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In a landmark decision, the First Circuit Court of Appeals held
in Patco Construction Company, Inc. v.
People's United Bank, No. 11-2031 (1st Cir. July 3,
2012) that People's United Bank (d/b/a Ocean Bank) was
required to reimburse its customer, PATCO Construction Co., for
approximately $580,000 which had been stolen from PATCO'S bank
account. In so doing, the Court reversed the decision of the
United States District Court for the District of Maine which had
granted summary judgment in the bank's favor.
The dispute arose when Ocean Bank authorized six fraudulent
withdrawals over seven days from an online account held by
PATCO. While the bank's security system flagged each one
of the transactions as "high risk" because they were
inconsistent with the timing, value, and geographic location of
PATCO's regular payment orders, the bank's security system
did not notify PATCO of this information and allowed the payments
to go through. In light of this omission, PATCO sued, alleging that
Ocean Bank should bear responsibility for the loss because its
security system was not "commercially reasonable" under
the Uniform Commercial Code, as codified under Maine Law.
Ocean Bank moved for summary judgment on the basis that its use
of a one-time log-in and password security requirement for
transaction authentication was sufficient to comply with the
"commercially reasonable" standards. The District
Court agreed and granted the bank's motion.
On appeal, the First Circuit reversed, based on its
determination that the bank's "generic
'one-size-fits-all' approach to customers violates Article
4A's instruction to take the customer's circumstances into
account." The Court explained that Ocean Bank's
failure to implement enhanced security procedures was unreasonable
in light of its knowledge of ongoing fraud involving the same
measures as had been used with respect to PATCO's
account. When the fraud re-occurred in this
"unordinary" situation, the Court held that it was
"commercially unreasonable" for Ocean Bank's security
system to trigger only those security measures which were
applicable to "ordinary" transactions. The Court
reasoned the "unprecedentedly high risk scores" on the
potential transactions were well above PATCO's regular risk
scores and therefore should have triggered extra security measures
to authenticate the transactions. The Court stressed, however, that
it was the bank's "collective failures" taken as a
whole, rather than any single failure, which rendered its security
system commercially unreasonable under the circumstances.
The PATCO decision could have significant implications
for financial institutions and their insurers, as it has the
potential to open the "floodgates" for businesses
victimized by cyber fraudsters to sue their banks in order to
recover misappropriated funds. It also could impact similar
lawsuits currently pending, such as Choice Escrow and Land Title, LLC v.
BancorpSouth Bank, Case No. 2010cv03531 (W.D. Miss.),
which involves loss arising from ACH and wire fraud.
On the other hand, the First Circuit in PATCO suggested
several proactive measures which might enable financial
institutions to avoid the fate suffered by Ocean Bank. Among
other things, the Court identified the following enhanced security
procedures: (i) manual reviews of suspect transactions by
actual personnel to determine the legitimacy of a transaction, (ii)
eschew a "one-size-fits-all" security approach for
customers, and (iii) "customer verification" or
notification to authenticate uncharacteristic or suspicious
transactions.
At the same time, the Court noted that customers such as PATCO
also might have certain responsibilities under Article 4A of the
UCC, even when its bank's security measures are found to be
"commercially unreasonable," although the Court
left open the question of what those obligations might be. Of
course, whatever they may be, they did not exist on the facts
presented.
PATCO is but one more example of the value and import
of insurance products such as cyber, fidelity and related E&O
coverages in an ever-changing virtual economy. Financial
institutions, commercial entities and even individual
account-holders cannot rely on others to protect them. Rather, they
need to take pro-active steps to secure their interests, including
purchasing tailored insurance which responds to their changing
needs. At the same time, the insurance industry must continue
to stay ahead of the curve by anticipating the evolving risks and
providing products which will address a rapidly-evolving
market.
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guide to the subject matter. Specialist advice should be sought
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