacco companies "to jointly confer, coordinate or act in concert" to reach the settlement's goals, including eliminating billboard advertising and vending-machine sales. The companies, the attorneys said, believe they need the exemption to carry out these goals without violating antitrust laws. But Mr. Pitofsky said the provision, "although possibly not intended ... would allow the tobacco companies to coordinate their behavior and raise prices far in excess of levels necessary to cover the annual payments and keep the extra profits for themselves." Highly Concentrated Industry The FTC study said the tobacco industry has historically passed on to consumers more than government-required price increases. That is in part because the industry is highly concentrated, there are high barriers to entry by competitors, and customers are relatively insensitive to price increases. Rep. Martin Meehan said the exemption's effect "has been completely overlooked" and provides the industry with benefits "that go well beyond the original justification." Indeed, the Democrat from Massachusetts said the companies can make the required payments without it. Republican Orrin Hatch of Utah, who as chairman of the Senate Judiciary Committee will play a crucial role in drafting legislation, said he is working with Ohio Republican Mike DeWine, chairman of the Senate antitrust subcommittee, to ensure that "any necessary antitrust exemption will be narrowly tailored to accomplish the legislative goal of reducing [youth] smoking." Separately, Brooke Group Ltd.'s Liggett Group Inc. unit said it settled Nevada's tobacco-related Medicaid-reimbursement claims. Nevada is one of several states that filed suit against tobacco companies to cover billions of dollars in Medicaid costs. Among the terms of the settlement, the unit will put an added warning on its packs stating "smoking is addictive," and agreed to pay as much as 22.5% of its pretax earnings into a settlement fund for the next 25 years. Return to top of page Copyright (c) 1997 Dow Jones & Company, Inc. All Rights Reserved.