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ALPHA MEDIA GROUP, LLC 33 New Montgomery Street, Suite 400, San Francisco, CA 94105 USA | Direct: +1 (650) 489.4182 Fax: +1 (415) 520-5651

January 8, 2016

Jason Stoogenke

WSOCTV.COM

RE: Media Inquiry

Dear Mr. Stoogenke:

The essential business model of AFG is to take advantage of an arbitrage opportunity

involving the use of frequent flyer award miles to book deeply discounted flights for

international first and business class travel. Airlines have traditionally, since the inception of

frequent flyer programs (“FFP’s”), taken the position that miles credited to an account may not

be transferred for consideration. The Airline Deregulation Act, enacted in 1978, signaled a

turning point for the way airlines approached advertising and marketing. No longer subject to

heavy regulation by the Civil Aeronautics Board, airlines were free for the first time since

the enactment of the Federal Aviation Act of 1958 to decide their own interstate airfare rates

and flight routes. The Civil Aeronautics Board was subsequently abolished in 1985, and

jurisdiction now lies with the Department of Transportation. In 1981, American Airlines became

the first commercial airline to adopt a Frequent Flyer program offering free travel in return for

customer patronage. The AAdvantage® program was designed to increase sales and improve

customer “brand loyalty” to American Airlines in the highly competitive atmosphere spurred by

this governmental deregulation of the airline industry. Following American’s lead, almost every

other major airline soon launched its own version of the frequent flyer program and began

offering repeat customers free flights or other benefits in return for their continued use of the

same airline. Most airlines have also expanded their programs to allow customers to earn

mileage by using “tie-in services.” All airlines seek, by their FFP rules, to prevent members from

realizing any monetary benefit from their mileage accounts.

For example, American Airlines AAdvantage program terms and conditions state:

At no time may AAdvantage mileage credit or award tickets be purchased, sold

or bartered (including but not limited to transferring, gifting, or promising

mileage credit or award tickets in exchange for support of a certain business,

Christopher R. Miller

General Counsel

chris@alphaflightguru.com

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product, or charity and/or participation in an auction, sweepstakes, raffle, or

contest). Any such mileage or tickets are void if transferred for cash or other

consideration. Violators (including any passenger who uses a purchased or

bartered award ticket) may be liable for damages and litigation costs,

including American Airlines attorney’s fees incurred in enforcing this rule.

Not surprisingly, United Airlines Mileage Plus rules are essentially identical (as are the rules of

all airlines which have FFP’s):

The sale or barter or attempted sale or barter of any such mileage, certificates,

awards or benefits other than as authorized and/or sponsored by United is

expressly prohibited. Any mileage, certificates, awards or benefits transferred,

assigned or sold in violation of the Program Rules, in addition to exposing the

member to the penalties otherwise associated with violations, may be

confiscated or canceled. The use of award tickets that have been acquired by

purchase, barter or other conduct in violation of Program Rules may result in

termination of membership, cancellation of accrued mileage, certificates,

awards or benefits, confiscation of the tickets, denial of boarding with respect

to the ticket holder, and, at United’s discretion, completion of the travel only

upon payment of an applicable fare.

Airlines have created a secondary market in FFM, and actively cooperate to prevent any

other secondary market participants from entering that market. They have created an actual

currency from the miles programs, but will not allow the holders of the miles to enjoy the same

monetary benefit from those miles as the airlines themselves enjoy. In today’s marketplace,

frequent flyer program members commonly accrue and redeem substantial mileage credits

without ever setting foot on an airplane. Through agreements with credit card issuers,

mortgage lenders, and various merchants, airlines have created a virtual marketplace, and,

essentially, a new and valuable currency, in which flight mileage plays only a minor role. As will

be discussed below, this trend toward monetization of FFP awards has greatly diminished the

ability of the airlines to hide behind the umbrella of the ADA under the theory that any

challenge to the validity of the rules prohibiting transfer of awards for compensation is related

to issue concerning “rate, route or service”, or to claim any measure of damages from the

“unauthorized” use of mileage awards.

The close ties between airlines services and frequent flyer programs began to unravel

when frequent flyers began to earn many of their miles without actually flying, and the

proportion of miles spent on flights decreased. In the late 1980’s, airlines began developing

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relationships with non-travel-related entities, such as credit card companies, to allow members

to earn miles without traveling. i At first, these alternate sources offered limited miles, but

today they are the dominant means by which miles are obtained. For example, in the late

1980’s, one obtained only 5,000 bonus miles for obtaining a new credit cardii. However, by

2009, credit cards were offering up to 100,000 miles to sign up. Today “[t]he majority of airline

frequent flyer miles are now earned outside an airplane, by frequent buyers [rather]than

frequent flyers. Airlines miles are earned for the use of credit cards, hotel stays, car rentals,

retail purchases, dining out, and even for mortgage and real estate agents. …[T]hree times

more airline miles are being generated than are being consumed.”iii

Indeed, “if you pay by credit card you can earn miles for hospital surgery, income-tax

payments and funerals.” iv Not only are most miles earned without consuming airline services,

many miles are spent without consuming airline services, and most miles are not spent at all as

a result of the airlines’ own policies and actions. “Airline revenue management is programmed

to discourage sale of free seats or upgrades using redemption of milesv “The average rate of

success of getting an upgrade or free ticket using miles” is 37 percent.vi

Not only do airlines make it very difficult for mileage members to redeem their miles for

flights, but the airlines earn huge profits from the mileage programs, not through providing

airline services, but rather by selling their miles to partners, who in turn award the mile to

frequent flyer members in connection with various non-travel-related transactions. Airlines

typically earn one or two cents per mile awarded, which can amount to four cents for each

dollar a consumer spends when multiple miles are awarded per dollar.vii As early as 2005, one

estimate put the revenue from non-airline-service-related sales at $10 Billion.viii Thus, “airline

loyalty programs [are]…run as independent profit centers.ix That independence is not at all

figurative, as the airlines have been spinning off their programs as separate businesses

altogether from that of providing air services. x

The tight nexus that airlines must show between frequent flyer programs and airlines’

“price, route or service” in order to invoke the umbrella of the ADA [49 U.S.C. § 41714(b)(1)]

simply no longer exists. The attenuated relationship between frequent flyer programs, on the

one hand, and “rate, route or service” on the other, should not come as a surprise for the

airlines. The airlines themselves often invoke state law in their own lawsuits targeting claims of

wrongdoing with regard to their frequent flyer programs against both parties with whom they

contract (program members) and parties with whom they lack contractual privity (e.g., mileage

brokers). However, as the Supreme Court has explained, a party invoking preemption “cannot

have it both ways”—“[i]t cannot rely on [a state] regulatory framework…yet argue that its own

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claims, invoking the same state-law rules, are preempted.” Dan’s City Used Cars, Inc. v. Pelkey,

(2013) 133 S.Ct. 1769, 1781.

The importance of the analysis of the application of the ADA to claims against airlines is

that in most of the cases brought by FFP members against airlines, the various federal courts

reviewing those cases have determined that the claims, whether they were based on state law

(i.e., unfair competition, fraud) or federal claims were pre-empted by the ADA, with sole

jurisdiction to address those claims resting with the Department of Transportation. For

example, in December 2014, in Lagen v. United Continental Holdings, Inc.,xi the U.S. Court of

Appeals for the Seventh Circuit affirmed the airline's contractual right to modify or cancel

benefits in its award program despite promising "lifetime benefits" to members who achieved

"Million-Miler Flyer" status. The court also determined that any claim based on consumer fraud

would be preempted by the ADA, leaving the plaintiff with the recourse of complaining to the

Department of Transportation (DOT) or to the airline directly.

The most recent of these cases, Northwest, Inc. v. Ginsberg, __ U.S. __, 134 S.Ct. 1422

(2014) concerned a claim that the airline terminated the plaintiff's Platinum Elite membership

in reliance on program terms giving it discretion to do so. Although the 7th Circuit had upheld

the plaintiff’s right to bring an action based upon violation of the covenant of good faith and

fair dealing (a state law remedy), the Supreme Court found that the claim was preempted by

the ADA. The primary basis of the finding was the traditional view that the issues surrounding

the termination of FFP membership were issues affecting “price, route or service” and were

therefore within the exclusive jurisdiction of the DOT. However, in Ginsburg, which began

winding its way through the courts in 2007, there was no strong argument made that such an

analysis no longer applies due to the manner in which the airlines themselves have changed the

nature of their FFP’s by spinning them off into separate entities and monetizing mileage points.

A potentially different result in a case that does raise that issue is foreshadowed by a

comment by Justice Samuel Alito, who, in writing the unanimous opinion of the Court in

Ginsberg, said:

“Respondent and amici suggest that Wolensxii is not controlling because frequent

flyer programs have fundamentally changed since the time of that decision. We

are told that “most miles [are now] earned without consuming airline services”

and are “spent without consuming airline services.”...But whether or not this

alleged change might have some impact in a future case, it is not implicated

here. In this case, respondent did not assert that he earned his miles from any

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activity other than taking flights or that the attempted to redeem miles for

anything other than tickets and upgrades...” [Emphasis added].

Clearly the Court is leaving the door open to a different view of the vulnerability of the FFP’s to

attack when, not if, such an argument is made.

Claims Brought Against Airlines by FFP Members

There are presently pending several cases which challenge the structure of the FFP rules. In

Banakus v. United MileagePlus , Daniel Banakus from California has filed a suit claiming that

United breached contracts with United MileagePlus members when it combined the frequent

flyer programs of United and Continental in March 2012 and changed some of the rules of

United MileagePlus in the process, specifically for Premier members of the program. That case

recently survived a motion to dismiss on preemption grounds and is moving forward in federal

court in Illinois.

In Hirsch v. Citibank , a class action lawsuit was filed Feb. 4, 2012 against Citibank

alleging that the bank enticed consumers to open a checking or savings account by offering

40,000 American Airlines AAdvantage miles without informing them that the miles would be

reported to the IRS as taxable income.

The lead Plaintiffs in the case, Bertram Hirsh and Igor Romanov, also claim that Citibank

grossly overvalued the miles at a value of 2.5 cents per mile. The complaint states, "It is widely

understood in the marketplace that airline miles are not reported to the IRS as being taxable for

income tax purposes. Indeed, Citibank expressly informed plaintiff Hirsch that the American

Airlines miles that he would receive for opening up Citibank checking and savings accounts

were not taxable."

It further states that "Even if the airline miles were taxable, Citibank's practice of valuing

the airline miles at 2.5 cents per mile is grossly unfair and deceptive. Airline miles have no value

to Citibank customers that can be fixed at the time they are awarded. If redeemed, these miles

typically have an average value to customers of between .76 cents per mile and 1.2 cents per

mile. At least one study recently concluded that American Airlines miles in particular are only

worth about .76 cents per mile." Although this case concerns primarily tax issues, the core

question revolves around the recognition that airlines have created a currency which has value.

Frequent Flyer Plaintiffs vs. US Airways, Hawaiian Airlines, EasyCGI and FreeCause, Inc.

is a lawsuit just starting to make progress toward a resolution for frequent flyers involves bonus

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miles promotions that appeared in June 2011. There are currently 26 Plaintiffs listed in the

complaint that was filed last month, although it is likely that the case will be transformed into a

class action. One bonus promotion offered US Airways Dividend Miles members 4,757 miles for

making one purchase with web hosting company EasyCGI through the Dividend Miles online

shopping mall. The terms and conditions explicitly stated that there were no restrictions on the

type of purchase made or the number of purchases eligible for the bonus with terms such as,

"There are no restrictions at this time" listed under "Restrictions" and the Frequently Asked

Questions stated, "Q. Is there a limit to the amount of miles I can earn? A. NO, you can earn as

many miles as you like. There is no cap."

A similar bonus promotion offered bonus miles for Hawaiian Airlines HawaiianMiles

members. But as members jumped at the offer and made purchases, many noticed that their

orders had been cancelled without notice and realized that they would not be getting the miles

they were promised. The complaint states, "Within a week after said purchases had been made,

however, Defendants wrongfully and without good cause rejected all of Plaintiffs' purchases, as

well as all of the bonus miles that were supposed to be awarded in connection therewith."

From what members could ascertain, the companies making the offer simply decided to no

longer offer the miles and even went so far as to not honor the purchases already made and

cleared through credit cards. As these issues are bringing the fact of monetization to the

forefront, courts will be less sympathetic to the position that airlines can dictate what use can

be made of awards once they are obtained, and more to the point, that such awards are not

the property of the FFP member, with all rights attendant upon the ownership of any property.

Claims Brought Against Brokers by Airlines

Although airlines have in the past made strong efforts to eliminate the secondary

market for airline mileage points, there has not been much activity in recent years. In the cases

that have been brought, and won, by the airlines, the claims were brought against brokers who

directly solicited and bought mileage points from FFP members and then used those points to

purchase award tickets.xiii Of these cases, two are most often discussed and are instructive for

this discussion.

In Alaska Airlines Inc. v. Carey, NO. 09-35979 (9th Circuit, 2010)[Not Certified for

Publication], all allegations were based on Alaska's contention that Carey was buying and selling

its miles on an illegitimate black market (directly from FFP members), in violation of its Mileage

Plan. It originally sought damages and a permanent injunction, but then dropped its request for

damages. Carey filed a countersuit against Alaska Airlines and filed a cross-complaint against

Alaska Airlines's employees Ann Ardizzone (Managing Director for Customer Experience and

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Vice President, Inflight Services) and Kyle Levine (In-House Counsel), and Points International,

Inc. (the only authorized dealer of Alaska Airlines's mileage points), alleging a number of

antitrust and state law counterclaims. With regard to the state law claims brought in the

counterclaims, the Court found that “Carey's state law claims were brought in an effort to

invalidate Alaska Airlines's Mileage Plan because it allows Alaska Airlines unilaterally to change

the terms of the contract. These claims are pre-empted by the Airline Deregulation Act of 1978

(ADA). 49 U.S.C. §§ 41712(a), 41713(b)(1); Am. Airlines v. Wolens, 513 U.S. 219, 228 (1995)

(holding that state law claims seeking to invalidate an airline's frequent flyer program would

frustrate the purpose of the Airline Deregulation Act and were thus preempted).”

The court also ruled against Carey’s antitrust claims, finding that “Carey's antitrust

claims fail because he is buying and selling in a "black market" of frequent flyer miles, which is

not a valid market for purposes of antitrust law. See TransWorld Airlines v. Am. Coupon Exch.,

Inc., 682 F.Supp. 1476, 1487 (C.D. Cal. 1988), rev'd in part on other grounds, 913 F.2d 676 (9th

Cir. 1990.”

It is significant that the court deemed this case not suitable for publication, meaning

that it cannot be cited as precedent in other decisions in federal courts. It is also significant

that the court based its finding on the antitrust issue on TWA v. A.C.E., discussed below, a case

that was decided in 1990, long before there was significant monetization of FFM. With regard

to the AFG business model, especially in the context of dealing with Alaska Airlines, there are

two major distinctions: 1. Carey was buying miles directly from FFP members, not brokers, and

2. the court focused on an assume loss of revenue suffered by Alaska: “Under the so-called

"stowaway" theory of damages, Alaska Airlines suffered damages each time Carey redeemed a

free ticket for someone other than the traveler who earned the miles. Bitterman v. Louisville &

Nashville R.R., 207 U.S. 205, 221 (1907). Had the person traveling not used the free ticket, he

would have needed to buy a ticket from Alaska Airlines, which consequently lost the sales

revenue of that ticket.”

In distinction to the facts of Carey, does not solicit miles directly from FFP members, and

with regard to Alaska Air, does not use Alaska Air miles to book flights on Alaska Air, but rather

on its partner alliance airlines.

The second case for discussion, and upon which the court in Carey relied in rejecting the

antitrust claims, is Trans World Airlines, Inc. v. American Coupon Exchange, Inc. 913 F. 2nd 676

(1990). In this case, TWA sought to obtain an injunction against ACE to prevent it from buying

mileage coupons from FFP members and reselling those coupons to other travelers. ACE

brought counterclaims against TWA, claiming tortious interference with business and antitrust

violations. The court summarized those claims as follows:

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“ACE urges that TWA's restrictions on transfer violate public policy. In doing so, it

relies exclusively on the argument that the transfer restrictions run afoul of the

time-honored rule against unreasonable restraints on the alienation of property.

TWA responds, first, that frequent flyer award coupons are not "property" to

which the policy in favor of free alienation applies; and second, that even if the

public policy advanced by ACE is applicable, the tariffs are not unreasonable

restraints, and must therefore survive scrutiny.”

The court found that the prohibition against transferring mileage points was in fact reasonable,

stating:

“... TWA's [Frequent Flyer Bonus ("FFB")] Program is structured to balance the

benefit of receiving additional publicity and customer loyalty with the cost of

providing travel awards. Had TWA intended its FFB awards to be redeemable for

cash, it might have scaled its mileage redemption rates differently, or precluded

assignability of these awards entirely in an effort to reach a different balance.

Accordingly, the nontransferability of these awards is an element of their value

intended by TWA. To the extent that a FFB award may constitute "property," the

award provided to the qualifying passenger is accompanied by restrictions which

are an integral part of that right. There is nothing unreasonable about this

scheme.”

TWA made the argument that the mileage coupons had no monetary value, and therefore were

not “property” but merely “contract rights”. The court, basing its reasoning on the underlying

assumption that mileage entitlements in fact had no intrinsic value, decided that:

“In summary, prior judicial treatment of tickets in general and tickets of passage

in particular has emphasized their contractual nature. The frequent flyer

coupons before us resemble paradigmatic property rights even less than do the

tickets considered by those earlier courts. Even if our predecessors did not

analyze the conceptual bases for their decisions as clearly as one might have

wished, we believe their determinations that the instruments at issue involved

contract rights were sensible, and that consistency as well as reason dictates that

we follow in their path. Consequently, we hold that the policy against restraints

on alienation of property has no application to Frequent Flyer Bonus award

coupons; thus, that ancient doctrine — the only tenet of public policy on which

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we are asked to rule — presents no barrier to the enforcement of TWA's tariffs

against holders of brokered coupons.”

The above reasoning is very important, because it is based upon the underlying

assumption that the miles have no monetary value, and were not intended by TWA to have any

monetary value. Clearly, the airlines have changed the game by recognizing the immense

monetary value of mileage awards, and themselves monetizing these awards to recognize billions

of dollars in annual revenue as a separate revenue center. It is quite probable that a similar

challenge brought today would have a completely different result, primarily because of the clear

monetary value of mileage awards established by the airlines themselves.

Exposure of Airlines to Antitrust Liability

The Sherman Anti-Trust Act of 1890 (15 U.S.C.A. §§ 1 et seq.), the first and most

significant of the U.S. antitrust laws, was signed into law by President Benjamin Harrison and is

named after its primary supporter, Ohio Senator John Sherman.

The prevailing economic theory supporting antitrust laws in the United States is that the

public is best served by free competition in trade and industry. When businesses fairly compete

for the consumer's dollar, the quality of products and services increases while the prices

decrease. However, many businesses would rather dictate the price, quantity, and quality of

the goods that they produce, without having to compete for consumers. Some businesses have

tried to eliminate competition through illegal means, such as fixing prices and assigning

exclusive territories to different competitors within an industry. Antitrust laws seek to eliminate

such illegal behavior and promote free and fair marketplace competition. The Sherman Act

made agreements "in restraint of trade" illegal. It also made it a crime to "monopolize, or

attempt to monopolize … any part of the trade or commerce." The purpose of the act was to

maintain competition in business.

The courts have interpreted the act to forbid only unreasonable restraints of trade. The

Supreme Court promulgated this flexible rule, called the Rule of Reason, in Standard Oil Co. of

New Jersey v. United States, 221 U.S. 1, 31 S. Ct. 502, 55 L. Ed. 619 (1911). Under the Rule of

Reason, the courts will look to a number of factors in deciding whether the particular restraint

of trade unreasonably restricts competition. Specifically, the court considers the makeup of the

relevant industry, the defendants' positions within that industry, the ability of the defendants'

competitors to respond to the challenged practice, and the defendants' purpose in adopting

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the restraint. This analysis forces courts to consider the pro-competitive effects of the restraint

as well as its anticompetitive effects.

The Supreme Court has also declared certain categories of restraints to be illegal per se:

that is, they are conclusively presumed to be unreasonable and therefore illegal. For those

types of restraints, the court does not have to go any further in its analysis than to recognize

the type of restraint, and the plaintiff does not have to show anything other than that the

restraint occurred.

Restraints of trade can be classified as horizontal or vertical. A horizontal agreement is

one involving direct competitors at the same level in a particular industry, and a vertical

agreement involves participants who are not direct competitors because they are at different

levels. Thus, a horizontal agreement can be among manufacturers or retailers or wholesalers,

but it does not involve participants from across the different groups. A vertical agreement

involves participants from one or more of the groups—for example, a manufacturer, a

wholesaler, and a retailer. These distinctions become difficult to make in certain fact situations,

but they can be significant in determining whether to apply a per se rule of illegality or the Rule

of Reason. For example, horizontal market allocations are per se illegal, but vertical market

allocations are subject to the rule-of-reason test.

Section one of the Sherman Act prohibits concerted action, which requires more than a

unilateral act by a person or business alone. The Supreme Court has stated that an organization

may deal or refuse to deal with whomever it wants, as long as that organization is acting

independently. But if a manufacturer and certain retailers agree that a manufacturer will only

provide products to those retailers and not to others, then that is a concerted action that may

violate the Sherman Act. A company and its employees are considered an individual entity for

the purposes of this act. Likewise, a parent company and its wholly owned subsidiaries are

considered an individual entity.

The evolution of FFP’s from a marketing device to garner loyalty from passengers to a

separate business generating billions of dollars from activities having little or nothing to do with

the business of an airline has eroded the protection from antitrust liability that airlines have

enjoyed for the last several decades. The language of the FFP terms and conditions, nearly

identical in every respect from airline to airline, clearly raises the inference of concerted

activity. The uniform rules preventing transfer of miles for consideration, in a world where the

airlines have made mileage a virtual currency, are now vulnerable to attack as an unreasonable

restraint of trade. A refusal to sell miles to an entity such as AFG certainly could be

characterized as a refusal to deal.

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The airlines have not made an effort in at least five years to challenge the secondary

FFM market, though they are indisputably aware of its existence. It is not unreasonable to

assume that a major factor in the lack of “enforcement” attempts is a valid concern for

exposure to antitrust liability.

I trust that this rather lengthy discourse has helped to augment your understanding of

the FFM industry and the role our plays in it.

Regards,

Christopher Miller

General Counsel

i See,e.g., Credit Card Competition, InsideFlyer (Jan. 2011). ii Credit Card Competition, supra iii Pankaj Narayan Pandit, Infosys, Perspective: Airline Loyalty Programs 1 (2009) [Available at http://www.infosys.com/industries/airlines/Documents/frequent-flyer-programs.pdf iv Special Report, Frequent-Flyer Miles: Funny Money, The Economist (2005)[Available at http://www.economist.com/node/5323615. v Pandit, Id. At 2. vi Funny Money, supra vii See,e.g., Chase, UnitedPlus Explorer Credit Card [Available at https://creditcards.chase.com/credit-cards/united-airlines-credit-card2.aspx?unitedmileageplussplit+2&iCELL+6ZJ4 ]. viii Funny Money, supra. ix .” Pandit, supra, at 1. x Evert de Boer, Carlson Marketing, Spinning of Frequent Flyer Programs in Turbulent Times (2009)[Available at http://loyalty360.org/images/uploads/spinning_off_frequent_flyer_programs_in_turbulent_times.pdf . xi 2014 WL 7251178 (7th Cir. Dec. 22, 2014 xii The Supreme Court ruled in American Airlines vs. Wolens that consumers could sue an airline in state court for breach of contract. xiii See, e.g., American Airlines, Inc. v. Christensen, 967 F.2d 410 (10th Cir. 1992); Transworld II, 913 F.2d 676 (9th Cir. 1990); Northwest Airlines, Inc. v. Ticket Exch., Inc., 793 F. Supp. 976 (W.D. Wash. 1992). (Enforcement actions taken by airlines); Transworld Airlines, Inc. v. American Coupon Exchange, Inc., 913 F.2d 676,680-81 (9th Cir. 1990) While the

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variety of allegations, ranging from fraud to antitrust, complicated the jurisdiction issue, the court considered the determination of the legal effect of a federal tariff restricting the transfer of awards to be an independent matter of federal jurisdiction.