Eliminating Externalities in Financial Security
This is a good thing:
An Illinois district court has allowed a couple to sue their bank on the novel grounds that it may have failed to sufficiently secure their account, after an unidentified hacker obtained a $26,500 loan on the account using the customers’ user name and password.
In February 2007, someone with a different IP address than the couple gained access to Marsha Shames-Yeakel’s online banking account using her user name and password and initiated an electronic transfer of $26,500 from the couple’s home equity line of credit to her business account. The money was then transferred through a bank in Hawaii to a bank in Austria.
The Austrian bank refused to return the money, and Citizens Financial insisted that the couple be liable for the funds and began billing them for it. When they refused to pay, the bank reported them as delinquent to the national credit reporting agencies and threatened to foreclose on their home.
The couple sued the bank, claiming violations of the Electronic Funds Transfer Act and the Fair Credit Reporting Act, claiming, among other things, that the bank reported them as delinquent to credit reporting agencies without telling the agencies that the debt in question was under dispute and was the result of a third-party theft. The couple wrote 19 letters disputing the debt, but began making monthly payments to the bank for the stolen funds in late 2007 following the bank’s foreclosure threats.
In addition to these claims, the plaintiffs also accused the bank of negligence under state law.
According to the plaintiffs, the bank had a common law duty to protect their account information from identity theft and failed to maintain state-of-the-art security standards. Specifically, the plaintiffs argued, the bank used only single-factor authentication for customers logging into its server (a user name and password) instead of multi-factor authentication, such as combining the user name and password with a token the customer possesses that authenticates the customer’s computer to the bank’s server or dynamically generates a single-use password for logging in.
As I’ve previously written, this is the only way to mitigate this kind of fraud:
Fraudulent transactions have nothing to do with the legitimate account holders. Criminals impersonate legitimate users to financial institutions. That means that any solution can’t involve the account holders. That leaves only one reasonable answer: financial institutions need to be liable for fraudulent transactions. They need to be liable for sending erroneous information to credit bureaus based on fraudulent transactions.
They can’t claim that the user must keep his password secure or his machine virus free. They can’t require the user to monitor his accounts for fraudulent activity, or his credit reports for fraudulently obtained credit cards. Those aren’t reasonable requirements for most users. The bank must be made responsible, regardless of what the user does.
If you think this won’t work, look at credit cards. Credit card companies are liable for all but the first $50 of fraudulent transactions. They’re not hurting for business; and they’re not drowning in fraud, either. They’ve developed and fielded an array of security technologies designed to detect and prevent fraudulent transactions. They’ve pushed most of the actual costs onto the merchants. And almost no security centers around trying to authenticate the cardholder.
It’s an important security principle: ensure that the person who has the ability to mitigate the risk is responsible for the risk. In this case, the account holders had nothing to do with the security of their account. They could not audit it. They could not improve it. The bank, on the other hand, has the ability to improve security and mitigate the risk, but because they pass the cost on to their customers, they have no incentive to do so. Litigation like this has the potential to fix the externality and improve security.