TWENTY SECOND ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE

Transcription

1 TWENTY SECOND ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE nd rd SEPTEMBER 22-23, 2011 COMPUTER FRAUD COVERAGE: A DISCUSSION OF RECENT CASE LAW PRESENTED BY: SUSAN EVANS JONES Wolf, Horowitz & Etlinger, LLC 99 Pratt Street, Suite 401 Hartford, CT 06103

2 COMPUTER FRAUD COVERAGE: A DISCUSSION OF RECENT CASE LAW I. INTRODUCTION Many commercial crime policies contain a Computer Fraud coverage agreement. While there is little case law interpreting this insuring agreement, recent claims and case law suggest that insureds are more frequently looking to the computer fraud insuring agreement for coverage, even for crimes that do not involve computer hacking or computer-generated transfers. In one recent case, a state trial court found a standard computer fraud insuring agreement to be ambiguous and found that coverage was afforded under the computer fraud insuring agreement for a crime where the involvement of a computer in the fraud consisted of communications between the perpetrator and the insured and the creation of a counterfeit instrument on a computer. This paper will consider the computer fraud insuring agreement as well as recent court decisions interpreting the computer fraud insuring agreement and certain exclusions. Section II of this paper will address language typically found in computer fraud insuring agreements. Section III of this paper will discuss recent cases interpreting the computer fraud insuring agreement and its causation requirement. Section IV of this paper will address the Exchange or Purchase Exclusion and case law interpreting this exclusion. Section V of this paper will discuss a Money Orders or Counterfeit Money Exclusion and how one recent case interpreted the definition of Counterfeit Money in a commercial crime policy. II. THE COMPUTER FRAUD INSURING AGREEMENT A typical Computer Fraud Insuring Agreement, such as the one found in the ISO form, may provide as follows: We will pay for loss of or damage to money, securities and other property resulting directly from the use of any computer to fraudulently cause a transfer of that property from inside the premises or banking premises : a. To a person (other than a messenger ) outside those premises ; or b. To a place outside those premises. 1 Other policies may contain variations of this language, stating, for instance: We will pay you for your direct loss of, or your direct loss from damage to, Money, Securities and Other Property directly caused by Computer Fraud. Computer Fraud may then be defined as: The use of any computer to fraudulently cause a transfer of Money, Securities or Other Property from inside the Premises or Banking Premises: 1. to a person... outside the Premises or Banking Premises; or 2. to a place outside the Premises or Banking Premises. 1 See ISO Form CR ; ISO Form CR

3 Certain policies may contain Computer Fraud insuring agreements that depart from the ISO language or its variations. For instance, a crime policy may provide that the insurer will pay for direct loss sustained by Insured resulting from Computer Fraud committed by a Third Party, with Computer Fraud defined as the unlawful taking of Money, Securities or Property resulting from a Computer Violation and Computer Violation defined as:... an unauthorized: (1) entry into or deletion of data from a Computer System; (2) change to data elements or program logic of a Computer System, which is kept in machine readable format; or (3) introduction of instructions, programmatic or otherwise, which propagate themselves through a Computer System; directed solely against any Insured.... Another Computer Fraud insuring agreement in a policy may provide that the insurer will pay for direct loss to an insured from damage to... Money, Securities, or Property resulting from Computer Fraud..., with Computer Fraud defined as the Theft of Money, Securities or Merchandise by a Third Party, through the use of any Computer System. Such computer fraud coverage provisions are typically intended to provide coverage for computer hacking incidents, or losses caused when a person uses a computer to transfer money or property from the insured to another person or place. However, recent trends suggest that claimants are attempting to invoke the Computer Fraud insuring agreement for losses other than what is typically considered within the scope of a Computer Fraud insuring agreement, based on some connection of a computer to the alleged loss. With the pervasiveness of computer use in today s business world, a computer may have some attenuated involvement with all types of crimes that are not intended to be covered under the computer fraud insuring agreement. III. CASE LAW INTERPRETING THE COMPUTER FRAUD INSURING AGREEMENT As set forth in Section II above, many computer fraud coverage provisions will contain language similar to a requirement that the loss result directly from the use of any computer to fraudulently cause a transfer of that property from inside the premises... [t]o a person... outside those premises ; or [t]o a place outside those premises. 2 A Connecticut trial court recently determined that such a computer fraud insuring agreement was ambiguous as to the amount of computer usage necessary and found coverage under the computer fraud insuring agreement for a crime where the computer involvement was communications between the insured and the perpetrator and the creation of a counterfeit instrument on a computer. 3 In Owens, Schine & Nicola v. Travelers 2 See ISO Form CR ; ISO Form CR See Owens, Schine & Nicola, P.C. v. Travelers Cas. & Sur. Co. of Am., No. CV , 2010 WL (Conn Super. Sept. 20, 2010). 2

4 Casualty & Surety Co. of America, the insured law firm sought coverage under a Computer Fraud Insuring Agreement for a loss sustained after it directed its bank to wire just under $200,000 to an overseas banking institution following its receipt of a fraudulent financial instrument from a purported creditor of a purported client of the insured. The fraudulent scheme began when one of the insured s attorneys received an , purportedly from an attorney in North Carolina, who requested the law firm s assistance in a collection matter in Connecticut for a client of the attorney located in China. After responding to the , the law firm was contacted, again by , purportedly from an individual from the Chinese business. The law firm entered into an agreement with the Chinese business to collect an alleged debt owed to it by a business in Connecticut. Prior to the law firm s attempted collection of the alleged debt, the Chinese business contacted the law firm by and advised that, as a result of its own negotiations, the alleged debtor was going to send a check to the law firm as partial payment of the debt. The law firm then received a check in the amount of $198,610, which purported to be a Wachovia Official Check. Through communications, the Chinese business directed the law firm to deposit the Official Check and wire the amount of the check, less the law firm s fee, to a banking institution in South Korea. The law firm deposited the check into its IOLTA account at Chase Bank. The law firm claimed it confirmed the check had posted to its account and then contacted Chase Bank in person, by telephone and in writing to direct the bank to wire $197,110 to the banking institution in South Korea. Chase wired the funds. The Wachovia Official Check was fraudulent and Chase debited the law firm s IOLTA account after the check was not honored by Wachovia. The law firm made a claim under the Computer Fraud Insuring Agreement of its commercial crime policy. The basis for the law firm s assertion that its claim fell within the computer fraud insuring agreement was that the law firm had communicated with the Chinese business only through s and the fraudulent Wachovia Official Check was produced on a computer. Travelers denied the claim and litigation ensued. Travelers filed a Motion for Summary Judgment in which it argued that the claim did not fall within the computer fraud insuring agreement. 4 The computer fraud insuring agreement at issue contained language similar to that in the ISO form, requiring the use of any computer to fraudulently cause a transfer.... Travelers argued that the use of a computer did not fraudulently cause a transfer because the transfer was directed by the insured itself in person, by telephone and in writing and there was no unauthorized transfer or entry into a computer. The insured law firm argued in its Objection that the Computer Fraud Insuring Agreement applied because a computer caused the transfer in two ways. First, the perpetrator communicated with the plaintiff law firm by s and second, a computer was used to create the fraudulent instrument. One of the insurer s arguments in response was that the law firm s interpretation of the policy rewrote the computer fraud insuring agreement to render the term transfer meaningless, since under the insured s interpretation, a computer only needed to cause a fraud, not a transfer. It also pointed out that the law firm s interpretation was unreasonable because, given the prominence of computers in everyday business functions, its interpretation would yield coverage in limitless contexts. The court found that the policy was ambiguous as to the amount of computer usage necessary to constitute a computer fraud and resolved the ambiguity in favor of the insured. 5 4 The insurer also argued that two exclusions applied. These exclusions are discussed in Sections IV and V of this paper. 5 Id. at *7. 3

5 On summary judgment, Travelers also argued that a computer fraud was not the direct cause of the loss. The subject computer fraud insuring agreement provided coverage for the insured s direct loss of... Money, Securities or Other Property directly caused by Computer Fraud. 6 The court held that proximate causation principles applied, despite that the computer fraud insuring agreement at issue used the term direct twice. The court also rejected the insurer s argument that the insured s receipt of the fraudulent check and direction to its bank to wire funds constituted intervening causes. The Owens Schine court determined that the use of the computer, in this case, for s proximately caused the plaintiff s loss. 7 The court denied the insurer s motion for summary judgment. In Brightpoint, Inc. v. Zurich American Insurance Co., 8 a court reached the opposite conclusion as the Owens Schine court in determining whether there was coverage under a computer fraud insuring agreement for a similar claim. The insured, Brightpoint, regularly sold large volumes of phone cards to a dealer, Genato. It typically accepted payment from Genato by post-dated checks with bank guaranties certifying the sufficiency of funds in Genato s account. Genato would fax copies of the checks, bank guaranties and purchase orders to Brightpoint and Brightpoint would then purchase the phone cards and deliver them to Genato in exchange for the original checks, guaranties and purchase order. On two consecutive days, Brightpoint received copies of purchase orders, post-dated checks and bank guaranties believed to be from Genato by facsimile. Brightpoint sent one of its employees to purchase the phone cards at a distributor s office. Immediately after purchasing the cards, Brightpoint s employee met with a person he believed to be a representative of Genato and turned the cards over to him after receiving originals of the post-dated checks and guaranties previously faxed. Genato later denied issuing the purchase orders and denied authorizing the representative to pick up the phone cards. Brightpoint was never paid for the phone cards and made a claim under its policy with Zurich. Zurich denied the claim on the basis that that there was no evidence submitted that a computer was used to fraudulently cause the transfer of phone cards and therefore there was no covered loss. On summary judgment, one of Zurich s arguments was that the faxed post-dated checks and bank guaranties did not fraudulently cause a transfer of the phone cards. The court agreed with Zurich that the receipt of the facsimile transmission was not the cause of Brightpoint s loss. The court reasoned that it was only after receipt of the original documents that Brightpoint would release the cards and they would not have been released only on the basis of the facsimile. The court further noted that the fraud occurred through the use of unauthorized checks and guaranties, not the manipulation of numbers or events through the use of a computer. It held that, while the facsimile transmission caused Brightpoint to purchase the cards from its supplier, it did not cause it to transfer the cards and therefore did not directly or proximately cause the theft. Brightpoint argued that the policy only required that the theft follow and be directly related to the use of a computer and that the policy did not require that the use of a computer be the proximate cause or predominate cause of the loss. It 6 Id. at *4. 7 Id. at *8. 8 No. 1:04-CV-2085-SEB-JPG, 2006 WL (S.D. Ind. 2006). 4

6 further argued that all that was required for coverage was the use of a computer followed by a theft in some way connected to the use of the computer. The court rejected that argument and noted that Brightpoint s interpretation of the term directly related represented a distortion of the policy terms. The court looked to the Black s Law Dictionary definition of directly as in a straight line or course and immediately. The court further reasoned that, applying Brightpoint s interpretation, coverage would be provided where a customer sends an saying he is coming to the office to make a purchase of phone cards and then comes to the office and completes the transaction with the use of counterfeit money. The court noted that, if coverage were allowed under this hypothetical, it would reflect an interpretation other than a plain and ordinary interpretation of the policy and any reasonable person would not give the coverage for computer fraud that spin. The court held that both in its example and under the facts of the case, intervening events became the direct and proximate cause of the loss. The computer fraud insuring agreement has been referenced in other trial court decisions, but without any substantive analysis. For instance, in Milwaukee Area Technical College v. Frontier Adjusters of Milwaukee, 9 the Court of Appeals of Wisconsin considered a claim made under the computer fraud coverage, but did not directly address the computer fraud insuring agreement because it determined an exclusion applied to exclude coverage for the loss. In that case, a college hired a third party agent to evaluate the college s workers compensation claims and to pay the approved claims. The agent perpetrated a scam whereby he told the college he had sent checks to health care providers, when he had not done so, and then kept the reimbursement checks sent to him by the college. The agent sent dummy check ledgers to the college that represented he had paid the health care providers. The insured college sought coverage under various provisions of its policy with St. Paul Travelers, including the Computer Fraud coverage provision. The insured based this claim on the fact that the perpetrator of the fraud used a computer to print the ledgers which he sent to the college seeking reimbursement and used a computer to manage the bank account into which he put the college s funds and from which he issued checks as part of his scheme. The court did not determine whether such actions brought the claim within the Computer Fraud coverage because it determined that the exclusion for dishonest or criminal acts of the insured s authorized representatives applied to exclude coverage. Likewise, in Methodist Health System Foundation, Inc. v. Hartford Fire Insurance Co., the Eastern District of Louisiana considered a claim made under a Computer Fraud insuring agreement, but declined to analyze whether the loss fell within the Computer Fraud coverage because it determined there was no direct loss and that two policy exclusions applied. 10 In that case, the insured sustained losses to its investment portfolio after it invested funds with a mutual fund that in turn invested the funds with a hedge fund, that in turn invested the funds with a fund managed by Bernard Madoff. The insured filed a claim under the Computer Fraud Insuring Agreement of its commercial crime policy, asserting that the loss was covered because Madoff used a computer to generate false documents that misled investors and gave the appearance of a legitimate investment operation. 11 The court declined to address whether the loss occurred as a result of computer fraud because it determined the direct loss N.W.2d 396 (Wis. 2008). 10 No , 2011 WL (E.D. La. July 1, 2011). 11 Id. at *1. 5

7 requirement had not been met and that a Trading Loss Exclusion and Entrustment Exclusion both applied to exclude coverage. 12 In Great American Insurance Co. v. AFS/IBEX Financial Services, Inc., 13 a court considered whether a loss fell within a computer fraud provision, along with various other provisions of a crime policy. The alleged loss involved an unauthorized representative of an insurance agent submitting false applications for premium financing to the insured and then depositing the checks issued to the agency by the insured into his own personal bank account. The court s decision does not contain much analysis of the Computer Fraud provision, though it did grant the insurer summary judgment with respect to coverage under the Computer Fraud provision, finding the insured failed to present an issue of fact that a computer caused the transfer of any funds from the insured s bank account. While the opinions in Milwaukee, Methodist and AFS/IBEX do not contain analysis of the computer fraud insuring agreement, they indicate that insureds are seeking coverage under computer fraud insuring agreement for crimes where the involvement of a computer is attenuated and not the instrumentality of a transfer. In both Milwaukee and Methodist, the insured s argument was that documents used to perpetrate the fraud were created or produced using a computer. Neither claim involved any hacking or computer-generated transfer. Likewise, in Owens Schine, the insured argued that the use of a computer to create the counterfeit instrument and to send s constituted a computer fraud. If the arguments advanced by the insureds in Owens Schine, Milwaukee and Methodist were accepted, this would potentially mean that any time a document created on a computer was at all involved in the scheme or loss, the computer fraud insuring agreement would apply. This is clearly well beyond the coverage intended by the computer fraud insuring agreement. Given the prevailing use of computers on a day to day basis by individuals and businesses, such an interpretation would bring within the scope of the coverage incidents not at all related to computer hacking or the use of a computer to cause a transfer. Such an interpretation would seemingly bring within the coverage limitless commercial crimes, given that one would be hard-pressed to find a document not created on a computer. While such an argument seems to defy common sense, it has been raised by insureds in at least three litigated cases. IV. EXCHANGE OR PURCHASE EXCLUSION Many computer fraud insuring agreements contain an exclusion for the surrendering of money or property in an exchange or purchase. Such an exclusion may provide that the insuring agreement does not apply to [l]oss resulting from the giving or surrendering of property in any exchange or purchase. 14 Other policies may similarly provide that the policy does not cover loss resulting directly or indirectly from the giving or surrendering of Money, Securities or Other Property in any exchange or purchase, whether or not fraudulent, with any other person not in collusion with an Employee.... or loss due to an Insured knowingly 12 Id at *5. 13 No. 3:07-CV-924-O, 2008 WL (N.D. Tex. July 21, 2008). 14 See ISO Form CR ; ISO Form CR

8 having given or surrendered Money, Securities or Property in any exchange or purchase with a Third Party, not in collusion with an Employee.... In Harrah s Entertainment, Inc. v. ACE American Insurance, 15 a court considered whether an exchange or purchase exclusion applied to preclude coverage. In Harrah s, a patron presented the casino with fraudulent cashier s checks, which were accepted by the casino in exchange for that amount in gambling credit. After the patron lost over $1.4 million of the gambling credit and cashed out the $38,200, Harrah s discovered that the cashier s checks were fraudulent. The policy contained an exclusion providing that coverage did not apply to the giving or surrendering of Money or Securities in any exchange or purchase. 16 The court found that Harrah s had given or surrendered gambling credit, which constituted Money or Securities, in exchange for the forged checks. It therefore determined that the exchange or purchase exclusion applied to exclude coverage. In Owens Schine, the facts of which are discussed in more detail in Section III above, a Connecticut superior court held that an exchange or purchase exclusion was ambiguous. 17 The insurer argued on summary judgment that the exchange or purchase exclusion applied because the insured directed its bank to wire funds to South Korea after receiving what purported to be a Wachovia Official Check and taking out its $1, fee. Without much analysis of the exclusion, the court held it was ambiguous. In support of this determination, the court cited to Harrah s and characterized the Harrah s decision as having found that an exchange or purchase exclusion was ambiguous because it stated that exclusion was loosely worded. 18 V. MONEY ORDERS AND COUNTERFEIT MONEY Some commercial crime policies may contain a Money Orders or Counterfeit Money Exclusion, which applies if an insured does not purchase coverage for Money Orders and Counterfeit Money. The scope of the Money Orders and Counterfeit Money insuring agreement and definitions of Counterfeit Money vary greatly between policies. For instance, some commercial crime policies provide coverage only for money orders and counterfeit paper currency. 19 Others may define Counterfeit Money as an imitation of money that is intended to deceive and to be taken as genuine and Money as: a. Currency, coins and bank notes in current use and having a face value; and b. Travelers checks, register check and money orders held for sale to the Fed. Appx. 387 (6th Cir. 2004). 16 Id. at Owens, Schine & Nicola, P.C. v. Travelers Cas. & Sur. Co. of Am., No. CV , 2010 WL , at *10 (Conn Super. Sept. 20, 2010). 18 Id. at * See ISO Form CR

9 public. 20 Still others may define Money as a medium of exchange in current use and authorized or adopted by a domestic or foreign government, including currency, coins, bank notes, bullion, travelers checks, registered checks and money orders held for sale to the public. 21 There is a dearth of case law construing either the Money Orders and Counterfeit Money Exclusion or Money Orders and Counterfeit Money Insuring Agreement. In a recent case, a Connecticut superior court considered a Money Orders and Counterfeit Money Exclusion and determined that what purported to be a Wachovia Official Check did not constitute Counterfeit Money or a Money Order. 22 In Owens Schine, discussed in more detail in Section III above, the insured sustained a loss after it accepted a fraudulent Wachovia Official Check and wired money overseas to the perpetrator. The subject policy contained an Exclusion for [l]oss resulting directly or indirectly from your acceptance of money orders or Counterfeit Money, unless covered under Insuring Agreements A.1, A.2, A.3, or E. 23 The insured had not purchased coverage under Insuring Agreement E, the Money Orders and Counterfeit Money Insuring Agreement. The subject policy defined Money as a medium of exchange in current use and authorized or adopted by a domestic or foreign government, including currency, coins, bank notes, bullion, travelers checks, registered checks and money orders held for sale to the public. 24 The court held that the Wachovia Official Check does not fall within the recognized definition of money as listed in the policy or in the recognized definitions of money in its usual or ordinary meanings. 25 The court then went on to cite a Black s Law Dictionary definition of money that defined money as currency and specifically provided that it did not embrace notes, bonds or other evidence of debt. 26 The court appeared to rely upon an external definition of money that is contrary to the definition contained in the subject policy. The court further found that ambiguity clouds the meaning of the phrase [money order] in the subject policy. 27 VI. CONCLUSION Though the computer fraud insuring agreement has existed in commercial crime policies for some time, the reported case law interpreting the computer fraud insuring agreement is sparse. However, cases under the computer fraud insuring agreement indicate that insureds are attempting to invoke coverage under the computer fraud insuring agreement 20 See ISO Form CR See Owens, Schine & Nicola, P.C. v. Travelers Cas. & Sur. Co. of Am., No. CV , 2010 WL , at *9 (Conn Super. Sept. 20, 2010). 22 Id. at * Id. at *8. 24 Id. at *9. 25 Id. 26 Id. 27 Id. 8

10 for incidents beyond what would traditionally be considered fall within the computer fraud coverage. In analyzing such claims, the language of the computer fraud insuring agreement itself will be significant, as will the various exclusions that may apply to the computer fraud coverage. 9