Cigarette Companies Escape Major Financial Penalty in Suit

18 Aug 2006 // A federal judge overseeing the government's landmark lawsuit against the tobacco industry ruled that the cigarette companies violated racketeering laws by deceiving the public about the dangers of tobacco but said she didn't have the authority to order major financial remedies.

The 1,653-page ruling, which followed a nine-month trial that ended more than a year ago, is a mixed one for the tobacco industry. For most companies, a finding from a federal judge that they were racketeers would be a stinging blow. But cigarette companies have seen their image tarnished for years, and their efforts to hide the risks of smoking are well known.

As a result, the lawsuit's impact depended in part on whether U.S. District Judge Gladys Kessler would levy a significant penalty as punishment. The government had at one point requested a penalty of as much as $280 billion, though during the trial it scaled the request back to roughly $14 billion for smoking-cessation programs and antismoking advertising.

But Judge Kessler's reluctance to impose any penalty, which stems in part from an earlier appeals-court ruling mandating that remedies must be forward-looking, is a major reprieve for the industry. "I think that the government came out short," says Jonathan Turley, professor at George Washington University Law School. "The judge essentially told the government lawyers the industry is every bit as bad as you say it is, but my hands are tied in what remedies I can award in response."

The outcome did illustrate the major change in the litigation landscape for cigarette makers, which just a few years ago were dealing with concerns about their viability. Last month, cigarette makers scored a major legal triumph as the Florida Supreme Court upheld a lower-court decision tossing out a $145 billion class-action award against tobacco companies, saying the award -- the largest punitive-damages award ever -- was "excessive as a matter of law." That decision alone could chill plaintiff lawyers' attempts to bring the industry to its knees through class actions.

In her decision, in the District of Columbia, Judge Kessler did order the major cigarette companies to abandon terms such as "light" or "low tar" and to admit they lied about the harmful effects of smoking cigarettes and to warn consumers in advertisements and packaging that tobacco is addictive. The order requires the tobacco companies to take out full-page newspaper ads in the weekend editions of about 35 major U.S. papers. However, she elected not to include industry-funded smoking-cessation and -education programs that would have cost billions.

The decision paves the way for Altria Group Inc., parent to Philip Morris USA, to spin off its 88.1% stake in Kraft Foods Inc. Investors have been clamoring for such a transaction, arguing it would help unlock additional value. The company has a board meeting Aug. 30, and a decision could come as soon as then.

"Altria's board has this window now where there are no major class actions that would prevent them from doing [a restructuring], and the intention is to do it right away," says David Dreman of Dreman Value Management LLC, which recently owned 16.2 million Altria shares "This encourages them to keep moving and to break the company into two or three parts."

Tobacco stocks, which have been on a tear thanks in part to the industry's winning streak against private lawsuits, gained in after-hours trading. Altria, whose shares have risen 70% in the past two years, rose 3.2% to $83.30; and Reynolds American Inc. rose 2.2% to $65.49.

"It's not the recovery for the federal treasury that the Clinton administration hoped for, but the wide-ranging relief she awarded vindicates the government's effort," says Paul M. Honigberg, a partner at Blank Rome LLP and a former member of the Justice Department's tobacco-litigation team.

The ruling accepted the government arguments about nicotine manipulation and the harmful effects of second-hand smoke, Mr. Honigberg added. "I would say that Judge Kessler was convinced that the government proved its case and that she awarded all the relief that she could consistent" with an earlier decision by the appellate court limiting the available remedies in the case.

Melanie Sloan, executive director of the Citizens for Responsibility and Ethics in Washington, said the value of yesterday's ruling might come in private litigation with individuals using it as ammunition in their cases. "This is an opinion that could have precedential value in future cases," she said. "But when you come down to flat-out dollars, it's not the worst thing that could happen to the companies."

However, Mr. Turley, the law professor, said that because the case was a huge investment by the government that didn't pay off, plaintiff lawyers may no longer view tobacco companies as particularly attractive targets. One exception could be the growing number of class-action cases alleging fraudulent marketing of "light" cigarettes. "That will remain a long term liability though it is finite because the industry has changed a lot of the marketing approaches that led to these claims," Mr. Turley said.

"We are gratified that the court did not award the unjustified and extraordinarily expensive monetary penalties sought by the government," said Mark Smith, a spokesman for Reynolds American, the Winston-Salem, N.C., maker of Kool and Camel cigarettes. "We are disappointed that she found for the plaintiffs on the underlying claim and ordered some injunctive relief. We are going to analyze the lengthy ruling and decide our next course of action," Mr. Smith said.

Altria said it will appeal the ruling. "Philip Morris USA and Altria Group Inc. believe much of today's decision and order are not supported by the law or the evidence presented at trial, and appear to be constitutionally impermissible or infringe on Congress' sole right to provide for the regulation of tobacco products," William Ohlemeyer, an Altria vice president, said in a statement.

The lawsuit began in 1999 when Justice Department lawyers alleged under civil racketeering laws that cigarette makers engaged in a five-decade scheme to defraud the public on the dangers of smoking, and originally sought $280 billion in disgorgement to prevent future fraud.

The suit was in trouble almost from the beginning, struggling for funding. In 2000, then-Attorney General Janet Reno had to transfer funds from other Justice Department accounts to fund the cost of the lawsuit after Congress appropriated practically none of the $20 million she had requested for the litigation that year.

The tobacco industry later won a major component of the case when a panel of the District of Columbia Circuit Court of Appeals limited the government's ability to collect up to $280 billion in financial remedies from the industry.

In a statement, the Justice Department said it was "pleased with the Court's finding of liability on the part of the defendants, but disappointed that the Court did not impose all of the remedies sought by the government. Nevertheless, we are hopeful that the remedies that were imposed by the Court can have a significant, positive impact on the health of the American public."