Evan Schuman's StorefrontBacktalk

Attorney Mark D. Rasch is the former head of the U.S. Justice Department’s computer crime unit and today is a lawyer in Bethesda, Md., specializing in privacy and security law.

When a land title company in Missouri checked its bank account, it found it short by $440,000. Seems that someone had logged into its account at BancorpSouth and wire-transferred the funds to some strange entity’s bank account in the Republic of Cypress. Now the escrow and title company had never done a wire transfer like that. It had never done an international wire transfer. It had never wired money to Cypress, and had never done any business with the strange entity known simply as “Brolaw Services.” The transaction was entirely fraudulent.

Someone had hacked the escrow company’s computers, installed a Trojan horse program, captured the login information, logged into the bank, and transferred the funds without the knowledge or authorization of anyone at the Missouri escrow company. When the Missouri escrow company called its bank to get the money back, the bank told the merchant to go pound sand.

In what has become a trend in this area of law, the federal Magistrate ruled that, when it came to bank fraud, the merchant was essentially on its own. The answer was for the merchant to have better security, not for the bank to have better alerting procedures.

The case involves the interplay between fraud, risk, loss, law and technology. Unfortunately, in this case, fraud wins.

Online banking is a boon for merchants, customers and banks alike. It’s easy, cheap, and usually effective. It saves the banks billions in not having to staff bricks-and-mortar banks with tellers, clerks or even people to answer the phones. The customers are responsible for data entry and quality control. With online banking, everybody’s computer (and iPad, Android phone, or Internet device) becomes a branch office or ATM.

The problem is that your computer, network, iPad, or phone simply lacks the security or authentication systems you would find in your average bank. Online banking systems are vulnerable to a host of attacks–many of them on the client (or merchant) side of the transaction. As a result, passwords, credentials or other authentication systems used by banks in online transactions can be stolen, forged, subjected to a “man in the middle” attack or otherwise compromised. Same is true for user IDs, passwords, or other ways used to validate the merchant to their bank. Nothing beats stopping by the branch office in Missouri and saying howdy to ’ol Mr. Watson at the bank, right? Online, nobody can tell the difference between Clayton, Mo., and Cypress.

For consumer transactions, we have something called “Reg E” and a federal statute, 15 USC 1693(g). With a few exceptions, the law provides that consumers are liable for unauthorized funds transfers only up to $50, and as a practical matter, banks usually waive the $50 fee. Of course they do. They want consumers to use online banking. They want consumers to use credit cards. They want consumers to use debit cards. This saves banks billions in bricks-and-mortar outlets. The more people feel comfortable doing online banking (even if there is occasional fraud), the more they will do it, and the better off the banks will be.

But for merchants, not so much. The law presumes that commercial entities (unlike moronic consumers) are smart and can protect themselves from online fraud. Thus, under the Uniform Commercial Code (UCC) adopted in almost every state, for commercial fraudulent transactions, the courts balance the liability between the commercial entity (merchant) and the bank. If the bank had “commercially reasonable” security (e.g., we did what many other banks do), then–for the most part–poof! That money in Cypress is YOUR problem, not theirs.

So what happened in the Missouri bank case was that the bank saw an upsurge of fraud, particularly the use of Trojan horse programs to steal passwords of its customers. It notified the escrow company, and suggested that the escrow company impose a “dual control” rule. Wire transfers could only be done if two agents of the company agreed and signed (digitally) the request. Sort of like nuclear missile silos – insert key, turn key, arm missile, launch.

Problem was, this was a small company, and the two people responsible were rarely in the same place at the same time. So the escrow company rejected this as unworkable for them.