In another fairly typical business email compromise/social engineering scheme, a cybercriminal  impersonating a vendor induced a business to send four large ACH transfers totaling  $558,868.17 to the fraudster’s account at a credit union. The plaintiff asserted various claims against the beneficiary’s bank, alleging:

● Around August 2018, the credit union opened a personal checking account for an individual, John Doe, but did not verify his identity, address, prior banking history, source of funds, membership eligibility

● In October 2018, Doe transmitted fraudulent emails to plaintiff

● Plaintiff then sent an ACH transfer of $156,834.55 identifying itself, Studco, as the originator and its vendor Olympic Steel, by corporate address, as the receiver, which did not match any account holder with the credit union

● The ACH credit identified Doe’s personal account number, but it was commercially coded as “CCD,” i.e., “Corporate Credit or Debit,” for business transactions under Rules of the National Automated Clearing House Association (NACHA)

● NACHA Rules restrict CCD payments to transactions that involve only businesses, and require that any CCD payments directed to personal accounts be rejected

● Shortly thereafter, the credit union accepted three additional high-value commercial ACH credit payments for Doe’s account, totaling $558,868.17

● Over a one-month period, Doe then withdrew over $558,868.17 incrementally and in-person at the credit union’s branch with the assistance of the credit union, through 13 cashier checks or wire transfers totaling $558,868.17

● Nine (9) of the thirteen (13) withdrawals were made out to an individual or entity that is alleged to be known to the credit union or its employee(s).

Id. at *1-4.

While the district court dismissed several claims brought by the plaintiff, it permitted two key counts to go forward, in large measure due to the plaintiff’s reliance on NACHA’s rules.

The first was a claim under UCC § 4A-207 for misdescription of beneficiary, with the court finding: “While it is true that [the credit union] has no duty to proactively discover a conflict, the Complaint alleges that [it] had actual knowledge of the misdescription because the transfers were codified as ‘CCD’ and, thus, that it was automatically required to reject the misdescribed ACH transfers, pursuant to NACHA, but it did not. . . . Therefore, the issue of whether [the credit union] had actual knowledge is a factual determination for the jury.” Id. at 12-13.

The second claim the court permitted was a claim for bailment, concluding, “Although bailment requires a common law duty of care . . . the NACHA Rules and [UCC § 4A-207] establish that 1st Advantage must act in a commercially reasonable manner or that it exercised ordinary care when it has control over ACH transfers.” Id. at 16. Like the UCC claim, the court stated: “the question of whether 1st Advantage acted in a commercially reasonable manner in exercising control over [plaintiff’s] ACH transfers is one that the jury must answer[.]” Id. at 16-17. “Specifically, the Complaint alleges that the NACHA Rules provide that ‘it is not commercially reasonable to deposit commercially-coded ‘CCD’ transfers expressly identified as ‘business transactions’ into a personal checking account. Furthermore, NACHA Rules require that depositing ‘CCD’ coded transfers into consumer accounts is not commercially reasonable. . . . Moreover, [plaintiff] has adequately alleged that [the credit union] did not act in a commercially reasonable manner in allowing John Doe to fraudulently withdraw money over a month in-person.” Id. at 17.

This case, like L&R’s recent ACH matter, is an important illustration of how effective application of the NACHA Rules can be critical in resolving such cases.

For further information, contact Salvatore Scanio at sscanio@ludwigrobinson.com or 202-289-7605 or Robert Ludwig at rludwig@ludwigrobinson.com or 202-289-7603.

The Advisory highlights how the COVID-19 pandemic is being exploited in “cyber-enabled crime through malware and phishing schemes, extortion, business email compromise (BEC) fraud, and exploitation of remote applications.” FinCEN identifies numerous “red flag indicators of COVID-19 cyber-enabled crimes to assist financial institutions in detecting, preventing, and reporting suspicious transactions associated with the COVID-19 pandemic.”

At the same time, FinCEN warns financial institutions they should continue to “consider additional contextual information and the surrounding facts and circumstances, such as a customer’s historical financial activity, whether the transactions are in line with prevailing business practices, and whether the customer exhibits multiple indicators, before determining if a transaction is suspicious or otherwise indicative of potential fraudulent COVID-19-related activities.” In other words, fundamental, long-established signs of suspicious activity apply equally, if not more so, in the COVID-19 era.

The impact of COVID-19 on funds transfer schemes was recently reviewed in an ABA webinar Salvatore Scanio presented with Ben Wallach, Cybercrime and Funds Transfer Fund – Recent Developments. 

The lively program discussed the latest trends in cybercrime involving fraudulent funds transfers. They reviewed recent funds transfer schemes, including those arising as a result of the COVID-19 era. The program discussed the latest developments in the legal regime applicable to fraudulent ACH and wire transfers, and explained the allocation of liability in such cases. They also addressed schemes involving law firms. The webinar featured numerous questions and answers throughout the event.

For a copy of the program materials, please contact Salvatore Scanio at sscanio@ludwigrobinson.com.

The subsidiary reported the unauthorized ACH debits to its bank, a major U.S. commercial bank, which declined reimbursement because the ODFI, another major U.S. commercial bank, declined the claim as its customer, the Originator, also declined responsibility.

Upon being retained, L&R quickly investigated and pursued the matter with the banks under Operating Rules and Guidelines of the National Automated Clearing House Association (NACHA).  While corporate ACH debits are not subject to the substantial protections afforded consumer ACH debits under Regulation E and NACHA’s rules, numerous other provisions of NACHA’s rules and guidelines do apply to unauthorized corporate debits.  Of particular significance is NACHA’s warranty under which an ODFI warrants to the RDFI that transactions have been properly authorized by the Receiver, for which it is required to indemnify the RDFI for “all claims, demands, losses, liabilities, and expenses, including attorneys’ fees and costs, that result directly or indirectly” from the breach of warranty.

In less than a month after L&R contacted the RDFI, both banks reversed their positions, and the U.S. subsidiary was reimbursed for its full loss.

For further information, contact Salvatore Scanio at sscanio@ludwigrobinson.com or 202-289-7605 or Robert Ludwig at rludwig@ludwigrobinson.com or 202-289-7603.

In Midlothian Enter., Inc. v. Owners Ins. Co., 2020 U.S. Dist. LEXIS 30237 (E.D. Va. Feb. 5, 2020), hackers obtained access to a business owner’s email and directed a fraudulent email to an employee to send a $42,000 wire. The insured sought coverage under policy endorsements for “money and securities” and “forgery or alteration.” The court held the first “does not cover a loss caused by an employee . . . voluntarily wiring money to another account due to a fraudulent email,” finding its “voluntary parting exclusion” applicable. Id. at *9-10. As to the latter, the court found “an email from a business owner telling an employee to wire money to a bank account does not have the same form or legal effect as a check, draft, or promissory note” and “does not constitute a ‘covered instrument’ under the explicit terms of the endorsement.” Id. at *11.

Weeks before another judge found emails covered in Quality Plus Services, Inc. v. Nat’l Union Fire Ins. Co., 2020 U.S. Dist. LEXIS 7337 (E.D. Va. Jan. 15, 2020). There an insured’s employee sent five wires totaling $1.6 million to overseas accounts based on fraudulent emails ostensibly from its CEO. The court held coverage otherwise existed under the policy’s Funds Transfer Fraud Provision, which covered “loss of Funds resulting directly from a Fraudulent Instruction directing a financial institution to transfer, pay or deliver Funds from the Insured’s Transfer Account.” Id. at *8. Though the emails were not payment orders (i.e. under UCC Article 4A), the court appeared to find them covered under the policy’s partial definition of Fraudulent Instruction as “an electronic, computer . . . or written instruction initially received by the Insured” which was “fraudulently transmitted by someone else without the Insured’s or the Employee’s knowledge or consent,” and thus constituted an “Occurrence” or an “act or event” that “directly” causes the insured’s loss. Id. at *20. Applying a but-for test, the court concluded: “Without the emails, Quality Plus would not have suffered the losses.” Id. at *21. Ultimately, the court denied cross-motions for summary judgment, given fact disputes over (1) the location from which the fraudulent emails were sent, implicating the policy’s territory condition that was limited to the United States and Canada, and (2) the number of individuals who sent them, implicating the $1 million per Occurrence limit of liability. Id. at *22-28. The case then settled, weeks before trial.

Similarly, in Cincinnati Ins. Co. v. Norfolk Truck Ctr., Inc., 2019 U.S. Dist. LEXIS 220076 (E.D. Va. Dec. 20, 2019), an insured sent a wire transfer of $333,724.00 in response to an imposter’s email with fraudulent payment instructions for legitimate invoices. The commercial crime policy’s “Computer Fraud” provision covered “loss of . . . money . . . resulting directly from the use of any computer to fraudulently cause a transfer of that property from inside the premises or banking premises . . . [t]o a person . . . outside those premises.” Id. at *2-3. The court defined “directly” as “something that is done in a ‘straightforward’ or ‘proximate’ manner and ‘without deviation’ or ‘without intervening agency’ from its cause,” citing various dictionaries. Id. at *31. Relying primarily on American Tooling Ctr., Inc. v. Travelers Cas. & Sur. Co. of Am., 895 F.3d 455 (6th Cir. 2018), and noting contrary appellate authority is unreported, the court concluded:

the Imposter here somehow learned of the [legitimate] invoices, created a false Internet domain to mimic [the] vendor, impersonated [the] vendor, learned about [the] balance due, and sent e-mail messages . . . with false payment information. Upon receiving that fraudulent e-mail, [the insured] immediately communicated with its bank through a series of e-mails to initiate a transfer by computer as requested. Since the wire transfer involved a loan requiring documentation, it continued in a straightforward and proximate manner, uninterrupted, until the money was wired to the Imposter.

Id. *32.

Each case involved different policy provisions, which may superficially explain the varying outcomes, but coverage results in email funds transfer claims continue to be unpredictable. The computer fraud and funds transfer fraud policies in Norfolk Truck and Quality Plus were not designed to cover fraudulent emails, but rather computer hacking or unauthorized payment orders from an insured to its bank. This essential point was lost in both cases, and absent it being more effectively developed and presented, similar results may be expected to continue.

For further information, contact Salvatore Scanio at sscanio@ludwigrobinson.com or 202-289-7605 or Robert Ludwig at rludwig@ludwigrobinson.com or 202-289-7603.

Previously, the court dismissed all non-UCC Article 4A counts, including breach of contract and violation of federal banking statutes.  Federal Ins. Co. v. Benchmark Bank, 2018 U.S. Dist. LEXIS 11152 (S.D. Ohio Jan. 24, 2018).  Addressing the contract claim, the court found the account holders were not parties to any relevant electronic banking agreement with the bank; rather, the agreements were between their related entity and the bank.  Id. at *13-15.  Apparently not raised in that earlier decision was the settled rule that in the absence of an applicable agreement identifying an agreed security procedure, the bank would bear strict liability for any unauthorized payments.  See UCC §§ 4A-202(b), 4A-204(a).

Now on summary judgment, the court concluded the bank’s security procedures were commercially reasonable as a matter of law under UCC § 4A-202(b), though it did not use common multifactor authentication (i.e., the use of two of: something the user knows, something the user has, and something the user is).  2020 U.S. Dist. LEXIS 23315, at *32.  The court held nonetheless that the bank’s use of “layered security by utilizing unique usernames and passwords, security challenge questions triggered by a risk algorithm, account lockout after three unsuccessful login attempts, IP blacklisting, and dual authorization” satisfied banking agency guidelines, relying primarily on dual authorization.  Id. at *25-29.

In considering Article 4A’s good faith requirement, the court initially indicated the bank “acted according to the reasonable expectations of the parties,” where the customer understood it was “not checking whether a receiving entity had a relationship to or prior history” with the customer, “whether a recipient’s name was of Eastern European origin, or where an originating IP address was located,” because the ACH agreement provided the “purpose of the security procedures in place was ‘for verification of authenticity and not to detect an error in the transmission or content of an Entry.’”  Id. at *34-35.  The court nowhere took into account customary industry practices in considering whether the bank should have applied fraud detection to the transactions, including if the customer previously sent transfers to such recipients.  The court concluded, however, there were genuine issues of material fact on whether the bank accepted the transfers in good faith and in compliance the ACH agreement and customer instructions, noting numerous transfers exceeded the agreement’s $50,000 limit per ACH transfer, and a dispute over whether the customer’s employee had authority to conduct transactions on certain accounts.  Id. at *36-40.

In a remarkable coda, the court upheld the bank’s setoff defense for attorney’s fees based on an indemnification provision in the customer agreement.  The court concluded that indemnification was not inconsistent with UCC Article 4A, allowing the bank to set off its attorneys’ fees and costs against a plaintiff’s damages claims, 2020 U.S. Dist. LEXIS 23315, at *46-49, misciting Choice Escrow and Land Title, LLC v. BankcorpSouth Bank, 754 F.3d 611, 625 (8^th Cir. 2014), where the bank was the prevailing party.  In contrast, Benchmark Bank sought to invoke the provision even if it were found to be the responsible, non-prevailing party.  The court’s holding adopting that notion is inconsistent with the objectives of UCC Article 4A, if not the contractual indemnification language irtself, which the court did not construe.  Apparently no motion for reconsideration was filed, and shortly after the decision issued, the case settled.

For further information, contact Salvatore Scanio at sscanio@ludwigrobinson.com or 202-289-7605 or Robert Ludwig at rludwig@ludwigrobinson.com or 202-289-7603.

Cybercriminals are exploiting the pandemic in countless ways, from preying on human vulnerability to taking advantage of the increased use of online banking and electronic payments. The scams include credential phishing, spam email campaigns, malware, and business email compromise (BEC).

According to the FBI’s Alert No. I-040120-PSA, Cyber Actors Take Advantage of COVID-19 Pandemic to Exploit Increased Use of Virtual Environments (Apr. 1, 2020), its Internet Crime Complaint Center received over 1,200 complaints as of March 30, 2020.  The FBI Alert warns that “during this pandemic, BEC fraudsters have impersonated vendors and asked for payment outside the normal course of business due to COVID-19.”  As defined by the FBI’s Internet Crime Report (2019), BEC “is a sophisticated scam targeting both businesses and individuals performing a transfer of funds. The scam is frequently carried out when a subject compromises legitimate business email accounts through social engineering or computer intrusion techniques to conduct unauthorized transfers of funds.” In 2019, there were 24,000 complaints of BEC scams, with a total loss of $1.7 billion.

On April 6, 2020, the FBI issued a press release, FBI Anticipates Rise in Business Email Compromise Schemes Related to the COVID-19 Pandemic, in which it detailed recent examples of BEC attacks:

• A financial institution received an email allegedly from the CEO of a company, who had previously scheduled a transfer of $1 million, requesting that the transfer date be moved up and the recipient account be changed “due to the Coronavirus outbreak and quarantine processes and precautions.” The email address used by the fraudsters was almost identical to the CEO’s actual email address with only one letter changed.
• A bank customer was emailed by someone claiming to be one of the customer’s clients in China. The client requested that all invoice payments be changed to a different bank because their regular bank accounts were inaccessible due to “Corona Virus audits.” The victim sent several wires to the new bank account for a significant loss before discovering the fraud.

Also on April 6, 2020, the FBI issued a further warning, Money Mule Schemes Exploiting the COVID-19 Pandemic.  The FBI anticipates a rise in work-at-home schemes to recruit money mules to wittingly or unwittingly facilitate the laundering of fraudulent funds transfers.

On April 13, 2020, the FBI issued another release, Advance Fee and BEC Schemes Related to Procurement of PPE and Other Supplies During COVID-19 Pandemic.  The FBI’s warning reports on evolving schemes being utilized to exploit the coronavirus pandemic.

The FBI is often the first place to turn for assistance when a business is the of a cyberattack that results in fraudulent wire transfers or ACHs. If contacted within 48 hours of the theft and a loss threshold is met, the FBI may be able to identify whether any of the funds may be recovered.

The next option would be potentially responsible third-parties.  L&R recently presented a paper at an American Bar Association Conference, titled Technology and Salvage: Using Social Media in Recovery and Allocating Cybercrime Funds Transfers to Third Parties (Jan. 31, 2020), that discusses the latest trends in cybercrime involving fraudulent transfers and how losses are allocated between businesses and third-parties, particularly banks.

Generally, the focus is on the beneficiary’s bank in the business email compromise scenario and on the receiving bank in the malware/account takeover situation.

As detailed in L&R’s recent paper, the beneficiary’s bank (i.e., the bank of the beneficiary of the funds transfer where the funds are ultimately transferred) has potential liability exposure for fraudulent funds transfers arising in the business email compromise scenario under any of the following:  (1) the bank “knows” that the name and account number on the wire transfer order refer to different persons; (2) improper bank conduct took place before the funds transfer, such as at account opening; (3) improper bank conduct took place after the wire transfer; or (4) where the bank accepted funds when it knew or should have known that the funds were fraudulently obtained.

In the malware/account takeover scenario, the receiving bank (i.e., generally the customer’s bank from where the transfer originated) has liability exposure for fraudulent funds transfers, unless the bank proves: (1) the bank and customer agreed that the authenticity of a payment order would be verified through a “security procedure;” (2) the security procedure agreed upon is “commercially reasonable;” (3) the bank processed the payment order in “compliance” with the security procedure; (4) the bank processed the order in compliance with any written agreement or instruction of the customer; and (5) the bank accepted the payment order in “good faith.”

For further information, contact Salvatore Scanio at sscanio@ludwigrobinson.com or 202-289-7605 or Robert Ludwig at rludwig@ludwigrobinson.com or 202-289-7603.

The conference theme was, “A Whole New World: The Impact of Technology and Cybercrime on Fidelity Policies.”  They were joined by Joseph S. Szary of Great American Insurance Group.  Their presentation addressed the latest trends in cybercrime involving fraudulent funds transfers and how losses are allocated between insureds and third-parties, particularly banks. They also discussed how social media may be used effectively in locating businesses and individuals, their income and assets, and covered applicable regulatory guidelines. Their discussion included the recent opinion by the 11^th Circuit Court of Appeals, Peter E. Shapiro, P.A. v. Wells Fargo Bank, N.A., 2019 U.S. App. LEXIS 35604 (11^th Cir. Nov. 27, 2019).

For further information, contact Salvatore Scanio at sscanio@ludwigrobinson.com or 202-289-7605 or Robert Ludwig at rludwig@ludwigrobinson.com or 202-289-7603.

The Secure Payments Task Force, a coalition of over 200 payment industry stakeholders convened by the Federal Reserve, recently concluded.  For the last three years, the Task Force has worked to advise the Federal Reserve on payment security matters and address payment security challenges.  Its work covered identifying the key challenges and opportunities related to improving payment security, including identity management, data protection and information sharing to mitigate fraud.  The Task Force’s website, SecurePaymentsTaskForce.org, features its deliverables, including Payment Lifecycles and Security Profiles and a list of Information Sharing Data Sources.

The Secure Payments Task Force developed the feature Payment Lifecycles and Security Profiles to help payment participants understand eight payment types.  This educational resource provides perspectives related to:

• The lifecycles of the most common payment types, covering enrollment, transaction flow and reconciliation
• Security methods, identity management controls and sensitive data occurring at each step in payment lifecycles
• Relevant laws and regulations, and other references, as well as challenges and improvement opportunities related to each payment type

The Payment Lifecyles and Security Profiles cover the following payment types: ACH; Card Present; Card Not Present; Card Present PIN; Check; Contactless; Wallet; and Wire.

The Secure Payments Task Force also published an expansive set of cybersecurity and fraud information resources, styled Information Sharing Data Sources. The data sources highlight intelligence reports, payments fraud trends, best practices and benchmarks, and additional resources that can help organizations address payments fraud risk. The Information Sharing Data Sources is also available on the Task Force’s website as a searchable tool.

As a member of the Fed’s Task Force, Ludwig & Robinson is seeking feedback on these payment use cases, which has created an online Payment Use Cases Industry Survey for that purpose.

In addition, the Task Force is presenting Payment Use Case webinars to provide an opportunity to gain a high-level overview of each use case as a supplement to the use case documents, as follows:

Payment Use Cases Webinar – ACH, Wire and Check
Date and Time: Thursday, May 11 from 3:00 – 4:00 p.m. ET

Payment Use Cases Webinar – Card Signature, Card PIN and Card Not Present
Date and Time: Friday, May 12 from 2:00 – 3:00 p.m. ET

Payment Use Cases Webinar – Card Not Present, Contactless and Wallet
Date and Time: Monday, May 15 from 2:00 – 3:00 p.m. ET

You may register for one or more of these webinars to learn about each of the payment use cases and provide your input.  This information can also be found on FedPaymentsImprovement.org.

For further information, contact Salvatore Scanio at sscanio@ludwigrobinson.com or 202-289-7605.