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Tobacco May Be Partying Too Soon


Only a decade ago the tobacco industry seemed untouchable. It intimidated politicians, won every case filed against it, and wowed investors with awesome financial performance. Then a surge of lawsuits hit -- the so-called Third Wave of litigation -- that toppled Big Tobacco's defenses, ended cigarette makers' long history of mutual cooperation, subjected them to once-unthinkable levels of regulation, stalled their stocks, and sent reverberations throughout American politics and culture. It was one of the most important chapters in U.S. business history.

With the Florida Supreme Court's final dismissal on July 6 of the Engle class action, the last major Third Wave case threatening the industry, the tide appears to have subsided. Tobacco executives can barely hide their exhilaration. "The trends are incredibly favorable," said Martin L. Holton III, deputy general counsel for R.J. Reynolds Tobacco.

To a certain extent, he's right. It doesn't appear as if suits filed by individual smokers against cigarette makers will ever become big business for the plaintiffs' bar. Defendants are winning most of these cases, and the number of such claims is down from 5,047 in 2000 to 4,068 in 2006. The class-action picture is also brighter, in part because state and federal judges have been reluctant to bundle the health claims of people who may have smoked different products for varying lengths of time while enduring diverging maladies. The number of class actions on file against R.J. Reynolds, for instance, has fallen from 41 in 2000 to 21 today.

At the same time, tobacco companies have launched massive PR campaigns to boost their images. Journalists and politicians no longer get much of a reaction from the public by attacking cigarette makers. And share prices are starting to perk up. As recently as March, 2003, the average price-earnings ratio for companies in the Standard & Poor's 500-stock index was 30.18, nearly five times Altria's 6.51. Today the gap has gotten much smaller, with S&P 500 companies at 17 times estimated 2006 earnings to Altria's 14.04.

So the Marlboro Man should have plenty of reason to cheer. Altria, Reynolds American, Loews, and other major manufacturers appear to have a chance to reenter the community of respectable American businesses. Can they start acting like normal businesses that are free to make strategic moves, such as spin-offs, without triggering a barrage of lawsuits? Will analysts, journalists, and investors ever be able to discuss Big Tobacco without referring to litigation?

Well, not so fast. True, the Engle class action has been eliminated as a $145 billion threat, but the Florida high court's decision still allows individual lawsuits by customers alleging that they were harmed by cigarettes. That could cost hundreds of millions annually. The industry also faces a giant, if largely unheralded, potential class action before maverick federal judge Jack B. Weinstein, based on claims that companies misled consumers about the dangers of low-tar smokes. New cases are sprouting up across the globe, which could put a damper on profits in rapidly growing international markets.

And while Big Tobacco is starting to dig its way out of the hole, it's a deep one. The overall level of litigation is still high enough to alarm investors, who are unlikely to buy the industry's arguments that legal expenses should be treated as ordinary costs of business, like rent. That means a "litigation discount" in tobacco shares is likely to endure. It also suggests that Altria's plan to complete the spin-off of Kraft Foods Inc., which was supposed to be a sure thing if the Engle class action got dismissed, might be susceptible to challenge in the courts. Here's how things look on the key legal battlefronts:

"LIGHTS" CASES

The biggest remaining courtroom threat probably is a series of class actions in which smokers argue that they were deceived by false advertising into believing they were better off smoking low-tar "light" smokes than regular cigarettes when the companies allegedly knew they weren't. Big Tobacco has fended off most of these cases, but it faces a potentially huge challenge in the Brooklyn courtroom of Judge Weinstein, where plaintiffs are seeking damages of $120 billion. This is one of the few remaining cases where market-shaking, Engle-size, 12-figure damages awards are theoretically possible (if unlikely).

JUSTICE DEPT. LAWSUIT

The other courtroom drama that potentially could produce a big judgment stems from the Justice Dept.'s landmark case against the industry. In 1999 the agency sued to recover billions of taxpayer dollars spent by Medicare and other federal programs to care for sick smokers. Tobacco ducked the biggest legal threat in 2005 when Justice backed off its original demands that manufacturers cough up some $280 billion in allegedly ill-gotten gains. But cigarette makers could still be liable for $14 billion -- $10 billion over five years to help smokers quit and $4 billion over 10 years to finance a federal anti-smoking campaign. A verdict from U.S. District Court Judge Gladys Kessler is expected by late summer or fall.

SECONDHAND SMOKE

Lawsuits by nonsmokers got a big lift on June 27, when Surgeon General Dr. Richard H. Carmona released a 670-page study that found that any exposure to secondhand smoke is risky. Expect to see more cases based on such claims. Until now these lawsuits, which started surfacing in the late 1990s, haven't gained much traction. In 1997 the industry reached a deal in a Miami class action brought by nonsmoking flight attendants who had been exposed to secondhand smoke in airline cabins. Tobacco defendants paid $300 million to set up a research foundation to study the prevention and cure of tobacco-related illnesses. Flight attendants in the class were allowed to file individual suits but gave up the right to seek punitive damages. Nearly 500 claims have been dismissed since 2000; more than 2,600 remain. In 2002 a jury awarded $5.5 million in damages in tobacco's first losing secondhand-smoke case. A judge later reduced that amount to $500,000. Another case ended in a mistrial, and defendants have won six others.

GLOBAL

Even as the number of U.S. lawsuits shrinks, the industry is facing a menacing wave of litigation worldwide. In May, British Columbia's high court upheld class certification in a case alleging that Imperial Tobacco Canada deceptively labeled its cigarettes as "light" and "mild." Canada's provinces last year also got a green light to sue companies to recover the cost of caring for sick smokers. "They've taken the theories we've developed here and are using them in Canada," says Stephen A. Sheller, managing partner at Philadelphia law firm Sheller Ludwig & Badey. France, Israel, Spain, and other nations also are suing to recoup health costs.

Law enforcement agencies in some countries, including Canada and Colombia, are claiming tobacco companies engaged in cigarette smuggling and money laundering. Those governments hope to recover tax revenue lost as a result of smuggling. That's in addition to product-liability cases being filed by thousands of smokers in at least 35 countries, notably Argentina, Brazil, Canada, and Italy. Nonprofit groups also are using the courts to push for policy changes. They've succeeded in India and Uganda, which have imposed strict smoking bans and limitations on cigarette advertising. "I think you'll see more creative use of litigation to change government policy," says Heather Selin, an adviser for the Pan American Health Organization.

Add it all up, and it's clear that Big Tobacco's troubles are far from over. The industry is no longer a favorite punching bag. But litigation is going to be a huge worry long after the Third Wave recedes.

By Lorraine Woellert, with Jane Sasseen in New York and Nanette Byrnes in Chapel Hill, N.C.


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