Federal Court Limits FTC’s Power to Police Data Breaches

The Federal Trade Commission (FTC) is the government agency primarily responsible for imposing penalties on companies that fail to protect consumer data.  It does so under Section 5 of the Federal Trade Commission Act, which prohibits “unfair and deceptive acts or practices in or affecting commerce.”

This case began in 2008, when someone found a document containing over 1700 pages of LabMD billing information on a peer-to-peer file sharing service. The file contained the personal information of over 9,000 patients, including their names, birthdates, social security numbers, codes indicating specific medical tests, and health insurance information. The company that found the data referred the matter to the FTC.

The breach was ultimately traced to a billing manager, who had allegedly installed a file sharing program onto her work computer for downloading and listening to music. Because her “My Documents” folder was designated for sharing, all documents in that folder (including the document at issue) found their way online. Several years later, in 2012, while raiding the home of individuals suspected of utility theft, the Sacramento Police Department found excerpts from that LabMD document containing the names and social security numbers of 600 people.

Based on these facts, this seemed to be a typical case for the FTC.  LabMD’s allegedly unreasonable data security practices allowed ne’er-do-wells to steal patients’ identities and other information.  LabMD did not monitor traffic across its firewalls, it failed to adequately train its employees, it failed to update its software or to require strong passwords, and it allowed employees to download and use peer-to-peer file sharing services. Thus, in 2013, the FTC filed a complaint against LabMD, alleging that its lax cybersecurity standards constituted an “unfair business practice” under the FTC Act.  

Notably, the FTC Act contains an explicit injury requirement, which provides that an act or practice is unfair only if it “causes or is likely to cause substantial injury to consumers.”  The statute left interpretation of this provision to the FTC.  In its order against LabMD, the FTC interpreted “substantial injury” to include “an intangible but very real harm like a privacy harm resulting from the disclosure of sensitive health or medical information.” The FTC found that the mere “disclosure of sensitive health or medical information causes additional harms that are neither economic nor physical in nature but are nonetheless real and substantial and thus cognizable” under the FTC Act.

Put another way, the FTC found that subjective injuries, like reputational harm or embarrassment, are sufficient to sustain an FTC action.  Not only did the FTC find that subjective feelings qualified as a sufficient injury, and that further consumer injury was likely based on the facts of the case, but also that substantial injury had actually occurred (or was presumed to have occurred), without presenting evidence of a specific aggrieved consumer.  

Then, LabMD did something unusual.  Rather than accepting a settlement and the stigma that would have accompanied it (as most companies do), LabMD made the unusual decision to appeal the FTC’s findings directly to a federal appellate court.  It asked the court to stay the FTC’s order pending that appeal.  

In its decision issued November 10, 2016, the 11th U.S. Circuit Court of Appeals held that in cases of a security breach, mere emotional harm and acts causing only a low likelihood of consumer harm are not sufficient to support a claim for unfair business practices under the FTC Act.  The appellate court acknowledged the FTC’s considerable authority to interpret the FTC Act given its expertise in consumer protection, but nevertheless found that the FTC had misinterpreted the FTC Act, and that merely exposing sensitive data was not “reasonably likely” to cause consumer harm.   

Notably, for purposes of granting a stay, the 11th Circuit needed only to find that LabMD was likely to later prevail on the case’s merits. It is important to note that the 11th Circuit has not actually decided the merits of the suit.  When and if it does so, its holding may elaborate on the standard for maintaining an action under the FTC Act.

What does this holding mean?  The FTC’s enforcement powers may be limited by the Eleventh Circuit’s opinion. Whereas the FTC found that it could pursue companies whose poor security infrastructure makes consumers vulnerable — even if consumers have not yet suffered injury — the court disagreed and found that something more is required. It remains unclear how much risk, exactly, consumers must face before the FTC can pursue companies with inadequate security.

The finding was consistent with the recent U.S. Supreme Court ruling in Spokeo v. Robins, which underscored the basic principle that parties to lawsuits must have suffered an “injury in fact” to pursue violations of U.S. statutes.

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