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A criminal investigation on illegal drug shipments against two of the biggest global logistics companies – FedEx Corporation (FDX - Analyst Report) and United Parcel Service, Inc. (UPS - Analyst Report) – is what the market least expected from an industry, especially when the market is already dwindling with  poor demand trends.

The biggest players in the parcel industry are now under the scrutiny of federal grand jury for dealing in shipments of illegally operated online pharmacies. Both the companies have already mentioned this legal probe in their regulatory filings and expect the case to be reconsidered. 

However, there is hardly any near-term visibility in the dismissal of such litigation as recent investigations project difficult times ahead for both FedEx & UPS. According to reports, the case dates back to 2005, when an investigation done by the U.S. Drug Enforcement Administration (DEA) exposed approximately 4600 online pharmacies that were operated illegally.

The disclosure was followed by an immediate shutdown of these online stores and several arrests were made that resulted in further investigations proving involvement of shipping companies. According to news, recent arrests pertaining to the case have revealed involvement of FedEx and UPS in delivering drugs without proper prescriptions. However, the companies have been in denial regarding such revelations.

In July 2006, UPS and FedEx both served subpoena from grand jury as a part of the investigation by the Antitrust Division of the U.S. Department of Justice. The subpoena required them to furnish records that could provide an insight into possible antitrust violations in transportation of packages for online pharmacies.

Although this legal battle has been going on for many years, it did not draw much attention. Even now, the market seems to be less responsive with no significant changes in the stock prices of FedEx and UPS.

Regulatory issues have not been new to the parcel industry. Companies like UPS and Expeditors International of Washington Inc. (EXPD - Analyst Report) have been in the news earlier this year for price fixation. In March 2012, the European Union (EU) commission’s antitrust regulators have charged $225 million as fine to 14 international freight forwarding companies for perusing price fixing activities for freight transactions in Europe.

According to investigation under the EU commission antitrust department, these logistics companies were involved in four cartel activities, fixing air freight prices between 2002 and 2007. Cartel activities that are undertaken through the collusion of various groups of people or companies involve fixing of any underlying factor that influences market behavior, such as price or production, in order to reduce competition and derive maximum benefit from consumers.

Coming back to the news, how far these shipping companies can be held responsible for verifying prescription before delivering medical products is yet to be proven. As a matter of fact, do these shipping companies really have a contractual binding beyond delivering goods to the user end in desired condition? Was there any rule set in the preview of federal laws that establish regulatory bindings for shipping different products or something as cautionary as drugs?

Further, nothing much has been revealed in the investigation regarding the nature of the drugs shipped i.e., whether these were merely over the counter drugs or involved prescription drugs. In addition, it is also not transparent that these shipping companies actually verified records on legality of such online pharmacies with which they held business transactions.  

All these questions still remain unanswered but in the coming days we expect more visibility in this legal action.

We assume the legal proceeding may not have a material adverse impact given the mammoth financial strength of these companies. However, the rising number of litigations does call over a closer look into the existing regulations that continue to govern the freight forwarding companies.

The emergence of e-commerce does not only require advancement of technology but also calls for a revival of age old laws that continue to govern modern day businesses. As for the parcel industry, will there be any change in the regulatory environment yet to be discovered. Even if the change does take place, the benefits it would have for carriers as well as consumers would be something to watch out for.

We have a long-term Neutral recommendation on UPS and FedEx. The stocks retain a Zacks #3 Rank, implying a short-term (1-3 months) Hold rating.

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