Can market competitors police false ads better than class actions?

June 13, 2014

Companies should not mislead consumers about their products. Some do anyway. Those companies should be held accountable for their deception, not only because they lied but also to deter other companies from lying.

No one can seriously dispute any of these points, but what is the most effective way to stop businesses from deceiving consumers? We have state and federal regulatory agencies, of course, but regulators would be the first people to tell you that they can’t police every advertisement, label and package put out by businesses selling products to American buyers. That’s why state consumer protection laws give customers the rights to bring their own cases — except that, as a practical matter, individual consumers don’t really drive litigation against corporations that supposedly deceived them. Class action lawyers do, because they can represent buyers whose individual claims wouldn’t otherwise be worth pursuing.

Consumer class actions over deceptively advertised low-cost items are a remarkably inefficient vehicle for assuring the integrity of the consumer marketplace. Here, again, there’s really no legitimate argument to the contrary. I don’t mean to impugn the intentions of class action lawyers. Most (though not all) of them are prosecuting legitimate cases on behalf of consumers they truly believe to have been deceived by false corporate advertising. They force defendants to change misleading labels, ads or packaging and to agree not to use the deceptive material again. They also sometimes deliver money unclaimed by class members to charities, usually ones involved in righting the alleged wrongs in the case.

On the other hand, plaintiffs lawyers are awarded fees based on the size of the settlement they obtain, which is an incentive to sue deep-pocketed companies, but not necessarily the most egregious offenders. Class actions are procedurally complex, so they eat up a lot of judicial time. And in the end, an infinitesimal number of consumers end up with cash compensation for being snookered. There’s scant empirical data on claims rates in class actions over low-cost items, but in a recent declaration in a suit involving false advertising allegations against Duracell, a claims administrator said that the median claims rate across hundreds of cases in which purchasers received indirect notice — which is how consumers find out about most settlements involving low-cost items — was .023 percent. That means that for every 4,350 purchasers of an allegedly deceptively advertised product, one person actually filed a claim for compensation.

Proponents of consumer class actions argue that their most important benefit is something that can’t be calculated: They scare corporations straight. No business wants to spend money paying its own lawyers to defend a class action, and then paying lawyers for the class through a settlement. That’s a good argument, especially because it’s impossible to refute. We’ll never know how many companies thought better of a misleading label because it was worried about defending a class action.

Here’s where I’m going to make a lot of class action lawyers angry. I believe there’s a more efficient way — thanks to a pair of rulings this term from the U.S. Supreme Court — to achieve the same deterrent benefit, as well as the same injunctive relief, that successful class actions deliver. What if we relied on corporations to police their competitors’ advertising and packaging and sue for deceptive ads under the federal Lanham Act?

The Lanham Act protects trademarks, but it also has provisions permitting competitors to sue one another over supposedly false advertising. In March, in a case called Lexmark International v. Static Control, the Supreme Court widened the range of plaintiffs who can sue under the Lanham Act. Consumers still can’t bring these cases against their alleged deceivers, wrote Justice Antonin Scalia for a unanimous court. But if the supposedly false advertising injured another company’s “commercial interest in reputation or sales,” the court said, that company has standing to sue, even if it’s not a direct competitor. On Thursday, the court issued a second Lanham Act opinion, Pom Wonderful v. Coca Cola. In the Pom case, the Supreme Court held unanimously (with Justice Stephen Breyer recused) that the Food, Drug and Cosmetic Act does not preclude Lanham Act suits involving businesses regulated by the U.S. Food and Drug Administration.

Taken together, the Lexmark and Pom Wonderful rulings give the marketplace considerable power to regulate itself. I talked Friday about the decisions with Edward Rosenthal of Frankfurt Kurnit Klein + Selz, who pointed out that competitors frequently conduct market research on one another’s advertising and labeling, so they’re already well positioned to bring suits if — like Pom Wonderful in the Coke case or Static Control in the Lexmark case — they believe consumers are being misled. “Competitors dive deep into the weeds, using all the resources private parties have,” Rosenthal said. “From the point of view of consumers, private Lanham Act litigation is a way to get better labeling.”

Fee-shifting is very rare in Lanham Act false advertising cases, Rosenthal said. That’s a quality control: A competitor presumably won’t spend the money to prosecute a frivolous claim. And because, according to Rosenthal, most Lanham Act false advertising cases end at the injunction stage, which determines whether the supposedly deceptive ad or label is prohibited or can continue to appear, the suits are much less of a drain on scarce judicial resources.

I ran my theory past Brian Wolfman, a law professor at Georgetown and longtime consumer rights public interest lawyer. He pointed out the big unknown: Will corporations really sue one another for deceiving consumers? In many instances, Wolfman said, an entire market sector is engaged in the same sort of consumer deception, so purchasers can’t rely on competitors to end the false claims.

“I’d like to see some research on Lanham Act suits — how many are there? What do they look like?” Wolfman said. (He added that he believes in the value of consumer class actions over low-dollar products but thinks judges need to do a better job watching over class counsel.)

The vast majority of consumers, as we see from the minuscule claims rates in class actions, don’t care much about the few dollars they’re entitled to in these cases. They just don’t want to be deceived. I’m laying down a challenge to corporations: If you want to serve your customers, make sure your competitors aren’t lying to them.

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