Are Lawyers the New Regulators?

National Journal  August 30, 2003

 

This should be a celebratory time for corporate America. After all, it is dealing with the most business-friendly White House and Congress in decades, numerous regulations--from workplace safety standards to environmental rules--have been rolled back, and the main engine of economic policy is corporate tax breaks. But something is wrong. Despite all of these newly acquired freedoms, industry after industry is being forced to change its practices and pay out hundreds of millions of dollars in legal damages.

Lawsuits are nothing new, of course, but the current flurry represents a new breed. By demanding corporate reform, these suits seem to be mimicking government's regulatory role--and then, there are those damages. All of which raises a provocative question: Would corporate America be better served by not fighting reform, but instead embracing it? Some companies have already started down that road.

Last month, Kraft Foods, the country's largest maker of processed foods, announced it was initiating changes in its manufacturing and marketing practices for several of its major products. Among other things, the company will stop using trans fats--a particularly unhealthy ingredient--in some of its most popular products and cease its marketing campaigns in schools (although it will continue to sell snacks in school vending machines).

Kraft is coy yet revealing about its reasoning: "We are making these changes, first and foremost, because we think it is the right thing to do for the people who use our products and for our business," said spokesperson Kathy Knuth. "If it also discourages a plaintiff's attorney because he or she would have an even tougher time trying to portray us as a company that doesn't care, that's OK with us."

When the producer of Oreos, Oscar Mayer wieners, and Cheez Whiz suddenly announces it has discovered the virtues of healthy eating--or "better-for-you foods," in food-industry lingo--something is clearly up.

Kraft, of course, is part of the conglomerate that owns Philip Morris USA, which knows a thing or two about plaintiffs' attorneys. Associate General Counsel William Ohlemeyer of Philip Morris USA said that if he had known about the billions of dollars in damages the company now may have to pay, he would have advised his bosses, "Early regulation would be preferable to litigation. It would be more focused, more predictable, more precise, and more certain to address the issues that give rise to the litigation."

While Kraft has not faced the multibillion-dollar judgments that have hit the tobacco giant in the past several years (and recently prompted the conglomerate Philip Morris Cos. to change its name to the hygienic sounding Altria Group), the trial bar has made it clear that its next target is the fast-food industrial complex. Plaintiffs have already filed suits against Kraft and McDonald's, and more are in the works. The suit against Kraft was dropped after the company agreed to stop putting trans fats in Oreos.

In an attempt to pre-empt the obesity backlash, other mega-food distributors have already introduced their own changes. PepsiCo is eliminating trans fats in Doritos and Tostitos, and McDonald's has introduced a range of healthier offerings. And now the Bush administration has announced a crackdown on trans fats.

Other industries have made changes as a result of recent litigation, with varying degrees of success. In the wake of the Wall Street scandals, for instance, investment analysts now make a point of disclosing their firm's interest in companies they report on, so as to avoid conflict-of-interest charges. But some industries remain recalcitrant about reform. When firearms manufacturer Smith & Wesson tried to introduce safer guns and require dealers to follow a code of conduct, the company became a pariah in the arms world.

To be sure, the corporate community is focusing most of its energy on its long-standing campaign to limit liability and court judgments. With the GOP in control in Washington, the golden chalice of tort reform seems as if it might, at last, be within reach.

The same business-GOP alliance that constantly opposes regulation on the grounds that it interferes with the free market is now, ironically, trying to pass a law to restrict litigation against industry.

But to some, lawsuits are the ultimate form of free-market regulation, in which lawyers capitalize on the failures of industry. "Trial lawyers are businessmen," observes David Vogel, chair of the business and public policy program at the University of California (Berkeley).

All of which leads to an interesting question that is not often raised in corporate boardrooms, or among GOP congressional leaders and Bush administration officials: Are trial lawyers doing a better job than the government at restraining corporate excess?

"There's no question that lawsuits are a form of regulation in the United States" and that they sometimes make up "for a shortfall of regulation by government agencies," said University of Chicago law professor Cass Sunstein, co-author of the book Punitive Damages: How Juries Decide.

In fact, corporate America's dreamed-of protections already exist across the Atlantic. The countries of "Old Europe" do not, as a rule, permit courts to impose punitive damages, allowing only economic compensatory damages. In addition, European civil trials are usually held before a judge, not a jury. The price for all of this, though, is that businesses are heavily taxed and regulated by government.

The irony is probably lost on American shareholders, but consider: The very companies that for decades spent hundreds of millions of dollars on campaign contributions, influential lobbyists, and sophisticated public relations to fight regulations are now paying out as much or more in fines, and are changing their business practices in ways that go beyond what government regulators would have imposed.

While a big-dollar lawsuit may induce a company to change its ways, the impact of litigation on stock prices is what really moves companies to alter their practices, according to John C. Coffee, a professor at Columbia University Law School who specializes in corporate law and white-collar crime. "The stock price creates incentives," he said.

The best example of that is probably Philip Morris USA, which, faced with more than $12 billion in fines, is now supporting limited FDA regulation of cigarettes.

Ohlemeyer said, "That's one of the things that business is learning; that's an attitude that's evolving. A business can't automatically ignore and shouldn't ignore the idea that people want to see third-party regulation." Still, even proponents acknowledge that lawsuits are clumsy instruments for making public policy. Nothing illustrates that point better than tobacco. While the so-called master settlement between the industry and state attorneys general was widely seen as a win for advocates of tobacco control, many say the outcome has been hit-and-miss.

For example, a key provision, which requires tobacco companies to pay states more money if smoking rates among young people do not decline, has created a perverse alliance between cigarette makers and cash-strapped state governments. Money meant for anti-smoking initiatives has instead gone to highway projects. And the tobacco companies' payments to the states are coming out of consumers' pockets in the form of higher cigarette prices.

"It would have been a lot more orderly and efficient if the states had gotten together and simply raised their tobacco taxes. But that has been politically impossible," said Philip J. Cook, a professor of public policy at Duke University who studies the regulatory impact of litigation.

After a bitter political battle in 1998 between the tobacco companies and public health advocates, Congress failed to codify the settlement into law. In hindsight, some major players in the fight think it might have been better to compromise rather than deal with the current haphazard method of continual lawsuits. "In the end, public health is worse off because we didn't pass the bill," said Matt Myers, head of the Campaign for Tobacco-Free Kids who helped broker the settlement. Myers angered some of his public health colleagues by supporting yearly liability caps for the industry in exchange for major concessions on marketing and increased regulation.

Yet even without the legislation, the tobacco industry made many major changes in its marketing practices, such as dropping the "Joe Camel" cartoon character, and submitted to many new local regulations. And, of course, tobacco companies might still have to pay out billions of dollars in damages.

The threat of lawsuits is a powerful tool for harnessing corporations, said Pamela Gilbert, a partner in the law firm Cuneo Waldman & Gilbert. Gilbert, who is a former executive director of the Consumer Products Safety Commission, said that nearly all of her cases at the commission were resolved by voluntary agreements with industries that were afraid of lawsuits. "It is less the threat of government action and more the threat of private litigation that compels companies to go along," she said.

And that is exactly what makes the business community so unhappy. "They are usurping and doing an end run around the legislative and regulatory processes," said Lisa Rickard of the Institute for Legal Reform, the tort-reform lobbying arm of the U.S. Chamber of Commerce.

John Banzhaf III, a professor of public-interest law at George Washington University, points out that judicial actions outside the regulatory process were re- sponsible for major civil-rights, environmental, and consumer-safety reforms. He notes that, unlike the tobacco industry, food companies are extremely susceptible to public pressure, which probably accounts for their pre-emptive moves.

So, does an automatic anti-regulation approach make the most sense for business? Executives might want to ask themselves what the stock price of Altria Group, currently hovering around $40 a share, might have been without the tobacco litigation.