80 FR 32374 - Reynolds American Inc. and Lorillard Inc.; Analysis of Proposed Consent Order To Aid Public Comment

FEDERAL TRADE COMMISSION

Federal Register Volume 80, Issue 109 (June 8, 2015)

Page Range		32374-32383
FR Document		2015-13861

The consent agreement in this matter settles alleged violations of federal law prohibiting unfair methods of competition. The attached Analysis to Aid Public Comment describes both the allegations in the draft complaint and the terms of the consent order-- embodied in the consent agreement--that would settle these allegations.

Federal Register, Volume 80 Issue 109 (Monday, June 8, 2015)

[Federal Register Volume 80, Number 109 (Monday, June 8, 2015)]
[Notices]
[Pages 32374-32383]
From the Federal Register Online [www.thefederalregister.org]
[FR Doc No: 2015-13861]

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FEDERAL TRADE COMMISSION

[File No. 141-0168]

Reynolds American Inc. and Lorillard Inc.; Analysis of Proposed
Consent Order To Aid Public Comment

AGENCY: Federal Trade Commission.

ACTION: Proposed consent agreement.

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SUMMARY: The consent agreement in this matter settles alleged
violations of federal law prohibiting unfair methods of competition.
The attached Analysis to Aid Public Comment describes both the
allegations in the draft complaint and the terms of the consent order--
embodied in the consent agreement--that would settle these allegations.

DATES: Comments must be received on or before June 25, 2015.

ADDRESSES: Interested parties may file a comment at online or on paper,
by following the instructions in the Request for Comment part of the
SUPPLEMENTARY INFORMATION section below. Write ``Reynolds American Inc.
and Lorillard Inc.--Consent Agreement; File 141-0168'' on your comment
and file your comment online at https://ftcpublic.commentworks.com/ftc/reynoldslorillardconsent by following the instructions on the web-based
form. If you prefer to file your comment on paper, write ``Reynolds
American Inc. and Lorillard Inc.--Consent Agreement; File 141-0168'' on
your comment and on the envelope, and mail your comment to the
following address: Federal Trade Commission, Office of the Secretary,
600 Pennsylvania Avenue NW., Suite CC-5610 (Annex D), Washington, DC
20580, or deliver your comment to the following address: Federal Trade
Commission, Office of the Secretary, Constitution Center, 400 7th
Street SW., 5th Floor, Suite 5610 (Annex D), Washington, DC 20024.

FOR FURTHER INFORMATION CONTACT: Robert Tovsky, Bureau of Competition,
(202-326-2634), 600 Pennsylvania Avenue NW., Washington, DC 20580.

SUPPLEMENTARY INFORMATION: Pursuant to Section 6(f) of the Federal
Trade Commission Act, 15 U.S.C. 46(f), and FTC Rule 2.34, 16 CFR 2.34,
notice is hereby given that the above-captioned consent agreement
containing a consent order to cease and desist, having been filed with
and accepted, subject to final approval, by the Commission, has been
placed on the public record for a period of thirty (30) days. The
following Analysis to Aid Public Comment describes the terms of the
consent agreement, and the allegations in the complaint. An electronic
copy of the full text of the consent agreement package can be obtained
from the FTC Home Page (for May 26, 2015), on the World Wide Web, at
http://www.ftc.gov/os/actions.shtm.
You can file a comment online or on paper. For the Commission to
consider your comment, we must receive it on or before June 25, 2015.
Write ``Reynolds American Inc. and Lorillard Inc.--Consent Agreement;
File 141-0168'' on your comment. Your comment--including your name and
your state--will be placed on the public record of this proceeding,
including, to the extent practicable, on the public Commission Web
site, at http://www.ftc.gov/os/publiccomments.shtm. As a matter of
discretion, the Commission tries to remove individuals' home contact
information from comments before placing them on the Commission Web
site.
Because your comment will be made public, you are solely
responsible for making sure that your comment does not include any
sensitive personal information, like anyone's Social Security number,
date of birth, driver's license number or other state identification
number or foreign country equivalent, passport number, financial
account number, or credit or debit card number. You are also solely
responsible for making sure that your comment does not include any
sensitive health information, like medical records or other
individually identifiable health information. In addition, do not
include any ``[t]rade secret or any commercial or financial information
which . . . is privileged or confidential,'' as discussed in Section
6(f) of the FTC Act, 15 U.S.C. 46(f), and FTC Rule 4.10(a)(2), 16 CFR
4.10(a)(2). In particular, do not include competitively sensitive
information

[[Page 32375]]

such as costs, sales statistics, inventories, formulas, patterns,
devices, manufacturing processes, or customer names.
If you want the Commission to give your comment confidential
treatment, you must file it in paper form, with a request for
confidential treatment, and you have to follow the procedure explained
in FTC Rule 4.9(c), 16 CFR 4.9(c).\1\ Your comment will be kept
confidential only if the FTC General Counsel, in his or her sole
discretion, grants your request in accordance with the law and the
public interest.
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\1\ In particular, the written request for confidential
treatment that accompanies the comment must include the factual and
legal basis for the request, and must identify the specific portions
of the comment to be withheld from the public record. See FTC Rule
4.9(c), 16 CFR 4.9(c).
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Postal mail addressed to the Commission is subject to delay due to
heightened security screening. As a result, we encourage you to submit
your comments online. To make sure that the Commission considers your
online comment, you must file it at https://ftcpublic.commentworks.com/ftc/reynoldslorillardconsent by following the instructions on the web-
based form. If this Notice appears at http://www.regulations.gov/#!home, you also may file a comment through that Web site.
If you file your comment on paper, write ``Reynolds American Inc.
and Lorillard Inc.--Consent Agreement; File 141-0168'' on your comment
and on the envelope, and mail your comment to the following address:
Federal Trade Commission, Office of the Secretary, 600 Pennsylvania
Avenue NW., Suite CC-5610 (Annex D), Washington, DC 20580, or deliver
your comment to the following address: Federal Trade Commission, Office
of the Secretary, Constitution Center, 400 7th Street SW., 5th Floor,
Suite 5610 (Annex D), Washington, DC 20024. If possible, submit your
paper comment to the Commission by courier or overnight service.
Visit the Commission Web site at http://www.ftc.gov to read this
Notice and the news release describing it. The FTC Act and other laws
that the Commission administers permit the collection of public
comments to consider and use in this proceeding as appropriate. The
Commission will consider all timely and responsive public comments that
it receives on or before June 25, 2015. For information on the
Commission's privacy policy, including routine uses permitted by the
Privacy Act, see http://www.ftc.gov/ftc/privacy.htm.

Analysis of Agreement Containing Consent Order To Aid Public Comment

The Federal Trade Commission (``Commission'') has accepted from
Reynolds American Inc. (``Reynolds'') and Lorillard Inc.
(``Lorillard''), subject to final approval, an Agreement Containing
Consent Order (``Consent Agreement'') designed to remedy the
anticompetitive effects resulting from Reynolds's proposed acquisition
of Lorillard.
Reynolds's July 2014 agreement to acquire Lorillard in a $27.4
billion transaction (``the Acquisition'') would combine the second- and
third-largest cigarette producers in the United States. After the
Acquisition, Reynolds and the largest U.S. cigarette producer, Altria
Group, Inc. (``Altria''), would together control approximately 90% of
all U.S. cigarette sales. The Commission's Complaint alleges that the
proposed Acquisition, if consummated, would violate Section 7 of the
Clayton Act, as amended, 15 U.S.C. 18, and Section 5 of the Federal
Trade Commission Act, as amended, 15 U.S.C. 45, by substantially
lessening competition in the market for traditional combustible
cigarettes.
Under the terms of the Consent Agreement, Reynolds must divest a
substantial set of assets to Imperial Tobacco Group plc.
(``Imperial''). These assets include four cigarette brands, Lorillard's
manufacturing facility and headquarters, and most of Lorillard's
current workforce. The Consent Agreement also requires Reynolds to
provide Imperial with visible shelf-space at retail locations for a
period of five months following the close of the transaction. This
Consent Agreement provides Imperial's U.S. operations with the
nationally relevant brands, manufacturing facilities, and other
tangible and intangible assets needed to effectively compete in the
U.S. cigarette market. Reynolds must complete the divestiture on the
same day it acquires Lorillard.
The Consent Agreement has been placed on the public record for 30
days to solicit comments from interested persons. Comments received
during this period will become part of the public record. After 30
days, the Commission will review the Consent Agreement, and comments
received, to decide whether it should withdraw or modify the Consent
Agreement, or make the Consent Agreement final.

I. The Parties

All parties to the proposed Acquisition and Consent Agreement are
current competitors in the U.S. cigarette market.
Reynolds has the second-largest cigarette manufacturing and sales
business in the United States. Its brands include two of the best-
selling cigarettes in the country: Camel and Pall Mall. It also manages
a number of smaller cigarette brands that it promotes less heavily.
These include Winston, Kool, and Salem. Reynolds primarily sells its
cigarettes in the United States.
Lorillard has the third-largest cigarette manufacturing and sales
business in the United States. Its flagship brand, Newport, is the
best-selling menthol cigarette in the country, and the second-best-
selling cigarette brand overall. In addition to recently introduced
non-menthol styles of Newport, Lorillard manufactures and sells a few
smaller discount-segment brands, such as Maverick. Like Reynolds,
Lorillard competes primarily in the United States.
Imperial is an international tobacco company operating in many
countries including Australia, France, Germany, Greece, Italy, Turkey,
Taiwan, the United Kingdom, and the United States. It sells tobacco
products in the U.S. through its Commonwealth-Altadis subsidiary.
Imperial's U.S. cigarette portfolio consists of several smaller
discount brands, including USA Gold, Sonoma, and Montclair.

II. The Relevant Market and Market Structure

The relevant line of commerce in which to analyze the effects of
the Acquisition is traditional combustible cigarettes (``cigarettes'').
Consumers do not consider alternative tobacco products to be close
substitutes for cigarettes. Cigarette producers similarly view
cigarettes and other tobacco products as separate product categories,
and cigarette prices are not significantly constrained by other tobacco
products.
The United States is the relevant geographic market in which to
analyze the effects of the Acquisition on the cigarette market. Both
Reynolds and Lorillard sell cigarettes primarily in this country. U.S.
consumers are in practice limited to the set of current U.S. producers
when seeking to buy cigarettes.
The U.S. cigarette market has experienced declining demand since
1981. Total shipments fell by approximately 3.2% in 2014, with similar
annual declines expected in the future. The market includes three large
producers--Altria, Reynolds, and Lorillard--who together account for
roughly 90% of all cigarette sales. Two smaller producers--Liggett and
Imperial--have roughly 3% market shares apiece. All other producers
have individual market shares of 1% or less.

[[Page 32376]]

Competition in the U.S. cigarette market involves brand
positioning, customer loyalty management, product promotion, and retail
presence. Cigarette advertising is severely restricted in the United
States: Various forms of advertising and marketing are prohibited by
law, by regulation, and by the terms of settlement agreements between
major cigarette producers and the individual States. The predominant
form of promotion remaining for U.S. cigarette producers is retail
price reduction.

III. Entry

Entry or expansion in the U.S. cigarette market is unlikely to
deter or counteract any anticompetitive effects of the proposed
Acquisition. New entry in the cigarette market is difficult because of
falling demand and the potentially slow and costly process of obtaining
Food and Drug Administration clearance for new cigarette products.
Expansion by new or existing cigarette producers is further obstructed
by legal restrictions on advertising, limited retail product-visibility
for fringe cigarette brands, and existing retail marketing contracts.

IV. Effects of the Acquisition

The proposed Acquisition is likely to substantially lessen
competition in the U.S. cigarette market. It would eliminate current
and emerging head-to-head competition between Reynolds and Lorillard,
particularly for menthol cigarette sales, which is an increasingly
important segment of the market. The Acquisition would also increase
the likelihood that the merged firm will unilaterally exercise market
power. Finally, the Acquisition will increase the likelihood of
coordinated interaction between the remaining participants in the
cigarette market.

V. The Consent Agreement

The purpose of the Consent Agreement is to mitigate the
anticompetitive threat of the proposed acquisition. The Consent
Agreement allows Reynolds to complete its acquisition of Lorillard, but
requires Reynolds to divest several of its post-acquisition assets to
Imperial.
Among other terms, the Consent Agreement requires Reynolds to sell
Imperial four of its post-acquisition cigarette brands: Winton, Kool,
Salem, and Maverick. These brands have a combined share of
approximately 7% of the total U.S. cigarette market. Reynolds must also
sell Lorillard's manufacturing facility and headquarters to Imperial,
give Imperial employment rights for most of Lorillard's current staff
and salesforce, and guarantee Imperial visible retail shelf-space for a
period of five months following the close of the transaction. Finally,
Reynolds must also provide Imperial with certain transition services.
This divestiture package, including the nationally recognized
Winston and Kool brands, provides Imperial an opportunity to rapidly
increase its competitive significance in the U.S. market. Imperial will
shift immediately from being a small regional producer with limited
competitive influence on the larger firms to become a national
competitor with the third-largest cigarette business in the market.
While Imperial's plans call for it to reposition the acquired brands,
which have lost market share as part of the Reynolds portfolio,
Imperial has successfully executed similar turnarounds with brands in
other international markets.
Imperial will have greater opportunity and incentive to promote and
grow sales of the divested brands because, unlike Reynolds, incremental
sales of these brands are unlikely to cannibalize sales from more
profitable cigarette brands in its portfolio. Imperial's incentive to
reduce the price of the divestiture brands, in order to grow their
market share, is a procompetitive offset to the reduction in
competition that will result from the consolidation of Reynolds and
Lorillard. Imperial's incentive to reduce prices and promote products
in new areas likewise reduces the threat of anticompetitive
coordination following the merger--as coordination on price increases
and other aspects of competition may be relatively difficult given
Imperial's contrary incentives. Ultimately, the divestiture package
provides Imperial with a robust opportunity to undertake procompetitive
actions to grow its market share in the U.S. cigarette market, and
address the competitive concerns raised by the merger.

IV. Opportunity for Public Comment

By accepting the Consent Agreement, subject to final approval, the
Commission anticipates that the competitive problems alleged in its
Complaint will be resolved. The purpose of this analysis is to invite
and facilitate public comment concerning the Consent Agreement to aid
the Commission in determining whether it should make the Consent
Agreement final. This analysis is not an official interpretation of the
Consent Agreement, and does not modify its terms in any way.

By direction of the Commission, Commissioners Brill and Wright
dissenting.
Donald S. Clark,
Secretary.

Statement of the Federal Trade Commission

In the Matter of Reynolds American, Inc. and Lorillard Inc.

The Federal Trade Commission has voted to accept for public comment
a settlement with Reynolds American, Inc. (``Reynolds'') to resolve the
likely anticompetitive effects of Reynolds' proposed acquisition of
Lorillard Inc. (``Lorillard'').\1\ The settlement will allow the
acquisition to move forward, subject to large divestitures by the
parties to another major competitor in the tobacco industry.
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\1\ This statement reflects the views of Chairwoman Ramirez,
Commissioner Ohlhausen, and Commissioner McSweeny.
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The merging parties chose to present this acquisition to the
Commission with a proposed divestiture aimed solely at securing our
approval of the acquisition.\2\ As proposed, Reynolds will purchase
Lorillard for $27.4 billion and then immediately divest certain assets
from both Reynolds and Lorillard to Imperial Tobacco Group plc
(``Imperial'') in a second $7.1 billion transaction. At the end of both
transactions, Reynolds will own Lorillard's Newport brand and Imperial
will own three former Reynolds' brands, Winston, Kool and Salem, as
well as Lorillard's Maverick and e-cigarette Blu brands, and
Lorillard's corporate infrastructure and manufacturing facility.
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\2\ The only transaction before the Commission for purposes of
Hart-Scott-Rodino review was the Reynolds-Lorillard transaction.
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As we explain below, we have reason to believe that Reynolds'
proposed acquisition of Lorillard is likely to substantially lessen
competition in the market for combustible cigarettes in the United
States. We conclude, however, that the parties' proposed post-merger
divestitures to Imperial would be effective in restoring competition in
this market, and we therefore approve the divestitures as part of a
consent order.
I. Reynolds' Acquisition of Lorillard Is Likely to Substantially Lessen
Competition in the Combustible Cigarette Market
Today, the market for combustible cigarettes in the United States
contains three major players and several additional smaller
competitors. Philip Morris USA, a division of Altria Group, Inc.
(``Altria''), is the largest, with a share of about 51%, roughly twice
the

[[Page 32377]]

size of its nearest competitor. Reynolds and Lorillard are the second-
and third-largest firms, with shares of approximately 26% and 15%,
respectively. Other players in the market include Liggett and Imperial,
each with about 3% of the market, and roughly 50 other small players
focused mainly on discount or regional business.
In light of their size and relative positions in the market, if
Reynolds and Lorillard were attempting their transaction without any
divestitures, the acquisition would likely substantially lessen
competition, with the post-acquisition Reynolds controlling 41% of the
market and Reynolds and Altria together holding 92% of the market. In
particular, we have reason to believe that the transaction would
eliminate competition between Reynolds' Camel brand and Lorillard's
Newport brand. For example, we found evidence that Camel has been
seeking to gain market share from Newport. There is also evidence of
discounting by Newport in response to Camel. In addition, our
econometric analysis showed likely price effects resulting from the
combination of Camel and Newport.\3\
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\3\ While our main concern is with the transaction's likely
unilateral effects, there is also evidence that the transaction
would increase the likelihood of coordination by creating greater
symmetry between Reynolds and Altria in terms of their market
shares, portfolio of brands, and geographic strength in the United
States. When the Commission last publicly evaluated this market in
the context of the 2004 R.J. Reynolds Tobacco Holdings, Inc.
(``RJR'')/British American Tobacco p.l.c. (``BAT'') transaction, we
noted in our statement that conditions in the cigarette market at
the time would make coordination difficult. The market has changed
considerably over the last decade, perhaps most importantly in that
the RJR/BAT transaction left the market with three major players
relying on complex, differentiated product placement and pricing
strategies. Unlike the combination of Reynolds/Lorillard, which
would leave only two symmetric players with major national brands
competing directly, the RJR/BAT transaction and market environment
in 2004 presented a less pronounced coordination issue.
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Having concluded that Reynolds' acquisition of Lorillard is likely
to result in anticompetitive effects, we explain next why we believe
the parties' proposed divestitures to Imperial are sufficient to
restore competition.
II. The Divestitures to Imperial Will Offset the Competition Lost From
the Reynolds-Lorillard Merger
Imperial is an international tobacco company with operations in 160
countries and global revenues of roughly $11.8 billion. Today, Imperial
is a relatively small player in the United States with a 3% share of
the market.\4\ Through the divestitures, Imperial is purchasing a
collection of assets from both Reynolds and Lorillard. In addition to
buying several prominent brands from both companies, Imperial is
receiving an intact American manufacturing and sales operation from
Lorillard, including Lorillard's offices, production facilities, and
2,900 employees. Lorillard's national sales force, which will be moving
to Imperial, is an experienced team with knowledge of brands and
customers.
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\4\ Imperial entered the United States market through its
acquisition of Commonwealth's cigarette brands in April 2007.
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We believe that these divestitures to Imperial will address the
competitive concerns arising out of the Reynolds-Lorillard combination.
Following the divestitures, Imperial will immediately become the third-
largest cigarette maker in the country, with a 10% market share.\5\
Imperial has a clearly defined strategy for the United States, and it
will have both the capability and incentives to become an effective
U.S. competitor.
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\5\ After the divestitures to Imperial, Reynolds will have a 34%
market share in the United States.
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Winston is the number two cigarette brand in the world and will be
the main focus of Imperial's strategy in the United States. Imperial's
consumer research strongly indicates that Winston could see increased
brand recognition and acceptance in the United States. Imperial plans
to reposition Winston as a premium-value brand and invest in the growth
of the brand through added visibility and significant discounting.
Imperial also plans to refocus and invest in Kool through discounting
on a state-by-state basis. The evidence shows that Imperial can grow
the market share of these brands through discounting and other
promotional activity.
In her dissent, Commissioner Brill questions Imperial's ability to
restore the competition lost due to the Reynolds-Lorillard transaction,
noting that the Winston and Kool brands have been declining for
years.\6\ In our view, however, Reynolds' track record with these two
brands is not indicative of their potential with Imperial. As
Commissioner Brill acknowledges, Reynolds made a conscious decision to
promote Camel and Pall Mall aggressively as growth brands, and to put
limited marketing support behind Winston and Kool. Going forward,
Imperial will have greater incentives to promote Winston and Kool than
Reynolds did because, unlike Reynolds, Imperial does not risk
cannibalizing other brands in its portfolio. Moreover, Imperial is also
acquiring Lorillard's Maverick, a value brand that competes well with
Reynolds' Pall Mall.
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\6\ Dissenting Statement of Commissioner Julie Brill at 6-7.
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Imperial has a successful record of repositioning cigarette brands
in other jurisdictions and growing the market share of those brands.
Although it has had a relatively small presence in this country,
Imperial is acquiring an experienced, national sales force from
Lorillard that will help it to grow the acquired brands and more
effectively compete against Reynolds and Altria. Imperial has
agreements in place with Reynolds to ensure continuity of supply of the
acquired brands and to ensure their visibility at the point of sale.
The agreements will enable Imperial to have immediate access to retail
shelf space and give Imperial time to negotiate contracts with
retailers.
Following the divestitures, Imperial's business in the United
States will account for 24% of its worldwide tobacco net revenues, thus
making it important for Imperial to succeed in the United States. The
acquisition will enable Imperial to be a national competitor, give it a
portfolio of brands across different price points, and make its
business more important to retailers, thereby enabling it to obtain
visible shelf space and build stronger retailer relationships.
We are therefore satisfied that Imperial is positioned to be a
sufficiently robust and aggressive competitor against a merged
Reynolds-Lorillard and Altria, and to offset the competitive concerns
arising from Reynolds' acquisition of Lorillard. Indeed, Imperial's
incentives will stand in contrast to those of the pre-merger Lorillard,
which has not been a particularly aggressive competitor in this market,
having instead been generally content to rely on Newport's strong brand
equity to drive most of its sales. We believe that Imperial will behave
differently.
For these reasons, we are allowing the merger of Reynolds and
Lorillard to go forward and accepting a consent decree to ensure that
the divestitures to Imperial occur on a timely and effective basis.\7\
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\7\ Although he agrees that the merger of Reynolds and Lorillard
is likely to substantially lessen competition and that a consent
order increases the likelihood that the divestitures to Imperial are
properly and promptly effectuated, Commissioner Wright believes a
consent order is unwarranted and on that basis dissents. We
respectfully disagree with Commissioner Wright's suggestion that our
action is improper under these circumstances. Our obligation under
the Hart-Scott-Rodino Act is to take appropriate steps to ensure
that any competitive issues with a proposed transaction are
addressed effectively and that is precisely what we have done here.
Indeed, we believe that our responsibility would not be fully
discharged if we did not guard against the risks that Commissioner
Wright himself acknowledges exist in the absence of a consent order.

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[[Page 32378]]

Dissenting Statement of Commissioner Julie Brill

In the Matter of Reynolds American, Inc. and Lorillard Inc.

A majority of the Commission has voted to accept a consent to
resolve competitive concerns stemming from Reynolds American, Inc.'s
$27.4 billion acquisition of Lorillard Tobacco Company, a transaction
combining the second and third largest cigarette manufacturers in the
United States. Under the terms of the consent, Reynolds will divest
some of its weaker non-growth brands--Winston, Kool, and Salem--as well
as Lorillard's brand Maverick to Imperial Tobacco Group plc, a British
firm that currently operates as Commonwealth here in the United
States.\1\ The Commission will allow Reynolds to retain its sought-
after growth brands, Camel and Pall Mall, as well as Lorillard's
flagship brand Newport. I respectfully dissent because I am not
convinced that the remedy accepted by the Commission fully resolves the
competitive concerns arising from this transaction. By accepting the
parties' proposed divestitures and allowing the merger to proceed, the
Commission is betting on Imperial's ability and incentive to compete
vigorously with a set of weak and declining brands. For the reasons
explained below, Imperial's ability to do so is at best uncertain. I
thus have reason to believe that Reynolds' acquisition of Lorillard,
even after the divestitures to Imperial, is likely to substantially
lessen competition in the U.S. cigarette market. As a result of the
Commission's failure to take meaningful action against this merger, the
remaining two major cigarette manufacturers--Altria/Philip Morris and
Reynolds--will likely be able to impose higher cigarette prices on
consumers.
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\1\ Reynolds will also sell Lorillard's e-cigarette Blu to
Imperial; that sale is not part of the Commission's proposed order.
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I have reason to believe this merger increases both the likelihood
of coordinated interaction between the remaining participants in the
cigarette market, and the likelihood that the merged firm will
unilaterally exercise market power. While both theories are presented
in the Commission's Complaint,\2\ I describe below additional facts and
evidence not included in the Complaint that I believe illustrate why
the transaction remains anticompetitive, notwithstanding the
divestitures to Imperial.
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\2\ Complaint, ] 8, In the Matter of Reynolds American Inc. and
Lorillard Inc., File No. 141-0168, (May 26, 2015).
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Coordinated Effects
Under a coordinated effects theory, as set forth in the 2010
Horizontal Merger Guidelines, the Commission is likely to challenge a
merger if the following three conditions are met: ``(1) The merger
would significantly increase concentration and lead to a moderately or
highly concentrated market; (2) that market shows signs of
vulnerability to coordinated conduct [ ]; and (3) the [Commission has]
a credible basis on which to conclude that the merger may enhance that
vulnerability.'' \3\ Importantly, the Guidelines explain ``the risk
that a merger will induce adverse coordinated effects may not be
susceptible to quantification or detailed proof . . .''.\4\ The
Guidelines also instruct that ``[p]ursuant to the Clayton Act's
incipiency standard, the Agencies may challenge mergers that in their
judgment pose a real danger of harm through coordinated effects, even
without specific evidence showing precisely how the coordination likely
would take place.'' \5\
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\3\ U.S. DEP'T OF JUSTICE & FED. TRADE COMM'N, HORIZONTAL MERGER
GUIDELINES Sec. 7.1 (2010) [hereinafter Guidelines].
\4\ Id.
\5\ Id.
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I have reason to believe that the facts in this case demonstrate a
substantial risk of coordinated interaction because all three
conditions for coordinated interaction spelled out in the Horizontal
Merger Guidelines are satisfied.
The first condition is easily satisfied. After the dust settles on
the merger and divestitures, Reynolds and market leader Altria/Philip
Morris will have over 80 percent of the U.S. market for traditional
combustible cigarettes.\6\
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\6\ As the majority notes, the relevant market is combustible
cigarettes in the United States. Statement of the F.T.C., In the
Matter of Reynolds American Inc. and Lorillard Inc., File No. 141-
0168, May 26, 2015, at 1 [hereinafter Majority Statement].
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The second condition is also easily satisfied. The Guidelines
identify a number of market characteristics that are generally
considered to make a market more vulnerable to coordination.\7\ These
include (1) evidence of past express collusion affecting the relevant
market; (2) firms' ability to monitor rivals' behavior and detect
cheating with relative ease; (3) availability of rapid and effective
forms of punishment for cheating; (4) difficulties associated with
attempting to gain significant market share from aggressive price
cutting; and (5) low elasticity of demand. The cigarette market has
many of these characteristics.
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\7\ Guidelines, supra note 3,. at Sec. 7.2.
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First, for the last decade, the cigarette market in the United
States has been dominated by three firms--Reynolds, Lorillard, and
Altria/Philip Morris--which together represent over 90 percent of the
market. Over the same 10-year period, these ``Big Three'' tobacco firms
have made lock-step cigarette list price increases unrelated to any
change in costs or market fundamentals.\8\
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\8\ In this context, it is worth noting that, in 2006, U.S.
District Judge Kessler held Reynolds, Lorillard, Philip Morris, and
a number of other cigarette manufacturers liable under the Racketeer
Influenced and Corrupt Organizations Act (RICO). United States v.
Philip Morris, 449 F. Supp 2d 1 (D.D.C. 2006), aff'd 566 F.3d 1095
(D.C. Cir. 2009). In a lengthy decision containing over 4000
paragraphs of findings of fact, the district court highlighted the
coordinated nature of the defendants' activities in furtherance of
the racketeering scheme. The conduct involved was indirectly related
to price, as the overarching purpose behind the scheme was to
maximize the competing cigarette firms' profits. The district court
explained that ``[t]he central shared objective of Defendants has
been to maximize the profits of the cigarette company Defendants by
acting in concert to preserve and enhance the market for cigarettes
through an overarching scheme to defraud existing and potential
smokers. . . .'' (Philip Morris, 449 F. Supp 2d at 869). The court
also found that ``[t]here is overwhelming evidence demonstrating
Defendants' recognition that their economic interests would best be
served by pursuing a united front on smoking and health issues and
by a global coordination of their activities to protect and enhance
their market positions in their respective countries.'' (Id. at
119). I find this evidence troubling when viewed in conjunction with
the evidence in this case showing the U.S. cigarette market's
vulnerability to coordinated interaction relating to prices.
---------------------------------------------------------------------------

Second, there is a high degree of pricing transparency at the
wholesale and retail levels in the cigarette market, giving cigarette
manufacturers the ability to monitor each other's prices and engage in
disciplinary action necessary to maintain coordination. The major
manufacturers all receive detailed wholesale volume information from
firms collecting data. Reynolds and Lorillard also receive numerous
analyst reports that track manufacturers' pricing behavior and project
whether the industry will enjoy a stable or aggressive competitive
environment as a result. These conditions will allow the new ``Big
Two'' cigarette manufacturers to quickly detect volume shifts due to
price cuts and other competitive activity, allowing them to monitor
each other's prices, detect cheating, and quickly discipline each
other--or threaten to do so. Third, many U.S. smokers are addicted to
tobacco, resulting in fairly inelastic market demand, and rendering
successful coordination more profitable for industry members. As the
Guidelines

[[Page 32379]]

describe, coordination is more likely the more participants stand to
gain from it.
Apart from the market characteristics identified in the Guidelines
that make a market more vulnerable to coordination, it is important to
consider that the cigarette market in the United States has experienced
an ongoing decline in volume for over 20 years. This creates pressure
on manufacturers to increase prices to offset volume losses,
potentially easing the difficulties associated with formation of
coordinating arrangements by making price increases a focal strategy.
In 2004, the Commission elected not to challenge the merger of
Reynolds and Brown & Williamson in part because it found that the
cigarette market was not vulnerable to coordinated interaction.
However, three key market dynamics have changed since then. These three
changes have limited the market significance of the discount fringe and
its ability to constrain cigarette prices, and increased entry
barriers--both of which make the market more vulnerable to
coordination. First, Reynolds' Every Day Low Price (EDLP) program,
substantially modified in 2008 to reposition and grow Pall Mall as the
EDLP brand, requires participating retailers to maintain Pall Mall as
the lowest price brand sold in the store, creating an effective price
floor that discount manufacturers are not allowed to undercut. Second,
the vast majority of states that signed the Tobacco Master Settlement
Agreement (``MSA'') have enacted Non-Participating Manufacturer
Legislation and Allocable Share Legislation, further diminishing the
impact of discount brands.\9\ Under this legislation, companies that do
not participate in the MSA--typically the discount cigarette
manufacturers--are required to pay an escrow fee to approximate the
costs incurred by the participating cigarette companies, thereby
eliminating much of the cost advantage that discounters had previously
enjoyed. Third, the FDA's 2010 regulations,\10\ implementing the 2009
Family Smoking Prevention and Tobacco Control Act,\11\ restrict tobacco
advertising and promotion in the United States. Thus the 2010 FDA
regulation limits the ability of new firms to enter the market, and
limits the ability of existing fringe market participants to grow
through aggressive advertising. The combined effect of these three,
relatively new market dynamics has been a reduction in the competitive
significance of the fringe discount brand manufacturers. Indeed, the
number of discount brand manufacturers has fallen from over 100 in
2005, to around 50 today, now representing just two percent of the
market.
---------------------------------------------------------------------------

\9\ The Tobacco Master Settlement Agreement (``MSA'') was
entered in November 1998, originally between the four largest U.S.
tobacco companies--Philip Morris Inc., R.J. Reynolds, Brown &
Williamson and Lorillard--the original participating manufacturers
(``OPMs''), and the attorneys general of 46 states, the District of
Columbia, Puerto Rico, Guam, the Virgin Islands, American Samoa, and
the Northern Marianas. The MSA resolved over 40 lawsuits brought by
the states against tobacco manufacturers to recover billions of
dollars in costs incurred by the states to treat smoking related
illnesses and to obtain other relief. The OPMs agreed (1) to make
multi-billion dollar payments, annually and in perpetuity, to the
states and (2) to significantly restrict the way they market and
advertise their tobacco products, including a prohibition on the use
of cartoons in cigarette advertising or any other method that
targets youth. In exchange, the states agreed to release the OPMs,
and any other tobacco company that became a signatory to the MSA,
from past and future liability arising from the health care costs
caused by smoking. All MSA states subsequently enacted legislation
requiring non-participating manufacturers (``NPMs'') to make certain
payments based on the number of cigarettes sold into the state.
These payments are placed in an escrow account to ensure that funds
are available to satisfy state claims against NPMs. Although all MSA
states enacted this legislation, many NPMs were not making the
required payments, or were exploiting a loophole by withdrawing
their escrow deposits in a way that conflicted with the
legislation's intent. To address those issues, many states adopted
additional legislation to provide enforcement tools to ensure that
NPMs make the required escrow payments (``complementary enforcement
legislation''), as well as legislation to close a loophole in the
state escrow statutes by preventing NPMs from withdrawing escrow
payments in a way that was never contemplated when those statutes
were enacted (``Allocable Share Legislation'').
\10\ Regulations Restricting the Sale and Distribution of
Cigarettes and Smokeless Tobacco to Protect Children and
Adolescents, 75 FR 13225 (March 19, 2010).
\11\ 21 U.S.C. 301 (2009).
---------------------------------------------------------------------------

The third and final condition identified in the Guidelines as
leading the Commission to challenge a proposed merger based on a theory
of coordination--that the Commission has a credible basis to conclude
that the merger may enhance the market's vulnerability to
coordination--is also satisfied in this case. Prior to the transaction,
a large percentage of Reynolds' portfolio consisted of non-growth
brands (including Winston, Kool, and Salem), and overall Reynolds'
volumes were declining. In the years leading up to this transaction
Reynolds also had a noticeable portfolio gap, as it lacked a strong
premium menthol brand. Reynolds initiated new competition in the
menthol segment with the introduction of Camel Crush and Camel Menthol,
but Reynolds was still playing catch-up. Seeking to stop further volume
loss to its competitors' menthol brands--Lorillard's Newport and
Altria/Philip Morris' Marlboro--Reynolds implemented a strategy of
aggressive promotion of Camel and Pall Mall. The proposed merger
eliminates many of Reynolds' incentives to continue these strategies.
With Newport added to its portfolio, Reynolds will no longer face a gap
in menthol and will not be subject to the same level of volume losses.
Post-transaction, there will be greater symmetry between Altria/Philip
Morris and Reynolds, bringing Reynolds' incentives into closer
alignment with Altria/Philip Morris to place greater emphasis on
profitability over market share growth. This increase in symmetry
between Reynolds and Altria/Philip Morris thus enhances the market's
vulnerability to coordination.\12\
---------------------------------------------------------------------------

\12\ See Statement of the F.T.C., In the Matter of ZF
Friedrichshafen AG and TRW Automotive Holdings Corp., File No. 141-
0235, May 8, 2015, available at https://www.ftc.gov/system/files/document/cases/150515zffrn.pdf. See also Marc Ivaldi, et al., The
Economics of Tacit Collusion 66 & 67, Final Report for DG
Competition, European Commission (2003), available at http://ec.europa.eu/competition/mergers/studies_reports/the_economics_of_tacit_collusion_en.pdf. (``By eliminating a
competitor, a merger reduces the number of participants and thereby
tends to facilitate collusion. This effect is likely to be the
higher, the smaller the number of participants already left in the
market.'') (``[I]t is easier to collude among equals, that is, among
firms that have similar cost structures, similar production
capacities, or offer similar ranges of products. This is a factor
that is typically affected by a merger. Mergers that tend to restore
symmetry can facilitate collusion.'').
---------------------------------------------------------------------------

Unilateral Effects
This transaction also raises concerns about unilateral
anticompetitive effects, because it eliminates the growing head-to-head
competition between Reynolds and Lorillard. The Guidelines explain that
``[t]he elimination of competition between two firms that results from
their merger may alone constitute a substantial lessening of
competition.'' \13\ As the majority explains, the Commission's
econometric modeling showed likely price effects from the combination
of the parties' cigarette portfolios.\14\
---------------------------------------------------------------------------

\13\ Guidelines, supra note 3, at Sec. 6.
\14\ Majority Statement, supra note 6, at 2.
---------------------------------------------------------------------------

The econometric analysis supports the substantial qualitative
evidence of unilateral anticompetitive effects. For years, Lorillard's
Newport brand has been able to rely on strong brand equity and brand
loyalty to sustain its high market share and high prices for its
menthol product line. As noted above, Reynolds, on the other hand, has
been lagging behind Altria/Philip Morris and Lorillard in terms of
profitability and pricing, with no comparably strong menthol product.
As a result, in recent years Reynolds has been making efforts to
challenge Newport's established leadership position and increase its
share in menthol through increased

[[Page 32380]]

promotional activity. Reynolds also engaged in the first innovation in
this industry in many years with the introduction of Camel Crush,\15\
which has generated strong sales growth for a new brand. Post-merger,
with Newport in its hands, Reynolds will no longer need to innovate or
increase its promotional activity to increase its share in menthol.
---------------------------------------------------------------------------

\15\ Camel Crush allows consumers to change the cigarette from
non-menthol to menthol or from menthol to stronger menthol by
crushing a menthol capsule inside the filter.
---------------------------------------------------------------------------

* * * * *
In sum, I have reason to believe that this merger poses a real
danger of anticompetitive harm through coordinated effects and
unilateral exercise of market power in the U.S. cigarette market.
Adequacy of Divestitures To Imperial To Restore Competition
As the Supreme Court has stated, restoring competition is the ``key
to the whole question of an antitrust remedy.'' \16\ Both Supreme Court
precedent and Commission guidance makes clear that any remedy to a
transaction found to be in violation of Section 7 of the Clayton Act
must fully restore the competition lost from the transaction,\17\ and a
remedy that restores only some of the competition lost does not
suffice.\18\ Because Clayton Act merger enforcement is predictive, it
is hard to define what will precisely fully restore lost competition in
any given case. The agency has on occasion allowed for remedies that
are not an exact replica of the pre-merger market, usually when there
is evidence that the buyer can have a strong competitive impact with
the divested assets. Yet the focus of the inquiry is always on whether
the proposed divestitures are sufficient to maintain or restore
competition in the relevant market that existed prior to the
transaction.\19\
---------------------------------------------------------------------------

\16\ United States v. E.I. du Pont de Nemours & Co., 366 U.S.
316, 326 (1961).
\17\ Ford Motor Co. v. United States, 405 U.S. 562, 573 (1972)
(``The relief in an antitrust case must be `effective to redress the
violations' and `to restore competition.' . . . Complete divestiture
is particularly appropriate where asset or stock acquisitions
violate the antitrust laws.'').
\18\ See F.T.C. Frequently Asked Questions About Merger Consent
Order Provisions, available at https://www.ftc.gov/tips-advice/competition-guidance/guide-antitrust-laws/mergers/merger-faq.
(``There have been instances in which the divestiture of one firm's
entire business in a relevant market was not sufficient to maintain
or restore competition in that relevant market and thus was not an
acceptable divestiture package. To assure effective relief, the
Commission may thus order the inclusion of additional assets beyond
those operating in the relevant market . . . In all cases, the
objective is to effectuate a divestiture most likely to maintain or
restore competition in the relevant market . . . At all times, the
burden is on the parties to provide concrete and convincing evidence
indicating that the asset package is sufficient to allow the
proposed buyer to operate in a manner that maintains or restores
competition in the relevant market.'').
\19\ Id. (``Every order in a merger case has the same goal: To
preserve fully the existing competition in the relevant market or
markets . . . An acceptable divestiture package is one that
maintains or restores competition in the relevant market . . .'').
See also Statement of the F.T.C.'s Bureau of Competition on
Negotiating Merger Remedies, at 4, January 2012, available at
https://www.ftc.gov/system/files/attachments/negotiating-merger-remedies/merger-remediesstmt.pdf. (``If the Commission concludes
that a proposed settlement will remedy the merger's anticompetitive
effects, it will likely accept that settlement and not seek to
prevent the proposed merger or unwind the consummated merger.'').
---------------------------------------------------------------------------

Under these well-grounded principles, I have serious concerns about
whether the divestiture remedy in this case is sufficient to restore
competition in the U.S. cigarette market. As a preliminary matter, it
is worth noting that, post-transaction, Imperial will be less than one-
third the size of the combined Reynolds/Lorillard, with a 10 percent
market share compared to the combined Reynolds/Lorillard's 34 percent
market share. Prior to the transaction, Reynolds and Lorillard were
more comparable in size to each other--Reynolds with a 26 percent
market share and Lorillard with a 15 percent market share. And despite
the divestitures, the HHI will increase 331 points to 3,809. Moreover,
there is nothing dynamic about the cigarette market by any measure that
could plausibly make these measures less useful in analyzing the
likelihood of the divestiture to fully restore the competition lost
from this transaction.
Beyond the resulting increased concentration, the question is
whether Imperial can nonetheless maintain or restore competition in the
market with the divested brands due to its own business acumen and
incentives post-divestiture. I have reason to believe Imperial will not
be up to the job. Indeed, I believe Imperial's post-divestiture market
share may overstate its competitive significance. Through this
transaction, Reynolds will obtain the second largest selling brand in
the country (Newport), and keep the third largest selling brand
(Camel). Imperial, on the other hand, will continue to have no strong
brands in its portfolio. Reynolds' Winston, Kool, and Salem are
declining and unsuccessful. Their combined market share has gone from
approximately 14 percent in 2010 to 8 percent in 2013 (a 6 percent
decline), and they are still losing share. It is no surprise that
Reynolds would want to unload these weak brands, and refuse to provide
a meaningful divestiture package that would replace the competition
lost through its merger with Lorillard. I am not convinced that
Imperial will have any greater ability to grow these declining brands.
Indeed, I have reason to believe that Winston, Kool, and Salem, as well
as Maverick, will languish even further outside the hands of Reynolds
and Lorillard.
There is no doubt that Imperial hopes to make these brands
successful and will make every attempt to do so. Imperial's strong
global financial position will help. The Commission cannot rely on
hopes and aspirations alone, however. We must base our decision on
facts and demonstrated performance in the market. And it is by this
measure that Imperial, with the added weak brands from Reynolds, comes
up short. Imperial has a poor track record of growing acquired brands
in the U.S. Imperial entered the U.S. market in 2007 by acquiring
Commonwealth.\20\ At that time Imperial also aspired to increase share.
However, Imperial was not successful. Commonwealth's market share has
declined since it was acquired by Imperial, and stands at less than
three percent today. While in FY 2014 Imperial may have achieved modest
growth with one of its other brands, USA Gold, that growth was only
focused on limited geographic markets, and doesn't give me confidence
that Imperial can implement a national campaign growth strategy.
Reynolds, with much greater experience in the U.S. market, made
numerous efforts to reinvigorate Winston, Kool, and Salem, but
failed.\21\ In light of Imperial's much worse track record here in the
U.S., I am unconvinced that it will have more luck in making its
wishful plans a reality.
---------------------------------------------------------------------------

\20\ In 1996 Commonwealth acquired brands required by the
Commission to be divested to resolve competitive concerns stemming
from B.A.T. Industries p.l.c.'s $1 billion acquisition of The
American Tobacco Company. B.A.T. Industries p.l.c., et al, 119
F.T.C. 532 (1995).
\21\ The majority interprets the evidence before us as showing
that Reynolds emphasized Camel and Pall Mall but only put ``limited
marketing support behind Winston and Kool.'' See Majority Statement,
supra note 6, at 3. In contradistinction to the majority, I believe
the evidence before us demonstrates that on numerous occasions
Reynolds sought--valiantly but without success--to grow Winston and
Kool, even while emphasizing Camel and Pall Mall.
---------------------------------------------------------------------------

The majority notes that, outside the United States, Winston is the
number two cigarette brand, and Imperial plans to make Winston the main
focus of its strategy in the United States post-transaction.\22\ But
Winston's dichotomous position--a strong brand outside the United
States and a weak brand in the United States--has held for many years.
And Reynolds' multiple

[[Page 32381]]

efforts to reposition Winston in light of its strong global position
have not had any effect on slowing the dramatic decline of Winston in
the United States. Indeed, by placing Winston at the center of its U.S.
strategy, Imperial is demonstrating the same tone-deafness to the
unique dynamics of the U.S. market that has caused Imperial to lose
market share since it entered the U.S. market in 2007.
---------------------------------------------------------------------------

\22\ Majority Statement, supra note 6, at 2.
---------------------------------------------------------------------------

My concerns about Imperial's ability to succeed where Reynolds has
failed is heightened by the fact that Imperial will have no ``anchor''
brand to gain traction with retailers, and as a result will have
limited shelf space available to it. The divestitures of Maverick from
Lorillard and Winston, Kool, and Salem from Reynolds effectively de-
couple each divested brand from a strong anchor brand. These anchor
brands--Newport and Camel, the second and third best-selling brands in
the country--gave Maverick, Winston, Kool, and Salem increased shelf
space and promotional spending, helping to drive the limited sales they
had. Maverick in particular benefits from Newport's brand success:
Lorillard gives it a portion of Newport's shelf space, and when
Lorillard advertises Newport, it advertises Maverick too. In Imperial's
hands, the divested brands will not have the same shelf space or the
benefit of strong advertising that comes with their anchor brands. I
believe that the decoupling of the divested brands from Camel and
Newport will serve to further exacerbate their decline.
Recognizing Imperial's shelf space disadvantage, the proposed
Consent requires Reynolds to make some short term accommodations in an
attempt to give Imperial a fighting chance in its effort to gain some
shelf space in stores. First, the Consent envisions Reynolds entering
into a Route to Market (``RTM'') agreement with Imperial, whereby
Reynolds agrees to provide Imperial a portion of its post-acquisition
retail shelf space for a period of five months following the close of
the transaction. Imperial will pay Reynolds $7 million for this
agreement. Under the terms of the RTM agreement, Reynolds commits for a
period of five months to continue placing Winston, Kool, and Salem on
retail fixtures according to historic business practices, and to assign
Imperial a defined portion of Lorillard's current retail shelf-space
allotments to use as it sees fit. Second, Reynolds is also undertaking
a 12-month commitment to remove provisions in new retail marketing
contracts that would otherwise require some retailers to provide it
shelf space in proportion to its national market share, where Reynolds
national market share is higher than its local market share. The intent
of this commitment is to increase Imperial's ability to obtain shelf
space at least proportional to its local market share in many retail
outlets for a period of 12 months.
I have reason to believe that these provisions are insufficient to
make up for Imperial's significant shelf space disadvantage. The five-
month RTM Agreement and 12-month commitment pertaining to Reynolds'
allocation of shelf space according to its local market share are too
short. While Imperial may be optimistic that it can establish
sufficient shelf space in this limited time frame, nothing in the RTM
Agreement and 12-month local market share commitment will alter
retailers' incentives to allocate their shelf space to popular products
that sell well when those time periods expire. Even if Imperial offers
better terms and uses former Lorillard salespeople who have preexisting
relationships with retailers to push for greater shelf space, it likely
will still be in retailers' economic interest to allocate shelf space
to the strong Reynolds and Altria/Philp Morris brands, not to
Imperial's collection of weak and declining brands.\23\ And at the end
of Reynolds' 12-month local market share commitment, Reynolds will be
able to squeeze Imperial's shelf space by requiring many retailers to
provide it shelf space in proportion to its higher-than-local national
market share. While Imperial may attempt to maintain its retail
visibility by offering stores lucrative merchandising contracts,
Reynolds and Altria/Philip Morris will no doubt counter those efforts
with their own lucrative contracts. In the short run, arguably this may
be beneficial for competition, but in the long run, Imperial's market
presence will diminish and the market will in all likelihood become a
stable duopoly.\24\
---------------------------------------------------------------------------

\23\ The majority places its bet on Imperial in part based on
the transfer to Imperial of ``an experienced, national sales force
from Lorillard.'' Majority Statement, supra note 6, at 2. I do not
believe the transfer of some of Lorillard's sales staff to Imperial
will transform Imperial into a significant competitor in the U.S.
market. Lorillard's transferred sales staff will not be able to
overcome the significant market dynamics described herein. Moreover,
Lorillard's sales staff likely will be unable to fundamentally
transform Imperial's lackluster competitive performance in the U.S.
market because, as the majority itself acknowledges, ``pre-merger
Lorillard . . . has not been a particularly aggressive competitor in
this market, having instead been generally content to rely on
Newport's strong brand equity to drive most of its sales.'' Majority
Statement, supra note 6, at 3.
\24\ The majority relies on the fact that Imperial will have
more favorable incentives as compared with those of the pre-merger
Lorillard, since Lorillard was not a particularly aggressive
competitor. Majority Statement, supra note 6, at 3. But that
comparison does not capture the full picture of the competitive harm
from this transaction. Reynolds, not Lorillard, was the firm
injecting some competition into the market. And as described herein,
once Reynolds adds Lorillard's flagship Newport brand to its
portfolio, Reynolds will have a portfolio of brands that is
symmetrical to Altria/Philip Morris, resulting in a significant
change in its incentives post-merger. In considering whether
Imperial will fully restore the competition lost from this
transaction, the majority seems to omit from its analysis Reynolds'
changed incentives post-merger, and the effect that these changed
incentives will have to substantially lessen competition in the U.S.
market.
---------------------------------------------------------------------------

Conclusion
There is a great deal of discussion among academia, industry and
other stakeholders about the negative impact on the market stemming
from over enforcement of the antitrust laws.\25\ There is consensus
that over enforcement, also known as ``Type 1 errors'' or ``false
positives'', can harm businesses and consumers by preventing what could
otherwise be procompetitive conduct; many commentators believe Type 1
errors can also have a chilling effect on future procompetitive
conduct.\26\ However, failing to bring antitrust enforcement actions
can also cause significant harms to consumers. As has been recently
demonstrated by an in-depth study of merger retrospectives, harm from
under enforcement, also known as ``Type 2 errors'' or ``false
negatives'', can come in the form of significant price increases.\27\
The Commission has always been very careful not to take enforcement
action that turns out not to be warranted, an approach I fully support.
This Commission also normally pays close attention when we are
presented with insufficient divestitures or other remedies, to avoid
under enforcement errors that can cause significant harm to consumers.
Unfortunately, the majority has failed to do so in this case.
---------------------------------------------------------------------------

\25\ See, e.g., Christine A. Varney & Jonathan J. Clark, Chicago
and Georgetown: An Essay in Honor of Robert Pitofsky, 101 Geo. L.J.
1565 (2013); Bruce H. Kobayashi and Timothy J. Muris, Chicago, Post-
Chicago, and Beyond: Time to Let Go of the 20th Century, 78
Antitrust L. J. 147 (2012); Alan Devlin and Michael Jacobs,
Antitrust Error, 52 Wm. & Mary L. Rev. 75 (2010); Verizon Commc'ns,
Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, 414
(2004); Frank H. Easterbrook, The Limits of Antitrust, 63 Tex. L.
Rev. 1, 15-16 (1984).
\26\ Id.
\27\ John Kwoka, Mergers, Merger Control, and Remedies, A
Retrospective Analysis of U.S. Policy, 2015.
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For all of these reasons, I respectfully dissent.

[[Page 32382]]

Dissenting Statement of Commissioner Joshua D. Wright

In the Matter of Reynolds American Inc. and Lorillard Inc.

The Commission has voted to issue a Complaint and Decision & Order
against Reynolds American Inc. (``Reynolds'') to remedy the allegedly
anticompetitive effects of Reynolds' proposed acquisition of Lorillard
Inc. (``Lorillard''). I respectfully dissent because the evidence is
insufficient to provide reason to believe the three-way transaction
between Reynolds, Lorillard, and Imperial Tobacco Group, plc
(``Imperial'') will substantially lessen competition for combustible
cigarettes sold in the United States. In particular, I believe the
Commission has not met its burden to show that an order is required to
remedy any competitive harm arising from the original three-way
transaction. This is because the Imperial transaction is both highly
likely to occur and is sufficient to extinguish any competitive
concerns arising from Reynolds' proposed acquisition of Lorillard. This
combination of facts necessarily implies the Commission should close
the investigation of the three-way transaction before it and allow the
parties to complete the proposed three-way transaction without imposing
an order.
In July 2014, Reynolds, Lorillard, and Imperial struck a deal
where, as the Commission states, ``Reynolds will own Lorillard's
Newport brand and Imperial will own three former Reynolds' brands,
Winston, Kool and Salem, as well as Lorillard's Maverick and e-
cigarette Blu brands, and Lorillard's corporate infrastructure and
manufacturing facility.'' \1\ Thus, this deal came to us as a three-way
transaction. As a matter of principle, when the Commission is presented
with a three (or more) way transaction, an order is unnecessary if the
transaction--taken as a whole--does not give reason to believe
competition will be substantially lessened. The fact that a component
of a multi-part transaction is likely anticompetitive when analyzed in
isolation does not imply that the transaction when examined as a whole
is also likely to substantially lessen competition.
---------------------------------------------------------------------------

\1\ See Statement of the Federal Trade Commission 1, Reynolds
American Inc., FTC File No. 141-0168 (May 26, 2015).
---------------------------------------------------------------------------

When presented with a three-way transaction, the Commission should
begin with the following question: If the three-way deal is completed,
is there reason to believe competition will be substantially lessened?
If there is reason to believe the three-way deal will substantially
lessen competition, then the Commission should pursue the appropriate
remedy, either through litigation or a consent decree. If the deal
examined as a whole does not substantially lessen competition, the
default approach should be to close the investigation. An exception to
the default approach, and a corresponding remedy, may be appropriate if
there is substantial evidence that the three-way deal will not be
completed as proposed. In such a case, the Commission must ask: What is
the likelihood of only a portion of the deal being completed while the
other portion, which is responsible for ameliorating the competitive
concerns, is not completed? In this case, this second inquiry amounts
to an assessment of the likelihood that Reynolds' proposed acquisition
of Lorillard would be completed but the Imperial transaction would not
be.
I agree with the Commission majority that the first question should
be answered in the negative because the proposed transfer of brands to
Imperial makes it unlikely that there will be a substantial lessening
of competition from either unilateral or coordinated effects.\2\ I also
agree with the Commission majority that if Reynolds and Lorillard were
attempting a transaction without the involvement of Imperial, the
acquisition would likely substantially lessen competition.\3\ Thus,
taken as a whole, I do not find the three-way transaction to be in
violation of Section 7 of the Clayton Act.
---------------------------------------------------------------------------

\2\ Statement of the Federal Trade Commission, supra note 1, at
3.
\3\ Statement of the Federal Trade Commission, supra note 1, at
1. While I agree with the Commission's ultimate conclusion that
Reynolds' proposed acquisition of Lorillard would substantially
lessen competition, I do not agree with the Commission's reasoning.
In particular, I do not believe the assertion that higher
concentration resulting from the transaction renders coordinated
effects likely. Specifically, I have no reason to believe that the
market is vulnerable to coordination or that there is a credible
basis to conclude the combination of Reynolds and Lorillard would
enhance that vulnerability. For further discussion of why, as a
general matter, the Commission should not in my view rely upon
increases in concentration to create a presumption of competitive
harm or the likelihood of coordinated effects, see Statement of
Commissioner Joshua D. Wright, Holcim Ltd., FTC File No. 141-0129
(May 8, 2015).
---------------------------------------------------------------------------

The next question to consider is whether there is any evidence that
the Imperial portion of the transaction will not be completed absent an
order. In theory, if the probability of the Imperial portion of the
transaction coming to completion in a manner that ameliorates the
competitive concerns arising from just the Reynolds-Lorillard portion
of the transaction were sufficiently low, then one could argue the
overall transaction is likely to substantially lessen competition. I
have seen no evidence that, absent an order, Reynolds and Lorillard
would not complete its transfer of assets and brands to Imperial. While
there are no guarantees and the probability that the Imperial portion
of the transaction will be completed is something less than 100
percent, I have no reason to believe it is close to or less than 50
percent.\4\
---------------------------------------------------------------------------

\4\ I would find a likelihood that the Imperial portion of the
transaction would be completed less than 50 percent to be a
sufficient basis to challenge the three-way transaction or enter
into a consent decree.
---------------------------------------------------------------------------

I fully accept that a consent and order will increase the
likelihood that the Imperial portion of the transaction will be
completed. Putting firms under order with threat of contempt tends to
have that effect. I also accept the view that a consent and order may
mitigate some, but perhaps not all, potential moral hazard issues
regarding the transfer of assets and brands from Reynolds-Lorillard to
Imperial. Specifically, the concern is that, post-merger, Reynolds-
Lorillard would complete the Imperial portion of the transaction but
more in form but not in function and artificially raise the cost for
Imperial. Higher costs for Imperial, such as undue delays in obtaining
critical assets, would certainly materially impact Imperial's ability
to compete effectively. Given this possibility, a consent and order,
including the use a monitor, would make such behavior easier to detect,
and consequently would provide some deterrence from these potential
moral hazard issues.
It is also true, however, that a monitor in numerous other
circumstances would make anticompetitive behavior easier to detect and
consequently deter that behavior from occurring in the first place.
Based upon this reasoning, the Commission could try as a prophylactic
effort to impose a monitor in all oligopoly markets in the United
States. This would no doubt detect (and deter) much price fixing. Such
a broad effort would be unprecedented, and of course, plainly unlawful.
The Commission's authority to impose a remedy in any context depends
upon its finding a law violation. Here, because the parties originally
presented the three-way transaction to ameliorate competitive concerns
about a Reynolds-Lorillard-only deal, and they did so successfully,
there is no reason to believe the three-way transaction will
substantially lessen competition; therefore, there is no legal
wrongdoing to remedy.
The Commission understandably would like to hold the parties to a

[[Page 32383]]

consent order that requires them to make the deal along with a handful
of other changes. But that is not our role. There is no legal authority
for the proposition that the Commission can prophylactically impose
remedies without an underlying violation of the antitrust laws. And
there is no legal authority to support the view that the Commission can
isolate selected components of a three-way transaction to find such a
violation. In the absence of such authority, the appropriate course is
to evaluate the three-way transaction presented to the agency as a
whole. Because I conclude, as apparently does the Commission, that the
three-way transaction does not substantially lessen competition, there
is no competitive harm to correct and any remedy is unnecessary and
unwarranted.\5\ Entering into consents is appropriate only when the
transaction at issue--in this case the three-way transaction--is likely
to substantially lessen competition. This one does not.
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\5\ The Commission points to the HSR Act as providing the legal
basis for the FTC to enter into consent orders ``to ensure that any
competitive issues with a proposed transaction are addressed
effectively.'' Statement of the Federal Trade Commission, supra note
1, at 4 n.7. When a proposed transaction or set of transactions
would not substantially lessen competition, as is the case with the
three way transaction originally proposed here, there are no
competitive issues with the proposed transaction to be addressed,
and the belief that a consent order may even further mitigate
concerns regarding the transfer of assets is not material to our
analysis under the Clayton Act. The HSR Act is not in conflict with
the Clayton Act and does not change this result.

[FR Doc. 2015-13861 Filed 6-5-15; 8:45 am]
BILLING CODE 6750-01-P

Document Created: 2018-02-22 10:12:59
Document Modified: 2018-02-22 10:12:59

Category		Regulatory Information
Collection		Federal Register
sudoc Class		AE 2.7: GS 4.107: AE 2.106:
Publisher		Office of the Federal Register, National Archives and Records Administration
Section		Notices
Action		Proposed consent agreement.
Dates		Comments must be received on or before June 25, 2015.
Contact		Robert Tovsky, Bureau of Competition, (202-326-2634), 600 Pennsylvania Avenue NW., Washington, DC 20580.
FR Citation		80 FR 32374