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.        

Will the Supreme Court Save the FTC’s Disgorgement Authority?

In January, I wrote about emerging caselaw questioning the long-held view in the federal courts that federal law enforcement agencies, like the Federal Trade Commission and Securities and Exchange Commission, have the legal authority to require violators of their statutes to disgorge their “ill-gotten” gains. (See “Is the FTC’s Most Fearsome Power Now in Peril Before the Supreme Court?”)  I discussed two cases in particular that are before the Supreme Court now.  In one, FTC v. Credit Bureau Center, the FTC is asking the Court to hear and reverse a decision of the Seventh Circuit Court of Appeals holding that the FTC lacks disgorgement authority under its statute. The Court has not yet decided whether to take the case.  In the other, SEC v. Liu, which the Court has accepted, it heard oral argument this month and will be issuing a decision by the end of June.  Because of arguable similarities between the SEC’s and the FTC’s statutory schemes, I and other FTC attorneys and observers have been keenly interested in how the Court decides the disgorgement question in Liu because of what it could mean for the FTC’s own disgorgement powers.  From the oral argument, we now have our first insights into the justices’ thinking on the issue and perhaps our first clues as to what the decision will be and its implications for the FTC’s disgorgement authority.  In my judgment, having listened to the argument, both the SEC and the FTC have more reason to be optimistic about the outcome than the defendants in the two cases.

The SEC statute in question authorizes the agency to seek an injunction against a violation and any equitable relief that may be appropriate or necessary for the benefit of investors.”  It says nothing about disgorgement. The question presented to the Court, therefore, is whether “equitable relief”, as provided for in the statute, includes disgorgement.  In SEC v. Kokesh, in 2017, the Supreme Court held that disgorgement was a penalty, thus making it a legal, rather than an equitable, remedy.  It did so, however, only in the context of deciding whether a federal statute of limitations, which covers actions seeking penalties, applied to a case in which the SEC was seeking disgorgement.  Further, in holding the statute of limitations did apply, it emphasized that it was expressing no view on the underlying issue of whether the SEC possesses disgorgement authority. During argument, Justice Ginsberg was quick to note this disclaimer and the distinction between the two cases, pointedly observing that the fact the Court held that disgorgement is a penalty (thus, not equitable relief) in one context does not mean it would reach the same conclusion in another.

While there was much esoteric argument and questioning about the parameters of “equitable relief” in the statute in light of the historical development of equitable remedies in the law, a number of justices – liberal and conservative alike – honed in on a couple of very practical questions, in a way that suggested they were looking for a solution to save the SEC’s disgorgement power.  One was to inquire how often the SEC actually returns disgorged assets to victimized investors, versus simply turning the money over to the U.S. Treasury.  This led to some justices suggesting that the SEC, as a condition of obtaining disgorgement, be required to return recovered funds to victims wherever feasible.  The other was to ask how the disgorgement calculation worked in actual practice, specifically, what if any business expenses were excluded from the calculation.  The justices seemed to show an interest in narrowing the profits to be disgorged by permitting deduction for  expenses except those that directly contributed to the securities violation (i.e., expenses associated with making misrepresentations about an investment).  It is always hazardous to predict an outcome in a case based on oral argument, but several members of the Court certainly seemed to be looking for a practical way to save the SEC’s disgorgement authority, while placing limits on it.

Like the SEC’s statute, the FTC’s authorizes injunctions, but unlike it, makes no provision for “equitable relief.”  Because of this difference, how the Court interprets “equitable relief” in the SEC statute vis a vis disgorgement may tell us very little about how it would construe the FTC’s statute on the same question, since it does not contain those two important words. Without the “hook” of those words, the Court, should it hear Credit Bureau Center or another case challenging the FTC’s disgorgement authority, conceivably could have a harder time finding that authority in the FTC’s statute than it did in Liu.  As a matter of statutory interpretation, it could come down to whether the single word “injunction,” an equitable remedy employed to prevent future harm, encompasses disgorgement, a tool used to redress past harm.  If so, and if it were to be as determined to save the FTC’s disgorgement powers as it seems to be to save the SEC’s, the Court could look for inspiration to the dissenting opinion in the 7th Circuit decision in Credit Bureau Center.  It argues that injunctions come in many varieties, mandatory as well as prohibitory; they are flexible enough to contain a disgorgement component for equitable restitution; and disgorgement of ill-gotten gains has a forward-looking purpose of deterrence, not just a backward-looking function of redress.

Pending the Court taking up Credit Bureau Center or a similar FTC case directly, a decision in Liu upholding but limiting the SEC’s disgorgement authority could circumscribe the FTC’s disgorgement authority in the same way.  The FTC, like the SEC, has complete discretion whether to return disgorged assets to harmed consumers or give the money to the Treasury, and frequently opts for the latter.  It also routinely seeks disgorgement not just of a defendant’s illicit profits, but its entire gross revenue from the challenged business activity, less chargebacks and credits.  A decision in Liu limiting the SEC’s discretion in disposing of disgorged assets, by mandating their return to victims whenever feasible, and requiring deduction of business expenses not directly incurred in furtherance of the illegal scheme in the disgorgement calculation, appropriately should carry over to the FTC as well.  While this would not represent the total victory that opponents of the FTC’s disgorgement authority might want, it could make a meaningful difference to FTC defendants in individual cases, and certainly provide fresh legal ammunition to their counsel as they oppose disgorgement, or seek to limit its impact on their clients.                                                   

FTC Hammers Offshore Processor for “Unfairly” Enabling Deceptive Free Trials

We think of the Federal Trade Commission as an anti-deception agency, and it is just that.  The vast majority of its cases are brought against deceptive business practices.  By statute, however, the FTC is also empowered to prevent practices that are “unfair.” This authority comes in handy when the FTC may not be able to make a deception charge stick.  It is a particularly convenient tool to use against third parties who allegedly facilitate deception but are not involved in the deceptive conduct itself and may be able to defeat a deception count on that ground.       

As interpreted by the FTC, a business act or practice is unfair if it: (a) causes substantial consumer injury; (b) the injury is not “reasonably avoidable;” and (c) the injury is not outweighed by any benefit to consumers or competition.  This standard has been upheld against third party facilitators of consumer deception, including payment processors.  In the 2009 case of FTC v. Interbill, Ltd. et al, a federal district court found that a processor engaged in unfair conduct by processing sales that resulted in substantial and unavoidable consumer injury with knowledge that the merchant was billing consumers without authorization.  The court ordered redress of $1.7 million and prohibited Interbill from processing unless it first conducted a “reasonable investigation” of a prospective client and instituted a compliance monitoring system.   

Since Interbill, the FTC, using its unfairness authority, has obtained more settlements against payment processors for facilitating consumer fraud or deception by their merchant clients.  Last month, extending its global reach over the payments industry, it announced a settlement of charges it had brought against a Latvian-based processor, SIA Transact Pro, and its owner, for processing allegedly deceptive and unauthorized free trial negative option offers for dietary supplements and personal care products sold by a U.S. company, Apex Capital Group, which had previously settled with the FTC. In an amended complaint adding the Transact Pro defendants to the case, the FTC alleged that they committed unfair acts by engaging in “credit card laundering” by providing processing for dozens of shell companies fronting for Apex, and by helping Apex evade excessive chargeback monitoring, resulting in substantial and unavoidable consumer injury.   

After failing to knock out the complaint on jurisdictional grounds (the court having found sufficient contacts between defendants and the U.S. even though the company is in Latvia and the owner is a Latvian citizen), Transact Pro, to settle, agreed to pay $3.5 million.  Equally if not even more significantly, it also agreed to a truly startling set of restrictions on its business – more sweeping and intrusive than in any previous FTC payment processor settlement.  They include categorical bans on payment processing for: negative option and free trial offers; several specifically named verticals; and merchants on the MATCH list for excessive chargebacks or fraud.  Also imposed are a ban on credit card laundering and numerous merchant account practice prohibitions, including on misrepresentations, use of shells and nominees to obtain processing, and “load balancing”, transaction splitting and “microtransactions” to evade fraud and risk monitoring.  Most striking of all, however, are a set of incredibly detailed and prescriptive requirements for screening and monitoring of high risk” and other “covered” merchant clients. A “high-risk” client is one who processes 15% or more “Card Not Present” transactions generating $500,000 or more in revenue.  A “covered client” is anyone doing business in one or more of 15 named verticals or who sells through outbound telemarketing.

The screening requirements include obtaining: (1) exact information on clients’ owners and controlling persons; (2) a list of all business and trade names and websites used in marketing; (3) the name of every acquiring bank and payment processor used in the preceding two years, and all merchant identification numbers used; (4) past chargeback rate and total return rate (for ACH or RCPO transactions) for the preceding 3 months and estimates of future rates; (5) trade and bank references; and (6) whether the client has ever been placed in a chargeback monitoring program the preceding 2 years or been the subject of an FTC or other law enforcement agency complaint.  Defendants must also take reasonable steps to assess the accuracy of the information, including reviewing: the client’s websites; recent monthly processing statements; and marketing materials. They must reject any client who appears to be engaged in deceptive marketing or billing practices.

The monitoring requirements include: (i) seeing if current clients are “high-risk” and, if so, promptly screening them as required; (ii) regularly reviewing all such clients’ websites, chargeback rates and total return rates; (iii) regularly calculating and updating their chargeback and total return rates; (iv) immediately stopping processing and closing all accounts for any “covered client” whose total return rate exceeds 2.5% and whose total number of returned ACH Debit or RCPO transactions exceeds 50; or whose monthly chargeback rate exceeds 1% and whose total  chargebacks exceeds 50 in 2 of the past 6 months; (v) immediately conducting an exhaustive investigation of any “high-risk” client, excluding a covered client, whose total return rate exceeds 2.5% and whose total number of returned ACH Debit or RCPO transactions in any month exceeds 50; or whose monthly chargeback rate exceeds 1% and whose total chargebacks exceed 50 in 2 of the past 6 months; (vi) stopping processing and close all accounts for any such investigated high-risk client within 60 days, unless defendants establish, by clear and convincing evidence, the absence of an FTC violation; (vii) and immediately stopping processing and closing all accounts where defendants know or should know the client is engaged in fraud and risk monitoring evasion.

Transact Pro is the latest but surely not the last reminder that payment processors continue to have a big FTC bullseye on their chests and that those located offshore are not beyond the FTC’s reach.  It is also a warning that if they don’t redouble their risk underwriting and monitoring efforts voluntarily, the FTC is more than ready to impose its own set of onerous and laborious due diligence measures, of the type that Transact Pro is now under a federal court order to conduct.



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