Dear Mr. Schapiro:
Philip Morris International ("Philip Morris") appreciates the opportunity to respond to your recent inquiry concerning litigation arising from the alleged smuggling of cigarettes in Colombia and other countries. While the lawsuits against Philip Morris and its affiliates have all been dismissed, the plaintiffs have indicated their intention to file appeals. Therefore, we will not discuss the specific allegations of those cases in the media. We will, however, offer the following general comments concerning our position on these issues, including the smuggling situation in Colombia, initiatives we have implemented to reduce the likelihood of genuine Philip Morris products being smuggled, and the recent litigation.
Philip Morris’ Position on Cigarette Smuggling
Philip Morris does not condone, facilitate or support the smuggling of cigarettes and cooperates with governments in their efforts to prevent illegal trade in the products we manufacture. We have taken significant steps, both internally and in cooperation with foreign governments, to prevent the smuggling of our products. We believe, and recent statements by government officials in Colombia confirm, that there is no meaningful problem with genuine Philip Morris cigarettes entering Colombia though contraband channels. The biggest problem with respect to smuggled cigarettes involves counterfeit products, which cause damage to both Philip Morris and the Colombian government. We are continuing to work with the relevant party – the central government in Colombia – to address this issue.
Smuggling is a problem that affects not only cigarettes but also many other consumer products. As PBS itself has already noted, alcohol, computers, cameras, cars, electronics, washing machines and dishwashers are just some of the goods that have appeared in contraband channels. See Zill and Bergman, U.S. Business and Money Laundering . By definition, any consumer product that is subject to taxation or import or other trade restrictions is susceptible to smuggling. That the smuggling phenomenon has existed for centuries is ample proof that the solution is not a simple one. Preventing smuggling requires the resolve and effort of government agencies around the world, as well as the cooperation of manufacturers.
Smuggling of Cigarettes
There are several important points we would like to make in relation to the issue of contraband cigarettes:
- Cigarette smuggling is a serious issue but it is limited in scope. Some countries, such as Colombia, have experienced significant contraband problems but in many countries there has never been and exists today no substantial issue. This suggests both that particular conditions must exist for smuggling to arise and that smuggling can be avoided.
- Cigarette smuggling is not necessarily an intractable problem. For instance, in Spain, there was a serious problem but the government decided to address it and to take concrete steps to exercise its authority and influence. In doing so, the government significantly reduced the problem over three to four years. According to El Pais, following and as a direct result of the government’s initiative, contraband sales of cigarettes in Spain fell by 40 percent in 1998. In July 2000, El Mundo concluded that, "In Spain, smuggling already belongs to the culture of the past."
- Cigarette smuggling is not limited to international brands such as those produced by Philip Morris but also includes local brands in many places around the world. For example, the United Kingdom is generally acknowledged to have by far the most significant problem with cigarette smuggling in Europe. Yet the main brands that are reported to be smuggled are local brands that are manufactured in the U.K. The situation is similar in other countries with substantial problems of smuggling.
- No serious treatment of the subject of cigarette smuggling can ignore the increasing and dramatic impact of counterfeit cigarettes. Billions of counterfeit cigarettes are produced each year and smuggled into markets around the world. This results in incalculable damage to the brand owners’ goodwill and integrity of the brands through the mistaken attribution of contraband cigarettes of inferior quality to producers such as Philip Morris, as well as tax losses to governments. China’s tobacco monopoly has estimated that 100 billion counterfeit cigarettes are produced in China each year, which makes counterfeit cigarettes our fourth largest competitor in worldwide trade. China is not the only country where cigarette counterfeiters have set up operations -- counterfeiting factories have been discovered in Albania, Bulgaria, Indonesia, Macedonia, Malaysia, Montenegro, Myanmar, North Korea, Paraguay, Philippines, Russia, Thailand, the United Arab Emirates, and Vietnam. Of course, counterfeit cigarettes are sold in contraband channels and therefore deprive governments of substantial tax revenues. This increasingly significant threat therefore presents a major challenge to governments and brand owners alike, and we have a mutual interest in resolving the problem.
Governments, international organizations (including the World Health Organization) and researchers have put forward a number of proposals to address the smuggling problem, many of which we agree with. For example, Philip Morris supports the adoption of the following measures designed to prevent cigarette smuggling:
- country-specific tax stamps;
- marking of duty-free products;
- country-specific health warnings and country of destination markings;
- licensing of distribution chains;
- regulation of warehouse keepers and transport companies;
- appropriate marking and record keeping to facilitate product tracking;
- mandatory destruction of contraband and counterfeit products seized by authorities;
- industry "best practices," including "know your customer" and fiscal compliance procedures;
- technical training to assist customs officials in detecting illegal products;
- industry-funded awareness and educational awareness campaigns;
- more effective enforcement of current anti-contraband and anti-counterfeit laws; and
- action against counterfeit cigarette production.
In fact, Philip Morris already employs and practices a number of these and other measures that have been put forward as means to reduce cigarette smuggling, such as specific destination and country identifications on products, and computerized records of transactions. An example of our use of such country specific markings is Colombia, where the local Philip Morris affiliate uses a special tear tape for our product carrying the legend "Imported by Philip Morris Colombia S.A." Experience has shown, however, that these measures, in the absence of responsible governmental policies, will not solve the problem. In short, there is a limit to what we, as manufacturers, can do unilaterally to combat smuggling. A multi-faceted approach, where government and industry work together, is required.
Smuggling in Colombia
Historically, Colombia has faced a significant contraband issue in a wide range of products, including cigarettes. The trade in contraband cigarettes was a part of a centuries-old smuggling problem that was endemic to the Colombian economy and that involved many products other than cigarettes, including liquors, appliances, automobiles, tires, electronics, textiles, and carpets.
As the current Colombian central government itself has recognized, Colombia’s unusual and historic problems are largely the result of past governmental policies, failed law enforcement and other local factors. There are a number of conditions that fostered the contraband situation in that country.
- Generally, it is well-known that Colombia has a long tradition of smuggling, a well-developed smuggling infrastructure, a weakness in law enforcement and economic dependence on the contraband trade.
- For most of Colombia’s history, smuggling was not considered a crime but an administrative violation. The Colombian central government criminalized smuggling for the first time in 1987. However, the law was repealed four years later and smuggling was again considered an administrative violation. In 1997, the government criminalized smuggling again. However, the penalties applied only when the value of the smuggled goods exceeded $130,000. Later, in 1999, the central government reduced the threshold to $13,000. These exemptions encourage smuggling.
- Colombia has "special customs zones" or "free trade zones" where large volumes of products that subsequently become contraband are lawfully imported into the country without import duties. It is only when those products are moved out of these special zones and into the adjacent areas, without payment of duties, by people operating within Colombia that they become contraband. The areas selected for those zones have been known to the authorities as contraband entry points for decades, and because the local authorities do not control the movement of goods out of the zones, the maintenance of the zones in essence "legalizes" the entry of contraband. In 2000, the central government announced reforms to close these channels for smuggling into the country, but fierce local opposition and other considerations defeated any real reform.
- Throughout Colombia, there are large shopping areas called "San Andresitos," well known to Colombian society and government officials, where contraband products of many varieties are openly sold – apparently without fear of law enforcement. San Andresitos are permitted to exist and have become part of the local economy. The local authorities even issue municipal permits and licenses for their operations. This has given the San Andresitos – and smuggling – the government seal of approval.
This history is well known to both the Colombian and the U.S. governments. For example, in 1996, the New York Times reported that San Andresitos offered "the best prices for everything from television sets and clothes to perfume and toys" and "generate[d] about half a million jobs over the country." See All Colombia Is a Smuggler’s Cove, New York Times, Nov. 21, 1996 at A7. The smuggling problem was also addressed in detail in Congressional hearings that took place in June of 1999. The then head of the Colombian customs authority (DIAN), Dr. Fanny Kertzman, highlighted the problems caused by the free trade zones and the San Andresitos that exist in every major city in Colombia. The former U.S. Ambassador to Venezuela likewise noted the "responsibility of the Colombian government progressively to attack the San Andresitos" but stated that the issue was problematic because "it’s embedded in the political culture." See Sen. Comm. Hrg. on International Narcotics Control, June 21, 1999, at 19, 60-61.
It would appear that this situation has improved over the past couple of years, which is attributable in part to the more proactive approach that the Colombian central government and DIAN have taken to address this complex and difficult issue. According to press reports, contraband in all goods, including cigarettes, is substantially reduced. An El Herald report of November 6, 2000 of a speech by the Colombian President, for example, indicated that the value of contraband goods – of which cigarettes are only one part – was down by more than 50% in 2000.
Philip Morris has in place comprehensive compliance policies designed to address the smuggling issue. The specific initiatives we have in place include the following:
- "Know your customer" guidelines covering the selection of customers and other business partners;
- Communications to our customers regarding our expectations of them with regard to compliance;
- "Know your form of payment" procedures designed to assure that we receive funds that are derived only from legitimate sources; and
- Product tracking and shipment – we have established marking and coding procedures in appropriate cases that can in many instances assist us in tracing information about our products, including the date and location of manufacture and first purchasers. These systems support and enhance our other policies and procedures and enable us to respond to appropriate governmental inquiries relating to instances in which our products have been diverted into contraband channels.
In addition, the only cigarettes we sell for consumption in Colombia are sold to our Colombian affiliate, Philip Morris Colombia S.A. We do not sell cigarettes to any other person or entity for resale to eventual purchasers in Colombia, and we have taken and continue to take reasonable and demonstrably effective steps to ensure that these restraints are honored worldwide.
We believe that, through these policies and procedures, we meet the highest standards of responsible business practices in this area.
Support for Government Anti-Contraband Initiatives
While the fight against smuggling and money laundering are, at least in the first instance, the responsibility of law enforcement and government authorities, we agree that manufacturers and other private parties can play an important role by cooperating with and supporting governments in their efforts. For example, in March of 2000, the central government of Colombia and Philip Morris entered into an agreement to cooperate in the fight against contraband. Commenting on the agreement, DIAN’s Dr. Kertzman said:
I am proud to announce this significant achievement reached with the world’s largest producer of consumer packaged products. I am confident that in the near future the commitment we formalize today will produce excellent results in the battle against contraband, an illegal activity that constitutes a serious threat to our nation.
We believe that our compliance programs and the cooperation agreement with DIAN have been successful. Based on the available information, we do not believe that there is any meaningful problem with respect to genuine Philip Morris cigarettes being smuggled into Colombia. According to DIAN, 95% of the cigarettes seized last year in contraband channels and which carried Philip Morris trademarks were counterfeit cigarettes and not genuine products. In fact, just three months ago, Mr. Santiago Rojas, the current head of DIAN, stated that the cooperation agreement with Philip Morris was having positive results and that smuggled cigarettes are usually counterfeit. See, El Tiempo, Dec. 18, 2001. Since both Philip Morris and the central government lose money from the counterfeit situation (Philip Morris in the form of lost sales and Colombia in the form of lost taxes), this provides us with yet another reason to support the government’s efforts.
Philip Morris has also developed and signed cooperation agreements with the Italian government (the most recent of which was signed in 1999) and, as a member of the German cigarette industry association, with the German government in 1994. We have also signed cooperation agreements outlining our support for the fight against contraband with the governmental authorities in Kazakhstan, Slovakia and, as a member of the local manufacturers’ association, with the Ministry of Finance in Lithuania. In other countries, we have supported different measures, such as advertising campaigns designed to educate the public about contraband, including counterfeit, and to discourage people from buying cigarettes in illicit channels. We have also assisted customs authorities by providing financial support for programs that are not being funded by governments.
The Colombian Departments’ Litigation
While we will not, for the reasons stated previously, comment on the specific allegations of the lawsuit filed by the Colombian Departments, it is significant that neither the Republic of Colombia nor DIAN, which are the entities primarily responsible for this issue, have elected to join the lawsuit. In addition, many of the suggested causes of contraband (the implicit endorsement of the smuggling culture, the lack of meaningful law enforcement, political corruption, and the existence of the San Andresitos) apply directly to the Departments themselves. Those facts, together with the continued operation of the San Andresitos within the Departments’ territories, demonstrate the hypocrisy of these lawsuits seeking to hold U.S. companies liable for conditions that these government entities have played a major role in creating and supporting. And while to date the Departments have sued only cigarette manufacturers, they have already stated that they are laying the groundwork for their next U.S. target. See El Tiempo, Dec. 10, 2001 (Alvin Cruz, Governor of Cundinamarca, alleging that liquor companies are responsible for tax losses "20 times that of tobacco" and threatening to file suits).
The Departments have apparently elected to roll the dice in what they perceive to be the litigation casino in the U.S. courts, no doubt inspired by aggressive plaintiffs’ lawyers motivated by the prospect of large contingency fees. That, together with a desire to avoid negative media attention in their own country, is the most plausible explanation for their decision to file a lawsuit in a Brooklyn court to recover Colombian taxes based on the alleged smuggling of cigarettes into that country. As the district court properly recognized, the Revenue Rule prevents foreign governments from using the U.S. courts to collect tax revenues, just as the Colombian courts would not allow the U.S. government to collect its taxes there. We are confident that this judgment will be upheld on appeal.
Before these lawsuits were filed, Philip Morris expressed a willingness to work with any government interested in resolving the contraband problem within its borders. We have done so in many regions throughout the world. We would also note that the anti-smuggling policies outlined above were implemented before this litigation was ever filed, and we are continuing to enforce the policies despite the fact that the litigation has been dismissed. The suit by the Colombian Departments has no impact on the cooperation agreement between Philip Morris and DIAN, to which we will continue to provide our full support. This is part of our continuing commitment to responsible business practices in the marketing and sale of our products.
We hope this letter is helpful to you and contributes to your understanding of this complex issue and Philip Morris’ efforts. Thank you for taking the time to obtain our thoughts.