Big Tobacco: Back in Legal Limbo

A massive new class action lawsuit against the industry may not hold up on appeal, but investors are still worrying

The last few months have seen a string of favorable legal developments for the tobacco industry. In July, the Florida Supreme Court threw out the long-running Engle class-action case, eliminating the threat of a $145 billion damage award handed down in the case years earlier. And in August, U.S. District Judge Gladys Kessler sent tobacco stocks through the roof in a case brought by the Justice Dept. Kessler declined to levy any financial penalties on the industry, despite finding it guilty of racketeering. After years in which an unprecedented wave of litigation had threatened to bankrupt the industry, the tide seemed to have turned decisively in Big Tobacco's favor.

Yet it seems every time the industry appears to be out of the woods, a new legal threat arises to scare investors off once again. And that pattern proved true again on Sept. 25, when U.S. District Judge Jack Weinstein allowed a massive new class-action case against Philip Morris USA, R.J. Reynolds Tobacco, and other tobacco companies to move forward.


  The suit alleges that the industry misled smokers of so-called "light" cigarettes for decades by fraudulently marketing lights as healthier than regular smokes, when manufacturers knew they weren't. "This is a tremendous victory in the attempt to hold the industry accountable for its misbehavior," says Richard Daynard, a law professor at Northeastern University and the head of the Tobacco Products Liability Project. "The threat of potentially enormous damages is back."

Just how big is that threat? Plaintiffs' attorneys are seeking damages that could run up to $200 billion, the largest potential liability the industry has faced since the Justice Dept. asked for $280 billion in its 1999 suit. The new suit—called the Schwab case, after the lead plaintiff—potentially covers tens of millions of people who bought lights, going back as far as 1971.

"There was a fraud," says lead plaintiffs' lawyer Michael Hausfeld, of Cohen, Milstein, Hausfeld & Toll, based in Washington, D.C. "Clearly the public relied on that fraud and believed it was buying a safer alternative."


  That's not all. William Ohlemeyer, Associate General Counsel of Philip Morris parent Altria Group (MO) acknowledges that by muddying the legal environment, the decision will delay the planned spin-off of its Kraft Foods (KFT) unit. The Sept. 25 decision "is not a step towards clarity; it's a step backwards of sorts," he says. Inevitably, that "delays any restructuring."

The sudden jolt of uncertainty spooked investors. Altria shares lost $5.21 on the day, to close at $77.11. Shares in Reynolds American (RAI), the parent of R.J. Reynolds, fell $2.27, to $59.75.

Still, the decision wasn't much of a surprise. Weinstein, a maverick 84-year old judge who has championed class actions in controversial cases ranging from Agent Orange to asbestos, has long been known for aggressively backing mass suits, even as much of the rest of the judiciary has tried to rein them in. While critics complain that Weinstein often pushes the law too far, he has argued that large class actions are the most efficient way to press manufacturers to provide remedies when large numbers of people have been hurt.


  "For the industry, this is a nightmare realized," says Jonathan Turley, a professor at George Washington University Law School. Far more than most judges, "Judge Weinstein is someone who thinks in broad terms, and is more likely to entertain sweeping remedies if finds merit to a complaint."

Of course, that assumes that Judge Weinstein's ruling stands up on appeal, which is far from certain. Judge Weinstein has set a trial date of Jan. 22, but Philip Morris and R.J. Reynolds say they will immediately appeal. "I believe this is a temporary setback, and not much of one at that," says lead defense lawyer Theodore Grossman of lawfirm Jones Day. "No judgement based on the certification of this class will stand up on appeal."

The tobacco companies argue that no class exists. The particular reasons why any individual smoker chose lights, how they viewed the marketing, or what they knew about the health impact of smoking lights vs. regular cigarettes would far outweigh any commonalities they shared. They will now turn to the more conservative Second Circuit Court of Appeals in New York City to overturn the class certification, and will ask for the trial to be postponed until a decision is reached.


  That court has overturned numerous class action rulings by Judge Weinstein in the past—including several involving previous tobacco class actions. Many investors and analysts are counting on that to happen again. "It would be extraordinary if this case went forward," says Thomas Russo, who holds several million shares of Altria in the $3 billion portfolio he manages for investment firm Gardner, Russo & Gardner. "This judge has had several bites at the tobacco apple in the past, and none have withstood appeal."

Given the stakes, the case promises another long, drawn-out litigation battle if it does move forward. While Draynard says the prospect of such enormous damages once again raises the possibility that Philip Morris or others could face bankruptcy if a verdict went against them, most observers think any damages would be whittled down to a much smaller number. "The worst threats have dissipated," says George Washington University's Turley. "What remains is a largely manageable level of litigation and damages."

Yet even if the Second Circuit throws out the class certification, the plaintiffs' lawyers vow they will keep on fighting. "We're prepared to try these cases individually," says Hausfeld. One way or the other, he says, "we'll stick with the January trial date." With tens of thousands of potential plaintiffs, this could be a long process, indeed.

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