FTC lacks jurisdiction over most nonprofits, even sham ones, court rules

Federal Trade Commission v. Grand Canyon Education, Inc., --- F.Supp.3d ----, 2024 WL 3825087, No. CV-23-02711-PHX-DWL (D. Ariz. Aug. 15, 2024)

The court here holds that the FTC lacks §5 jurisdiction over a nonprofit, even if the nonprofit was in fact a sham diverting money to its controller. I wonder if the FTC will appeal, or accept the court’s baby-splitting of allowing it to sue the principal controller.

The FTC sued Grand Canyon Education, Inc.; Grand Canyon University; and Mueller, GCU’s president and GCE’s CEO and chairman of the board, for (1) making deceptive representations concerning GCU’s status as a non-profit institution; (2) making deceptive representations concerning GCU’s doctoral programs; (3) making both sets of deceptive representations in connection with the telemarketing of educational services; (4) initiating telemarketing calls to persons who requested that GCU not contact them; and (5) initiating telemarketing calls to persons registered on the national Do-Not-Call Registry.

Nonprofit allegations: In 2004, GCE—which became a publicly traded company—purchased what is now GCU and began operating it as a for-profit institution. In 2014, GCE chartered GCU as an Arizona nonprofit corporation. Mueller has continuously been in charge since 2017. He received salary, bonuses, and other compensation from both GCU and GCE. His compensation included cash and stock incentives linked to GCE’s financial performance. Despite GCU’s classification as a nonprofit, the FTC alleged that it “was, in fact, organized by GCE and Defendant Mueller to advance GCE’s for-profit business and advance Defendant Mueller’s interests as officer, chairman, director, stockholder and promoter of investment in GCE” and therefore is “operated to carry on business for its own profit or that of its members, within the meaning of Section 4 of the FTC Act.”

In 2018, GCE transferred the trademarks, campus, and certain assets and liabilities of the institution that GCE had operated as ‘Grand Canyon University,’ to GCU in exchange for GCU agreeing to pay GCE more than $870 million plus 6% annual interest.” A master services agreement “executed as part of this transaction makes GCE the service provider for certain essential GCU operations in exchange for a bundled fee that is equal to 60% of GCU’s ‘Adjusted Gross Revenue.’ ” GCE has since been the exclusive marketing provider for GCU, responsible for communicating with prospective GCU students regarding applications, program requirements, and financing options. GCE is also the exclusive provider for GCU of student support services and counseling, technology (including GCU’s platform for online education) and budget analysis services. GCU isn’t permitted to contract with any third party for these services. And GCE is the sole provider of GCU’s student records management, curriculum services, accounting services, technology services, financial aid services, human resources services, procurement, and faculty payroll and training.”

The fees are allegedly not limited and not proportionate to GCE’s costs: “GCE receives 60% of GCU’s revenue from tuition and fees from students, including 60% of charitable contributions to GCU for payment of student tuition and fees. … In addition, GCE does not provide services for student housing, food services, operation of the GCU hotel conference center, or athletic arena, but still receives 60% of the revenue from these operations.” GCU has consistently generated profit for GCE, and is GCE’s most significant source of revenue.

Nonetheless, defendants allegedly promoted GCU in advertising and telemarketing as a private ‘nonprofit’ university and disseminated digital and print advertising” suggesting that “GCU had gone ‘Back to Non-Profit Roots’ and ‘transitioned back to a nonprofit institution.’ ” Mueller said in 2018 that “the characterization of GCU as a non-profit educational institution is a tremendous advantage. We can recruit in high schools that would not let us in the past. We’re just 90 days into this, but we’re experiencing, we believe, a tailwind already just because of how many students didn’t pick up the phone because we were for-profit.” He made a similar statement in 2019 during a GCE earnings call attributing unexpectedly good new student online growth to the non-profit advertising.

In 2019, the US Department of Education “rejected GCU’s request that it be recognized as a nonprofit institution under the Higher Education Act, and classified GCU as a for-profit participant in federal education programs.” The DOE also ordered GCU to cease advertising “nonprofit” status. Defendants mostly complied.  

Telemarketing: GCE has hundreds of sales reps who engage in telemarketing GCU. It has initiated tens of millions of telemarketing calls on behalf of GCU. It allegedly did not respect either individual do not call requests or the National Do Not Call Registry, making more than a million calls in defiance thereof.

Doctoral program: The FTC alleged that defendants marketed “‘accelerated’ programs that enable students to quickly complete their degree, including quickly completing a dissertation.” Its materials allegedly described the GCU programs as twenty course programs that require a total of 60 credits. For example, an enrollment agreement for a “Doctor of Business Administration: Marketing (Qualitative Research)” stated the program costs $702 per credit, lists a “Total Program Tuition and Fees” of “$43,720” based on the 60 credits, and also stated that “[p]rogram cost is estimated based on current tuition rates and fees.” The FTC alleged that this was misleading:

GCU’s requirements for dissertations include eight distinct levels of review that students must complete from the initial prospectus to final approval. Throughout the multi-level review process, GCU requires students to produce multiple drafts with extensive revisions. After a student has completed two years of coursework, GCU appoints one or more faculty members to supervise satisfaction of the requirements. GCU often imposes these dissertation requirements in courses after the three dissertation courses listed in the agreements and requires any student satisfying these requirements to enroll in, and pay additional tuition for, ‘continuation courses.’ … The number of continuation courses and time required for doctoral students to advance through GCU’s doctoral program depends, in substantial part, on services provided by GCU. Students’ ability to satisfy GCU’s requirements may be, and has been, thwarted and delayed by GCU’s actions or inaction, such as reassignment of faculty, inconsistent demands during the dissertation review process, and delays caused by the conduct of faculty appointed by GCU to various roles in the dissertation review process.

In practice, the FTC alleged, GCU rarely awarded a doctoral degree after 60 credits. The average number of courses GCU required for graduates awarded degrees over 2019-2022 was 31—at a cost of over $10,000 to each student. And, unsurprisingly, “[m]ost of the students that enroll in GCU doctoral programs never receive the doctoral degree for which they enrolled. Many of these students are thwarted because they cannot afford the additional costs and time necessary to fulfill GCU’s requirements beyond the twenty courses identified as required.” Any disclosures, the FTC alleged, were insufficient.

The court initially rejected a constitutional challenge to the FTC’s enforcement authority. The Supreme Court both explicitly upheld the constitutionality of the FTC’s commission structure in Humphrey’s Executor v. United States, 295 U.S. 602 (1935), and explicitly distinguished its more recent holding on the President’s removal power as to single-head agencies therefrom, Seila Law LLC v. CFPB, 591 U.S. 197 (2020). Unlike some other district courts I could name, the court here thought those cases—along with binding circuit precedent specifically upholding the FTC’s post-1935 expanded enforcement powers as constitutional—meant that it wasn’t going to toss out those enforcement powers. Pointedly, the court noted that even the Fifth Circuit has yet to go so far. Illumina, Inc. v. FTC, 88 F.4th 1036 (5th Cir. 2023) (“[A]lthough the FTC’s powers may have changed since Humphrey’s Executor was decided, the question of whether the FTC’s authority has changed so fundamentally as to render Humphrey’s Executor no longer binding is for the Supreme Court, not us, to answer.”).

However, GCU’s argument that it wasn’t a “corporation” under the FTC and the Telemarketing Sales Rule fared better.

The FTC has jurisdiction over “persons, partnerships, or corporations.” As to that last, it only covers a company/trust/association that is “organized to carry on business for its own profit or that of its members.” The FTC responded that it sufficiently alleged that GCU was, in fact, for-profit “because it was organized to, and does, benefit its for-profit founder, GCE, and President, Defendant Mueller” and because “[a] genuine nonprofit does not siphon its earnings to its founder, or the members of its board, or their families, or anyone else fairly to be described as an insider.” 

The key question: was GCU “organized to carry on business for its own profit or that of its members”? The FTC argued that the answer was yes, because it was set up and operated for profit. But the court didn’t think that was the same thing as “organized” for profit. After all, GCU, had a nonprofit charter under state law, and its “articles of incorporation ... represent that it is organized and operated exclusively for charitable, religious, and scientific purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code.”

Does the FTC’s authority depend on state corporation filings or IRS status? In a footnote, the court acknowledged that several courts have agreed with the FTC that it doesn’t, but the court here disagreed because “organized” for profit is not the same as “operated” for profit. [Not a very consumer-protection-friendly interpretation of the law.]

Congress has specified in other contexts (that is, the tax law itself) that an entity should be treated as a nonprofit only if it was both “organized” as a nonprofit and thereafter “operated” as a nonprofit. But it only authorized the FTC to pursue claims against an entity that is “organized to carry on business for its own profit or that of its members.” That at least raised an inference that the certificate of incorporation did determine the FTC’s authority.

Still, GCU was willing to rely on a narrower argument, which was that the FTC didn’t make the necessary showing that GCU was in fact organized to profit itself or its members. Mueller wasn’t actually a member of GCU. The court didn’t accept the FTC’s theory that, if an ostensible nonprofit entity is being operated to benefit “insiders,” “related ... businesses,” or “officers” that are not members, it qualifies as a company “organized to carry on business for its own profit” within the meaning of the FTCA. But this theory had never been adopted by a court and the court found that, while “debatable,” the better plain-language meaning was that it wasn’t a viable theory. Congress could have said that the law covered fake nonprofits; the tax code specifically requires an evaluation of whether any “part of the net earnings” of an asserted nonprofit charity “inures to the benefit of any private shareholder or individual.” “Although there may be persuasive policy reasons why the FTC should be allowed to pursue claims against nonprofits that operate for the benefit of non-member insiders, related businesses, and officers, the Court must take the statute as written.”

The statutory reference to the corporation’s “own” profit couldn’t be extended to “insiders,” “related businesses,” or “officers.” [I’m not sure there’s consistency in the greater law of agency, but I am pretty sure that for some purposes, agency law is totally happy to make this attribution.] That was “a seemingly unlimited list of third-party beneficiaries” and would make “own” superfluous.

This result kicked out both §5 and TSR claims against GCU.

But there were still claims against Mueller. Mueller argued that the “nonprofit” statements were truthful, because GCU was “organized as a nonprofit under Arizona law and recognized by the IRS as a 501(c)(3) tax-exempt entity.” The DOE’s disagreement, they argued, was not relevant or material, and students couldn’t have been deceived before the DOE ordered defendants to stop the ads.

The court allowed the claims to proceed. The FTC disputed whether the IRS had found GCU to be a nonprofit at the time defendants marketed it as one, and argued that the Arizona Corporation Commission and Higher Learning Commission never made an actual finding that GCU qualified as a nonprofit. “If, as the FTC seems to contend, Defendants made false representations to the IRS to secure GCU’s nonprofit classification,” then there wouldn’t be a binding government determination of status.

Additionally, FTCA liability turns on misleadingness to a reasonable consumer. Whatever the legal niceties, whether “nonprofit” advertising meant something other than the legal definition to students and was deceptive needed factual development. Mueller’s own statements “easily suffice[d]” to raise a plausible inference of materiality.

Doctoral degree misrepresentations: Mueller argued that there was no deceptiveness because GCU tells students the doctoral programs usually require additional coursework. All the representations referred to 20 courses/60 credits as a minimum, and they said a doctoral degree could be completed in less than seven years, not that it typically is. The FTC pointed out that the complaint identified a lot of 20 courses/60 credits claims, including enrollment agreements listing “ ‘Total Program Credits 60,’ and ‘Total Tuition Program and Fees:’ followed by a dollar figure based on the tuition and fees for twenty courses.” And it pointed out that disclaimers that don’t work don’t stop deceptiveness. The court agreed that there was a factual issue, despite some “non-actionable puffery” in the allegations related to an “accelerated path” to a doctorate.

The court also noted that, although some of the challenged representations appeared on GCU’s website and GCU was now out of the case, the allegations that GCE prepared all marketing materials plausibly kept the website in.

The court declined to require the TSR claims to meet the heightened pleading requirement of Rule 9(b), although it noted that the allegations were specific enough to do so. The FTC’s claims generally didn’t require knowledge of falsity or intent to defraud.

Individual claims against Mueller: There were no allegations in the complaint specific to his role in crafting GCE’s challenged representations concerning GCU’s doctoral degree requirements or addressing his knowledge of the alleged inaccuracy of those representations. Individual monetary liability for a corporation’s violations of § 5 of the FTC Act requires proof of both (1) authority to control the challenged representations and (2) some degree of awareness of, or reckless disregard concerning, the challenged representations. The FTC plausibly alleged (1) because he was GCE’s CEO. And there were extensive allegations about Mueller’s role in structuring the operations of GCU and GCE and overseeing the operations of both entities in his roles as president (of GCU) and CEO and chairman of the board (of GCE). That was sufficient to plausibly establish knowledge or recklessness for purposes of individual liability at the pleading stage.

In addition, “when the FTC seeks injunctive relief against an individual based on corporate-entity violations, the only required showing is that the individual participated directly in the violations or had authority to control the entity.”

The same analysis applied to individual liability for TSR violations.