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February 14, 2017 Articles

Eleventh Circuit Nudges Operation Choke Point Toward a More Proportional Remedy

Payment card processors and ISOs have been subjected to increasing scrutiny when the merchants those processors and ISOs serve engage in consumer fraud

by Edward A. Marshall

For the past several years, payment processors and independent sales organizations (ISOs) have seldom received good news about Operation Choke Point—the moniker used to describe the pursuit of the payments industry by agencies such as the Federal Trade Commission (FTC) and the Consumer Financial Protection Bureau (CFPB), for the untoward acts of the merchants the industry serves.

The arc of enforcement actions seemed to be accelerating—a trajectory of more litigation and the pursuit of increasingly draconian remedies. Indeed, processors and ISOs went from being sources of information for government actors pursuing businesses engaged in consumer fraud to targets themselves. The FTC and the CFPB began to seek contempt sanctions against processors that allowed their contractually established reserve funds to be used to satisfy consumer chargebacks, claiming that those processor dollars were subject to freezes imposed on the target merchant's assets. Then the government began naming processors and ISOs (along with individual principals) as defendants in cases alleging unfair and deceptive practices against merchant codefendants, with the government seeking to hold them liable, not just for the revenues associated with "bad apple" merchants, but for the entirety of the consumer harm perpetrated by their merchant customers.

Those initiatives by the FTC and the CFPB show little sign of abating. And, even from the vantage point of industry advocates, it is difficult to dispute that some boarding, underwriting, and risk-monitoring practices—at least at the periphery of the acquiring world—appropriately are subject to criticism and disruption by regulators. What has become increasingly difficult to accept is the severity of the remedies the government is seeking to extract from processors, ISOs, and their (individual) principals when those practices are exploited by merchants seeking to engage in deceptive consumer conduct. Often the relief pursued by the regulators is disconnected from the limited role acquirers played in the allegedly improper conduct, and grossly disproportionate to the relatively small fraction of transaction value that went to the processor or ISO in the form of processing fees or residuals (as opposed to the bulk of the transaction proceeds that went to the merchant).

FTC v. WV Universal Management, LLC
The FTC's case against Universal Processing Services of Wisconsin, LLC (UPS), which it initiated in a Florida federal court, underscores both the dangers of litigation and the extent to which a finding of liability can result in a shockingly disproportionate result. See FTC v. WV Universal Mgmt., LLC, No. 6:12-cv-1618 (M.D. Fla. filed Nov. 1, 2012). There, the FTC alleged that a telemarketing scheme, known as "Treasure Your Success," was able to gain and maintain access to the payments grid through UPS despite the presence of multiple red flags (e.g., a high-risk business model, extremely high chargeback ratios, 20 percent reserves, and failure to abide by internal UPS policies). It contended that UPS provided "substantial assistance" to the telemarketers while knowing or "consciously avoid[ing] knowing" of multiple violations of the Telemarketing Sales Rule (TSR), 16 C.F.R. part 310. Based on those allegations, the FTC sought relief under section 13(b) of the FTC Act, 15 U.S.C. § 53(b), which authorizes equitable relief, including disgorgement and restitution, and section 19 of the FTC Act, 15 U.S.C. § 57b, which authorizes a court to redress consumer injury.

Several defendants, including the telemarketers themselves, settled quickly for either no money or relatively miniscule sums. UPS nevertheless chose to fight, claiming that the individual who facilitated the boarding of the telemarketers and allegedly turned a blind eye to the red flags was acting in violation of company policy. Ultimately (and given the referenced individual's leadership role within the company, perhaps unsurprisingly), the court rejected that argument and awarded the FTC summary judgment. And that is where the case took a disturbing turn. When asked to fashion a remedy, the court—while never finding that UPS was part of a "common enterprise" with the telemarketing defendants—held that UPS was responsible for the entire consumer harm caused by the telemarketers under section 13(b) of the FTC Act. That is, while the fraudulent telemarketers themselves settled for virtually nothing, UPS, which had netted just a few thousand dollars in processing fees (before giving over $400,000 in refunds to injured consumers prejudgment), was held jointly and severally liable for $1.7 million—the totality of the telemarketers' processing activity minus only chargebacks and refunds.

Such a result, if left intact, had the potential to have an incredible chilling effect on processors' willingness to work with other high-risk, even if wholly legitimate, businesses. After all, the amount of the judgment against UPS was orders of magnitude greater than the fees it received from the parties' processing relationship. But it was not just an unsettling award from a proportionality perspective. As UPS argued on appeal to the Eleventh Circuit, the award did not seem sustainable under section 13(b) of the FTC Act, which contemplates a defendant's "disgorgement" of ill-gotten gains, not the gains received by third parties (such as the deceptive telemarketers themselves). As UPS persuasively argued before the appellate court, the concept of a "joint-and-several equitable disgorgement" had little to no precedent outside of the context where the party assisting and facilitating the fraudulent conduct was part of a "common enterprise" with the other bad actors.

While not expressly holding that the district court "got it wrong," the Eleventh Circuit seemed troubled by the result. It questioned how the district court had arrived at such a severe sanction and, forecasting its disinclination to affirm such an outcome outside the context of a common enterprise or other uniquely extenuating circumstances, explained:

If UPS was not included in the common enterprise, then the district court provided no explanation as to why joint and several liability in the amount of $1,734,972 was appropriate, and made no findings which made such an award obviously appropriate. Accordingly, we vacate the judgment of the district court with respect to UPS . . . , and we remand this case for findings of fact and conclusions of law as to whether and why UPS is jointly and severally liable for restitution and in what amount.

FTC v. HES Merch. Servs. Co., No. 15-11500, 2016 WL 3254652, at *1 (11th Cir. June 14, 2016).

Implications of the Eleventh Circuit's Opinion
On its face, the import of the Eleventh Circuit's reasoning is difficult to ignore. For the first time, and at the highest level to date, there is judicial pushback against the idea that a processor or an ISO should be held liable for the entirety of the harm caused by its merchants' misdeeds. Rather, the Eleventh Circuit seemed to suggest that where a processor or ISO is not determined to be part of a common enterprise with a deceptive merchant, an equitable remedy should be crafted based on what the processor or ISO received from the processing relationship—not the totality of the merchant's transactions. In short, the appellate court's reasoning offers a glimmer of hope that the arc of Operation Choke Point may be headed toward a more positive, and proportional, direction.

That said (and somewhat surprisingly), the district court, on remand, seemed unmoved by the Eleventh Circuit's suggestion that joint and several liability should attach only in cases where a common enterprise existed between the merchant and the processor or ISO defendant. In a decision issued in late October 2016, it instead reentered its original award, reasoning that in other FTC cases (and in cases brought by the SEC), courts had imposed joint and several liability in certain circumstances, providing precedential support for its earlier decision. See FTC v. WV Universal Mgmt., LLC, No. 6:12-cv-1618 (M.D. Fla. Oct. 26, 2016). The court stopped short, however, of issuing any factual findings supporting the existence of a common enterprise. In doing so, it left largely unaddressed the Eleventh Circuit's articulated concern that the original award lacked the factual predicates necessary to sustain joint and several liability. Consequently, another appeal, and another opportunity for a circuit court to address the appropriate contours of liability under the FTC Act, seems highly probable.

Of course, even if the Eleventh Circuit were once again to reverse the lower court, it scarcely would defang Operation Choke Point. First, the Eleventh Circuit was focused on section 13(b) of the FTC Act, which permits only equitable relief (and, interestingly, was the sole statutory authority invoked by the FTC in briefing related to the appropriate remedy). The court did not explicitly address section 19 of the Act, which authorizes "such relief as the court finds necessary to redress injury to consumers or other persons" in instances where a defendant violates a specific rule, such as the TSR. Thus, while it may be cause for optimism in cases where the FTC is pursuing a processor or ISO for generic "unfair" or "deceptive" conduct, the Eleventh Circuit's decision may not offer the same degree of comfort in other cases brought under the TSR. Second, even if the courts were to find disgorgement to be limited to the ill-gotten gains of a particular defendant, the standard for disgorgement in FTC litigation remains a painful one. Under prevailing precedent, such disgorgement is calculated as the defendant's gross receipts, which do not take into account expenses, including, e.g., hefty residuals to sub-ISOs or sales agents. See, e.g., FTC v. Wash. Data Resources, Inc., 704 F.3d 1323, 1326–27 (11th Cir. 2013). Thus, a processor or ISO called upon to make disgorgement has the potential to lose much more than it ever netted in its relationship with a dubious merchant.

Even a more proportional Operation Choke Point has significant teeth and counsels strongly in favor of rigorous underwriting and risk-monitoring standards designed to prevent and detect consumer fraud.

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