Is a 1935 Alcohol Beverage Federal Trade Practice Law Stifling Innovation?
Note from John Hinman: Rob is the most experienced and astute observer of regulatory and business practices in the alcohol industry today. Rob has authored several articles posted on the Booze Rules Blog site. (He tells us he likes to use our Blog as the messenger because of our broad base of readership and respect.) Rob is the former Chief Counsel, TTB, from 2003 to 2012 and a former independent consultant. Today is he the President of the National Association of Beverage Importers (NABI), in Washington, DC, serving as the leading advocacy trade association for importers of distilled spirits, wines, beer/malt beverages, and low-alcohol beverages. The views expressed in this article are his alone and do not reflect the views of NABI or any of its Members. Given his 34 years of public service, he writes these articles as a continued contribution to public service.
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The Temperance Fountain, Prohibition and Rule-Making
The memory still remains. Around 1980 during a TTB trade practice investigation, the Washington Post’s editorial page published an item by a private attorney representing the industry member who remarked about the Temperance Fountain in the above photograph. This water fountain sits today at Seventh Street and Pennsylvania Avenue, NW in Washington, DC. Dr. Henry Cogswell, a successful dentist in San Francisco and Temperance Movement supporter placed these fountains around the United States. Dr. Cogswell believed that access by the public to cold fresh water would deter folks from going to nearby saloons. The attorney writer said that the non-operating water fountain was an artistic piece from another era that did not function today for its original purpose and epitomized the ATF trade practice enforcement of that day in 1980—some old hold over that looks pretty but does not function to fulfill its original purpose. Fast forwarding to today, how does this 1935 law as administered by TTB in its present enforcement initiative fit the innovative marketplace of today?
Congress’ aim to prevent the recurrence of the “social evils” that led to Prohibition is the centerpiece of the unfair trade practice provisions of the Federal Alcohol Administration Act of 1935, Title 27, United States Code, Section 205(a) to (d). These four provisions described below remain unamended since their enactment. Between 1935 and 1980, they were interpreted by formal administrative rulings of the Federal Alcohol Control Administration, Internal Revenue Service, and Bureau of Alcohol, Tobacco and Firearms. In 1980, regulations were promulgated codifying many of these rulings in the Code of Federal Regulations. ATF pursued two formal notice and comment rulemakings—one from 1979 to 1980 and one from 1994 to 1995. The motivation for the latter rulemaking was not to modernize the regulations but respond to an adverse ruling in the Fedway decision by the Federal Court of Appeals for the District of Columbia that focused on the Congressional purpose in preventing upper tiers from dominating lower tiers or threatening the independence of those other tiers in the three-tier system. In its 16 years of existence, TTB has undertaken no rulemaking to update or modernize the trade practice regulations. It has, however, recently undertaken an aggressive trade practice investigation and enforcement initiative following the increased budget line item for trade practice enforcement in its annual appropriations bills.
It is this initiative that raises the question I would like to explore, to wit, has the 1935 law as implemented by TTB through the current trade practice enforcement initiative stifled innovation in the alcohol industry of today’s world… a world quite different from the alcohol industry world of post-Prohibition?
The FAA Act, “Subterfuge” and Innovation
Sir Winston Churchill prophetically said “History is written by the victors” or at least so he is attributed as saying. TTB is writing that history today through a series of Press Releases on its “successful” trade practice investigations and settlements. But, factually speaking, what is behind these settlements of large monetary offers in compromise and one-day suspensions. What is the impact on legitimate innovation in the marketplace of today? Is TTB’s claim of “subterfuges” (an undefined standard) stifling innovation? For full disclosure, as a consultant, I assisted lawyers and industry members in some of the recent trade practice investigations and settlements. All the material I cite is from the public record and not from my work on those matters in order to protect the confidences of these clients.
As a quick overview and for context, the Federal Alcohol Administration Act covers four unfair trade practices: exclusive-outlet; tied-house; commercial bribery; and consignment sales. The 1980 regulations explain certain types of activities that are allowed and certain types of activities that are means to induce that may lead to an actionable violation. Following the Fedway decision in 1992, the regulations also establish a framework for proving the statutory element of exclusion. Regarding tied-house arrangements, the regulations identify certain allowable promotional activities that will not result in a tied-house violation; these exceptions apply only to the tied-house prohibitions. True “pricing arrangements” are outside the scope of regulation under the trade practice provisions and this longstanding policy is articulated in Revenue Ruling 54-161 (on the TTB website) issued by the IRS.
For purposes of this article, the key take-away from that administrative ruling is the notion of “subterfuge.” The “pricing arrangement” defense does not apply if it is a subterfuge to otherwise violate one of the trade practice provisions. TTB has never defined or explained the standard or criteria used for determining some activity is a “subterfuge.” Unfortunately, the general position of the TTB Trade Investigations Division’s (TID) use of subterfuge appears to be any successful promotion program is a “subterfuge” because “I say it is. I am the administrator of the law with expertise, remember.”
Since leaving TTB in 2012, I have asked TID officials what is this standard and no one has yet explained it. I agree that it is an important concept and for that reason a clear articulation of the subterfuge standard is required by due process of law, if not principles of administrative law. Without a clear understanding of what is a “subterfuge,” innovation—a legitimate and essential goal in any industry in today’s global economy – is stifled. The concept of “subterfuge” dates to 1954, but even then, it was never defined by a standard or explained.
Catch-22 – a safe harbor under one regulation yields a violation under another regulation
Following the acceptance of the six offers in compromise from the Harrah’s “slotting fee” investigation in Las Vegas (and before the commencement of the current trade practice enforcement initiative), TTB issued an industry circular on participation in retailer sponsored activities. This industry circular uses the term “subterfuge” to describe a situation where conduct expressly authorized by one trade practice regulation is deemed by TTB as violating a separate trade practice regulation.
It does not matter that the outcome of the conduct is identical. That is, it is okay to provide something to a retailer that leads to certain conduct by the retailer but that very same and identical retailer conduct becomes a violation by subterfuge when TTB decides another regulation applies. Why is conduct allowed under one section of the law an automatic violation of another section of the same law?
A clear articulation of the subterfuge standard is required by due process of law, if not principles of administrative law. The reality that it is a difficult concept to define with standards is not an excuse under due process not to put others on notice on how they are expected to comply. Uncertainty here means that new and innovative business models will be avoided in order not to risk being charged by TTB with a subterfuge that results in a violation.
Let’s look at one set of example from the current trade practice enforcement initiative and evaluate it against the backdrop of legitimate 21st Century innovation. There are several other examples out there that involve equipment but the minimal information available from the public Abstract and Statements from the offers in compromise accepted during the past four years of the enforcement initiative makes it hard to assess the landscape. Hopefully a future blog article may address these.
Is TTB approach to Consignments Sales consistent with congressional intent or is it the "scorched earth" approach that Foremost and Fedway condemned?
Recently, a series of consignment sales alleged violations have resulted in several suspensions of basic permits. The facts below are drawn from the redacted versions of the stipulations appearing on the TTB website and the recent Booze Rules Blog article by John Hinman titled “TTB Consignment Sales Investigations – What is Behind the Curtain of the TTB Press Releases?”
Business models are a form of innovation. For example, consider the evolution of “credit cards.” In the 1950s department stores introduced “charge plates” that were soon evolved into “bank cards” issued by financial institutions. “Debit cards” followed next and today we are using “app cards on our mobile phones” as the credit card payment medium of choice. The TTB enforcement actions on alleged consignment sales is directly challenging innovative changes in sales transactions.
A little background on the consignment sales provision in the Federal Alcohol Administration Act, 27 USC 205(d). This provision applies to sales transactions between suppliers and distributors, distributors and retailers, and suppliers and retailers (to the extent these actually occur in the marketplace under State law). The provision flows up and down - - both the seller and the purchaser can be charged with a violation and the mere offer to sell or purchase on a consignment sale basis is a violation.
The legislative history of the consignment sales provision strikingly shows that Congress was concerned that a large and economically powerful buyer could use its purchasing power to compel a seller to it to sale on consignment or force the seller to take back products. It was designed to protect the business independence of each of the three tiers. This purpose follows the goal of the trade practice provisions as articulated in the Fedway decision; the court in that case did not need to address consignment sales because none were alleged as violations by the distributor in that investigation and proceeding.
The Ways and Means Committee of the House of Representatives explained the purpose of this provision:
It has been brought to the attention of the committee that certain large buyers are in such a strategic position with respect to sellers that they often have sufficient economic power to compel the sellers to deal with them on a consignment or return basis. Buyers less powerful are unable to exact such terms from the sellers.
TTB appears to have followed this notion of over domination by one tier over another tier in the consignment sales offers in compromise accepted in 2015 and 2016 from two major brewers for pushing the overstocking of season malt beverages on beer distributors. The suppliers were compelling distributors accept larger quantities of inventory than they wanted and implied the privilege of return. In this light, the enforcement of the consignment sales provision followed the legislative intent and purposes cited in Fedway.
The Small Winery “Consignment” cases- Innovations or Violations?
Based on the stipulated suspensions and Mr. Hinman’s article, these wineries appear to be very small operations with similarly small productions each year. Many of these are family run wineries and unlikely do they produce more than a few thousand cases of wine in any one year. Major distributors are not interested in these wineries. Without the wholesaler they are dealing with, these wineries would not have their products available outside of California. The sales and credit arrangements are mutually reached by both the seller and buyer.
This is not a situation where one tier is exacting a favorable economic position from the other tier because of the former’s economic power. There is no evidence available (at least publicly) that any of these parties (suppliers or distributors) were being dominated by the other tier extracting favorable conditions from them.
Additionally, and importantly, the small wineries were trying to work within the three-tier system. They want their wines available to retailers outside of California. Rather than fighting for direct shipments to these retailers, they are reaching a mutually beneficial arrangement with a distributor who can legally sell their wines to local retailers. The option of direct shipments to consumers probably did not work well for them because local retailers are better positioned to promote their wines to consumers.
Essentially, again, this is innovation in today’s marketplace. It represents parties working together to bring a wider market to small suppliers and still distribute their wines within the legal confines of the three-tier system while reaching a wider range of consumers with wider choices. It is a reasonable business model in today’s world. The policy harm identified by Congress is simply not present.
TTB may say it is just enforcing the law as written by Congress so if you do not like it, your quarrel is with Congress and not with TTB. Given the role of Executive Departments in executing the laws within a reasonable range of administrative discretion, this is not a fair response, nor one reflective of past administrative actions.
For example, the consignment sales provision in section 205(d) includes “conditional sales.” What exactly is a conditional sale? In 1935, Congress viewed a conditional sale as a chattel mortgage arrangement. Today the Uniform Commercial Code establishes “security interests” to meet this business purpose. In 1979, the proposed trade practice regulations defined a conditional sale as the holding of a security interest. The public comments were very adverse and argued these are legitimate financing arrangements. ATF retrenched and removed the language on security interests.
This is an example where the bureau adopted an interpretation that recognized the reality of the business world in 1980 as compared with the business world of the mid-1930s. It can do the same with consignment sales when looking at the original congressional purpose.
The Public Interest – Blind Enforcement or Studied Analysis?
“History is written by the victors.” The Washington, DC contemporary version of Sir Winston’s statement is “Something is a success if you declare it is a success.” Social media era may be upending some of that paradigm. Debates over the results of public policies may also upend it. Looking at it from a larger picture of public policy, the omnipresent question is always what exact public interest is being advanced by any program such as the TTB trade practice enforcement initiative.
Is the 1935 law as enforced by TTB advancing the right goals in today’s marketplace? Is it stifling what is clearly legitimate innovation such as new technologies that benefit consumers, retailers, and the environment? Is it stifling innovation in marketing arrangements and business models that are consistent with the social policy goals of the law in making sure small businesses can compete effectively with larger players? How far can TTB go in using new rulemaking to modernize the unfair trade practices to recognize the current marketplace realities given no initiatives are moving forward to amend the law itself? Do the courts need to intervene again to “re-write” or “re-right” the interpretations?
As a college junior in 1974, I took a course in the Graduate School of Public Policy at the University of California, Berkeley that taught you methodologies for developing and evaluating public policy programs and initiatives. To this day, I remember how fascinating that course was in looking at ultimate outcomes compared to original goals of a program. Reflecting back, when the final chapter is written on the current TTB trade practice initiative it may be equally as fascinating.
Have the Outcomes in the Current Cases furthered Public Policy?
So, what are the actual outcomes here of this public policy program trade practice enforcement initiative?
The TTB Press Releases, among other things, routinely talk about leveling the playing field to allow competition and ensuring consumers a wide selection of brand choices. When the scorecard is in (balanced or otherwise), what will the results be? So far, small to medium size enterprises, many family operations, are the entities with the offers in compromise and stipulated settlements. In the aggregate their share of the wine market is minuscule. One day suspensions on the Friday after Thanksgiving Day reflects a day they are likely closed anyway.
Are these the companies preventing a level playing field and restricting consumer choices? Do these companies reflect real market share players that threaten to undercut the competition in the huge United States marketplace for alcohol beverages? Yes, TTB can say it has ordered permit suspensions. But are these really the “movers and shakers” of the alcohol players in the United States marketplace?
Look at what actual business entities are standing behind the raw numbers of alleged violations. Success of a public policy is not determined by raw unexplained numbers; rather, it is determined by what change did make or accomplish in the marketplace. Transparency is the number one tool for keeping governments fair and accountable to the public they service and the industries they regulate.
What is next – will the Congressional Oversight Hearings and Governmental Accountability Office Review? The Beginning of the end, or the end of the Beginning?
The writer or writers of the final chapter are also unknown. This was a major program and high-profile initiative funded by Congress and tasked to TTB. Lots of trade media hype. Congress through oversight hearings, the Government Accountability Office (GAO) at the request of Congress to investigate programs, or the program review arm of the Office of the Treasury Inspector General are all appropriate, suitable, and skilled entities to conduct such a review.
Such reviews can be done individually, concurrently, or cumulatively. The recent budget justification for TTB released by the Treasury Department for fiscal year 2020 indicates that TTB plans to scale back its trade practice enforcement program to the previous enforcement levels with a remaining focus on some high-profile cases.
This would suggest that TTB is coming to the end of many investigations, so the time is ripe for the public policy review of the nature that excited me in college.
The industry suffering through investigations, the American public as both alcohol consumers and taxpayers funding this TTB program, the Congress authorizing the funding, and TTB itself in evaluating its “success” here, all deserve nothing less.
 One sits today in Tompkins Square in the East Village of New York City.
 The water fountain no longer works and within a one-minute walk of it there are four or five drinking establishments that do work.
 As a young attorney at ATF, I was tasked with writing a rebuttal in the form of a Letter to the Editor that, alas, was never mailed.
 Fedway Associates, Inc., et al. v. United States Treasury, Bureau of Alcohol, Tobacco and Firearms, Respondent, 976 F.2d 1416 (D.C. Cir. 1992).
 https://ttb.gov/rulings/54-161.htm In the 1979 to 1980 rulemaking, ATF proposed to issue regulations on the discounts and pricing position in this revenue ruling but pulled it from the final rule in light of the adverse decision in National Distributing Company v. U.S. Treasury Department by the Federal Court of Appeals for the District of Columbia on April 22, 1980. See, Notice No. 327, 44 Federal Register 45298 (August 1, 1979) and T.D. ATF-74, 45 Federal Register 63242 (September 23, 2980). This would have been an opportunity to provide more guidance on the “subterfuge” standard.
 The statutory element of exclusion is not included in section 205(d), unlike the other three trade practice subsection of the Federal Alcohol Administration Act. The absence of this element does not undercut the legislative history that Congress shared the same concerns about the ability of each tier to make independent business decisions without undue influence or threats to its independence by another tier.
 https://archive.org/details/legislativehisto00unit/page/8 at pages 64-65.
https://www.ttb.gov/rulings/2017-2.shtml Also, please note at the end of the TTB Ruling the reference to the “purpose was a mere subterfuge…”
 I left TTB in 2012, so I am not aware of the thinking behind these investigations by the Trade Investigations Division and the Office of Field Operations.
 For those of us who are long time alcohol law practitioners, this echoes the words of my respected professional colleague and good friend, California ABC General Counsel Matt Botting. Matt frequently retorts to questions at conferences with “I don’t make the laws. Go down the street and talk with the legislature if you don’t like the outcome.”
 Notice No. 327, 44 Federal Register 45298, 45304 (August 1, 1979).
 T.D-ATF No. 74, 45 Federal Register 63242, 63251 (September 23, 1980).
 I have done extensive research on the role of transparency in facilitating regulatory systems. It is the number one tool for fighting corruption. See, “The Fake Alcohol Situation in the United States” (Center for Alcohol Policy, Alexandria, Virginia) at https://www.centerforalcoholpolicy.org/wp-content/uploads/2015/04/The_Fake_Alcohol_Situation_in_the_United-States_compressed.pdf See also, Transparency International at https://www.transparency.org/cpi2018
 https://home.treasury.gov/system/files/266/13.-TTB-FY-2020-CJ.pdf see page TTB-5, reducing the positions (that is, full time equivalents (FTEs)) by 13 positions.