“The government solution to a problem is usually as bad as the problem.” - Milton Friedman
The smoke has cleared. The dust has settled. In just one week’s time, a collection of regulatory considerations hanging over the U.S. tobacco industry, which have received substantial coverage over the last several years, have magically dissipated.
So ordered
It has taken fifteen months since writing The FDA Is Wasting Its Time Chasing Cigars. On January 24, 2025, the FDA’s appeal was squashed, with the D.C. Circuit Court having vacated the FDA’s regulatory influence over premium cigars.
We agree with Judge Mehta that the FDA’s final Rule was arbitrary and capricious.
First, the FDA’s rationale was factually incorrect. We have held that “agency action is arbitrary and capricious if it rests upon a factual premise that is unsupported by substantial evidence.” Genuine Parts Co. v. EPA, 890 F.3d 304, 346 (D.C. Cir. 2018) (quoting Ctr. for Auto Safety v. Fed. Highway Admin., 956 F.2d 309, 314 (D.C. Cir. 1992)). The FDA’s explanation for its rejection of Option 2 in the final Rule rested on a false factual premise, as discussed above. That in itself constituted arbitrary agency action. See, e.g., County of Los Angeles v. Shalala, 192 F.3d 1005, 1021 (D.C. Cir. 1999).
Second, even if the FDA had said nothing about the supposed lack of evidence, its analysis of the choice between Option 1 and Option 2 shows that it did not “examine the relevant data,” a defect rendering its action “arbitrary” within the meaning of APA section 706. See Motor Vehicle Mfrs. 2 Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983); see also, e.g., Env’t Health Tr. v. FCC, 9 F.4th 893, 907 (D.C. Cir. 2021); Viasat, Inc. v. FCC, 47 F.4th 769, 776 (D.C. Cir. 2022); Home Box Off., Inc. v. FCC, 567 F.2d 9, 35 n.58 (D.C. Cir. 1977). In some cases, the relevance of the 3 unexamined “data” might be debatable. But not here. As we have discussed, the FDA’s notice of proposed rulemaking placed this sort of evidence at the heart of its inquiry.
This conclusion is in no way a shock. Likewise, it is no surprise that the single greatest beneficiary of this conclusion is Scandinavian Tobacco Group. While the doors for potential competition will conceivably open a degree wider, the takeaway from Liberation captures it best:
Granted, the ruling can be appealed by the FDA until October 9th, but if the FDA does not pursue that route, or if that route concludes with the final opinion upheld, the long-term effects will be pronounced. New premium handmade cigar products will no longer be bound by requirements such as the Substantial Equivalent pathway, promoting faster and greater breadth of variety. While S.E., PMTA, and other pathways have acted as additional barriers against new competition, scaled vertically-integrated infrastructure, including superior distribution, alongside significant brand recognition still remains a considerable advantage. More importantly, being freed from the FDA will spare the industry from what could have been future potential arbitrary and capricious actions, greatly reducing regulatory tail risks.
Kicking the can
Despite the new Unified Agenda not being due for several more months, the new executive administration has wasted no time showing its intentions. If you peek at this Federal Register, several points will stand out.
First, the Tobacco Product Standard for Characterizing Flavors in Cigars has been moved to Long-Term Actions. This is akin to kicking the can down the road—it may be picked up later, but not by this administration. This standard encompasses handmade cigars infused with flavors, as well as machine-made cigars such as Black & Mild, produced by Altria’s John Middleton.
Second, the Tobacco Product Standard for Menthol in Cigarettes has also been moved to Long-Term Actions. British American Tobacco is the greatest beneficiary, as it has disproportionate exposure to the U.S. menthol market.
Third, the Tobacco Product Standard for Nicotine Level of Certain Tobacco Products was moved to Long-Term Actions. Although considerable ink has been spilled on the topic, there has always been immense doubt that it would ever materialize. While an eventual future administration will likely pick up where this standard was paused, our minds will be spared from this distraction for at least several years.
Still looming
The above developments reinforce the rigidity of legacy tobacco regulation in the United States and assure a degree of protection for associated cash flows. However, while some direct threats have been muted, others remain. Specifically, how the government continues to tackle the growing illicit market will be paramount. With the FDA having worked through most of its PMTA backlog, anticipated determinations and potential changes to the authorization pathways still provide considerable additional uncertainty.
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Ownership Disclaimer
I own positions in tobacco companies such as Altria, Philip Morris International, British American Tobacco, Scandinavian Tobacco Group, and Imperial Brands. I also own positions in Haypp Group, a major online retailer of reduced-risk nicotine products.
Disclaimer
This publication’s content is for entertainment and educational purposes only. I am not a licensed investment professional. Nothing produced under the Invariant brand should be thought of as investment advice. Do your own research. All content is subject to interpretation.
Just saw this Colorado bill proposing to reduce state taxes on premium cigars to 20%: https://leg.colorado.gov/bills/sb25-056. I don’t know enough about Colorado politics to understand how likely the bill is to pass. I wonder if that’s part of a broader trend.
Thank you very much for the write up