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Katharine Gibbs School v. Federal Trade Commission

decided: December 12, 1979.


Petitions to review Federal Trade Commission Trade Regulation Rule Concerning Proprietary Vocational and Home Study Schools. Rule set aside as unlawful and matter remanded to Commission for further proceedings.

Before Van Graafeiland and Newman,*fn* Circuit Judges, and Bonsal, District Judge.*fn**

Author: Van Graafeiland

Twelve petitions have been filed with this Court seeking review of a Trade Regulation Rule issued by the Federal Trade Commission on December 18, 1978, entitled "Proprietary Vocational and Home Study Schools." See 16 C.F.R. § 438.*fn1 The Rule's broadly stated purpose, as set forth in the Commission's Statement of Basis and Purpose,*fn2 is "to alleviate currently abusive practices against vocational and home study school students and prospective students." Although the Rule does not define "abusive practices", the Commission's Statement of Basis and Purpose shows that the Commission's concern was with unfair and deceptive advertising, sales, and enrollment practices engaged in by some of the schools. See 43 Fed.Reg. at 60802.

The more than 7,000 proprietary vocational schools that will be covered by the Rule on its January 1, 1980, effective date are no strangers to regulation. Almost every State has legislation aimed at eliminating some or all of the abuses that trouble the Commission. The United States Veterans Administration and Office of Education have also been active in this area. In 1972, the Commission itself issued a set of guidelines for private vocational and home study schools, See 16 C.F.R. § 254, and has since instituted proceedings against several schools under section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45.

The Commission decided, however, that all of the foregoing regulatory efforts were inadequate, and, in 1974, it published for comment and public hearing a proposed Trade Regulation Rule. The Commission proceeded originally under the rulemaking power granted it in section 6(g) of the Federal Trade Commission Act, 15 U.S.C. § 46(g), which in National Petroleum Refiners Association v. FTC, 482 F.2d 672, 157 U.S.App.D.C. 83 (D.C.Cir. 1973), Cert. denied, 415 U.S. 951, 94 S. Ct. 1475, 39 L. Ed. 2d 567 (1974), was held broad enough to permit the issuance of substantive as well as procedural rules. However, on January 4, 1975, in the midst of the Commission's hearings, Congress passed the Magnuson Moss Warranty-Federal Trade Commission Improvement Act, Pub.L.No.93-637, 88 Stat. 2183, Title II of which prescribes with preciseness the Commission's authority to issue rules and general statements of policy and outlines the rulemaking procedures to be followed in connection therewith. See 15 U.S.C.A. § 57a (Supp.1979). Following enactment of this legislation, the Commission changed its hearing procedures to comply with the new statutory requirements. Our primary task on this appeal is to determine whether the Rule finally adopted was within the general powers of the Commission under the Federal Trade Commission Act as refined and limited by the specific provisions of section 57a and, if so, whether the Rule was supported by substantial evidence and was neither arbitrary nor capricious.

Section 5(a) of the Federal Trade Commission Act, 15 U.S.C. § 45(a), declares that "unfair or deceptive acts or practices in commerce" are unlawful, and section 6(g) empowers the Commission to make rules and regulations for the purpose of carrying out this provision. Section 57a(a)(1) redefines this grant of authority by providing that the Commission may prescribe:

(A) interpretive rules and general statements of policy with respect to unfair or deceptive acts or practices in or affecting commerce (within the meaning of section 45(a)(1) of this title), and

(B) rules which define with specificity acts or practices which are unfair or deceptive acts or practices in or affecting commerce (within the meaning of section 45(a)(1) of this title). Rules under this subparagraph may include requirements prescribed for the purpose of preventing such acts or practices.

The Magnuson-Moss Act also provides that, after any Commission rule takes effect, a violation thereof shall be an unfair or deceptive act under 15 U.S.C. § 45(a)(1) unless the Commission otherwise provides. 15 U.S.C. § 57a(d)(3). It empowers the Commission to commence a civil action for a violation of any rule, in which action the Commission may seek, among other remedies, rescission or reformation of contracts, the refund of money or the return of property, and money damages. 15 U.S.C. § 57b(b).

Petitioners contend, and we agree, that in order to comply with section 57a(a) (1)(B) the Commission must define with specificity in the Rule those acts or practices which are unfair or deceptive and may include requirements for preventing them. Petitioners contend further, and again we agree, that the challenged Rule does not comply with these statutory provisions. Instead of defining with specificity those acts or practices which it found to be unfair or deceptive, the Commission contented itself with treating violations of its "requirements prescribed for the purpose of preventing" unfair practices as themselves the unfair practices.*fn3 We think that Congress expected more than this.

Requirements designed to prevent unfair practices are predicated upon the existence of unfair practices. These unfair practices, which are the statutorily required underpinning for the Commission's "requirements", should have been defined with specificity.

"Because the prohibitions of section 5 of the Act are quite broad, trade regulation rules are needed to define with specificity conduct that violates the statute and to establish requirements to prevent unlawful conduct." Conf.Rep.No.93-1408, Joint Explanatory Statement of the Committee of Conference, Reprinted in (1974) U.S.Code Cong. & Ad.News, pp. 7702, 7755, 7763.

The statute requires that the Commission's Statement of Basis and Purpose, which must accompany a Rule, shall include statements as to the prevalence of the acts or practices treated by the Rule and the manner in which such acts or practices are unfair or deceptive. 15 U.S.C. § 57a(d)(1). These provisions would be meaningless if the only unfair acts or practices defined in the Rule were possible future violations of its remedial requirements.

We conclude that the Commission erred in failing to comply with the procedural requirements of section 57a(a)(1)(B). We also find several substantive provisions of the Rule to be defective, and the combination of procedural and substantive errors requires that the Rule be set aside. We will remand the Rule to the Commission so that the Commission may comply with section 57a(a)(1) (B) and delete or amend those provisions which we find to be improper.

In the paragraphs that follow, we deal with petitioner's additional claims of error.



Instead of defining with specificity the advertising, sales, and enrollment practices it deemed unfair and deceptive and setting forth requirements for preventing them, the Commission decided to make it financially unattractive for schools covered by the Rule to accept a student who, for any reason whatever, was unlikely to finish the course in which he or she had enrolled. The Commission did this by directing its attack against the tuition refund policies of the schools.

Although the Commission concededly did not find that existing refund policies were either unfair or deceptive, See 43 Fed.Reg. at 60809, it directed that they be completely revised so as to make them financially more onerous for the schools. This the Rule accomplishes by requiring schools to make refunds on a strict pro rata basis, the percentage of the refund to be determined by matching the number of classes attended or lessons completed against the total of classes, hours, or lessons required to complete the course. See 16 C.F.R. § 438.4. Refunds on such a pro rata basis do not take into account those costs that are fixed at the time of enrollment, such as salaries for teachers and staff, classroom and boarding facilities, administration overhead, books, and supplies. The Rule does not require a student to return "records, tapes, slides, films, books or any other written course materials" as a condition of obtaining a refund. Id. § 438.1(u); See id. § 438.4. The cost of other equipment furnished a student must be prorated in the same manner as tuition, unless a separate equipment charge is made in the enrollment contract. Even if a separate charge is made, it will be refunded on a pro rata basis if the equipment is returned, regardless of its then condition or usability. Id. § 438.4(c)(2). Although the Commission did not fault existing refund policies, it provided, nonetheless, that any failure to comply with its newly prescribed refund regulations would constitute an unfair or deceptive act or practice in connection with the sale or promotion of a course. Id. § 438.0.

These regulations, the Commission says, are designed "to alter the incentive structure for obtaining vocational school enrollments." 43 Fed.Reg. at 60809. Elaborating on this subject in its brief, the Commission states that the schools "make little effort to screen candidates to determine if they possess the required verbal, reading or mechanical skills necessary for the courses of study" and that they sign up "unsuitable enrollees". The rationale of the Rule is said to be the "(creation of) structural disincentives to indiscriminate enrollment", which, translated into less dainty language, means "the creation of structural incentives for discriminate enrollment."

The Commission argues that this foray into the field of education is a "reasoned exercise of its legislative judgment" in an area "plainly within its expertise, I. e., unfair selling practices."*fn4 Commission counsel describe this as an exercise of the Commission's "broad remedial discretion", subject to as little judicial review under the Magnuson-Moss Act as had been exercised prior thereto. We disagree.

When Congress provided that the Commission's rules must define unfair and deceptive acts with specificity, it clearly intended that the Commission's definition would be subject to judicial review. See S.Rep.No.93-1408, 93d Cong., 2d Sess. (1974), Reprinted in (1974) U.S.Code Cong. & Admin.News, pp. 7702, 7755, 7766-67. And when Congress, after being informed that the Commission was "strongly opposed" to the substantial evidence standard of review,*fn5 nonetheless incorporated that standard in the statute, See section 57a(e)(3)(A), it obviously intended that a Commission rule not receive judicial approval "unless the Commission's action was supported by substantial evidence in the record taken as a whole." H.R.Rep.No.93-1107, 93d Cong., 2d Sess. (1974), Reprinted in (1974) U.S.Code Cong. & Ad.News, pp. 7702, 7729.

Although courts normally give weight to an agency's interpretation of its own enabling legislation, the judiciary is the final authority on issues of statutory construction. Volkswagenwerk Aktiengesellschaft v. FMC, 390 U.S. 261, 272, 88 S. Ct. 929, 19 L. Ed. 2d 1090 (1968). An agency interpretation must be granted deference only when it is consistent with the congressional purpose, Morton v. Ruiz, 415 U.S. 199, 237, 94 S. Ct. 1055, 39 L. Ed. 2d 270 (1974), and when there are no "compelling indications that it is wrong." Espinoza v. Farah Manufacturing Co., 414 U.S. 86, 94-95, 94 S. Ct. 334, 339, 38 L. Ed. 2d 287 (1973) (Quoting Red Lion Broadcasting Co. v. FCC, 395 U.S. 367, 381, 89 S. Ct. 1794, 23 L. Ed. 2d 371 (1969)).

Assuming, without deciding, that the Commission has the power to alter the schools' incentive structure for engaging in high pressure or deceptive sales and enrollment practices, its Rule was clearly not so limited in its scope. The Rule penalizes every vocational school for every student dropout, regardless of cause.

This Court is obligated to take a close look at what the Commission has done and to determine whether it has articulated a "rational connection between the facts found and the choice made." Burlington Truck Lines, Inc. v. United States, 371 U.S. 156, 168, 83 S. Ct. 239, 246, 9 L. Ed. 2d 207 (1962); Office of Communication of United Church of Christ v. FCC, 560 F.2d 529, 532 (2d Cir. 1977); Home Box Office, Inc. v. FCC, 567 F.2d 9, 35, 185 U.S.App.D.C. 142, 168 (D.C.Cir. 1977), Cert. denied, 434 U.S. 829, 98 S. Ct. 111, 54 L. Ed. 2d 89 (1977). We have taken a close look, and we find no rational connection between the Commission's universally applicable refund requirements and the prevention of specifically described unfair and deceptive enrollment practices.



The Commission's Rule contains a number of provisions dealing with job-placement statistics and graduation rates. See 16 C.F.R. § 438.3. These provisions require the making of certain disclosures and prohibit the making of other factually correct disclosures. Again, no unfair or deceptive acts or practices are defined with specificity, except as a violation of the disclosure requirements may be said to be such. Although, unlike the provisions for refunds, the disclosure provisions may properly be said to fall within the field of advertising, sales, and enrollment, petitioners contend that they too are invalid.

1. Job-Placement Statistics

Under the Commission's Rule, each student is given a fourteen day "cooling-off" period during which he may cancel his enrollment without any financial obligation to the school. After the school has accepted the student's enrollment contract it must mail to the student a notice aptly entitled "HOW TO CANCEL YOUR CONTRACT". If the school has made any prior reference to the availability of jobs or the ability of its graduates to find jobs, it must also enclose in the same envelope a form entitled "How Our Students Are Doing." The information contained in this form must be based on the school's "actual knowledge" of its graduates' job experience, 16 C.F.R. § 438.3(c), which must be stated in the following manner:

"Since we made job placement or earnings claims in promoting this course, we have prepared our record in these areas for your review. As the Graduation Record pointed out, 50 students graduated from this course from to . We found that 38 or 76% Of these 50 graduates got jobs in the field of within 4 months of their graduation." 16 C.F.R. § 438, Appendices A-C.

The form must then show the number of students and the "percent of total" in each of several salary brackets.

No other job-placement information may be contained in the same envelope. The school may not show how many students could not be contacted or did not respond to its job placement inquiries. It may not disclose how many of them did not seek jobs within four months after graduation because of marriage, pregnancy, prior employment, self-employment, continued schooling, or other reasons. Proof in the record shows that adherence to the Commission's Rule would require one school to show a job placement rate of 5.8%, when in fact the true employment success rate of those who responded to the school's inquiry was 54%, or 80%, if those who became self-employed were included. Another school would have to show a placement figure of approximately 67%, although almost 100% Of its graduates who sought employment obtained it. Nonetheless, each school must content itself with the anemic caveat quoted in the margin*fn6 and the privilege of sending additional information in other mailings.

Obviously, statements so factually distorted do not disclose the schools' "record" in the area of job placement and earnings. It is unfair to both the school and the misguided student to require the school to say so without adequate explanatory comment. The failure to disclose material information may cause an advertisement to be false or deceptive even though it does not state false facts. Simeon Management Corp. v. FTC, 579 F.2d 1137, 1145 (9th Cir. 1978). Commission rules should be designed to eliminate deception, not to foster it by requiring the dissemination of a deceptively incomplete "record". See Friedman v. Rogers, 440 U.S. 1, 19-26, 99 S. Ct. 887, 59 L. Ed. 2d 100 (1979) (Blackmun, J., concurring in part and dissenting in part). Because the Commission is attempting to exercise a power "inconsistent and at variance with the over-all purpose and design of the Act," Heater v. FTC, 503 F.2d 321, 323 (9th Cir. 1974); See § 5 U.S.C. § 706(2)(C); Papercraft Corp. v. FTC, 472 F.2d 927, 933 (7th Cir. 1973), or, alternatively, is exercising its assigned authority in an arbitrary and capricious manner, 5 U.S.C. § 706(2)(A); See National Nutritional Foods Ass'n. v. Mathews, 557 F.2d 325, 338 (2d Cir. 1977), that portion of its Rule dealing with job-placement disclosure cannot stand.

2. Graduation Statistics

On the disclosure form entitled "How Our Students Are Doing," the schools are also required to show the number and percentage of enrollees in past classes who graduated. 16 C.F.R. § 438.3(a). The schools are prohibited from enclosing any additional information with this communication. For example, they may not state why dropouts occurred, nor may they give comparative dropout statistics for the public schools. 16 C.F.R. § 438.3(e). They are permitted, however, to make the following statement:

"In evaluating these figures, you should know that students may drop out of a course for a variety of reasons. These range from dissatisfaction with the course to inability to do the work. Other students drop out of school for personal reasons." 16 C.F.R. § 438.3(a)(5).

The Commission did not find as a factual basis for this regulation that all, or even a substantial portion, of the schools misrepresented their graduation rates. 43 Fed.Reg. at 60805. On the contrary, it found that most schools do not disclose them. Id. However, the Commission found that the disclosure of graduation rate information is essential for a proper evaluation of claims concerning placement success. Id. It concluded that, on one occasion, this disclosure should be made without being buried in a mass of accompanying material.

Giving deference to the Commission's reasoning, we find this to be a proper requirement for preventing unfair and deceptive practices. There is a valid distinction between this requirement and the job-placement regulations that we have heretofore found to be invalid. Dropout figures are in the school's possession and can be accurately stated. Petitioners do not argue that the Commission cannot require this to be done, but contend instead that the Commission's ban against the inclusion of additional dropout information violates their First Amendment rights as enunciated in Linmark Associates, Inc. v. Township of Willingboro, 431 U.S. 85, 97 S. Ct. 1614, 52 L. Ed. 2d 155 (1977). This is a strong argument that cannot be lightly brushed aside. See Cotherman v. FTC, 417 F.2d 587, 596 (5th Cir. 1969); Ultra-Violet Products, Inc. v. FTC, 143 F.2d 814, 816-17 (9th Cir. 1944); FTC v. Civil Service Training Bureau, Inc., 79 F.2d 113, 115 (6th Cir. 1935).

The Supreme Court has held, however, that commercial speech "(is) less likely than other forms of speech to be inhibited by proper regulation," Friedman v. Rogers, supra, 440 U.S. at 10, 99 S. Ct. at 894 and "regulatory commissions may prohibit businessmen from making statements which, though literally true, are potentially deceptive." Young v. American Mini Theatres, Inc., 427 U.S. 50, 68, 96 S. Ct. 2440, 2451, 49 L. Ed. 2d 310 (1976); See id. at 68 n.31, 96 S. Ct. 2440. We believe that when the Commission prescribed its requirements for preventing unfair or deceptive acts or practices, the First Amendment permitted it reasonable latitude to avoid the emasculation of its preventive requirements that might result from their being buried in a mass of ...

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