Decision in Section 13(b) case has major implications for direct sellers; battle far from over
By Rick Redding
“This ruling takes away the FTC’s power, except over injunctions.”
—Spencer Reese, co-founder, Reese Poyfair Richards LLC
“This is good news for direct sellers, but this battle is far from over … making the issue ripe for appeal to the Supreme Court.”
—John Sanders, partner, Winston and Strawn
Even though the Seventh Circuit Court of Appeals only has appellate jurisdiction over Illinois, Indiana and Wisconsin, its recent decision limiting the Federal Trade Commission’s (FTC) powers sets a precedent that will change the way companies and their owners are treated during FTC investigations.
The FTC’s policing operation has been sniffing out suspected scammers and pyramid scheme operators for decades, handing out injunctions, freezing assets and doling out financial penalties on companies it considers guilty of illegal activities.
Vemma, along with its owner and CEO BK Boreyko, was one such company that experienced the harsh approach of the FTC. On the morning of Aug. 24, 2015, Boreyko was driving to work when he got a call from one of his executives telling him the FTC was on the premises of his company, along with U.S. Marshals, FTC agents and local police. Vemma was being shut down as the result of a secret 11-month investigation that claimed Boreyko was operating a pyramid scheme.
The FTC placed his company in receivership, his employees were fired immediately, and Boreyko lost access to his office, his products, and his operation that had been shipping 100,000 packages per month.
According to John E. Villafranco of law firm Kelley Drye & Warren LLP, between July 2017 and June 2018, the FTC obtained 114 court orders totaling $563 million and supported refund programs administered by FTC defendants or another federal agency to deliver more than $2.3 billion in refunds to consumers.
Now things appear to be changing, primarily as a result of the Seventh Circuit Court of Appeals decision in August. The decision, which goes against the court’s own previous rulings and decades of precedence, has the potential to take the teeth out of FTC enforcement by removing the agency’s ability to claim restitution for victims. Of course, attorneys familiar with the ruling are quick to say that it’s just one court, one ruling, and doesn’t immediately apply to other cases. But they also say that the ruling has major implications for the direct selling channel.
Spencer Reese, a Utah-based attorney active in the direct selling arena, says it is a game changer.
“The FTC has been the 800-pound gorilla in shutting down pyramid schemes and has taken many visible actions against network marketing companies,” he says. “This ruling takes away the FTC’s power, except over injunctions.”
The facts of this particular case, involving a firm named Credit Bureau Center, are a textbook example of fraudulent behavior. The company placed online ads for rental properties that didn’t exist and told consumers that before they could pursue the properties they had to obtain a credit report through company websites.
Consumers were led to believe the credit reports were free but were unknowingly enrolled in a credit monitoring service and charged a monthly fee.
The FTC sued, proving the company deceived consumers unlawfully. An Illinois federal court ordered restitution of $5.2 million to consumers. In its appeal to the Seventh Circuit, the company successfully argued that under Section 13(b) of the Federal Trade Commission Act, the FTC is only able to seek injunctions, not restitution.
“The language in 13(b) gives authority for injunctions, but not asset freezes and restitution,” says Reese, explaining that courts have nonetheless supported FTC penalties for decades. “It’s rare for a court to overturn its own prior ruling.”
In 1989, the Seventh Circuit supported a restitution award in a case, FTC vs. Amy Travel Service, that has served as precedent for similar cases ever since. But now that has changed with the Seventh Circuit’s recent ruling.
“The decision significantly limits the FTC’s powers under Section 13(b),” says Katrina Eash of law firm Winston and Strawn. “The injunctive power of Section 13(b) will always be a powerful tool to force an organization’s capitulation, although that injunctive power has been recently reduced in some circuits (e.g., the Third Circuit’s Shire decision). The Seventh Circuit’s decision further limits the FTC’s Section 13(b) enforcement powers.”
The aforementioned case, FTC v. Shire Viropharma, also limited the FTC’s power by ruling a case could not be brought under Section 13(b) unless it could articulate specific facts that a defendant “is violating” or “is about to violate” the law.
The FTC’s Next Move
The FTC could pursue a change in the law in Congress, but that’s a lengthy process that may not be successful. Legislators may even get behind new bipartisan restrictions on fraudulent behavior toward consumers, a popular sentiment for either party’s voters.
The FTC could also wait for the Supreme Court to take up a case involving 13(b), but getting a case to the court is also full of potential delays.
“The decision makes clear that if the FTC wants to pursue an organization for monetary damages, it must do so through time-consuming administrative and judicial processes to ensure that appropriate checks and balances, along with notions of due process, are honored,” says John Sanders of Winston and Strawn. “This is good news for direct sellers, but this battle is far from over given that the Seventh Circuit created a circuit split, making the issue ripe for appeal to the Supreme Court.”
Whether other circuit courts will follow the lead of the Seventh Circuit remains to be seen. It is clear that defendants in cases brought under 13(b) will cite the Credit Bureau Center case in attempting to avoid paying restitution.
“The Credit Bureau Center decision is significant. The FTC will need to decide its next move.” says attorney John Villafranco. “They may push for a legislative fix or seek a writ of certiorari, which would require at least four of the Justices concluding that the circumstances here are sufficient to warrant review by the Supreme Court. In the meantime, I would expect the Credit Bureau Center decision to lead to many defendants raising the issue in cases brought by the Commission.”
Following the ruling, an FTC spokesperson stated, “We are disappointed by this decision, and we are evaluating our options. The FTC’s ability to recover money for consumers is an essential and long-established tool in our enforcement arsenal.”
Villafranco added that it’s difficult to predict how other courts will react to the ruling in the Seventh Circuit, but there may be a willingness to reconsider past precedent regarding the FTC’s ability to obtain restitution.
“It’s well-established we’re seeing a transformation of the federal judiciary,” says Villafranco. “In the first two years of his Administration, President Trump appointed more than 100 federal judges. That is more than 10 percent of the federal judiciary and 20 percent of the appellate courts. How these judges will view prior precedent on this issue, particularly when it involves an argument that focuses on statutory construction, remains to be seen.”
Meanwhile, the FTC could make use of its Section 19 authority, which allows for restitution in situations where the defendant’s conduct is dishonest and fraudulent, but involves a higher hurdle—the agency must first prevail in an administrative proceeding before bringing the case to federal court.
Finally, there is speculation that the ruling is a victory for scammers and will embolden some who will proceed with illegal acts without fear that an FTC investigation might result in a large restitution award. “I am not so sure,” says Villafranco, “I don’t think companies who engage in fraudulent practices think that far ahead. Once a company is being investigated, however, they might think twice about their next move if the Seventh Circuit’s decision in this case becomes the law of the land.”
The Seventh Circuit’s decision will spark plenty of debate about the FTC’s power, and direct selling companies who come under the FTC’s review now have a case to use in their defense against claims of illegal activity.
Meanwhile, Boreyko says by the time he got his company back, the damage had been done. Though he has recovered for the most part, his company may never get back to the $200 million in sales it enjoyed in its heyday. He says his story is even being considered for a motion picture, and he’s writing a book about the experience.
Concerning this latest news, Borekyo says, “Hopefully this will bring some balance to the process.”