The New Path to PCI Liability: 3rd Party Beneficiary Theory

An easy-to-read PDF version of this article can be found here: LINK.

Merchants face a potentially huge liability if they suffer a security breach exposing payment card data. Issuing banks (those banks that issue credit cards to consumers) have filed lawsuits to recover reissuiance costs allegedly ranging from $20-$50 per card (multiplied by thousands or millions of cards depending on the magnitude of the breach). A recent decision from the U.S. Court of Appeals for the Third Circuit (“3^rd Circuit” or “Appellate Court”) appears to have expanded the potential liability merchants face for payment card security breaches. In Sovereign Bank v. B.J. Wholesale Club & Fifth Third Bank, No. 06-3392/3405 (3^rd Circuit, July 13, 2008)(hereinafter the “BJW Decision”), while the Appellate Court affirmed the lower court’s dismissal of most of the claims against B.J. Wholesale Club, it reversed the lower court’s dismissal of Sovereign Bank’s breach of contract action that was based on a third party beneficiary theory. This article explores how the Appellate Court reached its decision, how the decision could increase the legal risk faced by merchants that suffer security breaches and potential actions merchants can take to better understand and mitigate their legal risk.

Background

The BJW Decision arose out of a payment card security breach suffered by B.J. Wholesale Club (“BJW”) that was first reported in March 2004. Criminals were able to steal (and commit crimes using) the magnetic stripe information from payment cards stored by BJW. In reaction to this security breach, Sovereign Bank and the Pennsylvania State Employee’s Credit Union (hereinafter “Issuing Banks”) incurred costs to reissue the payment cards that were the subject of the BJW breach. Litigation ensued in 2005 when the Issuing Banks separately sued BJW and BJW’s merchant bank (Fifth Third Bank) to recover their reissuance costs. The federal lawsuits were eventually consolidated in the U.S. District court for the Middle District of Pennsylvania (the “Lower Court”) and alleged the following causes of action: (i) negligence; (ii) breach of contract (Third Party Beneficiary Theory) and (iii) equitable indemnification; (iv) breach of fiduciary duty and (v) promissory estoppel. The Lower Court fully granted the defendants’ motion to dismiss and motion for summary judgment, which lead to the plaintiff’s to appeal (see Sovereign Bank v. B.J. Wholesale Club, 385 F.Supp.2^nd 183 [M.D. Pa. 2005] and Sovereign Bank v. B.J. Wholesale Club, 427 F.Supp.2d 256 [M.D. Pa. 2006]).

Relationship Between the Players in the Payment Card System

In order to understand the Appellate Court’s ruling one must first be aware of the relationships (contractual or otherwise) between the players in the payment card system.

In this case, BJW was the merchant that accepted payment cards from consumers (some of whom were issued their cards by the Issuing Banks). In order to accept credit cards and become part of payment card networks such as Visa or Mastercard, merchants must work through and contract with an acquiring bank (a.k.a. “acquirer” or “merchant bank”). In this case Fifth Third acted as BJW’s merchant bank and had a “Merchant Agreement” in place with BJW. In turn, moving upstream, Fifth Third had a “Member Agreement” in place with VISA. Pursuant to the Member Agreement, Fifth Third became a “member” of the VISA network and agreed that it would comply with VISA’s Cardholder Information Security Program (“CISP”) and VISA’s Operating Regulations (note that at the time of the breach the PCI Standard was not in effect and each card brand had its own security standard).

Sovereign Bank, was one of the Issuing Banks that had issued payment cards to various consumers that were impacted by the BJW security breach. Sovereign Bank is also a member of the VISA network by virtue of its own Membership Agreement with VISA. However, the Issuing Banks had no direct contractual relationship with Fifth Third or BJW. A graphic representation of the contract chains can be found at this link: BJW Contract Relationship Chart.

Sovereign Bank’s Breach of Contract Allegations

Despite not having a direct contractual relationship with Fifth Third, Sovereign Bank alleged a breach of contract claim based on Fifth Third’s breach of the Membership Agreement between Fifth Third and VISA. Although it was not a party to the Membership Agreement, Sovereign alleged that it was an intended third party beneficiary of the agreement (see BJW Contract Relationship Chart).

Pursuant to the Membership Agreement, Fifth Third agreed comply with VISA’s Operating Regulations (which included VISA’s Cardholder Information Security Program). The version of the Operating Regulations applicable to this case provided the following:

• Fifth Third agreed to ensure that its merchants (BJW in this case) complied with the Operating Regulations

• Fifth Third agreed to enter into a Merchant Agreement with each of its merchants requiring each merchant to comply with VISA’s Operating Regulations

• A prohibition against retaining or storing the data encoded on the magnetic stripe on the back of payment cards after a transaction is authorized (this is essentially the same prohibition set forth now in section 3.2 of the PCI Standard), and a duty for Fifth Third to impose this obligation on merchants like BJW

• Provisions concerning dispute resolution between members, including chargeback and representment procedures, and arbitration provisions.

Significantly the Operating Regulations in place at that time did not eliminate any other rights an issuing bank may have to pursue any legal remedy that may otherwise be available. As discussed further below, unless Visa’s Operating Regulations have changed, this suggests that there is no real “safe harbor” for PCI compliance.

Sovereign Bank alleged that both BJW’s failure to delete the magnetic stripe data, and Fifth Third’s failure to ensure BJW’s compliance with the deletion requirement constituted a breach of the Operating Regulations by Fifth Third. Sovereign Bank further contended that these contract breaches allowed the unauthorized access to, and use of, payment card data at BJW, and that Sovereign Bank was legally obligated to reimburse cardholders for fraudulent charges that resulted. Moreover, the resulting unauthorized access to payment card data also required Sovereign Bank to incur the expense to reissue the compromised payment cards. Finally, the Issuing Banks alleged that their customer goodwill was adversely impacted by the BJW breach. The Appellate Court was called upon to rule on these issues in a motion to dismiss/summary judgment context.

The Issue to Resolve: 3^rd Party Beneficiary Theory.

The Appellate Court considered the following issue:

Was Sovereign Bank an intended third party beneficiary of the Member Agreement between Fifth Third and VISA?

Although Sovereign Bank conceded that it is not an express third party beneficiary of the Member Agreement between Visa and Fifth Third, it based its argument on § 302 of the Restatement (Second) of Contracts (which had been adopted under Pennsylvania law, which governed this case):

Intended and Incidental Beneficiaries

(1) Unless otherwise agreed between promisor and promisee, a beneficiary of a promise is an intended beneficiary if recognition of a right to performance in the beneficiary is appropriate to effectuate the intentions of the parties and either:

(a) the performance of the promise will satisfy an obligation of the promisee to pay money to the beneficiary; or

(b) the circumstances indicate that the promise intends to give the beneficiary the benefit of the promised performance.

(2) An incidental beneficiary is a beneficiary who is not an intended beneficiary.

In the context of § 302, the court framed the issue as follows:

Under § 302, Sovereign’s contract claim depends on whether “the recognition of a right to performance” in Sovereign is “appropriate to effectuate the rights of” both Visa and Fifth Third in entering into their Member Agreement and whether “the circumstances indicate that” Visa (the promisee) “intended to give Sovereign the benefit of the promised performance.”

To establish whether Visa intended to give issuing banks like Sovereign the ability to rely on Fifth Third’s promises in the Member Agreement, Sovereign relied on the deposition testimony of Visa’s representative, Alex Miller. Miller testified that he was not aware of any intent on Visa’s behalf to create a direct right to benefit third parties, and that no documents existed that allowed issuing banks to “step into [Visa’s] shoes” to enforce the Membership Agreement with Fifth Third.

However, Miller also stated:

It’s fair to say that the core purposes of the operating regulations is to set up the conditions for participation in the system, to set up rules and standards that apply to that ultimately for the benefit of the Visa payment system, the members that participate in it and other stakeholders such as cardholders, merchants and others who may participate in the system as well.

Miller further testified that the purpose of Visa Operating Rules (including CISP in this case) was to maximize the value of the Visa system as a whole, including “to protect issuers.” Fifth Third argued that Miller’s statements evidenced that Visa’s Operating Regulations were intended not to benefit any individual member or class of members, but the Visa system as a whole.

Sovereign argued that Visa’s Operating Rules were specifically intended to benefit issuers. In addition to Miller’s testimony, it pointed to an August 1993 memo sent by Visa to its members that specifically alerted members of the (then) new requirements to delete magnetic stripe data (hereinafter referred to as “August 1993 Memo”).

That memo started off with the following:

To protect the Visa system and Issuers from potential fraud exposure created by databases of magnetic-stripe information, Section 6.21 has been revised. Effective September 1, 1993, the retention or storage of magnetic stripe data subsequent to the authorization of a transaction is prohibited. Acquirers are obligated to ensure that their merchants do not store the magnetic-stripe information from Visa Cards for any subsequent use.

Sovereign also relied on a May 2003 article printed online by Visa entitled “Issuers and Acquirers Are At Risk When Magnetic-Stripe Data Is Stored,” which indicated that magnetic stripe data compromises “impact[] Issuers” (hereinafter referred to as “May 1993 Memo).

The Appellate Court’s Decision and Reasoning

The Appellate Court considered the arguments by both sides and ultimately held that genuine issues of material fact did exist as to whether Sovereign was an intended beneficiary of the Member Agreement between Fifth Third and Visa, and therefore the case should be remanded for further proceedings (e.g. trial) rather than decided on a summary judgment motion.

The Appellate Court rejected Sovereign’s reliance on the May 2003 Memo, indicating that it simply stated the reason for the prohibition against retention of magnetic stripe data. However, the Appellate Court agreed that the August 1993 Memo and Miller’s “core purpose” testimony (referenced above), raised genuine issues of fact.

The court noted that Sovereign is a Visa member and that the core purpose the Operating Regulations according to Miller was to benefit members that participate in the Visa system. Just because Miller also indicated the Operating Rules were to benefit other stakeholders (such as cardholders, merchants and others who may participate in the system), the possibility that Visa intended to benefit individual users such as Sovereign was not negated.

Moreover, the Appellate Court held that the August 1993 Memo clearly stated that acquirers (such as Fifth Third) must act to protect Issuing Banks (like Sovereign) by ensuring that merchants (like BJW) do not retain magnetic stripe data. The Appellate Court held that this piece of evidence alone was sufficient to get Sovereign past summary judgment. Based on the foregoing, the Appellate Court remanded Sovereign’s breach of contract claim for further proceedings (e.g. trial in front of a judge or jury).

Analysis -- Increased Merchant PCI Liability

Similar to Minnesota’s Plastic Card Protection Act (discussed at this LINK), this decision has the potential to significantly increase the liability risk faced by merchants that are not compliant with PCI and that suffer a security breach.

First, although the Appellate Court’s breach of contract decision only involved the acquirer and the issuing bank, merchants such as BJW may ultimately be liable for the issuing bank’s costs. The source of this liability will also be contractual. However the contract at issue in this case is the direct contract between the merchant bank and the merchant (hereinafter “Merchant Agreement” -- see BJW Contract Relationship Chart). As the court ruled, this case will now be remanded to the lower court. A judge or jury could find Fifth Third liable to Sovereign for reissuance costs, or Fifth Third and Sovereign may settle the case based on the strength of Sovereign’s breach of contract claim. If Fifth Third wanted to recover the damages it paid to Sovereign, it may be able to rely on language in the Merchant Agreement between it and BJW to recover directly from BJW.

It is not atypical for a merchant to enter into a very one-sided Merchant Agreement with an acquiring bank (or the acquiring bank’s processor). Such Merchant Agreements often require the merchant to comply with the card association’s operating rules, security program and/or PCI. A sample of how such language may read is as follows:

Merchant agrees to comply with all security standards and guidelines that may be published from time to time by Visa or MasterCard and any other applicable industry security standards, including, without limitation, the Visa U.S.A. Cardholder Information Security Program (“CISP”), the MasterCard Site Data Protection (“SDP”), and the Payment Card Industry Data Security Standard (the “Security Requirements”).

If BJW agreed to comply with Visa’s Operating Rules and/or CISP, Fifth Third may have a right to recover any damages paid to Sovereign under a breach of contract theory (BJW having breached the Merchant Agreement).

In fact, merchant banks may have an explicitly contractual right to recover reissuance costs they are forced to pay issuing banks. It is likely that the Merchant Agreement requires the merchant to indemnify the merchant bank for liability it incurs because the merchant allowed a security breach. A sample of how such language might read is as follows:

Merchant agrees to indemnify Acquiring Bank, Member, the Associations, affiliates, officers, directors, employees, agents and issuing banks from any losses, expenses, costs, liabilities, and damages of any and every kind (including, without limitation, our costs, expenses, and reasonable legal fees) arising out of any claim, complaint, or chargeback caused by the merchant’s noncompliance with this Agreement, any Security Requirements or the Association Rules.

If similar language exists in the Merchant Agreement between BJW and Fifth Third, Fifth Third may demand that BJW indemnify it for any issuing costs that Fifth Third is required to pay to Sovereign. Of course, if BJW refuses, Fifth Third will again need to file a claim against BJW for breach of the Merchant Agreement. In short, by allowing an issuing bank to use the Visa Member Agreement to go after the merchant bank, the Appellate Court opened a path to merchant liability for the costs incurred by the issuing bank to reissue credit cards. The path starts with the Member Agreement, goes through the Merchant Agreement and ends up at the merchant.

PCI Compliance as a Defense – Existence of “Safe Harbor?”

Despite the existence of this contractual path to liability, the question arises whether a merchant’s compliance with the PCI and card association operating regulations will insulate the merchant from liability if it suffers a payment card security breach. Unfortunately, from the issuing bank’s point of view the merchant’s PCI compliance status is irrelevant – the issuing bank still must pay to reissue payment cards after a security breach of a PCI-compliant merchant. There are several points which may illuminate whether PCI compliance provides an automatic “safe harbor” from liability.

First, at least under the version in effect during the BJW case, according to the Appellate Court, issuing banks were not precluded by Visa Operating Rules from pursuing any available remedies at law. Thus, even if a merchant had fully complied with PCI and the applicable operating rules, an issuing bank’s status as a member of Visa or Mastercard does not block it from going after merchants. In fact, even if an issuing bank had agreed with Visa to refrain from pursuing merchants that were PCI compliant, the only party that could enforce that agreement would be Visa (unless, ironically, the merchant could be argued to be a third party beneficiary of the Member Agreement between Visa and the Issuing bank). Significantly, while compliance with the industry standard for protecting cardholder information will offer merchants a strong defense, it is still possible that a merchant could be liable under other theories of liability (e.g. negligence) if a court finds that the PCI standard itself is inadequate (see e.g. T.J. Hooper case).

Second, a PCI-compliant merchant’s liability will be largely contingent on the language set forth in the Member Agreement between the acquiring bank and the card association, and the Merchant Agreement between the acquiring bank and the merchant itself. If the Member Agreement makes the acquiring bank responsible for merchants’ security breaches in general (regardless of PCI compliance) and the Merchant Agreement requires the merchant to indemnify the acquiring bank for any losses, then the path to liability described above could apply. In such a case, in order to “block” the path from issuing bank through the Member Agreement, the Member Agreement would have to contain specific language providing a PCI “safe harbor” (alternatively, as discussed further below, the merchant may be able to negotiate a “safe harbor” in the Merchant Agreement to block the liability path).

Significantly, gaining access to the card associations’ operating rules and Membership Agreements has been notoriously difficult. Without the ability to read to those documents it may be hard to ascertain the scope of the liability risk under this theory since the merchant will not be aware of the merchant bank’s obligations to the card association in the event of a merchant security breach.

Limited Applicability?

Variations in the terms and conditions of Member Agreements and card association operating rules may also impact the path to merchant liability. As such, the holding in the BJW may not apply if there have been changes in subsequent versions of these documents. For example, if the current versions of Visa’s Member Agreement specifically precludes enforcement of the Merchant Agreement by third parties, then the issuing banks would not be able to use employ the 3^rd party beneficiary theory used by Sovereign. However, if the Member Agreement between the card association and acquirer bank remains silent, then the same rationale in the BJW decision could apply.

With respect to Visa’s Member Agreements, where intent is unclear, issuing banks may be able to rely on Mr. Miller’s deposition testimony in the BJW decision. As such, cases brought in jurisdictions that follow section 302 of the Restatement (Second) of Contracts may be prone to agree with the Appellate Court’s decision. Again, unfortunately, merchants will not be able to ascertain the full extent of their risk unless they can get access to the acquiring bank’s Member Agreement or be informed of whether it prohibits third party beneficiaries.

Merchant Actions to Potentially Reduce the Risk of Liability

There may be some steps that merchants can take to reduce their risk of liability for a payment card security breach. The BJW path to liability is a two step process. First the issuing bank must successfully sue the acquirer for breach of the Member Agreement between the card association and the acquirer, then the acquirer must pursue the merchant under the Merchant Agreement. Thus, merchants should consider both steps to determine the extent of their potential liability and for purposes of cutting off the path.

• Attempt to Determine Existence of 3^rd Party Beneficiary Prohibition in Member Agreement

The first step on the path to liability under the 3^rd party beneficiary theory is whether the Member Agreement between the card association and acquirer bank precludes third party enforcement of the Member Agreement. Merchants should ask their acquirer banks if they can examine their Member Agreement. It is likely, however, that the acquirer bank will be unwilling to provide the agreement itself. If not, the merchant should at least attempt seek assurances that there is a prohibition against third party beneficiaries. If the Merchant Agreement does not contain such a prohibition, then it is possible that the first step on the BJW liability path is open. Therefore, the merchant should seek to cut off the second step on the path, the Merchant Agreement.

• Negotiate a “Safe Harbor” in the Merchant Agreement

Obviously, the merchant has little control over what third party beneficiary terms its acquirer may have agreed to in the Member Agreement. However, a merchant does have some control over the terms it agrees to in its Merchant Agreement with its acquirer. It may be possible for a merchant to cut-off liability even if the issuing bank has been successful as a third party beneficiary of the Member Agreement. When entering into negotiations with acquirers (or their payment processors) merchants should attempt to negotiate a “safe harbor” into their Merchant Agreement. In essence, the safe harbor language would indicate that in the event of a security breach involving payment card information, if at the time of the breach the merchant was compliant with PCI and/or the card association’s operating rules, the acquirer would have no right to indemnification or any other recourse against the merchant. Rather than relying on (mostly likely) illusory safe harbors identified by the card associations, this would provide a direct right to avoid contractual liability if the merchant has done everything it promised with respect to PCI.

The parameters of the safe harbor should be defined to protect the merchant. First, the merchant agreement should identify a truly independent third party responsible for performing a post-breach PCI/operating rules audit, and set-up a process for the audit itself (note that one issue to consider is that the auditors findings will not be protected by attorney-client privilege, so caution is warranted). This third party would be the last word on whether the merchant was PCI-compliant at the time of the breach. Currently this post-incident response is performed by auditors hand-picked by the card associations, and some believe, because of close relationships these auditors have with the card associations, they could be less than “neutral” when performing these audits. Second, the standard for compliance should not be strict compliance. Rather, the merchant should be deemed to be compliant unless it is in material non-compliance with PCI. Finding technical non-compliance with some section of PCI or card association rules, as any security expert can tell you, is not difficult. Even better would be language requiring the non-compliance with PCI to be the actual cause of the security breach at issue – if the non-compliance was not in anyway relevant to the breach the merchant would not be liable. Last, if possible, the Safe Harbor should include indemnification from the acquiring bank if the merchant is PCI-compliant at the time of the breach. This would allow the merchant to cut off direct suits from other stakeholders (consumers, issuing banks, card associations). Admittedly, however, it will likely be difficult to convince an acquiring bank to go this far.

Whether a merchant will be able to negotiation a safe harbor or any other term of the Merchant Agreement will depend a large part on negotiating leverage. Larger merchants with clout, or any merchant willing to “shop around” between multiple acquiring banks, will be in the best position to negotiate favorable terms. Some of the same negotiating leverage issues apply for this route as well.

• Limitation of Liability

In addition, merchants should consider a limitation of liability that caps the merchant’s potential liability in the event of a security breach exposing credit card data. Merchants that have expended significant resources in becoming PCI compliant may be able to justify the cap more easily.

• Insure Against Payment Card Security Breaches

The insurance market has created information security and privacy liability policies which may cover liability arising out of a payment card breach. Since the risk of a security breach can never be 100% eliminated, insurance may be a good risk management tool to transfer unwanted risk. The key for utilizing insurance is to make sure the risk the merchant desires to transfer is actually transferred in light of the terms, conditions and exclusions in the insurance policy.

Conclusion

Merchants can no longer afford to treat PCI compliance as a pure security issue. Merchants should carefully analyze their PCI liability risk and determine ways to mitigate that risk. Laws like Minnesota’s Plastic Card Protection Act and the BJW decision have likely increased the risk significantly. The potential for huge damage is great - issuing banks have alleged that the costs of reissuing payment cards range from $20-$50 per card (multiplied by thousands or even millions of cards). For smaller and medium companies highly reliant on payment cards, the failure to address this risk ahead of time can mean bankruptcy. For larger retailers, the prospect of spending tens of millions of dollars defending and settling lawsuits against issuing banks and merchants should spur on a careful examination of all merchant agreements, and the possible shopping around for merchant banks and payment processors that provide reasonable terms.

As such, more than ever, merchants must work with their legal counsel and risk managers to understand and mitigate the risk. Merchant lawyers must analyze their clients’ current contractual relationships with acquiring banks and assist in negotiating favorable terms with payment processors and merchant banks. Since the risk is somewhat unpredictable and may be difficult to eliminate, information security and privacy risk insurance should also be considered. Lawyers should carefully analyze the scope of information security liability coverage to make sure their PCI risk is being transferred to the insurers. If the proper steps are taken, merchants may be able to avoid or mitigate significant losses in the event of a security breach.

Forever 21 -- Breached and PCI Compliant

I anticipate we will be seeing a lot more instances of merchants suffering payment card breaches while PCI compliant. The question is, will they be held liable for those breaches. An article soon on that. For now, here is an article on Forever 21, which just reported a breach involving over 98,000 card numbers. Forever 21 claims that is has been certified as PCI compliant since 2007. However, all of the incidents happened from March 2004 to August 2007. Therefore it is possible that Forever 21 was not PCI-compliant at the time of the incidents, but became so in after August 2007.

Best Western: PCI Compliant and Hacked

While the details are still murky on the number of records impacted (somewhere between 13 and 8 million), it appears that we have a security breach of another high profile corporation claiming PCI compliance at the time of breach. SC Magazine has the story here.

Here is Best Western's statement on the breach:

“We comply with the Payment Card Industry (PCI) Data Security Standards (DSS). To maintain that compliance, Best Western maintains a secure network protected by firewalls and governed by a strong information security policy. We collect credit card information only when it is necessary to process a guest’s reservation; we restrict access to that information to only those requiring access and through the use of unique and individual, password-protected points of entry; we encrypt credit card information in our systems and databases and in any electronic transmission over public networks; and again, we delete credit card information and all other personal information upon guest departure. We regularly test our systems and processes in an effort to protect customer information, and employ the services of industry-leading third-party firms to evaluate our safeguards.”

Obviously, the facts are still murky, but it will be interesting to see what, if any, protection PCI compliance will have from a liability perspective and a "safe harbor" perspective.

FACTA Development: The “Credit and Debit Card Receipt Clarification Act of 2007” Signed into Law.

The FACTA class action litigation saga has taken a new twist. Congress has passed and the President has signed the Credit and Debit Card Receipt Clarification Act of 2007 (the “Act”) into law. The Act will likely provide a large set of FACTA class action defendants with the ability to escape expensive litigation and liability.

As previously reported, plaintiffs have filed FACTA class action lawsuits based not on the printing of the payment card number on an electronically printed receipt, but simply based on the printing of the expiration date on a receipt (see for example the StubHub case referenced in this post). In fact, the relevant FACTA section establishes an “either/or” scenario:

Except as otherwise provided in this subsection, no person that accepts credit cards or debit cards for the transaction of business shall print more than the last 5 digits of the card number or the expiration date upon any receipt provided to the cardholder at the point of the sale or transaction.

15 U.S.C. 1681c(g) (emphasis supplied). If a plaintiff is able to establish a willful violation of FACTA, a court could award statutory damages ranging from $100 to $1,000 without the having to establish that he or she suffered actual harm.

Unfortunately dozens of companies that had made the effort to truncate the payment card numbers nonetheless were sued in FACTA class actions alleging a failure to remove the expiration date from payment card receipts (see e.g. Troy v. Home Run Inn, No. 07CV4331 (N.D. Ill 2008)); Cicilline v. Jewell Food Stores, No. 07CV2333 (N.D. Ill 2007)).

Congress passed the Act in light of these “expiration date only” FACTA lawsuits. The relevant part of the Act states:

(d) Clarification of Willful Noncompliance- For the purposes of this section, any person who printed an expiration date on any receipt provided to a consumer cardholder at a point of sale or transaction between December 4, 2004, and the date of the enactment of this subsection but otherwise complied with the requirements of section 605(g) for such receipt shall not be in willful noncompliance with section 605(g) by reason of printing such expiration date on the receipt.

(emphasis supplied). In essence this language appears to block plaintiffs from going after statutory damages under FACTA. Since those statutory damages are the only reason these cases are attractive to plaintiffs attorneys, it is likely that class actions on this basis will not be pursued.

Significantly, the Act applies retroactively: it would apply to FACTA lawsuits already filed on the basis of printing the expiration date on the receipt.

This is obviously good news for defendants. However, the way Congress went about this raises some questions. Rather than “clarifying” the law by stating that printing just the expiration date is not a violation of FACTA, Congress left the door open for plaintiffs that suffer “actual harm” based on the “non-willful” printing of the expiration date. Admittedly, few if any plaintiffs will be able to establish actual harm in this context.. However, there is a certain logic gap at play here.

Congress has said unequivocally, regardless of the actual facts of the case, that printing the expiration date shall not be “willful noncompliance.” What if, in an (extreme) hypothetical, a defendant wrote an email stating:

I, President of ABC company, understand that FACTA prohibits the printing of a credit card expiration date on the receipt, but for financial reasons I intend to not follow that legal requirement.

Based on the Act, there would still be no willful violation even though under this hypo there was one in laymen’s terms. Of course in “real life” this email likely does not exist, but there could be lesser evidence establishing “willfulness” that could be in play. In short, Congress took an awkward somewhat Alice-In-Wonderland approach to rectify the situation, and hopefully it does not give plaintiffs a hook to keep these cases in court (clearly more research would be needed as to how legislative intent is factored in these scenarios). Regardless, at the minimum, this gives the FACTA defendants great litigation leverage on this issue.

Another “Victory” on the Issue of “Damages” in a Security Breach Negligence Case

As has been reported on this blog previously (here and here), many courts that have considered the issue of damages in a security breach scenario involving personal information have concluded that taking pre-emptive actions (such as purchasing credit monitoring services) do not amount to “damages” for purposes of a negligence claim. some chinks, however, have begun to develop in the “damages” armor used by defendants in security breach negligence cases. A recent decision sets forth another possible theory of liability to get a plaintiff at least beyond a motion to dismiss.

In Ruiz v. Gap, 07-5739 (N.D. Cal. 2008), a class of plaintiffs sued the Gap alleging that their unencrypted personal information resided on one of two laptops stolen from one of the Gap’s vendor (the personal information of approximately 800,000 Gap job applicants was stored on the laptops). The Gap offered the plaintiffs 12 months of credit monitoring services and fraud assistance without charge, as well as access to $50,000 worth of identity theft insurance.

The Ruiz court analyzed the plaintiffs’ complaint to determine whether the plaintiff properly alleged an “injury in fact” for purposes of standing and the issue of damages with respect to the plaintiffs’ negligence claim. In particular, the court noted that the plaintiffs had merely alleged that they were at “an increased risk of identity theft” and did not allege that their identity had been stolen.

The court noted that the plaintiffs’ allegations seemed “conjectural or hypothetical, rather than actual or imminent,” and that there was nothing else to allow the court to determine that the risk was actual, imminent or credible. Nonetheless, the court presumed that the general allegations embraced the specific facts supporting them and denied the motion to dismiss. The court did, however, issue a warning to the plaintiffs indicating that if it became apparent that their allegation of injury was too speculative or hypothetical the plaintiffs’ case may be dismissed later in the proceeding. In addition, the court noted that the extent of recoverable damages was unclear even if the plaintiffs were to prevail on a negligence claim.

Unfortunately, as with other negligent security cases allowing plaintiffs to proceed past a motion to dismiss, the court did not provide a highly developed legal rationale to support its decision. In this case it appears that the court simply accepted on its face that the alleged “increased risk of identity theft” constituted an injury. It went further and allowed the negligence claim to proceed even though no specific facts were alleged supporting that the plaintiffs were at increased risk. For the time being at least, it appears to be another small chip off the damages security breach defense rationale.

"Damages" in a security breach case... er.. maybe kinda...

A recent opinion came out of the U.S. District Court for the District of Columbia that denies defendant's motion to dismiss a case against the Transportation Safety Administration arising out of the loss of hard drive containing the personal information of 100,000 TSA employees (including names, SSNs, DOBs, bank account numbers, etc.).

The plaintiff's alleged a violation of section 522a(3)(10) of the Privacy Act, which provides:

Each agency that maintains a system of records shall . . . establish appropriate administrative, technical, and physical safeguards to insure the security and confidentiality of records and to protect against any anticipated threats or hazards to their security or integrity which could result in substantial harm, embarrassment, inconvenience, or unfairness to any individual on whom information is maintained .

In various contexts, the defendants argued that the plaintiff's had not alleged actual damages, that damages should be construed as only encompassing "out-of-pocket" pecuniary loss, and that plaintiffs' concerns about harm were speculative and dependent on future events (e.g. criminal misuse of the plaintiff's personal information by third parties).

The court analyzed the following injury allegations by plaintiffs:

“embarrassment, inconvenience, mental distress, concern for identity theft, concern for damage to credit report, concern for damage to financial suitability requirements in employment, and future substantial financial harm, [and] mental distress due to the possibility of security breach at airports."

In rejecting the defendant's motion to dismiss on the issue of injury/harm/damages, the Court focused on the "embarrassment... mental distress.... and concern" allegations. It held that those emotional distress allegations were not speculative nor dependent on future events.

The court also noted that the plaintiffs conceded that they were not alleging "current, actual, financial loss" or seeking out-of-pocket expenses. The court cited a case interpreting the Privacy Act that held that actual damages were not limited to "pecuniary losses" and that actions under the Privacy Act could survive the motion to dismiss phase based on pain and suffering and non-pecuniary losses. In this case the allegation of emotional distress was sufficient to surviving a motion for summary judgment.

There are several issues to address in this case:

(1) First off, since the plaintiffs did not appear to allege "out-of-pocket" expenses related to the security breach, it does not appear that the logic of this case would apply to situations where a plaintiff incurs costs (e.g. credit monitoring) to head off potential future harm that could arise out of identity theft (e.g. bad credit, cleaning up credit reports, credit monitoring, etc.). Rather, this case focused on whether "emotional distress" or "concern" was itself actual damages or an adverse impact under the Privacy Act. So I am not sure it helps support the theory that out-of-pocket expenses post breach, pre-Identity Theft are actionable.

(2) This case arose in the context of the Privacy Act, and in particular an alleged violation of a section intended to prevent "substantial harm, embarrassment, inconvenience." Since the intended harm includes "intangibles" such as embarrassment and inconvenience it seems that emotional distress can easily fall into that type of "injury."

(3) Another contextual matter: the reason the plaintiffs have to establish actual damages is to satisfy a U.S. Supreme Court case that ruled that "actual damages" were necessary for a plaintiff to recover the $1,000 statutory penalty available under the Privacy Act. More research needs to be done to determine whether "damages" in a negligence context is the same as "actual damages" in the Privacy Act coverage.

(4) It seems to me the logic employed here was a little loose. Most of the "emotional distress" and "concern" clearly ties to what might happen to the plaintiffs' personal information (e.g. concern for identity theft, concerning for damage to credit report, concern for damage to employment suitability, etc.). I suppose its possible that somebody could suffer emotional distress simply knowing their information was breached. However, its how that information might be used in the future after the breach that is actually of concern. It seems to me without some alleged facts (e.g. evidence of visits to a psychiatrist, starting anti-anxiety medication, evidence of depression) that this is fairly weak tea. I suppose courts are more lenient at the motion to dismiss phase (all you need to do is state a claim) and are likely to be more demanding on the evidentiary front if/when a motion for summary judgment is filed.

(5) In my view, since the ruling was fairly conclusory and did not dive deep into the details concerning how to define "damages," I am not sure how persuasive this reasoning will be in other contexts.

PCI: "Follow the Standards to the Letter"

An interesting quote from Bob Russo on how the PCI standard should be followed:

Bob Russo, the general manager for the PCI Security Standards, a group that devises data security measures for the five major credit card companies, said almost all data breaches are the fault of the merchant.

"Everybody that has been breached has been noncompliant with the standard," he said, noting that the circumstances of the Hannaford breach are still too murky for him to render a judgment about. "If you follow the standards to the letter, it puts enough of a hard shell around the data that it is hard to get to."

Full story here.

My question, what about all those emails from the PCI Council, the card brands, acquiring banks and payment processors that purport to resolve ambiguities and which may not be "to the letter" of the PCI Standard? And that question reveals the potential problem from a legal standpoint.

More Evidence of Hannaford-like Exploits?

While I will have to defer to my tech/security-oriented friends, we have reports of exploits that may be similar to the one suffered in Hannaford: Vermont ski area reports Hannaford-like theft of payment card data.

This exploit may be more common than just Hannaford:

And Hannaford and Okemo may not be the only businesses disclosing breaches involving payment card data in transit between systems. According to McPherson, law enforcement authorities who are investigating the breach at Okemo told resort officials that they currently are looking into about 50 reported incidents of the same sort in the Northeast alone.

So what does this all mean? Do the controls required under the PCI Standard address this issue? What about encryption under 4.1 and the language concerning "networks that are easy and common for a hacker to exploit." In general, has the security community anticipated this sort of attack? Is it reasonably foreseeable that hackers would exploit the point-of-sale systems? Legally, is failure to address this type of exploit "unreasonable" for purposes of negligence claim?

PCI, "Safe Harbor" and Hannaford

This Computerworld article was some issues: Hannaford may not have to pay banks' breach costs under PCI, says Gartner

This key part of the article is problematic:

“If true, Hannaford has a safe harbor under PCI and will not be required to reimburse banks and credit unions for any breach-related costs they may incur, according to information that Gartner analyst Avivah Litan said she has previously received from Visa Inc. Typically under PCI rules, if a company is noncompliant at the time of a beach, it faces two potential costs: fines from the payment-card companies and reimbursements of breach-related costs sustained by card-issuing banks and credit unions. Those costs can include payment of fraud losses resulting from the use of compromised payment-card data as well as breach notification and the costs associated with reissuing cards.

The fines and the reimbursement costs are not collected directly from the breached entity but through the "acquiring bank" that authorizes a company such as Hannaford to accept payment-card transactions. Under PCI rules, it is these acquiring banks that are directly responsible for ensuring that their merchants are PCI-compliant.

In Hannaford's case, while its acquiring bank may still get hit with a fine, "the buck stops there," Litan said. "Under the guidance Visa gave me, the acquiring bank wouldn't be able to take it back to the retailer," she said.”

It appears that Litan is referencing the VISA CISP “Safe Harbor.” Interestingly, if you go to VISA’s CISP website, the reference to the Safe Harbor has been removed. Here is what it used to say (as late as August 9, 2007 according to the Internet Archives) :

Safe Harbor

Safe harbor provides members protection from Visa fines in the event its merchant or service provider experiences a data compromise. To attain safe harbor status:

1. A member, merchant, or service provider must maintain full compliance at all times, including at the time of breach as demonstrated during a forensic investigation.
2. A member must demonstrate that prior to the compromise their merchant had already met the compliance validation requirements, demonstrating full compliance.
3. It is important to note that the submission of compliance validation documentation, in and of itself, does not provide the member safe harbor status. The entity must have adhered to all the requirements at the time of the compromise.
   

Link Here.

That language has been replaced on VISA’s website with this:

Visa may waive fines in the event of a data compromise if there is no evidence of non-compliance with PCI DSS and Visa rules. To prevent fines a member, merchant, or service provider must maintain full compliance at all times, including at the time of breach as demonstrated during a forensic investigation. Additionally, a member must demonstrate that prior to the compromise the compromised entity had already met the compliance validation requirements, demonstrating full compliance.

Link Here

A few things to say:

(1) Safe Harbor for Fines Only. According to VISA’s website the Safe Harbor (whatever version is applicable) only applies to fines. Therefore, unless there is information out there that says it applies to reimbursing banks, it would appear that the Safe Harbor is limited. Litan indicates that she has seen some information; it would be excellent if she shared that.

(2) Safe Harbor at Visa's Discretion? As you can see, the VISA website has gone from “to attain safe harbor status” to “Visa may waive fines.” Its not clear from this language whether safe harbor is “automatic” if a company can establish PCI compliance and VISA validation requirements, or whether its at VISA’s OPTION to (e.g. “may waive”) to waive fines if the merchant can establish compliance and validation.

(3) PCI Compliance and Validation Required. The safe harbor requires not only a demonstration of PCI compliance, but also requires (in both versions) that the merchant meet “compliance validation requirements.” So, by this language, a merchant may have been PCI compliant, but it is unclear whether or not the safe harbor would be available if the merchant it did not “validate” that compliance with VISA (basically do a bunch of paperwork: link here)

(4) Safe Harbor Limited to Visa; Not Other Card Brands. Visa’s safe harbor on its face would not provide protection from the other card brands, including MasterCard, Discover, AMEX, etc. If there is a side agreement between the card brands to honor compliance with VISA’s safe harbor, I have yet to see it. This article gives the impression that compliance with VISA rules will somehow protect you from other card brands.

(5) Article Misidentifies "PCI Rules." As a follow up to (4), the article refers to the contractual arrangements between banks, credit card companies and merchants as “PCI Rules.” In fact, those relationships are governed by each of the card brand’s security programs. VISA’s program is the Cardholder Information Security Program. Mastercard’s is the Site Data Protection Program. So if a merchant deals with all five card brands it must comply with not only the PCI Standard (a security standard) but also five security programs. These programs have different definitions, procedures and requirements. To avoid confusion, people need to be careful to not conflate “PCI” with the card brand security programs.

(6) No Proof that Issuing Banks Bound to Honor Safe Harbor. the article appears to suggest that attaining VISA safe harbor will somehow prevent a merchant from having liability to issuing banks for the costs to reissue credit cards. It is not clear how an issuing bank would be bound by VISA’s safe harbor; (a) as discussed below the safe harbor only deals with fines; and (b) the issuing bank is not in a contractual relationship with a merchant with respect to PCI so a merchant would have no basis to enforce the safe harbor against the issuing bank. If there is a document that requires all VISA issuing banks to respect the safe harbor it should be shared publicly so everybody can assess their liability.

(7) The Buck Only Stops if the Contract Stops It. The article suggest that in terms of fines, if safe harbor is attained, “the buck stops” at the acquiring bank. I would maintain that where the buck stops between a merchant and its acquiring bank is dictated legally by the terms of their contract and you cannot make a blanket statement.

On the broader issue, claiming PCI compliance and even actually achieving it does not automatically mean immunity in a lawsuit setting by any stretch

It is entirely possible to be PCI compliant and still have “unreasonable security” for purposes of negligence suit by consumers or banks. Its possible to state you are PCI compliant and not actually be compliant. Moreover, it’s even possible for the PCI Standard itself to be “unreasonable” (although that is obviously a more difficult argument to make to the extent the PCI Standard is “industry standard). A case that every security professional should know about: T.J. Hooper In short, the issues around PCI are much more complex then being presented here and I think people need to be careful since there is already enough confusion out there already.

Much, much more to come...

Are the PCI Council's FAQs Incorporated and Part of the PCI Standard?

This is the basic question I posed to Bob Russo, General Manager of the PCI Council, during an online PCI forum put on by SC Magazine:

Are the FAQs incorporated into and automatically made part of the PCI Standard when published? If so, is there a document or some sort of proclamation indicating that the FAQs are part of the PCI Standard?

Mr. Russo orally indicated "yes," the FAQs are intended to become part of the PCI Standard when they are published. Mr. Russo, however, was not aware of any document or proclamation that indicated that the FAQs were incorporated/made part of the PCI Standard. He indicated that he was making a note on that point to see about creating such a document.

What does this potentially mean in terms of legal liability issues? Well at least with FAQs, if they are made part of the PCI Standard, merchants and QSAs will have a stronger argument of the authoritative weight of the FAQs if ever challenged on the issues addressed in the FAQ. However, this still does not mitigate potential risk around receiving "informal" advice on ambiguities from the PCI Council, processors or merchant banks. Since this type of informal advice is not officially made part of the PCI Standard, its ability to be relied upon as interpretative authority in court or otherwise is arguably weaker. More on these issues to come.

Correction Re: Connecticut Retailer Liability Law

All, I have to issue a correction concerning my reference to a Connecticut law in the article entitled "The Legal Implications of PCI." In that article I indicated that Connecticut had passed a law allowing banks to sue retailers. I received information from a source that turned out to be erroneous. In fact, Connecticut considered a bill with retailer liability in it, but ultimately the provisions providing for retailer liability were stricken. The only State with a specific law providing relief to financial institutions for a security breach involving cardholder data is Minnesota. The updated/corrected article is here: Legal Implications of PCI. I apologize for the mistake.

Hannaford Class Action Update

Looks like four were filed last week (click on each to get a copy of the complaint):

Ryan v. Delhaize Am. Inc., D. Me., No. 1:08-cv-00086JAW, complaint filed 3/18/08;

Dobryniewski v. Delhaize Am. Inc., M.D. Fla., No. 2:08-cv-00235-JES-DNF, complaint filed 3/18/08;

Doherty v. Hannaford Bros. Co., D. Me., No. 2:08-cv-00089-DBH, complaint filed 3/19/08; and

Major v. Hannaford Bros. Co., D.N.H., No. 1:08-cv-00106-JL, complaint filed 3/20/08.

These pleadings may be a little sparse considering the lack of public knowledge of what happened at Hannaford. I have not read through them yet, but will try to do so later to see how the plaintiff attorneys are approaching this situation.

The "Circle of Blame"

I prefer the "Chain of Blame" because of the better rhyme scheme... all kidding aside, Andrew Conry-Murray has done some good reporting on this story.

One money quote:

While PCI provides more concrete guidelines than, say, Sarbanes-Oxley, merchants are quick to complain that it's both too specific and too vague. For instance, the standard requires use of stateful packet inspection firewalls. "What if I choose to use another technology that I believe is equivalent?" says Michael Barrett, chief information security officer of PayPal, a Level 1 merchant. "You have a whole big fight with your auditors or you hold your nose and do it."

Level 1 merchants also clash with QSAs over issues such as "compensating controls"--technologies or processes used in place of specific requirements on the PCI checklist. "We believe our controls are adequate, but they are different from how the standard is written," Barrett says. "So you argue with auditors. Those kinds of things make you want to tear your hair out."

There's also a level of subjectivity in PCI that many find disturbing. The training for QSAs provides few guidelines for resolving this subjectivity. One PCI expert, who requested anonymity, says of the training: "When you ask if X or Y would be acceptable, or how to apply X in situation Y, they always answer 'Use your best judgment.'" He says that when others in the class pointed out how wildly their opinions could differ in a given situation, the instructor "had no answer other than to say 'do your best.'"

"It's a question of interpretation of the auditor, and the sophistication and skill set of the auditor," says Jay White, global information protection architect at Chevron, also a Level 1 merchant. "PCI was more painful than it had to be, but we've learned we have to help the auditors understand how we meet their objectives, even if they don't at first see it."

This lack of guidance can lead to significantly different approaches to compliance, even among auditors at the same Qualified Security Assessor. In one case, a company brought in a PCI expert to monitor a QSA's recommendations. The expert says the QSA had insisted the company deploy a million-dollar technical control when a simple change in operational procedure would have addressed the issue. "The assessment company then sent out someone completely different," the expert says, "and he disagreed with the recommendations of the prior QSA from his own company!"

This inconsistency can have significant repercussions for Level 1 merchants. If a merchant exposes card data, Visa dispatches a team of forensics security consultants to determine if the merchant was compliant with PCI at the time of the breach. "If a 'compliant' merchant gets compromised, I can guarantee you I can find at least one thing in the compliance report I could argue about," says the PCI expert. "This provides just enough wiggle room for the brands to point at the merchant or QSA and argue the standard was interpreted wrong."

Being judged noncompliant can result in substantial fines for the merchant and its acquiring bank, including higher per-transaction card processing fees. A judgment of noncompliance would also be useful to law firms contemplating action against the merchant.

More interesting points:

One major clothing retailer we spoke with said auditors examined four out of 1,000 stores, a sample size of just 0.4%. The retailer says all its stores share the same configuration and are centrally managed, but it's all too easy for security problems to go undiscovered with such small samples. "I could hide a multitude of sins from a QSA," says the PCI expert.

And while some retailers complain that auditors are too strict, the current system lets retailers seek out QSAs who may apply the standard less rigorously than others. "I've read several compliance reports that have been provided to us after the fact, and I wouldn't consider them appropriate," says the PCI expert. "They passed, but I don't know how." When asked if merchants are shopping for QSAs that provide an easy assessment, he says: "I can guarantee you that. Why wouldn't they?" Even the PCI Security Standards Council, which trains and certifies QSAs, admits that quality levels may not be consistent among the more than 100 active QSAs.

"It's a competitive game," says Bob Russo, general manager of the council. "One QSA might do an on-site assessment for X number of dollars, and another QSA will do the exact same assessment for less. A merchant thinks, 'If this guy is charging me $50K and this guy charges me $10K, there's a question there.'"

In response, the council is introducing a quality assurance program, due later this quarter, to ensure that all QSAs are performing assessments with the same rigor. "The goal is to make sure it's a level playing field so we don't have accusations from QSAs or merchants that some people are rubber-stamping," Russo says.

The question of rubber-stamping ties to the issue of liability. If a compliant merchant is breached, does the QSA bear any responsibility? It's a question that makes QSAs uncomfortable.

"Who's to say a retailer doesn't take what we say and toss it into the garbage?" says Barbara Mitchell, manager of security product marketing at Verizon. Along with Internet Security Systems and TrustWave, Verizon wins much of the assessment business for Level 1 merchants. "We should have some skin in the game, but if a retailer decides to not listen to our recommendations, it's a murky area," Mitchell says. "If we assume liability, we want to review all the stores, all the servers. That shoots the cost up to a prohibitive degree."

Retailers we spoke with were unclear about the liability question. "I think it would depend on whether our controls were deficient and on the audit process," says the network architect at the major clothing retailer. "I think there would be some level of liability, but we've not dug into that. There may be language in the contract I'm unaware of, but my focus has been on controls to prevent a breach rather than where we will point a finger." Unfortunately, finger-pointing is inevitable if credit card data gets stolen. "When a breach happens, if they see something out of whack, they will go back to the auditor, like Enron and Arthur Andersen," says Teri Quinn-Andry, product marketing manager for Cisco Security Solutions.

Then there's the problem of depending on what is, essentially, an honor system for Level 2, 3, and 4 merchants. There is no outside validation of a company's responses to the self-assessment questionnaire. "The reality is, you don't have to be compliant, if your business wants to take that risk," says the IT director of a Level 2 cruise ship operator.

"A lot with PCI is left to your interpretation," agrees Alan Stukalsky, CIO of Church's Chicken restaurant chain, also a Level 2 merchant.

So what does it all mean. I think it means a very volatile system with a lot of liability risk and uncertainty. I think it means that taking shortcuts could get both merchants that self-assess and QSAs into hot water (including hot water of the "going out of business" type for smaller merchants and QSAs). I think it means probably more comprehensive and expensive assessments when QSAs start getting hit with lawsuits.

So what can be done to smooth out the risk? More on that later from me... any thoughts from others?

Article Exploring PCI-related Risks in the Hannaford Breach

Interestingly, some reporters are digging deeper to explore the implications of a PCI-compliant company suffering a payment card breach: see here.

I think we don't have all the information so we everybody is engaging in various levels of speculation. However, we do know two facts: (1) compliance with PCI was represented in Hannaford's privacy policy (last visited 3-21-2008); and (2) there was a breach exposing cardholder data. In my view, here are some of the possibilities (in no particular order of likelihood, and by no means an exclusive ilst):

(1) the qualified security assessor (QSA) (or internal assessor) may have misinterpreted or loosely interpreted a section of the PCI standard (and the reality was there were security weaknesses);

(2) the PCI compliance may have been old or outdated (e.g. they may have been PCI compliant 9 months ago, but perhaps added new systems that were not secured consistently with PCI);

(3) Hannaford may not have provided all of the information to the QSA (assuming one was used) that it needed to validate its decision (e.g. this could include mistakes in defining which parts of Hannaford's networks were in-scope/out-of-scope);

(4) Hannaford may have been 100% PCI compliant and reasonably secure in general and just got unlucky (e.g. there is no such thing as 100% perfect security). Under this scenario, Hannaford would argue that it was not negligent because it did all the right things and that unfortunately these things just happen.

(5) Hannaford and/or its QSA may have had a security weakness or questions about an ambiguity and may have had either the PCI Council, its upstream payment processor or its merchant bank give a bad interpretation.

The interesting issue will be, assuming that some sort of negligence is shown, who was/is ultimately responsible? Hannaford? The QSA? A merchant bank that accepted Hannaford's certification?

Much more to come on this one.

Update: well that was quick. The class actions come flooding in.

The Hannaford Breach and PCI Compliance

More on this yet to come, but the Hannaford breach may be the perfect illustration of where false reliance on "PCI Certification" could get a company in big trouble. See my previous post on the Legal Implications of PCI here.

More to come, but long story short, the company's chief executive said the data "was illegally accessed from our computer systems during transmission of card authorization." This means the data was likely not encrypted in transit.

In this case the ambiguity appears to be in section 4.1 of the PCI Standard, which requires "Encrypt transmission of cardholder data across open, public networks" and also states "Sensitive information must be encrypted during transmission over networks that are easy and common for a hacker to intercept, modify, and divert data while in transit"

Section 4.1. provides examples where encryption is required, including, the Internet, WiFI, global systems for mobile communications and GPRS.

So the question is, does the encryption requirement include open "internal" networks of a merchant that may be "easy and common" for a hacker to intercept. Or did Hannaford get a rubber stamp of approval without actually complying with 4.1. or only partially complying with 4.1?

If all of the supposition is true, it appears that Hannaford (or its Qualified Security Assessor) interpreted 4.1 to mean that only transmission across "public" networks like the Internet required encryption of data before transmission.. and perhaps not its internal networks that may have been vulnerable...

More details here, here and here.

FACTA Class Action Certified (N.D. Illinois)

All, a link to a recent case that certified a class action under FACTA based on credit card receipts with more than the last five digits and expiration date: (Meehan v. Buffalo Wild Wings Inc., N.D. Ill., No. 07 C 4562)

Interestingly this case goes against rulings in the 9th, 10th and 11th Circuits, which ruled that the "superiority" requirement of Rule 23(b) had not been met because of the potentially staggering statutory damages available under FACTA ($100 to $1000 per violation).

In this case, the court followed 7th Circuit precedent that held that classes could be certified despite staggering damage potential. In this Circuit the issue of staggering damages, however, can still be challenged as a violation of due process rights after the certification.

In short, the certification provides the plaintiffs with more leverage because the class has been established and plaintiff's attorneys will have a large economic incentive to argue all the way through the due process arguments. Companies operating in the jurisdiction of the 7th Circuit should be very careful with their credit card receipts.

Legislative Update: 2 New Plastic Card Protection Bills Pending (Alabama and Iowa)

Plastic Card Protection laws continue to be proposed in state legislatures. This time its Alabama and Iowa that are jumping into the fray with bills that incorporate the Payment Card Industry (“PCI”) Data Security Standard and/or provide financial institutions with the legal right to seek reimbursement for costs associated with payment card security breaches. However, the Iowa and Alabama bill provide some new wrinkles.

Alabama SB 382. Here are some of the wrinkles in the Alabama bill:

(1) Personal Information Deletion Requirement. Requires the deletion/destruction of personal information that is “longer necessary to be retained.”

(2) PCI Tie-In – PCI Section 3.2.. The bill prohibits the storage “in either encrypted or unencrypted form, subsequent to authorization, the card security code data, the PIN verification code data, the full contents of any track of a magnetic stripe or data chip, card-validation code, or value, or any other security information in a manner that permits access to an individual financial account.” This is essentially the same duty as section 3.2 of the PCI Standard. Note this language appears to go beyond payment card security since it relates to “any other security information that permits access to an individual financial account.” This language could possibly include passwords for online banking sites, online payment sites and other access codes tied to financial accounts (beyond credit card accounts).

(3) Financial Institutions Recovery of Reasonable Costs. Like other Plastic Card Protection laws, in the event the of a violation of the law and a security breach exposing personal information, the Alabama bill provides bank with the right to reimbursement for the reasonable costs of actions taken “to protect the personal information and account information of the customer or to continue to provide financial services to the customer,” including the costs to reissue cards, open/close accounts, contacting cardholders and refunds or credits made to customers.

(4) Private Cause of Action. In a new twist the bill specifically provides a private cause of action for financial institutions against those that “are responsible for the security breach.” The financial institution may receive not only actual damages, but also incidental and consequential damages, as well as court costs and reasonable attorney fees. Significantly, this language may help financial institutions recover damage elements that would be very difficult to recover under a traditional negligence claim.

Iowa S.S.B 3183. Here are some of the wrinkles in the Iowa bill:

(1) PCI Tie-In – Entire PCI Standard. The Iowa bill requires compliance with the entire PCI Standard by any entity that accepts a payment card in connection with transactions in the ordinary course of business. However, the bill also indicates that the Iowa attorney general must adopt rules necessary to implement the bill, including identifying the payment card industry standards to be applied.

(2) PCI Certification. Financial institutions initiating an action must request a certification of compliance from the party that suffered the security breach. The certification must be made by a payment card industry approved independent auditor. It appears that an action cannot be commenced against an entity that has not been found in violation of the PCI Standard.

(3) Financial Institutions Recovery of Reasonable Costs. The bill provides for the right to recover similar damage components as those in the Alabama bill.

(4) Attorney Fees for Prevailing Party. The bill provides that the prevailing party in an action will be entitled to recover attorney fees. However, if the prevailing party is an entity that has refused to certify PCI compliance it cannot recover attorney fees.

BOTTOMLINE: the legal liability will change radically if these bills get passed (like the Minnesota and Connecticut laws, as well as the bill in Washington State that has passed one house).