In November 1998, Rhode Island was part of a historic settlement with the tobacco industry to pay for the health care costs of smoking that would keep the 46 states involved flush with cash for decades to come.
The state has received more than $1 billion in total tobacco payments since 1999, with annual payments continuing in perpetuity, based on cigarette sales moving forward, according to the R.I. Office of the Attorney General.
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But for Rhode Island and eight other states that wanted to get more of the money upfront, the windfall comes with a potentially devastating fiscal downside in future years – billions of dollars in bond debt.
Today, another potentially big settlement looms for Rhode Island and every other state except Nebraska and Michigan, the lone holdouts from lawsuits accusing pharmaceutical companies of covering up and downplaying the addictive effects of opioid medications. And that’s not including about 1,800 other lawsuits by individual cities and counties nationwide.
Although it’s too soon to tell how the opioid litigation will play out, some of the defendants have indicated a willingness to settle.
Even if that happens, however, it’s no sure thing the state and local municipalities will see a windfall – or make good decisions on how to spend it if they do.
While the tobacco settlements can be considered the “granddaddy” of them all, Rhode Island has seen mixed results from such lawsuits involving government officials going after Big Business in the name of the public’s welfare.
A 1999 lawsuit by Rhode Island accused makers of lead paint of knowing it was dangerous, especially to children, and covering up the risk. The litigation ended in 2008 with the state losing the case, though a few million dollars for lead paint removal and related efforts were recovered from some companies in the process.
More recently, a 2012 settlement with Google Inc. netted five Rhode Island law enforcement agencies $230 million for their roles in exposing online ads from Canadian pharmacies illegally selling prescription drugs to Americans. Much of the money went to fund law enforcement pension plans and new police facilities, equipment and programs, though concerns about oversight over some of the spending prompted lawmakers this year to require General Assembly approval going forward.
“It’s good to use [settlement] money to pay down state debt,” said Gary S. Sasse, director of the Hassenfeld Institute for Public Leadership at Bryant University and former director of the R.I. Department of Revenue. “You have to look at what the situation was at the time [the money was spent] … but anytime you use one-time revenue to meet budget obligations, it’s problematic.”
Rhode Island has done both with its settlement money, he says.
“If the state uses [a settlement] to finance a structural deficit in the budget,” he added, “it’s like pulling a rabbit out of a hat” to resolve a recurring issue.
COSTLY WINDFALL?
Rhode Island is one of nine states that set up corporations to get more of the tobacco-settlement money upfront by selling bonds backed by their future tobacco payments. The resulting bond-obligation payments are projected to balloon into tens of billions of dollars over the next 20 to 30 years, including about $2.5 billion in Rhode Island.
Rhode Island created the Tobacco Settlement Financing Corp. in 2002. In doing so, it turned over rights to the state’s future tobacco-settlement money to the corporation. The corporation’s stated purpose was to sell bonds, which would be repaid with the state’s future tobacco payments. However, the debt attached to those bonds – the amount owed to private investors as the bonds mature – will far exceed the amount raised upfront from the sale of the bonds.
Meanwhile, the proceeds of the bond sales have been spent – put into the state’s general fund for five fiscal years, in addition to a lump sum to pay down state debt and for assorted other purposes. However, the debt hasn’t gone away. When the last of the bonds mature in 2052, bondholders will be owed more than $2.5 billion, according to an independent 2018 auditor’s report obtained by Providence Business News. What will happen then is anyone’s guess.
Thomas Mullaney, executive director of the R.I. Office of Management and Budget and the Tobacco Settlement Financing Corp.’s chairman, confirmed the $2.5 billion figure and says it’s likely there won’t be enough money to fully repay tobacco bondholders on schedule.
Mullaney says bondholders will just have to wait to get all their money because they won’t have any other recourse. The way the corporation was set up, he says, the state cannot be held liable for the corporation’s debts. He said investors were fully aware of that when they purchased the bonds years ago.
“I’m not a lawyer, but there’s a statement on the bond documents that the state is not liable,” he added, so he doesn’t think the state made a mistake.
But Jim Estes, a professor of finance at California State University and formerly an arbitrator for the Financial Industry Regulatory Authority, thinks Rhode Island and the eight other states did make a potentially costly mistake.
Estes has studied how states have used the tobacco-settlement money. He told PBN that the buyers of the tobacco bonds are powerful financial institutions and wealthy individuals unlikely to be willing to wait and hope their investments pay off someday.
As payouts to the tobacco bondholders eventually dry up, Estes says, they are likely to challenge the idea that the state cannot be held liable for the Tobacco Settlement Financing Corp.’s debts. They could argue it functions as a shell corporation, is managed by state officials and the state is its primary beneficiary, he says.
If bondholders win that argument in court, Estes added, the affected states could face a tremendous financial crunch.
“The ownership of these bonds rests primarily with banks and mutual funds,” he wrote in a 2014 opinion piece in The New York Times. “These institutional investors are betting that the states will step in and bail out these bonds with some combination of all future settlement payments and taxpayer dollars. The idea is that the states won’t risk the stigma of a default and will protect their relationships with the institutional investors and the bond brokers who also handle their municipal bonds. They will do this by sticking future taxpayers with the bill.”
In Rhode Island, the Tobacco Settlement Financing Corp. has had three major bond offerings, raising $685.4 million in 2002, $197 million in 2007, and $620.9 million in 2015. The 2015 bond sales were mainly used to pay off investors in the 2002 bonds, Mullaney said.
Minus money set aside for debt service, interest payments and other purposes, as well as banking and transaction fees for bond brokers and related services, the state received roughly $775 million from all the tobacco bond proceeds, according to figures supplied by Mullaney.
Of that total, about $420 million went into the state’s general fund for fiscal years 2002, 2003, 2007, 2008 and 2015. About $295.5 million was used to pay down state debt. About $26.3 million went into an “information technology” investment fund; $22.2 million went into a “pay-go” fund for capital costs; about $6.4 million went into a state revolving loan fund; and $5 million went into a municipal road and bridge fund.
So far, Mullaney said, the corporation has paid out roughly $300 million to bondholders, mainly debts from the bonds issued in 2002. It would cost about $731 million for the corporation to pay off all its bond debt now. It currently does not have the money to do that – not even close. According to the independent auditor’s report, initiated by the corporation’s board each year, the corporation’s liabilities exceeded its assets by more than $723 million as of June 30, 2018.
House Minority Leader Blake A. Filippi, R-New Shoreham, doesn’t think the state should be held liable for the corporation’s debt.
“It’s a quasi-public debt that’s not backed up by the full faith and credit of the people of Rhode Island,” he added. “If Wall Street tries to prop that [issue] up by threatening the state’s credit rating, I say we call their bluff.”
‘HEARTBREAKING’
Following the model of the tobacco litigation, then-R.I. Attorney General Sheldon Whitehouse, now the state’s junior U.S. senator, filed a lawsuit against lead paint makers in 1999 that was the first of its kind. Whitehouse, a Democrat, alleged the paint companies marketed and sold lead-based paint with “full knowledge” that it was toxic. He estimated the costs of treating lead-poisoned children and removing such paint from buildings around Rhode Island would be in the hundreds of millions of dollars.
The case went to trial in 2002 and ended with a hung jury. In 2007, another jury ruled the paint companies were responsible for the effects of lead paint before it was banned in 1978. In 2008, however, the R.I. Supreme Court reversed the ruling and tossed out the lawsuit, stating the case “should have been dismissed from the outset.”
“It was a heartbreaking day,” Whitehouse said about the court’s decision.
He recalled how Rhode Island’s lawsuit faced a barrage of editorials by some leading news outlets around the country he says were hostile toward the state’s position. Although Rhode Island ultimately lost the case, he says it was at least partially vindicated last year when California’s Supreme Court ruled in favor of similar lawsuits against lead paint makers.
In the years since the Rhode Island case, he added, there have been lead paint remediation efforts around the country, though they often have been funded by taxpayers, rather than the paint industry.
PENSION FIX
In the Google settlement, five Rhode Island law enforcement agencies joined the federal government in an investigation that found Google allowed Canadian pharmacies that illegally imported drugs into the United States to advertise on its “Adwords” platform.
As a result, Google ended up forfeiting $500 million in 2012. Of that, $270 million went to the federal government and the remaining $230 million was divided among the state attorney general’s office, the East Providence Police Department, the R.I. National Guard, the North Providence Police Department and the R.I. State Police.
East Providence Chief of Police William Nebus said his department received about $60 million of the Google money. Nearly $50 million was placed into the department’s pension fund. About $1 million was used for building improvements to the department, and the rest was spent on equipment and related purchases, including about $400,000 for an armored SWAT truck – something the department had not had before.
In the year and a half since the truck arrived, the chief said, the department has used it regularly for training exercises and has taken it out on actual calls once or twice. If a serious situation arises, he added, it’s good to know the truck is available.
“Has it ever been shot at? No,” the chief said about the SWAT truck. “It’s like the police vehicle used in that Orlando nightclub shooting [when a gunman killed 49 people and wounded 53 others in 2016]. The police used it to poke through a wall.”
Nebus said the department’s pension fund doubled in size to about $100 million from the Google settlement, easing the city’s pension-payment obligations. Today, several years later, the fund stands at about $133 million.
MORE SCRUTINY
The Google settlement also indirectly led lawmakers this year to require more scrutiny of how future settlement money is used.
The General Assembly last month included a provision in the fiscal 2020 state budget to place settlement money obtained through the attorney general’s office in a restricted account – with expenditure of those funds now subject to the annual appropriation process and approved by the legislature.
The House Republican Caucus, which spearheaded the provision, called it “a victory for the Rhode Island taxpayer.” The caucus said it pushed for the change after receiving resistance from the attorney general’s office when it sought information on how it used its $60 million share of the Google settlement.
“Settlement monies are obtained through the diligent efforts of resourceful state employees, whose positions are funded by state tax revenue,” said Filippi. “As a result, while many of these settlement funds have restricted use, it is time for proposed expenditures to receive the same scrutiny as all other expenditures in state government through General Assembly oversight.”
This year, the attorney general’s office also unsuccessfully sought extra state funding from the General Assembly to add staff who would exclusively handle multistate initiatives such as the tobacco settlement and the current opioid litigation, Filippi added.
Kristy dosReis, a spokeswoman for Attorney General Peter F. Neronha, refuted the claim that the attorney general’s office resisted inquiries to release the details of how it spent its share of the Google settlement.
“This administration has been fully transparent with the General Assembly regarding the expenditure of those funds,” dosReis wrote in an email to PBN, adding that the information was included in the office’s 2018 annual report.
The report highlights line-item spending of $51.7 million on building construction, renovations and a purchase, along with technology upgrades and other expenses, but does not explain why each was needed.
Scott Blake is a PBN staff writer. Contact him at Blake@PBN.com.
