What You Don’t Know Just Might Hurt You.

“As we know, there are known knowns. There are things we know we know. We also know there are known unknowns. That is to say we know there are some things we do not know. But there are also unknown unknowns, the ones we don't know we don't know.”

—Donald Rumsfeld, Feb. 12, 2002

Regardless of what one thinks of Donald Rumsfeld’s tenure as Secretary of Defense, these words hold a pearl of wisdom that applies to organizations struggling to comply with privacy and security laws. One of the major difficulties for modern organizations working with private personal information is simply knowing what privacy and security laws apply to their operations. This problem is exacerbated by the fact that, even for smaller- and medium-sized organizations, modern commerce often involves transacting with consumers in multiple legal jurisdictions (e.g. local, State, Federal and international). In short, since privacy and security laws from several jurisdictions may apply, it is highly likely that a lot of “unknown unknowns” exist, which can cause adverse impacts. This month’s newsletter explores an instance where unknown unknowns may have come into play in the privacy context, and how organizations can begin to address the problem.

Too Much Information?

FACTA Credit Card Receipt Class Action Suits a Cause for Serious Concern.

In what appears to be a classic case of “unknown unknowns,” a rash of over 100 class action lawsuits have been filed in California alleging violation of the Fair and Accurate Transaction Act of 2003 (“FACTA”). Section 15 U.S.C. § 1681c(g) of FACTA limits the information that can be printed on an electronically printed credit card receipt to the last five digits of the credit card number, and specifically prohibits printing a credit card’s expiration date on the receipt. Organizations were provided with a three-year grace period to comply with this Federal law (December 4, 2006 was the first date that compliance was required).

A single willful violation of FACTA (which is incorporated into and part of the Fair Credit Reporting Act [“FCRA”]) could result in damages ranging from $100 to $1,000. Plaintiffs are also entitled to actual damages if they can prove a negligent violation of the FACTA. With companies processing millions of credit card transactions each year the damage potential for these lawsuits is staggering.

These class action suits have been filed against companies such as: Urban Outfitters; IKEA; Chanel Inc.; Toys-R-Us Delaware Inc.; Oakley, Inc.; Rite Aid Corp.; Costco Wholesale Inc.; The Walt Disney Parks and Resorts; California Pizza Kitchen Inc.; El Pollo Loco; Levy Restaurants; United Artists Theatre Circuit Inc.; FedEx Kinkos Office and Print Services Inc.; Valero Energy Corp.; and Avis Rent-A-Car Systems Inc. Lawsuits are also spreading outside of California – two lawsuits were filed on March 14, 2007 in the Western District of Pennsylvania.

Thus far, many of the cases have survived motions to dismiss. Defendants have argued that dismissal is warranted because, while section 1681c(g) of FACTA applies to “cardholders,” private rights of action are only available to “consumers” under section 1681n of FCRA. This argument was rejected by California courts when raised by Oakley, Inc. and IKEA.

The success of these cases could ultimately hinge on the meaning of “willfully fails to comply” under section 1681n of FCRA. Two 9^th Circuit cases (the Federal Appellate Court for California and other western States) have ruled on the meaning of “willfully.” In Geico v. Edo, the court alluded to a “recklessness” standard:

In sum, if a company knowingly and intentionally performs an act that violates FCRA, either knowing that the action violates the rights of consumers or in reckless disregard of those rights, the company will be liable under 15 U.S.C. § 1681n for willfully violating consumers’ rights. A company will not have acted in reckless disregard of a consumers’ rights if it has diligently and in good faith attempted to fulfill its statutory obligations and to determine the correct legal meaning of the statute and has thereby come to a tenable, albeit erroneous, interpretation of the statute. In contrast, neither a deliberate failure to determine the extent of its obligations nor reliance on creative lawyering that provides indefensible answers will ordinarily be sufficient to avoid a conclusion that a company acted with willful disregard of FCRA’s requirement. Reliance on such implausible interpretations may constitute reckless disregard for the law and therefore amount to a willful violation of the law (emphasis added).

This interpretation differs from interpretations in other Federal Appellate Districts, and this issue has now been argued before the U.S. Supreme Court (additional Supreme Court briefs and other information can be found here). If the Supreme Court disagrees with the 9^th Circuit’s (and the 3^rd Circuit’s) interpretation of “willfully,” then these class actions may be difficult for plaintiffs to win (it is doubtful that plaintiffs will be able to establish actual damages to recover for “negligent” failure to comply with FCRA).

Many corporate defendants reported that they were “surprised” by the FACTA credit card receipt requirements despite the three-year grace period to achieve compliance. That seems like a plausible explanation considering that most rational companies, had they known of this requirement, would most likely have chosen to limit the information on their credit card receipts rather than face a potential fine of up to $1000 per violation and expensive attorney fees to defend class action lawsuits. Nonetheless, these companies are now experiencing the risks and expense associated with unknown privacy laws.

What should companies do to address “unknown unknowns” when it comes to privacy laws?

Organizations are not omnipotent – they cannot possibly know all things at all times at all places. However, they can take action to minimize their risk of unknown privacy and security laws, including: (1) designing their privacy programs consistent with Fair Information Practice Principles; (2) acquiring resources to stay on top of privacy and security regulations and case law; and (3) insuring against the unknown.

Fair Information Practice Principles. While the legal requirement to limit credit card receipt data may not be intuitive to all companies, there are certain general activities that rational actors know could get them into trouble when it comes to handling customer information. For example, selling or collecting personal information without notice or consent can obviously be problematic, and as a result there are laws that address those general categories of privacy violations. Addressing general privacy activities and principles can decrease risk even if specific regulatory requirements are unknown.

In fact many, if not most, privacy and security-related laws reflect the principles and framework set forth in the Fair Information Practice Principles (“FIPP”). FIPP includes: notice/awareness, choice/consent, access/participation, security/integrity and enforcement/redress. If FIPP is the goal and the organization strives to meet that goal with due diligence, that organization will likely have reduced its regulatory privacy risks (relative to organizations that do not consider FIPP).

The problem, of course, is that FIPP does not address every single detail of every privacy law. Some organizations that follow FIPP may have missed the specific requirements of FACTA or may not be aware of the specific notices (and fines) required under the CAN-SPAM Act, HIPAA, GLB and other more obscure laws. These class action lawsuits demonstrate how compliance to FIPP can help. Those companies diligently concerned about the security/integrity prong of FIPP, even without knowledge of FACTA’s specific legal requirement, may have made an independent determination that truncating credit card numbers on receipts is a good practice to secure credit card information from identity theft. In fact, some organizations likely adopted this practice prior to the FACTA law as the result of due diligence with general privacy principles.

Due Diligence Investigation. Legal violations arising out of privacy or security incidents increasingly threaten organizations in terms of reputation damage, legal fees and damage awards. In fact, more and more companies are dedicating specific resources toward addressing privacy and security legal compliance. The first step is establishing accountability within the organization by creating a manager solely responsible for privacy compliance (a C-level executive with direct reporting to the CEO is a best case), and providing he or she with a budget. The lead privacy compliance officer should hire or work with attorneys to develop a formal process for inventorying the personal information the company handles, tracking the flow of that information across jurisdictions from collection to storage/disposal and determining the laws that apply to the organization.

Companies should attempt to address the lowest hanging fruit first. In certain industries, such as finance and healthcare, comprehensive privacy laws exist such as GLB and HIPAA. If the personal information of European or Canadian companies is at issue, the national privacy law of those countries should be considered.

Determining the applicability of privacy and security laws requires a continuous effort that considers changes in both the organization’s internal privacy practices and the law. Those responsible for privacy compliance should engage in frequent and comprehensive communications with business managers whose units collect and handle personal information. Companies should track laws and legislation, and subscribe to privacy and security reporters and websites (feel free to contact me for a list of sources). A person who can make the link between organizational practices and changes in privacy laws, and how those practices laws might impact the organization, should be dedicated to tracking internal practices and privacy laws.

Privacy and Security Liability Insurance – Risk Transfer. Insurance is a very important tool for managing the “unknown unknowns.” For companies that operate across multiple jurisdictions, it is virtually impossible to know every law and how every part of an organization is reacting or failing to react to that law. This means that residual risk exists that must either be tolerated by the organization or transferred to a third party.

Privacy and security liability insurance is an excellent tool for decreasing a company’s risk load under these circumstances. While the uncertainty inherent in complying with every security or privacy law still exists for insurers, insurers can spread their risk across thousands of organizations. Moreover, even if aggregated events occur, as long as the insurer has a good financial rating, they should be able to absorb the loss. Even insurance companies without the highest financial ratings are typically reinsured by large reinsurers who are able to weather adverse situations.

The ability of insurers to underwrite privacy and security liability risks in a world where such risks are sometimes “unknown” addresses the main problem of modern organizations. Instead of expending huge amounts of resources to achieve an unattainable level of “perfect security,” or researching, discovering and analyzing every possible privacy law that applies to them, insurers can take the risk and help their insureds avoids those expenses.

That is not to say that insurers will insure companies with bad privacy practices or poor information security. To be insurable, at a minimum, “reasonable” security and privacy practices must be present (and what is reasonable can vary from insurer to insurer). Nonetheless, most companies that can establish “due diligence,” and have practices and policies adhering to FIPP and generally accepted security standards such as ISO 17799, will likely be insurable.

There are two key challenges for companies that want to use insurance as a risk management tool in this context. First is implementing security and privacy practices that meet a level of reasonableness at the lowest price. As long as insurance is available, spending more to achieve “more than reasonable” privacy/security may not be cost-effective. Moreover, large security and privacy overhauls can be disruptive to business. The risk avoided by implementing costly controls can be transferred for the price of an insurance policy which typically costs less than the controls.

Second, and perhaps most important for an organization that wants to manage risk through insurance, is ensuring that the privacy and security insurance policy it chooses actually covers the risks the organization desires to transfer. If it does not, the organization will be left handling the costs of that risk on its own. It takes a concerted effort by risk managers and key business stakeholders to understand not only the potential risks, but also how they might impact the organization if the risk is realized.

On the other side of the equation, since the current crop of security and privacy policies vary in their approach and coverage scope, it is not always easy to get a clear picture of what is covered. Organizations should make sure they have good brokers or insurance consultants who understand the specific risks of their company and the insurance products available to cover such risks. In all, if some time and effort is taken to understand the range of security and privacy insurance options, insurance can be a very cost-effective and efficient tool for dealing with “unknown unknowns.”

Conclusion

While the risks and problems associated with unknown privacy or security regulations may never be fully solved, the awareness of organizations and the skill and talent available to address the problem are probably at their highest. Companies simply need to acknowledge the fact that unknown unknowns exist in the privacy world, and dedicate time and resources toward at least converting them into “known unknowns.” Even unaddressed privacy laws are better than unknown laws because at least the organization is aware of some risk and presumably has factored it into their overall risk management scheme. Organizations that are serious about understanding the full scope of their risk need to engage in a due diligence investigation, and need to at least try to adhere to common industry privacy practices and security standards. Companies should also seriously consider transferring their residual risk rather than engaging in potentially never-ending and expensive attempts to “eliminate” their risk. When these steps are taken, organizations can decrease the risk and loss associated with unknown security and privacy laws.

Proposed Massachusetts Security Breach Notice Law Creates Additional Liability for Companies Accepting Credit Cards.

Proposed Massachusetts Security Breach Notice Law Creates Additional Liability for Companies Accepting Credit Cards.

For companies that store or process credit card data, the legal landscape may be getting a little more risky.

Similar to breach notice laws passed in thirty-five other States, a proposed Massachusetts bill (H. 213) requires notice to residents of the State if, as the result of a breach of system security, “misuse of information about a Massachusetts resident has occurred or is reasonably likely to occur.” The bill also requires entities that do not own or license personal information (which appears to include service providers working on behalf of the company that originally collected the information) to report to the owner or licensee of the personal information.

However, the bill goes a step further and requires organizations to reimburse banks for banks’ “reasonable actions” in response to a data security breach where notice is required. Reimbursable costs include:

(a) the cancellation or reissuance of any credit card issued by any bank or access device;

(b) the closure of any deposit, transaction, share draft or other account and any action to stop payments or block transactions with respect to any such account;

(c) the opening or reopening of any deposit, transaction, share draft, or other account for any customer of the bank; and

(d) any refund or credit made to any customer of the bank as a result of unauthorized transactions.

This new remedy may be related to recent unsuccessful lawsuits by banks seeking to recover the costs of reissuing credit cards exposed as the result of a security breach.

In 2005 B.J. Wholesalers suffered a security breach and was sued by several “issuing banks” to recover costs to reissue credit cards (B.J. Wholesalers faced suits by four banks alleging millions of dollars in losses). However, the courts presiding over those cases rejected the banks’ third party beneficiary, negligence, promissory estoppel and breach of fiduciary duty claims, and dismissed the cases (see e.g. B.J. Wholesaler Summary Judgment Ruling, PSECU Motion to Dismiss).

More recently, TJX Companies (holding company of such retailers as TJ Maxx, Homegoods and Marshalls and headquartered in Massachusetts) was sued by an Alabama-based AmeriFirstBank Inc. bank in the wake of a security breach. AmeriFirstBank alleges that it costs the bank approximately $20 to reissue a single card. News reports indicate that the breach may have exposed more than 40 million credit cards and approximately 60 banks have been notified of potential exposure. Some of these banks, including Chase, Citibank, the Maine Credit Union and TD Bank North, have already reportedly reissued millions of credit cards based on the TJX breach.

This Massachusett’s bill may not be an isolated event -- other States and the Federal government are reportedly considering similar legislation according to this credit union source.

What might this mean in terms of managing information security risk?

For companies handling credit card information it means a fairly direct path to legal liability if a breach exposes credit card information. The legislation is not limited to a narrow definition of retailer, but applies to the “commercial entities” (broadly defined). Assuming damages of $20 for each card reissued, if a breach involves several thousands or millions of cards, the potential damages could be staggering. For smaller organizations a potential security breach could result in bankruptcy. For larger retailers with millions of credit cards stored, it could result in tens of millions of dollars in damages.

Moreover, the standard of proof for banks is arguably not very high. First, there must have been a security breach that resulted in the misuse of information about a Massachusetts resident, or such a misuse is reasonably likely to occur. Second, the banks actions must have been “reasonable actions,” which includes those broad actions listed above. Therefore, a decision to report arguably guarantees that the organization will have to reimburse some bank costs. Ironically, since consumers do not have a direct remedy in the statute, the law may produce a strong incentive to avoid reporting to consumers if there is uncertainty as to whether misuse has occurred.

What should companies do to if a law like this is passed?

From a risk management perspective, organizations should conduct a risk analysis to determine how much credit card information they are handling, and whether it is subject to being stolen in large quantities. Since the potential liability for a breach could be enormous, the justification for enhanced security should be present. Regardless, companies should work hard toward at least achieving PCI compliance if handling credit card data. Since companies may be liable if their service provider suffers a breach, they should work to assess the controls of those service providers (or only work with those that are certified as PCI compliant)

In addition, the existence of a law like this creates a very strong argument for insurance to transfer the risk of loss. Risk managers should check their insurance policies to determine if any coverage exists under their current forms, and should consider the purchase of information security and privacy policies. Some policies now provide coverage for liability arising out of a security breach and with respect to the costs of providing notice of a security breach.

From a legal perspective, it appears that legal liability could arise out of a breach related to a third party service provider. Therefore, attorneys for companies collecting credit card information and passing it on to service providers for processing must make sure that there are contractual duties to maintain adequate security, report security breaches and potentially indemnify for losses (in fact the PCI Standard actually requires the development of contract terms that mandate compliance with the PCI Standard). In addition, attorneys need to be versed in the details of such laws so they can provide good counseling when a suspected security incident occurs.

Conclusion.

It is very interesting that the liability potential for security breaches is now being pushed from the commercial side (while being pushed more slowly from the consumer side). If a bill such as H. 213 is passed it has the potential to radically change the information security risk management dynamic for companies handling credit cards. There will be strong interests on both sides (banks versus retailers) that will push for and against a scheme like this, so it is unlikely that it will be passed in its current form. Nonetheless, it will be very interesting to see if and how these laws develop further, and it is important for risk managers to pay close attention to the progress of bills of this type.