Firm Sees Red Over Knockoff Smokes

The lady had an orange van and a plausible story: She was closing her store and offering good prices on cigarettes. So Adel Simon, owner of a gas station and convenience store in Los Angeles, bought 25 cartons of Marlboros and Marlboro Lights for about $650 -- $100 less than he would have paid at Costco.

It may have been the worst business decision of his life.

Soon after, an undercover agent for Philip Morris USA dropped in on Simon’s Chevron on Los Feliz Boulevard to buy a couple of packs. He sealed the cigarettes in zip-lock bags and shipped them by courier to Philip Morris in Richmond, Va., where, according to the company, lab tests revealed that they were counterfeits.

Before long, Simon was sued in U.S. District Court in Los Angeles for trafficking in knockoff smokes.

Exasperated, Simon believes “he could have murdered someone and had less problems,” said his lawyer, Ronald Schy.

Simon, a Syrian immigrant in his 60s, told Philip Morris lawyers through an Arabic translator that he had no idea he was getting counterfeits from the lady in the van -- and still has only the company’s word that they were fakes.

“I didn’t do anything that’s fraud,” he said.

Simon has plenty of company. Determined to guard its huge cash flows from the world’s most popular brand, Philip Morris has charged 415 retailers with illegally selling imitation Marlboros and Marlboro Lights.

Greater L.A. Targeted

Simon was caught in a first wave of suits, filed last fall against nearly 90 small merchants. Philip Morris ramped up the offensive Monday, suing an additional 325 retailers in Los Angeles, San Francisco, San Diego, Sacramento and eight other cities around the country. Nearly 90% of the defendants are California merchants, most of them in Greater Los Angeles.

The lawsuits are the centerpiece of a ferocious campaign to protect the powerhouse brand from ingeniously made knockoffs from China and other countries. Marlboro last year provided Philip Morris parent Altria Group Inc. with about $7 billion in operating profit.

The merchants were snagged in a nationwide dragnet involving undercover buys at thousands of stores. Rather than pushing for damages, Philip Morris is squeezing the defendants for information. Company lawyers are debriefing the small fry one by one -- sometimes using Hindi, Farsi, Arabic, Korean, Cantonese, Mandarin, Vietnamese or Spanish translators -- in hopes of catching the big fish.

The targets, including many operators of small central-city markets, say the company’s tactics are heavy-handed. They contend that they were tricked into buying the fakes and would gladly have assisted the probe without being hauled into court.

Philip Morris is running the campaign through a newly organized strike force called the brand integrity group. With a staff of about 20 -- including former agents of the FBI, the Secret Service, the U.S. Customs Service and the Bureau of Alcohol, Tobacco, Firearms and Explosives -- the group feeds investigative leads to law enforcement agencies and files lawsuits after being assured that they won’t compromise criminal probes.

The unit has retained Pinkerton Consulting & Investigations Inc., which sent out scores of agents last summer and fall to make the undercover buys.

Philip Morris also has held at least 450 briefings for law enforcement officers in 19 states on how to identify the counterfeits, which cannot be distinguished from the real thing with the naked eye. Separately, the company has filed lawsuits against Internet sites offering discount prices on “gray market” smokes -- genuine Marlboros produced for foreign consumption but illegally redirected into the U.S.

“We are trying to fight illegal activity that criminals are engaged in,” said John E. “Jack” Holleran, Philip Morris vice president for brand integrity.

Some tobacco foes say the company is just getting a taste of its own medicine.

Global tobacco firms, including Philip Morris, have been dogged by charges that they knowingly funneled huge volumes of cigarettes to smuggling rings in Europe, Asia and Latin America during the 1980s and ‘90s. According to allegations in various lawsuits, the companies colluded with black marketeers to penetrate new markets and boost consumption by creating a glut of cheap, tax-free cigarettes.

“They’re getting hung on their own petard,” said Matt Myers, president of the Campaign for Tobacco-Free Kids, a leading U.S. anti-smoking group. “The only thing they seem to be objecting to is the illegal behavior that’s cutting off their market share.”

Philip Morris executives say they are committed to fighting contraband in all its forms. Even critics who impute the worst motives to cigarette makers concede this may be true -- if only because the risks of the illicit trade to the companies exceed the rewards. The rise of counterfeiting, which steals away sales, is a major reason.

Driving Away Loyalists?

The cheap knockoffs are raising double-barreled anxieties, taking money from the company’s pockets and, because of their inferior quality, possibly driving Marlboro loyalists to other brands. How many of the fakes are out there is a matter of conjecture, but Philip Morris says that 900 million counterfeits of its brands were seized outside the U.S. last year.

Seizures by U.S. Customs inspectors confirm that the problem is getting worse. Last year, Customs intercepted about 13 million packs of contraband smokes -- mostly counterfeits -- a fourfold increase over 2000. Most were seized at Los Angeles-Long Beach harbor, the gateway for Asian trade.

As the top-selling cigarette in the U.S., with a 37% market share, Marlboro naturally has been the favorite target of counterfeiters. According to a Southern California tobacco dealer who did not want to be identified, a recent joke within the cigarette trade was that “there was probably more Chinese product in California than there was Philip Morris product.”

Because sales of counterfeits also mean lost taxes, the problem has aligned the interests of tobacco firms and federal and state revenue agencies. In California, the knockoffs typically carry phony tax stamps. Each counterfeit pack represents a loss of $1.26, comprising California’s cigarette tax of 87 cents and the federal excise tax of 39 cents. According to the state Legislative Analyst’s Office, California is losing $130 million to $270 million a year to various tobacco tax-evasion schemes.

Along with being the world’s top maker of legitimate cigarettes, China also is the lead- ing producer of counterfeits. Although Chinese authorities seized 13 billion counterfeit cigarettes and made 8,000 arrests during a recent 2 1/2-year period, an estimated 100 billion knockoffs a year still are being produced -- both domestic and foreign brands.

Counterfeiting has been raised to an art. The quality of the packaging is “phenomenal,” said Thomas Ryan, a spokesman for Philip Morris. At a recent demonstration, when company executives were asked to distinguish between packs of fake and genuine Marlboros, “everybody at the table had a different guess,” Ryan recalled.

And that’s one of the beefs of shop owners caught up in the Philip Morris sweeps. If the fakes are dead ringers for genuine Marlboros, they ask, and can be detected only through proprietary tests, how can retailers be expected to know the difference?

However, the Lanham Act, the trademark protection law on which the Philip Morris suits are based, prohibits sales that trick consumers into believing they are getting brand-name goods -- even when the seller is unaware.

And company representatives say they had repeatedly warned retailers in letters last year to avoid dealing with suppliers they did not know.

Distribution Question

Greg Pensa, owner of a Mobil gas and convenience market in Buellton in Santa Barbara County, has been fuming since he was served with papers in October.

Pensa said every pack of cigarettes he ever stocked was purchased from one of two giant distributors: the Core-Mark unit of Fleming Cos. or Costco Wholesale Inc. So after getting over the shock, Pensa did a little checking.

He reached a Costco cigarette buyer in Los Angeles, who acknowledged that some counterfeits had made it onto the shelves -- apparently because Costco’s liberal return policy had enabled customers without receipts to “return” cigarettes they had obtained somewhere else.

Dick Dicerchio, Costco senior executive vice president and chief operating officer, said the problem had been limited to a few West Coast stores and had been eliminated by a recent change in Costco return policies.

But this did not help Pensa.

“I had to take a day off of work ... and haul an attorney down there and make a deposition,” he said in an interview. “I would have gladly given them the same information on a phone call. It got a little heated when we were down there.”

Philip Morris has reached 22 settlements and is negotiating more. The agreements will give Philip Morris free rein to make unannounced inspections at each defendant’s store. A merchant caught with counterfeits the first time would pay $500, with damages doubling on each subsequent occasion in which fake Marlboros are found.

Some defendants and their lawyers have complained about the terms, saying it’s possible they still could obtain counterfeits without knowing it. Despite these reservations, they say they cannot afford a court fight with the tobacco giant and would probably sign the deal.