Last week a small New England bakery announced that its point-of-sale (POS) devices were infected with malware that may have put card data at risk. The bakery’s letter to its customers stressed that it did not store card data on its computer systems, but the malware allowed an unauthorized person to gather card data as the cards were swiped. Merchants similar to the bakery often ask us the following question: "We use a third party vendor for processing transactions and have no card data in our computer system, do we have any risk from a data breach?" The simple answer is "YES!" Indeed, although there are advantages of outsourcing payment processing, doing so does not immunize the business from all risk. If a merchant suffers a breach that allows an unauthorized person to gain access to card data, there are two primary areas of compliance obligations and liability.
(1) State Notification Law Obligations
First, almost every state has a notification law that requires the owner of data to notify individuals whose personal information was compromised. Depending on the type of compromise and the nature of the data collected by the merchant, a merchant may have an obligation to notify the affected individuals. Just the cost of printing and mailing notification letters can reach $2-3 per person notified. The merchant also faces the decision of offering credit monitoring, which ranges in cost from $10-25 per person. Some merchants, who may not have address information, elect to put notices of the compromise on their website. And some state attorneys general post notification letters on their website. A public disclosure of a breach, especially if a significant number of individuals are involved, can result in affected individuals filing putative class action lawsuits. The merchant can also face an investigation by a state attorney general as well as an investigation by the Federal Trade Commission.
(2) Credit Card Association Regulations
Second, the merchant has to report card data compromise events to its merchant bank, who in turn will notify the credit card associations. Doing so triggers a process set forth in the credit card association regulations that can end in the merchant paying millions of dollars in paying fines and assessments.
The contract a merchant signs with its bank to be able to accept credit cards, in general, requires a merchant to: (1) comply with credit card association regulations, including the Payment Card Industry Data Security Standards (PCI DSS); and (2) pay for any fines and assessments issued by the card associations following a card data compromise event.
If a merchant reports an account data compromise event, the merchant is often required to retain a Payment Card Industry Forensic Investigator (PFI) to conduct a forensic examination of the merchant’s processing environment. The current version of the Visa International Operating Regulations (the process imposed by the MasterCard Security Rules and Procedures is similar), which was released on April 15, 2012, sets the rules for what happens next.
If the PFI finds evidence of a breach, the PFI’s report to the card associations will detail the period of time when card data was at risk and whether the merchant was in compliance with PCI DSS at the time of the breach. The merchant will then have to provide the numbers of all cards that were processed during the at risk period to the card associations, who will then notify the banks that issued the cards. If the merchant was not PCI DSS compliant at the time of the breach, Visa can fine the merchant bank up to $50,000 for the first incident. It may also fine the merchant bank up to $100,000 if the incident is not reported immediately. If the merchant was not PCI DSS compliant, the breach put the magnetic stripe data of 15,000 or more Visa cards at risk, and there is $150,000 in fraud and operating expenses associated with the at risk cards, Visa will determine the amount it will require the merchant bank to pay under Visa’s Global Compromised Account Recovery program (generally, breaches involving card not present transactions, such as an online transaction, do not qualify for this recovery program).
If a breach qualifies for the GCAR program, several months after the PFI report is submitted, Visa will send the merchant bank a preliminary determination of the fines that will be assessed and the estimate of counterfeit fraud and operating expenses liability amounts. This assessment can often amount to $2-3 per compromised card. The merchant bank has 30 days to submit an appeal letter if it disagrees with the preliminary assessment. If the merchant bank appeals, Visa will then notify the merchant bank of the final disposition of the appeal—the “decision on appeal [by Visa] is final and not subject to any challenge or other appeal rights.”
When the process is complete, by virtue of the indemnity provisions in the merchant services agreement, the merchant bank will require the merchant to pay the amount assessed by the card associations. This process and the amount of fines and assessments that can result often come as a surprise to merchants. One restaurant in Utah that went through this process refused to reimburse its merchant bank for $82,000 in assessments, and when the bank filed suit to require the restaurant to pay, the restaurant brought a counterclaim against the bank alleging that the indemnification provision in the contract was unenforceable. On a larger scale, a shoe retailer recently disclosed that it is considering filing suit against the card associations to recover over $15 million in assessments following a potential POS breach.
Heightened Risk for Small Merchants
There have been surveys reporting that 85% of breaches occur at merchants who have less than one million annual transactions. Security companies continue to write about the lack of awareness by small merchants when it comes to cardholder data security in the face of an increasing threat landscape. Yet merchants often continue to simply rely on their vendor without doing any auditing and without negotiating for appropriate contractual protections. If the vendor improperly installs the payment application with a weak default password or does not adequately secure remote access and cardholder data is compromised, it is the merchant—not the vendor—who will be required to reimburse the merchant bank. Merchants in this scenario may then look to vendor for indemnity, only to find that the contract with the vendor limits the vendor’s liability to a small amount (e.g. the amount of three months of fees paid by the merchant to the vendor).