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Q

What is the latest news on the Freedom Holdings case? And how about this new ruling by the Supreme Court on Dec. 15 regarding the light cigarettes suits going forward? Will these rulings lower the prices of tobacco bonds? Do you think they can recover along with the rest of the muni market as the economy heals?

A

James A. Klotz responds:

Freedom Holdings, a challenge to New York State’s implementing legislation for the Master Settlement Agreement (MSA), has been lingering in the courts for the last several years. The plaintiffs in the case accused New York of using the MSA to create a cartel of large cigarette manufacturers in order to limit price competition, which would benefit smaller producers.

Our latest information on Freedom Holdings is that some have reported orally that Judge Alvin Hellerstein of the Southern District of New York has ruled from the bench in favor of New York, throwing out the plaintiff’s case. This ruling, which we believe may have taken place in late November, has yet to appear in a formal written decision. So, while we are hopeful that this case will finally conclude, we have no written opinion on which to rely at this time. As soon as such an opinion is released, we will report back on where the case stands.

In another case, Altria v. Good, the U.S. Supreme Court ruled on Dec. 15, in a 5-4 decision, that federal law does not prevent smokers from filing suit under state law alleging fraudulent conduct on behalf of cigarette manufacturers. As described on an internet site that follows Supreme Court rulings (www.scotuswiki.com): “The case tests whether individual smokers are barred, by federal law, from suing under state law to challenge alleged deception in the ads promoting ‘light’ cigarettes as being low in tar and nicotine. The industry is making two claims to try to head off such lawsuits: First, that federal law on cigarette labeling and other marketing tactics expressly preempts state law claims, and, second, that actions by the FTC over the years allowed such ads, actions that amounted to implied preemption of state law claims.”

The court ruled, however, that consumers can sue Altria’s Philip Morris USA cigarette manufacturer on economic grounds. Suits filed alleging that consumers had been defrauded because they had overpaid for “light” cigarettes will be allowed to go forward in state courts. Since smokers typically smoke more “light” cigarettes to get the same amount of tar and nicotine as they would have gotten from regular cigarettes, they would need to smoke more to gain the same benefit received from regular cigarettes. Altria had argued that federal regulation and Surgeon General warnings precluded such suits. The court ruled otherwise.

It is unclear how successful the plaintiffs will be in filing such suits. Legal proceedings against a large cigarette producer such as Altria would be costly, and the economic gain from such suits is questionable. In a statement following the court’s ruling, Altria indicated it “continued to view these cases as manageable.”

The impact of this case on tobacco bond issues is unclear. The greatest impact would first be felt by the tobacco manufacturers, which would have to pay any judgments resulting from future lost cases. With lengthy appeals processes, awards in favor of plaintiffs could be expected to be spread over many years. Tobacco producers have been historically very profitable, so it is not certain how many such cases will be filed and won – and what the financial impact may ultimately be. Since manufacturers that are signatories to the MSA must meet their annual obligation based on market share, we don’t expect any impact on MSA payments to be felt anytime soon.

As far as the market for tobacco bonds is concerned, it remains a desirable investment sector for many investors. A recent industry report was largely positive on the future of tobacco bonds and increased issuance is possible by states in need of revenues during upcoming difficult financial times.