We’ve seen this movie before. Highly regulated industry gets disrupted by a tech-based startup that derives much of its advantage over its old-school peers by simply ignoring the regulations its boring rivals slavishly follow. Airbnb provides hotel rooms without irritating details like “zoning” or “hotel taxes.” Uber (UBER) doesn’t love all these old-fashioned niceties like “insurance” and providing rides to the “disabled” so they mostly ignore them—boom, $50 billion valuation.
It looks as though we’re starting to see the same pattern emerge in the sky.
Wheels Up is a private aviation startup based in New York. Its “revolutionary membership model” claims to “significantly reduce the cost of flying privately while providing unparalleled flexibility and service,” and the firm has raised millions in funding rounds joined by the likes of T. Rowe Price. Entrepreneur magazine recently dubbed its founder, Kenny Dichter, “the Kevin Bacon of Entrepreneurship,” because of his extensive contacts to previous startups. With his buddy Jesse Itzler, he co-founded Marquis Jets, the prepaid flight card, which he sold to Berkshire Hathaway’s NetJets division. He and Itzler had previously co-founded Alphabet City Sports Records. Mr. Dichter has enjoyed success outside of air travel, too, as he’s been involved in organic foods via his startup Juice Press (in an email, Mr. Dichter advised me to cope with my pernicious winter cold: “Drink lots of green juice & flush the flu out”) as well as the “world’s best-tasting tequila,” Tequila Avion.
Wheels Up has just over 2,100 members, who are entitled to fly with 24-hour advanced notice on the company’s fleet of 40 King Air turboprops and 15 Citation Excels/XLS business jets. A membership costs $17,500 for the first year and then $8,500 a year to renew.
Last week, Wheels Up launched a different sort of travel option—public charter flights they’re marketing as “Hot Flights” and/or “Shared Flights” via their new app 8760, in partnership with Apollo Jets, a luxury charter broker. A membership costs only $5,950 a year and entitles users to be part of ad hoc groups that sign up and comprise a group big enough for Wheels Up to secure a plane. These are scheduled flights on aircrafts that carry under 30 passengers. The rub is they don’t appear to be registered with the FAA, as all flights that can be purchased like this are required to be.
The Observer carefully inspected the Department of Transportation’s website. If one searches “Charter Reports for 2015” and “Charter Reports for 2016,” Wheels Up and its partner Apollo Jets are nowhere to be found.
Many others are listed. For example, a company called PrimeSport chartered a Southwest Airlines 737 to Phoenix on January 9 and 12 to bring college football fans back and forth to the championship game between Alabama vs. Clemson. A company called Cuba Travel Services is planning a trip for 50 from Miami to Havana on March 16. It’s boring stuff, but that’s the kind of thing a company has to pay people to stay on top of—and it’s just one of the reasons air travel, one of the most highly regulated businesses imaginable, costs so much.
So where are Wheels Up’s flights?
Mr. Dichter told the Observer that his company is exempt. “Neither the Hot Flights nor the shared flight opportunities are being flown under DOT Regulation 14 CFR 380. All of these flights are being flown as FAR Part 135 on-demand operations, all operated by FAA-certified and DOT-registered air carriers.”
How’s that?
“The simplest answer to your question about offering seats is that no seats are being offered or sold in the Hot Flights or the Shared Flight opportunities,” countered Mr. Dichter. “The Hot Flights opportunities are only available for booking and purchase as whole aircraft, which means a person who books a Hot Flight is taking the entire aircraft.”
“For Shared Flight opportunities, here too, there are no booked flights being offered and no seats being sold.” And then the hard sell: “Shared Flights are member-aggregated, meaning our members propose flights for sharing to the membership, self-aggregate, agree amongst themselves to a sharing of the costs and then book the flights based on the specifics agreed amongst all the passengers sharing a flight. Wheels Up does not play an active role in the formation of the groups traveling together, the selection of any points of arrival or departure or the dates or times for flights that are proposed. Wheels Up merely facilitates through its Member App the ability of members to find one another and arrange for the shared transportation.”
Got that? Wheels Up “merely facilitates.” Just like Uber doesn’t drive you; it merely facilitates the passenger meeting the independent contractor who drives you. Passengers might feel like they’re “in an Uber,” but they’re in some car owned by some guy—Uber just made the shiddich. And just to make sure one gets the point, Mr. Dichter reminded the Observer, “Wheels Up is not an operator for the flights arranged by or through Wheels Up and that FAA-licensed and DOT-registered air carriers exercise full operational control of the aircraft.”
‘There are millions of people who can afford $5,950 a year. It’s like belonging to a yacht club without needing a yacht.’—Kenny Dichter, CEO, Wheels Up
According to Part 380 of the U.S. Department of Transportation’s (DOT) regulations (14 CFR 380), “All persons who wish to arrange public charter flights are required to first submit a charter prospectus to the Special Authorities Division with the required information about the proposed charter program.” In other words, firms are required to register these flights with the FAA in order to be insured and for safety reasons having to do both with aircraft maintenance and Transportation Security Administration-type screening.
In much the same way that hedge funds are restricted to so-called “qualified investors,” and thus face fewer restrictions on their investments than, say, ordinary mutual funds, the idea for private charter brokers is that a passenger who has $40,000 to drop on a seat from New York to Los Angeles is a big boy and can assess risk. But this new service—charter flights open to the public on what anyone would think of as aircraft that look and feel like private planes—is literally uncharted territory.
Is it even legal to offer a seat to the public on a plane that appears to be private and whose flight is not registered with the FAA? Maybe. Jeff Wieand, the senior vice president of Boston JetSearch, Inc. and a columnist on Taxes, Laws, and Finance at Business Jet Traveler, told the Observer that he believes “Wheels Up doesn’t qualify as public charter because they don’t fill seats to predetermined destinations. As far as I understand it, they are just a regular charter operator [using GAMA’s certificate], or perhaps more accurately, a charter broker who happens to own the aircraft.” In other words, his opinion is that there’s nothing wrong with the service they’re offering.
But that view is not universally held.
Part of the problem here is that it’s not 100% clear what the law is. Wheels Up’s lawyers think they’re doing is perfectly fine. Not surprisingly, their competitors do not. David M. Kirstein is one of the foremost expert in the arcane field of private aviation law, having served as General Counsel of the Civil Aeronautics Board (CAB) and Majority Counsel to the Aviation Subcommittee of the U.S. Senate Committee on Commerce. He does not represent Wheels Up or its competitors. And he thinks it’s probably not legal. And he expects the DOT to act soon.
“You’re talking mainly about empty leg or repositioning charter,” Mr. Kirstein told the Observer in an extensive interview. “When a plane needs to get from Chicago to New York to pick up a regular party that paid to fly from New York to wherever. Rather than flying empty from Chicago to New York, the app finds people who want to fly that route and sells it to them as Part 135 demand operators. That means they don’t have authority to operate any kind of scheduled aircraft.” The problem is that the 8760 app, as judged by Mr. Kirstein, at least, quacks like a scheduled aircraft, even if they carefully decline to call it that.
“Why is it scheduled? Because it’s giving a departure point, an arrival point and a specific time of when the eflight is going to depart. Once the FAA and the DOT view something as scheduled you have to be at a much higher level of regulatory supervision. You have to be a Part 121 Carrier under FAA regulations. If they’re holding it out as a public charter to anyone who becomes a member of their club, it may or may not be legal. Since they’re holding out specific departure destination and time, they wouldn’t be able to unless they comply with the public charter rules.”
So why is the DOT allowing it?
“My understanding is that they should have to file as a public charter. There are others who are doing that. And if they are a public charter then the passenger gets all kinds of protections, such as that they’re actually going to fly and if they don’t fly they get their money back. The fact that the DOT hasn’t done anything yet doesn’t mean that they won’t. They have a certain number of staff and a lot to deal with but they might take issue next week or next month. If they keep what they’re doing, I expect there will be an action.”
The marketing of “empty legs” is not new for private air travel. The FAA put the kabosh on it in 2007 and the National Air Transportation Association said its members would suspend the practice, according to an October 2007 Aviation Today story.
The Observer has also obtained a letter that the Rebecca MacPherson, the FAA’s Assistant Chief Counsel for Regulations, sent to Patton Boggs, regarding its client Windsor Jet Management. The letter makes it pretty clear that the private jets may not offer a specific time of departure, and also may not offer even a window, which seems to be the strategy 8760 is using to avoid the restrictions on scheduled flights. The FAA letter, dated March 1, 2010, says “If Windsor were to offer in advance the following three elements- the departure location, the departure time, and the arrival location – then its proposed operations would be scheduled operations. … Regarding the departure time, you state that Windsor would not advertise any precise departure time. You do not state, however, whether Windsor would offer a departure window – e.g., from 1:30 p.m. to 2 p.m. – and if so, how large the window would be. As indicated in a previous interpretation of the regulations, the smaller the departure window, the more it would appear that the air carrier is offering in advance the departure time. ”
Public charter flights are essentially private flights that can be shared by up to 30 people. There are a few important differences between these public charter flights and regular on-demand private flights. First, the charter operator, usually a third party, sets the origin and destination of the flight and dictates the departure time, rather than the traveler. Second, while on-demand flights are booked on a plane-load basis—meaning that one person or entity books the whole plane—public charters are offered to the consumers on a per-seat basis. That means that each flight can be occupied by people who are strangers to one another. Lastly, unlike a regular on-demand charter transaction that involves a buyer, an operator, and sometimes a broker, a public charter involves an additional party, a charter operator, who collects money for the flights and acts as a principal in arranging the transportation.
Due to these differences, public charter flights are thought to be subject to higher oversight because the DOT needs to ensure that the rights of the individual passengers are protected. These public charter regulations can be found in a document titled 14 CFR Part 380 that, among other things, outlines in detail the cancellation policies of public charter flights, provides for extensive financial protections for the passengers, and outlines requirements for advertising of the flights. According to that regulation, all public charter flights must be filed with the DOT prior to offering such flights for sale to the public. The regulation also provides strict guidelines that operators and brokers have to meet, such as posting a bond for all flights to ensure that passengers will have recourse in the event a public charter operator goes out of business after fares have been paid but before the trip has taken place.
Wheels Up and Apollo Jets, unsurprisingly, market their service as “democratizing” private travel, rather than sidestepping regulations.
Mr. Dietrich told the Observer, “The business we’re working on with Apollo, [the 8760 Club], there’s 25,000 people we’ve projected who can join and it doesn’t have to be a private flyer in the way that private flyers were traditionally defined. In the way Uber set out to disrupt the black car service, but the market is 10 times larger than the original black car market. Our membership for 8760 is $5,950 a year and if you times that by 25,000 you have a pretty healthy number. There are millions of people who can afford $5,950 a year. It’s like belonging to a yacht club without needing a yacht.”
In fact, Wheels Up recently inked a deal to market its subscription to Costco members—the ultimate high-low marketing coup as a $17,500 subscription is marketed to 81 million people trying to save 50 cents on a prison-sized box of Cheerios.
The high profiles of Apollo and Wheels Up’s CEOs are actually a marketing lure of the app and its service. A recent subscription application obtained by the Observer shows that the CEOs of both companies actually countersign the subscription agreement.
Apollo is the brainchild of Al Palagonia, a larger-than-life figure who dreamed up the idea of flying professional athletes around as a lure for rich people who are so sad and lonely that they need to be seen in the company of professional athletes. Yeah, that’s the business plan. He told Bloomberg Businessweek in 2012, “My entire business model revolves around sports. I do business with a lot of athletes. Then you have the big wealthy business guy, spending half a million a year on front-row seats. He doesn’t have any access to the players. But I do.”
And it worked. Apollo became “one of the industry’s fastest-growing jet brokers.”
But this is where the story gets even murkier. Apollo is basically a broker of private charter flights. It owns no planes of its own and simply rents planes from owners who are not using them. There are dozens of brokers like Apollo and they are lightly regulated. The Businessweek article quotes James Wynbrandt, a prolific author on private travel and the author of a book about JetBlue founder David Neeleman, as saying, “All you need is a computer and a cell phone to become a private jet charter broker.”
Before becoming a flight broker, Mr. Palagonia was a stock broker legendary for the hours he’d spend on the phone pushing stocks.
In a less-than-generous January 2000 write-up of the underrated movie Boiler Room in the Observer, Nick Paumgarten describes Mr. Palagonia, who sold stock for the now-defunct D.H. Blair, as “The biggest legend of the bucket-shop world.” A former colleague of Mr. Palagonia said, “Al would run the morning meeting, kind of like Ben Affleck in the movie. He’d play the Rocky theme, just trying to get everyone all pumped up to get on the phones.”
According to the article, in 1997, Mr. Palagonia’s “hard-sell tactics got him sanctioned and fined by securities regulators. He was banned from the industry. (His basketball team was also banned from a West Side night league, after they started a brawl.)”
Shortly after the January 2000 Observer article, Mr. Palagonia’s legal troubles worsened. On March 2, 2000, the so-called “Bucket Shop King,” already banned from the industry, was indicted for his role in a pump-and-dump scheme hatched by members of New York’s Gambino and Colombo families. According to Born to Steal, Gary Weiss’ account of “When the Mafia Hit Wall Street,” Mr. Palagonia was indicted for his role at State Street brokers in a scheme to plump up the price of chicken restaurant Chic-Chick (casual dining stocks were in fashion in the wake of Boston Chicken’s hot IPO). Mr. Palagonia found his name before the Second Circuit, along with guys like Stevie “Two Guns” Ernest, “Butch” Montevecchi, Frank Coppa, Rocco Basile and Giuseppe “Joe” Temperino. These were serious guys with intimidating nicknames.
The companies are selling a lifestyle as much as a mode of getting from point A to point B.
Mr. Palagonia pleaded guilty to securities fraud and enterprise corruption and spent 24 months in prison. He does not try to disguise his past and discusses it frankly with reporters. As a rule, the Observer does not hold a youthful mistake against someone who has repented and been punished.
Along the way, Mr. Palagonia had befriended Spike Lee and Woody Allen through their shared love of the Knicks—Mr. Palagonia makes cameo appearances in Chiraq and Blue Jasmine and had his most notable role as the sleazy agent Dom Pagnotti in Mr. Lee’s He Got Game. He’s actually an excellent actor and you can see his sales chops in action as he tries to get Jesus Shuttlesworth to sign a contract to skip college basketball and head straight for the pros. “Gold? Forget about it. Silver? Forget about it. You have platinum and diamonds. That’s like having speed and power in the NBA.” (That character has gone on to star in the video game NBA2K16.)
After serving his sentence, Mr. Palagonia went to Halcyon Jets to learn the private jet brokerage business and discovered that prison hadn’t deprived him of the ability, as Boiler Room memorably put it, to “sell bubble gum in the lock-jaw ward in Bellevue.” A year later, he founded Apollo and was soon whisking Shaquille O’Neal and Michael Jordan around the country, along with the businessmen desperate to tell their friends they’d just flown with greatness.
The companies are selling a lifestyle as much as a mode of getting from here to there. The Wheels Up testimonial page shows people like dishy Fox broadcaster Erin Andrews and official Friend of Kenny, Entourage creator Doug Ellin (and his awesome giant-eared dog), touting the company’s virtues. Observer columnist Richard Kirshenbaum, who is also close to Mr. Dichter, even gets a turn at the mic, noting with a perfectly straight face that “since the King Air 350i lets our team access shorter runways and more remote locations, we can land closer to our clients and make all the meetings on time.” The convenience of relatively affordable private air travel, and all the access and prestige it promises, is seductive, no doubt about it.
Meanwhile, the pathetic grovel of the sports hanger-on continues to factor prominently in the marketing of both companies. Yesterday, Wheels Up congratulated its member, Golden State Warrior Klay Thompson, for an important achievement—”winning the NBA’s “3 Point Contest!” A day earlier, golfer and “#WheelsUp Member and Ambassador Bernhard Langer” was patted on the back for victory at the Chubb Classic. And a few days before that, fans were treated to an adorable video of Seahawks quarterback Russell Wilson “in a ‘huddle’ with Kenny Dichter and the #WheelsUp team.” The post was titled “No pain, no plane!”
“It’s not just about sports stars, it’s about winners,” the charming and likable Mr. Dichter told the Observer in an interview. “Live sports and the male demographic—the millennial male and males that act like millennials—when you look at who you market to, we’re not focused on athletes or entertainers, we’re focused on winners. One of our biggest coups this year was American Pharoah. Our focus on the jockey and the horse itself. We had Wheels Up on the silks. Or look at Erin Andrews. She uses Wheels Up to get from the sidelines to the ballroom. You know, working women.” Uh huh. Working women. The sports tip is not new to Mr. Dichter. The record label he co-founded with his Marquis Jets buddy Itzler specialized in arena mixes of “rev the crowd up” songs; Mr. Itzler later became a co-owner of the NBA’s Atlanta Hawks.
Meanwhile, Mr. Palagonia said he has learned a lot since his missteps more than a decade ago. He shared his wisdom with the Observer in a phone interview. “This is not a sales business, it’s a service industry. The great salesmen in this business don’t make it. You have to be willing to be at the airport when the guy lands and wake up at three in the morning when someone needs an emergency flight. And you gotta be willing to back up a plane when you have a mechanical issue even when you’re going to lose $40,000. So many people who left Wall Street can’t make it in this business because they get confused between selling and servicing.”
As Uber and Airbnb have shown with the occasional driver rapist or dangerous rooms, there are consumer perils for those who want all the benefits of low-friction transactions, but without all the protections these heavily regulated industries presumably deliver.
Another example comes in the realm of the highly regulated employee benefit bureaucracy. Buzzfeed reporter William Alden seems to have made it his full-time job to prove that San Francisco valuation darling Zenefits is essentially a scam. And last week, he kind of did. The firm seems to have written a program that allowed its insurance brokers in California to appear to be getting mandatory training that they hadn’t in fact received. Zenefits then instructed them to affirm, under the penalty of perjury, that they had done so. Buzzfeed also reported that 83 percent of the policies sold by Zenefits in another state, Washington, were handled by unlicensed brokers.
Zenefits dumped its shlumpy founder and CEO Parker Conrad, but it’s an open question how hard it will be to unravel the deals sold by unlicensed or improperly trained brokers. The company’s meteoric growth—six months before these revelations, Zenefits had raised $500 million, which gave the company a valuation of $4.5 billion—had attracted the eye of gold-plated investors including Andreessen Horowitz, Ashton Kutcher’s Sound Ventures and Khosla Ventures.
These are very smart investors pouring money into untested, inexperienced companies on the notion that the Internet will allow a rascally, energetic company to fundamentally alter the way a product is delivered. That’s why Netflix has a market cap of $36 billion and Blockbuster essentially no longer exists.
One private air executive who requested anonymity told the Observer that the comparisons to Uber are not quite apt. “The FAA and the DOT are a lot tougher than the taxi commission of this or that city. All of the folks that are playing in this world are very cognizant of the FAA and DOT.” He recounted an example of regulators recently cracking down. “People who owned airplanes in Part 91 started a service like Lyft—people were giving people rides. They were advertising it. And the FAA shut the whole thing down. Part 135 and 380 are there to protect people and when people get out of line in our business it’s not like Airbnb and Uber, where they can just grind the regulators out.”
From an investment point of view, it’s not yet clear that what worked for home-movie viewing will necessarily work for highly regulated businesses, especially those in which regulations protect lives. If Netflix fails to abide paragraph 55 subsection B12, maybe my screen goes dark during Columbo. But if Wheels Up ignores a regulation buried in the million-page book that governs air travel, maybe the door of the plane flies open mid flight. The stakes are different.
The door flying open isn’t the only incident Wheels Up has experienced. Myron Yoder, an independent contract pilot in Fort Wayne, Ind., described an incident that occurred when he was the chief flight instructor at an Indiana flight school called Sweet Aviation. Mr. Yoder was “walking around our airplane at FWA [Fort Wayne Airport] just now when Wheels Up King Air just blasted me and my customer [and his airplane] by parking and doing the engine check facing directly away from us. Rocks and sand hit us so hard it actually stung. The ramp is huge and they had all sorts of good options for pre-taxi parking. Wow. Rarely do I see such bad decision making on the ramp.”
Mr. Yoder told the Observer that it wasn’t a matter of Wheels Up violating any laws or rules, more like a protocol breach. “Propellers are like huge fans. They have to blow air behind the airplane in order to move the airplane forward. These guys parked so that the rocks and air and everything was blown toward us. There is no manual saying that they did anything wrong, it was just them not thinking about how they were affecting the other aircraft.”
For its part, Wheels Up insists that it places a high premium on safety. Mr. Dichter told the Observer, “Safety is our No. 1 thing. The first person we hired was Netjets director of safety Dave Hewitt,” who serves as the chairman of the Air Charter Safety Foundation and is himself an experienced pilot.
Even as the government figures out its regulatory role, the appeal of the convenience and the lifestyle isn’t likely to fade. “Our ambassador stuff isn’t just about the ads or the TV spots. We had an ambassador event in San Francisco where we had Bobby Weir for the 50th anniversary of the Super Bowl and the 50th anniversary of the Grateful Dead and he did a six-song set for our members. One thing about all of these folks is that time is something they can’t buy. If you can get people from A to B to C in a day and be a utility for them, that’s where Wheels Up wants to be.”
Meanwhile, Mr. Palagonia remains a peerless dealmaker. He told me, using that voice mixture of charm and threat that has made Dom Pagnotti a video game star, that if he likes the way this article comes out he’s got two tickets to Spike Lee’s next premiere for me.
