Affiliate marketers VCLK, ICGE's exposure to Spitzer's attack on Adware: more details

The Internet Danger List: stocks at risk from Spitzer's attack on Adware included a section on affiliate marketing companies ValueClick (ticker: VCLK), Commission Junction (partially owned by Internet Capital Group, ticker: ICGE) and Think Partnership (ticker: THK). Here's more detail on those companies' potential exposure to the Adware/Spyware issue, aided by input from readers' since the original article was published:

The affiliate networks face three potential legal threats:

1. Legal action from Eliot Spitzer and other State and Federal authorities. The affiliate marketing network companies provided the primary means by which the Adware and Spyware vendors translated clicks into profits.
2. Legal action from merchants. Spyware and Adware programs can make direct traffic to a merchant's web site look as though it is generated from an affiliate. In that case, merchants would pay an affiliate commission (sometimes as high as 20% or 30% of sales) to the Adware/Spyware provider when in reality no affiliate commission is justified. The merchant's commercial relationship is not with the individual affiliates (and Adware/Spyware companies), however; it is with the affiliate marketing networks. The merchants could therefore sue the networks. One estimate: if a third of PCs are infected with Adware/Spyware,
   merchants like Dell could be paying considerable sums in illigitamate affiliate
   commissions.
3. Legal action from other affiliates. Adware/Spyware programs often over-write other (legitimate) affiliates' cookies with their own, thereby stealing revenue from legitimate affiliates. Those affiliates could hold the affiliate networks responsible for allowing the Adware/Spyware vendors into their networks.

How real are these threats to the affiliate marketing companies?

Wayne Porter says:

My guess is that most of the revenue currently flowing through affiliate aggregators is through the use of loyaltyware and not CPC-deal structured "adware". Insiders tell me that much of the more aggressive adware has been purged from the major aggregators and some of the trackable activity back to the adware is due to media buys conducted by other affiliates in the PPCSE arbitrage fashion or through the traditional pure performance revenue split.

However, it's not clear how seriously the affiliate marketing companies have tried to eliminate Adware and Spyware vendors from their networks. LinkShare gives a $15,000 cash prize (its Titanium Award) to its top affiliate, and three times this has been awarded to a company and then revoked by LinkShare on the basis that the recipient's business is fraudulent. In October 2004 the award was given to EdealsEtc.com and then revoked, and before that the same occured with TheDeskTopShopper.com. In reaction to this, Michael Coley of Amazing-Bargains.com commented:

More than anything, I think this points out just how lousy of a job Linkshare's compliance team is doing. They had a very small number of affiliates to look at. It should have been very simple to determine if their was fraudulent activity going on. They missed it.

Even if VCLK's Commission Junction and ICGE's LinkShare have succeeded in eliminating fraudulent companies from their affilate networks, this still leaves open the possibility that the affiliate marketing companies have exposure from past relationships. According to one (anonymous) source:

Most industry insiders, I think, would agree that they [ValueClick, ticker: VCLK and Commission Junction, partially owned by Internet Capital Group, ticker: ICGE] are in many ways ultimately responsible for the "success" of spyware. They have most of the bigger brands as clients, and created an easy way for spyware to drive traffic to those brands and make money. Commission Junction and LinkShare made money from these relationships as well (30% of each commission in most cases), and many think a good chunk of their overall revenue may be from these relationships. Had they blocked spyware from their networks from the beginning, I believe it is very unlikely that it would have proliferated so quickly and successfully, as spyware needed those big brands to establish a foothold.

In fact, Wayne Porter wrote in July 2004:

...180Solutions' [an Adware/Spyware provider] Sawicki acknowledges that both LinkShare and Commission Junction are aware of its deployment of double and hidden pop-ups through 180Solutions' software, a practice that has been going on for 4-6 months. Irrespective of the actions of its members, (including 180solutions) LinkShare and Commission Junction benefit financially from such transactions.

Additionally, Wayne Porter (and other insiders I have spoken with) believe that the affilate marketing companies now generate significant revenues from "loyaltyware", which gives purchasers cash-back or some other form of reward for online purchases. But loyaltyware itself exposes the affiliate companies to two risks.

1. Some loyaltyware is installed through some of the same questionable methods that Spitzer is suing Intermix for.
2. Some loyaltyware is open to the same accusation that merchants are unfairly billed for commissions. For example, if someone goes to a vendor's site, selects a product, and prior to the purchase fires-up a loyaltyware program to earn points or cash-back, the vendor might pay an affiliate commission even when the user did not arrive at the site via an affiliate link.

To summarise: it seems the affiliate networks' greatest potential exposure is from litigation from their merchant customers, on the basis that the affiliate networks defrauded the merchants of significant dollar amounts of merchant commissions by allowing Adware and Spyware vendors into their affiliate networks.

Meanwhile, I'd welcome comments and clarification on the loyaltyware issue: how much of a problem is it, and what is Commission Junctions (VCLK) and LinkShare's (ICGE) exposure to it?

Full disclosure: at the time of writing I'm short VCLK.