Fed. Trade Comm'n v. Neovi Inc

• Decision Date: 14 May 2010
• Docket Number: No. 09-55093.,09-55093.
• Citation: 604 F.3d 1150
• Parties: FEDERAL TRADE COMMISSION, Plaintiff-Appellee,v.NEOVI, INC., DBA Neovi Data Corporation, DBA Qchex.com; G7 Productivity Systems, Inc., DBA Qchex.com; James M. Danforth, individually, and as an officer of Neovi, Inc. and G7 Productivity Systems, Inc.; Thomas Villwock individually, and as an officer of Neovi, Inc., Defendants-Appellants.
• Court: U.S. Court of Appeals — Ninth Circuit

604 F.3d 1150

FEDERAL TRADE COMMISSION, Plaintiff-Appellee,v.NEOVI, INC., DBA Neovi Data Corporation, DBA Qchex.com; G7 Productivity Systems, Inc., DBA Qchex.com; James M. Danforth, individually, and as an officer of Neovi, Inc. and G7 Productivity Systems, Inc.; Thomas Villwock individually, and as an officer of Neovi, Inc., Defendants-Appellants.

No. 09-55093.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted March 4, 2010.

Filed May 14, 2010.

As Amended June 15, 2010.

COPYRIGHT MATERIAL OMITTED

Michael L. Mallow (argued), Los Angeles, CA, for the appellants.

Lawrence DeMille-Wagman (argued), Washington, DC, for the appellee.

Appeal from the United States District Court for the Southern District of California, Janis L. Sammartino, District Judge, Presiding. D.C. No.3:06-cv-01952-JLS-JMA.

Before: HAWKINS, SIDNEY R. THOMAS, and M. MARGARET McKEOWN, Circuit Judges.

ORDER

The court's opinion, filed May 14, 2010, is amended as follows:

At page 6989 of the slip opinion , replace “We examine here the reach of § 5 of the Act, which empowers the FTC to prevent the use of “unfair methods of competition in or affecting commerce....” 15 U.S.C. § 45(a)(1).> with .

OPINION

McKEOWN, Circuit Judge:

The Federal Trade Commission (“FTC”) has broad powers under the FTC Act to prevent businesses from engaging in unfair or deceptive practices. 15 U.S.C. §§ 41-58. This case arises from a website-managed by Neovi Data Corporation (DBA Qchex.com), G7 Productivity Systems (DBA Qchex.com), James Danforth, and Thomas Villwock (together “Qchex”)-that created and delivered unverified checks at the direction of registered users. During its six-year run, fraudsters and con artists extensively abused the website.

We examine here the reach of § 5 of the Act, which empowers the FTC to prevent the use of “unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce....” 15 U.S.C. § 45(a)(1). The key issue on appeal is whether Qchex is liable for causing substantial injury to consumers that is not reasonably avoidable or outweighed by countervailing benefits. 15 U.S.C. § 45(n). The district court granted summary judgment in favor of the FTC, finding that Qchex's profound lack of diligence, coupled with the affirmative acts of creating and delivering hundreds of thousands of unverified checks-over 150,000 of which were from accounts later frozen for fraud-warranted liability under the Act. Qchex was ordered to disgorge $535,358 in revenue and permanently enjoined from operating any similar business without taking appropriate, specified measures to protect consumers. We affirm.

Background

I. Qchex.Com

From 2000 to 2006, Qchex marketed a series of software programs on a website called “Qchex.com.” The software allowed registered users to create and send checks by post or email. In October 2006, the website was shut down. The governing corporation, Neovi,¹ filed for Chapter 11 bankruptcy a year later in October 2007.²

To register for a Qchex account, users were prompted to enter a name and email address, and then to create a password. The account could be activated simply by clicking on a link that Qchex sent to the email address provided. Setup was completed after Qchex received pertinent information about the user's bank account, such as the routing and account numbers. Registered users could submit a request on the website that a check drawn from their account be created and delivered to a third party. To achieve this end, users needed only to enter the name of a payee, the check amount, and the payee's email or mailing address, depending on the preferred method of delivery. Qchex.com then converted the information into a negotiable instrument that, when printed, conformed to U.S. banking regulations. The instrument was designed to be negotiable without the user's signature, but users could choose to upload their signatures if they so desired.

If the user chose to send the check electronically, the payee would receive email instructions to sign up for an account on Qchex.com. Once registered, the payee could print the check, and a confirmation email would be sent to the “payor.” ³ If the user chose to send the check by post, it would be printed at a “print service center” operated in the main by employees of G7 Productivity Systems, a California corporation that produced the check software, ink, and paper that was marketed by Neovi on the Qchex website. ⁴ G7 employees mailed the checks to the payees.

II. Fraud

The Qchex system was highly vulnerable to con artists and fraudsters. Because the information necessary to set up an account was relatively public and easy to come by, it was a simple matter for unscrupulous opportunists to obtain identity information and draw checks from accounts that were not their own. Indeed, over a six-year period, Qchex froze over 13,750 accounts for fraud. Those accounts spawned nearly 155,000 checks, supplied over 37,350 bank account numbers, and were the source of checks totaling more than $402,750,000-an amount more than half of the total drawn during that time.

As one would expect, Qchex received hundreds of letters and thousands of telephone calls from consumers, banks, and law enforcement agencies complaining about funds drawn from accounts without authorization. Victims included not only individuals and businesses, but also large institutions and agencies like the University of Chicago, Goldman Sachs, the Federal Communications Commission, and, ironically, the FTC itself.

Qchex contends that it was attuned to the risk of fraud from the outset and acted responsibly to curtail it. Before 2005, Qchex argues that it took multiple fraud reduction measures, pointing specifically to the “Qchex Monitor” system that enabled employees to spot irregular activity like the presence of large volumes of high-denomination checks. Internet Protocol addresses associated with fraudulent transactions were blacklisted and Qchex placed warnings on the checks alerting the payees that it could not verify whether the check was duly authorized by the payors. On a case-by-case basis, Qchex froze suspicious accounts. Finally, Qchex encrypted the check data it transmitted over the Internet and used barcoding to obscure account data on the face of the checks it issued.

None of these measures proved successful. The Qchex Monitor was underutilized and does not appear to have been employed in any focused way to target or unearth fraud. The rest of the measures were either reactive-taking place after fraud had already occurred-or unresponsive to the chief concern that checks were being drawn against unauthorized accounts.

In 2005, after meeting with the American Banking Association and the Federal Deposit Insurance Corporation, Qchex implemented a “micro-deposit” program called the “Qchex Validation System” (“QVS”). To verify that a user's account was legitimate, Qchex made a single, nominal deposit of somewhere between three and twenty cents in the account the user provided. The user was required to check the account to determine the deposit's value. Qchex declined to deliver checks from a provided account unless the user was first able to accurately report the value of the micro-deposit. After three failed attempts, the Qchex account would be frozen.

Although it was a step in the right direction, QVS had a number of loopholes that rendered it ineffective. For example, it only applied to accounts that were newly activated. Users who had balances established before the new security system was adopted were still able to send checks by mail. Even for new users the system was easy to game. Because QVS validated just one bank account per registered user, as long as a user had legitimate access to one bank account, other accounts-possibly unauthorized-could be used without verification through QVS. Significantly, the new system did not apply to emailed checks at all. Whatever its failings, the QVS system was short lived. For reasons that are unclear, the payment processor that enabled Qchex to run the system terminated its contract in April 2006.

Analysis

I. Unfair Practices Under § 5 of the FTC Act

Under § 5 of the FTC Act, an unfair practice or act is one that “causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition.” 15 U.S.C. § 45(n).

A. Causation

The district court found that Qchex is liable for the “[u]nfair creation and delivery of unverified checks.” Qchex urges that this charge is both “legally” and “literally” impossible. It claims that only users can create checks because “without user input nothing, and certainly not a check, ... could be created or delivered.” This semantic argument is meant to encompass not only the causation requirement, but also Qchex's claim that it was not given adequate notice of the charges.

Qchex's challenge to causation is best captured in its statement that it did not “obtain, input or direct” the delivery of consumer information nor facilitate the theft. This spin ignores the fact that Qchex created and controlled a system that facilitated fraud and that the company was on notice as to the high fraud rate. Qchex's approach would immunize a website operator that turned a blind eye to fraudulent business made possible only through the operator's software. Even if the creation of the checks was impossible without user input, that does not mean Qchex did not create the checks that it later delivered.

By Qchex's logic, a publishing house cannot be said to create and distribute books, because it is impossible to print books without content provided by an author. Indeed, the creation and distribution of most any good is subject to a host of sequential steps. Some of those steps involve the contribution of independent causal agents, but those contributions do not magically erase the role of the...