Litigation Alert: Third Circuit Permits Federal Trade Commission to Bring Unfair Practice Claim Based on Cybersecurity Practices

In a closely-watched cybersecurity case, a three-judge panel of the U.S. Court of Appeals for the Third Circuit held in Federal Trade Commission v. Wyndham Worldwide Corporation (No. 14-3514) that the Federal Trade Commission (“FTC”) may bring a claim that a company’s data security practices, or alleged lack thereof, are “unfair” business practices in violation of Section 5 of the Federal Trade Commission Act, even in the absence of formal rulemaking. While the facts in Wyndham fall at one end of the spectrum, and the panel did acknowledge the possibility of “borderline” scenarios, the opinion demonstrates that companies that fail to take action in response to known cybersecurity holes that they could reasonably foresee leading to the loss of sensitive consumer information do so at their peril.

The Federal Trade Commission Act, 15 U.S.C. § 41, et seq. (the “FTCA”) confers authority to the FTC to bring enforcement actions against a person or entity, either in U.S. district courts or in administrative proceedings before the FTC, to prevent “[u]nfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce,” § 45(a) (emphasis added). Whether a practice is unfair is informed by the balance of factors set forth in § 45(n), which are whether it “causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition.” Prior to bringing its case against Wyndham, the FTC had brought enforcement actions concerning a company’s allegedly deficient cybersecurity practices under the “deceptive” prong of Section 5 of the FTCA, or it had reached non-litigated consent agreements with the targeted companies, in which the respondents had not admitted liability. Wyndham marks the first cybersecurity case the FTC has brought in federal court under Section 5’s “unfair” prong to be litigated.

The claims against the hotel brand were prompted by three successful hacks into Wyndham Worldwide Corporation’s computer network, which are alleged to have resulted in at least $10.6 million in losses associated with fraud from payment information of over 619,000 customers. In 2008, hackers broke into a local network of a Wyndham-branded hotel and were then able to access an administrator account on the corporate network by guessing IDs and passwords. A year later, in 2009, hackers accessed Wyndham’s network through an administrative account, and their access allegedly went undetected by the company for two months. Later that year, hackers again accessed an administrator account and used it to access servers of other Wyndham-branded hotels.

The FTC’s complaint alleges that Wyndham engaged in a litany of lax data security practices that, in sum, placed their customers’ sensitive information at an unreasonable risk. These alleged shortcomings include: storing of payment information in clear readable text; use of easily guessed or default login credentials by personnel; failing to use firewalls or security measures to control access between each hotel’s system, the corporate network, and the internet; allowing hotels to connect to the corporate network without security policies or precautions; allowing hotels to use outdated operating systems that had not received security patches, failing to adequately restrict access to its network by third-party vendors; failing to use detection or prevention measures for unauthorized access; and failing to monitor its network for methods, such as malware, used in previous intrusions. The FTC also alleges that Wyndham’s privacy policy, which is published on its website, deceptively overstates the company’s cybersecurity practices.

In August 2012, Wyndham moved to dismiss the FTC’s complaint, arguing that the FTC did not have the authority to bring enforcement actions against companies for allegedly unfair data security practices. The district court denied Wyndham’s motion, finding that the FTC has “unfairness authority” over data security practices, and rejecting the contention that the agency is first required to issue formal rules and regulations. While the district court cautioned that its “decision does not give the FTC a blank check to sustain a lawsuit against every business that has been hacked,” it found the FTC’s allegations against Wyndham sufficient to sustain the unfairness and deception claims. Only the unfairness claim was certified for interlocutory appeal and considered by the Third Circuit.

The Third Circuit first rejected Wyndham’s arguments that its alleged conduct cannot be deemed “unfair” under the statute. In doing so, it held that the FTC’s allegations regarding Wyndham’s poor security practices were sufficient to state a claim for unfairness under the statutory factors set forth in § 45(n). The Court also rejected several additional requirements for unfairness proposed by Wyndham, including arguments that the practice must involve “unscrupulous or unethical behavior” or be “marked by injustice, partiality, or deception.” Noting that the “deceptive” and “unfair” prongs often overlap, the court referenced the Wyndham’s public facing privacy policy, finding “[a] company does not act equitably when it publishes a privacy policy to attract customers who are concerned about data privacy, fails to make good on that promise by investing inadequate resources in cybersecurity, exposes its unsuspecting customers to substantial financial injury, and retains the profits of their business.” Finally, the court rejected Wyndham’s argument that it could not have acted unfairly where Wyndham, itself, was the victim of criminal action by hackers.

The Court also rejected Wyndham’s constitutional due process argument that the FTC failed to give fair notice of what specific cybersecurity standards were required, and in doing so, shed some light on what companies must do to avoid an FTC enforcement action in federal court. The Court considered whether Wyndham had fair notice of what the statute requires, rather than whether Wyndham had fair notice of the agency’s interpretation of the statute, which would have imposed a higher standard of what constitutes fair notice. The Court noted that the allegations did not concern “weak” cybersecurity practices, but rather lack of certain practices, and opined that after the second hack, “it should have been painfully clear” to Wyndham that a court could find that its practices fail the cost-benefit analysis under § 45(n). Perhaps of significance for future cases, the Court found that the FTC’s “expert views”—including, a published guidebook and other complaints filed by the FTC for inadequate cybersecurity practices—could inform a corporation’s assessment of what is required to avoid liability, even if those guidelines were not formal rulemaking.

The actual allegations against Wyndham are yet to be adjudicated on the merits, but the Third Circuit’s decision may encourage the FTC to push the boundaries of alleged “unfair” practices with respect to cybersecurity practices. While the decision only governs in the Third Circuit, given the incorporation of many companies in Delaware, the decision may invite the FTC to pursue additional suits in that forum.