FDA E-Cig Regulations Will Benefit Big Tobacco

Due to the complexity of the FDA's rules governing e-cigs, big tobacco will benefit.

Jun 17, 2014 at 7:00AM

E-cigs, widely considered to be the "next big thing" in the world of big tobacco with sales eventually outpacing those of traditional cigarettes, are running into trouble. With big tobacco companies like Altria (NYSE:MO), Reynolds American (NYSE:RAI), and Lorillard (NYSE:LO) falling over themselves to get in on the action, regulators have started to take notice.

Powerful enemies
E-cigs have gained several powerful enemies, one of which is the FDA. The FDA and e-cigs are long-term enemies; the agency tried to ban them back in 2009 as unapproved "drug-device combination products." This move was blocked by the courts .

However, in April of this year, the FDA took a different view on the devices and branded them as "tobacco products." Essentially, this means that e-cigs cannot be sold to anyone under 18 and must list their ingredients on the side, similar to the rules placed on traditional cigarettes.

This is potentially a problem. All tobacco products are controlled by the Family Smoking Prevention and Tobacco Control Act, a law passed in 2009 that gave the FDA authority over tobacco products. The problem is that the cut-off date for this stature was Feb. 15, 2007; any products brought to market after this date may only gain FDA approval by demonstrating that their products are "substantially equivalent" to existing devices.

Now, an e-cig company has to prove that its product is "substantially equivalent" to existing products. There are no rules or criteria for this definition, but substantial evidence is required in order to apply and seek approval from the FDA.

What's more, according to insiders, of the 3,000 or so substantial equivalence applications the FDA has received since 2009, only around 25 have been approved; that's a success rate of 0.83%.

More power, influence, and experience
This is where the big tobacco companies will benefit and their smaller peers will go under. After all, big tobacco has experience of dealing with regulators.

Companies like Altria and Reynolds have been fighting the courts and regulators for decades now. Their regulatory compliance teams have the capacity to meet the FDA's demands.

That said, the FDA has not yet decided on how it will treat e-cigs. While it has warned the industry that they could be treated like tobacco products, it could be years before the FDA's true intentions become clear.

Companies can continue to sell their products before the FDA's rules come into force, and it is likely that the e-cig industry will be given a grace period of two years or so after regulation is introduced. Still, this adds plenty of uncertainty going forward; tobacco-like regulations are something that the smaller producers may not be able to survive.

Foolish summary
As the FDA moves to regulate e-cigs, smaller producers could find themselves running into trouble. The FDA's demands mean that extensive studies and documentation will have to be put together to prove that e-cigs are "substantially equivalent" to existing devices, and this may be too much for smaller producers to handle.

For the big players such as Altria, Reynolds, and Lorillard, this additional regulation should be easy to overcome. The FDA's regulations are likely to make it easier for the big boys to take over the market.

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Rupert Hargreaves owns shares of Altria Group. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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