The Third Circuit recently issued its highly anticipated ruling in the Federal Trade Commission v. Wyndham Worldwide Corp., Case. No. 14-3514, holding that the FTC has authority to regulate the cybersecurity practices of companies under the “unfair” prong of section 5 of the FTC Act. In a ruling that is likely to frustrate companies, the court held that Wyndham was "not entitled to know with ascertainable certainty the cybersecurity standards by which the FTC expected it to conform." Which means that companies must not only consider the many laws, rules and regulations that impact data privacy and security but also attempt to anticipate regulators’ “state of mind” when creating and implementing cybersecurity programs. However, there are several “takeaways” from the recent ruling.

Background

Between 2008 and 2009, hackers accessed Wyndham’s systems on three separate occasions, stealing the personal and financial information for hundreds of thousands of consumers, leading to more than $10.6 million in fraudulent charges. In the wake of these breaches, the FTC filed suit against Wyndham and related subsidiaries under the caption FTC v. Wyndham Worldwide Corp., Case. No. 13-cv-01887, which was eventually venued in the U.S. District Court for the District of New Jersey. The complaint alleged that Wyndham’s lax cybersecurity policies constituted unfair business practices and that the company’s privacy policy was deceptive in violation of the FTC’s prohibition on “unfair or deceptive acts or practices in or affecting commerce” as codified in 15 U.S.C. § 45(a).

The FTC alleged that the following, “taken together, unreasonably and unnecessarily exposed consumers’ personal data to unauthorized access and theft.” Specifically, Wyndham:

  • Allowed its hotels to store payment card information in clear, readable text.
  • Allowed the use of simple passwords to remotely access hotel systems.
  • Failed to use readily available security measures, such as firewalls, to limit access to hotels’ systems, the corporate network and the Internet.
  • Allowed hotels to connect to its network without ensuring that the hotels had adequate information security policies and procedures, without ensuring the hotels had up-to-date operating system and security updates, and without maintaining an adequate inventory of computers connected to the Wyndham network to manage the devices.
  • Failed to adequately restrict the access, either in time or IP (Internet protocol) address, of third-party vendors to its network and the servers of its hotels.
  • Failed to employ reasonable measures to detect and prevent unauthorized access to its computer network or to conduct security investigations.
  • Failed to follow proper incident response procedures, such that although the hackers used similar methods in each attack, Wyndham failed to monitor its network for malware used in the previous intrusions.

Wyndham filed a motion to dismiss, arguing that the FTC did not have the authority to regulate cybersecurity under the unfairness prong of section 45(a) and that, even if it did, Wyndham did not have fair notice that its specific cybersecurity practices could fall short of that provision. The District Court denied the motion in its entirety.

On appeal, Wyndham argued three major points:

  • The alleged conduct falls outside the plain meaning of “unfair.”
  • Legislative history shows that cybersecurity is not covered by section 45(a).
  • Section 45(a) does not provide fair notice of the specific cybersecurity standards the company was required to follow, and thus violates due process.

The Third Circuit affirmed the lower court’s decision, issuing an extensive memorandum opinion.

The Third Circuit’s Rationale

Wyndham’s Argument that the Alleged Conduct Falls Outside the Plain Meaning of “Unfair”The Third Circuit began its analysis by discussing the FTC’s historical issuance of policy statements defining what could be regulated as an “unfair method of competition,” and the construction and treatment thereof by courts and Congress.

In 1994, Congress codified the FTC’s current policy statement on unfair competition in 15 USC § 45(n):

“The [Federal Trade Commission] shall have no authority under this section … to declare unlawful an act or practice on the grounds that such act or practice is unfair unless the act or practice 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. In determining whether an act or practice is unfair, the Commission may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations may not serve as a primary basis for such determination.”

Wyndham argued that while the three requirements found in section 45(n) (i.e., the harm causes or is likely to cause substantial injury to consumers, the practice is not reasonably avoidable by consumers, and the harm is not outweighed by countervailing benefits to consumers or competition) are necessary components of an “unfair practice,” alone they are not sufficient to trigger FTC regulation under section 45(a). The court was unmoved by Wyndham’s first proposal that an unfair practice must be unscrupulous or unethical, citing FTC v. Sperry & Hutchinson Co., 405 U.S. 233, 239–40 (1972), in which the Supreme Court specifically rejected that requirement. The court was similarly not persuaded by Wyndham’s argument that, per one dictionary definition of unfair, the practice must be “not equitable” or “marked by injustice, partiality, or deception” in order to be unfair. The court stated that “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 … exposes it [sic] unsuspecting customers to substantial financial injury, and retains the profits of their business.”

The court then discussed the interplay between the “reasonably avoidable” requirement and a finding of unfair conduct. The court adopted the FTC’s argument that consumers could not reasonably avoid the injury, i.e., Wyndham’s retention of consumers’ personal and financial information in an unsafe manner, because Wyndham had published a misleading privacy policy that overstated its cybersecurity measures. The court stated that even if the misleading privacy policy only partially satisfies the “reasonably avoidable” requirement, “then the policy is directly relevant to whether Wyndham’s conduct was unfair.”

Wyndham’s argument that a business “does not treat its customers in an ‘unfair’ manner when the business itself is victimized by criminals” was also unsuccessful. The court stated that section 45(n) expressly contemplates the possibility that conduct can be unfair before actual injury occurs, explaining that the unfairness did not arise from the compromise of the consumer information, but rather the deception leading to the consumer providing the information to Wyndham. The court further noted that just because Wyndham was not the most proximate cause of the fraudulent charges, that fact alone does not immunize Wyndham from liability for foreseeable harms. Wyndham did not argue that the attacks were unforeseeable.

On these bases, the court held that Wyndham’s alleged conduct did not fall outside of the meaning of “unfair.”

Wyndham’s Argument that Legislative History Excludes Cybersecurity from Regulation under Section 45(a)Wyndham argued that recent legislative acts – directing the FTC to develop regulations for the proper disposal of consumer data; to establish standards for financial institutions to protect consumers’ personal information; and to promulgate regulations requiring children’s websites to provide notice about the collection, use and disclosure of information – would be inexplicable if the FTC already had general authority over cybersecurity under section 45(a). The court found this argument unpersuasive, as legislative action must be incompatible with agency regulation for it to preclude agency involvement, which was not the case here.

Similarly unsuccessful was Wyndham’s argument that the FTC’s interpretation of section 45(a) is inconsistent with its repeated efforts to obtain from Congress “the very authority it purports to wield here,” which the court dismissed as lacking persuasive authority.

Wyndham’s Argument that Section 45(a) Does Not Provide Fair NoticeFocusing on the argument most frequently espoused by companies, Wyndham argued that it did not have “fair notice” of the cybersecurity standards it was required to follow. Where, as here, a court is tasked with interpreting a statute in the first instance without deferring to any agency interpretation of the statute, ordinary statutory construction applies. Thus the court framed the relevant question as “not whether Wyndham had fair notice of the FTC’s interpretation of the statute, but whether Wyndham had fair notice of what the statute itself requires.”

The court pointed out that the standards for fair notice are “especially lax” for civil statutes regulating economic activities. Under such statutes, “a party lacks fair notice when the relevant standard is so vague as to be no rule or standard at all.” The court stated that fair notice would be satisfied in this case so long as Wyndham “can reasonably foresee that a court could construe its conduct as falling within the meaning of the statute.”

While acknowledging that section 45 was “far from precise,” the court held that the statute provided sufficient notice that the “relevant inquiry here is a cost-benefit analysis … that considers a number of relevant factors, including the probability and expected size of reasonably unavoidable harms to consumers given a certain level of cybersecurity and the costs to consumers that would arise from investment in stronger cybersecurity.” The court stated that “[a]t least after the second attack it should have been painfully clear to Wyndham that a court could find its conduct failed the cost-benefit analysis,” particularly in light of the fact that an FTC guidebook on sound data security practices and numerous FTC complaints and consent decrees related to corporate cybersecurity had been published prior to the attacks.

Analysis

The Third Circuit’s decision clarifies that the FTC has the authority to regulate consumer-facing corporate cybersecurity measures, without regard for whether a breach has occurred. Unlike many other cyber-related regulations, however, section 45 does not provide metrics by which organizations can measure their compliance. The court even conceded that focusing on the consent orders was “of little use … in trying to understand the specific requirements imposed by §45(a).” However, a company would be advised to examine cybersecurity-related FTC complaints, determine the alleged acts that triggered the FTC complaint, draw analogies to its own cybersecurity practices, and analyze whether it conducts itself in a similar or analogous way such that the organization is at risk for litigation under section 45(a). This case being the first of its kind, organizations should be advised to review the list of Wyndham’s alleged bad acts above and ensure that it is not – at a minimum – committing the same sins.

To help mitigate the somewhat uncertain environment this decision has created, organizations are advised to have an up-to-date information governance plan, review published privacy policies against actual cybersecurity measures in place, continually test their systems, and have and test an incident response plan that includes remediation measures in the event their systems are compromised. And if their systems are breached, organizations should implement – and document – the remediation steps taken to prevent a similar event in the future. While specific cybersecurity requirements under section 45(a) may be unclear, one thing is certain: ignoring obligations to protect consumers’ information may land an organization in the crosshairs of the FTC.