Pushing for a
by Jim Surowiecki
NEW YORK, N.Y. (Apr. 30, 1997) -- As last week began, much of the
talk on Wall Street had to do with negotiations between American tobacco
companies and a group of state attorneys general about the possibility of
a deal that would limit the companies' liability for cigarette-related deaths
in exchange for an enormous financial settlement. Reports from the negotiations
suggested that the tobacco companies -- most notably PHILIP MORRIS
(NYSE: MO) and RJR TOBACCO (NYSE: RJR) -- were willing to create a
fund worth as much as $300 billion over 25 years out of which compensation
would be paid to smokers dying of lung cancer or other ailments. Both sides,
it seemed, preferred a one-time settlement to years of protracted and potentially
Today, though, the picture for the tobacco companies looks somewhat more
complicated, and not necessarily for the better. Two court decisions -- the
first handed down on Friday and the second on Monday -- have expanded both
the reach and the power of state regulation of tobacco, and in doing so have
strengthened the hand of the anti-tobacco forces in their talks with the
companies, talks that resumed on Monday. Investors, who had driven up shares
of both Philip Morris and R.J. Reynolds on the news of a possible settlement,
have responded predictably, with both stocks suffering sharp drops over the
last four trading sessions.
The two decisions deal with substantively different issues, and in one
interesting respect might be seen to conflict with each other. But taken
together, they represent a serious challenge to the tobacco companies' insistence
that cigarettes should not be government-regulated and that the First Amendment
protects cigarette advertising of any sort.
Friday's decision was, in some respects, the more surprising of the two.
Federal Judge William Osteen, a North Carolina judge and former tobacco lobbyist
whom many had believed would be sympathetic to the tobacco companies, ruled
that cigarettes were "drug-delivery devices" and that the Food and Drug
Administration could therefore regulate them. In doing so, Osteen essentially
gave the imprimatur to departing FDA chairman David Kessler's five-year quest
to bring cigarettes under his agency's jurisdiction. Surprising as it may
seem, knowing all that we do about the addictiveness of nicotine, cigarettes
have always occupied a curious place in the law, almost drugs and yet not
regulated as even something like aspirin is. Osteen's decision opens the
door to major changes in that area.
On the other hand, Osteen actually struck down some of the seemingly more
important aspects of the FDA regulations that the tobacco companies were
challenging in the case. The FDA had formulated restrictions on a wide array
of outside advertising and tobacco promotion -- all designed, at least
rhetorically, to limit children's exposure to toabcco ads -- that were scheduled
to go into effect on August 28. But Osteen ruled that the agency did not
have the legal authority to implement these restrictions, which means that
for the foreseeable future tobacco ads in magazines will still be in color,
that there will still be cigarette billboards near schools, and that you'll
still get to wear that Joe Camel hat.
Still, while both sides will be appealing the decision to a higher court,
Osteen's ruling is clearly landmark in its acceptance of the concept of FDA
regulation of tobacco. In practical terms, it takes away one of the tobacco
industry's key bargaining chips, since the industry had been expressing a
willingness to accept FDA regulation in exchange for protection from liability.
More importantly, it's possible that an aggressive FDA could promulgate a
series of regulations that would essentially destroy tobacco as a consumer
When FDA chairman Kessler started this fight, after all, he said that he
would bring nicotine levels in cigarettes down to zero in a decade by regulating
it as a medical device. And a forthcoming article in the trade journal Medical
Device Approval Letter argues that the agency has a wide range of weapons
at its disposal, including requiring tobacco companies to pay "user fees"
to the FDA and, more strikingly, forcing cigarettes to be dispensed by
Opinions on the impact of the ruling differ widely, though. Kenneth Reid,
editor of MDAL, said in a statement released with the article that Osteen's
decision could cause "legal Armageddon." And Mississippi Attorney General
Michael Moore, who has been one of the industry's most implacable opponents,
said: "We're going to shoot for it all ... and then tightly regulate the
industry." President Clinton, meanwhile, called it "a historic and landmark
day for the nation's health and children." But tobacco analysts downplayed
the long-term ramifications of the decision, while an attorney for the American
Advertising Federation told Reuters, "Joe Camel lives. Winston Cup is alive.
Billboards are alive." And in context the market's reaction, while definite,
was relatively mild, with MO's shares off 2 1/2 and RJR's down 2 3/4.
Monday's decision by the Supreme Court, though, calls into question just
how alive Joe Camel really is. The Court refused to hear an appeal of a case
in which in a Baltimore law restricting outdoor tobacco and liquor ads was
upheld. In refusing to hear the case, the justices let the lower court's
decision stand. That means that the Baltimore ordinance, which imposes strict
zoning regulations on billboards and other outside advertising, is constitutional
and does not violate the First Amendment. (Osteen's decision that the FDA
couldn't regulate such ads had to do with the agency's authority, not with
the First Amendment.) And it also means that other cities could adopt similar
On the other hand, the Baltimore law did permit cigarette and liquor billboards
in industrial areas and along freeways. And one might read the decision as
having more to do with zoning than with an explicit judgment on tobacco or
liquor advertising more generally. Still, it's important to see that the
decision that the Supreme Court allowed to stand was handed down by a Richmond
court, just as Friday's decision was handed down by a North Carolina judge.
The regional divisions that had once seemed to be crucial to the protection
of tobacco interests no longer seem to have the weight they once did.
Nonetheless, all indications are that a settlement may very well still be
in the offing, and in that sense what these decisions may have done is make
Philip Morris and RJR even more willing to settle. Ironically, in any such
settlement advertising -- at least of the sort that has come to pervade magazines
and billboards -- will likely be the first thing to go. Given the importance
attached to ads by anti-smoking forces, the tobacco companies' willingness
to give up Joe Camel and the Marlboro Man may seem surprising. But there's
been very little real work done on the effectiveness of advertising. In
particular, if no company in an industry is advertising, it's not clear that
all companies necessarily suffer.
The real stumbling block in any settlement will be the precise nature of
the companies' immunity from further lawsuits. While a deal is conceivable
that would protect companies from state or federal suits, it will be impossible
to prevent suits by individual smokers unless a law is passed by Congress.
And that, in turn, means that the parties to any deal will have to convince
legislators that it makes sense. On the other hand, it's possible that an
end to the ceaseless litigation and a recognition that adults who smoke do
so in full knowledge of the eventual consequences may be appealing to a country
that oscillates permanently between the desire for security and the desire
The most curious thing about the settlement talks, at least from the perspective
of investors, is that any settlement will be, at worst, valuation-neutral
for the tobacco companies. A strong argument can be made, in fact, that a
real settlement -- even if it comes at the cost of $300 billion and a 25-50-cent
hike in the price of a pack of cigarettes -- will boost the P/Es of Philip
Morris, in particular, to such an extent that the stock will trade significantly
higher, even with reduced earnings. Philip Morris may never trade at the
elevated P/E of a consumer staple like Coke, for instance. But Philip Morris'
growth in earnings over the last five years has been faster than Coke. The
only reason it trades at such a discount is because investors wonder if tomorrow
they'll wake up to find out that cigarettes are now being treated as prescription
drugs. If a settlement takes away that worry, the market caps of tobacco
companies may very well rise significantly. All of which seems like a rather
ironic consequence of the quest to put tobacco on trial.