The Anatomy of an FTC Data Security Lawsuit

Snell & Wilmer

The Federal Trade Commission (“FTC”) has described itself as “Your cop on the privacy beat” and a top federal regulator of consumer-facing data security practices.  An example of how the FTC asserts itself when it comes to data security and privacy associated with Internet of Things (“IoT”) devices can be found in the case of Federal Trade Commission v. D-Link Systems Inc., currently pending in federal court in California.

FTC Stance: Poor IoT Security +/or Misleading Ads = Deceptive/Unfair Trade Practice  

The D-Link case stems from the FTC’s January 5, 2017 complaint against Taiwanese IoT hardware device manufacturer D-Link Corporation and its U.S. subsidiary D-Link Systems Inc.  The FTC seeks to stop D-Link from engaging in allegedly unfair or deceptive acts in violation of Section 5(a) of the Federal Trade Commission Act (“FTC Act”).  The FTC claims that the defendants failed to reasonably secure IoT network routers and Internet-accessible cameras that they sold in the U.S. and made deceptive statements about the degree of data security of those products.

As the FTC explained in a press release, these security flaws could lead to compromising sensitive consumer information, including live video and audio feeds from D-Link internet cameras.  According to the complaint, hackers could exploit these vulnerabilities using any of several simple methods. For example, using a compromised router, an attacker could obtain a consumer’s tax returns or other files stored on the router’s attached storage device. They could redirect a consumer to a fraudulent website or use the router to attack other devices on the local network, such as computers, smartphones, IP cameras, or connected appliances.

Even worse, in a truly nightmare scenario, the FTC warns that by using a compromised camera, an attacker could monitor a consumer’s whereabouts in order to target them for theft or other crimes or watch and record their personal activities and conversations.

Given these potential security and privacy risks associated with consumer IoT devices, the FTC notes that, “when manufacturers tell consumers that their information is secure, it’s critical that they take the necessary steps to make sure that’s true.”

In this case, the FTC faulted D-Link for, among other things, failing to take reasonable security measures, for not keeping the private key used to sign software confidential and for storing users’ mobile app login credentials in readable text on user devices.  Further, the FTC deemed to be deceptive certain statements made by D-Link Systems Inc. in advertising and manuals which used headings like “EASY TO SECURE” and “ADVANCED NETWORK SECURITY”, and statements such as: “best possible encryption protections” and “the latest wireless security features to help prevent unauthorized access.”  Defendant D-Link Corporation was dismissed without prejudice, leaving D-Link Systems Inc. (“D-Link”), the U.S. subsidiary, as the lone defendant.

D-Link Pushes Back Against FTC’s Authority

D-Link denied the allegations against it, and specifically argued that the FTC’s unfairness claim was beyond its power to regulate, as Section 5 of the FTC Act does not discuss data security.  This is not the first time that a company has argued that the FTC exceeded its authority to regulate the data security practices of private companies.  Two recent cases brought by the FTC in the data security context are instructive.

The LabMD Case

In May 2013, the FTC filed a Section 5 FTC Act complaint alleging unfair practices against LabMD, Inc. (“LabMD”), a laboratory that performed cancer diagnostic testing.  In 2005, the billing manager of LabMD downloaded LimeWire, a file sharing application that was popular for sharing music and other files.  LimeWire connected to a particular network that had up to 5 million people logged in at one time.  Using this particular network, a data security firm was able to download personal information from 9,300 LabMD patients.  The data security company attempted to sell its services to LabMD, but when LabMD refused to pay, the data security company turned over the personal information to the FTC.

Like the D-Link case, the FTC faulted LabMD’s data security measures.  In response, LabMD filed a motion to dismiss for failure to state a case under Section 5 of the FTC Act.  Not surprisingly, the FTC found that it had authority and denied the motion.  An evidentiary hearing was held before an administrative law judge (“ALJ”) in July 2015.  The ALJ dismissed the FTC’s complaint, which the FTC appealed – to the full FTC.  Once again, not surprisingly, the FTC decided that it had authority and reversed the ALJ’s decision.  LabMD then took the matter out of the FTC’s arena and petitioned the U.S. Court of Appeals for the Eleventh Circuit to review the case.

In June 2018 the Eleventh Circuit unanimously held in favor of LabMD and against the FTC, holding that the FTC improperly made an indefinite complaint by failing to determine the specificity with which LabMD allegedly violated any laws.  The FTC also attempted to impose penalties “for violating an imprecise cease and desist order,” which would have denied LabMD due process.  As the Eleventh Circuit noted, the FTC “does not enjoin a specific act or practice.  Instead, it mandates a complete overhaul of LabMD’s data security program and says precious little about how this is to be accomplished.”  For these reasons, the Eleventh Circuit deemed the FTC’s case against LabMD unenforceable.   (It was a symbolic victory for LabMD, which closed its doors during the course of litigating the case).

The Wyndham Case

In another case that included resistance to the FTC’s authority to regulate data security practices, the FTC sued Wyndham Worldwide Corp (“Wyndham”) in August 2012.  Between 2008 to 2010, Wyndham’s computer network, as well as several other independent hotel networks, were hacked, exposing over 600,000 hotel customers’ personal information.  According to Wyndham, no hotel guests were negatively financially impacted, and remedial measures were implemented to prevent future cyberattacks.

However, in June 2012 the FTC filed an amended complaint against Wyndham, alleging that Wyndham’s privacy policy misrepresented the security measures that the company and its subsidiaries took to protect consumers’ personal information, and that its failure to safeguard personal information caused substantial consumer injury.  Wyndham moved to dismiss the lawsuit on the grounds that the FTC had no authority to assert an unfairness claim in the data security context, and that the FTC must first establish regulations before bringing an unfairness claim.  In 2014 the federal court denied the motion to dismiss, and the case proceeded.

Thereafter, in 2015, the FTC and Wyndham “resolved” the case by way of a Stipulated Order for Injunction which acknowledged the FTC’s authority in the data security context.  Wyndham was required to overhaul several aspects of its data security program to better protect customers’ credit card information.  This included implementing and maintaining for 20 years’ time, a comprehensive information security program, cardholder data assessments for up to twenty years, compliance reporting for ten years, recordkeeping reporting, and compliance monitoring.

Judge Donato: No Actual Losses = No Unfairness

The LabMD and Wyndham cases reached different conclusions as to how much authority the FTC has in setting and policing data security regulations,  but the opinion written by U.S. District Judge James Donato regarding D-Link’s Motion to Dismiss gives some guidance as to how the case will proceed.  The parties have agreed to hold a settlement conference in March, and the trial is currently scheduled for June 2019.

Using the Wyndham case as a “sharp contrast,” Judge Donato dismissed the FTC’s unfairness claim, concluding that, despite D-Link’s lack of fair practice standards, the FTC failed to meet its own 5(a) requirement of showing any actual consumer losses, and instead made “out a mere possibility of injury at best.”  While Judge Donato suggested that tying in the unfairness claim to the deception claims may “have had a more colorable injury element,” this is not what the FTC did.  Therefore, the unfairness claim was dismissed with leave to amend.

The FTC’s claims regarding alleged misrepresentations in promotional materials were also dismissed, as the FTC did not provide facts showing that the promotional materials were likely to mislead consumers.  Only one of the FTC’s exhibits supported alleged misrepresentations, but it did not contain any representations about digital security.  This lack of information did not afford D-Link fair notice.

Remaining Claims for Resolution

Of the six initial claims brought by the FTC against D-Link, three remain pending:

  • a data security misrepresentation claim;
  • a first allegedly deceptive statement; and
  • a second allegedly deceptive statement.

Concerning the misrepresentation claim, the FTC alleged that D-Link made misleading statements about its own data security policies and security practices between December 2013 to September 2015.  Judge Donato held that the claim was specific enough as to the “who, what, when, where, and how of the misconduct charged.”  Because D-Link tried to shift all risk to consumers in a wide liability disclaimer of its products, this claim remains for trial.

The first claim for an allegedly deceptive statement is that D-Link misrepresented that the routers it sold were secure from unauthorized access.  The second allegedly deceptive statement D-Link made was in incorrectly stating that the IP cameras it sold were also secure from unlawful access and control.  Judge Donato stated that both claims adequately provide the “why and how” of the statements’ false or misleading content, and thus remain for trial.

The March 6 settlement conference has passed with no apparent resolution to the case, which is presumably still set for trial in June 2019.  In the meantime, privacy advocacy groups continue to press Congress to enact updated federal data privacy legislation.  Stay tuned!

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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