Quickhits: Dog Days of Summer Edition
The heat is on as we enter the dog days of summer. The same is true at the intersection of law, technology, privacy and security where tricky issues continue to heat up. Things are moving so fast now it is a challenge to keep track of all the developments. Here are a few "quickhits" to help keep you up-to-date . . .
- Another interesting online banking security breach recently occurred. This time the bad guys scored $465,000. If a lawsuit is filed this one may again test the issue of “commercially reasonable security” and the responsibility of the small business customer whose account was compromised. In this case (unlike for instance Shames-Yaekel or EMI ) a login by two separate individuals was required before a wire transfer could go out. It appears that the customer opened an unknown attachment to an email, which launched a Trojan horse that allowed the thieves to obtain the login credentials of BOTH people needed for a wire transfer. The sophistication of the attack was impressive, involving a fake email based on a real UPS delivery and the use of multiple “mule” companies (unwitting individuals trying to start a “get rich quick business from your own home”) to transfer funds to the criminals’ accounts.
- Healthnet settled with the Connecticut AG over its security breach and alleged violations of HIPAA. The fine was $250,000, but rumors have it that Healthnet spent in the vicinity of $7 million handling the breach, providing notice and responding to the investigation.
- Mexico’s data protection law recently went into effect. If you want to read a really bad English translation (created using Google Translate), click here (DISCLAIMER: do not rely on this translation it is full of errors, but will give an idea of what this law entails; the Mexican government will eventually release an official English translation).
- Germany launches legal proceedings against Facebook for allegedly illegally accessing and saving personal information of people that do not use Facebook.
- The 2010 Betterley Report on the "cyber insurance" market was recently released. Cyber insurance is being sold by more and more insurers at all levels of the economy. Will it become a standard purchase as information security and privacy legal risks increase? You can read an excerpt of the report HERE.
Thanks for reading us, and enjoy your summer!
Social Networking: Setting Boundaries in a Borderless Brave New World
The explosive growth and morphing applications of social media such as Facebook and Twitter create new opportunities and challenges for individual users, parents, employers, organizations, governments, and marketers. Where a social phenomenon has such a wide and unpredictable impact, it almost inevitably attracts a retinue of lawmakers and regulators, as well as lawyers and HR managers struggling to craft appropriate policies for employees. And given the globalization of social media, those policies have to take account of the evolving rules in multiple jurisdictions.
When I was a kid in Las Vegas, I had a “pen pal” in France. We exchanged the occasional letter, painfully translating into each other’s languages and then trying to figure out how much postage to stick on the envelope. It seems quaint now.
Thanks to Facebook, LinkedIn, and Twitter, I’ve enjoyed meeting people with similar interests and reconnecting with people I knew socially or professionally in years past, in several countries. It’s usually pretty easy to look up people as you think of them, and there’s no postage and little delay.
Those services, and an array of other social media, have become truly international. Some 15% of the world’s Internet users are American, so even successful social media operators in the US naturally look abroad to expand their increasingly monetized networks. Competing with national and regional social networks throughout the world, leading social networking providers in the US, Europe, China, and India have turned social media into a global phenomenon. To take one prominent example, US-based Facebook now translates into more than 100 languages and reported this month at InsideFacebook.com that nearly 70% of its hundreds of millions of users reside outside the United States.
Facebook aggregates users’ self-reported demographic data and sells the information to advertisers, who are understandably eager to tap the advertising possibilities of social media. In several developed countries, a third or more of the population uses Facebook, many on a daily basis.
Facebookers and other social networkers often end up sharing a large amount of personal and professional information over time with friends . . . and friends of friends, and friends of friends of friends, and ultimately with a lot of people they wouldn’t recognize across a restaurant. By some estimates, roughly a third of Facebook users ultimately divulge their home address and current employment to an unknown number of people who are perhaps not all really their friends. New York Senator Charles Schumer recently called on the Federal Trade Commission to develop guidelines for social networking sites, and the FTC has already had occasion to investigate the extent to which identity theft and fraud are attributable to bad hygiene, or bad policies, in social media.
Most of the social networking groups I belong to are professional ones, linking lawyers, business people, inventors, IT managers, academics, and government officials who share certain interests and follow developments in particular fields. Those who participate often share ideas and some personal and career information, and they sometimes comment about their own companies or organizations or the offerings of their competitors.
So, as a lawyer, it strikes me that some social networkers may be exposing themselves not only to embarrassment and unwanted solicitations but also to fraud or identity theft. They also may be setting themselves up for trouble with prospective employers, or with their current employers or business partners who feel the talkative social networker has violated confidentiality policies or nondisclosure agreements (in surveys, many large US employers acknowledge that they have fired or disciplined employees for the contents of their posts or blogs). Advertising thinly disguised as a Tweet or post may not conform to advertising rules in all the relevant states, provinces, or countries. An intemperate rant or sly aside, broadcast to a few hundred of the user’s “closest friends,” raises the potential of liability for defamation or commercial disparagement. Comments about associates or coworkers, especially in the context of social media that blur the lines between personal and professional life, may trigger sanctions under privacy and data protection laws. And thanks to the global nature of social media, the hapless social networker could conceivably run afoul of laws in multiple jurisdictions.
It’s not only the FTC that has started worrying about the dark side of social media. The Article 29 Data Protection Working Party (comprised of EU authorities and European national data protection commissioners) issued a statement this month declaring that Facebook’s new default privacy settings are dangerous. The group has also warned social media applications developers (such as FarmVille) to be careful in their handling of user data. Regulators on both sides of the Atlantic have expressed concern as well about behavioral marketing applications based on gathering information about an individual’s participation in social media.
It’s easy to over-react to the hazards of social media, of course. Some parents forbid their children from joining in (and some teens have created a “safe” MySpace page that their parents can see, while secretly maintaining a more dubious version to share with their peers). Some users decide to drop out entirely, finding the risks, or just the implied obligation to post and respond frequently, unmanageable; there is even a “Quitting Facebook” Community Page on Facebook itself. Reasonably careful social networkers simply look at the privacy policies and options and adjust their settings appropriately to their intended use – and then watch what they say about employers, competitors, and other sensitive types. Some corporations have blocked access to social networking sites from company computers and adopted policies against their employees saying, well, pretty much anything about the company or its competitors or regulators. But other companies have already designated a “director of social media” to help the organization make effective use of social networking, internally and externally.
It seems that the trend is for employers to expand their “acceptable use” policies on email and web browsing to encompass blogging and social media as well. This is a necessary step, but it is also fraught with concerns arising from labor law, privacy law, and rights of association and free expression, and the rules differ across the many jurisdictions that may be at issue.
It is possible to set some boundaries that will pass muster just about anywhere and articulate policies that guide employees toward safe and sensible use of social media. There is much to be learned in the way of evolving best practices, especially among large multinational employers. Just don’t forget to check with a knowledgeable lawyer when crafting such policies and determining how to enforce them.
Massachusetts's Highest Court Delivers BJ Wholesalers (and other Retailers) a Data Breach Liability Gift
While the proverbial jury is still out concerning retailers’ sales success this 2009 holiday season, Massachusetts’s highest court (the Supreme Judicial Court or “Supreme Court” as referenced herein) delivered retailers a significant holiday gift in the form of an opinion slamming the door on some financial institutions seeking to recover reissuance costs arising out a retailer’s payment card data breach. The Cumis Insurance Society, Inc. v. B.J. Wholesale Club, Inc. decision (“Supreme Court Decision”) analyzed and ruled upon most of the mainstream legal theories issuing banks have used to attempt to recover card reissuance costs, including breach of contract under a third party beneficiary theory, fraud, negligence, negligent misrepresentation and breach of unfair/deceptive practices laws (in this case M.G.L. Chapter . 93A, section 11). We have previously commented on multiple decisions involving retailer payment card breaches similar to the BJ Wholesale breach and PCI liability in general, including a 3rd Circuit federal appellate decision that allowed issuing banks to proceed forward with a third party beneficiary breach of contract theory. This blog post dives into and analyzes the Supreme Court Decision, and looks at it in context against similar decisions. Overall, in terms of issuing banks recovering for payment card breaches, the game does not appear to be litigation in the courts, but rather in the backroom contracts and recovery processes contained in the card brand operating regulations that most retailers agree to comply with.
Relevant Facts
The Supreme Court Decision arises out of a payment card breach of BJ’s Wholesale Club, Inc. (“BJs”) involving approximately 9.2 million payment cards and millions of dollars in fraud. The plaintiffs in this case are credit unions and their insurer who incurred costs to reissue the payment cards that were impacted by the breach (as well as costs for fraudulent charges that arose out of the breach). The plaintiffs allege that thieves were able to compromise BJ Wholesale Club’ s systems because BJs and their acquiring bank (Fifth Third Bank) breached two sets of contractual obligations. With respect to BJs, the plaintiffs alleged that BJs breached their contract with Fifth Third bank, which prohibited the storage of the magnetic stripe data after authorization of card transactions. In turn, the plaintiffs alleged that Fifth Third breached its Membership Agreement with Visa and Mastercard requiring Fifth Third to ensure that merchants like BJs did not store magnetic strip data post-authorization.
Alleged Claims and the Supreme Court’s Decision
The plaintiffs alleged several causes of action against BJs and Fifth Third, including breach of contract under a third party beneficiary theory, fraud, negligence, negligent misrepresentation and breach of unfair/deceptive practices laws (in this case M.G.L. Chapter . 93A, section 11). The lower court had granted the defendants a motion to dismiss all of the plaintiff’s causes of action, and the Supreme Court was asked to review the lower court’s decision. Ultimately, as described below, the Supreme Court agreed with the lower court’s decision and upheld it.
Breach of Contract – 3rd Party Beneficiary Theory
The plaintiff’s alleged that they were the intended third party beneficiary of two separate contracts. First, the Merchant Agreement between BJs and Fifth Third prohibited the storage of magnetic card data, and the plaintiffs alleged they were the beneficiaries of, and should be able to enforce, the agreement against BJs. Second, the plaintiffs also alleged that they were the intended third party beneficiaries of the Membership Agreement between Fifth Third and Visa/Mastercard. Pursuant to the Membership Agreement, Fifth Third agreed to ensure that its merchants did not store magnetic stripe data.
Unfortunately for the plaintiffs, the Merchant Agreement contained the following language:
This Agreement is for the benefit of, and may be enforced only by [Fifth Third] and [BJ’s] and their respective successors and permitted transferees and assignees, and is not for the benefit of, and may not be enforced by, and third party.
Despite this language, the plaintiffs maintained that the prohibition against storing magnetic stripe data was intended to benefit them. Citing a lower court judge who had indicated that any benefits to the plaintiffs in the Merchant Agreement were incidental, and relying on the specific intent referenced in the disclaimer, the Supreme Court upheld the dismissal of the breach of contract claim based on BJs Merchant Agreement.
With respect to the Membership Agreements between Fifth Third and the card brands, the Supreme Court held that the plaintiffs’ third party beneficiaries allegations were conculsory in nature and not supported by any facts establishing Visa or Mastercard’s intent to have them as beneficiaries able to enforce the Membership Agreemwent. While Visa and Mastercard’s operating regulations did not have a specific third party beneficiary disclaimer, both Visa and Mastercard, reserved the right to interpret and enforce such regulations. The Supreme Court viewed this as indicating an intent to prohibit enforcement of the Membership Agreement by others like the plaintiff (the Supreme Court viewed that as consistent with the TJX decision). Interestingly, this case involved the same facts as another BJ Wholesale Club in federal court that allowed the plaintiff-banks to proceed with a third party beneficiary claim. In the Federal case, Visa and Mastercard representatives actually testified at deposition that operating regulations around magnetic stripe data were intended to protect the participants in the system, including issuers. However, the Supreme Court found that the plaintiffs failed to submit that deposition testimony into the court record so that testimony apparently was not considered by the Supreme Court.
Negligence – Economic Loss Doctrine
The Supreme Court did not address whether BJs or Fifth Third, for purposes of a negligence theory, had a duty to employ reasonable security with respect to cardholder data. Rather, the Supreme Court relied on the economic loss doctrine to dismiss the plaintiff’s negligence claim. Under the economic loss doctrine, plaintiffs cannot recover using a theory of negligence unless physical harm or harm to property exists (as opposed to pure “economic loss”). The plaintiffs argued that tangible harm did exist because the physical credit cards had to be reissued after the BJs breach. On this issue, the Supreme Court again followed the BJ Wholesaler’s decision rendered in Federal district court (see the 3rd Circuit Appellate Decision upholding that rationale), which held that reissuance costs are economic in nature even if related to a physical card. In this case the cards themselves were not harmed since consumers could still use them after the breach. Rather, the Supreme Court found that the plaintiffs chose to cancel the cards for the purpose of avoiding future economic loss.
Fraud and Negligent Misrepresentation
The Supreme Court also rejected the plaintiff’s fraud and negligent misrepresentation claims. The basis for these claims was again tied to the defendant’s contractual promises to comply with the card brands’ operating regulations. In disposing of the fraud claim, the Supreme Court noted that the plaintiffs admitted neither BJs nor Fifth Third made any direct representations to the plaintiffs indicating that they were storing magnetic stripe data. Moreover, despite alleging that they would have changed their behavior had they known about the risk of magnetic stripe exposure, the reality was that the plaintiffs continued to participate in the Visa and Mastercard system. There was no evidence that the plaintiffs would have acted any differently had they been aware that BJs was storing magnetic stripe data.
With respect to the negligent misrepresentation claim, the Supreme Court cited case law indicating that failure to perform a contract does not equate to a negligent misrepresentation claim. Moreover, false statements of opinion or conditions to exist in the future cannot support a negligent misrepresentation claim. In this case, dismissal was warranted because there was no evidence that BJs never intended to comply with its Merchant Agreement at the time it entered into it.
In addition, the Supreme Court held that even if entering into an agreement constituted a representation of compliance with the magnetic stripe disposal requirements, there was no evidence that plaintiffs’ alleged reliance on that representation was justifiable. The Supreme Court essentially held that no reasonable person would rely on the regulations prohibiting the storage of magnetic stripe data. The court pointed to evidence indicating that the participants in the payment card system expected that the operating regulations would be breached because Visa and Mastercard instituted a system of fines and penalties for non-compliance. In addition, the plaintiffs’ purchase of insurance to cover credit card fraud was listed as evidence that plaintiffs anticipated this type of fraudulent activity. Finally, the plaintiffs had received numerous alerts from Visa and Mastercard concerning payment card breaches and fraud involving compromised magnetic stripe data (I find this reasoning very convoluted, at best. The existence of rules to deter certain behavior seems to create some certainty that such behavior should not be happening).
M.G.L. Chapter . 93A, section 11
Since the plaintiffs’ M.G.L. Chapter . 93A, section 11, equitable indemnification and subrogation claims were all based on the dismissed fraud and negligent misrepresentation claims, they were also dismissed. Interestingly, unlike the First Circuit Appellate court’s decision in the TJX matter, the Supreme Court did not consider whether the plaintiffs had a viable cause of action based on the “unfairness” prong of the Massachusetts’ law (e.g. whether BJs information security was so poor that it constituted an “unfair practices).
Conclusion
This case is yet another in the increasingly long series of cases that allow retailer plaintiffs to escape liability arising out of data breach litigation at the motion to dismiss phase. What lessons does it hold for the various payment card stakeholders?
On the merchant side, for any agreement where the merchant is making promises about data security or PCI compliance, make sure there is a strong disclaimer of third party beneficiaries. This will cut issuing banks off on that theory fairly early. Also on the merchant side, be careful of what you say about security and compliance with card brand rules and operating regulations. To the extent a merchant makes representations concerning security (especially direct representations), they may be opening themselves up to misrepresentation claims. The consequences could be serious since negligent misrepresentation and fraud claims are not barred by the economic loss doctrine (and at least one court has provided those theories some legs).
From the issuing banks’ point of view, the question becomes whether litigation is worth it in this context. This is especially true now that both VISA and Mastercard (*I believe, their regulations are not all public) have explicit recovery mechanisms within their systems that can allow an issuing bank to recover without going to court. VISA and Mastercard have both tightened up their contracts and operating regulations to disclaim third party beneficiary theories (although if an issuing bank is to pursue such a theory make sure to get the deposition testimony from the Visa and Mastercard officials referenced in the 3rd Circuit’s BJs Wholesale case). One area for issuing banks to take a harder look at is State unfair/deceptive trade practice acts. As mentioned above at least one high court has indicated that inherently poor security may amount to an unfair practice. This line of thinking also happens to be consistent with several high profile FTC actions , including of course one involving BJ Wholesale Club.
