Suspended judgment, “avalanche clauses,” and the FTC; Arizona federal judge lifts suspended judgment in HCG case

suspended judgmentFrom time to time you will read that, when the FTC has settled a case, any potential monetary judgment is “partially suspended based on the defendants’ inability to pay.”  The FTC refers to allowing settling defendants to avoid paying a judgment in full as a suspended judgment.  However, if a settling defendant was less than truthful to the FTC about its financial condition, then they may be caught in an avalanche set off by the FTC.

Arizona Federal Court Lifts Suspended Judgment

A recent ruling from an Arizona federal judge explained the consequences that result when a defendant fails to disclose the true nature of its financial condition as part of a settlement with the FTC.  The FTC announced in a press release that U.S. District Court Judge Neil V. Wake had entered an Order lifting the suspension of monetary judgment against HCG Diet Direct, LLC (“HCG”) and Clint Ethington, which was entered in 2014.  Judge Wake ruled that HCG and Mr. Ethington had “failed to disclose material assets in 2014 when they settled FTC charges related to their deceptive advertising of a supposed weight loss supplement based on the hormone HCG,” the FTC said.HCG Diet Direct, LLC

The FTC’s 2014 complaint against HCG and Mr. Ethington alleged that the defendants marketed an unproven human hormone that they touted as a weight-loss treatment.  Specifically, the FTC asserted that HCG marketed homeopathic hormone drops via YouTube videos, product packaging, and in consumer statements and testimonial videos, which made false promises to consumers about rapid weight loss.

In order to settle the FTC’s charges, HCG and Mr. Ethington agreed to stringent injunctive provisions, which required HCG products to undergo at least two clinical studies to validate their weight-loss claims.  The settlement also imposed a $3.2 million judgment against HCG and Mr. Ethington, but that judgment was suspended based upon representations from the defendants that they could not afford to pay the judgment.

The FTC’s “Avalanche Clause”

In the HCG settlement documents, as is customary for the FTC, the FTC stated that “[t]he Commission’s agreement to suspension of this Judgment is expressly premised on the truthfulness, accuracy, and completeness of the sworn financial statements and related documents … submitted to the Commission.”  Furthermore, the settlement states that “[t]he suspension of this Judgment will be lifted as to any Defendant if … the Court finds that Defendant failed to disclose any material asset,” and if lifted, “the Judgment becomes immediately due….”  The aforementioned provisions are collectively referred to as an “avalanche clause” in FTC lexicon.

In September 2015, the FTC moved an Arizona federal court to lift the suspension of judgment against HCG and Mr. Ethington.  Or in other words, the FTC asked the court to unleash the avalanche clause on the defendants.  The FTC alleged as a basis for its motion that HCG and Mr. Ethington had made a number of misstatements and other misrepresentations about their financial condition as it related to their ability to pay the monetary judgment owed to the FTC.

Mr. Ethington’s Misstatements and Misrepresentations

In relation to misstatements and misrepresentations the FTC attributed to HCG and Mr. Ethington, the FTC alleged:

  • Ethington reported income of approximately $8,500/month from his company Ethington Management, Inc., but in fact the income was at least $13,500/month.
  • Ethington reported income of approximately $8,500/month from his company Ethington Management, Inc., but in fact the income was at least $13,500/month.
  • Ethington did not mention that the Related Companies paid more than $200,000 to its owners in 2013, or that one of those companies paid $120,000 toward various credit cards the day before Mr. Ethington’s financial statement.
  • Ethington did not mention that the Related Companies paid more than $200,000 to its owners in 2013, or that one of those companies paid $120,000 toward various credit cards the day before Mr. Ethington’s financial statement.

In response, Mr. Ethington argued that his misstatements and other misrepresentations were not material, and that, even if accurate information would have been provided, it would not have required him to pay any of the suspended judgment.  Judge Wake apparently disagreed, picking off Mr. Ethington’s arguments one by one.

Court Rejects Mr. Ethington’s Arguments

Judge Wake’s Order found that Mr. Ethington’s misstatements and other misrepresentations were material, finding that a reasonable person would attach importance to the information in question in deciding what, if anything, the defendants would pay as part of a monetary judgment.

The court’s Order also rejected the argument from Mr. Ethington that he was entitled to discovery regarding whether providing different information would result in him being ordered to pay any part of the suspended judgment.  There, the court noted that the proper inquiry was not whether the FTC would conclude in this particular case that Mr. Ethington had to pay any portion of the suspended judgment, but, rather, whether a reasonable person in the FTC’s position would have attached importance to the alleged inaccuracies.

Likewise, the court gave no credence to Mr. Ethington’s arguments that he should be afforded the opportunity to show that the inaccuracies he reported regarding his financial condition were unintentional, or that the inaccuracies didn’t change his inability to pay any part of the suspended judgment.  In that regard, the court found that there was no intent requirement for triggering the avalanche clause, and whether the inaccuracies made a difference in Mr. Ethington’s ability to pay was irrelevant to whether the inaccuracies were material.

Settling Defendants Need to Mind Potential “Avalanches”

While the amount of the judgment in this case is relatively small, $3.2 million, and the inaccuracies listed above do not appear to be major, the FTC’s actions to lift the suspended judgment and enforce the monetary judgment represent the FTC’s overall approach to the financial disclosure process.  The FTC has made it clear, in their settlement documents, and through actions like that against HCG, that they will rigorously hold defendants accountable for their disclosures regarding their financial condition.  The FTC is ever-concerned that defendants will attempt to plead poverty for purposes of an FTC settlement, but all the while continuing to live luxuriously.  Therefore, even if a FTC defendant thinks certain aspects of its financial condition are not material, the FTC may think otherwise, and may seek to release an avalanche upon an unsuspecting business or individual.

* Photo cred.: thestudioexec.com; urweightlosspoint.com