Post-Liu, The Whittling Away of the FTC’s Monetary Authority Begins

As reported here (“Did the Supreme Court Just Save the FTC’s Disgorgement Authority,” June 2020), in June the Supreme Court, in Liu v. SEC, saved the Securities and Exchange Commission’s disgorgement authority, permitting it to continue to force securities law violators to cough up their “ill-gotten gains,” but also placed two potentially crippling limitations on that authority. The decision directs lower courts, in applying Liu, to: (1) limit disgorgement to “net profits” rather than sweeping in all revenue to be returned to victims of wrongdoing; and (2) limit a defendant’s disgorgement liability to only its net profits, rather than having “joint and several liability” for the net profits of multiple defendants.

While Liu is an SEC case, its principles arguably apply to other law enforcement agencies which claim to possess equitable monetary remedies such as disgorgement.  One, obviously, is the Federal Trade Commission.  Wasting no time, in a ruling last month, a federal district court has now applied the Liu disgorgement restrictions in a case involving the FTC, and extended its reach beyond disgorgement to restitution, the FTC’s other claimed equitable monetary power.   

In FTC v. Electronic Payment Solutions of America, in federal district court in Arizona (“EPS”), the FTC sued payment processors and their principals for facilitating a fraudulent business opportunity scheme perpetrated by a merchant-client and is seeking equitable monetary relief, including restitution and disgorgement.  Relying on Liu, defendants moved for summary judgment to limit any equitable monetary liability to their “net profits” and to bar joint and several liability for consumer losses.

On the first question, defendants contended that while the FTC styled its monetary claim to include restitution as well as disgorgement, its claim is actually for disgorgement and therefore, as an equitable remedy, is limited to each defendants’ net profits.  The FTC countered that disgorgement is not the sole remedy it seeks; disgorgement need not be limited to an individual defendant’s net profits; and Liu is inapplicable to the FTC because it decided only the question of the SEC’s statutory authority to award equitable relief.

The court resolved the question in defendants’ favor. While the law recognizes that disgorgement and restitution are distinguishable – the former aimed at preventing unjust enrichment and the latter at compensating victims – the court found that restitution and disgorgement operate in the same manner in a “court of equity,” which seeks fairness, not punishment, a conclusion supported by Liu.  Quoting Liu, the court observed that while equity practice has “long authorized courts to strip wrongdoers of their ill-gotten gains…to avoid transforming an equitable remedy into a punitive sanction, courts restricted the remedy to an individual wrongdoer’s net profits to be awarded for victims…. Thus only a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible” under the SEC’s statute. (emphasis added)  In short, a disgorgement order, to be an equitable form of relief, must be “restitutionary,” for the benefit of victims.  Because Liu reached this conclusion by relying on “equity jurisprudence generally, as opposed to relying on SEC jurisprudence specifically,” its holding – that a disgorgement award must be limited to a defendant’s net profits – is not “cabined” to SEC proceedings. Thus, to the extent the FTC is entitled to a disgorgement award, the court held, it must be limited to defendants’ net profits and awarded to victims.  In so holding, the court noted that its conclusion differs from those of two other district courts in the Ninth Circuit, F.T.C. v. Noland (D. Ariz.) and F.T.C. v. Cardiff (C.D. Cal.), which held that Liu is inapplicable to the FTC.

On the question of joint and several liability, defendants argued that under Liu they could now be held collectively liable only if they were “partners engaged in concerted wrongdoing,” an allegation the FTC had not made. The FTC argued that all defendants involved in consumer losses are held jointly and severally liable in the Ninth Circuit and that Liu did not foreclose its ability to seek joint and several liability.  Again siding with defendants, the court said while the Ninth Circuit has broadly held all defendants jointly and severally liable for consumer losses, under Liu joint and several liability is now limited as a permissible form of equitable relief to “partners engaged in concerted wrongdoing.” Again, because the rationale articulated in Liu was not specific to the SEC but was based on common law joint and several liability principles generally, the court held that Liu was equally applicable to the FTC.  Thus, to hold defendants jointly and severally liable for consumer losses, the FTC would be required to prove at trial that defendants were partners engaged in concerted wrongdoing.                  

Because the difference between net profits and total revenue can be so obviously enormous (in EPS, $63,000 vs. $4.67 million), the stakes of post-Liu FTC litigation are enormous.  This ensures that until the Supreme Court directly addresses the question of the FTC’s own equitable authority in the two cases it will hear this term – FTC v. Credit Bureau Center and F.T.C. v. AMG Cap. Mgmt – that squarely present the issue, the applicability of Liu to the FTC will continue to be a hotly litigated issue, as EPS, which came out one way, and two other decisions in the same circuit the other, vividly illustrate.

Relief Defendants Defeat CFPB Claim for Disgorgement

When a law enforcement agency like the Federal Trade Commission or Consumer Financial Protection Bureau seeks disgorgement of “ill-gotten gains” from alleged wrongdoers, and has reason to believe some of the funds were passed to a third party who had no hand in the wrongdoing, it can name that party as a “relief defendant” and seek disgorgement from it as well.  A claim against a relief defendant does not allege liability but only that it is in receipt of ill-gotten gains from a defendant as to which it has no legitimate claim, and thus must relinquish those funds upon a final monetary judgment against the defendant.  To allow otherwise, according to the law, would result in the unjust enrichment of a third-party recipient of illegally acquired monies.    

The legal test of a claim against a relief defendant is whether it has an ownership interest in and legitimate claim to the funds it received from an alleged wrongdoer.  The FTC, CFPB and other enforcement agencies typically plead relief claims quite generally, alleging few if any predicate facts to support an allegation of lack of an ownership interest in and legitimate claim to the funds in question.  This pleading practice was put to the test recently in a case brought by the CFPB against a mortgage lender and student loan debt relief affiliates that were accused of using consumer credit reports in an unlawful way and misleading consumers seeking loan modifications.  In addition to the defendants, the complaint named a number of relief defendants, including two – an investment entity and its owner – who the author represented.  These relief defendants were named because they were investors in the student loan debt relief entities and had received profit distributions in return for their investment.  The CFPB complaint sought disgorgement of those profits.

A claim against a relief defendant that has no ownership interest in the funds, but is a mere custodian, such as a trustee, agent or depository, is straightforward.  As there is no dispute over ownership, the relief defendant merely holds the funds pending the outcome of the case and turns them over to the government at the end if the defendant is found monetarily liable.  It becomes more complicated, however, when a relief defendant credibly asserts an ownership interest in and legitimate claim to funds received from a defendant in return for fair consideration paid for those funds.  In that case, a real dispute exists and the court’s jurisdiction over the relief defendant – who has not been charged with wrongdoing and is before the court only as an alleged possessor of funds with no valid claim to them – is called into question.

In the CFPB case, the relief defendants moved to dismiss the complaint on the dual grounds that it did not adequately allege that they lacked a legitimate claim, and that the court lacked jurisdiction over them upon a factual showing that they had paid valuable consideration for the distributions and thus there would be no unjust enrichment in allowing them to keep the money – even though it was paid from proceeds of alleged unlawful conduct.  The motion further asserted that the pleading deficiency was incurable because the complaint alleged that the relief defendants had limited partnership interests in the student loan debt relief defendants, thus affirmatively admitting their ownership interest in the distributions.  The CFPB opposed, arguing the complaint was adequately pled and the court had jurisdiction over the relief defendants even though they were investors who had paid consideration in the form of capital contributions to the entities, because investors as a class (in contrast to, say, creditors) have no legitimate claim to profits derived from ill-gotten gains – a position for which there is scant support in the law.

Last month, a federal court, in the Central District of California, granted the motion to dismiss on the ground that the complaint was not pled adequately.  It wrote that:

…the Complaint insufficiently alleges that the Relief Defendants lacked a legitimate claim to the profits they received…. The Complaint conclusorily alleges that the Relief Defendants “have received…distributions of profits from the Student Loan Debt Relief Companies that are traceable to funds obtained from consumers through the violations…” and that “[t]hey have no legitimate claim to such funds and would be unjustly enriched if not required to disgorge the funds….” The allegation that the Relief Defendants “have no legitimate claim to such funds” is a bare assertion that lacks adequate factual enhancement.

(Emphasis in original.)

Picking up on relief defendants’ point that the CFPB had made a damning admission, the court reinforced its conclusion by noting that the complaint “affirmatively alleges facts showing that the Relief Defendants have a legitimate claim to the funds, because [they] “owned limited partnership interests in each of the Student Loan Debt Relief Companies….That [relief defendants] were investors in the entities – rather than trustees, agents, or depositories – counsels in favor of granting the motion.”  (Emphasis in original.)

Since the court was able to decide the motion on the pleading alone, it did not reach the jurisdictional question, including the evidentiary showing that relief defendants had made in support of their claim to an ownership interest in and legitimate claim to the distributions.                  

The CFPB was given a chance to replead, which may not be easy given that the court has already found that it has “affirmatively” alleged the relief defendants have a legitimate claim to the funds by virtue of its acknowledgement, in the dismissed complaint, of their limited partnership interests in the student loan debt relief defendants.  In any event, the takeaway for current and future relief defendants and their counsel from the court’s ruling is: do not be afraid to challenge the FTC, CFPB, or other enforcement agencies at the pleading stage if you feel the relief claim is pled too generally, or you were an investor in a defendant or held some other capacity in which you gave consideration for the funds the government is trying to take away from you.  You might just win.  

Did the Supreme Court Just Save the FTC’s Disgorgement Authority?

In March, in “Will the Supreme Court Save the FTC’s Disgorgement Authority,” I wrote about the oral argument before the Supreme Court in Liu v. SEC, which considered whether the Securities and Exchange Commission possesses disgorgement authority over federal securities law violators, requiring them to cough up their “ill-gotten gains.” The issue is of great interest and relevance to the Federal Trade Commission community because of arguable similarities between the SEC’s and the FTC’s statutory schemes and because a case raising a similar question about the FTC’s disgorgement authority, FTC v. Credit Bureau Center, is also before the Supreme Court on a pending petition for certiorari.  What could a decision in Liu potentially mean for the FTC’s own disgorgement powers?  I wrote in March that from the oral argument, it was my judgment that both the SEC and the FTC hade more reason to be optimistic about the outcome than the defendants in the two cases.

This week, Liu was decided.  Was I right?  In boxing terms, the result could be called a split decision.  The SEC has definite cause to be happy because the Court, in an 8-1 decision, upheld its disgorgement authority, and, as I explain, the FTC could have reason to breathe easier, too, over the survival of its own authority.  But the SEC cannot be happy about the limitations the Court placed on disgorgement, and neither can the FTC given the Court’s reasoning underlying those limitations which could apply to its disgorgement power.

While the two agencies’ statutes have some broad similarity, one difference, which potentially disfavors the FTC on the disgorgement question, is that the SEC statute explicitly provides for any equitable relief that may be appropriate or necessary for the benefit of investors,” while the FTC statute only explicitly allows for an injunction and make no mention of other equitable relief.  While Liu interpreted the scope of express equitable relief in the SEC statute to include disgorgement, the decisionseems to rest less on the fact that the SEC’s equitable authority emanatesfrom statute, and more on a conclusion that disgorgement fits within traditional common law equity principles and practice.  The Court’s reasoning in holding disgorgement is compatible with the traditional exercise of equity would seem to apply with equal force whether an enforcement agency is acting under express permission from Congress to seek equitable relief or under a federal court’s historically recognized inherent equitable authority, which the Court majority seemed to reaffirm in its decision (“[u]nless otherwise provided by statute, all . . . inherent equitable powers . . . are available [to the federal courts] for the proper and complete exer­cise of that jurisdiction.”

To be sure, since the SEC’s statute explicitly provides for equitable relief, the issue of the federal courts’ inherent equitable powers was not squarely at issue in Liu, as it would be in Credit Bureau Center or another case the Court might hear addressing the implications of the lack of explicit equitable relief in the FTC’s statute.  Liu therefore by no means forecloses the possibility that the Court could find that the FTC lacks disgorgement authority by virtue of the absence of express equitable relief in its statute.  Given the virtually unanimous Court’s passing nod to the federal courts’ inherent equitable powers in Liu, however, which was not necessary to its decision, should the Court take up the FTC’s disgorgement authority, and should it apply the Liu reasoning, then it seems a decent if not sure guess that the absence of explicit equitable relief in the FTC statute should not prove fatal to the survival of its disgorgement power  as well.        

This is only half the story, though.  While the SEC (and, if my guess is right, the FTC) gets to keep its disgorgement authority, Liu promises to place some real reins on its use.  This is bad news for the SEC (and likely the FTC) since for years the threat and imposition of disgorgement has been one of their biggest weapons of deterrence and enforcement.  While the Court emphasized that its holding is limited to a finding that the SEC possesses disgorgement authority, it signaled in crystal clear terms that its proper exercise is subject to three restrictions: (1) disgorgement limited to “net profits,” allowing for deduction of legitimate business expenses, rather than of all revenue; (2) limitation of a defendant’s disgorgement liability to only its net profits, rather than having “joint and several liability” for the net profits of multiple defendants; and (3) distribution of disgorged net profits to the victims of the wrongdoing, rather than to the federal treasury.

Disgorgement has to be limited to net profits, the Court explained, to ensure that it serves the purpose of equity, which is to restore the status quo and not to punish (“the wrongdoer should not be punished by ‘pay[ing] more than a fair compensation to the person wronged’”).  Past decisions in SEC cases, it said, had violated this equity principle by allowing disgorgement of a wrongdoer’s total take, without deduction of legitimate business expenses.  Unless the “entire profit of a business or undertaking” results from the wrong­ful activity, the Court stated, expenses such as salaries, rent, equipment and vendor payments should be deducted in calculating the disgorgement award.  In an FTC context, this presumably would include as well advertising, marketing, media, fulfillment, customer service and other expenses not directly tied to the alleged unfair or deceptive business practice.  The potential impact of a “net profits” limitation on disgorgement on both the FTC and FTC defendants cannot be overstated.  In any give case, it could make a difference of millions or tens of millions in the size of a monetary judgment, or result in no disgorgement at all from a defendant that has no net profits.      

The doctrine of joint and several liability does not fit with disgorgement, the Court concluded, because in equity liability is limited to one’s own ill-gotten gains, and does not extend to the illicit net profits of others.  To apply it, to make an individual liable for another wrongdoer’s net profits, could transform disgorgement into a prohibited punitive sanction.  An exception, however, where collective liability could be appropriate, the Court said, is in the case of “partners…equally culpable codefendants…engaged in concerted wrongdoing.”  In an FTC context, this exception could swallow the rule, at least where multiple defendants either directly participated to a substantial degree in the wrongdoing and/or had authority over the conduct.  

The Court strongly stressed that to be consistent with the practice in equity that the fruits of wrongdoing go to the victim, the SEC must return disgorged net profits to those harmed by it, unless it can show that their deposit in the U.S. Treasury would somehow be for the “benefit of investors.”  Like the SEC, the FTC does not always return disgorged funds to injured consumers but instead passes them to the Treasury.  While there is no express statutory command to effect equitable relief “for the benefit of consumers” in the FTC Act, under Liu, the FTC’s future discretion to reward the government rather than victims with disgorged ill-gotten gains would seem to be sharply, if not entirely, circumscribed.

While preserving the SEC’s disgorgement authority, Liu dramatically alters the legal landscape on which it can now be exercised, and tilts the playing field toward defendants, both in settlement negotiations and in litigation.  Under its reasoning, the same should hold true for the FTC.  Will the Court grant certiorari in Credit Bureau Center, to let the FTC and those it regulates know sooner rather than later if that is the case, or will it let lower courts decide whether, how and to what extent the equity principles laid out in Liu apply to the FTC.  That is the next big unanswered question in the unfolding legal drama over the traditionally assumed, but now heavily disputed, power of the FTC to take money from its defendants.  Stay tuned….

The FTC Finally Takes Down A CBD Marketer, Over COVID-19 Claims

Since hemp-derived CBD containing less than 0.3% THC was decriminalized by Congress at the end of 2018, the Federal Trade Commission has policed CBD health claims with a soft touch. On three different occasions (April, September, October, 2019), seeing unsubstantiated claims that CBD treats virtually every disease under the sun (i.e., cancer, heart disease, Alzheimer’s, MS, PTSD, schizophrenia, ALS, stroke, Parkinson’s, diabetes, AIDS), it has allowed the makers of those claims to get off with a simple warning.  A claim by a company that received one of those warnings, however, that its product treats Covid-19, apparently was a bridge too far. 

Accordingly, late last month, the FTC finally brought its first law enforcement action against a CBD marketer, Whole Leaf Organics, a California-based company, and its supplement, Thrive. The complaint alleges that the company falsely claimed that the product, which consists mainly of Vitamin C and herbal extracts, prevents, treats or reduces the risk of COVID-19. It also contests a cancer treatment claim for a CBD product sold by the firm.  Whether or not the FTC would have sued Whole Food Organics for ignoring its warning to cease the CBD cancer claim if it hadn’t also started making an entirely bogus Covid-19 health claim, only the FTC knows.  But the company was certainly inviting more serious attention by doing that, especially since the FTC also has been publicizing warning letters it has sent to companies making baseless Covid-19 health claims since the pandemic began.      

While it should not be surprising that the FTC would finally crack down on untrue health claims made by CBD marketers, especially by one who was also touting an unproven treatment that preys upon the pandemic health anxieties of consumers, the procedural approach the FTC took was highly unusual and could signal some concern on its part about the continuing viability of its authority to obtain consumer restitution in federal court.  Normally, when the FTC sues a false advertiser, it will bring a single action in federal court, under its so-called Section 13(b) authority, seeking a preliminary and permanent injunction and monetary relief, including disgorgement of “ill-gotten” gains and restitution.  This time, for the first time in a long time, it brought a bifurcated action, seeking, and obtaining, by stipulation, only a preliminary injunction in federal court (under a different statutory authority (Section 13(a)), with the rest of the case to be adjudicated in an administrative proceeding. While this route doesn’t foreclose the FTC from ultimately forcing Whole Food Organics to cough up assets and make restitution, it is a more circuitous and difficult one than the direct, one track path of Section 13(b).  First, it has to prevail in the administrative trial, and then, if it wants money, it has to go back to federal court and prove that the Covid-19 and cancer claims were not only false and unsubstantiated, but, under another provision of the FTC statute (Section 19), “dishonest or fraudulent.”  This requirement, to essentially have to prove intent to defraud, is absent from a Section 13(b) case, where the judge has broad equitable authority to order monetary relief, without any finding of willful wrongdoing.

While the FTC was deciding on this legal strategy, a petition for certiorari in the Credit Bureau Center case, which challenges the FTC’s ability to obtain equitable monetary relief under Section 13(b), remains before the Supreme Court, as does a final decision expected to be handed down soon in a Securities and Exchange Commission case presenting the same issue under its statute, which has similarities to the FTC’s.  Could these pending judicial developments, which bear so heavily on the FTC’s enforcement capabilities, have been on its mind when it embarked anew on a long-disused and less efficient procedural path against Whole FoodOrganics, or were other, more prosaic factors at play?  Again, only the FTC knows, but that doesn’t prevent FTC watchers from wondering.  Perhaps the answer as to whether this case was a “one off” or the start of a trend will become clearer when we see what procedure the FTC follows in its next enforcement cases.        

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