Feds Should Think Twice About Regulating For-Profit Colleges

Business is booming at America’s for-profit colleges. With steady high unemployment rates, many of the job-hungry have opted to pursue higher or specialized degrees in an effort to make themselves more marketable. Pricy for-profit institutions, like the 400,000 strong University of Phoenix, are flourishing with this increased demand as students flock to their courses to invest in new career prospects.

But recent regulatory activity at both the state and federal levels may signify that the party is over … or, more likely, that it must settle down quite a bit. Questionable recruiting and student financing practices at some career colleges have brought these education companies to the attention of many state attorneys general, the Department of Education, and the Senate Committee on Health, Education, Labor and Pensions, with the latter holding hearings on student financing at for-profit colleges.

Federal-level issues largely center on less-than-desirable statistics regarding federal student loans. Apparently, nearly half of federal student loan defaults come through these for-profit colleges, while financing for students at the institutions grows rapidly. Significant to these statistics is how expensive for-profit colleges are as compared to state schools. A 2010 GAO Report noted that, while enrollment in career colleges jumped from 1 million to 1.8 million students from 2003-2008, federal student aid to those institutions tripled from $8 billion to $24 billion.

State-level issues revolve around alleged violations of consumer protection statutes through aggressive recruiting tactics. For instance, for-profit colleges are being investigated for potential false or deceptive claims to prospective students on accreditation for degree programs and post-graduation career prospects. Also at issue are colleges’ disclosures of student loan financing and loan default rates.

Some ten states’ attorneys general formed a task force in March to combine efforts and share investigative information as they pursue actions against these institutions.  According to a recent op-ed by Kentucky Attorney General Jack Conway, who is leading the task force, the number of states investigating has jumped to 18.  States, including New York and California, are and have been going after for-profit colleges on their own (including a recent action by New York AG Schneiderman against Trump University).

At the federal level, the Department of Education has been busy establishing new regulations for career colleges. The most notable of late, the “gainful employment” rule, will require colleges to demonstrate that at least 35 percent of students are repaying their loans, or that loan repayments do not exceed 30 percent of their discretionary income or 12 percent of their total earnings. Schools failing to meet the standard in three out of four years will no longer be able to accept student payment with federal loans.

These government efforts may make it seem that career colleges are nothing more than greedy institutions preying upon the unemployed during bad economic times, and that the white hat-donning government regulators are nobly reining them in.

However the economics of, or the basis of, for-profit colleges does not appear to have been considered: for-profit colleges are not as much in the business of educating and graduating stellar students as they are in the business of making money. These companies have an interest – and obligation to their shareholders/investors – to maximize profit and minimize cost. The more money they can charge students and the less money they must dole out for the service they provide (i.e. education), the better off they are. And again, that is their overarching duty to their investors.

In a perfect free market, career colleges could not charge exorbitant fees to attend their schools if their students could not get jobs after graduation – because students would not pay. But in our current structure where the cash cow of federal student loans exists, both for-profit colleges and prospective students have almost unlimited access to big funds. For-profit colleges would be irresponsible to their investors if they did not tap this resource. Students often are not responsible enough to understand the consequences of accruing significant student loan debt.

Bottom line, much of the issue of for-profit colleges in the social context is that they have both a financial and legal duty to act in their own interest. The problems federal and state regulators seek to address are largely problems created by the federal government’s presence in the first place. Without the federal cash cow, private lenders (who would be the sole source of student financing) would insist both for-profit colleges and students behave differently. Colleges would have to improve performance and students would have to be more judicious about how they spend their money.

Should FTC Sue Law Schools For Misrepresentation?

On May 25, 2011, a class action was filed against the Thomas Jefferson School of Law (TJSL) in San Diego for intentionally misrepresenting employment data of recent alumni. The complaint states that in order to continue attracting students despite exorbitant law student debt and a depleted legal job market, TJSL has “adopted a practice of misrepresenting its post-graduation employment statistics.”

These facts aren’t unique. According to a non-profit devoted to this issue, until very recently almost all 198 American Bar Association-accredited law schools deceptively touted churning out graduates with at least a 90 percent employment rate within nine months of graduation.

The Above the Law blog very recently referred to UCLA Law’s claim that 97.9 percent of its class of 2010 was employed within nine months of graduation at a median starting salary of $145,000 as “frankly unbelievable.”

According to Paul Campos in The New Republic, only about 60 percent of law graduates nationwide obtain permanent, full-time legal employment nine months after graduation.

Some observers say the Federal Trade Commission should step in to have turned to investigate whether the law schools have engaged in false advertising. However, we doubt that this would be a good idea, for several reasons.

Is there jurisdiction? The FTC’s jurisdiction is limited to entities such as for-profit corporations and partnerships and nonprofits that provide a pecuniary benefit to members. This may not include law schools, which are nonprofit institutions of higher education that provide scholastic rather than economic benefits. For the FTC to assert jurisdiction in this instance would be tantamount to an effort to regulate the advertising and marketing of all institutions of higher education, which would be far from the original purpose of the FTC to regulate the trade practices of businesses.

Are law schools completely at fault? Employment statistics are gathered according to the industry standard — a compilation of voluntary student responses to questionnaires provided by the ABA. However, many schools are not receiving anything near full participation from their students, resulting in skewed statistics. Schools tend to indicate this by inserting a disclaimer of the true percentage of student participation, making it clear that the statistic is not fully reliable. However, U.S. News & World Report publishes these statistics without the disclaimer. USNWR remains the most popular resource for potential law students in researching which law schools to attend, and its readers will find no disclaimer.

Is there a violation? Even if the FTC could regulate law schools, in order for there to be a false advertising violation, the misrepresentation must be material. There are numerous factors that go into a perspective student’s decision: location, student body, student/faculty ratio, tuition, and the average GPA/LSAT scores of admitted students. Further, the misrepresentation must also have been reasonably relied upon. Nearly all perspective students who view these statistics already have or nearly have obtained an undergraduate degree. It may not be reasonable to assume that these highly educated consumers have actually relied on claims of a 90 percent-plus employment rate in today’s economy, where unemployment is known to be historically high. The FTC normally protects the most vulnerable consumers against marketing practices that target the gullible, the poor, and the less educated. A lawsuit on behalf of law school applicants hardly seems consistent with the agency’s priorities.

Internet Affiliates Fight Back in Court Against Illinois Retail Tax

An organization that represents online affiliates filed suit in federal court this month challenging the constitutionality of a new Illinois law targeted at collecting sales tax from Web retailers. Internet retail giant Amazon.com has threatened to cut off its marketing affiliates in Illinois in an effort to avoid paying the tax, and other companies are threatening similar action. We have previously examined the potential effects on affiliates of this type of state tax.

Internet retailers cite a 1992 Supreme Court decision, Quill Corporation v. North Dakota, which ruled that states could require only companies that had a physical presence within the state to act as a tax collector. Online retailers have used this ruling to justify the payment of taxes only in the few states in which they have a physical presence.

The suit claims that the Illinois law goes beyond the state’s power to regulate interstate commerce, since the state legislature seems to be taking the view that an online retailer, with no physical presence in the state, establishes a presence in Illinois merely by advertising on websites owned by Illinois affiliates.

With many states facing significant budget shortfalls, legislative momentum is growing throughout the country to tax Internet retailers.  A University of Tennessee study has estimated that between 2007 and 2012, states will sustain over $52 billion in losses from uncollected taxes on e-commerce sales. Connecticut has already signed into law a state tax on online purchases earlier this month, and California lawmakers have passed a bill, now awaiting approval from the governor, that would force out-of state Internet retailers to collect taxes.  Bills are pending in at least five other state legislatures.

These bills are all, in one way or another, efforts by the states to circumvent the court’s ruling in Quill.  Last year, New York enacted a law that stated that the practice of paying commissions to marketing agents based in the state constituted a presence in the state. Amazon has challenged the law in court. Several other states, including Arkansas, Colorado, Illinois, North Carolina, and Rhode Island all followed by passing laws similar to New York’s.

With companies threatening to leave states that enact taxes and in some cases actually cutting all ties with the states, state legislatures are debating what to do.  While some states are looking at enacting their own taxes, other states are considering different routes.  In April, the South Carolina legislature defeated a law that would have provided a five-year sales tax exemption to Amazon in exchange for Amazon building a distribution center in the state.  Amazon then cancelled its plans to build a distribution center in South Carolina.

The one action that would break the logjam would be federal legislation requiring states to collect sales tax on Internet retailers. Last summer a bill entitled the “Main Street Fairness Act,” (H.R. 5660) was introduced in Congress that would require all businesses to collect taxes in the state where the consumer resides. The bill did not make it out of committee, but some feel that the tides are shifting towards federal action.  Sen. Dick Durbin (D. Ill.) has stated that he plans to reintroduce legislation to tax online retailers, calling the idea “overdue.”  However, federal legislation could be complicated if voters perceive this as a new tax.

As states look to close the gap on budget shortfalls, there will be continued debate on the viability of taxing Internet retailers. Unless action occurs at the federal level, states will have to decide if it’s preferable to tax Internet retailers and risk losing their presence in the state or not to tax them in an attempt to maintain or grow their presence in the state.

FTC Goes After a Consumer-Endorser for the First Time

When deciding whether to buy a product or service, how often do you check out product reviews or testimonials and how often does that research impact your purchasing decision?

The FTC seems to consider consumer reviews and testimonials as pretty persuasive – most notably in the context of online write-ups. In 2009, the Commission revised guidelines on testimonials and endorsements to address the importance of these reviews and especially the growing prevalence of online reviews. Significant in the revisions was that the FTC highlighted the possibility of endorser liability for false or unsubstantiated claims. (FTC regulations typically are directed at advertisers as opposed to those who give product endorsements or testimonials.)

Less than two years later, the FTC has filed a complaint against a consumer-endorser. The Commission, along with the Colorado Attorney General, filed an action in U.S. District Court in Colorado against Marsha Kellogg for her alleged false or misleading representations in support of an infomercial program, “Winning in the Cash Flow Business.” According to the complaint, Kellogg falsely claimed that she earned an artificially high amount of money through the infomercial program – some $50,000 more than what she actually earned.

The action was incorporated in a suit filed against the CEO/founder of that infomercial enterprise, Russell Dalbey, and related defendants. However, Kellogg already agreed to an order settling the FTC’s charges – an order that generally prohibits her from making several types of misrepresentations in the future.

Significantly, this is the FTC’s first order against a consumer on charges of misrepresentations in a product/service testimonial. As it foretold in the 2009 guidelines, the FTC has now broken ground by going after a new type of defendant. Now, seemingly little guys, i.e. the random individual who is paid for a testimonial on a product or service, may find themselves in hot water for making inflated endorsements.

Should the FTC persist in going after this new breed of defendant, it is likely to focus on the web-related aspects of its revised 2009 guidelines: bloggers and other “word-of-mouth” marketers. The FTC noted that these types of endorsers are subject to the long-standing principle “that ‘material connections’ between advertisers and endorsers – connections that consumers would not expect – must be disclosed.” The FTC likely means to address blogs and other online write-ups that feign objectivity when in reality they are somehow connected to the product they are reviewing.

While this is merely speculation, more information may come to light as the FTC works on new online advertising guidelines (something the Commission recently announced and something we will be monitoring). In the interim, what a world of exposure this could lead to if the FTC is persistent! How many Amazon consumer reviews could be deemed deceptive because they are actually written by sellers or a seller’s employees? It may be time for advertisers to start curbing employee online enthusiasm.

Ifrah Law’s Blog Wrap-Up, June 1-20

This is the sixth of a regular series of posts that summarize and wrap up our latest thoughts that have appeared recently on Ifrah Law’s blogs.

1. Perjury, Obstruction and Barry Bonds’ Conviction

Read why we regard the Barry Bonds obstruction of justice verdict as troubling: It sets a bad precedent for the grand jury system and allows prosecutors to unfairly pin an obstruction of justice charge on a witness.

Read the full post here on the Crime in the Suites blog.

2. FTC Says These ‘Free’ Offers Were Anything But Free

In yet another salvo aimed at online marketers, the FTC goes after a Canadian company in the latest federal action targeting companies involved in what is known as the upsell industry. Our post looks at how the FTC wants ads to be worded.

Read the full post here on the FTC Beat blog.

3. Disqualification of AUSA in Scruggs Case Is Message to Prosecutors

In this case, the government may have imprisoned an innocent defendant for 14 months. The only remedy that took effect was the removal of a particular prosecutor. We wonder: Was that really enough?

Read the full post here on the Crime in the Suites blog.

4. FTC Tries to Stay One Step Ahead of Internet Fraud

In this interesting case of “location fraud,” the FTC calls out an Internet seller who allegedly misled British purchasers by claiming to be based in the U.K. and therefore supposedly subject to stringent U.K. consumer protection rules.

Read the full post here on the FTC Beat blog.

5. Online Poker Finds New Supporter on the Hill

An outspoken GOP conservative House member is also a poker player – and he has pledged to support legalization and to move it through a House committee.

Read the full post here on the Crime in the Suites blog.

6. Good-Faith Rule Applies to Document Destruction

A court rejects charges that in a civil case, DuPont was guilty of “spoliation,” or the intentional destruction of evidence. The court says the proper test for document destruction is one of reasonableness and good faith in the circumstances, and DuPont didn’t act in bad faith.

Read the full post here on the Crime in the Suites blog.

FTC Tries to Stay One Step Ahead of Internet Fraud

The FTC’s recent settlement with a California-based Internet marketer may provide a good example of why the Commission is revising its online advertising guidelines. The FTC announced last Thursday that it has reached a settlement with Jaivin Karnani, his company, Balls of Kryptonite, and several associated companies.  The settlement resolves charges the FTC brought against Karnani in 2009 for allegedly deceptive tactics in marketing products to consumers in the United Kingdom.  The defendant allegedly misled British purchasers that his company, which sold a variety of electronics online, was based in the U.K.  The ruse was accomplished by tactics like using foreign website domains ending in .co.uk, listing prices in British pounds, and asserting that goods purchased would be shipped via “Royal Mail.”

British purchasers consequently believed that the websites were

Among the terms of the settlement, Karnani and his companies will no longer be able to pose as U.K.-based.

The case highlights new complications faced by consumers and regulators in dealing with Internet sales and marketing. Just as people can create fictional personalities online through avatars and the like, so too can companies create artificial existences. How easy it is to create a false front when you don’t need to start with bricks and mortar! Karnani’s alleged shenanigans and manipulation of domain names provide a good example of the many things regulators and consumers need to look out for.

Such challenges, and the evolving dynamics of online marketing and sales, are part of why the FTC recently announced its plans to overhaul current Internet advertising guidelines. The current guidelines date back to 2000 and are pretty basic. In effect, they simply pronounce that consumer protection standards that apply to more traditional media also apply to the Internet.

The Commission’s announcement regarding the guidelines overhaul, which requests public comment through July 11, notes its seeks to address more specifics on the technical and legal issues of online marketing and sales, from dynamics of social media to “Apps” to pop-up blockers.

It obviously remains to be seen what exactly the new guidelines will address, but they may reflect issues brought out by this case. Other likely issues to be addressed, as we’ve seen them come up in FTC enforcement actions and as we have addressed them in this blog,  are (1) multi-party selling arrangements (e.g., affiliate marketing) and (2) privacy concerns over online tracking of consumer data.

We’ve been monitoring the public comments regarding the new guidelines and will post developments of interest.

FTC Says These ‘Free’ Offers Were Anything But Free

Last month, the Federal Trade Commission filed a lawsuit against a Canadian entrepreneur and a group of web-based businesses that promised “free” offers that were far from free. In its lawsuit, the FTC charges the online marketers with scamming consumers in the United States, the United Kingdom, Canada, Australia, and New Zealand out of more than $450 million by charging them for products and services that the customers did not purchase. The lawsuit is the latest federal action targeting companies involved in what is known as the upsell industry and comes as a warning to online marketers to be careful in wording their advertisements.

Among those targeted in the FTC action is 24-year-old Jesse Willms, the owner of ten web-based businesses that touted free trials or risk-free offers on several products, including acai berry weight-loss pills, teeth whiteners, health supplements, work-at-home opportunities, access to government grants, free credit reports, and penny auctions. The lawsuit alleges that Willms obtained customers’ credit or debit card information through the promise of free or risk-free trial offers. Willms and other defendants allegedly contracted with affiliate marketers that used banner ads, pop-ups, sponsored search terms, and unsolicited email to lead consumers to the defendant’s websites. Once there, customers would be unknowingly charged for trial products or extra bonus products, plus a monthly recurring fee of typically $79.95.

The FTC alleges that the defendants provided banks with false or misleading information, in order to acquire and maintain credit and debit card processing services from the banks in the face of mounting charge-back rates and consumer claims. Thus, in addition to the FTC violations, Willms and his companies also face charges of violating the Electronic Funds Transfer Act and other U.S. regulations by debiting consumers’ bank accounts without their signed, written consent and without providing consumers with a copy of the written authorization.

Willms and his companies are not the first to engage in this type of sales strategy. Online marketers often engage in a technique commonly referred to as upselling, whereby the seller provides opportunities to the customer to purchase related products or services for the purpose of making a larger sale. In this case, however, the customers had no reason to believe that other products or services were being sold to them because the defendants “buried” important terms and conditions in fine print, the FTC alleged. According to David Vladeck, the director of the FTC’s Bureau of Consumer Protection, “The defendants used the lure of a ‘free’ offer to open an illegal pipeline to consumers’ credit card and bank accounts …. ‘Free’ must really mean ‘free’ no matter where the offer is made.”

The defendants’ sites also made penny auction offers that promised free bonus bids, but the FTC alleged that customers were hit with unexpected charges, including $150 for introductory bonus bids and $11.95 a month for ongoing bonus bids. Willms and his companies also allegedly made false weight loss and cancer cure claims for their products.

Interestingly, Willms, an avid blogger, talked about companies that make false claims online in a September blog post. “I know it’s tempting to make false or borderline claims,” the blog said. “We get excited about products and services and want to yell from the rooftops about how great they are. But, you need to keep it realistic.” In another blog post, Willms wrote that he never uses the word “free” to promote products because customers will assume the free products are useless.

For online marketers, this lawsuit is just another reminder that the FTC requires advertisers to substantiate all claims made in their ads. Put simply, under the FTC Guidelines, you cannot make claims about a product or service that require proof you do not have. This lawsuit should come as a warning to those who run penny auction sites as well: No online marketer is exempt from the FTC Guidelines.

Ifrah Law’s Blog Wrap-Up, May 1-13

This is the fifth of a regular series of posts that summarize and wrap up our latest thoughts that have appeared recently on Ifrah Law’s blogs.

1. Bank Hit With FCA Complaint Over Mortgage Lending

The Justice Department uses a Civil-War era statute in a very unusual context – to try to recover more than $1 billion in a civil case from Deutsche Bank for statements it made to a federal agency about the quality of mortgages that it wrote.

Read the full post here on the Crime in the Suites blog.

2. What’s Next for Online Poker Players?

In the wake of the April 15 indictments in the online poker industry, we discuss the options available to people who still want to play poker but don’t have access to the websites they normally use.

Read the full post here on the Crime in the Suites blog.

3. Barney Frank’s Advice to Poker Players After ‘Black Friday’

The influential congressman gives a legal and political interpretation of the poker indictments and urges players to exert pressure on members of Congress.

Read the full post here on the Crime in the Suites blog.

4. Since When Did the FTC Start Regulating Cyber Security?

In a consent order with Twitter, the FTC resolves claims that the site deceived consumers regarding privacy protection. But is the agency trying to use the order as a wedge to regulate the entire online industry, arguably without a legal basis?

Read the full post here on the FTC Beat blog.

5. Supreme Court May Examine GPS Surveillance Issue

Do prosecutors need a warrant from a judge before they place a GPS device on a suspect’s vehicle? Federal appeals courts disagree on this issue, and the government has asked the Supreme Court to review it.

Read the full post here on the Crime in the Suites blog.

Sellers Beware: Regulatory Action May Lead to Criminal Charges

Having the Federal Trade Commission – or any other government agency – initiate an action against you or your company may seem like very bad news. But it can get much worse. Sometimes, what starts as a civil action by a government regulator can culminate in jail time. This is the hard lesson learned by Donald Barrett, founder and president of iTV Direct, an infomercial company.

Barrett and iTV Direct came under fire by both the Food and Drug Administration and the FTC in 2004 for marketing a purported health product, Supreme Greens. Barrett’s company had marketed the product with some pretty bold claims, such as that the product could prevent major health problems including cancer, Parkinson’s disease and heart disease. The FDA initially issued a warning letter to the company for marketing a non-licensed drug with false and misleading claims. The FDA letter was quickly followed by an FTC lawsuit for deceptive advertising, among other charges.

Not only were the assets of the defendants (Barrett, his company and additional related parties) frozen, but they were also ordered to pay a staggering $48.2 million in consumer refunds. And that wasn’t the end of it. As Barrett and other defendants lost a lengthy battle through the appeals process, the Department of Justice came in with criminal charges against Barrett for subscribing to a false tax return and misbranding. Barrett pled guilty earlier this month to those charges and is awaiting sentencing in July. He may face up to three years imprisonment.

Barrett’s experience demonstrates a difficult reality for individuals and companies that have evoked the interest of a government agency: a government investigation into one matter may lead to more and increased government involvement. Once an agency starts looking into a subject’s affairs, the proverbial can of worms is opened. There will almost invariably be some problems, some irregularities, identified. The investigated party may find themselves suddenly facing a panoply of issues across government agencies. With Barrett, what began as a matter with the FDA, then the FTC, opened him to issues with the IRS and the DOJ.

What is a company or individual to do in order to minimize exposure once a government agency initiates an action? Proceed with caution … and review the steps we suggest taking.

Since When Did the FTC Start Regulating Cyber Security?

There’s no question that the Federal Trade Commission has the authority to prevent deceptive and unfair trade practices, such as false or misleading claims directed at consumers. Somehow, however, that authority has morphed into a much broader reach than one would have expected on the basis of common sense. We’ve written extensively about such jurisdictional overreaching by the FTC in the health food industry (see, for instance, this article). One of the latest examples of the FTC’s expansion of its powers is its recent settlement agreement with Twitter.

The FTC and Twitter entered into a settlement agreement in March to resolve claims that the company deceived consumers regarding its privacy protection practices. The FTC’s action was a result of two security breaches at Twitter in 2009 that permitted hackers to obtain unauthorized administrative control of Twitter, including access to non-public user information and tweets. The security breaches and underlying security practices at Twitter, according to the FTC, were in contravention of Twitter’s published privacy policy.

The variance between Twitter’s stated policy and its practice was the “hook” for the FTC, which alleged that Twitter thus deceived its users regarding its privacy protection measures. To address this alleged deception, the settlement agreement between the FTC and Twitter requires that Twitter not make any misrepresentations about its security measures and its protection of non-public user data. This portion of the settlement makes sense and appears to be within Commission jurisdiction, but the settlement terms are far more extensive. One troubling aspect is that the agreement outlines security measures for Twitter to follow and institutes external monitoring requirements.

So how does the FTC go from preventing deceptive trade practices to regulating cyber security? And where is the statutory authority for this power? The Commission appears to be engaging in an increasingly common practice of creating new standards and expanding its reach – outside its authority, outside the traditional rulemaking process – by developing those standards through settlement agreements with companies under investigation. These companies are likely to agree to a variety of terms in order to get the government off their back. From their perspective, it often makes sense to end a dispute with the FTC rather than to challenge its power.

So Twitter may have determined that it was in its interest to agree to the FTC’s cyber security requirements. It may already have instituted adequate measures to comply with the terms of the agreement. But the FTC may next “shop” the terms of the Twitter settlement agreement to other companies it is considering investigating. The terms of the agreement will gradually become industry policy, and the FTC will go after companies that don’t adhere to that policy (which was never formally instituted).

This process of informal power expansion has been undertaken by the FTC in the health food industry and is being challenged by POM Wonderful LLC in federal district court. It remains to be seen whether the Commission will be reined in by the courts. In the interim, companies with a significant online customer base should be aware that the FTC is inching its way into regulating data privacy and data security.