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The California legislature made headlines on June 28 when it passed—and the Governor signed—AB 375, a sweeping new data privacy bill known as the “California Consumer Privacy Act.” As further described in our colleagues’ report, the Act grants broad new privacy rights to customers of certain companies doing business in California.  In addition, the Act both provides for enforcement by the California Attorney General and creates a private right of action for some violations. Because of the latter feature, this new legislation may pave a new road to court for class actions in the wake of data breaches affecting California consumers.

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After much anticipation, the Third Circuit heard oral arguments (audio) last Tuesday in the interlocutory appeal in FTC v. Wyndham Worldwide Corp. We have written previously about this case, which likely will be a significant one in the privacy and data-security field. At issue is whether Section 5 of the FTC Act authorizes the FTC to regulate data security at all, as well as what constitutes “unfairness” in the data-security context. The case may have a large impact on future FTC enforcement actions and major implications for class action litigation.

But after all the build up, the panel of the Third Circuit hearing argument might change the script. Questioning by the judges (Thomas Ambro, Jane Roth, and Anthony Scirica) indicated that the panel was seriously considering a ruling that the FTC should have brought any unfairness claim in an FTC administrative action in the first instance (as it did in the LabMD action), not in federal district court. If that happens, we will have to wait even longer to learn whether the federal courts agree with the FTC’s views on the scope and contours of its unfairness authority in the data-security context.

Counsel for the FTC and for Wyndham spent large portions of the oral argument emphasizing the positions they had briefed. Wyndham’s counsel, for example, argued at length that negligence alone cannot satisfy an “unfairness” standard, that businesses had not received adequate notice of what triggers such liability, and that the FTC had not adequately alleged substantial injury. But the panel may not reach those issues. Instead, the court focused on the threshold question of whether the FTC had the authority in the first place to sue in federal court under Section 13(b) of the FTC Act. That section permits “the Commission [to] seek, and after proper proof, the court [to] issue, a permanent injunction,” but limits such relief to “proper cases.”

Is the Wyndham action a “proper case”? According to the FTC—which invoked decisions of the Ninth Circuit and the Seventh Circuit for support—it is “proper” to sue whenever the FTC alleges a violation of a law that the FTC enforces. For its part, Wyndham did not disagree, instead arguing that such a rule would have practical benefits—including that, in its view, the company would get a fairer shake in federal court than in an FTC administrative action. But the Third Circuit panel appeared to be unconvinced on this point, and focused instead on whether a case presenting novel and complex issues should first be brought in an administrative action. In fact, the panel asked the parties to provide supplemental briefing on the point.

It is always perilous to read the tea leaves after an oral argument. But it is an understatement to say that the Third Circuit’s panel was dropping some hints, especially by requesting further briefing on whether the FTC action belongs in federal court. There is therefore a substantial possibility that the court will send the action to the FTC for administrative adjudication in the first instance.

That result would serve to underscore a point we have made before—that post hoc litigation is a poor way to impose data-security standards. Litigation moves forward in fits and starts, and by its nature is unlikely to produce clear rules or standards in complex areas like data security. In short, it is an unpredictable and expensive method of forging broadly applicable standards. All stakeholders—both businesses and their consumers and employees—are likely to suffer from a lack of meaningful direction if data-security standards are generated via litigation. With the cyber threat continuing to grow—from garden-variety hackers to sophisticated operations that may be sponsored by foreign governments—consensus-based standard setting is far more likely to provide practical guidance for American businesses that seek to protect private information, intellectual property, and business-critical systems from the continuing cyber onslaught.

We have written previously about the FTC’s action arising out of the data breach suffered by the Wyndham hotel group, and the company’s petition for permission to pursue an interlocutory appeal regarding the FTC’s use of its “unfairness” jurisdiction to police data security standards. On Tuesday, the Third Circuit granted Wyndham’s petition. Even the FTC had agreed that the “the legal issues presented are ‘controlling question[s] of law,’ and they are undoubtedly important.”  Yesterday’s ruling promises that these questions soon will be considered by the Third Circuit.

We have written previously about FTC v. Wyndham Worldwide Corp., currently pending in federal district court in New Jersey, and its potential significance for data security class actions. A recent opinion in that case has brought it back into the news—and made clear that the stakes are as high as ever.

Over the FTC’s opposition, the district court certified an interlocutory appeal to the Third Circuit regarding its earlier denial of Wyndham’s motion to dismiss. Specifically, the district court certified two questions of law for appellate review: (1) whether the FTC has the authority under Section 5 of the FTC Act to pursue an unfairness claim involving data security; and (2) whether the FTC must formally promulgate regulations before bringing such an unfairness claim. Here is a copy of Wyndham’s petition to the Third Circuit to accept the certified appeal.

Already, 2014 has been an eventful year in the world of data breaches and cybersecurity. In addition to a flurry of litigation over high-profile breaches at the start of the year, the National Institute for Standards and Technology released its long-anticipated Cybersecurity Framework. The latest development is the recent decision in the closely-watched Wyndham case, in which a federal district court has just held that the Federal Trade Commission may use its “unfairness” authority under Section 5(a) of the FTC Act to enforce data-security standards. As a result, companies can expect the FTC to continue—and perhaps even expand—its efforts to regulate data-security standards through enforcement actions. And (as we have seen time and time again) where the FTC leads, the plaintiff’s bar often follows by filing class actions piggybacking on the agency’s allegations.

What happened in Wyndham?

The Wyndham action arose when a group of hackers allegedly penetrated the hospitality chain’s networks from 2008 to 2010, and compromised over a half-million payment card numbers. Already facing the substantial financial and reputational harm caused by the hackers’ crime, Wyndham next found itself facing a civil action filed by the FTC. In its initial and amended complaints, the FTC alleged that Wyndham had not maintained reasonable and appropriate data security measures. The agency claimed that Wyndham had engaged in (1) deception through alleged misrepresentations of the company’s data-security practices; and (2) “unfair” conduct based upon the harms allegedly suffered as a result of the purportedly unreasonable data-security practices.

Wyndham moved to dismiss the amended complaint, arguing, among other things, that the FTC’s “unfairness” authority does not extend to data security, that the FTC had failed to provide fair notice of what Section 5 of the FTC Act requires, and that Section 5 does not govern the security of payment card data. Wyndham—joined by a number of amici—pointed to the FTC’s lack of clear statutory authority, the continued legislative debates about data-security standards, and the FTC’s failure to establish standards through rulemaking as powerful reasons why the FTC lacked the authority to regulate data-security practices through Section 5 enforcement actions.

The district court was not persuaded. It concluded that more narrow data-security requirements enacted by Congress complemented, rather than precluded, the FTC’s assertion of authority under Section 5. The court also disagreed with defendants about the import of the ongoing legislative debates and prior statements by the FTC about the limits of its authority to regulate data security. The court thus declined “to carve out” what it understood to be “a data-security exception to the FTC’s authority.” The court likewise held that the FTC did not need to promulgate rules before exercising that authority, and that the FTC had adequately pled its unfairness claim. Finally, the court rejected the defendants’ challenge to the FTC’s deception claim.

Implications of the Wyndham decision

Many observers believe that the district court’s decision—and the resulting headlines—may serve to boost the FTC’s efforts to regulate data security. From our perspective, the decision (unless it is overturned on appeal) may have a significant effect on data-breach class actions as well for at least three reasons.

First, past FTC actions have spawned follow-on class litigation. Continued or possibly expanded FTC activity in the field of data security thus does not bode well for companies that must defend themselves first from hackers and then from regulators and plaintiffs’ attorneys who seek to turn a company’s victimization into a basis for claimed liability.

Second, the district court’s highlighting of what it called “data-security insufficiencies” may foreshadow a focus on simplistic checklists rather than on risk-based data security practices. These supposed “insufficiencies” include allegations that the company stored unencrypted data, used outdated operating systems, and failed to require the use of complex passwords. These purported “insufficiencies” were described in a manner bereft of any context—and in particular, without any reference to the specific risks facing the company or the company’s overall security response. But data security is not one-size-fits-all. Context does matter. For that reason, the creation of a data security checklist through litigation, whether by the FTC or by a putative class representative, will benefit no one.

Third, the district court’s willingness to authorize case-by-case development of security standards—including through the use of consent orders that provide little or no guidance to non-parties—promises legal and regulatory uncertainty for companies in an area that cries out for stable and predictable guidelines. This uncertainty will only increase if class actions are allowed to further complicate the existing patchwork of data-security standards.

At bottom, the Wyndham decision is troubling for companies that seek to manage data-security risks and stave off unnecessary and inappropriate litigation. Indeed, the district court appeared resigned to the prospect of more litigation in this area, noting that “we live in a digital age that is rapidly evolving” and that will raise “a variety of thorny legal issues that Congress and the courts will continue to grapple with for the foreseeable future.” Companies certainly should hope that the district court was wrong to forecast more litigation, but should be prepared for continued legal uncertainty and the opportunistic litigation it will generate.

We’ll be discussing the Wyndham decision—along with many other new trends and strategies in data breach and privacy class actions—in a webinar next week. We hope that clients and friends of the firm will consider joining us for that discussion.

After a year of public-private collaboration and considerable anticipation, the National Institute for Standards and Technology’s (NIST) cybersecurity framework for critical infrastructure has arrived. The interest in the framework has only grown after several high profile data breaches in late 2013 have cast an unrelenting spotlight on cybersecurity issues. The framework presents businesses with important questions about whether and how they should use it, and—as cybersecurity-related class actions multiply—how the plaintiffs’ bar intends to invoke the framework.

After attempts at more comprehensive legislation faltered, President Obama issued an executive order (EO 13636) requiring development of the framework. By design, the framework is both voluntary and limited in its application. Most significantly, it only applies to critical infrastructure. In addition, it contemplates the creation of incentives to support its adoption and possible follow-on regulatory “actions to mitigate cyber risks,” and leaves unresolved the ongoing debate over information sharing and attendant liability protections.

But while the framework is voluntary, it likely will be influential. The Administration, for example, has said that in developing the framework it intended to “leverage” “common cybersecurity practices” to improve the cybersecurity of critical infrastructure. For critical infrastructure operators, multiple questions arise, including (1) will regulators rely on the framework; (2) how, if at all, will insurance markets account for the framework; and (3) will plaintiffs’ attorneys invoke the framework to exert leverage of their own via class action litigation.

Even before the framework’s introduction, many observers recognized the possibility that—in light of the SEC’s increasing emphasis on the appropriate disclosure of cyber risks— the plaintiff’s bar would press securities litigation alleging material omissions or misrepresentations about such risks. Recognizing that such lawsuits may be inevitable, businesses that operate critical infrastructure surely will want to take account of the framework both in assessing their cybersecurity posture and in disclosing the existence of cyber risks. In particular, companies should consider whether to incorporate elements of the framework (e.g., a “Framework Profile”) into their public disclosures.

Another significant issue is that, because the framework arguably may facilitate board-level awareness and management of cyber risk, plaintiffs may be more likely to bring actions against officers and directors for breach of fiduciary duties in connection with cyber incidents. Although the success of such actions remains to be seen, the release of the framework underscores the importance of cybersecurity to corporate boards and top executives.

At the same time, in our view, businesses should be reassured by the fact that nothing in the framework suggests that a company’s decision not to adopt an individual element—what it calls an “informative reference”—should form the basis of a future lawsuit, whether for data breach or other harm. Indeed, the framework specifically states that it is not a checklist and that it is not “one-size fits all.” Transforming an “informative reference” from the framework into a stand-alone requirement is not a mandate that the framework contemplates or supports. Attaching liability to individual “informative references” would create static cybersecurity checklists that the framework specifically rejects; indeed, it would frustrate the continued development of appropriate cybersecurity protections that the framework itself is aimed to encourage. Companies should therefore be prepared to defend against attempts to elevate the framework into liability standards, which would frustrate the Framework’s goal of providing a “prioritized, flexible, repeatable, performance-based, and cost-effective approach” to managing cybersecurity risk.

The stakes of cyber attacks are high. So too are the stakes of litigation that are likely to ensue. The NIST Framework doubtless will be cited in that litigation, but, properly understood, it should not form the basis of a claim. To that end, we will be watching closely to see whether the plaintiff’s bar seeks to use the framework in ways that would defeat its stated purposes.