By striking

down the

Food and Drug Administration's

ability to regulate and possibly ban tobacco, the

U.S. Supreme Court

cleared a path Tuesday for negotiations on moderate controls, including limits on nicotine levels and laws against marketing cigarettes to children, analysts said.

But winning the regulatory battle does nothing to temper the threat of an outstanding class action lawsuit that could devastate the companies financially, and tobacco investors showed only cautious optimism after the decision.

Shares of

Phillip Morris

(MO) - Get Report

, the maker of the Marlboro brand, gained 3/8, or 2%, to close at 20 5/16, while shares of

RJR Tobacco Holdings

(RJR)

, maker of the Camel and Winston brands, gained 9/16, or 3%, to close at 17 1/16.

"The FDA regulation issue was by far the most dangerous and catastrophic had it gone the other way," said Roy Burry, analyst for

Brown Brothers Harriman

. "Establishing the FDA authority is sort of a back-door way of banning tobacco." Burry rates both RJR and Phillip Morris shares a buy. His firm has not done equity underwriting for either company.

Until 1996, the FDA maintained that it could not regulate tobacco as a drug because cigarette makers did not claim their products provided health benefits. But it changed that policy, citing evidence that nicotine is addictive.

Fearing their product would be banned, tobacco companies sued, and the

U.S. Court of Appeals for the Fourth Circuit

in Richmond, Va., ruled in 1998 that the FDA did not have the authority to regulate tobacco. The Supreme Court upheld that ruling Tuesday.

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When the case reached the Supreme Court last year, tobacco lawyers made the extraordinary argument that the government would be forced to ban tobacco if it were classified as a drug.

To make the point, the industry's lawyers successfully borrowed the FDA's argument that the product is dangerous.

The court's acceptance of that argument "takes the gavel out of the hands of people who just want to raise the price of cigarettes until they go away," said Marc Cohen, analyst for

Goldman, Sachs

. "The very extreme critics of this industry now have a choice. They can hold progress hostage. It's up to the

Clinton

administration and frankly to

Vice President Gore

to decide whether progress is going to be made." Cohen rates RJR shares market outperform and recommends Phillip Morris shares for purchase. His firm has not done equity underwriting for neither company.

Cohen said the industry showed its willingness to compromise on March 3, when Steven Parrish, senior vice president of Philip Morris, told a conference on addiction in California that the industry would accept regulations on the composition and nicotine levels of cigarettes and on marketing to children.

But tobacco industry critics quickly expressed distrust of the cigarette companies' motives.

"We're clearly disappointed" by the Supreme Court's decision, said Roger Salazar, a spokesman for the

American Cancer Society

. "That doesn't change the need for FDA regulation. The key now is for

Congress

to pick up that ball."

The industry has not put forth specific proposals on more moderate regulations, he said.

"These are the folks that first said it wasn't dangerous," Salazar said. "Now they've come back and said it's too dangerous to regulate. We have learned to be cautious about what we call their Trojan overtures until the day when their actions match their rhetoric."

In a statement Tuesday, Philip Morris said it is "ready and eager to engage in a useful, positive discussion." The company said regulation of cigarettes could include actions designed to reduce youth smoking, oversight of ingredients, government-led efforts to define reduced-risk cigarettes and requirements to expand warnings to smokers.

With the FDA debate swept aside, "more than anything, the market is focusing on

Engle

," said Burry, the Brown Brothers analyst. Jurors in that Florida class action lawsuit ruled that cigarette makers produce a defective and deadly product. They are considering damages that lawyers say could exceed $300 billion. If the penalty is that large, and if it is actually enforced and paid, it would come in a lump sum, hurting the companies more than the annual payments required in a $206 billion settlement reached in November 1998 with state attorneys general, analysts said.