(FORTUNE Magazine) – In June 1996, New York Times columnist Bob Herbert wrote a pair of tough op-ed pieces accusing Nike Corp. of cruelly exploiting cheap Asian labor. He chided CEO Philip Knight, whose Nike stock was then worth $4.5 billion, for making fabulous profits on athletic shoes that were allegedly being manufactured by sweatshop laborers earning $2.20 a day in Indonesia or $30 a month in Vietnam. He contrasted those pittances to the $20 million a year Nike was then paying basketball legend Michael Jordan to promote its products and to Knight's own $1.6 million salary and bonus for fiscal 1995. "Nike executives...are not bothered by the cries of the oppressed," Herbert wrote. "Each cry is a signal that their investment is paying off."

A few days later CEO Knight replied in a letter to the editor, which the Times promptly published. "Nike has paid, on average, double the minimum wage as defined in countries where its products are produced under contract," Knight parried. "History shows that the best way out of poverty for such countries is through exports of light manufactured goods that provide the base for more skilled production."

Point. Counterpoint. The marketplace of ideas in action. Whoever you think got the better of this exchange, we can all agree that it was a tiny epitome of the robust, uninhibited debate that is so vital to our democracy, and that we are all privileged to engage in under the First Amendment.

But we'd all be wrong, according to a recent ruling of the California Supreme Court. While Bob Herbert's half of the argument was fully protected by the First Amendment, Knight's rebuttal, it turns out, was not. Since Knight was ultimately interested in persuading consumers to continue to buy his products, that court ruled this past May, portions of his letter were actually what's called "commercial speech," which enjoys much less constitutional protection than ordinary public discourse. Commercial speech is what companies engage in when, for instance, they tout their products in paid advertisements or on labels and packaging--describing them as, say, "low fat" or "chocolatey" or "new and improved." Unlike political speech, commercial speech can be, and routinely is, closely regulated by the government, most typically by the Federal Trade Commission. You can be sued over commercial speech if someone thinks it's false or misleading, and punished if the judge or jury sides with your adversary.

In April 1998, a San Francisco community activist named Marc Kasky did sue Nike, alleging that Knight's letter violated California's broad consumer protection laws against deceptive advertising and unfair business practices. The complaint also alleged that Nike officials had made false or misleading statements on at least eight other occasions in the course of responding to criticisms of its Asian labor practices: in five press releases, two personal letters to critics, and one form letter sent to scores of athletic directors at colleges and universities. Two lower courts dismissed the case, but on May 2, 2002, the California Supreme Court reinstated it, ruling four to three that all of these communications counted as commercial speech.

What does that mean in practice? It means that if Knight had any of his facts wrong in his letter--or even if he got them right but left a misleading impression in the view of the judge who will eventually sit in judgment on Knight's choice of words--then Nike loses the suit. Indeed, Nike loses even if Knight is found to have made the inaccurate or misleading statements unintentionally, since the consumer protection laws don't require malice. If Nike does lose, it can then be forced to cough up any profits it made in California that are attributable to the misleading statements; ordered to conduct a publicity campaign to correct the misimpressions those statements left; and required to pay Kasky's attorney fees.

What does Kasky have to do with any of this? Nothing, really. With refreshing candor his complaint acknowledges that he "alleges no harm or damages whatsoever regarding himself individually." But under the unusual terms of the California consumer protection laws, which encourage private citizens to ferret out corporate wrongdoing, "any person" can bring such a suit on behalf of "the general public." So Kasky did.

Relieved your company isn't based in California? Neither is Nike! Its headquarters are in Beaverton, Ore. Essentially, every big company is on the hook.

"The threat from the California decision is real and immediate," says Walter Dellinger, a First Amendment scholar and former acting solicitor general whom Nike has hired, along with Harvard Law School heavyweight Laurence Tribe, to try to persuade the U.S. Supreme Court to hear and overturn the case. "If your communication is received in California," explains Dellinger, a partner at O'Melveny & Myers, "and you're doing business there--which means every FORTUNE 500 company--you have to immediately worry, right now, about any public statements you make about your company's practices." Does your company, for instance, profess good corporate citizenship on its website while omitting facts that, in the opinion of its sharpest critics, are necessary to present a fair picture? Has your company ever distributed press releases setting out its position concerning a labor dispute or a government inquiry or a private lawsuit filed against it alleging, perhaps, antitrust violations, environmental wrongdoing, mass tort liability, securities improprieties, or discrimination on the basis of sex, race, age, or disability? Then you are no mere spectator here; you are in the cross hairs.

The good news for corporate executives is that several First Amendment scholars and practitioners think there is a good chance the Supreme Court will take the case and reverse. The bad news is that such an outcome is hardly assured, since the case is closer than it might look at first glance. Drawing a bright line between commercial speech and fully protected public discourse turns out to be exceedingly difficult.

"Say you go into Niketown," hypothesizes Alan Caplan, the San Francisco lawyer who brought Kasky's suit, "and Nike hands out a leaflet that says, 'We pay double the minimum wage in our factories, there's no dangerous chemicals in our factories, there's no forced overtime in our factories, and we comply with all local laws.'" Such fliers would clearly be commercial speech in that context, says Caplan--and though it's not crystal clear, he's probably right. "Now, suppose...48 Hours calls [Nike] on it...and says, 'We sent people [abroad] and that's not true.' Now, under Nike's interpretation of the world, they can say whatever they want.... Now they can lie because it's a public debate.... The First Amendment never contemplated that, ever."

In fact, given that Nike was periodically being threatened with boycotts because of its Asian labor practices, wasn't the California court plainly correct in concluding that Knight's goal in writing to the Times was a patently commercial one: keeping sales up? "They're not solving the great moral dilemmas of the world," says Caplan. "They're trying to sell you a pair of shoes."

Caplan's view is no mere self-serving, outre position. Briefs supporting Kasky's lawsuit were submitted not only by labor and environmental groups, who want to be able to police corporations' boasts of social responsibility, but also by the California attorney general and the San Francisco district attorney, who routinely bring consumer protection suits.

You can see why Nike has called upon professors Dellinger and Tribe--Michael Jordans of constitutional law--to argue their case before the U.S. Supreme Court. This case is no slam-dunk.

Did Nike lie?

The ultimate question--Did Nike really mislead consumers about its labor practices?--is legally irrelevant at this stage. The Supreme Court need only decide whether, even if Kasky's allegations were true, Nike is protected by the First Amendment.

But the rest of us are free to probe the ultimate question. Since Kasky hasn't begun the legal fact-gathering process--his suit is on hold until the constitutional question is settled--he doesn't know the answer. His complaint is based simply on a comparison of Nike's own descriptions of its labor practices with information published by third parties--labor activists, human rights workers, journalists--who claim to have inspected factories run by Nike's contractors. If the third-party accounts are accurate, they do cast doubt on the candor of some of Nike's statements. And some of those third-party reports have considerable credibility. One, for instance, is a 1997 labor audit, commissioned by Nike itself, of a Vietnamese factory. The audit results were leaked to the press. (Nike general counsel James Carter declines to comment on any of Kasky's allegations other than to deny them in a blanket fashion.)

From the time Phil Knight co-founded Nike's predecessor company in 1964, his plan was to compete with the then-dominant footwear brands, such as Adidas, by designing and marketing shoes that could be manufactured more cheaply by contractors in Asia--at that time, in Japan. In the 1970s, as the Japanese labor market matured, Nike tapped cheaper Taiwanese and Korean contractors, and over time those contractors opened factories in still less developed countries, including Indonesia, Thailand, mainland China, and Vietnam. As of 2001, contractors and subcontractors were making Nike footwear at 68 factories in 12 countries.

In the early 1990s, Nike began receiving criticism for sweatshop conditions at its contractors' factories. The company responded by becoming one of the first American corporations to publish a code of conduct--a statement of aspirational goals its contractors were supposed to live up to--and requiring contractors to "certify" that they were complying with local minimum-wage laws, overtime regulations, child labor laws, occupational safety and health rules, and other requirements designed to guarantee a humane workplace.

In subsequent years, whenever Nike was criticized for conditions at one of its factories, it referred to its contractors' certifications of compliance with the code of conduct and insisted that it was doing everything it could to ensure enforcement. It claimed to have employees in Asia engaged in "daily observation" of subcontracted factories, monitoring compliance, and said it periodically ordered unannounced Ernst & Young labor audits to be performed at contracted factories.

Though the company clearly did order occasional audits, its claim to have had staff members monitoring code compliance on a "daily" basis seems questionable. The leaked 1997 Ernst & Young audit--of a large Vietnamese factory that had been doing contract work for Nike since 1995--found that concentrations of the toxic chemical toluene in certain units was "six to 177 times" local allowable limits. Forty-eight of the 50 employees interviewed were working longer hours than local laws permitted. Forty of the 50 had never read the Nike code of conduct, and many did not know what "Nike" was.

Knight's claim in his letter to the Times--that Nike subcontractors "have paid, on average, double the minimum wage"--appears to be an allusion to figures explained in a 32-page response to critics that Nike had issued that March. There Nike said it had surveyed the average monthly wages at 20 of the 35 subcontracted footwear factories it was using in six Asian countries.

Nothing appended to Kasky's complaint directly contradicts those figures. Nevertheless, Kasky maintains that Knight's claim was misleading in light of subsequent third-party reports alleging that certain Nike contractors in Vietnam and China were paying less than the local minimum wage. Moreover, some of Nike's press statements allude to the carefully qualified assertions of its 32-page report in imprecise, shorthand ways that might also be considered "misleading." In Knight's letter to the Times, for instance, he writes that Nike contractors provide "free" meals and health care--when, in fact, according to the report, they only "typically" provide "subsidies for" meals and health care.

"It struck me as false advertising"

In November 1997, Marc Kasky, the former director of a community cultural center in San Francisco, read a story in the New York Times on the leaked labor audit. A jogger and former marathoner, Kasky, now 58, says he had stopped buying Nike shoes several years earlier because of concerns about sweatshops. He had been heartened, he says, when the company adopted its code of conduct. But the revelations of the audit suggested to him that the code had been a sham.

Kasky had sued corporations before to protect consumers' rights, twice alleging false advertising. In one suit he had challenged Perrier's claim that its water was "spring water." In another he took issue with Pillsbury Co.'s labeling vegetables "San Francisco style" when they were harvested in Mexico. Both suits were settled. (Kasky made no money from them.)

When Kasky read about the leaked audit, a light bulb went on. "It struck me as false advertising," he recalls. "The Nike code of conduct is marketing their products. They're marketing it to me under false grounds."

Kasky called Alan Caplan, a friend since 1969 when both were VISTA volunteers in Cleveland. An attorney in a three-lawyer San Francisco firm, Caplan now makes his living largely by bringing consumer suits under California's broad unfair competition and false advertising laws. Caplan thought Kasky had a claim, and as he often does when he takes on an expensive case against a mighty corporation, he brought in as co-counsel corporate America's worst legal nightmare, the class-action specialty firm of Milberg Weiss Bershad Hynes & Lerach.

Kasky's case against Nike didn't strike Caplan as posing a particularly vexing First Amendment question--and it still doesn't. "They can still get up and say whatever they want about globalization," he explains. "They can say, 'Look, wages are lousy, even by local standards, but we think it's okay because in the end, two generations from now, they'll be in the mainstream of wage earners in that part of the world.'" What Nike can't do--at least without subjecting itself to commercial-speech regulations--is make specific false or misleading factual claims about its products and how they're made, he argues. "If you're going to lie, commit a fraud, you can be sued over it," Caplan says. "The principle in this case is not earth-shaking."

In 1942 the U.S. Supreme Court drew a distinction between ordinary speech, which was fully protected by the First Amendment, and many types of business-related speech, which enjoyed no protection at all. Since states were generally entitled to regulate business transactions at will, it followed that they were entitled to regulate the speech that surrounded those transactions, the Court reasoned.

By 1976, however, the majority of the Court had changed its mind to a degree. It decided that some forms of commercial speech should get some First Amendment protection after all, albeit not as much as, say, fully protected political speech. States could no longer entirely prohibit lawyers from marketing their services, for instance. The increased protection for commercial speech was intended not to serve the interests of faceless businesses but to ensure the public's right to receive information from commercial sources.

Originally the Court's definition of commercial speech was narrow: speech that does "no more than propose a commercial transaction." But with the onset of more subtle, varied, and sophisticated advertising techniques, that definition was broadened. Soon courts recognized that commercial speech could include claims not just about products but also about the social responsibility of manufacturers. Since companies had begun advertising their products as "ozone friendly" or "dolphin safe" or "biodegradable" or "made in the U.S.A." or carrying "the union label," courts recognized such claims to be commercial speech.

Gradually some advertising claims were regulated that sounded an awful lot like public discourse. In 1975, for instance, the FTC enjoined an egg industry group from taking out newspaper ads minimizing the connection between eggs and heart disease. A federal appeals court upheld the FTC order, even though the egg industry's messages would have been fully protected by the First Amendment had they been uttered by anyone unconnected to the industry.

To make matters even more confusing, courts also acknowledged that commercial speech was not necessarily limited to paid advertisements, nor, conversely, did messages in paid advertisements necessarily amount to mere commercial speech. In fact, the most famous example of protected speech in First Amendment history--the subject of the Supreme Court's 1964 landmark ruling in New York Times Co. v. Sullivan, in which it found that public figures could sue for libel only if they had been victimized by "actual malice"--involved a paid advertisement taken out by civil rights workers.

As courts lurched from one thorny set of facts to another, both the contours of the doctrine and the reasoning behind it grew murkier. "The commercial speech doctrine is a mess," says professor Robert Post of the University of California at Berkeley's School of Law, one of the country's leading scholars in the area. "The Supreme Court of the United States has not addressed...the boundary between commercial speech and other forms of speech in many, many years, and the existing precedents are extremely vague."

Because of the disarray in the law, some First Amendment practitioners believed that the time was ripe for the high court to hear a commercial speech case even before Kasky v. Nike showed up on its doorstep, all tied up in a bow.

"This could be the most important free speech case since New York Times against Sullivan," says Dellinger, one of the lawyers preparing Nike's Supreme Court petition, which is due in late October. "This case is core speech on a public issue of enormous political, national, and international importance," he says. "And whatever else is true of the law in the area, this has to be protected speech."

Since Nike's critics are unquestionably entitled to full First Amendment protection, Dellinger continues, it simply cannot be that Nike's responses receive less protection. "If there's any inner core of the First Amendment, it would be that the Amendment prohibits the government from weighing in in a fashion that favors one viewpoint over another," he says. "The California decision, if upheld, will have both a chilling and a distorting effect on public debate. The public will be the loser.... The media ...will not be able to present a balanced account of a public controversy if one side of the controversy isn't free to speak out without [risking] substantial sanctions."

Then is Nike licensed to lie? "This case is not about a right to lie," he maintains. "It's about the chilling effect on speech that comes anytime you would face severe penalties if any jury were to find, rightly or wrongly, that your speech had been 'misleading.' One could have said of Times v. Sullivan, 'The newspapers will have nothing to worry about if they just tell the truth all the time.' But...truly free speech can't tolerate the risk of substantial penalties for misstatement--or an erroneous judgment [by a judge or jury] that you have made a misstatement."

Nike general counsel Carter claims that if the California court's ruling stands, spontaneous conversation between reporters and corporate officials over issues of public concern may become a thing of the past. "You'd be reading whatever some lawyers are comfortable allowing out of the company--or nothing at all," he says.

Other corporate CEOs have not been outspoken in publicly supporting Nike's legal position--evidently there's no percentage in getting entangled in another company's public relations fiasco, nor in inviting an inference that you've said something misleading in the past. Still, through intermediaries and surrogates, corporations have been expressing concern. The Product Liability Advisory Council--a group that includes some 132 manufacturers--has endorsed Nike's position in the case (even though the case presents no product liability issues), as has the Council of Public Relations Firms and several pro-business advocacy groups. Perhaps more telling, Nike's position has also been endorsed by the American Civil Liberties Union of Northern California--and even by Times writer Bob Herbert himself. "As much as it pains me to say it," Herbert wrote in a column in May, "I am not in favor of stifling the speech of the loud and obnoxious and terminally exploitative Nike Corporation."

Though Kasky v. Nike seems to present the courts with a dilemma--crippling public debate on the one hand, or licensing marketers to mislead consumers on the other--society may actually have other options. One much-discussed proposal, which CEO Knight has endorsed in principle, calls for requiring corporations to issue audited corporate and social responsibility statements. In such documents, corporations might be required to disclose specified information about, say, their environmental and labor practices, just as they already must disclose specified financial information in their 10-Ks. False statements would be punishable, but in a predictable manner and in accordance with guidelines that everyone would understand beforehand.

That way consumers could have the same confidence in a corporation's assertions about its social responsibility that they currently have in that corporation's earnings statements.

Oops--bad analogy.

FEEDBACK rparloff@nyc.rr.com