Federal Trade Commission v. Verity International, Ltd.

Citations: 124 F. Supp. 2d 193; 2000 U.S. Dist. LEXIS 17946Docket: 00 CIV 7422 LAK

Court: District Court, S.D. New York; December 13, 2000; Federal District Court

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Defendants Verity International, Ltd. operate a billing service for internet pornographic content, using Automatic Number Identification (ANI) to collect payments from telephone line subscribers for access to adult websites, regardless of whether these subscribers authorized the usage. The billing often misrepresents the nature of the charges as calls to Madagascar. The Federal Trade Commission (FTC) claims that this practice violates Section 5(a) of the FTC Act, as it imposes payment obligations on line subscribers who did not actually use the services.

Verity's billing system facilitates access to sexually oriented websites without requiring credit card information. Users connect to these websites via a dialer program that disconnects their ISP and connects them to an international number assigned to a Verity affiliate, Automatic Communications Limited (ACL). Subsequently, the ANI system identifies the telephone line subscriber, who receives the bill at a rate of $3.99 per minute. This billing arrangement stems from a 1999 agreement between ACL and Telecom Madagascar, allowing ACL to manage specific international telephone numbers and collect revenues independently of TM, including the ability to terminate calls from various locations. 

The FTC is currently seeking a preliminary injunction against Verity’s practices.

In January 1999, AT&T entered a revenue-sharing agreement with ACL and TM to manage call traffic to Madagascar numbers assigned to ACL, billing customers for calls that were never actually connected. By May 2000, call volume through AT&T reached one million minutes monthly, despite indications of consumer dissatisfaction, which was deemed irrelevant for the current motion. In May 2000, AT&T ended its contract with ACL, leading ACL to switch billing to Sprint and eventually to Verity, which outsourced billing and customer service to Integretel and its subsidiary eBillit. Verity began issuing separate bills in September 2000, detailing charges for calls to Madagascar, accompanied by a misleading address and a customer service number. However, the transition was plagued by customer service issues, including overwhelmed call lines, untrained staff, and misdirected complaints. From September 18 to 22, 2000, the FTC received 548 complaints from subscribers who denied making or authorizing the calls, citing various reasons such as unauthorized downloads by minors or existing call blocks on their lines.

The FTC has presented 81 declarations from bill recipients asserting they did not authorize the use of their telephones for services billed by Verity. Despite this evidence, the Verity defendants claim that all billed calls were made from subscribers' lines to Madagascar numbers. However, the Court finds ample evidence that many subscribers neither used nor authorized the use of their lines for these services, supporting the FTC's assertion that the defendants engaged in unfair and deceptive practices by demanding payment from subscribers who did not consent. The FTC initiated this action on October 2, 2000, against Verity and its principals, presenting three claims for relief under Section 5(a) of the Act related to false representations and deceptive billing practices. The Court granted a temporary restraining order to halt Verity's billing practices and froze their assets. Although the Verity defendants initially consented to the continuation of this order, they later sought to vacate it, claiming to have modified their business methods. The FTC rejected this offer, leading to a narrowed dispute focused on preventing the defendants from misrepresenting the obligation of line subscribers to pay for unauthorized services and misrepresenting call destinations or amounts owed.

An order is sought to prevent the Verity defendants from billing line subscribers without their express and verifiable authorization for services. The request includes freezing the defendants' assets, repatriating them, and obtaining complete financial disclosures. The Verity defendants propose a preliminary injunction to maintain the freeze on collections from September bills while allowing access to future receipts. They wish to continue ANI-based billing without express authorization, claiming adherence to terms that would protect consumers, although they acknowledge that the Commission deserves some form of relief.

The primary disputes concern the conditions under which the defendants can continue ANI-based billing and the extent of the asset freeze. The FTC can secure a preliminary injunction by demonstrating a likelihood of success and that such action is in the public interest, differing from the standard for private applicants which requires showing irreparable harm.

The FTC alleges that the defendants violated FTC Act Section 5(a) by misleading subscribers into believing they must pay for website access, even if they did not use or authorize such services. The Court finds the FTC likely to succeed in proving these practices are deceptive. To establish a violation, the FTC must show that the defendants made a materially misleading representation, specifically that Verity's bills implied a legal obligation to pay, regardless of actual usage or authorization of the services. While the bills do not explicitly state a legal obligation, common societal understanding suggests that a bill represents a statement of account, and the Court infers that recipients reasonably understand they are obliged to pay.

Defendants' bills are scrutinized for materiality, particularly regarding whether they can legally require payment from line subscribers who did not authorize or use services billed. The central issue is whether such subscribers are obligated to pay defendants for these services. Historically, subscribers have been required to pay for calls made on their lines, based on tariffs filed with the Federal Communications Commission (FCC), which outline the rights and obligations between telephone companies and subscribers. This principle is known as the filed rate doctrine.

Defendants contend that their use of ANI-based billing is standard in the telecommunications industry, presenting Sprint electronic codes to support the validity of their bills. However, the argument overlooks that subscribers would only be liable if a filed tariff explicitly covered the services rendered, which the FTC may demonstrate is not the case. The FCC differentiates between basic telecommunications services and enhanced services, which are not subject to the same regulatory framework and filed tariffs. Therefore, there is likely no legal basis for compelling subscribers to pay for enhanced services accessed over their lines if they did not authorize such access. The FCC has clarified that relying solely on ANI information to hold subscribers liable for unauthorized service charges is improper.

Absent a legal obligation under the filed rate doctrine, the determination of a contract's existence between the line subscriber and defendants hinges on whether the subscriber accepted the terms by clicking "I accept." Basic contract principles stipulate that a contract requires an offer and acceptance between the involved parties. If the subscriber is not the individual who accepted the offer, no contract exists. Bills sent to subscribers in September implied a payment obligation for services not accessed or authorized by those subscribers, likely leading to the FTC proving that these representations were false and deceptive.

Regarding call routing, the defendants admitted that calls billed as being to Madagascar were actually routed through a server in London, leading to potentially misleading disclosures about international charges. The defendants indicated they would stop this practice if allowed to resume billing.

The FTC's second claim concerns ANI-based billing as an unfair trade practice under Section 5(a) of the Act, indicating that it causes substantial injury to consumers who did not authorize the charges. The defendants argue that consumers can prevent such injuries by managing access to their phone lines. However, evidence suggests that some subscribers with blocking measures were still billed, indicating these measures are ineffective. The court finds it likely that the FTC will demonstrate that requiring consumers to manage unauthorized access imposes an unreasonable burden, especially compared to simply barring liability for charges without a verifiable agreement.

Defendants assert that providing an alternative to disclosing credit card information online benefits consumers; however, the Court finds this argument insufficient at this stage. The existence of such an alternative does not assist line subscribers who do not utilize the service, as they bear the costs imposed by unauthorized users. The Court acknowledges potential harm to defendants if they are required to establish pre-subscription agreements, but this harm does not outweigh the negative impact on consumers, who often pay bills without dispute due to fear of damaging their credit ratings. This scenario highlights the defendants' exploitation of consumer inattention and the power imbalance in billing practices.

Defendants claim a high customer satisfaction rate, citing a low uncollectible charge rate during their partnership with AT&T. However, evidence indicates over 35% of their charges from January 1999 to September 2000 were uncollected, significantly higher than industry standards, suggesting consumer dissatisfaction, particularly with misleading charges on bills for nonexistent services.

The Court is likely to find that defendants' ANI-based billing practices constitute an unfair trade practice. It also indicates that the FTC has a strong case for establishing individual liability against Green and Shein, who are involved in Verity’s operations. Both have direct roles in the activities in question, with Green demonstrating significant involvement and Shein actively managing consumer complaints.

Regarding relief, while defendants acknowledge the FTC’s entitlement to some injunctive measures, their proposals for improved disclosures and post-bill concessions are deemed inadequate by the Commission. The central dispute revolves around whether defendants should be allowed to continue using ANI-based billing during the litigation, with the Court tentatively concluding this practice is likely to violate the law.

Preliminary injunctions issued by courts of equity are based on incomplete records, leading to a heightened risk of error compared to final rulings. The relief sought could severely impact the defendants' business operations, prompting the court's cautious approach against imposing significant restrictions at this early stage if reasonable alternatives exist. The defendants’ ANI-based billing practices mislead line subscribers into believing they are liable for services they did not purchase or authorize. While defendants propose improvements such as enhanced disclosure on websites and more accommodating complaint policies, these measures are deemed insufficient. The central issue remains that many line subscribers may not see the improved disclosures, and deceptive practices could continue unchecked. 

A potential solution involves requiring an explicit statement on bills, clarifying that line subscribers have no legal obligation to pay unless they personally authorized the charges. This requirement, combined with the proposed improvements and a straightforward process for disputing unauthorized charges, would adequately protect consumers during the litigation. Consequently, the FTC's motion for a preliminary injunction against ANI-based billing is granted, with the condition that such billing can only occur if there is prior explicit consent from the line subscriber or if the bill clearly states the lack of obligation to pay without personal authorization.

Additionally, the FTC seeks restitution, refunds, and disgorgement of profits from the defendants due to alleged violations. Courts have affirmed that district courts can provide a full range of equitable remedies as part of injunctive relief under Section 13(b) of the Act. Therefore, an asset freeze is deemed appropriate as necessary ancillary relief. The scope of the amended complaint appears to extend beyond the current period of direct billing by Verity, potentially encompassing earlier activities that generated over $30 million in revenue through AT&T and Sprint.

A preliminary injunction is sought to freeze assets for two primary reasons: to facilitate restitution for previous alleged misconduct and to protect future customers from potential harm. The defendants propose maintaining the freeze only on amounts collected from bills sent before the temporary restraining order and posting a $1 million bond, which the Commission deems insufficient given that over $30 million was billed, with around $19 million collected. The defendants' liability could exceed $1 million, and they pose a risk of being unable to satisfy any monetary judgment due to their foreign status. 

For future billings, the need for a freeze is less critical; if defendants utilize pre-subscription agreements, restitution claims for future collections would likely be minimal. Nevertheless, the court will mandate a freeze on all amounts collected from September bills and require a more substantial bond or extend the freeze to future collections while demanding repatriation of the Verity defendants' assets. The defendants must also provide full and honest disclosures of their financial status. 

The Commission's motion for the preliminary injunction is granted as outlined. The Commission is to submit the proposed injunction by December 18, with the defendants responding by December 21. A hearing on the injunction and related matters will take place on December 22 at 10:30 a.m., and the temporary restraining order will stay in effect until the preliminary injunction is issued. The document also notes that no evidentiary hearing was requested, and there are issues regarding the correct identification of the Verity entity involved, which the court has acknowledged but deemed irrelevant given the defendants' assurances of compliance.

The FTC has not argued that the disclosures on certain screens are inadequate or misleading. The placement of an international telephone number does not guarantee a connection to its assigned country. TM entered an arrangement to share revenue. ACL collaborated with British Telecom to redirect calls to Madagascar numbers to servers of its clients, who provided pornographic material. AT&T billed over $30 million for calls to these numbers and issued significant adjustments to consumers. Integretel received detailed call information from Sprint for billing purposes. 

On December 1, 2000, the Verity defendants attempted to withdraw their consent to a temporary restraining order, but their withdrawal was ineffective since they had previously consented unconditionally. The court continued the restraining order on December 8, 2000. The order concerning Integretel and eBillit was later vacated by mutual agreement. Proposed preliminary injunction terms included a new disclosure statement, removal of specific references from bills, and provisions for billing inquiries. There was a concern that defendants might still use ANI-based billing without adhering to these terms, indicating a possible drafting oversight. 

Overall, the excerpt touches upon the FTC's actions, billing disputes, and regulatory compliance concerning deceptive practices related to telephone billing and services.

Disagreement exists among circuits regarding the consideration of private hardship in injunction cases. The Fourth Circuit's ruling in Food Town Stores, 539 F.2d at 1346, indicates that private equities should not significantly influence the granting or withholding of injunctive relief under Section 13(b) of the FTC Act, as the focus should be on protecting the public rather than individual competitors. The Ninth Circuit in FTC v. Pantron I Corp. and other cases reinforces this view, stating that the FTC does not need to demonstrate intent to defraud in misrepresentation cases. Relatedly, Section 203 of the Communications Act mandates common carriers to file tariffs with the FCC, which define the legal relationship between carriers like AT&T and their customers. The filed rate doctrine, which originated with the Interstate Commerce Act, is also applicable to communications and has been affirmed by the Supreme Court. Various cases illustrate the enforcement of tariff requirements and the implications of unauthorized access to services.

MCI Telecomms. Corp. v. AT&T Co. discusses the definition of "basic service" under FCC regulations, which is characterized as a pure transmission capability that is transparent to customer information. Telecommunications is defined as the transmission of user-selected information without alteration, while "information service" includes capabilities for processing and utilizing information via telecommunications. The text references the legal principle that minors lack the capacity to enter binding contracts, allowing contracts made during infancy to be voided. It also highlights consumer concerns regarding deceptive billing practices, suggesting that some consumers may inadvertently benefit from such services that obscure their online activities. Defendants proposed a disclaimer on their billing to inform subscribers that they are not liable for unauthorized charges, with a mechanism to block access to the service upon request. This proposal raises potential for misuse by subscribers who may deny usage to avoid payment, but the defendants can mitigate this risk by terminating service for those claims. The discussion indicates that this risk is manageable compared to a complete prohibition of billing practices without prior subscriptions.

The excerpt outlines the authority granted to district courts by Congress to issue permanent injunctions against law violations enforced by the Federal Trade Commission (FTC). This authority includes the ability to provide any necessary ancillary relief to ensure complete justice, without explicit limitations on equitable powers. It references several cases, including FTC v. World Travel Vacation Brokers, FTC v. United States Oil & Gas Corp., and FTC v. H.N. Singer, to support this assertion. Additionally, it notes a specific case, FTC v. Five-Star Auto Club, where the court's actions align with this authority. The excerpt also mentions a related case, SEC v. Cavanagh, where an asset freeze was deemed appropriate. As of October 2, 2000, an amount of $543,239.03 was frozen in relation to these proceedings, with indications that this figure may have increased due to significant billing by Verity through AT&T.