A recent ruling by the Ninth Circuit affirmed a district court’s order permanently enjoining an individual defendant (Kyle Kimoto) in an FTC action from engaging in a variety of marketing tactics and requiring the individual to pay restitution.  In doing so, the Ninth Circuit rejected the defendant’s argument that his being incarcerated for mail and wire fraud  related to prior FTC violations precluded the requisite level of involvement necessary to impose liability.  The court also rejected his effort to invoke an “advice of counsel” defense.

Kimoto has been the subject of three different FTC enforcement efforts all involving negative option or free to pay conversion marketing.  While facing criminal charges for his involvement in a prior “scheme,” Kimoto relocated to Las Vegas, opened a new corporate entity (Vertek) in his wife’s name, and hired many of the individuals who had worked with him in his previous ventures.  Kimoto then directed and participated in the development of marketing campaigns involving a $7,500 line of credit product, a government grant product, and a work from home product.  Each of these campaigns were found to be deceptive.

Kimoto’s criminal trial related to prior FTC issues began in March 2008 and he was convicted on counts of conspiracy, wire fraud and mail fraud.  During his trial and subsequent incarceration, Kimoto ceased participating in Vertek’s daily activities.

In July 2009, the FTC brought suit against Vertek, Mrs. Kimoto and others, and later amended the complaint to add Kimoto and still more defendants all of whom were found to operate in a common enterprise.  The FTC obtained summary judgment against all of the defendants.  Only Kimoto appealed.

On appeal, Kimoto argued that there was insufficient evidence of his personal involvement for the imposition of personal liability and that his liability ended when he left the company to prepare for his criminal trial.  He also argued that he could not be personally liable for violations of the Electronic Funds Transfer Act (“EFTA”) and that the injunction against him was overbroad.  The Ninth Circuit rejected his arguments, with one small exception for a Acai berry offer that began only after he was incarcerated.

Regarding personal liability, the Ninth Circuit reiterated the applicable standard:

Individuals may be held liable for injunctive relief based on corporate entity violations of the FTC Act 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.  In order to hold an individual liable for restitution as a result of the misconduct of a corporation, the FTC must also 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.  To satisfy the knowledge requirement, the FTC must show that [a defendant] had actual knowledge of material misrepresentations, [was] recklessly indifferent to the truth or falsity of a misrepresentatio, or had an awareness of a high probability of fraud along with an intentional avoidance of the truth.  The FTC need not show that a defendant intended to defraud consumers in order for that individual to be personally liable.  And [t]he extent of an individual’s involvement in a fraudulent scheme alone is sufficient to establish the requisite knowledge for personal restitutionary liability.

In finding Kimoto responsible for both injunctive and monetary relief, the Ninth Circuit pointed to Kimoto having arranged Vertek’s entire operation including the structuring of the deceptive offers.  The court also noted that Kimoto had created or had knowledge of the language used on the deceptive websites.  The court noted specifically that Kimoto knew the testimonials used for the government grant scheme were deceptive because he started using them at the inception of the scheme before there were any customers.  Quick tip: Don’t use testimonials before you have customers.

The court rejected Kimoto’s assertion that he lacked the requisite knowledge because he sought the advice of counsel, noting that it is well established that reliance on the advice of counsel is not a valid defense on the question of knowledge required for individual liability.

The court also rejected Kimoto’s argument that he lacked the requisite liability because many of the complaints and credit card chargebacks received by Vertek came in after he was incarcerated, and there was no evidence he was aware of the complaints and chargebacks.  While noting that knowledge of chargebacks and complaints can satisfy the scienter requirement for individual liability, the court held that such evidence is not required especially given the other evidence available regarding Kimoto’s knowledge and involvement.

The Ninth Circuit also affirmed the district court’s imposition of a ban on Kimoto’s future involvement in any negative option marketing, continuity marketing, preauthorized electronic fund transfers, use of testimonials, and marketing or selling grants, credit, business opportunities or nutraceuticals.  Rejecting Kimoto’s assertion that this relief was overbroad, the court found the bans reasonably tailored to prevent Kimoto from engaging in similar illegal practices in the future.

Finally, the court affirmed the imposition of personal liability for EFTA, rejecting Kimoto’s assertion that the Act does not provide for individual liability.  The Ninth Circuit noted that EFTA does not provide its own enforcement mechanism, but rather is to be enforced by the FTC through the FTC Act.  Because EFTA violations are also FTC Act violations, individual liability and corresponding relief can be assessed for EFTA violations.

In most instances, the FTC seeks to hold the principals of closely held companies it sues responsible for both injunctive and monetary relief.  The Ninth Circuit’s opinion endorsing the FTC’s view of the world is not likely to change that approach.