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Apple's kiddie app deal stirs controversy at the FTC

January 15, 2014: 6:12 PM ET

Sharp dissent among the commissioners who extracted a $32.5M settlement out of Apple.

One little girl spent $2,600 in Tap Street Hotel

One child spent $2,600 on pets in Tap Street Hotel.

FORTUNE -- There's fun to be had reading the documents that came with the Federal Trade Commission's announcement Wednesday that it had cut a $32.5 million deal with Apple (AAPL).

Apple was charged with letting kids spend millions on in-app purchases without their parents' consent. The company grudgingly agreed to settle.

The FTC's press release described the consent decree as a huge win for aggrieved parents.

"This settlement is a victory for consumers harmed by Apple's unfair billing, and a signal to the business community: whether you're doing business in the mobile arena or the mall down the street, fundamental consumer protections apply," said FTC Chairwoman Edith Ramirez. "You cannot charge consumers for purchases they did not authorize."

Now the fun begins.

First, there's Tim Cook's memo to the staff, which several blogs obtained and which Fortune can confirm is genuine. In it Cook points out that the case in which Ramirez just declared victory had already been adjudicated before the FTC took it up.

"Last year," Cook writes to his staff, "we set out to refund any in-app purchase which may have been made without a parent's permission. We wanted to reach every customer who might have been affected, so we sent emails to 28 million App Store customers — anyone who had made an in-app purchase in a game designed for kids. When some emails bounced, we mailed the parents postcards. In all, we received 37,000 claims and we will be reimbursing each one as promised."

A federal judge had signed off on this settlement and Apple had begun mailing out reimbursement checks when the FTC, under newly-appointed Chairwoman Ramirez, decided to get involved.

To Cook this "smacked of double jeopardy" but he says he decided to sign rather than fight because, as he put it, "the consent decree the FTC proposed does not require us to do anything we weren't already going to do."

Not quite. There's still a little matter of $32.5 million. But we'll get to that later.

Meanwhile, the commissioners have issued a flurry of statements, mostly responding to a pointed dissent filed by commissioner Joshua Wright, a former George Mason professor of law. In it, Wright takes issue with the premise of the case, arguing that the FTC had never before charged a company with "unfair acts or practices" for this kind of marketing behavior.

"The test the Commission uses to evaluate whether an unfair act or practice is unfair used to be different," he writes. "[Those] cases invariably involve conduct where the defendant has intentionally obscured the fact that consumers would be billed. Many of these cases involve unauthorized billing or cramming – the outright fraudulent use of payment information. Other cases involve conduct just shy of complete fraud – the consumer may have agreed to one transaction but the defendant charges the consumer for additional, improperly disclosed items."

Furthermore, he writes, rather than a substantial victory, "this is a case involving a miniscule percentage of consumers – the parents of children who made purchases ostensibly without their authorization or knowledge... The injury in this case is limited to an extremely small – and arguably, diminishing – subset of consumers."

Which brings us to that $32.5 million. It's not clear from any of the documents how this figure was arrived at, nor whether the refunds Apple has already paid will be subtracted from it. By the terms of the consent agreement, Apple must pay out "a minimum" of $32.5 million -- or roughly $880 for each of Apple's complainants.

Any money that's not spent -- which could, in theory, be millions of dollars -- goes to ... wait for it ... the commission.

So, bottom line, the FTC has hit an Apple trifecta: 1) headlines that paint the government as protectors of parents and children in the digital age, 2) a story in which the FTC gets to play the giant killer, and 3) a novel way to extract millions out of Apple's coffers -- and maybe send some of it directly to the FTC's.

Fun fact: Before she was appointed to the FTC, Chairwoman Ramirez was a partner in the Los Angeles office of Quinn Emanuel Urquhart & Sullivan.

See also: Apple's controversial cash cow: Free apps that sell extras

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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