Cybersecurity: Mitigating the Legal Risks of On-Line Banking With Business Customers

On-line or electronic banking (“e-banking”) offers many well-known advantages to financial institutions engaged in banking and to their business customers.  A significant risk of on-line bank accounts for both financial institutions and their business customers is unauthorized transfers from the customer’s account caused by a breach of the customer’s computer system.  A financial institution can shift the risk of loss for these fraudulent transactions to its business customers under the provisions of the Uniform Commercial Code.

To shift the loss to a customer, a financial institution and its customer must enter into an agreement that provides a security procedure for verifying the authenticity of payment orders.¹ In general, a payment order in the name of the customer, whether or not authorized by the customer, is binding on the customer, provided that (i) the security procedure is “a commercially reasonable method of providing security against unauthorized payment orders” and (ii) the financial institution can prove that it accepted the payment order “in good faith” and in compliance with the agreed security procedure and any written agreement or instructions of the customer restricting acceptance of payment orders.²

What constitutes a commercially reasonable security procedure is an issue of law for a court to decide.  In addition to considering the available security procedures and their appropriateness for the particular type of financial institution, a court will consider a number of factors, including the customer’s use of payment orders and their frequency and size. 

Reported cases dealing with these issues highlight several best practices and potential pitfalls for financial institutions involved in a dispute with their business customers:      

• A bank should follow the recommendations of the Federal Financial Institutions Examination Council on E-Banking with respect to security procedures and other loss prevention measures (http://ithandbook.ffiec.gov/it-booklets/e-banking).
• It is essential that an on-line banking service agreement contain provisions that require the customer to follow the agreed security procedures, maintain the confidentiality of the agreed security procedures, prevent unauthorized access to the account, and immediately notify the bank of any unauthorized access or disclosure of confidential information to unauthorized persons. These provisions can be incorporated into any ACH originator agreement as they may apply.
• If a financial institution uses a third-party processer, then it is important that the customer agrees that the third-party processer’s security procedures are satisfactory.  The financial institution should confirm that the third-party processor implements commercially reasonable security procedures and is required to provide immediate notification of suspicious activity to the financial institution.
• It is helpful if the customer is encouraged to implement its own security procedures such as “dual control,” which requires two independent authorized users to separately approve a large transaction.
• On-line banking agreements with existing customers should be reviewed periodically.  It is important to maintain up-to-date security procedures that will be commercially reasonable for each customer or, if applicable, require the third-party processors to do the same to address the known methods of cyber-attacks.
• A customer who sets an unnecessarily high dollar amount for authorized transactions increases its risk of loss.
• A delay in notifying a customer of the discovery of a suspicious transfer of funds may show a lack of good faith.  By contrast, immediate notification to a customer upon discovery of a suspicious transaction will show good faith.
• At least one court has opined that a financial institution did not act in good faith in processing numerous fraudulent wire transfers to an account in Moscow in a short period of time from an account that was normally empty.  This conclusion points to a failure to maintain operational controls that identify unusual and suspicious activity in an account.

Establishing appropriate security procedures in compliance with the Uniform Commercial Code may prevent or minimize losses for financial institutions and customers in the event of a cyber-attack on a customer’s account.  If a cyber-attack is successful, the financial institution can shift liability to the customer in its entirety.  The reality, however, is that in some instances, a financial institution that has taken all proper measures to shift the risk of loss to the customer may decide that it wants to maintain a banking relationship with the customer due to the value of the customer or that it wants to avoid the reputational risk of a lawsuit accusing it of maintaining an insecure on-line banking system.  In these situations, being in a position to shift the entire loss to the customer provides a financial institution with bargaining power to negotiate a sharing of the customer’s loss.