Netflix Owes $9 Million for Being Nosy for a Bit Too Long

Netflix CEO Reed Hastings
Netflix CEO Reed Hastings

Netflix (NFLX) can't seem to say goodbye -- and now it's paying the price for its inability to move on.

The country's leading video service will be shelling out $9 million to settle a class-action privacy lawsuit that accused Netflix of retaining customer information of canceled subscribers for longer than the Video Privacy Protection Act allows.

Like a scorned ex, Netflix never got around to destroying all of the old love letters.

Active Netflix subscribers -- and there are more than 26 million worldwide -- generally love the service's prying ways.

The Netflix recommendations engine uses a video buff's rental history and the movie and TV show ratings that they have provided to serve up timely selections.

Netflix's data-chomping ways helped it stand out years ago from the local video stores that would send renters listlessly down long aisles grouped by category. Netflix's online database excels at making timely recommendations by suggesting titles that others with similar viewing and rating patterns have gone on to enjoy.

The problem arises after users decide to leave the service.

Netflix likes to keep old data around. It allows the company to reach out to former subscribers, and those who do return probably appreciate that they don't have to start rating movies from scratch to receive proven movie picks.

The rub? Holding on to that data for too long -- under current law -- is illegal.

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Information Is King

Speaking at a JPMorgan conference two weeks ago, CFO David Wells revealed that a third of the company's new subscribers are users rejoining the service after canceling over the past year. In other words, leaving Netflix is often a temporary move.

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The Video Privacy Protection Act requires video rental services to destroy personal information -- and decouple submitted data from users -- "as soon as practicable" but no later than a year after the information collection is deemed necessary. The lawsuit alleged that Netflix was keeping renter records around for at least two years after nixing the service.

Netflix has been trying to get the privacy act overruled as archaic.

In spirit, Netflix is probably right. The law got its roots in 1988 when the movie rental history of a Supreme Court nominee was made public. Asking video rental companies to destroy unnecessary records was more about protecting civil liberties than what Netflix is trying to accomplish here. Netflix isn't going to tell anybody if Obama or Romney rented Pineapple Express.

Then again, it's not as if Netflix took things lying down before conceding defeat in a settlement that was initially revealed in February before a filing late last week offered up more details.

The former dot-com darling publicly backed House bill H.R. 2471 that would have overruled the Video Privacy Protection Act. At the time, Netflix framed it in terms of limiting opt-in sharing on Facebook (FB). Netflix lets subscribers in every country it offers its streaming service -- except the United States -- automatically share their Netflix views with their family members and friends if they want to. It can't offer that particular feature stateside. The Video Privacy Protection Act prohibits that from happening.

Scorned Subscriber? Sorry, No Dough for You

If you've ever canceled Netflix, don't wait up for a settlement check. As the terms stand now, only the users named in the original complaint will be receiving money -- and only $30,000. The lion's share of the settlement -- $6.75 million -- will go to privacy advocate organizations. Lawyers will snap up the other $2.25 million.

Things can always change between now and late June when the preliminary settlement is approved. However, even under the scenario where U.S. District Court Judge Edward Davila alters the settlement to reward some of that to the actual Netflix users, ex-Netflix customers won't be getting much.

There have been so many people who have canceled Netflix over the years -- millions in any given quarter -- that even a revised settlement amount that compensates the actual victims will be minimal after it's divided. The award may also come in the form of Netflix credit, and not actual pocket change.

Data has always been one of Netflix's greatest advantages, but this time it was a dagger.

Motley Fool contributor Rick Munarriz does own shares in Netflix. The Motley Fool owns shares of Netflix and Facebook. Motley Fool newsletter services have recommended buying shares of Netflix.

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