Privacy & Information Security Law Blog : Privacy Lawyer & Attorney : Hunton & Williams Law Firm : Personal Data, Information Security

In reaching the decision, Judge Reggie Walton is reported to have stated that he was reluctant to conclude that Congress intended to regulate lawyers when it enacted the FACT Act, which the Red Flags Rule implements.  The court also questioned the FTC's broad interpretation of the term "creditor." Judge Walton is reported to have questioned whether the term could be interpreted so broadly as to render a plumber who bills a customer after performing his work a "creditor" within the meaning of the Rule.  Notably, the Judge's comment may leave the door open for other challenges to the Rule by myriad small businesses whom the FTC considers "creditors" subject to the Rule.

It is reported that the court granted an injunction against the enforcement of the Rule and a declaratory judgment finding that lawyers are not subject to the Rule.  The FTC is expected to appeal the decision.

Although numerous organizations such as the American Medical Association have expressed their objections to the scope of the rule, the American Bar Association (“ABA”) escalated matters in August 2009 by requesting a federal court to issue an injunction that bars the FTC from enforcing the Red Flags Rule with respect to attorneys.  The ABA argues in its complaint that there is no “legally supportable basis for application of the red flags rule to lawyers engaged in the practice of law.”  On September 23, 2009, the ABA filed a motion for summary judgment in the case, and the FTC responded by filing a memorandum in opposition that argues that “subjecting attorneys to the Red Flags Rule is based on the attorney’s billing arrangement with clients—essentially an accounting function—and not on some essential element of the lawyer-client relationship, such as the protection of client confidences.”  The District Court of the District of Columbia has scheduled a hearing on the ABA’s motion on October 29, 2009, just three days before the Red Flags Rule is set to take effect.

On October 20, 2009, the House of Representatives approved H.R. 3763, which amends the Fair Credit Reporting Act to exclude health care, accounting and legal practices with 20 or fewer employees from being deemed “creditors” subject to the Red Flags Rule.  In addition to the specific exemptions for small health care providers, accounting firms, and law firms, H.R. 3763 also allows the FTC to exclude any other business from the definition of “creditor” if the business applies for an exclusion and either (1) knows all of its customers or clients individually; (2) only performs services in or around the residences of its customers; or (3) has not experienced incidents of identity theft and identity theft is rare for businesses of that type.  Finally, the bill requires the FTC to issue regulations within 180 days of the enactment of the bill that set forth the process by which businesses may apply for these exclusions.  Despite the House’s passage of the bill, there has been no similar legislation introduced in the Senate and it is unclear whether there are any plans to do so before the November 1st deadline.

While the Rule does not explicitly contemplate a category of entities that are "at low risk for identity theft," the imposition of less onerous requirements on lower-risk entities is consistent with the Rule'’s risk-based approach to combating identity theft.  To take advantage of the template, an entity first must assess whether it is at low risk for identity theft.  The FTC suggests that low risk may be shown by factors such as knowing customers personally, providing services at customers'’ homes, not having experienced fraud based on identity theft in the past and being in a line of business in which it is uncommon to experience fraud due to identity theft.  These factors are not exhaustive, however, as the template requires entities to also consider their unique circumstances in determining their identity theft risk level.  The assessment and the resulting conclusion must be documented in the template. 

The FTC template then guides low-risk entities through the requirements of the Rule by asking them to identify red flags they may experience in their business if a consumer tries to obtain a product or service via identity theft.  The template assists low-risk entities in selecting methods to detect and respond to red flags and administering their Identity Theft Prevention Programs, including implementing updates and managing service providers.  Unlike the Rule, the template requires low-risk entities to document only the final, streamlined Identity Theft Prevention Program (which may be done by simply printing the completed template) and, as compared to the Rule, appears to place less emphasis on the process by which the program is developed.  The template'’s program administration requirements are also less onerous than those contemplated by the Rule.

Notably, the template does not address the issue of whether an entity is subject to the Rule; rather, it assists only in implementation of an Identify Theft Prevention Program once the entity has determined that it is subject to the Rule and is a low-risk entity. In other words, the template does not assist entities in the determination of whether they are financial institutions or creditors, nor does it assist entities in determining whether they have "covered accounts" that necessitate implementation of an Identity Theft Prevention Program, although these issues have been the subject of much debate and confusion among business interests.  In order to make these determinations, businesses may look to the Rule and the FTC’s Red Flags Guide for guidance.

The FTC Identity Theft Prevention Program compliance template for entities that are at low risk for identity theft is available here.  

The guide follows the broad interpretation of the Rule that FTC lawyers have previously articulated on various panels and in FTC publications.  First, the guide confirms that any entity that is a “creditor” under the Rule’s broad definition is subject to the Rule.  The FTC appears to interpret this definition to encompass entities that may have little or no involvement in credit decisions, such as retailers that accept credit card applications for forwarding to credit card companies.  Second, the guide sets out an expansive view of “covered accounts.”  For example, the guide would require a “creditor” to evaluate not only accounts that involve credit but any accounts the business offers or maintains, including non-credit and single transaction accounts, to determine which of its accounts are “covered” under the Rule.  Financial institutions, which had been required to evaluate consumer and non-consumer accounts that involve multiple transactions and have check-writing or similar withdrawal or transfer privileges, may now also have to determine whether their single transaction accounts and accounts without check-writing privileges may be “covered.”

Broad Definition of “Creditor”
According to the guide, any business that sells goods or services and allows customers to pay for them later is a “creditor” under the Rule and, therefore, is subject to the provisions requiring the implementation of an Identity Theft Prevention Program.  This definition of “creditor” may encompass any “invoice billing” arrangements, including those often utilized by law firms, doctors, manufacturers, utility companies and myriad other businesses that do not require immediate payment for their products or services.  Based on the FTC guide, retailers that offer “no interest/no payment” programs are also likely “creditors” under the Rule. 

The second category of “creditors” is entities that “participate” in credit decisions.  This definition, found in Regulation B (from which the definition of “creditor” is derived for purposes of the Rule), covers businesses that may: (i) arrange for loans, (ii) participate in decisions to renew, continue or extend credit, (iii) set the terms of credit, or participate in credit decisions in other, often relatively tangential ways.   A business may be deemed a “creditor” under the Rule if it participates in conducting an initial assessment of credit applications, deciding which applications to send to a lender, receiving proceeds from a portion of the interest rate charged on a loan, restructuring the terms of the sale in order to meet the concerns of the creditor, or advocating for extending credit.  

Notably, Regulation B also defines “creditors” for certain purposes as businesses that “do not participate in credit decisions” but rather only: (i) accept applications, (ii) refer applicants to creditors, or (iii) select or offer to select creditors to whom credit requests can be made.  This definition, relevant only to the Equal Credit Opportunity Act’s anti-discriminatory provisions, suggests that businesses that merely accept credit applications and are in not involved in the approval process or any of the activities that constitute “participating” in a credit decision (for example, retailers, restaurants, hotels or airlines) are “creditors” subject to the Rule.  The FTC appears to take this position in its guide, which lists as an example of creditors, “retailers that offer financing or help consumers get financing from others… by processing credit applications.”

Expanded Scope of “Covered Accounts”
After a business determines that it is a “creditor” or a “financial institution” within the meaning of the Rule, the next step is to determine if the business offers or maintains any “covered accounts.”  If it does, the business must implement an Identity Theft Prevention Program for those accounts.

The guide appears to take a broader view of the definition of “covered accounts” than what had previously been the conventional wisdom.   For example, it was thought that “creditors” needed to consider only consumer and non-consumer credit accounts in deciding which accounts were “covered.”  Under the guide’s interpretation of the Rule, however, a creditor’s covered accounts could include any accounts, rather than only those involving credit.  Thus, for example, if an insurance company allows some consumers to pay for policies after the coverage period and requires others to make periodic payments that prepay coverage, the guide appears to suggest that all such accounts would be “covered” and that the insurance company would need to evaluate the risk of identity theft associated with its non-consumer credit and non-credit accounts to determine if those accounts are covered.  The implication of the guide’s interpretation for financial institutions subject to the FTC’s jurisdiction is that the coverage of the Rule would extend to non-transaction accounts (i.e., accounts that do not allow check writing or similar withdrawal or transfer transactions). 

Finally, the guide suggests that in deciding which accounts are “covered,” financial institutions and creditors  must evaluate the risks associated with “single transaction” accounts. This requirement appears to significantly expand the scope of the Rule, which defines an account only as a “continuing relationship.”  Here, the guide also appears to be in conflict with the position the FTC and the federal banking agencies articulated in the preamble to the Rule that the agencies “determined that… the burden that would be imposed upon financial institutions and creditors by a requirement to detect, prevent and mitigate identity theft in connection with single, non-continuing transaction by non-customers would outweigh the benefits of such a requirement.”

The FTC guide is available on the new FTC website dedicated to the Red Flags Rule, located here.
 

Massachusetts’ new May 1, 2009, compliance deadline coincides with the updated implementation deadline for the Federal Trade Commission’s Red Flags Rule. The Red Flags Rule contains provisions requiring certain financial institutions and creditors to put in place security measures aimed at detecting and preventing identity theft. Entities that are subject to both the Red Flags Rule and Massachusetts’ new regulations may be able to address the implementation requirements of both during the same program development process.

For details regarding the scope and requirements of the Massachusetts regulations, please click here.

For details regarding the updated Red Flags Rule compliance deadline, please click here.