Canada: Incomm: U.S. District Court Holds That Computer Fraud Coverage Does Not Respond In Prepaid Debit Card Scheme

Last Updated: March 31 2017
Article by David S. Wilson and Christopher McKibbin

On March 16, 2017, the U.S. District Court for the Northern District of Georgia released its decision in InComm Holdings, Inc. v. Great American Insurance Company. The Court held that Great American's computer fraud coverage did not respond where holders of prepaid debit cards used multiple simultaneous telephone calls to exploit a coding error in the insured's computer system, thereby fraudulently increasing the balances on the cards. The Court also applied the recent appellate decisions in Apache (see our October 24, 2016 post) and Pestmaster (see our August 4, 2016 post) in holding that the loss scenario did not meet the direct loss requirement in the computer fraud insuring agreement.

The Facts

InComm was a debit card processor. Individuals could purchase prepaid debit cards issued by banks and then utilize InComm's system to load funds onto those cards. InComm's processing system consisted of an Interactive Voice Response (IVR) system and an Application Processing System (APS). The IVR system permitted cardholders, using telephone voice commands or touchtone codes, to load credit onto their cards. The APS provided transaction processing in respect of transaction instructions received through the IVR system. After the APS carried out the requested instruction, it would communicate the result to the IVR system, which would then report the result to the cardholder.

To add value to a card, a cardholder could purchase a chit from a retailer, which would then relay the funds to InComm by transferring them to an account maintained by InComm with Wells Fargo. To redeem the chit, the cardholder would call the IVR system and provide the unique PIN printed on the chit. The IVR system would then relay the information to the APS, which would verify the data and then add the value of the chit to the card.

After a chit is redeemed, InComm transfers the equivalent amount of funds to the bank that issued the card. The funds are then maintained by the issuing bank for the benefit of the cardholder until the cardholder makes a purchase, at which point the issuing bank remits funds to the vendor. InComm is not involved in payments by banks to vendors.

InComm contracted with Bancorp to serve as program manager for cards issued by Bancorp. When a Bancorp cardholder redeemed a chit, InComm would transfer the equivalent dollar amount from its Wells Fargo account to a special settlement account held at Bancorp in Bancorp's name. The InComm-Bancorp contract provided that "[Bancorp] shall hold all Cardholder Balances in a fiduciary or custodial manner on behalf of [InComm] as holder[ ] of the Cardholder Balances for the benefit of Cardholders" and that "all Cardholder Balances shall be held in trust for the benefit of the Cardholders".

For a period of several months in 2013 and 2014, there was a coding error in the IVR system which permitted a chit to be redeemed multiple times. Cardholders could exploit the coding error by making multiple simultaneous telephone calls to the IVR system, redeeming their chit multiple times, and obtaining multiples of the value of the chits, which were then used by the cardholders to make purchases. As a result of the misuse of the IVR system, InComm wired $10,769,039 to Bancorp in connection with these fraudulent transactions. Bancorp transmitted most of these funds to vendors, but currently retains $1,880,769 of the wrongfully-redeemed funds in its trust account.

The Computer Fraud Coverage

InComm submitted a claim under its computer fraud coverage, which provided that Great American would:

... pay for loss of, and loss from damage to, money, securities and other property resulting directly from the use of any computer to fraudulently cause a transfer of that property from inside the premises or banking premises:

a. to a person (other than a messenger) outside those premises; or

b. to a place outside those premises.

Great American reasoned that the cardholders had not engaged in computer fraud within the meaning of the policy, as they had utilized telephones, not computers, to make the calls. Great American also took the view that any loss to InComm was not a loss "resulting directly" from computer fraud. The Court accepted Great American's position on both issues.

Relying on the Ninth Circuit's recent Pestmaster decision, the Court held that the cardholders' telephone usage could not be construed as the "use" of a computer, notwithstanding that their telephones were ultimately communicating with a computer system:

"Use" also is not defined in the Policy. The word commonly is defined as to "take, hold, or deploy (something) as a means of accomplishing or achieving something; ... A person thus "uses" a computer where he takes, holds or employs it to accomplish something. That a computer was somehow involved in a loss does not establish that the wrongdoer "used" a computer to cause the loss. To hold so would unreasonably expand the scope of the Computer Fraud Provision, which limits coverage to "computer fraud." Cf. Pestmaster ... ("Because computers are used in almost every business transaction, reading [a computer fraud insurance policy] provision to cover all transfers that involve both a computer and fraud at some point in the transaction would convert this Crime Policy into a 'General Fraud' Policy."). It also would violate the Court's obligation to read the Policy "as a layman would read it and not as it might be analyzed by an insurance expert or an attorney." ... Lawyerly arguments for expanding coverage to include losses involving a computer engaged at any point in the causal chain — between the perpetrators' conduct and the loss — unreasonably strain the ordinary understanding of "computer fraud" and "use of a[ ] computer". ...

 The Policy does not cover InComm's losses resulting from the unauthorized redemptions, because the cardholders used telephones, not computers, to perpetrate their scheme. [emphasis added]

Direct Loss

The Court also held that InComm had not established that it had sustained a loss "resulting directly" from the cardholders' conduct. The Court observed that, under the terms of InComm's contract with Bancorp, InComm retained an interest, as trustee, in the funds so long as they continued to be held by Bancorp. Consequently, a transfer from InComm's Wells Fargo account to Bancorp was not itself a loss. The earliest that a loss could occur was when funds were paid out by Bancorp to vendors to settle the cardholders' expenditure of the fraudulently-redeemed chits.

The Court continued:

This conclusion is underscored by the fact that funds wired to Bancorp, as a result of the fraudulent chit redemptions, are still in the Bancorp Account almost three years after the chits were wrongfully redeemed. That is, these funds have not been lost. InComm's loss thus did not result "directly" from the fraudulent redemptions, because it occurred only after InComm wired money to Bancorp, after the cardholder used his card to pay for a transaction, and after Bancorp paid the seller for the cardholder's transaction. ... The losses here did not occur when funds were sent to Bancorp's premises. They occurred when funds were sent, by Bancorp, to the premises or accounts of merchants from which cardholders purchased goods or services. [emphasis added]

The Court also observed that, even if the loss had occurred earlier in the process (i.e., when the funds left Wells Fargo), the loss still did not result directly from the chit redemptions. Great American pointed out that those fraudulent redemptions did not automatically transfer funds to issuers like Bancorp. A redemption did not reduce the available assets in InComm's hands; instead, a redemption only triggered InComm's contractual obligation to an issuer to fund the redemption.

The Court agreed. Relying on Pestmaster and Apache, the Court held that:

... InComm's loss resulted directly — that is, immediately — from InComm's decision to wire the funds to Bancorp, not from the cardholders' redemptions. Apache, and the cases it discusses, warn that to find coverage based on the use of a computer, without a specific and immediate connection to a transfer, would effectively convert a computer fraud provision into a general fraud provision. ... To accept InComm's argument that the cardholders' fraudulent redemptions resulted directly in the transfer of funds from InComm to Bancorp — where InComm itself chose to make the transfer — would violate the admonition in Apache and the other cases addressing computer fraud coverage.

The computer fraud insuring agreement in InComm's policy is identical to the one at issue in Apache. Apache involved a social engineering fraud where someone impersonating a representative of Apache's vendor sent "new" bank information to Apache via email, resulting in invoice payments being misdirected. In that case, the Fifth Circuit pointedly used language to lay the loss at the feet of the insured:

Doubtless, had the confirmation call been properly directed, or had Apache performed a more thorough investigation, it would never have changed the vendor-payment account information. Moreover, Apache changed the account information, and the transfers of money to the fraudulent account were initiated by Apache to pay legitimate invoices ... Arguably, Apache invited the computer-use at issue, through which it now seeks shelter under its policy, even though the computer-use was but one step in Apache's multi-step, but flawed, process that ended in its making required and authorized, very large invoice-payments, but to a fraudulent bank account.  

Similarly, the Court in InComm noted that:

InComm chose to wire funds to Bancorp because it was contractually required to do so and because, despite any reconciliation or verification process it had in place, it believed the redemptions were legitimate.

Then, borrowing language from Apache, the Court stated:

As in Apache, "the authorized transfer was made to the [Bancorp] account only because, after receiving [notice of the duplicate chit redemptions], [InComm] failed to investigate accurately new, but fraudulent, information provided to it." [emphasis added].

Not only did the Apache and InComm courts refuse to find an "immediate" relationship between the alleged conduct and the claimed losses, they each observed that investigatory lapses on the part of the insureds could be considered intervening and superseding causes of their losses.

Conclusion

Although it arises from a rather complicated set of facts and legal relationships, InComm provides helpful general guidance on both the "use of a computer" and the "direct loss" requirements found in computer fraud insuring agreements.

The courts in Apache and Pestmaster recognized that computers are involved in virtually every business transaction, and that interpreting computer fraud coverage to cover every loss that involves both a computer and fraud at some point in the transaction would turn such coverage into a "general fraud policy". The Court in InComm built on this insight by interpreting "the use of any computer to fraudulently cause a transfer" to require the fraudster's use of a computer, not the use of a telephone to interact with the insured's computer.

Further, the Court implicitly applied a "direct means direct" causation approach in finding that the loss was not one resulting directly from the cardholders' conduct. This is underscored by the Court's requiring a "specific and immediate connection" between the conduct and the loss, which could not be established, given the intervening steps which occurred here.

[Editors' Note: Our guest co-author, John Tomaine, is the owner of John J. Tomaine LLC, a fidelity insurance and civil mediation consultancy in New Jersey.  After over thirty-one years with the Chubb Group of Insurance Companies, he retired as a Vice President in 2009.  He is an attorney admitted in Connecticut and New Jersey, and holds a Master's Degree in Diplomacy and International Relations.  He is available to serve as an expert witness in fidelity claim litigation and to consult on fidelity claim and underwriting matters.]

InComm Holdings, Inc. v. Great American Insurance Company, 2017 WL 1021749 (N.D. Ga.)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
David S. Wilson
Christopher McKibbin
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.