Thinking about the fraud against Target

I read an interesting article in the Wall Street Journal today: http://online.wsj.com/news/articles/SB10001424052702304027204579332990728181278?mod=%3C%25mst.param%28LINKMODPREFIX%29

Basically, the theory presented in the article is that there are these wonderful credit/debit cards with embedded chips that are much more secure than the current system. If only Target (and other retailers) had adopted these, we would have less fraud. Apparently, the fault lies with Target.

I imagine that the expected response to this article is “What were they thinking?” as the reader realizes that more-effective technology was at hand at what might have been a reasonable price.

I got to watch some of this play out in the late 1990′s. At the time, I was working as a technology-focused lawyer and one of the areas I worked on was electronic payment systems. I published a few papers on this. One available from my website appeared in 1998 in the Journal of Electronic Commerce, called “SPLAT! Requirements bugs on the information superhighway“, see http://kaner.com/pdfs/splat.pdf

The issues I wrote about in this (and related papers) involved the use of public-key encryption systems to guarantee identity. The same commercial-liability issues were coming up for chip cards, with the same rationale.

These systems offered the potential of significantly reducing fraud in consumer transactions. Fraud was seen as a big problem. With these savings of billions of dollars of losses, some credit card company representatives spoke of being able to noticeably lower their fees and interest rates. Who wouldn’t want that?

Unfortunately, some financial services firms (and some other folks) saw two opportunities here.

  1. They hated paying money to criminals committing fraud
  2. They hated guaranteeing every credit card transaction in the event of fraud—they wanted to put this risk back on the consumer but current legislation wouldn’t let them

The proposals to adopt encryption-based identification systems in commerce tied these together. The proposed laws would:

  1. authorize the use of encryption-based identification as equivalent to an ink signature
  2. treat the encryption-based identification as absolutely authoritative, so that if someone successfully impersonated you, you would bear all the loss. Current law sticks the financial-services firms with the risk of credit-card fraud losses because they design the system and decide how much security to build into it. The proposed new system would be an alternative to the consumer-protected credit-card system. It would flip the risk to the consumer.

I think legislation would have easily passed that provided incentives to adopt encryption-based identification. For example, the legislation could have created a “rebuttable presumption” — an instruction to a court to assume that a message encrypted with your key came from you and if you wanted to deny that, you would have to prove it.  This legislation would have reduced fraud, which would benefit everyone. (Well, everyone but the criminals…)

Unfortunately, the demand went further. Even if you could prove that you were the victim of identity theft that was in no way your fault, you would still be held accountable for the loss. 

The lawyers advocating for incentivizing encryption-based identification weren’t willing to separate the proposals. The result of their inflexibility was opposition to encryption-based payment-related identification systems (including chip cards). One dimension of the opposition was technical–the security of the payment systems was almost certainly less (and therefore the risk of fraud that was created by the system and not by negligence of the consumer was greater) than the most enthusiastic proponents imagined. Another dimension was irritation with what was perceived as greed and unwillingness to compromise.

Back then, I saw this play out because I was helping a committee write the Uniform Electronic Transactions Act (UETA). This eventually passed in most states and was then federalized under the name ESIGN. ESIGN now governs electronic payments in the United States. The multi-year drafting process that yielded UETA/ESIGN offered a unique opportunity to write incentives for stronger identification systems into the laws governing electronic payments. Instead, we chose to write legislation that accepted a status quo that involved too much fraud, with prospects of much worse fraud to come. I was one of the people who successfully encouraged the UETA drafting committee to take this less-secure route because there was no politically-feasible path to what seemed like the obvious compromise.

Our economy has benefited enormously from legislation that lets you buy something by clicking “I agree”, without having to sign a physical piece of paper with a physical ink-pen. We could have done this better. Instead, we accepted the predictable future outcome that the United States would continue to use insecure payment systems, that would result in ongoing fraud, like the latest attacks on Target, Neiman Marcus, and (apparently, according to recent reports) at least six other national retailers.

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