Editor: We understand that the Federal Trade Commission staff was extremely interested in the proposed combination of R.J. Reynolds Tobacco and Brown & Williamson Tobacco. Was this predictable?
McFalls: Yes. The interest of the FTC staff in this transaction was reasonably predictable. Ten years earlier, the FTC actually pursued preliminary injunctive relief to stop the merger of Brown & Williamson and American Tobacco, which involved lower market shares than our transaction. In addition to everything else, we were well aware that a variety of interest groups - some representing growers, some representing distributors, some representing retailers - would be likely to complain about any transaction involving the tobacco companies. All of this led us to believe that we would have to be in a position to engage in a serious, substantial discussion with FTC staff to avoid delay in consummating the transaction and divestitures.
Editor: What did you do to prepare to engage the staff?
McFalls: We did what we always do during deals likely to elicit Second Requests, though on a faster timetable. In cooperation with our terrific co-counsel (Cravath, Swaine & Moore and Kaye Scholer), we examined our documents and discussed recent and significant changes in the marketplace with both our businesspeople and economic consultants. Our in-house counsel were essential in helping us navigate these waters in an early, productive fashion, especially in light of other business demands as well as the onset of the holidays last November and December. We identified the six or seven issues likely to be either outcome-determinative for us or crucial to staff's case.
Editor: In what kind of advocacy did you engage?
McFalls: After certifying compliance with the Second Request in a relatively short period of time, we focused on persuading staff that the transaction did not raise any serious antitrust issues. The parties submitted White Papers (together with 41 volumes of charts and documentary support) outlining our principal propositions. Our intention was for the FTC staff and management to see what our opening statement would be in a preliminary injunction proceeding. We focused first on the dramatic impact of the Master Settlement Agreement on the ability and incentive of the parties (as well as the impact on other Original Participating Manufacturers, or OPMs) to compete in marketplace. We then demonstrated the impact of the MSA on RJR and B&W in more detail, showing how both parties had lost market share as the result of increasing costs and effective entry from Fourth Tier manufacturers - smaller cigarette manufacturers not saddled with the sort of settlement costs that had increased both the cost and price of OPM cigarettes substantially across the country. We also explained how new entry and expansion had forced all manufacturers, even Philip Morris - the 800 lb. gorilla of the tobacco industry - to increase discounting and direct-to-consumer promotion substantially after 2001. Because these new dynamics would persist for a significant period of time (with or without the merger), we persuaded management from the Bureau of Competition and the Bureau of Economics (and, ultimately, all four acting Commissioners) that the transaction would not increase the likelihood of coordinated interaction among the tobacco companies.
We also persuaded FTC management that the post-merger firm would have neither the ability nor incentive to exclude Fourth Tier manufacturers from the shelf, which proved to be one of the more aggressive but unfounded contentions from interest groups. And because Newport from Lorillard and Marlboro Menthol from Philip Morris were the leading menthol brands in the marketplace, the FTC did not believe that combining Kool and Salem under the same roof would raise any substantial unilateral effects issues, especially when data showed that they were not each other's closest substitutes.
Editor: In retrospect, what were the keys to success?
McFalls: A lot of different factors came together quite nicely. First, we enjoyed a terrific relationship with our clients and co-counsel, which truly expedited document production, fact collection, and written advocacy, providing a crucial timing cushion throughout the process. Second, we had an aggressive, intelligent FTC staff that articulated wide-ranging concerns and engaged in a true debate over the issues throughout the process. And we had a Commission and Bureau management that maintained open minds throughout the process. Finally, and perhaps most importantly, we had a client - R.J. Reynolds - that was ready, able and willing to litigate these issues, and when the enforcement agencies know that this is a credible threat, they are far less willing or able to try to obtain settlements in cases that they would be likely to lose in court.
Published October 1, 2004.
