Federal Trade Commission v. Verity International, Ltd.

Citations: 443 F.3d 48; 38 Communications Reg. (P&F) 83; 2006 U.S. App. LEXIS 8184Docket: Docket No. 04-5487-CV

Court: Court of Appeals for the Second Circuit; March 26, 2006; Federal Appellate Court

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The billing system in question was designed to charge consumers for accessing adult entertainment services via a telephone line by treating the charges as international phone call fees to Madagascar. This system allowed users to download a dialer program that initiated a call to a Madagascar number, bypassing the designated carrier in favor of AT&T or Sprint. The call was then redirected to an internet server in the UK, connecting the user to the adult content without requiring credit card processing. However, the system lacked authorization mechanisms for the telephone-line subscribers, leading to potential unauthorized access by users. The Federal Trade Commission (FTC viewed this as a deceptive practice under §5(a)(1) of the FTC Act and sued the corporations involved—Verity International, Ltd. and Automatic Communications, Ltd.—as well as their controllers, Robert Green and Marilyn Shein, for violations. The district court found the defendants liable, and Green and Shein additionally faced contempt charges.

The lack of a billing mechanism resulted in subscribers receiving unexpected charges for adult-entertainment access, prompting the FTC to initiate a lawsuit. In May 1997, ACL contracted with Telecom Malagasy to carry calls to specific international numbers in Madagascar, enabling ACL to collect high per-minute charges from U.S. callers. Revenue from these calls was shared among ACL, Telecom Malagasy, phone carriers, billing agents, and adult-website operators. ACL partnered with Global Internet Billing, Inc. (GIB) to market a dialer program to adult-website operators, facilitating the use of Madagascar numbers. ACL paid GIB a portion of the call revenues, which GIB distributed to the website operators. 

To enable call connections from modems to U.K. servers hosting adult content, ACL contracted with AT&T and AT&T U.K. in January 1999. AT&T handled billing, charging subscribers only for the calls to Madagascar, which were listed in the 'Long Distance' section of their bills. From January to July 2000, AT&T billed $29 million for these calls, a significant increase from the previous year, and the rate of refunds for contested bills rose sharply from 8% to 38%. The billing structure involved a series of payments: AT&T collected amounts due to itself and AT&T U.K., which then compensated ACL, who subsequently paid GIB, and GIB paid the adult-website operators. Telecom Malagasy received separate compensation for providing the phone numbers. This arrangement lasted until July 2000, when AT&T terminated its contract. ACL subsequently sought to engage Sprint for similar services, but Sprint quickly released itself from those duties after entering an agreement.

Sprint agreed to transport calls to AT&T U.K.'s London facilities (now Viatel) while delegating billing and collection responsibilities to ACL, which received the caller's ANI information. ACL guaranteed call termination in Madagascar and paid a per-minute fee to Sprint and Viatel. This arrangement, termed the 'Sprint Period,' lasted from July 2000 to September 2000 before Sprint ceased carrying calls to ACL's Madagascar numbers. During this period, ACL, through Verity, contracted eBillit, a subsidiary of Integretel, to manage billing, which included preparing and sending invoices to subscribers. The bills, branded with the Verity logo, contained specific details like invoice numbers, a summary of charges, and a warning regarding payment consequences. A significant volume of bills (91,683) was sent, leading to over 24,986 subscriber inquiries, though many faced poor customer service, resulting in a 72% call abandonment rate. Callers were subjected to a strict policy of validating charges and threats of service disruption for nonpayment, directed by Robert Green and Marilyn Shein. This billing system generated $1.6 million in revenue and attracted more than 500 complaints to the FTC. The FTC subsequently filed a complaint alleging that aspects of the billing system constituted unfair or deceptive practices in violation of §5(a)(1) of the FTC Act, claiming relief on three grounds relevant to the appeal.

Count I of the FTC's allegations claims that the defendants-appellants misled consumers by stating they could not legally avoid charges for website content accessed via their telephone lines, regardless of whether they accessed the content or authorized others to do so. Count II alleges that the defendants engaged in unfair practices by billing and attempting to collect from subscribers whose lines were used to access adult content without their authorization. Count III asserts that the defendants deceived consumers by misrepresenting billing statements, indicating that outbound calls terminated in Madagascar when they did not. 

The parties involved include ACL, a Bahamian corporation operating the disputed billing system, initially controlled by Robert Green and Marilyn Shein, each holding 40% of ACL's shares until September 2000, when Oriel Communications, Ltd. acquired half. Following this, Green and Shein each retained 20% of ACL and approximately 11% of Oriel's shares. 

A preliminary injunction was issued on December 13, 2000, freezing assets of Verity, Green, and Shein to preserve funds for potential monetary remedies. It mandated financial disclosures to evaluate requests for asset unfreezing, which Green and Shein initially did not contest but later refrained from completing due to the extensive information required. Consequently, the district court found them in contempt, imposing coercive fines and civil confinement until compliance. As of October 7, 2005, fines totaled $16.1 million per contemnor.

The defendants-appellants filed a motion for judgment on the pleadings, arguing that the district court lacked subject-matter jurisdiction, citing ACL as a common carrier outside FTC jurisdiction, the filed-rate doctrine negating FTC standing, and the primary-jurisdiction doctrine requiring FCC involvement. The district court sought the FCC's input, which concluded ACL was not a common carrier, thus denying the defendants' motion and affirming its jurisdiction over the case.

On September 17, 2004, the district court issued a memorandum opinion following a bench trial that examined stipulated facts and evidence. The court reaffirmed its previous denial of the defendants-appellants’ motion for judgment on the pleadings and determined that the Federal Trade Commission (FTC) successfully proved Counts I, II, and III of its second amended complaint. It established both corporate and individual liability, ordered $17.9 million in disgorgement, and replaced a preliminary injunction with a permanent injunction that excluded a financial-disclosure requirement. The defendants-appellants filed a timely appeal.

The appellate review included several parts: Parts I-III found the defendants’ claims of lack of subject-matter jurisdiction to be without merit; Part IV upheld the district court’s finding that the defendants violated §5(a)(1) of the FTC Act; Part V identified an error in the monetary relief of $17.9 million; and Part VI vacated coercive contempt sanctions against specific defendants as moot. 

Additionally, the excerpt discusses the common-carrier exception to the FTC's enforcement powers, highlighting that the FTC cannot enforce §5(a)(1) against common carriers regulated under the Communications Act of 1934. The court clarified that the definition of 'common carrier' under the FTC Act is aligned with common law rather than the Communications Act, concluding that ACL does not qualify as a common carrier under either definition. Historical context is provided, referencing the Interstate Commerce Act of 1887 and the Mann-Elkins Act of 1910, which established the regulatory framework for common carriers and clarified the FTC's limited enforcement authority to avoid conflicts with the Interstate Commerce Commission.

Congress did not define 'common carrier' in the Interstate Commerce Act or the FTC Act. Regulation over telephone common carriers remained with the ICC until the Communications Act of 1934 established the FCC and transferred that regulatory authority. The Communications Act provided a circular definition of 'common carrier' as someone engaged for hire in interstate or foreign communications by wire or radio. Research indicates that the term 'common carrier' had an ordinary meaning at the time, justifying its lack of definition in both the Interstate Commerce Act and the Communications Act. The Wheeler-Lea Act of 1938 extended the exemption from FTC regulatory authority to common carriers under the Communications Act. Currently, the term 'common carrier' in §5(a)(2) of the FTC Act remains undefined. Following precedents, the term will be interpreted based on its ordinary meaning as understood by Congress. The concept is rooted in English common law, dating back to at least 1670, with early applications requiring service to the public on reasonable terms. Over time, the definition has narrowed to include only those enterprises considered 'public' due to legal monopolies or public funding.

The definition of a common carrier includes two key requirements: (1) the entity must offer to carry for all people indiscriminately; and (2) it must carry its cargo without modification. This aligns with the Communications Act's definition of 'telecommunications carrier,' which requires public service. In this case, defendant-appellant ACL does not qualify as a common carrier under the Communications Act and does not benefit from the FTC Act's common-carrier exemption. The telephone calls involved three carriers conceptually: an originating carrier (AT&T or Sprint), a transit carrier (AT&T U.K./Viatel), and a destination carrier (Telecom Malagasy). ACL's role was merely to facilitate billing; it did not actually carry any calls. Therefore, even though AT&T and Sprint may be exempt from FTC enforcement, ACL is not, as it does not meet the criteria for common carrier status and is considered a purely foreign terminating carrier, which is outside the jurisdiction of the Communications Act.

ACL argues on appeal that the §5(a)(2) common-carrier exemption applies to it as an entity with 'common carrier' status under the Communications Act, irrespective of whether its activities in the lawsuit qualify as common carriage. However, this argument only holds if ACL can demonstrate actual common carrier status. ACL claims such status is granted by its FCC-issued 214 license, which allows it to operate as a facilities-based or resale-based international common carrier. Yet, the license does not establish that ACL is currently engaged in common carriage, nor did ACL assert this in its application. Courts must focus on an entity's actual conduct rather than its authorized capabilities to assess common carrier status under the FTC Act. Precedent, such as Eagleview Techs., Inc. v. MBS Assocs., supports that holding an FCC license does not automatically confer common carrier status.

Furthermore, the doctrine of primary jurisdiction permits federal courts to refer complex issues beyond judicial expertise to the relevant administrative agency. Courts evaluate this through four factors: (1) whether the issue is typically within a judge's experience or involves agency-specific expertise; (2) whether the issue is within the agency's discretion; (3) the risk of inconsistent rulings; and (4) if prior applications to the agency have occurred. The defendants assert the case should be referred to the FCC due to its complexity concerning telecommunications policy. However, the only pertinent issue that may require primary jurisdiction analysis is the classification of ACL's services as either telecommunications or information services. The factors do not favor FCC jurisdiction here, as there are established precedents concerning the definitions of these terms, and applying them to this case is within the court's purview. No intricate interpretations necessitating FCC expertise are present in this record.

The excerpt addresses two key legal issues: the classification of services under the FCC’s discretion and the application of the filed-rate doctrine. 

First, the classification of services is not governed by abstract statutory terms like "reasonable" or "public interest," but rather by straightforward factual questions. The defendants-appellants failed to demonstrate any risk of inconsistent rulings regarding the classification of their service. They mistakenly referenced LO/AD Communications, which dealt with the reasonableness standard under the Communications Act rather than the specific terms applicable in this case. Therefore, none of the primary-jurisdiction factors support referring the matter to the FCC. Additionally, issues related to deceptiveness, unfairness, and common-carrier status fall under the Federal Trade Commission (FTC) Act, which the FCC is not specifically tasked to interpret.

Secondly, the defendants-appellants argue that the filed-rate doctrine, which requires common carriers to file tariffs for FCC approval, removes the FTC’s standing and necessitates dismissal of its complaint. Under this doctrine, once a tariff is approved, it becomes the only lawful charge, and all parties are bound by it unless deemed unreasonable by the FCC. This doctrine aims to prevent price discrimination by carriers and limits court intervention in tariff validity. The defendants-appellants claim that since the FCC approved the tariffs for calls to Madagascar, any lawsuit questioning subscriber obligations to pay these charges effectively challenges the validity of the approved tariffs, thus invoking the filed-rate doctrine as a bar to the current action.

The assertion regarding the validity of disputed bills relies on the assumption that these bills were for services covered by FCC-approved tariffs. If no applicable tariff exists for the services billed to line subscribers, the validity of the tariffs would not be undermined by the FTC's lawsuit. The filed-rate doctrine does not apply here, as the defendants-appellants fail to identify any tariff covering the actual services provided. They claim the tariffs from AT&T and Sprint are applicable, yet these only pertain to telecommunications services, not the information services in question. The Communications Act distinguishes between these categories: telecommunications services relate to the transmission of user-selected information without alteration, while information services involve capabilities for processing or providing information via telecommunications. The FCC has confirmed that these categories are mutually exclusive.

The defendants-appellants focus on their billing system's transmission aspect, neglecting the nature of the overall service billed to consumers. While the transmission by the carriers was a component of the service, the users were primarily motivated by access to adult content, which constitutes an information service not covered by the relied-upon tariffs. Consequently, since no other tariff applies to the information service provided, the filed-rate doctrine does not apply, affirming the FTC's standing to pursue this action.

Additionally, the FTC Act prohibits unfair or deceptive practices in commerce. The district court found that the FTC demonstrated three grounds for relief under this act after a bench trial, leading to a judgment against the defendants-appellants. On appeal, they argue that the FTC did not meet all required elements for relief, with the appellate review of legal conclusions being de novo and factual findings for clear error.

Count I of the FTC's allegations against the defendants-appellants asserts that they engaged in deceptive practices by misleading consumers into believing they could not avoid charges for adult-website content accessed via their telephone lines, regardless of whether they had authorized such access. To establish a deceptive act under § 5(a)(1), the FTC must demonstrate three elements: (1) a misleading representation, (2) likely to mislead consumers acting reasonably, and (3) materiality of the representation. The FTC argues that the defendants caused consumers to receive both explicit and implicit messages indicating that charges for adult entertainment were uncontestable, which the district court supported by finding that these charges appeared on phone bills as regular calls, exploiting consumers' belief that all charges must be paid. 

The court also determined that similar representations were made during the Sprint Period through billing formats and call-center messages. It concluded that it was not clearly erroneous to find these communications conveyed a sense of uncontestability. For the second requirement, the FTC contends that the representation was misleading, especially for consumers who did not use or authorize the services. The defendants-appellants counter that their representations were valid due to the filed-rate doctrine and common law agency principles. The court dismissed the filed-rate doctrine's applicability and considered the defendants' reliance on common law agency principles, arguing that all calls over a subscriber's line implied authorization. However, apparent authority exists independently of the principal's consent, complicating the defendants' defense.

In Towers World Airways, Inc. v. PHH Aviation Systems Inc., the court addressed the issue of apparent authority in relation to a computer user’s ability to make purchases on behalf of a principal, specifically a telephone line subscriber. The court distinguished this case from Towers World Airways, where an employee's use of a company credit card was considered authorized due to established industry customs. In the present case, a computer is described as a multipurpose tool, and it is not reasonable to infer that merely being authorized to use a computer implies that the telephone line subscriber has authorized purchases of online content. The court concluded that apparent authority did not exist under these circumstances, rendering the representation of uncontestability false and unsupported by legal principles.

The Federal Trade Commission (FTC) successfully proved the second element of its claim under Section 5(a)(1) of the FTC Act, demonstrating that the misrepresentation was likely to mislead consumers. Although the district judge did not explicitly address the materiality of the misrepresentation, his labeling of it as “materially false” indicates that he found it to be material. Evidence presented suggested that subscribers considered the representation significant when deciding whether to pay charges, influenced by fears of disconnection and credit score impacts. The defendants-appellants did not contest the materiality of the misrepresentation, leading to a waiver of that argument.

Ultimately, the FTC established all three elements of its deceptive representation claim under Section 5(a)(1), confirming violations of the FTC Act. The court noted that the FTC need not prove additional claims to secure relief under the Act, as one claim suffices for liability. Additionally, the district court found the defendants liable under Count II for engaging in unfair trade practices against billing line subscribers who had not authorized the use of Internet services.

Defendants-appellants waived their right to challenge the unfair-practices determination by failing to raise this issue on appeal until their reply brief, which is deemed insufficient. In their opening brief, they only addressed the district court's findings on deceptive practices related to FTC Act liability. Consequently, the court affirms the district court's ruling that billing subscribers who did not authorize internet services constitutes an unfair trade practice under the FTC Act. The court does not evaluate the merits of the district court's ruling on Count II due to the waiver, nor does it express an opinion on the deceptive practice claim in Count III regarding misleading billing for calls to Madagascar that actually terminated in the UK, since this liability is not essential for the relief granted. 

Regarding restitution, the determination of whether disgorgement relief awarded to the FTC should be upheld hinges on two issues: the availability of restitution under Section 13(b) of the FTC Act and the district court's proper administration of this remedy. Although Section 13(b) does not explicitly mention restitution, several circuit courts have recognized it as a permissible form of ancillary equitable relief. The defendants-appellants do not contest the district court's conclusion that restitution is available under this provision, but they assert that restitution should be limited to equitable restitution. The court agrees with this position, acknowledging the distinction between types of restitution as outlined by precedent.

In Annuity Insurance Co. v. Knudson, the Supreme Court clarified the distinction between legal and equitable restitution, noting that equitable restitution permits recovery of money or property that can be traced back to the plaintiff, while legal restitution is available even if the plaintiff cannot claim title to specific property but can demonstrate that the defendant received unjust benefits. The Court ruled that under Section 13(b) of the FTC Act, any restitution awarded is limited to equitable restitution, negating the defendants' argument for a jury trial under the Seventh Amendment.

The district court misapplied the two-step burden-shifting framework for disgorgement relief. Initially, the FTC must demonstrate that its calculations accurately reflect the unjust gains of the defendant, after which the burden shifts to the defendant to challenge those figures. However, the district court erred by misidentifying the baseline for restitution as the total amount lost by consumers instead of the unjust gain received by the defendants. This misinterpretation contradicts established principles which emphasize that restitution should be based on the defendant's gain rather than the plaintiff's loss. Although in some cases the defendant's gain may equal the consumer's loss, this is not universally applicable, particularly in scenarios where intermediaries are involved. The court's reliance on this incorrect principle led to a flawed calculation of restitution.

In FTC v. Febre, the court addressed the issue of disgorgement, emphasizing that its purpose is to deprive wrongdoers of ill-gotten gains rather than to compensate victims of fraud. The court upheld the district court's finding that consumers paid $16.3 million for videotext services during the AT&T Period but instructed a reassessment of how much of that sum was actually received by the defendants-appellants for restitution purposes. The payment structure indicated that AT&T and affiliated companies received portions of consumer payments before any funds reached the defendants, suggesting only a fraction of total payments unjustly enriched the defendants.

During the Sprint Period, the defendants received consumer funds through eBillit, which were then distributed to other parties. The district court was directed to determine the amount of the $1.6 million in total billings received by the defendants without deducting payments made to others. The focus for calculating restitution should remain on the defendants' unjust gains for both periods. 

Additionally, the burden of proof for establishing disgorgement size involves the plaintiff first demonstrating that their calculations reasonably approximate the defendant’s unjust gains. The district court failed to adequately account for the fact that some consumers authorized or used the services, meaning the unjust gains were only a portion of the total gains from the billing system. Consumer declarations indicated that AT&T provided credits to those who complained about charges, suggesting limited basis for claiming unjust gains during the AT&T Period compared to the Sprint Period.

The district court erroneously shifted the burden of proof to the defendants-appellants without first assessing the reasonableness of the FTC’s approximation of unjust gains. It invoked the principle that the risk of uncertainty falls on the wrongdoer without establishing a reasonable approximation of unjust gain, which is only applicable in the second stage of the burden-shifting framework. The FTC is required to provide a reasonable approximation of unjust enrichment before the burden shifts to the defendants to refute it. The court emphasized that the FTC has the investigatory power to estimate with precision how many consumers authorized the use of adult entertainment services. Consequently, the monetary award from the district court's October 26, 2004, order is vacated, and the case is remanded for further proceedings focused on the unjust benefits obtained by the defendants, requiring reasonable approximations before shifting the burden of proof.

Regarding contempt sanctions, the district court held defendants Green and Shein in contempt for failing to comply with a financial-disclosure requirement of a preliminary injunction and imposed sanctions intended to induce compliance. However, since the permanent injunction replaced the preliminary injunction and did not contain a financial-disclosure requirement, the sanctions are vacated as the court no longer mandates the action the sanctions were intended to enforce. The expiration of the judgment rendered the coercive per-day fines moot.

A contempt sanction against Green and Shein was vacated as moot on appeal, relieving them of imposed fines and civil confinement. The FTC retains the right to seek financial disclosures and impose new sanctions if future violations occur. The appellate court affirms the district court's final order from October 26, 2004, except for the monetary judgment, which is vacated, along with a May 2, 2001 contempt order. The defendants do not claim an exception under the FTC Act, which prohibits unfair methods of competition and deceptive practices in commerce. The Wheeler-Lea Act of 1938 expanded these prohibitions. The document discusses the classification of entities as common or private carriers, noting that a single firm can hold both statuses depending on the context. It references various cases establishing that district courts have broad equitable powers under Section 13(b) of the FTC Act to impose remedies not explicitly limited by the statute, affirming the court's authority to grant equitable relief in enforcement actions.

The excerpt analyzes the legal authority of district courts under the Federal Trade Commission (FTC) Act, specifically Section 13(b), to grant remedies such as asset freezes, rescission, consumer redress, restitution, and disgorgement. Citing Porter v. Warner Holding Co. and FTC v. H.N. Singer, Inc., it establishes that district courts possess inherent equitable powers unless limited by statute. Additionally, FTC v. Gem Merch. Corp supports the notion that these equitable powers extend to awarding consumer redress for violations, emphasizing that equitable restitution can involve tracing unjustly obtained funds, even if they are no longer in the defendant's possession. The excerpt references Great West's ruling, which affirms that recovery can occur if funds belonging to the plaintiff can be traced to specific property held by the defendant. It also mentions FTC v. Figgie Int'l, Inc., where the court authorized damages beyond the defendant’s gains based on the FTC Act. Furthermore, it notes that the FTC's approximation of damages during the "Sprint Period" is supported by evidence of poor customer service and improper billing practices affecting consumers.