Third Circuit Shire Decision May Spell Trouble for FTC Cybersecurity Enforcement Plans

In June 2018, medical laboratory LabMD obtained the first-ever court decision overturning a Federal Trade Commission (FTC) cybersecurity enforcement action. (The team directing that effort – led by Doug Meal and Michelle Visser – joined Orrick in January 2019). There, the Eleventh Circuit held that an FTC cease-and-desist order imposing injunctive relief requiring LabMD to implement “reasonable” data security was impermissibly vague. In the wake of LabMD, the FTC’s new Chairman, Joseph Simons, stated that he was “very nervous” that the agency lacked the remedial authority it needed to deter allegedly insufficient data security practices and that, among other things, the FTC was exploring whether it has additional untapped authority it could use in this space. In this regard, Chairman Simons and Commissioner Rebecca Kelly Slaughter announced that the FTC is examining whether it can “further maximize its enforcement reach, in all areas, through strategic use of additional remedies” such as “monetary relief.”

But on February 25, 2019, the Third Circuit issued a decision in FTC v. Shire Viropharma, Inc. that may make it extremely difficult for the FTC to obtain such “monetary relief” in most privacy and cybersecurity actions. In Shire, the court held that to pursue relief in federal court under Section 13(b) of the FTC Act, the FTC must allege facts plausibly suggesting that the company “is violating, or is about to violate,” the law – not merely that the company violated the law in the past, and not merely that the company is “likely” to violate the law in the future. Although Shire was an antitrust case that proceeded under Section 13(b), that same section of the FTC Act is the principal authority on which the FTC relies to pursue monetary relief in consumer protection actions, including privacy and cybersecurity enforcement actions. The FTC is likely to face hurdles in demonstrating that, in the ordinary privacy and cybersecurity action, a company “is violating, or is about to violate,” laws enforced by the FTC.

Background on the FTC’s Enforcement Powers

The FTC can initiate an enforcement action if it has “reason to believe” that Section 5 of the FTC Act, which prohibits unfair competition and unfair or deceptive trade practices, is being violated. The FTC takes the position that a failure to implement “reasonable” cybersecurity or privacy practices can constitute an “unfair” practice, and that making false or misleading statements about such practices can be a “deceptive” trade practice under the statute.

Prior to the enactment of Section 13(b) in 1973, the FTC relied on its traditional administrative enforcement authority, which allowed the FTC to initiate an administrative proceeding to issue an order to “cease and desist” violations of Section 5 but did not permit imposition of financial relief. Section 19 of the FTC Act permits the FTC to pursue a federal court action to obtain equitable money relief for violations of these administrative cease-and-desist orders, but only when a “reasonable man would have known under the circumstances” that the conduct was “dishonest or fraudulent,” and these actions are subject to a three-year statute of limitations. Section 19 also permits actions for equitable money relief in federal court when a company has violated a specific FTC rule, again subject to the three-year limitation period. Most privacy and cybersecurity cases, however, do not involve violations of cease-and-desist orders or FTC rules.

With the addition of Section 13(b), the FTC Act gave the FTC the authority to proceed against a company directly to federal court in certain circumstances, even before any administrative adjudication has occurred, and even in the absence of any rule violation. Specifically, under Section 13(b) the FTC gained the authority to (1) seek injunctive relief in federal court pending the completion of the FTC administrative proceeding when the FTC “has reason to believe” that a person or entity “is violating, or is about to violate” any law enforced by the FTC, and (2) seek a permanent injunction “in proper cases.” Subsequently, the FTC adopted an expansive view of its power to bring federal court enforcement actions under Section 13(b), and started bringing cases in federal court seeking monetary relief under equitable doctrines such as restitution, disgorgement and rescission of contracts. The FTC also asserted that its statutory power to seek a “permanent injunction” was a standalone grant of authority that entitled the FTC to bring a federal court action irrespective of whether a defendant “is violating, or is about to violate” the law. By tying its theories to these equitable doctrines, the FTC took much of its enforcement activity outside otherwise severe limitations on its ability to seek money relief. Until recently, courts universally accepted the FTC’s expansive view of its authority under Section 13(b). As a result, it is the FTC’s policy that “[a] suit under Section 13(b) is preferable to the adjudicatory process because, in such a suit, the court may award both prohibitory and monetary equitable relief in one step.”

FTC v. Shire ViroPharma, Inc.

The Third Circuit’s decision in Shire ViroPharma, however, delivers a stinging rebuke to the FTC’s “preferable” approach. The FTC sued the defendant in the U.S. District Court for the District of Delaware, alleging that between 2006 and 2012 Shire had engaged in an anticompetitive campaign of repetitive and meritless filings with the FDA to delay generic competition and therefore maintain its monopoly on its branded drug. Shire moved to dismiss the FTC’s complaint, arguing that the FTC had exceeded its authority under Section 13(b). Specifically, Shire asserted that Section 13(b) does not provide the FTC with independent authority to seek a permanent injunction and money relief under Section 13(b), but rather limits the actions to those cases where the FTC can plead that a defendant “is violating or is about to violate” the law. On March 20, 2018, Judge Richard Andrews granted Shire’s motion to dismiss, and rejected the FTC’s long-held assertion that Section 13(b) provides it with the independent authority to seek permanent injunctive and monetary relief in federal court for past violations of the FTC Act and regulations.

The Third Circuit affirmed last month, holding that “Section 13(b) requires that the FTC have reason to believe a wrongdoer ‘is violating’ or ‘is about to violate’ the law.” It found that the plain language of Section 13(b) does not permit the FTC to pursue conduct that merely occurred in the past; rather, it allows the FTC to pursue only “existing or impending conduct.” The court explained that this reading is bolstered by the history of Section 13(b), which Congress “expected to be used for obtaining injunctions against illegal conduct pending completion of FTC administrative hearings.” And, the court rejected the FTC’s assertion that it can plead a company is “about to violate” the law by demonstrating a mere “reasonable likelihood” that its past violations will recur. Rather, “‘is violating’ or ‘is about to violate’ means what it says – the FTC must make a showing that a defendant is violating or is about to violate the law.” And because “Shire indisputably is not currently violating the law, nor is it alleged to be poised to do so anytime in the foreseeable future,” the FTC’s complaint “fail[ed] to state a claim upon which relief can be granted.” The court thus affirmed the dismissal of the FTC’s claims for both permanent injunctive and monetary relief.

What to Do Now – Taking Advantage of Shire

Companies can take advantage of the Third Circuit’s decision in Shire and potentially cut off the FTC’s ability to obtain monetary relief for privacy and cybersecurity breaches by taking some basic steps. Because Shire limits damages to prospective violations, the key is to take immediate steps to identify, remediate and validate any security vulnerabilities to ensure that the company can demonstrate that it is no longer “about to” violate the law. Here is what to consider doing and including in your incident response plan:

  • Ensuring that a “root cause analysis” is a key part of incident response and investigation, where focus is placed on the “whats,” “hows” and “whys” that lead to the incident;
  • Developing a comprehensive understanding of the remediation measures that are necessary and appropriate to prevent the incident from recurring, which typically means identifying security vulnerabilities, missing patches, changes to data collection, use, sharing practices, etc. For security breaches, the forensics team can play a significant part in helping determine remediation activities.
  • Working with senior management to allocate the resources (both people-power and monetary) that will be needed to fully implement remediation measures, and developing a timetable for remediation efforts;
  • Implementing all agreed-upon remediation measures, whether policy-based, technical or physical, and validating that they are functioning correctly by conducting post-remediation testing (giving due consideration to testing that is broader than just the root-cause, to manage related risks);
  • Conducting regular assessments against affected systems and processes, generally, and remediating accordingly (with accompanied validation); and
  • Documenting the above, to maintain an accurate record of investigation, remediation, assessment and validation activities to be used with regulators and/or putative plaintiffs

FTC’s Response to Shire

While Shire may impose significant hurdles to the FTC’s ability to pursue federal court actions, the FTC may have other options. For example, the FTC may take the position that it is nevertheless permitted to utilize Section 19 of the FTC Act to obtain monetary relief in federal court following the issuance of an administrative cease and desist order for a first-time violation of Section 5. But even if that position were correct, any such monetary relief would be subject to a three-year statute of limitations and limited to conduct that was “dishonest or fraudulent.”

The FTC may also consider leveraging its administrative adjudication process, which is notoriously slow and burdensome and over which the FTC Commissioners exercise the final decision-making authority (subject to judicial review), to force companies to agree to unfavorable settlement agreements. In particular, the FTC may seek to have companies enter into 20-year administrative consent orders with broader conduct provisions regulating future privacy and cybersecurity actions. While FTC administrative consent orders do not usually contain monetary penalties, they carry the potential for fines of $42,530 per violation (which the FTC may contend applies to each consumer subject to a breach) that occurs at any point over the 20-year term of the order.

No doubt, Chairman Joseph Simons, with his deep background in antitrust regulation, watched these developments closely. It might be why he recently urged Congress to expand the FTC’s privacy-enforcement powers and allow it to impose fines more easily, write new rules and hire more experts. “It’s important that we get civil penalty authority,” he said. “For companies that have lots of money, the impact would be sufficient to deter them.” Championing the role of the FTC as the police for how all companies and nonprofits – not just technology companies – collect and handle people’s digital data, Chairman Simons has made clear that this chapter is not yet closed.