A New York Federal Judge Certifies a Nationwide RICO Class Action Against Big Tobacco: An Aggressive Decision that Pushed Legal Limits

On Monday, September 25, Big Tobacco got a rude reminder that its legal woes are not over yet. In Schwab v. Philip Morris, Federal Judge Jack Weinstein of the Eastern District of New York certified a nationwide class action against the tobacco industry, involving the sale of "light" or low tar cigarettes.

The decision, to put it mildly, has made it clear that the plaintiffs' bar still poses a threat to the industry.

A Tale of Two RICO Suits: A Big Win, and Now a Big Loss, For Big Tobacco

Just last month, the tobacco industry was celebrating an odd sort of victory, as I noted in a prior column: While a federal judge in Washington D.C. had found that the industry had violated the federal racketeering law known as RICO, she had also held that she was legally barred from imposing a remedy involving a significant amount of money.

The industry viewed this as a victory, since the injunctive relief the judge ordered posed relatively few threats to their ability to advertise, or to their bottom lines.

The suit in Judge Weinstein's courtroom is also brought under RICO, but, unlike the suit in D.C., the suit is being run by some of the best class action attorneys in America, not the Department of Justice. Moreover, since the suit has been brought in the name of all smokers who purchased "light" cigarettes since the 1970's, and not in the name of the U.S. Government, there is no legal restriction on the type of remedy that Judge Weinstein could award.

Indeed, the plaintiffs have estimated that the class-wide damages could be in the hundreds of billions of dollars (which, under RICO, would be trebled).

The Theory of the "Light"/ "Low Tar" Lawsuit, and Why It's Unprecedented

The theory of the lawsuit is simple: The lawyers for the class allege that "light" cigarettes offer no health benefits over "regular" cigarettes, and that the defendants knew as much when they developed, marketed and sold "light" cigarettes.

According to the suit, the tobacco industry knew that smokers would smoke cigarettes very differently than the way the FTC's testing machines "smoked" them, and that, therefore, virtually all smokers who bought light cigarettes were not getting what they paid for--a way to avoid some of the health hazards of smoking.

There have been a number of "lights" suits brought in various states under consumer fraud law, but nothing quite like this suit. It is a nationwide class action in the hands of federal judge who is reputed to be quite liberal, quite brilliant, and quite unlikely to shy away from taking controversial legal positions.

Why the Class Action Decision Was Crucial

As noted above, it was on Monday that Judge Weinstein decided whether the case could go forward as a class action. This was perhaps the most important issue facing the parties.

A number of courts, including the federal court in D.C., have already concluded that the tobacco industry committed fraud when it marketed "light" cigarettes. The problem with this legal conclusion, however, is that it is practically worthless absent a class action.

Why? Because RICO allows private citizens to sue if they suffered an economic injury. Not many persons smoked enough "light" cigarettes over a lifetime to make it worthwhile for them to sue, individually, for their personal pecuniary injury caused by the alleged fraud, even if the damages they suffered were trebled under RICO.

In contrast, the total pecuniary loss of all the "lights" smokers in America, taken together, can cover the cost of the lawyers, experts, and still leave a lot of money left to compensate the members of the plaintiff class.

Judge Weinstein's Prior Impatience with the Plaintiffs' Lawyers

Judge Weinstein's decision to certify the class was not a sure thing. After all, for the past twelve months, he has shown impatience with the plaintiffs' lawyers who have invested heavily in the case.

Judge Weinstein held off on ruling on the question of class certification until the plaintiffs' side was able to refine a number of their arguments, and to improve the quality of their expert reports. And at an all-day hearing on September 13, Judge Weinstein still seemed dissatisfied with the argument by Michael Hausfeld, the lead plaintiffs' lawyer.

Nevertheless, it seems that Weinstein is content to let the case go forward for now, and to let the Second Circuit clean up the mess on an interlocutory appeal. (Typically, appeals in federal court occur only at the end of the case, but occasionally an interlocutory appeal - that is, one in the midst of the case - will be accepted.)

The Argument for Certification: No Right Without a Remedy

The argument for certification is quite simple: Absent a class action, no one will hold Big Tobacco accountable for its fraud. This is why Judge Weinstein makes clear at the beginning of his massive opinion that in American law, there is "no right without a remedy."

Unfortunately, however, while it sounds nice to say that, it is simply not always true. Unless the various requirements of the Federal Rules of Civil Procedure for class actions (and of a number of legal doctrines relating to remedies) can be satisfied, a case cannot go forward -- even if that means a valid legal claim is left unsatisfied.

The law, then, sometimes prefers formality over justice. Judge Weinstein, however, plainly does not. Indeed, he really pushed the limits of legal formality in certifying the nationwide lights class action - with respect to three key issues, which I will consider in turn.

The First Issues: Damages Calculation

First, it is not clear that the plaintiffs have adequately shown the court how they would calculate damage if they win the suit. The problem with suing Big Tobacco and alleging fraud in the case of "lights" cigarettes is that, while Big Tobacco may have lied about the healthfulness of "lights," they didn't charge any more money for them than they did for regular cigarettes.

Thus, one could argue that had smokers never been offered the illusory hope of a "safer" pack of cigarettes, they would have just spent the same amount of money on a regular pack of cigarettes. (One could also argue, however, that for some, the allure of the "lights" option convinced them not to quit, based on a "Have one's cake and eat it too" mentality. Consider, for instance, the analogy to people who might drink tap water, instead of buying soda, except for their belief that soda labeled "diet" is calorie-free just as water is.)

The plaintiffs point out that in RICO, the measure of damages is not the "out of pocket" loss suffered by the victim of the fraud, but the "benefit of the bargain" they were promised and never received. They say it's simple: Plaintiffs were promised "light" cigarettes, and didn't get them.

But how does one measure the value of a product that does not, and maybe could never exist? Understandably, Judge Weinstein has expressed some skepticism about how the plaintiffs' experts who will prove the value of the illusory "safer cigarette" that was promised to smokers. Still, he is allowing the trial to go forward on the theory that the jury is in the best position to decide whether the plaintiff can prove damages.

The Second Issue: Damages Distribution

Second, there is a very difficult problem of what to do with the damages even if they can be calculated.

In most class actions, the plaintiffs have to come up with a plan of how to distribute the damages to the class members if the class action is successful. The plaintiffs in the Big Tobacco RICO action before Judge Weinstein, however, have not proposed any method of damages distribution -- since they freely admit that it may be impossible to determine who among the class members bought how many cigarettes, at which price.

There is a great deal of law suggesting that if a class action cannot succeed in its essential purpose of compensating the class, then it should not be certified. Nevertheless, Judge Weinstein decided he could create a "fluid recovery fund" into which the total estimated damages would be placed, until individual plaintiffs step forward to claim their rightful compensation.

But what if there is money left over, unclaimed? It could be distributed under the rules of cy pres. Under the "cy pres" doctrine, money in a fund need not be distributed exactly according to the original intent for which the fund was created. Rather, it can be distributed in a way as close as possible to that original intent. The idea is to effectuate the fund's spirit, when its specific instructions cannot be honored.

(In the case of a will or trust, the idea is that it's better to honor the fund's spirit, rather than letting the money lie fallow. In this case, the idea would be that it's better to honor the purpose of compensated harmed smokers, than to let the money rest with Big Tobacco as ill-gotten gains.)

In this instance, the purpose of the "fluid recovery fund" could be described as helping those defrauded by claims relating to "light" cigarettes. To vindicate that purpose, Judge Weinstein might direct that the remainder of the fund go to support some worthy public institution, like a cancer research hospital.

However, the appropriateness of using a fluid recovery fund in order to justify class certification is highly controversial.

The Third Issue: Classwide Reliance Under RICO

The third and final difficulty raised by Judge Weinstein's opinion is whether one can address the element of reliance on a class-wide basis in RICO.

Civil RICO requires proof of predicate acts of fraud by the defendant. But fraud is not just a one-way street. To prove fraud, the plaintiff also has to show that she relied on the defendant's misrepresentations to her detriment. That is, she both believed them, and based on her belief, she acted on them, in a way that harmed her.

How do we know that each of those smokers bought light cigarettes because of the lies about their healthfulness, as opposed to for other reasons? And, do we need to know the facts about each smokers' reliance (or lack thereof) on statements about "lights," or is it sufficient to generalize about the class as a whole?

The experts for the plaintiffs will testify that 90% of the purchasers of light cigarettes were motivated by a desire to reduce the health risks of smoking. After all, as Mr. Hausfeld, the lead lawyer for the plaintiffs, told Judge Weinstein in the September 13, hearing, why would a purchaser, given two identical cigarettes, which taste identical and cost the same, buy one over the other except for what one offers and the other does not: the promise of better health?

Weinstein thought that a jury could accept this argument for classwide reliance, and therefore certified the class. The problem, however, is that there is a serious debate within the federal courts over whether reliance must be proved individually in RICO.

By comparison, federal courts have accepted that reliance can be presumed in securities fraud cases. But there is a huge difference between "regular" fraud and securities fraud. (Indeed, the concept of "fraud on the market" had been developed to explain why reliance can be presumed in the latter case, but not the former; the idea is that the market as a whole relies on statements even if an individual buyer or seller can't prove he or she was exposed to the statements, and thus relied on them, before he or she traded in the market.)

How the Circuits Have Split on the Classwide Reliance Issue

The U.S. Court of Appeals for the Fifth Circuit has taken a strong stand that reliance can never be subsumed under class-wide treatment. In contrast, the U.S. Court of Appeals for the Seventh Circuit's Judge Richard Posner, whom Judge Weinstein enlists to support his position, does say that that reliance can be treated on a classwide basis. But that is not the end of the story.

In the 2004 ruling in Carnegie v. Household Int'l, Inc., Posner said that if a court were to certify a RICO class action and allow reliance to be treated on a classwide basis, then the damages caused to each class member as a result of their reliance would still have to be individually litigated. Significantly, the Florida Supreme Court also noted this point when, earlier this year, it decertified a huge class action brought against the tobacco industry, Engle v. Liggett Group, Inc..

In sum, Judge Weinstein's dream--that a single class action could resolve all the issues presented in a RICO suit against Big Tobacco--is not supported by precedent. The next step is for the U.S. Court of Appeals for the Second Circuit to accept interlocutory appeal, and tell the parties if the class certification will stand.

I predict that the Second Circuit will struggle with the very inventive and morally compelling arguments proposed by Judge Weinstein--and then decertify the class.