EC, Tobacco Firm Said to Be in Talks Over Illegal Trade

Philip Morris International and the European Commission are discussing a possible deal in which the tobacco giant would pay $1 billion to avoid lawsuits over the smuggling of its brands into EC member countries, sources said Friday.

A person at Philip Morris who is familiar with the talks, speaking on condition of anonymity, said they were intended to forge an alliance to fight the illegal trade in cigarettes -- which increasingly involves counterfeit products -- that is costing the company and European treasuries a fortune in sales and tobacco taxes, respectively.

Under such a deal, “governments will regain enormous amounts of revenue that are lost to counterfeit, and clearly our business interests are served by having people who buy Marlboro buy the real Marlboro,” the company representative said. The source said it was not clear when, or if, such a deal would be signed.

It was unclear whether other cigarette makers were involved in similar talks.

EC officials could not be reached late Friday.

The EC in November 2000 filed suit against Philip Morris and R.J. Reynolds Tobacco in federal court in Brooklyn, N.Y., accusing them of encouraging smuggling to boost sales, costing governments billions of dollars in taxes. The EC filed a separate complaint against Japan Tobacco Inc., which had acquired RJR’s international business in 1999.

The complaints were thrown out under the “revenue rule,” a centuries-old common law doctrine that generally prohibits foreign governments from recovering tax losses through U.S. courts.

However, the EC has threatened to bring another case against Philip Morris, this time based on a money-laundering theory. Indeed, it filed such a suit against RJR in October 2002, but it has not actively pursued it.

From the 1970s into the ‘90s, cigarette makers made money from sales of cheap, tax-free contraband smokes, because smugglers trafficked almost exclusively in genuine brands. According to government lawsuits, the companies encouraged smuggling by supplying corrupt traders whom they knew would sneak their brands past customs authorities. Tobacco firms say they never condoned smuggling.

In recent years, smugglers have increasingly relied on cheap but ingeniously made knockoffs from China, Paraguay and other counterfeiting havens. According to one estimate, 1 million packs of counterfeit cigarettes are being sold each day in Europe alone.

In Europe, “we’re probably losing $100 million per year to counterfeit,” the Philip Morris source said. But in terms of lost taxes, European governments “are losing billions.”

Although acknowledging the deal would wipe out potential liability, the Philip Morris source said it would not be a settlement per se. Forming a closer alliance with customs authorities “required that we ended past disputes,” the person said.

The deal would exceed the $613 million the EC recently fined Microsoft. Under the terms, Philip Morris would make payments to the EC over 12 years totaling “in the ballpark” of $1 billion, the person said. The money could be used for law enforcement, but that would not be a required.

Most important, the person said, is that the firm would begin furnishing customs officials with “real-time information” on shipments and deliveries to customers, making it easier to stop diversions of cigarettes into illegal channels.

In the last two years, Philip Morris USA has sued thousands of retailers, mostly in California, for allegedly selling counterfeit Marlboros made in China. Like Philip Morris International, the domestic firm is a unit of Altria Group Inc.