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.

In Jetcrete, the parties entered into an agreement for the purchase of trucks, with plaintiff seeking to buy $518,124 of trucks from defendant dealer. Like a typical email scheme, the dealer sent wire instructions to the buyer, the dealer’s email was then hacked, and new wire instructions were sent by the cybercriminal to the buyer.

The plaintiff argued that the seller “was in the best position to avoid the loss by employing reasonable security measures to prevent the hack of [its] email[.]” The seller contended “it took reasonable security steps by hiring an IT consultant[,] installing Symantec virus scanner software on its system, and hosting its email server at Intermedia,” and that plaintiff “was in the best position to avoid the loss by simply calling [it] to verify the wiring instructions.” Id. at *8-9.

In resolving the dispute, the court adopted plaintiff’s argument that because the contract involved the sale of goods resolution should be governed by the Uniform Commercial Code, and looked by analogy to UCC § 3-404, which provides in part:

(a) If an impostor . . . induces the issuer of an instrument to issue the instrument to the impostor, . . . by impersonating the payee of the instrument or a person authorized to act for the payee, an endorsement of the instrument by any person in the name of the payee is effective as the endorsement of the payee in favor of a person who, in good faith, pays the instrument or takes it for value or for collection.

. . . .

(d). With respect to an instrument to which subsection (a) . . . applies, if a person paying the instrument or taking it for value or for collection fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss resulting from payment of the instrument, the person bearing the loss may recover from the person failing to exercise ordinary care to the extent the failure to exercise ordinary care contributed to the loss.

UCC § 3-404 (emphasis added).

While UCC Articles 3 and 4 governing negotiable instruments provide a comparative negligence loss-allocation regime, UCC Article 4A governing electronic funds transfers does not, but rather a strict liability regime. See, e.g., Peter E. Shapiro, P.A. v. Wells Fargo Bank, N.A., 795 Fed. Appx. 741, 744, n.4 (11^th Cir. 2019) (quoting UCC § 4A-207, cmt. 2 and contrasting the Articles 3 and 4 approach, citing Salvatore Scanio & Robert W. Ludwig, Contracting Out of the Uniform Commercial Code: Reducing Bank Liability by Shortening the One-Year Notice Period for Reporting Check Fraud, 33:11 Banking & Fin. Servs. Policy Report 15, 17 n.8 (Nov. 2014)). UCC Article 4A was inapplicable because it applies to the parties to funds transfers; the email hacked business which did not receive the funds was never a party to a funds transfer.

The Jetcrete court concluded: “The hack of [the seller’s] email account created the scenario for the loss. But [plaintiff] was in the best position to prevent the loss by taking the reasonable precaution of verifying the wiring instructions by phone. Thus, even under an analysis based on [UCC § 3-404, plaintiff] should suffer the loss.” Jetcrete, at *12.

Even though the UCC did not apply directly to this cybertheft dispute, the court’s application of its loss allocation principles demonstrates the UCC’s continued importance in resolving commercial payment disputes involving fraud.

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.

The law firm filed a pro se claim against Citibank under the Computer Fraud and Abuse Act (“CFAA”), requiring a showing that Citibank aided and abetted the hacker by “knowingly and with intent to defraud, access[ing] a computer without authorization, . . . and by means of such conduct further[ing] the intended fraud….” 18 U.S.C. § 1030(a)(4).  The firm alleged the bank’s maintenance of the hacker’s account, allowing the deposit of stolen funds and permitting their withdrawal, constituted the requisite assistance. The district court rejected the allegations of Citibank involvement as insufficient “even under a willful-blindness theory,” noting the plaintiff did not allege “facts that indicate that the bank ‘closed its eyes’ to the hacker’s obvious crime” nor did it “allege any unusual activity that might have raised the bank’s suspicion or any vetting irregularities,” and dismissed the claim without prejudice.  2020 U.S. Dist. LEXIS 71713, at 10.

While this claim under the CFAA is novel, it is also serves to show that banks can be subject to aiding and abetting liability when properly plead.  L&R has successfully brought aiding and abetting claims, including in a major, serial loan fraud case, representing bank no. 2 against bank no. 1, where bank no. 1 discovered the fraud, forcing the fraudster to commit the same fraud against bank no. 2 in order to be repaid, with bank no. 1 later paying a substantial settlement.

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.

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.