DIRECTSHIPPING. Is it Dangerous for Your Business Health? By Perry Luntz

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Gordon Hicks
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1 DIRECTSHIPPING Is it Dangerous for Your Business Health? By Perry Luntz

2 There s a giant fuss hitting industry and consumer press over the use of the Internet and direct mail to ship wines into individual states for delivery to consumers. In many direct shipment cases, decisions have been rendered in Federal courts. Others are still being decided. Meanwhile, both sides are advertising and campaigning like mad, and have even hired celebrity constitutional attorneys to represent them in court. Does the Current System Work? Ever since the Repeal of the 18th Amendment, which ended Prohibition, the highly regulated, licensed and controlled system of beverage alcohol distribution has been debated. At a recent non-industry sponsored debate dealing with direct shipment, former White House Counsel, C. Boyden Gray, said that alcohol is not an ordinary product: Alcohol is different. Alcohol has a very, very troubled history in this country. However, almost from the beginning many have said that state laws governing the sale and distribution of beverage alcohol were in opposition to the Constitution s Commerce Clause, which gives control over interstate shipping to the Federal government. However, in a 1984 case, the U.S. Supreme Court held that the states enjoy broad power under section two of the 21 st Amendment. Prior Supreme Court decisions confirm that the Amendment created an exception to the normal functions of the Commerce Clause, since [the Amendment] reserves to the States: power to impose burdens on interstate commerce in intoxicating liquor that, absent the Amendment, would clearly be invalid under the Commerce Clause. Why the current controversy? Consolidations within the tiers and the great increase of brands in recent years forced distributors to be more discriminating in accepting brands to represent. At the same time, as rents and other business costs increase, retailers began feeling a space crunch and they too became more selective in items they stocked. Jeremy Benson, executive director, Free the Grapes!, a grassroots coalition of consumers and wineries lobbying for direct shipping, articulates these producers frustrations. There are now 3,000 wineries in the U.S., up from 370 in the early 1960s, and at least one in every state. But the number of wholesalers has shrunk during this same time frame. Of the Wine Institute s 660 winery members, they claim only 17 percent have national distribution and over half of them have not been able to find a wholesaler in a market willing to represent them. So while the total number of wineries has increased, Benson continues, and consumer demand for those wines has increased, the consumer s ability to purchase and enjoy those wines is severely curtailed or If small wineries want to distribute their wines to a larger audience, they should band together and distribute them through wholesalers as large wineries do. Robert Bork eliminated in those states that prohibit interstate shipments and/or by wholesalers unwilling to represent these wines. Many of the producers unable to gain distribution in key markets, started selling through clubs by mail, and then on the Internet. The laws in many states either banned such sales, some going to the extent of making direct shipment to consumers a felony. Other states made compromises, which some producers found were too costly to meet. A group of mostly small California winemakers formed coalitions to combat what they called monopolistic practices by states, which were brought on by a powerful distributor lobby. They turned to the courts for relief. Where do we stand now? This wine war, as the NY Times dubbed it, escalated when a group of states hired Robert Bork, also a former Federal judge, the U.S. Solicitor and a Supreme Court nominee to serve as their counsel. Local lights such as Randy Mastro, former Deputy Mayor of New York City, joined as attorney for various distributors. Then, this past year, to make certain that their message caught the public eye, proponents of direct shipping hired former Federal judge and Special U.S. Prosecutor Kenneth Starr. As the map below shows, things are just as confusing as they were before national Prohibition and it s apparent to some that decisions must be made. While no court has ruled that a ban on direct shipping is unconstitutional, some

3 states, like North Carolina have found that it is unconstitutional when there is a concurrent allowance for in-state wineries to ship. However, almost all cases confirm the validity of the three-tier system and the propriety of banning altogether. Clearly a U.S. Supreme Court decision will be required, and the state of Texas, having lost one suit, has already announced plans to bring the issue to Washington. It may take a year or two, but experts are convinced that the matter will ultimately have to be settled by the Supreme Court. Arguments for Direct Shipment At the recent Washington D.C. nonindustry sponsored debate, Starr dismissed arguments claiming sales over the Internet would make it easier for teenagers to purchase beverage alcohol. He argued that the real reasons for banning direct shipments are to protect instate wineries and the powerful distributor lobby. Those in favor of direct shipping cite a recent FTC report issued July 3, 2003 which concludes that states that allow direct shipping have procedural safeguards against shipments to minors and report few or no problems with these shipments. The FTC report further concludes that many states hold the view that minors are more likely to buy alcohol from local retailers than the Internet because of the high cost of shipping and the fact that minors would have to wait days before learning if a delivery would be made. The FTC found no evidence suggesting that direct shipping increases underage drinking beyond the levels attributable to sales by brick-and-mortar stores. Starr dismissed arguments claiming sales over the Internet would make it easier for teenagers to purchase beverage alcohol. Starr s interpretation of the 21 st Amendment is that it was passed to appease states that wanted to stay free of beverage alcohol with the Repeal of Prohibition, and that bans against direct shipment violate the Commerce Clause. Advocates of direct shipment also argue that consumers deserve to have the ability to get the wines they want directly at home and that the elimination of middlemen would lower the prices consumers would have to pay. A quick reference to your local situation, for more detail, see the Wine Institute website. Direct Shipment Laws by State for Wineries ( As of October 2003 ) Courtesy of the Wine Institute Copyright 2003 Wine Institute. All rights reserved. Reciprocity state (direct shipping permitted between other states which allow it.) Attorneys general interpretation or regulatory allowance of limited shipments Special order states (via three-tier system) Limited direct shipping & permit states Felony for non-basic permit holders to direct ship Direct shipments via common carrier prohibited Felony for wineries or retailers to direct ship

upper left: Kenneth W. Starr, Former Special Prosecutor upper right: Judge Robert H. Bork, Former Solicitor General lower left: Clint Bolick, VP, Institute for Justice lower right: C.

, defends the three-tier system. Enforcement works best when there is a face-to-face transaction. The argument that kids get alcohol anyway is a bad argument.

Randy Mastro, speaking on behalf of a major distributor pointed out; Opponents don t want equal treatment, they want to gain an advantage by being able to distribute at a lower price with greater

4 upper left: Kenneth W. Starr, Former Special Prosecutor upper right: Judge Robert H. Bork, Former Solicitor General lower left: Clint Bolick, VP, Institute for Justice lower right: C. Boyden Gray, Former White House Counsel Arguments Opposed to Direct Shipping J. Smoke Wallin, chairman of WSWA (Wine & Spirits Wholsalers of America) and VP of National Wine & Spirits, Inc., defends the three-tier system. Enforcement works best when there is a face-to-face transaction. The argument that kids get alcohol anyway is a bad argument. In a New York Appellate Division hearing, plaintiffs were reminded that New York State permits a winery obtaining a license to sell only within the state, provided it meets the requirements other distributors must meet. If small wineries want to distribute their wines to a larger audience, they should band together and distribute them through wholesalers as large wineries do, believes Robert Bork. Randy Mastro, speaking on behalf of a major distributor pointed out; Opponents don t want equal treatment, they want to gain an advantage by being able to distribute at a lower price with greater earnings to themselves by paying taxes on the honor system rather than through present tax collection methods. Mark Doll, incoming NBWA (National Beer Wholesalers of America) Chairman said of de-regulation of the three-tier system: The threat to the rights of states to regulate licensed beverage is a critical one for our industry and one that NBWA is addressing head on. Harry Wiles, president of the American Beverage Licensees, cut directly to the heart of the issue: The Constitution says that the states have the right to determine how and where beverage alcohol is sold. Our belief is that if people want to sell at retail they should have a state-issued license to do so in the state. As for the FTC report issued in July, proponents against direct shipping argue that none of the states responding to the FTC survey had done any sting or compliance check online. They also noted that certain testimony was ignored from the state of Michigan, which netted scores of wineries and retailers shipping illegally. Regarding the subject of availability in the marketplace, the September issue of Beverage Media, a trade publication for licensees in the New York Metro area, listed just under 20,000 distinct wine brands in their wholesaler brand and price index, hardly a lack of availability. While few retailers, if any, could carry that many products in their store, virtually all retailers will consider a special order to complete a sale. Consumers Have the Last Word Juanita Duggan, CEO of WSWA, wonders about the argument that there s not enough choice for consumers, asking, Who is really pushing the direct shipping agenda and why are they putting their profits ahead of protecting children? She answers: The only people who are pushing to dismantle our current alcohol safeguards are a vocal minority of wealthy elites and greedy Internet retailers, not the American people. WSWA commissioned the renowned Wirthlin Worldwide research organization to discover what consumers felt about direct shipping. The pollsters asked whether the respondents would favor or oppose allowing beer, wine or liquor to be sold to consumers over the Internet or by direct mail. The results: 77 percent oppose direct shipping. 90 percent of parents with teenage children think Internet sales are a bad idea. 80 percent of respondents believe that Internet commerce is generally a good thing for businesses and consumers, but consider alcohol a socially sensitive product that should be treated differently from others. 63 percent believe that the sale of beverage alcohol over the Internet will result in less control over alcohol sales in their communities. 85 percent of those who drink indicate they are satisfied with the selection of beer, wine and liquor available locally. Ask yourself, What would the advantage of direct shipping be to me as a retailer? Or, to put it another way, How much damage would direct shipping cause me? According to NY State, which allows intrastate wineries to ship directly, only a fraction of their annual outlet is sold that way. Most of it is either sold through their licensed tasting rooms or the normal distribution channels. The recent National Academy of Science

A decision in favor of proponents of direct shipping could soon encompass beer and spirits leaving producers open to a lot of liability litigation, justified or not.

5 study found that 10 percent of teenagers who purchased alcohol got it from the Internet. As for suppliers, they must consider that while the category under discussion right now is wine, all beverage alcohol could be affected. A decision in favor of proponents of direct shipping could soon encompass beer and spirits leaving producers open to a lot of liability litigation, justified or not. The industry led the way in accepting warning labels; the tobacco industry followed and it did them no good because their far more damaging product had no regulatory safeguards protecting minors and those who abuse the product. Many industry veterans believe the best way to accommodate the needs of smaller wineries is for them to accept compromises that almost every state already offers (such as obtaining a state The only people who are pushing to dismantle our current alcohol safeguards are a vocal minority of wealthy elites and greedy Internet retailers, not the American people. Juanita Duggan, CEO of WSWA license to distribute). Beverage Media chairman, William Slone offered this conclusion. Court mandated acceptance of direct shipping under the Commerce Clause could set a precedent by saying that greater access to beverage alcohol takes priority over the orderly control of distribution (as mandated by the 21st Amendment). This could, in turn, open the door to a serious eroding of the basic social controls that have been the foundation of our industry for over 70 years. An equitable resolution of this issue should be the concern of every level of the industry. For more information on both sides of this issue, go to: Wine & Spirits Wholesalers of America The Wine Institute Pharmacy Roulette & Direct Shipping What has the controversy about bringing lower-cost prescription pharmaceuticals into the U.S. from Canada got to do with the controversy about direct shipment of beer, wine and spirits to consumers? A lot. Take a quick look at how pharmaceuticals are sold in the U.S. They are produced under strict quality controls in federally registered and inspected plants, then sold to a regional distributor who breaks the shipment into smaller lots for local distributors to handle. Finally, they are sold to licensed, regulated pharmacies where certain items are registered when sold and sales are audited. A Washington Post investigative team spent nearly a year discovering what was right and what was wrong with Internet sales of prescription drugs to consumers. The five articles that resulted could serve as an object lesson for the beverage alcohol industry. They showed that Internet sales led to minors buying addictive and deadly medications such as Vicodan and OxyContin. But that wasn t all. The reporters found that "illegal trade in pharmaceuticals has undercut the safety of the United States system of distributing prescription drugs. It does that by selling The Internet has created networks of middlemen who are felons and other opportunists operating out of storefronts and garages. medication with no control by retailers over their legality and appropriateness for use. According to the Post, the Internet has created networks of middlemen who are felons and "other opportunists operating out of storefronts and garages. Overwhelmed inspectors check less than 1 percent of the estimated 2 million packages of medicines shipped into the country each year. To say nothing of rogue purveyors who establish Internet pharmacies to serve as pipelines for drug abusers and others who never see doctors or undergo tests. The Post believes these domestic merchants move tens of millions of doses of these legal pharmaceuticals creating a form of pharmaceutical roulette. Although high profile law suits have been brought against some of these illegal peddlers, these widely reported incidents are seen as part of a growing pattern of tainted medicines, overdoses on Internet bought drugs, and illegal cross-border pharmaceutical sales. Pricing is the major objection to buying medications from the neighborhood pharmacist, but there are compromises now being suggested by state officials to get the FDA to change some of regulations and permit importation of lower priced versions of approved pharmaceuticals from countries that safeguard their production and ship them in original sealed packages. The compromises also would apply specific restrictions on sale of certain items and sales to minors that include the necessity of obtaining the medicines through registered licensed retailers. The problems involved with Internet shipping as reported by the Post are obviously more serious to society than any that would arise with Internet shipping of beverage alcohol. But their findings could serve as a note of caution for those who advocate destroying the three-tier system in favor of an "everyone can play" system with limited regulation.

UNITED STATES DISTRICT COURT DISTRICT OF MASSACHUSETTS

UNITED STATES DISTRICT COURT DISTRICT OF MASSACHUSETTS STONINGTON VINEYARDS, INC. et al. Plaintiffs, CIVIL ACTION vs. No. 1:05cv-10982-JLT EDDIE J. JENKINS, et al. Defendants PLAINTIFFS MEMORANDUM IN SUPPORT