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Federal Trade Commission v. Cleverlink Trading Limited

September 28, 2007

FEDERAL TRADE COMMISSION, PLAINTIFF,
v.
CLEVERLINK TRADING LIMITED, ET AL. DEFENDANTS,
OCEANIC TELECOMMUNICATIONS SERVICES, LLC AND COLIN H. SHOLES, RELIEF DEFENDANTS.



The opinion of the court was delivered by: Judge Virginia M. Kendall

MEMORANDUM OPINION AND ORDER

The Federal Trade Commission ("FTC") brought this action against Cleverlink Trading Limited ("Cleverlink"), Real World Media, LLC, Crazy Protocol Communications, Inc., Brian D. Muir, Jesse Goldberg and Caleb Wolf Wickman ("Defendants"). Defendants sold memberships to Web sites that provided adult entertainment. The FTC sought injunctive and other equitable relief for Defendants' alleged violations of the Controlling The Assault of Non-Solicited Pornography and Marketing Act of 2003 ("CAN-SPAM"), 15 U.S.C. § 7701, et seq., and the FTC's Adult Labeling Rule, 16 C.F.R. Part 316.4. On May 16, 2005, this Court entered a temporary restraining order enjoining Cleverlink and the other Defendants from engaging in further violations of CAN-SPAM and freezing Defendants' assets, including assets held by third parties. On June 16, 2005, Cleverlink representatives provided the FTC with sworn financial statements indicating that Oceanic Telecommunications Services, LLC ("Oceanic") possessed approximately $370,000 of Cleverlink's funds. On June 29, 2005, this Court entered a Stipulated Preliminary Injunction between Defendants and the FTC. Paragraph VIII(D) of the Stipulated Preliminary Injunction directed that upon being served with the order, Oceanic "shall hold and retain within its control and prohibit the withdrawal, removal, assignment, transfer, pledge, encumbrance, disbursement, dissipation, conversion, sale or other disposal of any account or asset of, or held on the behalf of, any Defendant, including Cleverlink Trading Limited, unless authorized in writing by the Court or counsel for the FTC." The FTC served Oceanic with a copy of the Stipulated Preliminary Injunction on June 30, 2005. On October 3, 2005, the FTC filed a motion to preserve assets and for a rule to show cause as to why Oceanic should not be held in contempt of court. In that motion, the FTC alleged that Oceanic and its sole owner, Colin Sholes ("Sholes"), had dissipated funds held on behalf of Cleverlink in violation of the Court's order. The matter was referred to Magistrate Judge Cole who issued a Report and Recommendation that Oceanic should be held in civil contempt.

On January 12, 2006, the FTC filed a Second Amended Complaint naming Oceanic and Sholes as Relief Defendants in Count VI. Count VI alleges that Relief Defendants received assets which were the proceeds of Cleverlink's unlawful activities and to which Relief Defendants have no legitimate claim. On July 12, 2006, the FTC and Defendants entered into a Stipulated Order for Permanent Injunction and Final Judgment. In the Stipulated Order, Defendants admitted no liability, agreed to pay a fine and were permanently enjoined from violating the CAN-SPAM Act and the Adult Labeling Rule. The only claim remaining in this action involves the funds allegedly held by Oceanic on behalf of Cleverlink. The FTC seeks disgorgement of Cleverlink's funds from Relief Defendants and asks this Court to hold Oceanic and Sholes in civil contempt for dissipating those assets in violation of the Court's order. Now before the Court are: (i) the FTC's Motion for Summary Judgment Against Relief Defendants; (ii) Oceanic's and Colin H. Sholes' Motion for Summary Judgment as to Count VI; (iii) Oceanic's and Colin H. Sholes' Motion for Summary Judgment as to its Compliance with the June 29, 2005 Stipulated Preliminary Injunction and (iv) the parties' objections to the Magistrate Judge's Report and Recommendation regarding the FTC's Motion To Preserve Assets and For Rule To Show Cause As To Why Oceanic Should Not Be Held In Contempt Of Court.

Relief Defendants base their claim to the disputed funds on a Merchant Payment Process Services Agreement ("MPPSA") allegedly made between Oceanic and Cleverlink and a state court default judgment Oceanic obtained against Cleverlink. First, Relief Defendants offer no competent evidence that Cleverlink agreed to the version of the MPPSA submitted to this Court. Absent such proof, Relief Defendants may not rely on the increased fines and the forfeiture provision in Exhibit G, ¶ 10, of that document. Relief Defendants have no legitimate claim to the funds generated through Cleverlink's credit card sales beyond the fines and fees to which Cleverlink's representatives agreed in their telephone conversation with Sholes and reflected in the summaries Sholes prepared. Second, the state court default judgment does not preclude this Court from exercising its equitable power to order disgorgement. The limited scope of the Rooker-Feldman doctrine does not apply to this case because the state court proceedings were commenced after this action and the FTC was not a party to the state court action. This Court orders Relief Defendants to disgorge the $292,829.26 that were the profits of Cleverlink's unlawful activities and to which Relief Defendants have no legitimate claim.

As Cleverlink's agent, Oceanic held more than $300,000 on behalf of Cleverlink at the time it and Sholes were served with the Stipulated Preliminary Injunction. Sholes' statements that Oceanic imposed fines and fees against Cleverlink's funds prior to receiving the Stipulated Preliminary Injunction are neither support by the documents nor otherwise credible. This Court holds Oceanic and Sholes in civil contempt for willfully withdrawing and transferring those funds in violation of this Court's unambiguous and unequivocal order. This Court sanctions Oceanic and Sholes the amount of the disputed funds to which they had a legitimate claim -- $51,800.

Statement of Facts

Colin Sholes formed Oceanic on March 7, 2005 to provide services to clients who wished to process credit card transactions over the Internet. (FTC's Rule 56.1(a)(3) Statement ("FTC") ¶ 2; Oceanic Telecommunications Services, LLC's and Colin H. Sholes' Rule 56.1(a) Statement ("Relief") ¶ 18.) Sholes is the sole owner of Oceanic. (FTC ¶ 3; Relief ¶ 9.) Oceanic entered into an agreement with Mercarse, a company that manages small merchant accounts, for the purpose of facilitating the processing of credit card charges of Oceanic's customers. (FTC ¶¶ 12, 15.) Mercarse had a relationship with a credit card processor located in the Phillippines called CNP which processed credit card transactions for a bank in the Phillippines called Bankard. (FTC ¶¶ 12, 14; Relief ¶ 21-22.) Oceanic agreed to present applications from potential clients for Mercarse's review so that, upon approval, those clients would be able to process credit cards through the conduit of Oceanic and Mercarse. (FTC ¶ 16.)

Cleverlink is a company whose primary business was the sale of memberships to Web sites that offered adult entertainment. (FTC ¶¶ 18-19.) From at least January 2005, Cleverlink accepted credit cards as a method of payment for its Web site memberships. (FTC ¶¶ 21-22, 24.) In early March 2005, after losing its prior means of credit card processing, Cleverlink sought credit card processing services from Oceanic. (FTC ¶ 22; Relief ¶¶ 23-24.) Sholes, using the name "Rich," communicated to a Cleverlink representative, Caleb Wickman, that Oceanic could facilitate processing Cleverlink's credit card transactions. (FTC ¶¶ 23, 33; Relief ¶ 25.) "Rich" and Wickman discussed the terms of their agreement including Oceanic's charges, fines and fees for its services. (FTC ¶¶ 33, 34.) Based on this telephone conversation, Wickman states that he understood Oceanic would deduct 8% of the Cleverlink credit card transactions as a fee, $25 per chargeback*fn1 and certain other transaction and maintenance fees. (FTC ¶ 34.) Sholes swears that, in addition to this telephone conversation, the parties memorialized their business relationship in the MPPSA. (Relief ¶ 26; FTC Ex. 4 at ¶ 23.) Relief Defendants do not have a signed copy of the MPPSA. (Relief Ex. 10.) Sholes explains that he sent Cleverlink an e-mail containing a link to the web-based document. (FTC Ex. 4 at ¶ 23. ) In order to submit its application, Sholes contends that Cleverlink would have had to click an "Accept" box and then digitally sign the document. (Id.) Sholes declares that Cleverlink accepted and electronically signed the MPPSA, including the exhibits which contained the fees and fines schedules, via this process. (Id.) Sholes says that he then mailed a hard copy of the contract to Cleverlink. (Id.) In January of 2006, Sholes sent an email to his attorney containing lines of computer code. (FTC's Objections to R&R, Ex. 7.) Sholes stated in the email that the lines of code show that an email was sent to Cleverlink on March 11, 2005 with information on the processing agreement. (Id.)

The MPPSA includes many terms consistent with those stated by Wickman and contained on Oceanic's website. (Compare Relief Ex. 10 with FTC Ex. 6 at ¶ 3 and FTC Ex. 3, Att. C.) Exhibit D of the MPPSA sets forth the following schedule of fees: Merchant Discount fee is eight percent (8%) of total approved gross transactions; Transaction Fee is 70 cents ($0.70) per transaction; Decline Fee is 35 cents ($0.35) per declined transaction; Refund Fee is 25 cents ($0.25) per refunded transaction; Chargeback Fee is twenty-five ($25) per chargeback; Retrieval Fee is fifteen ($15) per retrieval request; Excessive Authorization Fee is thirty-five cents ($0.35) per excessive auth transaction; Monthly maintenance fee is $150; High Risk Fees are thirty-five cents ($0.35) per high-risk transaction; and Batch Fee is $1 per day transactions were processed. While these basic fees are comparable, Exhibit G entitled "Additional Terms, Provisions and Conditions" lists certain other terms. Of particular importance is the provision that "[a]t the time of account closure due to excessive chargebacks, all [Cleverlink] funds on hand are forfeited and shall be considered the property of [Oceanic] until the assessment is completed pursuant to this provision and the net excess funds remitted to [Cleverlink]." (Relief Ex. 10 at Exhibit G, ¶ 10 (e).) Additionally, if Cleverlink's account were closed due to chargebacks exceeding 1.75% of all transactions, Cleverlink would be fined at a rate of "$100 per chargeback . . . for all chargebacks assessed on the account, assessed after the time of account closure and will continue to be assessed for the twelve-month period following account closure." (Relief Ex. 10 at Exhibit G, ¶ 10(a), (b).) Wickman declares that he was never made aware of the terms in Exhibit G, ¶ 10, during his telephone conversation with "Rich," and that no one at Cleverlink ever saw a copy of the MPPSA. (FTC Ex. 6, ¶ 3.) An August 5, 2005 letter from an attorney for Relief Defendants to the FTC states that "[t]he business relationship between Oceanic and Cleverlink was never reduced to a signed, written agreement." (FTC Ex. 9, Att. A.)

Mercarse approved Cleverlink to process credit card transactions, and Cleverlink's credit card transactions began being processed through Oceanic and Mercarse on March 19, 2005. (FTC ¶¶ 25-26.) If a consumer made a credit card purchase on a Cleverlink Web site, the transaction passed through various parties until it reached the MasterCard and Visa network. (FTC ¶ 27.) If the transaction was approved, funds were remitted to Bankard, who remitted the funds to CNP, who remitted the funds to Mercarse, who remitted the funds to Oceanic, who remitted the funds to Cleverlink. (FTC ¶ 28.)

In the month that Oceanic assisted Cleverlink to process credit cards, Cleverlink's credit card transactions generated $974,068.11. (FTC ¶¶ 53-54.) Pursuant to an agreement between Oceanic and Mercarse, fees were deducted from these Cleverlink funds, including $25 per chargeback. (FTC ¶ 55.) Over $100,000 in fines were deducted from the Cleverlink funds for excess chargebacks and Bankard and CNP held ten percent of the Cleverlink proceeds as a reserve against future chargebacks. (FTC ¶¶ 56-57.) Mercarse identified the money deducted from the Cleverlink account in spreadsheets that it submitted weekly to Oceanic. (FTC ¶ 60.) These spreadsheets were produced from the records of Capstone Payment Systems, a company that provided transaction archiving for Mercarse. (FTC ¶ 61.) According to Sholes, Oceanic then used the Mercarse spreadsheets to prepare account summaries showing the amount that Oceanic owed Cleverlink for each payment period. (FTC ¶¶ 62, 66.) Oceanic received three payments from Mercarse based on credit card sales generated by Cleverlink. (FTC ¶ 63.) The three payments totaled $517,168.80. (Id.) Oceanic received the first payment in the amount of $142,581.09 on March 31, 2005. (Id.) After deducting its fees, as set forth in an account summary prepared by Sholes, Oceanic paid $136,539.54 to Cleverlink on April 7, 2005. (FTC ¶¶ 64-65.) Oceanic received the second payment in the amount of $260,231.65 on April 8, 2005 and the third payment in the amount of $114,356,06 on April 20, 2005. (Id.) Cleverlink's credit card transactions ceased being processed on April 20, 2005 due to excess chargebacks. (FTC ¶ 31.) Pursuant to Sholes' account statements, after deducting its fees, Oceanic owed: (1) $248,764.79 to Cleverlink from the second payment and (2) $95,876.19 from the third payment. (FTC ¶ 66.) Oceanic never paid this $344,629.26 to Cleverlink. (FTC ¶ 67.)

Sholes transferred the funds from Mercarse into Oceanic's savings account, commingling them with Oceanic's other funds. (FTC ¶ 70.) On June 30, 2005, Oceanic's savings account held $300,876.86. (FTC Ex. 14, ¶ 2(a).) Between June 13, 2005 and October 5, 2005, Sholes personally withdrew $154,500 from the Oceanic bank account. (FTC ¶ 71.) Sholes used this money to pay himself a salary and pay his personal bills. (FTC ¶ 72.) Additionally, between June 15, 2005 and September 19, 2005, Oceanic transferred $113,500 to Send Hits Now LLC, a company owned by Sholes. (FTC ¶¶ 73-74.) Between April 28, 2005 and September 30, 2005, Oceanic transferred $90,000 to a company called Created LLC. (FTC ¶ 77.) Sholes was a signatory to the Created LLC bank account, and the company is owned by a business partner of Sholes. (FTC ¶¶ 78-79.) Oceanic continued to withdraw money from the savings account until this Court entered an order on October 6, 2005 "freezing the account in issue."

Oceanic brought suit against Cleverlink in the Superior Court of New Jersey, Ocean County Law Division. The Superior Court issued an order stating: "Default and Default Judgment is hereby entered against the Defendant Cleverlink Trading Limited in the amount of $370,000.00 on this 30th day of June, 2006. (Relief Ex. 12.)

Procedural History

On May 16, 2005, this Court entered a temporary restraining order enjoining Cleverlink and the other Defendants from engaging in further violations of CAN-SPAM and freezing Defendants' assets. The TRO did not mention Oceanic specifically, but the asset freeze extended to funds owned, controlled or held by or for the benefit of any Defendant. On June 16, 2005, representatives of Cleverlink provided the FTC with sworn financial statements indicating that Oceanic was in possession of approximately $370,000 of Cleverlink's funds. On June 27, 2005, the FTC provided Oceanic a copy of the temporary restraining order freezing Cleverlink's assets. On June 29, 2005, this Court entered the Stipulated Preliminary Injunction ordering Oceanic, by name, not to disburse any assets held on behalf of Cleverlink.

The FTC served Oceanic and Sholes with the Preliminary Injunction on June 30, 2005. At that time, the FTC requested that Oceanic and Sholes provide the FTC with an accounting of all funds that they possessed on behalf of Cleverlink. (Relief ¶ 9.) On July 5, 2005, Sholes submitted a sworn statement that Oceanic held "$0.00 no available funds" on behalf of Cleverlink and that no assets held on behalf of Cleverlink had been removed from any account as of June 28, 2005 when he obtained notice of the injunction. (FTC's Reply In Support Of Its Motion For Rule To Show Cause, Att. E.) On September 16, 2005, Sholes certified a different "accounting" of Cleverlink's funds. (FTC's Memorandum In Support Of Its Motion For Rule To Show Cause, Att. D.) The certification stated that on or about April 20, 2005, Oceanic held $352,126.55 in Cleverlink funds. (Id.) The certification continued, however, that Oceanic imposed chargeback fines and multi-factoring fees against these funds reducing the amount held as of June 27, 2005 to $36,326.55. (Id.) On October 3, 2005, the FTC filed a motion to preserve assets and for a rule to show cause as to why Oceanic should not be held in contempt of court. With its Motion, the FTC attached bank records showing that since being served with the Court's order, Oceanic and Sholes had withdrawn over $175,000 from Oceanic's savings account. In response, Sholes submitted a third "accounting" and declaration on October 26, 2005. (FTC Ex. 5.) This third accounting states that "[a]s of June 28, 2005, the date Oceanic received the Stipulated Preliminary Injunction, the total amount of funds possessed by Oceanic to which Cleverlink might be entitled was $16,606.98 (total receipts of $517,168.80 minus the $136,539.54 transmitted to Cleverlink in April, minus $364,022.28 for fees and fines deducted by Oceanic)." (FTC Ex. 5, Att. A.) The "accounting" itself was a one-and-a-half page summary created by Sholes. (Id.) The summary lists the funds received by Oceanic from Mercarse, the amount Oceanic then transferred to Cleverlink and the fees and fines deducted by Oceanic. (Id.) Sholes submitted no business records, account statements or other documents to support this summary. (Oceanic's Opposition to FTC's Motion for Rule to Show Cause, Atts. 2-3.)

In light of the FTC's strong showing in support of its motion to show cause and the lack of documentary evidence from Oceanic, this Court gave Oceanic a short deadline to submit documents showing that the funds disbursed from its account rightfully belonged to someone other than Cleverlink. In response to this January 11, 2006 order, Oceanic produced certain documents to support its imposition of fines and fees against Cleverlink's sales receipts. Among the documents, Oceanic produced the MPPSA for the first time. Following this Court's determination that it had personal jurisdiction over Oceanic and Sholes pursuant to the nationwide service provision in § 13(b) of the FTC Act, the matter was referred to Magistrate Judge Cole for further discovery and any hearing regarding whether Oceanic or Colin Sholes should be held in contempt of court for violating the preliminary injunction.

Based upon a thorough review and analysis of the evidence that the FTC and Oceanic submitted, Magistrate Judge Cole issued his Report and Recommendation. Judge Cole first concluded that the MPPSA, executed electronically, governed the respective rights and obligations of Oceanic and Cleverlink. (Report and Recommendation ("R&R") at 11-12.) Additionally, Judge Cole concluded that Cleverlink's acceptance of Oceanic's services also bound it to the offered terms. Judge Cole then analyzed the documents that Relief Defendants submitted in response to this Court's January 11 order in light of Sholes' prior declarations and the evidence provided by the FTC. Judge Cole began by noting the obvious inconsistencies in the separate declarations and accountings that Sholes submitted to the Court. (R&R at 13.) Judge Cole next conducted a detailed review of the documentary evidence, concluding that Relief Defendants' "purported 'business records' are so jumbled that they appear to be contrived" and "[t]he documentation Oceanic has offered on these critical questions ultimately is uninformative and indecipherable." (R&R at 14, 24.) When comparing Sholes' ...


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