Puff, the Magic Settlement

The joy of enormous tobacco fees.

By now millions of words have been spilled on the $206 billion tobacco settlement engineered in late 1998 between 46 states and the major cigarette companies. The deal, which followed settlements with four other states totaling $40 billion, has been called the biggest privately handled redistribution of wealth in world history. It has simultaneously served as a rich source of funds for new state spending programs and as a confirmation of the newly emerging role of entrepreneurial private litigators as a fourth branch of government.

At the same time, many of the tobacco settlement's most curious features have received little public recognition. This was perhaps understandable at the time of the announcement a year ago, when most outsiders still found the settlement's terms sketchy and confusing. Since then, however, a wealth of details has emerged about how the settlement was meant to work, and does work, in practice. These details deserve a close look, if only because it's likely that the "tobacco model" will be replicated in other cases where government eyes some line of business as a source of revenue.

Start, then, with a basic question: Are the payments required by the settlement really an assessment of damages for past misconduct, or are they a tax in disguise? (Cigarette prices jumped by 45 cents a pack almost as soon as the ink was dry on the agreement and have risen again since.) "There'll be adjustments each year based on inflation," an Idaho official told the Spokane Spokesman-Review, referring to the state's take. "If cigarette volume goes down, our payments will go down. If volume goes up, our payments will go up even more."

That sure doesn't sound like a damage settlement. Yet the attorneys general take pains not to call what's happening a tax increase, and they have good reasons to maintain this view, one being that they plainly lacked the authority to negotiate an extra-legislative infliction of new taxes on their states' populations. So it's worth looking more closely into the question.

By its nature, a damage settlement for past misconduct could apply only to companies that did business in the past. A start-up tobacco company, or a foreign maker tackling the U.S. market for the first time, couldn't be made to pay based on the failure of U.S. companies to warn of their products' dangers in 1965 or 1980. Likewise, in a damage settlement, a company that was tiny in years past but has lately expanded could be made to pay based only on its old sales, not on any new market success it might enjoy.

But in fact the settlement contains a series of provisions designed to make sure that companies chip in proportionally to their new, and not their old, sales. "The tobacco companies," writes Rinat Fried of Law News Network, "got the states to agree to force small companies not participating in the settlement to fund a 30-year, multimillion dollar escrow account to be used as insurance against future health-related judgments against the small companies." Contributions to this escrow account will, it seems, be set high enough to discourage small companies from going it alone.

Moreover, small companies can participate in the settlement only if they agree to keep their market share from growing more than 25 percent above what it was in 1998--either that, or pay a prohibitive 35-cent penalty for every pack they sell above that level. This quite effectively deters entry into the market by cigarette discounters who have no liability for past conduct and could therefore undercut the higher prices generated by the settlement.

The word for this process is cartelization, and the irony is that had cigarette executives met privately among themselves to raise prices, freeze market shares, confine small competitors to minor allocations on the fringe of the market, and penalize defectors and new entrants, they could have been sent to prison as antitrust violators--quite possibly by the very same attorneys general who sued them in this case (they'd also have faced tag-along consumer lawsuits filed by some of the same plaintiffs' lawyers). This way it's all legal.

The effect is that smokers pay generously, while the other parties get cut into a sweetheart deal: State governments quietly turn the same tobacco companies they publicly vilify into captive milch cows for future spending, the attorneys general grab political credit, and the companies get protected from competition. And, not at all by happenstance, the private lawyers who served as middlemen will reap a vast fortune, probably tens of billions of dollars, in what are being called fees.

Traditional legal ethics has plenty to say about the role of lawyers who undertake to represent the general public, and one thing it says is that they must not overcharge, even when dealing with a government that (through foolishness or otherwise) is not watching its outlays carefully. Not very shockingly, the reasonableness of a fee depends on the amount of work done to earn it. How much work, and of what nature, did the private lawyers do in the tobacco cases?

There's no doubt that some lawyers representing some states did a substantial amount of work to research the Medicaid cases and engage in various stages of pretrial litigation--though, since only two of the cases reached trial (both were settled before a verdict), the lawyers generally did not have to worry about what is by far the biggest source of costs in an ordinary lawsuit. There were also many states like Illinois, where the law firms hired by the state, as an arbitration panel later pointed out, did "relatively little" to pursue its claims, taking no depositions and submitting no time records of hours spent on the case. Holding back on doing much work may have made sense as a legal strategy--other states were doing the heavy lifting, and Illinois could simply ride on their coattails--but it also meant the Illinois lawyers couldn't expect a huge fee, right?

Wrong. The arbitrators decided to award the Illinois lawyers $121 million, and the lawyers reacted by complaining bitterly that they deserved more like $400 million. According to the Chicago Sun-Times, Illinois Attorney General Jim Ryan had "close ties" to one of the two firms he hired to represent the state.

Or consider the case of Maryland, where the state hired asbestos lawyer Peter Angelos, best known as owner of the Baltimore Orioles, to represent it. It isn't clear how much work Angelos did on the case. Yet standing on the terms of a 25 percent contingency fee contract, Angelos now says he's owed a cool billion dollars.

This isn't to say that Angelos did nothing special to advance the state's tobacco suit. His influence is widely credited for one of the most remarkable episodes of the entire affair, in which Maryland lawmakers (like Florida's before them) agreed to change the law retroactively to extinguish legal defenses that would have been available to tobacco companies at the time they took the actions being sued over. "We changed centuries of precedent to ensure a win in this case," explained the president of the state Senate.

As The Washington Post reports, Annapolis legislators have grown accustomed to "the proposals known by their yearly shorthand, `the Angelos bill' "--legislation that the legal magnate sends over nearly every year to create some new way for him to extract more money from the parties he sues. Among the nation's most munificent Democratic donors, Angelos is, per the Post account, "viewed by many political insiders as the most powerful private citizen in Maryland." He sports his own personal lobbyist, glove-close relations with Gov. Parris Glendening, and a host of statehouse connections, such as with the president pro tem of the state Senate, who happens to be a lawyer with his firm.

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