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updated 3/12/2010 7:26:47 PM ET 2010-03-13T00:26:47

DVD-by-mail service Netflix has canceled a sequel to a $1 million movie-recommendation contest, avoiding a potential courtroom drama over the privacy rights of its subscribers.

The retreat announced Friday settles a lawsuit alleging Netflix's plans to release millions of movie-rental records that could have illegally exposed sensitive information about its subscribers' tastes and lifestyles.

The Federal Trade Commission also had raised questions about the company's ability to protect customers' privacy, Netflix disclosed Friday.

FTC spokeswoman Claudia Bourne Farrell declined to comment.

Netflix intended to release the movie records without any names or other personal information attached to the data, but critics contended that the protections wouldn't be enough to guarantee anonymity.

Those arguments were supported by two University of Texas researchers who said they were able to sift through data that Netflix released in its first movie-picking contest to identify certain people who rated movies.

The class-action lawsuit filed in a San Jose federal court had also alleged Netflix's first contest, which ran from October 2006 through August 2009, had violated a federal law prohibiting video rental firms from publicly sharing their customers' movie preferences.

Netflix released the data about its subscribers' movie ratings in an effort to improve its DVD-recommendation system by at least 10 percent. The offer of a $1 million prize attracted more than 51,000 contestants and generated a steady stream of free publicity for the company, based in Los Gatos, Calif.

A seven-member group of researchers, scientists and engineers prevailed in the competition and picked up their award at a September news conference where Netflix promised another contest that would help it do an even better job of recommending DVDs to its 12.3 million subscribers.

Netflix canceled the contest without every quantifying what the follow-up prize would be.

The company still hopes to work with researchers on ways to do a better job of identifying movies that people would enjoy watching, Neil Hunt, Netflix's chief product officer, wrote in a Friday blog posting.

There's nothing in the lawsuit settlement preventing Netflix from turning to outsiders for help in developing better technology as long as there are adequate safeguards on privacy, said Scott Kamber, a New York attorney who filed the class-action complaint.

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