Tuesday, April 8, 2008

Second Circuit Deals a Severe Blow

Last week, the U.S. Court of Appeals for the Second Circuit issued its opinion in McLaughlin v. American Tobacco Co. The decision constituted a major win for Big Tobacco - and a major loss for the plaintiffs.

The theory behind the case - which was a class action -- was simple. The plaintiff class was composed of persons (and the estates of persons) who had smoked lights cigarettes and allegedly suffered harm. The plaintiff class alleged that the tobacco industry has known for years that "light" cigarettes are not safer than regular cigarettes. Therefore, the class argued, the advertisement campaigns for light cigarettes constituted a form of consumer fraud, in which the seller promised one thing (a safer cigarette) and intentionally delivered something else (a cigarette that was not, in fact, safer).

Given this compelling, simple theory, why did the plaintiffs suffer a major loss? In this column, I'll explain the reasons. I'll also consider what that loss might mean for the future of consumer class actions in the Second Circuit.

A Prediction Made by Many Observers, Based on the Oral Argument, Is Now Fulfilled

Last July I wrote a column suggesting that Michael Hausfeld, one of America's greatest plaintiffs' lawyers, had made a crucial error in an oral argument in this case - an error that, I contended, ensured that the Second Circuit would hand him a defeat. In fact, my prediction was confirmed--Hausfeld lost 3-0 before the Second Circuit. Importantly, however, I was far from

the only person who predicted that Hausfeld would lose. To the contrary, it was the conventional wisdom among lawyers observing the case that the Second Circuit would reverse the lower court's decision. After all, the district judge was Jack Weinstein, and his decision was a true Weinstein special--brilliant, iconoclastic, and somewhat inconsistent with precedent.

Hausfeld's major error, as I explained in my prior column, occurred when he told the panel that there was nothing out of the ordinary with Judge Weinstein's decision, and that they would be breaking with twenty years of precedent if they did not affirm the lower court. That statement was, on its face, ridiculous, and it left the two moderates on the panel - Judges Walker and Pooler - nowhere to turn if they were inclined to help the plaintiffs in the case. (The last member of the panel, Judge Winter, was a lost cause from the start.)

Before the argument, it had seemed plausible that the McLaughlin class action might appeal to the sympathies of the two moderates.

Other lawyers have brought lights cases around the country with mixed success. Moreover, since lights cases are fraud cases involving money damages, not personal injury, they should, in theory, have been easier to certify as class actions, since class actions in tobacco have proven impossible to certify when they involved highly individualized questions regarding cancer and other ailments. But this case proved somewhat different.

Overextending the Reach of the "Fraud on the Market" Theory

Hausfeld hit upon the idea of bringing a nationwide class action based on a federal racketeering statute, the Rackeetering-Influenced Corrupt Organizations ("RICO") law. This strategy had the advantage of permitting Hausfeld to consolidate the millions of small-value individual claims into a single, huge, $800 million class action ($2.4 billion, if treble damages were awarded, as RICO allows).

Racketeering law is still the law of fraud, however, and fraud class actions have their own problems. The single most important problem is that fraud typically requires proof of reliance -- that is, proof that it was the defendant's intentional misrepresentation that caused the victim of the scheme to part with his or her money.

Judge Weinstein held that because the advertisement campaigns for light cigarettes were directed towards the public as a whole, the question of class-wide reliance could be solved by simply borrowing the concept of "fraud on the market" from securities fraud. This theory holds that generalized, class-wide reliance can be shown - and individualized reliance need not be shown - if the defendant engaged in "uniform misrepresentations" to which the entire market for a particular product (such as a stock) was exposed.

Hausfeld suggested at last year's oral argument that the Second Circuit had already held in previous cases such as Moore v. PaineWebber, Inc. that generalized proof of reliance could be adopted by the courts where the defendant engaged in "uniform misrepresentations," and that Weinstein had merely applied Moore to the lights case. In my view, this was Hausfeld's biggest error: to claim

that the facts in the "lights" cases were just like the facts in financial fraud cases like Moore. As the Second Circuit noted in its rejection of Hausfeld's argument, it had stated in Moore that generalized proof of reliance would only be appropriate in the absence of "material variation in the kinds or degrees of reliance by the persons to whom" the misrepresentations were addressed.

At oral argument, the panel in the "lights" case was very concerned that the record suggested that smokers had a variety of reasons for buying "lights" cigarettes -- even though the advertising by the tobacco industry had affected the choices of almost all purchasers. The problem was that no one knew how much that advertising mattered to the smokers' overall decision of which cigarettes to buy, and whether to buy cigarettes at all. People may have bought "lights" for non-health-related reasons.

In sum, by saying to the Second Circuit that its previous rulings obliged it to treat a consumer product like cigarettes just like a financial product or a security, Hausfeld may have caused the panel to rule exactly the opposite way from the way he had sought. In the decision last week, the court seemed to suggest that, notwithstanding Moore, plaintiffs would be hard-pressed to be able to come up with cases where circumstantial evidence would be sufficient to permit a presumption of reliance.

As I said earlier, the decertification of the lights class action was not, in itself, a great surprise. The case was always a bit of a gamble. (In fact, the Supreme Court has just granted review in a federal preemption case that might eliminate "lights" litigation entirely.) But did the Second Circuit go further than just decertifying this particular action, to foreshadow doom for similar consumer actions in the future?

Did the Second Circuit Shut the Door on Future, Similar Consumer Class Actions?

Put another way, by overreaching, did Hausfeld provoke the Second Circuit into overreacting, thus producing a decision that shuts the door for future consumer class actions?

I don't think so. It is important to note that the Second Circuit went out of its way to distance itself from the Fifth Circuit's 1996 decision in Castano v. Am. Tobacco Co,. which the Second Circuit described as imposing a "blanket rule" against class certification whenever issues of individual reliance exist.

Furthermore, the phrase "material variation," which the court used to map out the boundary between acceptable and unacceptable class-wide treatment, is not meaningless --- although Hausfeld, in oral argument, seemed to suggest it was.

Rather, "material variation" clearly contemplates that will be some individual differences between the reasons for reliance among the members of a class. Thus, it does not require, for certification, a presumption that all members of the class have identical reasons for acting (as is the case in fraud-on-the-market in the securities context, where investors are presumed to all know about and act on public information).

Consider, for example, a hypothetical consumer fraud claim based on the purchase of word-processing software that fails to work with a certain type of computer, despite contrary representations by the manufacturer on the box. It may be the case that some of the class of consumers who purchased the software did not, in fact, rely on that representation. For example, some of these purchasers might not have owned a computer incompatible with the software until after they bought the software, so the misrepresentation may have been irrelevant to them at the point of purchase.