Managing Risk: Legal Issues for Merchants and Affiliate Marketers

May It Please the Mozzers,

Welcome to Legal Monday! (It’s still Monday, right?) My goal is to present a checklist of legal issues and trends surrounding affiliate marketing. I hope this will be interesting to both merchants and marketers.

Affiliate marketing has unfortunately gained a bad reputation for being particularly high risk. While the industry is unlikely to ever be risk-free, it is possible to manage your risk by (1) investigating your prospective marketing partner; (2) using and maintaining a tight legal contract that allocates the risk and provides for the appropriate indemnifications, and (3) keeping informed about the current technology, marketing strategies, and regulatory climate.

Without further ado, let’s take a look at risk identification and management for merchants and affiliate marketers.

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The Best Defense is a Good Offense; Choose your Merchant or your Affiliate Carefully.

The single biggest risk-management decision a marketer can make is which merchant to work with. The same is true for merchants. Diligently and thoroughly research on your marketing partners.

• Go to forums and ask about the prospective merchant or marketer
• Merchants should ask to see current and past client lists.
• Requiring your prospective marketing partner to provide a credit report would also provide very valuable information.
• Merchants, you must ask potential affiliates how they plan on marketing your product. Are they going to send emails or make cold calls? Are they going to engage in anti-marketing campaigns? Discuss strategies ahead of time to make sure you have the same risk tolerance.
• Affiliates, you never want to be the first affiliate to work for a merchant. If the company is new, the people who operate it have probably engaged in other online enterprises. Ask what those other enterprises are and research them.
• It’s always a good idea to ask whether the merchant or affiliate has errors and omissions insurance as well.

Merchants, Require Affiliates to Identify Any Sub-Affiliates and Hold You Harmless For Their Conduct.
If you’re going to allow your affiliate to subcontract out some work, it is important to require your affiliate to identify in writing any and all sub-affiliates. You may be held liable for the sub-affiliate’s conduct so you need to a way to identify any problem affiliates quickly. Once you hear about a sub-affiliate, investigate them. You also need your affiliate to agree to indemnify and hold you harmless for any of its sub-contractors.

Beware Merchants with Poor Products or Dishonest Promotions
Affiliates, your reputation is an important asset. You are only as good as the product the merchant sells. You don’t want to be left holding the bag if your merchant fails to deliver the product you marketed. Heck, sometimes merchants don’t deliver at all!

Beware of Anti-Marketing Campaigns.
It’s no secret that negative, anti-marketing sells. Some affiliates create campaigns around negative advertisements that exploit and damage your brand. Make sure that your contract prohibits characterizing your brand as a ripoff or a scam.

Your Affiliates Should Generate their Own Content.
Your affiliates should generate their own content. There are at least two reasons for this. (1) You’re paying them to expand your brand into new space and to enrich your brand’s presence by identifying new markets. You’re not paying them to regurgitate your pre-packaged material into the same markets and attract the same clients. (2) Prohibiting affiliates from copying your content exactly will help minimize any duplicate content issues. Provide samples for your affiliates to view, but insist that the marketers add value to your product by creating their own marketing content.

Merchants, You Should Create an Affiliate Guide To Educate Affiliates About Your Products.
You don’t want duplicate content, but you do want your affiliates to have guidance and accurate information about your products. The more information you provide them, the better at marketing your product they can be. Guides also help set the expectations for both merchants and affiliates in terms of quality, style, and accuracy.

Brand Siphoning: Don’t Let Your Affiliates Bid On Your Brand Name.
While there are some differences of opinion, most people agree that you should not allow your affiliates to purchase your brand name for PPC campaigns. Why? You should not pay someone else for the value of the brand you have already created. You are supposed to be rewarding affiliates who expand your brand territory. If the affiliate obtains a conversion through your brand name in a PPC campaign, they are doing what you could have done without an affiliate. Talented affiliates create and monetize their own content. Don’t pay someone else for the work you already completed in developing your brand; include a prohibition against bidding on your brand name in the contract.

More Brand Siphoning: Don’t Let Your Affiliates Use Domains that Capitalize On Your Brand Name.
For the same reasons described above re: affiliates bidding on your brand name, you should not let your affiliates operate country-specific TLDs that include your brand name. The customers who find you on country-specific TLDs and domains with typographical errors are your “gimmee customers.” Why pay someone else for the work you already did? Make sure your contract deals with all brand-siphoning issues. As you can see below, merchants have also been using anti-cybersquatting statutes to recapture funds lost to affiliates through cyber-squatting:

Lands’ End, Inc. v. Remy, 2006 WL 2521321 (W.D. Wis. Sept. 1, 2006). An affiliate registered some typosquatted domain names as a way of “diverting” consumers through those URLs to get the affiliate commission. The Court ruled that there may be claims for Anti-Cybersquatting Consumer Protection Act, fraud, and breach of contract. Interestingly, the Court ruled that there was no false advertising because the consumer got what it wanted. For more information, see the excellent coverage here. As far as I know, this case is still pending final resolution.

Don’t Let Your Affiliates Embed Links in  Your Yahoo Local Search Profile.
Some affiliates are “spamming” Yahoo local search and Google Maps by embedding their affiliate links. Merchants should claim their profiles and prohibit Affiliates from marketing on local search directories. Any potential customer who looked you up on local search was a customer of yours anyway. This is another form of brand siphoning and should be prohibited in the contract.

Merchants–Look Out for Off-Topic Lead Generation.
ValueClick will pay the FTC $2.9 million for generating leads with false promises of free merchandise. Improperly incentivized leads damage the merchant’s reputation (as well as the affiliate!). Merchants, one way to monitor your affiliates is to ask your customers how they found you. Do not ignore red flags.

Beware Merchants Who Don’t Pay Their Bills
Affiliates, watch out for merchants who don’t pay their bills. Never be the first affiliate to work for a particular merchant. Even if you can prove that the merchant owes you money, the prohibitive cost and difficulty in tracking down a fly-by-night merchant seldom makes doing so worth it. This is why affiliates need to do their research and participate regularly in forums. Affiliate communities are an especially important way of leveling the playing field between merchants and solo affiliates.

CAN-SPAM Compliance.
The FTC aggressively pursues both merchants and affiliates who violate CAN SPAM requirements.

• Merchants, it is not enough to simply rely on layers of vendors to isolate you from liability for your affiliate’s conduct.
• Warning: Judgments for CAN SPAM violations cannot be discharged in bankruptcy; it will follow you for life.
• The easiest way to limit your liability is to prohibit your affiliate from sending commercial emails in the contract. When your customer makes a purchase, ask the customer how they found your site. If a customer ever indicates email, you should immediately follow-up with the affiliate. Don’t hesitate to terminate an affiliate who violates these rules.
• If you want to allow commercial emails, make sure that your affiliate signs a Can-SPAM Compliance Agreement. Further, be sure and monitor your affiliates.
• If you want a quick update on CAN  SPAM requirements, look here.

Children’s Privacy Online
If you’re marketing towards children (even incidentally) and collecting information, be sure your affiliates are aware of COPPA and guarantee their compliance. The Children’s Online Privacy Protection Act (COPPA) requires websites to obtain verifiable parental consent before collecting, using, or disclosing personal information from children. Here’s a smattering of cases that demonstrate how serious the FTC is in pursuing COPPA violations.

• United States v Xanga, No. 06-CIV-6853 (SHS) (S.D.N.Y. Sept 7, 2006) ($1 million civil penalty for allowing visitors to create more than 1.7 million accounts on social networking site although they provided a birthdate indicating they were under 13).
• United States v. UMG Recordings, Inc., No. CV-04-1050 JFW (ex) (C.D. Cal. Feb. 17 2004) ($400,000 civil penalty for music company’s knowing collection of personal information from children online without first obtaining parental consent and for engaging in the same activities on a website directed to children).
• United States v. Mrs. Fields Famous Brands, Inc., No. 2:03CV205-JTG (D. Utah Feb. 26, 2003) ($100,000 civil penalty for company’s collection of personal information from more than 84,000 children without first obtaining parental consent).

Merchants Should Reward Their Top Performers
In managing risk, not everything is about prohibition. It is also important to build long-term relationships with high-performing, trusted partners. Make sure you recognize when you have a top performer and reward them accordingly. Give generous performance bonuses to let the affiliate know that you value their high-quality work. Working with the same person or company repeatedly is a great way to reduce risk.

Affiliate on Affiliate Violence
Unfortunately, top performers are often the victims of affiliate-on-affiliate violence. A successful affiliate will soon discover unauthorized copies of her landing page and increased competition for the keywords she was using. Some merchants turn a blind eye to AOA violence because it results in incremental improvements to highly profitable landing pages. However, this view is short sighted; it alienates your top-performers. Really talented affiliates will not waste their time developing products for merchants who will not protect the value of their work. Merchants should listen to affiliate complaints and terminate affiliates who attempt to pass off other’s work as their own.

Adware
Adware (and other applications) is a liability risk for the merchant and the advertiser. The Department of Justice and the Courts have demonstrated that they will hold companies accountable for data and privacy violations. Here’s a smattering of cases:

• DirectRevenueLLc, C-4194 (Feb. 16, 2007) ($1.5 million disgorgement for company’s unfair and deceptive practice of downloading adware onto consumers’ computers without clear and conspicuous disclosure and obstructing its removal).
• Sony BMG Music Entertainment, C-4195 (Jan. 30, 2007) (Challenging company’s practice of selling CDs without telling consumers they contained software that limited the devices on which the music could be played, restricted the number of copies that could be made, and contained technology that monitored consumers’ listening habits to send them marketing messages).
• FTC v. ERG Ventures, No. CV-005-7777CAS (AJWx) (C.D. Cal. Sept. 6, 2006) ($2 million redress for company’s practice of downloading spyware and adware on consumers’ computers through the promise of free lyric files, browser upgrades, and ring tones and affiliates’ promise of free background music for blogs).
• FTC v. Seismic Entertainment Productions, Inc., No. 04-CV-0377-JD (D.N.H. May 4, 2006) ($4 million redress to settle charges that spyware company used a purported anti-spyware program to hijack computers, change their settings, barrage them with pop-up ads, and install adware and other software programs that monitor consumers’ web surfing).

Clearly, no one can afford to take Adware lightly. Your contract must include a provision stating that the affiliate shall not install or use any ad-delivering or consumer-monitoring applications unless the customer has agreed to installation after a conspicuous and clear explanation of the application’s purpose. To learn more about prohibited deceptive practices, read the FTC’s rules for dotcom businesses.

Stealware
Stealware is software that modifies affiliate tracking codes or replaces affiliate cookies on a user’s computer–resulting in advertising commissions going to another person or company. Unfortunately, there isn’t much that honest affiliates can do about this problem other than refuse to work for merchants that keep offending affiliates in their networks. Merchants are in a better position to resolve these issues by being proactive and terminating affiliates who use stealware.

Keyword Advertising
Unfortunately, the legal risks surrounding keyword advertising remain unresolved. Some courts feel that using someone else’s trademark in search advertising is a violation of the Lanham Act and others do not. The 9th Circuit has ruled that allowing a competitor to purchase a trademark for advertising purposes causes customer confusion and amounts to a “bait and switch.” Other courts have ruled that whether there is customer confusion over the source of the product must always be determined on a case-by-case basis and will require a careful examination of the relevant ad and the overall context in which it appears. Right now, everyone is proceeding at his or her own risk.

Contracts should state that affiliates are solely liable for all intellectual property right claims, including trademark and copyright violations, arising from their content. It will then be up to the affiliate to decide how risk tolerant he or she is. Some merchants may require affiliates to carry errors and omissions insurance as well. After all, there’s no point in having the affiliate indemnify you if they don’t have any assets to back up that promise in the event of  a lawsuit.

Click Fraud
Click fraud is perhaps the largest concern in affiliate marketing. Depending on who you talk to, there are differences of opinion regarding whether affiliates or merchants perpetuate the most click fraud. That said, there does seem to be universal agreement that click fraud appears to be decreasing with the rise of (1) affiliate networks with independent tracking systems (like Pepperjam), and (2) technological improvements at search engines based on better behavioral modeling of natural click patterns.

[If you’re interested in how click fraud affects the whole economic system, I commend to your attention an excellent article, entitled “Click Fraud,” by Kenneth Wilbur and Yi Zhu, both with the University of Southern California. Using economic modeling, they investigate whether it is in a search engine’s interest to prevent click fraud. They conclude that the advertising industry may benefit from using a neutral third party to audit search engine’s click fraud detection algorithms.]

For merchants and affiliates, click fraud cases usually boil down to breach of contract cases. That is why it is very important that contracts specify the payment mechanism, prohibits fraud and deception, and details a remedy. For example, here is an excerpt from CX Digital Media’s Terms of Service outlining the events that will trigger a fraud review:

Publisher accounts are flagged that:

• Have click-through rates that are much higher than industry averages and where solid justification is not evident to the reasonable satisfaction of CX Digital Media;
• Have ONLY click programs generating clicks with no indication by site traffic that it can sustain the clicks reported;
• Have shown fraudulent leads as determined by the Advertisers;
• Have much higher conversions per click rates than industry averages and where solid justification is not evident to the reasonable satisfaction of CX Digital Media; or
• Use fake redirects, automated software, and/or fraud to generate Events from the Programs.

Be Firm But Professional When Terminating an Affiliate.
If you have to boot off an affiliate, remember that affiliates make ruthless enemies. Break the news professionally and firmly. Remember that to protect the value proposition of online marketing, it is important to stick up for your trusted, top-performing affiliates and to cease doing business with affiliates who violate state and federal rules regarding open and honest advertising.