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Grand River Enterprises Six Nations v. Troy King et al

March 17, 2011

GRAND RIVER ENTERPRISES SIX NATIONS, LTD., PLAINTIFF,
v.
TROY KING ET AL., DEFENDANTS.



The opinion of the court was delivered by: John F. Keenan, United States District Judge:

Opinion and Order

Plaintiff Grand River Enterprises Six Nations, Ltd. ("Grand River" or "Plaintiff") brings this action against the Attorneys General of Alabama, Alaska, Arizona, California, Colorado, Delaware, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland, Massachusetts, Michigan, Missouri, Montana, Nebraska, New York, North Carolina, Ohio, Oregon, South Carolina, South Dakota, Tennessee, Washington, Wisconsin, and Wyoming (collectively, the "States" or "Defendants") asserting Commerce Clause and Sherman Act violations stemming from each state's participation in a tobacco Master Settlement Agreement ("MSA"). Before the Court are Defendants' motions to exclude the expert reports of Drs. Eisenstadt and Bulow as well as cross motions for summary judgment.

I.Background

The following facts are undisputed unless otherwise noted.*fn1

A.Overview of the MSA

In November 1998, the nation's four largest cigarette manufacturers entered into an agreement with forty-six states*fn2 and certain other jurisdictions (the "Settling States") settling pending and future claims in exchange for annual payments by the cigarette companies to compensate the states for health care costs associated with the treatment of tobacco-related illnesses. This agreement is embodied in the MSA. The four major tobacco companies who initially negotiated and signed onto the MSA are known as the original participating manufacturers ("OPMs"). Other tobacco manufacturers may elect to participate in the MSA at any time and be released from liability for any claims the Settling States could bring in exchange for specified settlement payments; these are known as subsequent participating manufacturers ("SPMs"). To encourage early participation, the MSA created special incentives for any manufacturer that signed on within sixty (later changed to ninety) days of its execution; this subset of manufacturers is known as the "grandfathered SPMs." Some manufacturers continue to sell cigarettes in the United States without joining the MSA; these are referred to as non-participating manufacturers ("NPMs"). Each Settling State receives a stipulated portion or "allocable share" of annual MSA payments. For example, New York receives 12.76% of total OPM, SPM, and grandfathered SPM MSA payments each year. (MSA Ex. A).

The MSA defines settlement payments for each group of tobacco manufacturers that participate in the MSA. With respect to OPMs, the MSA sets forth base amounts these companies collectively are required to pay to the Settling States each year. For example, in 2011, the base payment for OPMs is $8.139 billion. (MSA § IX(c)(1)). Each OPM pays a proportion of the base amount equal to its relative market share of the total number of cigarettes shipped by the OPMs in or to the fifty states, the District of Columbia, and Puerto Rico during the preceding year. (Id.; MSA § II(mm)). These base payments are subject to certain adjustments, including: (1) an upward adjustment for inflation (MSA § IX(c)(1); Ex. C); (2) a "volume adjustment" that reduces the base payment if the total number of cigarettes shipped in or to the U.S. market drops below a specified level (MSA § IX(c)(1); Ex. E); and (3) a downward "NPM Adjustment" that generally reduces the base payment by three times the amount of any market share OPMs lost to NPMs in a preceding year. (MSA § IX(d)).*fn3

SPMs pay a percentage of OPM base payments depending in part on their relative market shares. (MSA § IX(i)). SPM payments are also subject to the inflation adjustment and the NPM Adjustment. (MSA § IX(i)(3)). However, grandfathered SPMs are permitted to exempt a certain number of cigarettes from their payment obligations. This "grandfathered share" is equal to the greater of 125% of an SPM's 1997 market share of total U.S. cigarette sales or 100% of its 1998 market share of total U.S. cigarette sales. (MSA § IX(i)(1)). Thus, grandfathered SPMs only make MSA payments on cigarettes sold in excess of their grandfathered share.

B.Escrow and Contraband Statutes

Since NPMs do not make MSA payments, there was a concern that they could use this advantage to gain market share from OPMs and SPMs, in turn imposing unreimbursed healthcare costs on the Settling States. The MSA's solution to this problem came in the form of Escrow Statutes, with model legislation included at Exhibit T to the agreement. The Escrow Statutes aim to "effectively and fully neutralize[] the cost disadvantages that the Participating Manufacturers experience vis- a-vis Non-Participating Manufacturers within such Settling State as a result of the provisions of this Agreement," (MSA § IX(d)(2)(E)), by requiring NPMs that sell cigarettes in-state either to: (1) join the MSA and make settlement payments; or (2) pay a specified amount per cigarette sold in-state into an escrow fund used to satisfy any judgment the Settling State should win against the NPM. All of the Defendant States, along with all other Settling States, have enacted substantially similar Escrow Statutes. See Ala. Code § 6-12-3; Alaska Stat. § 45.53.020; Ariz. Rev. Stat. Ann. § 44-7101; Cal. Health & Safety Code § 104557; Colo. Rev. Stat. Ann. § 39-28-203; Del. Code Ann. tit. 29, § 6082; Ga. Code Ann. § 10-13-3; Idaho Code Ann. § 39-7803; 30 Ill. Comp. Stat. 168/15; Ind. Code § 24-3-3-12; Iowa Code § 453C.2; Kan. Stat. Ann. § 50-6a03; La. Rev. Stat. Ann. § 13:5063; Me. Rev. Stat. Ann. tit. 22, § 1580-I; Md. Code Ann. Bus. Reg. § 16-403; Mass. Gen. Laws Ann. ch. 94E, § 2; Mich. Comp. Laws § 445.2052; Mo. Ann. Stat. § 196.1003; Mont. Code Ann. § 16-11-403; Neb. Rev. Stat. § 69-2703; N.Y. Pub. Health Law § 1399-pp; N.C. Gen. Stat. § 66-291; Ohio Rev. Code Ann. § 1346.02; Or. Rev. Stat. § 323.806; S.C. Code Ann. § 11-47-30; S.D. Codified Laws § 10-50B-7; Tenn. Code Ann. § 47-31-103; Wash. Rev. Code Ann. § 70.157.020; Wis. Stat. § 995.10; Wyo. Stat. Ann. § 9-4-1202. The NPM retains ownership of and earns interest on the funds while they are held in escrow, a period generally lasting twenty-five years.

As originally enacted, the Escrow Statutes included an "allocable share release" provision through which an NPM could secure release of any escrow funds in excess of "the State's allocable share of the total payments that such manufacturer would have been required to make in that year under the Master Settlement Agreement . . . had it been a participating manufacturer." (Model Escrow Statute, MSA Ex. T-4). In other words, an NPM could recoup any escrow funds that exceeded the amount the Settling State would have received in MSA payments had the NPM been an SPM. This loophole allowed an NPM that concentrated its sales in a single state or small number of states to obtain release of most of its escrow deposits. Therefore, beginning in 2003, all of the Settling States except Missouri amended the allocable share release provision in their Escrow Statutes such that an NPM is entitled to the release of escrow only to the extent the escrow deposit in a given state exceeds the amount the NPM would have paid had it joined the MSA as an SPM. See, e.g., N.Y. Pub. Health Law § 1399-pp(2)(b)(ii).

In order to enforce compliance with the Escrow Statutes, the Settling States enacted complementary Contraband Statutes. The Contraband Statutes generally provide that an NPM's cigarettes cannot receive an excise tax stamp for sale, and therefore cannot be sold, in a Settling State absent an NPM's certification that it is in compliance with the state's Escrow Statute. Violation of a Contraband Statute may result in civil monetary penalties, suspension or cancellation of a distributor's license to stamp cigarettes, and/or seizure of an NPM's cigarettes. See, e.g., N.Y. Tax Law §§ 480-b, 481(1)(c), 1846. In some states, these statutes, known as "complementary legislation," establish a directory of manufacturers approved to sell cigarettes in-state. See, e.g., Ala. Code § 6-12A-3.

C.Payments to the Settling States

The following information is taken from the report of the States' expert Dr. Jonathan Gruber. The Court emphasizes that Plaintiff has not objected to the admissibility of Dr. Gruber's report, nor has it submitted contradictory empirical data. OPM MSA payments in 2007 were approximately $5.29953 per carton or $0.02650 per cigarette. (Gruber Rep. ¶ 5). SPM MSA payments in 2007 for cigarettes sold in excess of any grandfathered share were approximately $5.06638 per carton or $0.02533 per cigarette. (Id. ¶ 7). NPM escrow payments in 2007 were approximately $5.02138 per carton or $0.025107 per cigarette. (Id. ¶ 8).

Grandfathered SPM payments are slightly different. Grandfathered SPMs that sell at or below their grandfathered share make no MSA payments. Plaintiff submits that this exemption provides grandfathered SPMs with a competitive advantage over NPMs. However, Dr. Gruber notes that the vast majority of grandfathered SPMs sell above their grandfathered share, at which point they made the 2007 $0.02533 per-cigarette MSA payment. (Id. ¶ 17; Leung Decl., Ex. Z (listing fifteen grandfathered SPMs in 2008, only three of which sold below their grandfathered share)). While a grandfathered SPM's average per-cigarette MSA payment is lower than both OPM MSA payments and NPM escrow payments, the marginal cost of producing each cigarette above the grandfathered share is still higher than the cost increases NPMs incur due to escrow payments and lower than the cost increases of OPMs. To be sure, the MSA regulatory scheme imposes additional costs on all cigarette manufacturers, but the NPMs' escrow costs are less than OPMs' and SPMs' MSA payments. (Gruber Rep. ¶¶ 20-23).

OPMs, SPMs, and NPMs likely pass on these costs to consumers in the form of higher cigarette prices. But the differential in cost increases should logically create an opportunity for continued competition among OPMs, SPMs, and NPMs. Indeed, after the implementation of the MSA, NPM market share grew markedly, from about 0.4% of the market in 1997 to slightly more than 8% in 2003. (Eisenstadt Rep. ¶ 12). Although NPM market share subsequently declined to about 5.4% in 2007,*fn4 NPMs have substantially increased their share of the U.S. cigarette market since the inception of the MSA. This increase occurred in a shrinking cigarette market. Overall, this evidence paints a picture of an actively competitive cigarette market.

D.Grand River

Grand River is a Canadian tobacco manufacturer owned by First Nations members of the Iroquois Confederacy. Grand River operates on Six Nations' reservation land in Ontario. Grand River's Seneca brand cigarettes are imported into the United States through two companies, Native Wholesale Supply and Tobaccoville USA, Inc. Native Wholesale Supply sells Seneca brand cigarettes exclusively on Native American reservations in the United States. Tobaccoville imports Seneca brand cigarettes and distributes them off-reservation in several states. Because Grand River is an entity that "manufactures cigarettes anywhere that such manufacturer intends to be sold in the United States," see, e.g., N.Y. Pub. Health Law § 1399-oo(9)(a), the States consider Grand River to be an NPM. (Violi Decl. ¶ 3).

The undisputed deposition testimony establishes that Grand River and its distributors make independent pricing decisions. Jerry Montour, the de facto CEO of Grand River, testified that Grand River considers "potential for [sales] volumes in the future and long-term . . . [r]aw materials, wages, overhead, [and] profit" in determining the price at which it sells its cigarettes to Native Wholesale Supply and Tobaccoville. (Leung Decl., Ex. G, Deposition of Jerry Montour at 293-94). Grand River's pricing to Native Wholesale Supply and Tobaccoville is not affected by OPM, SPM, or NPM price changes. For example, Mr. Montour explained that "[i]f Marlboro or any of the other larger manufacturers choose to have a price increase because they are able to bear it in the U.S. market, no, we do not necessarily react to that by raising our costs to Tobaccoville." (Id. at 675). Similarly, Grand River's price point does not change in response to: an OPM's decision to increase the price of a premium brand of cigarettes (id. at 673-75); an OPM's decision to increase the price of a discount brand of cigarettes (id. at 676); a grandfathered SPM's decision to increase prices (id. at 678-80); or another NPM's decision to raise prices of a fourth-tier brand of cigarettes similar to Grand River's Seneca brand. (id. at 681).

Native Wholesale Supply and Tobaccoville set the price of Grand River cigarettes for the U.S. market. Arthur Montour, the sole owner and president of Native Wholesale Supply, testified that the MSA and Escrow Statutes have no affect on the price Native Wholesale Supply charges for Grand River cigarettes in Native American territories. (Leung Decl., Ex. K, Deposition of Arthur Montour at 295, 298). Larry Phillips, the president of Tobaccoville, explained that Tobaccoville has the discretion to sell Grand River cigarettes in any state, as long as it does not sell in Native American territory. (Leung Decl., Ex. J, Deposition of Larry Phillips at 64). As of June 2008, Tobaccoville sold Grand River cigarettes in North Carolina, South Carolina, Tennessee, and Georgia,*fn5 as well as in three nonMSA states. (Id. at 72). Tobaccoville sets the price for Grand River cigarettes sold in each state; no state has limited the number of cigarettes that can be sold or directed Tobaccoville to sell cigarettes at a particular price, either in that state or in any other state. (Id. at 92-94, 150-52). In fact Mr. Phillips testified that Tobaccoville has sold Seneca brand cigarettes at a loss in Tennessee, at the same time that it charged a profit-producing price in North Carolina and Georgia. (Id. at 75-76). In setting its prices, Tobaccoville considers the cost of purchasing cigarettes from Grand River, the federal excise tax, the U.S. Department of Agriculture tobacco settlement cost, escrow payments, and its own profit. (Id. at 72-74, 82). Seneca cigarettes are not the cheapest brand on the market; instead, Tobaccoville sets its price based on what the market will bear. (Id. at 80, 135, 151).

E.Procedural History

Grand River filed its initial complaint in 2002, alleging that the MSA and its implementing legislation violated the dormant Commerce Clause, the Foreign Commerce Clause, the Indian Commerce Clause, the Sherman Act, the Equal Protection Clause, the Due Process Clause, the First Amendment, 42 U.S.C. § 1983, and that the MSA was preempted by the Federal Cigarette Labeling and Advertising Act. On September 29, 2003, this Court dismissed all claims against the Attorneys General of each state except New York pursuant to Rule 12(b)(2) of the Federal Rules of Civil Procedure for lack of personal jurisdiction; it also granted Defendants' Rule 12(b)(6) motion to dismiss for failure to state a claim as to all States. See Grand River Enters. Six Nations, Ltd. v. Pryor, No. 02 Civ. 5068, 2003 WL 22232974 (S.D.N.Y. Sept. 29, 2003). On July 15, 2004, the Court granted Plaintiff's motion for reconsideration of the November 29, 2003 ruling and reinstated the Sherman Act claim against the New York Attorney General in light of the Second Circuit's decision in Freedom Holdings, Inc. v. Spitzer, 357 F.3d 205 (2d Cir. 2004), a case presenting claims essentially identical to those in the case at bar. See Grand River Enters. Six Nations, Ltd. v. Pryor, No. 02 Civ. 5068, 2004 WL 1594869 (S.D.N.Y. July 15, 2004). On November 3, 2004, the Court granted Plaintiff's Rule 54(b) motion and directed entry of final judgment so that Grand River could appeal the Rule 12(b)(2) and 12(b)(6) dismissals. See Grand River Enters. Six Nations, Ltd. v. Pryor, No. 02 Civ. 5068, 2004 WL 2480433 (S.D.N.Y. Nov. 3, 2004).

On appeal, the Second Circuit found that this Court could exert personal jurisdiction over the non-New York Defendants. Therefore, the Second Circuit reversed in part and reinstated the Commerce Clause claim, finding that Plaintiff had stated "a possible claim that the practical effect of the challenged statutes and the MSA is to control prices outside of the enacting states by tying both the SPM settlement and NPM escrow payments to national market share, which in turn affects interstate pricing decisions." Grand River Enters. Six Nations, Ltd. v. Pryor, 425 F.3d 158, 173 (2d Cir. 2005).

Plaintiff subsequently moved for a preliminary injunction preventing the Defendant States from enforcing the amended allocable share provisions of their Escrow Statutes. Following a three day hearing, the Court found that Grand River was not likely to suffer irreparable harm or to succeed on the merits of its Sherman Act and Commerce Clause claims. See Grand River Enters. Six Nations, Ltd. v. Pryor, No. 02 Civ. 5068, 2006 WL 1517603, at *8-10 (S.D.N.Y. May 31, 2006). The Second Circuit affirmed the denial of an injunction on the grounds that Grand River did not demonstrate a likelihood of irreparable harm. Grand River Enters. Six Nations, Ltd. v. Pryor, 481 F.3d 60 (2d Cir. 2007) (per curiam).

On November 9, 2009, the parties filed the instant cross motions for summary judgment.

II.Evidentiary Motions

Before delving into the summary judgment analysis, the Court must first determine what evidence may be considered in support of the parties' respective motions. See Raskin v. Wyatt Co., 125 F.3d 55, 66 (2d Cir. 1997) ("[O]nly admissible evidence need be considered by the trial court in ruling on a motion for summary judgment."). As previously mentioned, the States have submitted the expert report of Dr. Jonathan Gruber, and Grand River does not contest its admissibility. Grand River has submitted the expert reports of Dr. David Eisenstadt and Dr. Jeremy Bulow. The States move to exclude Grand River's expert reports under Rule 702 of the Federal Rules of Evidence.

Rule 702 provides:

If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise, if (1) the testimony is based upon sufficient facts or data, (2) the testimony is the product of reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case.

Rule 702 requires the district court to act as a gatekeeper to ensure that expert testimony "both rests on a reliable foundation and is relevant to the task at hand." Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 597 (1993). Thus, in assessing admissibility, the court must first determine whether the proffered expert testimony is relevant, that is whether it "ha[s] any tendency to make the existence of any fact that is of consequence to the determination of the action more probable or less probable than it would be without the evidence." Fed. R. Evid. 401. Then, the court considers whether "the reasoning or methodology underlying the testimony is scientifically valid and . . . whether that reasoning or methodology properly can be applied to the facts in issue." Daubert, 509 U.S. at 592-93. Daubert set forth a non-exclusive list of factors that the court might consider in gauging the scientific validity of proffered testimony, including: (1) whether the theory has been tested; (2) whether the theory has been subject to peer review and publication; (3) the known or potential rate of error and whether standards and controls exist and have been maintained with respect to the technique; and (4) the general acceptance of the methodology in the scientific community. Id. at 593-95.

In assessing the reliability of proffered expert testimony, the court must "focus on the principles and methodology employed by the expert, without regard to the conclusions the expert has reached or the district court's belief as to the correctness of those conclusions." Amorgianos v. Nat'l R.R. Passenger Corp., 303 F.3d 256, 266 (2d Cir. 2002). "Although expert testimony should be excluded if it is speculative or conjectural, or if it is based on assumptions that are so unrealistic and contradictory as to suggest bad faith or to be in essence an apples and oranges comparison, other contentions that the assumptions are unfounded go to the weight, not the admissibility, of the testimony." Boucher v. U.S. Suzuki Motor Corp., 73 F.3d 18, 21 (2d Cir. 1996) (per curiam) (internal quotations and citations omitted). In other words, Rule 702 "embodies a liberal standard of admissibility for expert opinions." Nimely v. City of New York, 414 F.3d 381, 395 (2d Cir. 2005).

Dr. Eisenstadt holds a Ph.D. in Economics from the University of Illinois at Urbana-Champaign. After completing his doctoral studies, Dr. Eisenstadt worked as a Senior Economist at the Antitrust Division of the U.S. Department of Justice. In 1991, he founded a private consulting company which offers economic advice to clients in antitrust and other litigation.

The overarching theme of Dr. Eisenstadt's September 29, 2008 initial report is that the NPM Adjustment provision in the MSA provides an incentive for OPMs to raise cigarette prices more than necessary to recoup MSA costs, in turn "shedding" market share to NPMs in order to reap the benefit of the NPM Adjustment and lower their MSA payments. He performs three analyses to link historical OPM price increases to the NPM Adjustment in support of his proposition that the MSA has an adverse effect on competition. Specifically, Dr. Eisenstadt conducted: (1) a game theory analysis, which indicates that the NPM Adjustment caused OPMs to increase their prices by approximately $0.02 to $0.05 per pack (in 2007 dollars); (2) an oligopoly simulation, which suggests that the NPM Adjustment caused OPMs to increase their prices by approximately $0.06 per pack (in 2007 dollars); and (3) a regression analysis, which indicates that the NPM Adjustment caused OPMs to raise their prices by approximately $0.04 to $0.05 per pack (in 2007 dollars). (Eisenstadt Rep. ¶ 89).

On May 14, 2009, Dr. Eisenstadt submitted a supplemental report to address questions raised by defense counsel during his deposition. After adjusting his analyses to account for various issues highlighted by defense counsel, Dr. Eisenstadt again concluded that the NPM Adjustment caused OPMs to raise their prices by between $0.01 and $0.05 per pack (in 1997 dollars). Additionally, Dr. Eisenstadt performed several new analyses to illustrate the amount of consumer loss attributable to: (1) the MSA and original Escrow Statutes; (2) the original Escrow Statutes alone; and (3) the current Escrow Statutes as amended to change the allocable share release provision.

There is no contention that Dr. Eisenstadt is unqualified to offer an expert opinion in this case. Instead, Defendants attack alleged flaws in Dr. Eisenstadt's models which render his conclusions unreliable. Specifically, Defendants argue that the game theory analysis fails to explain cigarette prices in time periods outside of those he considered, considers only two OPMs selling two products each, which is not reflective of the actual cigarette market, and contains two mathematical errors, including an "elasticities matrix" that produces economically impossible results. Regarding the oligopoly simulation, Defendants contend that Dr. Eisenstadt used the wrong discount rate when converting cigarette prices to 1997 dollars and that his model fails to account for attorneys' fees the OPMs must pay. Finally, Defendants argue that Dr. Eisenstadt's regression analysis, which includes a factor called NPMADJOPPCOST that is meant to represent an OPM's potential NPM Adjustment, does not take into account historical declines in the volume of cigarettes sold between 1997 and 2003 and is overly influenced by two outlier data points.

It is important to note that Defendants in no way challenge the scientific validity of game theory analysis, oligopoly simulation, or regression analysis. There is no dispute that these are textbook economic methodologies which are generally accepted and widely used by economists to predict prices in various contexts. Instead, Defendants question certain data Dr. Eisenstadt used in his calculations and conclusions he drew from the results.*fn6 These arguments do not diminish the reliability of the process or methodology employed. See Amorgianos, 303 F.3d at 267 ("A minor flaw in an expert's reasoning or a slight modification of an otherwise reliable method will not render an expert's opinion per se inadmissible. The judge should only exclude the evidence if the flaw is large enough that the expert lacks good grounds for his or her conclusions." (internal quotation omitted)).

Dr. Bulow received his Ph.D. in Economics from the Massachusetts Institute of Technology. He served as the Director of the Bureau of Economics of the Federal Trade Commission from 1998 to 2001, and currently works as a Professor of Economics at Stanford University's Graduate School of Business. He has published extensively in the areas of microeconomic theory, corporate finance, and pensions, and on the topic of tobacco taxes and the MSA. Dr. Bulow's September 29, 2008 report sets forth three main propositions: (1) the MSA and its implementing legislation are in essence a set of national excise taxes; (2) the MSA and its implementing legislation operate extraterritorially in that the regulatory payment scheme in each ...


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