March/April 2000

When Theft Masquerades as Law

Jonathan Clarke and Gary Dempsey Danish Ambassador K. Eric Tygesen challenges the view of the war in Kosovo presented in NATO's Empty Victory, edited by Ted Galen Carpenter. Cato scholars Jonathan Clarke and Gary Dempsey wait to respond at a Book Forum on January 20..
Grasping for the straw that will (not quite) break Joe Camel's back, the Clinton administration finally snookered Janet Reno into filing yet another lawsuit against the government's favorite whipping boy—the odious but still deep-pocketed tobacco industry. This time the stake is $20 billion per year, which the feds supposedly spend on smoking-related health care, mostly Medicare outlays.

Meanwhile, the U.S. Department of Housing and Urban Development, piloted by its politically ambitious secretary, Andrew Cuomo, has a plan to change the way the nation's gun makers do business. Already engulfed by litigation from 29 cities and counties for "negligently marketing" a "defective product," the gun industry could be crushed under the weight of legal action from a horde of 3,200 public housing authorities coordinated by HUD. Presumably, gun makers are responsible for defraying the cost of security guards and alarm systems installed to curb violence in public housing.

Then there's the problem of health maintenance organizations (HMOs), a litigation swamp created by a trio of feckless government policies. First, Congress allows employers, but not employees, a tax deduction for expenditures on employee health care. Responding to that incentive, most employers cover even minor expenditures rather than provide less costly catastrophic coverage. As a result, employees have little reason to limit their medical outlays, and costs not surprisingly have skyrocketed. Second, courts do not permit patients and health care providers to prescribe the contractual terms that will pertain if an accidental injury occurs. Instead, courts themselves have established "reasonable" standards of care, enforced by unpredictable tort liability. Third, to counteract extravagant tort awards and protect the assets of employee health plans, the federal government, through the Employee Retirement Income Security Act, immunizes those plans against some otherwise legitimate claims in state courts. The result of those three misconceived policies has been anger, confusion, and a potential bonanza for trial lawyers.

Tobacco, guns, and HMOs are not, of course, the only areas where litigation has run amok; but they are three of the most egregious examples. Let's examine each briefly—to see what they have in common, what issues each raises, and how we can prevent our judicial system from being exploited to exact tribute from corporate pariahs.

Milking the Tobacco Cow

Only 10 months after tobacco companies and 46 state attorneys general settled their differences for a meager quarter of a trillion dollars in "damages," the U.S. Department of Justice decided that it wanted a share of the plunder. DOJ's complaint, filed in September of last year, alleges that cigarette companies have conspired since the 1950s to defraud the American public and conceal information about the effects of smoking. Specifically, DOJ contends that industry executives knowingly made false and misleading statements about whether smoking causes disease and whether nicotine is addictive.

According to DOJ, those offenses, among others, justify recovery of billions of dollars in annual federal health care expenditures related to smoking. The lawsuit relies on three statutes: the Medical Care Recovery Act, the Medicare Secondary Payer Act, and the civil provisions of the Racketeer Influenced and Corrupt Organizations Act. In asserting a violation of RICO, which was designed to be invoked against organized crime, the feds have stooped to what nowadays is a standard tactic of plaintiffs' attorneys. This time, however, DOJ officials have to deal with an embarrassing admission, tucked away in the final sentence of the press release that announced their lawsuit: "There are no pending Criminal Division investi-gations of the tobacco industry."

After a five-year, multi-million-dollar inquiry by two dozen prosecutors and FBI agents, DOJ produced one misdemeanor plea resulting in a $100,000 fine against an obscure biotechnology company for violating a seed export law that has since been repealed. The government searched for perjury in tobacco executives' testimony before Congress that cigarettes were not addictive. Prosecutors plowed through documents for evidence that cigarette makers manipulated nicotine levels. Whistle blowers and company scientists testified before grand juries. The outcome: not a single indictment of a tobacco company or industry executive.

Nonetheless, President Clinton collared his diffident attorney general and she, somehow, conjured up a RICO claim that accused the industry of the very same infractions for which grand juries could not find probable cause. Despite consistent court rulings in union health fund cases that insurers—like Medicare—have no claim under RICO, Janet Reno and her minions at DOJ included among their 116 counts against the industry all sorts of foolishness intended to ratchet up the pressure for an exorbitant financial settlement, notwith-standing the inanity of the underlying assertions. Here's just one example, count number three: In November 1959, the industry "did knowingly cause a press release to be sent and delivered by the U.S. mails to newspapers and news outlets. This press release contained statements attacking an article written by then–U.S. Surgeon General Leroy Burney about the hazards of smoking."

There you have it—racketeering, in all its sordid detail.

DOJ's claims under the Medical Care Recovery Act aren't much better. The MCRA, passed in 1962, was intended to circumvent a 1947 Supreme Court case that denied a right of recovery under the common law for government medical outlays for a soldier's injuries that were caused by a defendant's negligence. In no instance has the MCRA been used to reclaim Medicare expenditures. Indeed, because MCRA was enacted three years before Medicare, it could not have been within the contemplation of Congress that Medicare costs would be recoverable. Nor is there anything in MCRA suggesting that multiple claims can be aggregated as in DOJ's suit. Nor can the government recoup from tobacco companies the costs of treating a smoker's illness when the smoker himself could not show that his illness was due to the companies' negligence.

As a fallback, DOJ is also claiming under the Medicare Secondary Payer Act of 1980, which expressly covers Medicare expenditures—implicitly confirming that the earlier MCRA did not do so. But MSPA is invoked against an injured party or his private insurer, not against the party that allegedly caused the injury. The purpose of the statute is to prevent an injured party from recovering twice—once from a private insurer and a second time from Medicare—and to ensure that a private insurer isn't let off the hook for a legitimate claim just because the claim might otherwise be covered by Medicare. MSPA has never been employed to establish liability for an injury; it was designed for cost recovery only after liability had been determined.

Interestingly, that legal analysis is well-known to the Clinton administration. That's why Attorney General Reno repeatedly rejected arguments that the federal government had a cause of action against tobacco companies for Medicare reimbursement. Commenting on the DOJ lawsuit, former Clinton aide Rahm Emmanuel put it this way: "If the White House hadn't asked, [Reno] would never have looked at it again." So it's politics, not law, that's driving this litigation. And what's worse, the entire scheme is cynically promoted as a way to protect the health of our children.

Yet now that the loot is rolling in from the multistate settlement, we know that kids' welfare is far down the list of priorities. In Los Angeles the money will be used to improve sidewalks; in Michigan it'll allow a cut in college tuition; in North Dakota flood control gets the nod. Only a handful of states is funding tobacco control programs significantly beyond presettlement levels. If the politicians were honest, they'd follow the advice of—hold your hat—Sen. Charles Schumer (D-N.Y.), who urges the states and localities to reduce taxes because "taxpayers bore much of the cost of treating tobacco illnesses." Actually, Schumer understates the case; cigarette taxes far exceed all reasonable estimates of the social costs of smoking. Still, the senator has the right idea.

Unhappily, Schumer's tax reduction proposal has zero chance. Money drives the tobacco wars. For every pack of cigarettes sold, the industry earns about 23 cents, the feds get 34 cents, and the states average 37 cents (not counting the recent 76-cent price increases to pay for the settlement). Thus, even at presettlement rates, government gets 71 of each 84 cents of pretax profits. In effect, the feds and the states are 76 percent stockholders in an enterprise that, according to government reports, kills 400,000 Americans every year. No matter the incongruity, politicians aren't likely to turn off that spigot.

Firing Blanks at Gun Makers

Quite a different dynamic is at work in the city, county, and HUD litigation against the gun industry. With a piddling $1.5 billion in annual revenues, gun makers will not yield the same treasure trove as the tobacco behemoths whose worldwide sales are $300 billion. But that's not a problem, because the real goals of the gun suits are twofold: first, to bypass the legislative process that, despite the recent scourge of high-profile multiple killings, has been remarkably unreceptive to a variety of gun control measures; and, second, to chalk up one more victory for the trial lawyers, thus demonstrating to future fat-cat defendants that groundless legal theories are good enough when the coercive power of multiple government entities is arrayed against an unpopular industry.

The gun suits aren't intended to go to trial. In fact, HUD's threat to coordinate litigation by 3,200 public housing authorities, on top of the claims filed by 29 cities and counties, points to a settlement, not a trial. Secretary Cuomo and his minions understand well that the smallish gun industry can't afford to defend itself—even against unfounded suits—in the face of such overwhelming firepower. A Wall Street Journal story emphasized that very point: "As with the municipal suits, one filed on behalf of housing authorities would be groundbreaking and certainly not a sure bet to succeed in court. But a suit by a large group of housing authorities could [exhaust] gun companies' resources in pretrial maneuvering—by making demands for documents concerning industry distribution practices in hundreds or thousands of localities." No better than thinly veiled blackmail.

In justifying HUD's litigation plans, Cuomo contended that "only 1 percent of the dealers are selling over 50 percent of the guns used in crimes." But if HUD has information linking guns sold by particular dealers to known criminals, why haven't the underlying data been turned over to authorities whose duty it is to shut down dealers who break laws against such sales—laws that are on the books in all 50 states? Instead, Cuomo wants to compel gun makers to become police, judge, and jury—denying to offending dealers, without due process of law, the merchandise that they sell for a living.

An obvious solution to the problem of violence in public housing would be for police to enforce laws that prohibit sales to minors, felons, the mentally incompetent, and "straw purchasers" surreptitiously buying on behalf of criminals. Evidently, HUD prefers to sue gun makers who lawfully sell to wholesalers who, in turn, sell to licensed retailers. The government wants to hold gun makers liable for the violent acts of criminals, most of whom did not buy from licensed retailers and over whom the manufacturers have no control.

So goes the battle for gun control. If the legislature doesn't cooperate, just find a friendly judge, or commandeer public resources to file suits across the nation until gun makers cry uncle. Never mind that 30 years ago a 13-year-old could buy a rifle from most hardware stores or even through the mail. Few states had retail age restrictions for handguns. Today federal gun laws have grown exponentially; state laws have kept pace. More laws, however, have gone hand in hand with an explosion of violent crime. Is anyone in Washington paying attention?

Taking Aim at HMOs

The common threads that link tobacco and gun litigation have predictably resurfaced in the current spate of suits against HMOs. Start with a friendless industry. Then attempt to redress the industry's perceived misbehavior by enacting remedial legislation. When the legislature resists, find a cadre of smart, unprincipled contingency fee lawyers who are willing to champion flawed legal theories to extort money from, or compel "better" conduct by, the wayward industry. Next step: sue, preferably as a class action in one or more states known to be sympathetic to plaintiffs. After judges rightly dismiss, or juries reject, one private lawsuit after another, bring in the big guns from the public sector. Procure local, state, or federal officials to threaten the industry with bogus claims in as many jurisdictions as possible. The rest is relatively easy. Announce your settlement terms and wait for the industry to cave.

That's roughly what's happening in the HMO arena. At the outset, HMOs aren't going to win any popularity contests. In part, that's because consumers feel they have little recourse when an HMO treats them badly. Most courts have held that HMOs and other managed care organizations (MCOs) are responsible for the actions of their employees but not those of independent contractors, and MCOs typically contract with physicians rather than employ them. Yet a doctor who depends on MCOs for patients may well fear "deselection" if his medical decisions are thought to impede the MCOs' cost control objectives. That leaves the physician exposed to a malpractice suit while the MCO, which may have exerted considerable influence over the disputed decision, is legally insulated from liability.

Like so many other inequities, the MCO liability problem can be traced directly to ill-advised legislation. Originally, Congress was receptive to arguments that increased liability for MCOs would translate to higher medical insurance premiums, which would end up lining the pockets of trial lawyers or deterring employers from offering health coverage. So far, so good. But instead of pressing their respective states to enact tort reform—about which more in a moment—our federal legislators decided to preempt the states from enforcing liability laws that would ordinarily apply to MCOs. ERISA was the vehicle; it largely limits insured employees to suits in federal court and provides no remedy for denial of treatment, other than eventual provision of the benefits promised under the plan. Thus, an employee cannot recover lost wages, pain and suffering, or even additional medical expenses incurred as a result of wrongly vetoed or delayed coverage.

Congress now realizes that consumers are livid. Still, it dithers at shrinking the power and autonomy that it granted to HMOs. The Senate and House have competing managed care bills, and members are polarized over where, whether, and to what extent patients should have the right to sue. Naturally, a wavering Congress opens the door for contingency fee lawyers, who have reinvented themselves as a quasi-legislature bent on effecting those polices that the real legislature has spurned and, in the process, snatching a big part of the lucre as their reward.

At least 16 class action suits against MCOs are pending, most filed by the same lawyers who won fat settlements from the tobacco industry. The Washington Post reports that "much of the litigation is being orchestrated from a suite of offices in downtown Atlanta, where a collection of plaintiffs' lawyers from a number of states have established what they call a ‘law firm of law firms' . . . funded primarily by lawyers who were awarded huge fees in the tobacco litigation." Those lawyers will proffer what one of the founding partners calls a "gumbo" of legal arguments, several of which have no more solid foundation than the tobacco and gun claims that spawned them.

Some lawsuits will push breach of contract; others will contend that HMOs overcharged participants; still others will ask that physicians be reimbursed for pay cuts they took in order to work for HMOs. Another legal concept, breach of fiduciary duty, is intended to skirt the proscriptions in ERISA against standard contract and tort claims. If that theory survives, employer-based health care is unlikely to endure. Managed care simply cannot function as a cost containment system if every treatment choice is regarded as a fiduciary decision.

Then there are two novel allegations: first, deceptive advertising of high medical standards without telling consumers that financial incentives could undercut those standards; second, discrimination under the Americans with Disabilities Act against physicians who run up big bills by treating the chronically ill and disabled. And if none of the above passes muster, trial lawyers will trot out their standard RICO claim, including treble damages, for engaging "in a nationwide fraudulent scheme" to mislead the public. Last, to be absolutely certain that no MCO can afford not to settle in the face of an avalanche of litigation, the public sector in multiple jurisdictions will join the fray with equally fishy theories. Attorneys general in Connecticut and Missouri have already weighed in with separate suits against MCOs.

That's the new litigation paradigm, born in the tobacco suits, adapted to the gun industry, and now extended to fleece the HMOs. But there is one notable difference. Although tobacco companies should not be accountable for voluntary assumption of risk by smokers and gun makers should not be liable when their legal product is misused by violent criminals, HMOs should be held responsible for their own dereliction—typically refusal of authorization for a necessary covered treatment. Indeed, according to a growing number of federal courts, if an HMO employs a physician or exercises substantial control over the physician's medical decisions, then an injured patient may sue both the physician and the HMO for negligence, notwithstanding ERISA. That same right is ordinarily not extended if the case is characterized as a coverage decision rather than a medical decision.

By weakening the immunity otherwise available to HMOs, federal judges might be contributing to the demise of managed care. That would be unfortunate from a cost control perspective. On the other hand, the right to recover foreseeable consequential damages—lost wages, for example—as well as pain and suffering and extra medical expenses that are caused by an HMO's negligence should not be sacrificed at the altar of cost control. If the principle of corrective justice cannot coexist with managed care as currently structured, perhaps that incompatibility will serve as the catalyst for needed reforms.

Where Do We Go from Here?

Two of those reforms, although beyond the scope of this article, are worth highlighting; several others are worth mentioning. Reform number one: We must implement medical savings accounts, funded by tax-deferred wages, that pay most routine medical expenses while providing savings for retirement and unexpected future health costs. The idea is for employers and self-employed individuals to buy low-cost, high-deductible insurance to cover catastrophic health problems. The considerable savings in premiums are then invested in an account that belongs to the individual; it accumulates earnings, tax-deferred, that can be used for ordinary, recurring medical outlays or, if unspent, can serve as a retirement fund. Because the patient becomes both a direct buyer and a user of health care, he monitors his expenses more closely, chooses the level of care that he desires, and conserves moneys otherwise spent on processing numerous smaller claims. In short, lower costs, more freedom of choice.

Reform number two: Courts must limit tort law to resolving disputes over injuries between strangers, who have no opportunity to assign liability in advance. Whenever individuals or businesses are able to bargain—either directly or through an intermediary—and they agree to terms that govern their relationship, constrain their conduct, and define the remedies if someone misbehaves, it is essential that courts honor the private deal. Today's torts "crisis" is due in major part to the rejection by courts of the terms and conditions to which parties have agreed, explicitly or implicitly, in their transactions with one another. If a court imposes its own standard of care and refuses to enforce express or implied contractual terms, especially in cases like medical malpractice where health providers and their customers can negotiate up-front, that refusal is an affront to personal autonomy and individual responsibility.

Finally, here are a few other laudable reforms, the details of which have been discussed elsewhere.

  • First, dispense with joint and several liability, the "deep-pockets" rule that permits plaintiffs to collect all of a damage award from any one of multiple defendants, even if the paying defendant was responsible for only a small fraction of the harm.


  • Second, eliminate punitive damages for accidents due to ordinary negligence. Punitive damages, which are intended for punishment and deterrence, should be granted only for intentional injuries or extraordinarily reckless conduct.


  • Third, where the government is the plaintiff and loses, require that it pay the defendant's attorneys' fees. That will discourage state-sponsored coercive lawsuits that are not firmly grounded in substantive law.


  • Fourth, make contingency fee contracts between government entities and private attorneys illegal. We must not let the sword of the state be wielded by those who have an incentive to increase the severity of punishment.


  • Fifth, expand the jurisdiction of federal courts over class actions. At present, state claims may not be litigated in federal court if any plaintiff is a citizen of the same state as any defendant. That rule encourages forum shopping to find friendly state judges. A better rule, proposed by Rep. Henry Hyde (R-Ill.), would allow the defendant to transfer most class actions to federal court if any member of the proposed plaintiff class is a citizen of a state different from any defendant.


  • Sixth, when government sues to recoup costs paid on behalf of another person, it should have no greater right to recover than that person would have if he were to sue directly. Sen. Mitch McConnell (R-Ky.) has introduced such legislation, which, however, should be limited to federal causes of action. Each state should then enact comparable legislation of its own.

Most important, the American public—prospective voters and jurors—must be warned that our tort system is rapidly becoming a tool for extortion by a coterie of politicians and trial lawyers. Sometimes they seek money; sometimes they pursue policy goals; often they abuse their power. Take it from former labor secretary Robert Reich, certainly not known for his opposition to imperious government. Reich tells us that his former boss in the White House "is launching lawsuits to succeed where legislation failed. The strategy may work," Reich adds, "but at the cost of making our frail democracy even weaker. . . . This is faux legislation, which sacrifices democracy to the discretion of administration officials operating in secrecy."

Reich has it just about right. But the problem extends further than the White House. It infests most of the statehouses and many city halls. Like most infestations, this one can be fumigated. To do so requires awareness, good sense, and political will. Not to do so profanes the rule of law and debases personal freedom. When we condone the selective and retroactive application of extraordinary legal principles, intended specifically to transfer resources from disfavored defendants to favored plaintiffs—or indeed to the public sector—we substitute political cronyism for fundamental fairness, make a mockery of justice, and trample on our precious liberty.

This article originally appeared in the March/April 2000 edition of Cato Policy Report.

<em><a href=”/people/robert-levy”>Robert A. Levy</a> is chairman of the Cato Institute’s board of directors.</em>