August 24, 2001 3:05 PM PDT

Egghead sale could crack on privacy issues

The proposed sale of Egghead.com to Fry's Electronics could be in jeopardy if too many customers decide they don't want to be on a Fry's mailing list, according to bankruptcy filings.

As part of the proposed $10 million sale, Fry's is requiring that no more than 10 percent of active customers--anyone who bought something at Egghead in the last two years--can "opt out" of a plan to transfer their information over to Fry's Electronics, according to a bankruptcy filing at U.S. Bankruptcy Court for the Northern District of California.

Complicating the matter is Egghead's privacy policy, which says that the company will not "sell or rent customer information to any outside party under any circumstances." Unlike statements from other companies, Egghead's policy does not make any exceptions for the sale of the company or its assets.

At the courthouse Friday, Egghead Chief Executive Jeff Sheahan said he thinks the company can transfer the data, calling the laws surrounding such privacy statements "very fluid."

"I think we are doing the responsible thing here. We're informing people of what we are doing," Sheahan said. "This is a very gray area of the law."

But privacy issues surrounding customer lists have been a hot-button issue since Toysmart tried to sell its customer list after it went bankrupt. Ultimately, the data was destroyed after vigorous complaints from consumer advocacy groups, the Federal Trade Commission, and a coalition of 39 states that tried to block the sale.

After that pivotal privacy debate, which drew attention to the fine print of these agreements, many companies--including Amazon.com--changed their policies to permit the sale of customers' data in the event of a sale or acquisition. Privacy advocates roundly criticized the privacy policy change at Amazon in particular and filed a complaint with the FTC.

An FTC spokeswoman declined to comment Friday on the Egghead situation. In recent months, new FTC Chairman Timothy Muris has said that the commission would step up investigations into online privacy issues.

Privacy advocates say the Egghead deal is reminiscent of Toysmart's situation.

Jason Catlett, chief executive of Junkbusters, said that Egghead shouldn't transfer the information unless customers actively approve through an "opt in" program. The proposed "opt out" plan means that if customers don't respond, their information will be transferred.

"If the company said it would not disclose information, then it must seek affirmative consent," Catlett said. While some companies have done it, transferring data without an "opt in" plan is "wrong and on shaky legal ground," he added.

Fry's spokesman Manuel Vallerio acknowledged Friday that while there are privacy issues, the company believes the proposed arrangement protects customers because it is allowing them to opt out if they wish, and Fry's will not share the data once it gets it.

"They can rest assured that we won't be sharing their data," he said. "If they aren't comfortable, they can opt out."

The transfer of the database did not come up during the hearing Friday. Instead, attorneys for Egghead, Fry's, Egghead's creditors and the potential bidders discussed with Judge Thomas Carlson issues such as honoring vacation pay and paying retention bonuses to Egghead employees, setting the terms for potential bids from companies other than Fry's, and allowing Egghead to pay $8,000 worth of airfare for a customer who won a trip to Australia.

Egghead's collection of customer data, one of the largest in e-commerce, is potentially the company's most valuable asset. According to the bankruptcy filings, Egghead had 4 million registered customers as of June 25, 1.3 million of which are considered "active."

And the 10 percent figure is so low, it indicates that the customer list is the main asset that Fry's cares about, said Rich Gray, an intellectual property attorney in Silicon Valley. The list includes customers' names, billing and shipping addresses, credit card numbers, and e-mail addresses, according to the documents filed with the bankruptcy court.

"What the guys at Fry's have successfully done is to incentivize Egghead to get as many customers as they possibly can to flip over," Gray said. "This gives (Fry's) bargaining leverage, and they may be able to use it to knock the price down" if Egghead doesn't meet the provision.

Chris Hoofnagle, legislative counsel at the Electronic Privacy Information Center, said the fact that Egghead wants to do this after the Toysmart uproar shows that self-regulation by the industry doesn't work.

"Consumers have the short end of the stick here," he said. "They have no protections in law, and the practice of simply changing privacy policies is pretty widespread."

Last fall, laws to protect consumers' online privacy seemed imminent, with a bipartisan coalition in Congress promising to introduce legislation early this year. Although several bills were introduced, those have become bogged down in recent months over concerns by legislators that such bills would do more harm than good.

The bankruptcy judge will have the final say in whether Egghead will be able to sell its customer data, Gray said. But Egghead's privacy policy could make the sale more difficult, he said.

"The whole privacy issue has caught some lawyers flat-footed," Gray said. "They didn't think ahead to the situation that Egghead is into today. A provision that is meant to reassure consumers about their privacy ends up being something that devalues a key asset of the company, which is its customer list."

According to the court documents, Egghead will send the opt-out notice to customers after the bankruptcy court approves the sale to Fry's but before the sale officially closes.

Egghead attorney John Murray said the company was in a difficult negotiating position and that the low threshold for opt-outs was one of several stringent conditions Egghead agreed to as part of the asset sale agreement. But while the percentage of customers needed to kill the deal appears low, Murray said he believes the percentage of customers who tend to opt out of having their data transferred is often lower.

"We don't expect the opt-outs to be at that magnitude," Murray said. "Even if they are, we don't expect that's going to prevent a close."

Although Fry's agreed to pay $10 million for Egghead's assets, according to the bankruptcy documents, the company will get far less. As part of the deal, Fry's agreed to loan Egghead up to $4.5 million at 8 percent compounded interest, all of which would be deducted from the sale price. Fry's can also deduct from the sale price payments made to vendors under contracts Egghead signed and the cost of relicensing some of Egghead's technology.

As part of the agreement, Fry's, which owns a chain of electronics stores in California, Texas, Arizona and Oregon, would get assets ranging from Dell Computer PCs and HP laser jet printers, Egghead's trademarks, and its patents related to online auctions and leases at Egghead's Vancouver, Wash. offices.

Fry's may not be the only suitor for Egghead. Up to four other potential bidders have asked Egghead for information, Murray said. A representative for Buy.com founder Scott Blum was at the hearing Friday, and there were representatives from at least two other potential bidders present. Under the terms of its agreement with Fry's, Egghead cannot solicit competing bids but can provide information to interested parties. The bankruptcy court will determine whose bid will be accepted.

 

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