Personal liability for corporate scheme appropriate for repeat offender

Federal Trade Comm’n v. Grant Connect, LLC, No. 11–18023, 2014 WL 3973402 (9^th Cit. Aug. 15, 2014)

Individual defendant Kyle Kimoto appealed from the district court’s grant of summary judgment to the FTC and its permanent injunction against a variety of marketing tactics and award of restitution.  Kimoto wholly controlled a company, Vertek, that had committed multiple violations of the FTCA.  The district court found that Kimoto was both personally involved in the practices and knew that the advertising was misleading or was recklessly indifferent as to that possibility.  The court of appeals upheld most of the district court’s rulings, except on restitution for one type of marketing.

Kimoto’s been in the FTC’s sights for over a decade, resulting in three different enforcement efforts against him.  All his schemes had some similar features: he “lured consumers with a deceptively advertised headline product, and then enrolled them in ‘upsells,’ or negative-option ‘free trials’ that required consumers to undergo a burdensome cancellation process in order to avoid inadequately disclosed recurring monthly fees.”  A previous case against Kimoto and one of his companies, alleged that Kimoto misleadingly marketed preapproved MasterCards, but provided instead applications for cash-secured debit cards or unusable plastic cards bearing an unauthorized reproduction of the MasterCard logo, and then enrolled them in additional negative-option plans with recurring fees both for the “credit cards” and for the “free trials,” with a variety of barriers to effective cancellation.  The Fifth Circuit found that Kimoto, through his company “committed multiple, egregious violations of the [FTC Act].”  He was permanently enjoined from telemarketing and ordered to pay $106 million in restitution. The FTC initiated criminal charges against Kimoto for his role here.

“Apparently undeterred,” Kimoto formed a corporate entity that eventually became Vertek. Vertek engaged in Internet marketing schemes and was legally owned by Kimoto’s then-wife to avoid regulatory scrutiny.  (Relationship tip: don’t let your then-spouse do this.)  As she testified, “this structure had the added—and intended—benefit of permitting her to profit from the company in the event that Kimoto was incarcerated.”  Kimoto actually organized and ran the company, hiring many of the employees involved in the previous scheme.

Kimoto directed and participated in a number of schemes, including marketing a “guaranteed” unsecured credit line.  The ads didn’t mention that consumers could only use the “line of credit” to make purchases from an affiliated online store, and this fact was “[h]idden deep in the fine print” of the terms and conditions.  In small print below the “submit” button, the signup page stated that consumers would be charged a $39.95 monthly fee and would be automatically signed up for additional programs with recurring monthly charges.  Consumers complained, but the site made cancellation “exceedingly difficult, needlessly transferring customers to different websites or phone numbers, even though all of the calls ended up in the same service center.” The scheme ran for nearly two years, during which time, “after considerable effort on their parts, approximately 94 percent of subscribers cancelled their subscriptions.” 

There were other similar schemes, such as one promising “grants” and using pictures either of President Obama and Vice President Biden, or of a scantily clad female model holding cash, along with phony testimonials from alleged grant recipients.  (There’s some A/B testing for you.)  False representations included claims that users could find government grants for personal expenses; 91% managed to cancel their memberships after considerable effort before the FTC shut this scheme down.  Lather, rinse, repeat with a “work from home” scheme.

Kimoto was convicted in early 2008 of conspiracy, mail fraud, and wire fraud.  During his trial and subsequent incarceration, he ceased to actively participate in Vertek’s daily activities.

The final Vertek scheme involved unsubstantiated claims that a supplement, Acai Total Burn, would help consumers build muscle, increase their metabolism, lose weight, gain energy, reduce fatigue, and retard the aging process.  This scheme used the same deceptive ordering process, tiny disclosures, and automatic enrollment in additional negative-option trials.  It was available only for two months in 2009, during which time it enrolled 670 customers, 159 of whom had already cancelled when the FTC took over the site.

Kimoto didn’t challenge the district court’s findings that the schemes were deceptively marketed; that the negative options were inadequately disclosed; that the testimonials were false; and that defendants violated the Electronic Funds Transfer Act (EFTA) by debiting consumers’ accounts without written authorization. The district court also found that the corporate defendants operated as a common enterprise: “[a]ll the various offers were run by the same individuals using different company names,” the defendants “swapped and shared personnel,” as well as “blurred the lines of corporate separateness in their activities,” and “engaged in concerted and coordinated action across campaigns, and [making] their profits interdependent.”

Kimoto argued that there was insufficient evidence of his personal involvement in many of the schemes, and that his liability ended when he left the company to prepare for his criminal trial.  Individuals may be personally enjoined based on a corporate entity’s violation of the FTCA if (1) the corporation committed misrepresentations of a kind usually relied on by a reasonably prudent person and resulted in consumer injury, and (2) individuals participated directly in the violations or had authority to control the entities.  Restitution additionally requires the FTC to show that the individual “had knowledge that the corporation or one of its agents engaged in dishonest or fraudulent conduct, that the misrepresentations were the type upon which a reasonable and prudent person would rely, and that consumer injury resulted.” Actual knowledge, reckless indifference, or awareness of a high probability of fraud along with intentional avoidance of the truth will satisfy the knowledge requirement, though intent to defraud is not required for personal liability.  Sufficient involvement in a fraudulent scheme may itself establish the requisite knowledge.

Under this standard, the district court properly held Kimoto liable for both injunctive relief and restitution, except for the Acai Total Burn scheme.  For the line of credit scheme, “Kimoto arranged Vertek’s entire operation. He organized the companies, recruited personnel who had been involved in his prior deceptive marketing schemes, and directed Vertek’s activities. This alone is enough to conclude that he had knowledge sufficient to support personal liability for restitution damages.”  He also declared that he believed it was “important for [him] to understand and know [the language on the deceptive landing pages], because that was [his] job to take it out to the affiliate marketer.”  “In light of Kimoto’s prior troubles with the FTC, which also involved inadequately disclosed ‘upsells,’ his level of participation in the scheme and knowledge of deceptive web pages shows that he knew about, or was recklessly indifferent as to Vertek’s deceptive practices.”

Neither Kimoto’s resort to advice of counsel nor the fact that he was imprisoned at the time Vertek received many of the consumer complaints and chargebacks changed matters.  Reliance on advice of counsel isn’t a valid defense on the question of knowledge, and Kimoto was well aware of the fraudulent nature of the schemes before he was imprisoned even without additional complaints from consumers (which can also constitute evidence of knowledge). 

Similar analysis applied to the grant scheme.  Kimoto controlled Vertek when the scheme was organized; continued that control for more than a year during which time Vertek began drafting its deceptive terms, landing pages, and ads; and directly participated in establishing the scheme, for example by telling team members about their responsibilities and personally receiving misleading ad materials.  He assembled the team of “con artists.”  Although the grant scheme wasn’t marketed to consumers until after his imprisonment, he still participated directly in the FTCA violation—the deceptive marketing that underlay the scheme.  There was no allegation that the marketing materials materially changed after he ceased active participation.  He also had the requisite scienter for personal liability for restitution because he reviewed “program specifics” and fake testimonials months before the product launched, when clearly the testimonials couldn’t have been legitimate.

As for the work from home scheme, Kimoto wrote the deceptive text for the landing pages associated with one of the variants and had other information about it.  He either knew about or was recklessly indifferent to the deceptive advertising given his history of trouble with the FTC; his coordinating role in the scheme; and the “clearly overstated incomes” in the draft product description that he received.

However, as to Acai Total Burn, the evidence didn’t show he directly participated in the scheme or controlled Vertek when the scheme was developed, at which point the other con artists had apparently learned enough to run on their own.  He was incarcerated in April 2008, and work on Acai Total Burn began in February 2009. Thus, he couldn’t be held liable for injunctive relief or restitution with respect to that scheme.

The court of appeals also ruled that individual liability was available for corporate violations of EFTA, which provides that “a violation of any requirement imposed under [the EFTA] shall be deemed a violation [of the FTC Act]” and provides that all the FTC’s powers are available to enforce EFTA.  It follows that individual liability is also available.

Finally, Kimoto challenged the scope of the district court’s injunction, including its ban on all use of testimonials and on preauthorized electronic fund transfers.  (The other restrictions banned him from negative-option marketing, continuity programs, and marketing or selling products related to grants, credit, business opportunities, diet supplements, or nutraceuticals.) No dice. An injunction’s breadth is assessed in relation to “(1) the seriousness and deliberateness of the violation; (2) [the] ease with which the violative claim may be transferred to other products; and (3) whether the respondent has a history of prior violations.”  The FTC doesn’t have to play whack-a-mole; adjudicated lawbreakers must expect some fencing in.  An injunction must merely bear a “reasonable relation to the unlawful practices found to exist.”

Kimoto could be held liable for the acts of Vertek and other companies in a common enterprise. “Kimoto has also consistently engaged in variations on the same deceptive marketing scheme, which, in its latest iteration alone, has defrauded consumers of more than $29 million.”  The common elements of his frauds, as the record showed, were easily transferable to new product lines and to new modes of communication.  Thus, the injunction was reasonably tailored to prevent him from engaging in similarly illegal practices in future ads.  You’ll note that the injunction thus prevents him from engaging in Acai Total Burn-type marketing, even though he was too causally distant from that particular scheme to be liable for restitution here.