Gary Black: AGs Throw Ball Back To Congress --Which Doesn't Want It. Outperforms MO, RN, UST.


TOBACCO

Vuja De -- Industry Moving Ahead With Plan B. Raising Estimates. Outperforms MO, RN, UST.

Gary Black (212) 756-4197
Jon Rooney (212) 756-4504

July 14, 1998

TOBACCO

AGs Throw Ball Back To Congress --Which Doesn’t Want It. Outperforms MO, RN, UST.

HIGHLIGHTS

  1. The attorneys general threw the tobacco ball back into Congress’ lap yesterday, giving Congress one last chance to pass comprehensive tobacco legislation before the AGs proceed with their own state-only settlement with the industry. We continue put high odds on the two sides reaching an agreement by end of summer to settle the remaining 46 state cases for $200 billion.

  2. Our Washington sources say the Administration is highly unlikely to file a Medicare recovery action against the tobacco industry. The federal government, unlike the states, cannot claim ignorance about the dangers of tobacco, having published at least a dozen surgeon generals reports since the first one in 1964, and requiring federal warning labels on packs since 1966. Any claim to recover Medicare expenditures must be filed in federal court, which has shown a penchant for tossing out these type claims.

  1. We believe the real agenda for the Administration talking up a federal Medicare recovery action is to pressure the industry to agree to new legislation that gives the FDA jurisdiction over tobacco -- which would dovetail with a state-only settlement of AG claims. This week, Senate Democrats will try to attach a bill calling for FDA jurisdiction over tobacco to one of the appropriations bills up for review. We believe Democrats will not get the 51 votes needed to give the FDA jurisdiction.

  1. We still expect the House to pass a narrow youth tobacco/drug access bill, such as the one outlined by Deborah Pryce a few weeks back (strict retail access, limited FDA authority, fines on retailers who sell to minors, fines on teens who buy cigarettes illegally, no excise tax increase). The House is expected to take up the tobacco issue the week of 7/27. If the AGs and the industry reach a state-only agreement, Republicans are unlikely to pass any final tobacco bill this year (House-Senate conference next session)..

  2. Washington AG Christine Gregoire indicated that the drop dead date for Congress to pass comprehensive tobacco legislation is September 14 -- the start of the Washington Medicaid trial. Judge Finkle will rule by next week on the defense’s motion for summary judgment on the remaining three state claims. If these claims are dismissed, tobacco stocks could move up sharply.

  3. We reiterate outperform ratings on Philip Morris, RJR, and UST.

ADDITIONAL DETAILS

  1. AGs still want Congress to act -- much to Republicans’ dismay. Our discussions with one attorney general who was at the five-hour tobacco meeting yesterday in Durango, CO, indicate there was strong agreement to move forward with a state only settlement -- if Congress failed to pass comprehensive tobacco legislation this year. The AG strategy, spelled out by lead negotiator Christine Gregoire (AG Washington state) in the press this morning, appears to be three-fold: 1) Keep the pressure on Congress to pass comprehensive legislation that follows the June 20 accord before Congress adjourns in October; 2) Allow the six AGs negotiating for the AGs to move forward with discussions to settle all remaining and unfiled AG claims; 3) Move forward with the states’ individual litigation, in case neither of the two settlement options pans out.

    2. Our interpretation of this mixed message is that the vast majority of the AGs support the notion of a state-only deal -- but only once it becomes clear that Congress "cannot get the job done it was supposed to do" (Christine Gregoire). As Maryland AG Joe Curran put it, "[My] preference is for national legislation ... but if Congress doesn’t do something, we will not just sit and wring our hands." One major concern expressed by the attorney general we talked to was that by announcing now that they favor a state-only settlement, the AGs remove the incentive for Republicans to pass any sort of tobacco legislation this year, given the political cover that such a state-only settlement generates (Logic -- If the teen smoking issue is already being addressed by the states, the federal government needn’t do anything). The AGs clearly would prefer a national deal to a state-only deal, since the former would give the FDA jurisdiction over tobacco, penalize the industry if it failed to meet youth lookback targets, and impose tougher marketing restrictions than the states could get locally. Unfortunately, this is not the message Republicans want to hear, since it forces Republicans to do something on tobacco, rather than run out the clock. There are now just 7 weeks left in this session of Congress -- including just two for the Senate and three for the House before the August break.

    One other comment about the AG discussions: Money does not appear to be the main stumbling block, despite the reports in the media that the industry needs to cough up more cash. To settle the remaining 46 states, the Attorneys General "asking" price appears to be $196 billion -- putting the likely final settlement figure within the $180 - $200 billion range we talked about last week (cigarette prices would go up by about $.35/pack over five years). We doubt the upfront money (AGs want $15 - $20 billion) is as much an issue as made out to be, since upfront funds of $15 - $20 billion could be spread over five years, as it was in Minnesota, given the graduated nature of the ongoing payment stream, which ramped up from $4 billion in year 1 to $8 billion in Year 5 under the original terms of the June 20 accord. Amortizing $15 billion over five years ($6 - $7 in Year 1, $2 over next four years) means that the $.35/pack price hike would occur at once in Year 1, and stay level.

  2. Why the Administration won’t file a national Medicare claim. The Administration’s comments that they are examining "in a very preliminary way" whether to file a claim against the industry for recovery of Medicare expenditures, appears to be a threat designed to get the industry to go along with new tentative legislation that gives the FDA clear jurisdiction over tobacco -- which the industry agreed to in the June 20 accord. White House staff indicated yesterday that a suit to recover Medicare expenditures (Medicare is for those over 65 and for those disabled), which could total $12 billion per year (federal portion of state Medicaid smoking-related expenses is another $8 billion per year -- hence, the numbers quoted in the press of $20 billion per year), is one of several options under discussion. White House press secretary Mike McCurry made it clear yesterday that the Administration would not likely move forward with any such claim until after Congress adjourned (October 9) and until there was no chance for a comprehensive settlement.

In theory, the United States government can sue to recover Medicare expenses under 42 USC §2651. Cases interpreting that law have said that the United States has a direct action against the alleged tortfeasor and is therefore not subject to defenses that the tortfeasor might have used against the injured party. We believe 42 USC § 2651 appears provides a more clear-cut right for the United States to directly recover medical expenses from third parties, such as the tobacco companies, than the state laws provide for the recovery of their Medicaid expenses. However, for reasons we point out below, an economic recovery claim brought by the federal government would probably be more difficult to win in court than a state recovery action.

According to 42 USC § 2651, in any case where the U.S. furnishes medical care "under circumstances creating a tort liability upon some third person to pay damages, …the United States shall have a right to recover from said third person the reasonable value of the care and treatment." The statute goes on to explain that the United States’ right to recover shall be subrogated to any right or claim that the injured or diseased person has against the tortfeasor to the extent of the reasonable value of the care and treatment. This provision seems unclear, but the cases interpreting the statute clarify its meaning. Federal cases interpreting 42 USC § 2651 say the United States government has three ways for recovering medical and hospital care: (1) by subrogation; (2) by intervening or joining in any action brought by an injured person; and (3) by instituting such action itself or in conjunction with the injured person. Another case says: "In construing the Medical Care Recovery Act, the Courts have uniformly held that the United States is not merely subrogated to the injured party’s claim, but has an independent cause of action under the Act." In that case, a woman suffered injuries while riding as a passenger in a car driven by her husband. Under the law of Arkansas, where the accident happened, a passenger cannot sue the driver of the car in which she was riding. But the United States was allowed to sue the husband because the court found that the United States was not subrogated to the wife’s claim.

Other cases explain that when the United States pays a victim’s medical expenses, the injured person is not entitled to recover the amount of those expenses from the tortfeasor – only the United States has the right to recover that money. The purpose of 42 USC § 2651 was to prevent injured people from double recovery – once from the government and once from the tortfeasor. One federal case focused on this issue, ultimately finding: "42 USC § 2651 is clear – the Federal Medical Care Recovery Act gives the United States an absolute, direct right of action to recover the reasonable value of medical expenses provided by law to anyone injured through the tortious conduct of a third party."

We believe it will be far more difficult for the federal government than the states to succeed in their claims for recovery of expenses for tobacco injuries. Unlike the states, the federal government has a long paper trail of documents showing awareness to the dangers of tobacco (1964 Surgeon General’s Report and every one since then; federal warnings labels on packs of cigarettes since 1966). Moreover, any claim filed by the Department of Justice on behalf of the federal government would have to be filed in federal court, which has demonstrated a penchant for tossing these type claims out. Yesterday, a fourth federal court, this time in Maryland, threw out a union health care recovery action brought against the tobacco industry, using the same logic as employed by federal judges in PA, CA, and FL, who had previously dismissed similar claims.

  1. What does Congress do now? We keep hearing rumors that Senate Democrats will try to push through a new piece of very narrow tobacco legislation that focuses exclusively on FDA jurisdiction over tobacco, and which would dovetail with the state-only settlement being contemplated between the industry and the AGs. The FDA legislation, which Democrats hope could be attached as an amendment to one of the appropriations bills now under review, would not call for any federal excise tax increase. Investors should recall that the technical maneuver used by Senate Majority Leader Lott to pull the McCain bill in June was a budgetary point of order -- that the McCain bill violated the terms of last year’s balanced budget agreement, and which then required 60 votes to overcome. An amendment such as the FDA provision, referred to as the Harkin amendment, would not be subject to a budget point of order. Yesterday, Senate Democrats tried again unsuccessfully to attach the "McCain II" bill (before amendments) to the Agriculture Appropriations bill, but were struck down (55-43 along party lines) after Republicans raised a budgetary point of order (43 votes in favor were 17 votes short of the 60 needed). If Democrats tried instead to amend an unrelated bill with the Harkin amendment giving the FDA jurisdiction over tobacco, Democrats would need 51 votes to pass it. Republicans could first file a motion to table the amendment -- for which they would also need 51 votes.

Given the mixed message sent yesterday by the attorneys general (Congress should be given one last chance to pass a comprehensive bill before AGs strike a new accord with industry), the House appears to have no choice but to pass a focused tobacco youth access bill such as the one outlined by Deborah Pryce a few weeks back (strict retail access, limited FDA authority, fines on retailers who sell to minors, fines on teens who buy cigarettes illegally, no excise tax increase). The House is expected to consider the tobacco issue the week of 7/27 -- leaving little time before the House adjourns for its Summer recess (August 7 - September 7). The approved House bill would then be "held at the desk" of the Senate until the Senate returns from its Summer recess September 1. Absent a state-only agreement by the time the Senate returns, the Senate would likely approve a variation of the Pryce youth access bill by mid- to late-September, which would still give both House and Senate Republicans cover to say they did something about teen smoking. Our best guess is that the AGs and industry would then announce their state-only settlement toward the end of September, since, at that point, they will know there is no chance for a comprehensive settlement along the lines of the June 20 accord or Hatch-Feinstein bill. This state-only settlement would give Republicans additional cover to wait until the next session of Congress (i.e., House-Senate conference next year) to enact a final tobacco bill that clears both chambers.

Lead AG Christine Gregoire indicated yesterday that Congress’ deadline for passing a comprehensive tobacco bill is September 14 -- the start of the Washington Medicaid trial. Investors should note that the judge in this case, Judge George Finkle, will issue a ruling by next week on the defense’s motion for summary judgment on the remaining three claims. The judge had previously dismissed three other claims in November 1996. If any or all of these three remaining claims are tossed, investors will likely bid up tobacco valuations in anticipation of a state-only deal.