[BreachExchange] 2nd Circuit hears data breach argument: Is fear of harm sufficient for Article III standing?

[Audrey McNeil]

http://www.jdsupra.com/legalnews/2nd-circuit-hears-
data-breach-argument-20021/

The 2nd Circuit recently heard oral argument in Whalen v. Michael Stores,
Inc., No. 16-260, a data breach case involving credit card data. Whether or
not the 2nd Circuit follows the 7th Circuit’s lead (established in the
Neiman Marcus and P.F. Chang’s decisions) will likely have far reaching
consequences for the development of Article III standing jurisprudence in
data breach cases.

The data breach in Whalen resulted from malware that skimmed credit and
debit card information from point of sale terminals, capturing credit and
debit card numbers and the associated expiration dates. The plaintiff filed
a class action lawsuit seeking damages related to the 2013 payment card
breach at Michael Stores. Although the plaintiff alleged that cardholders’
names were also captured, Michael Stores’ investigation revealed that
cardholders’ names, addresses and PINs were not compromised.

Prior to Michael Stores’ disclosure of the breach, a credit card bearing
the plaintiff’s American Express account number was physically presented in
Ecuador for two transactions on consecutive days. The plaintiff, who
shopped at Michael Stores in the United States, did not plead that the
charges were processed to her account (as opposed to being declined on the
spot) or that she ever had any liability whatsoever for either of the
attempted uses of her American Express. Plaintiff’s card was cancelled the
same day as the second attempted fraudulent transaction. No further
attempts involving the compromised card number were made.

The district court dismissed the plaintiff’s complaint for lack of Article
III standing, holding that she had not alleged any actual harm.

What is Article III standing?

Article III standing is a threshold requirement to invoke a federal court’s
jurisdiction. It is established by showing the plaintiff’s injury: (1) is
concrete, particularized to her and actual or imminent; (2) fairly
traceable to the defendant’s action; and (3) can be redressed by a
favorable ruling.

Previous cases have examined the nexus between a data breach and actual
injury to a plaintiff, which, in the context of a data breach, can be a
complex analysis. In general, to establish standing a plaintiff must show
more than a “highly attenuated chain of possibilities,” but what more must
be shown? Actual misuse of the stolen data resulting in financial loss
borne by a plaintiff is pretty clear; but what about a situation where
there is only a likelihood of misuse or a risk of financial harm? And do
incidental costs, such as the loss of time to reset security passwords or
greater vigilance in reviewing account statements, constitute sufficient
harm?

Did the Whalen plaintiff have standing?

In Whalen, the court noted the plaintiff’s failure to allege that she
suffered any unreimbursed charges. Furthermore, citing the Supreme Court’s
decision in Clapper (which held that plaintiffs “cannot manufacture
standing merely by inflicting harm on themselves based on their fears of
hypothetical future harm that is not certainly impending”), the district
court in Whalen found the plaintiff could not create standing by alleging
lost time and money associated with credit monitoring, particularly because
her card was cancelled.

The district court was similarly unmoved by her allegations of future harm,
finding any increased threats of identity theft and fraudulent charges too
remote to constitute an injury-in-fact. The plaintiff’s card was quickly
cancelled and she had not suffered any fraudulent charges or other harm in
the intervening two years. The court explicitly distinguished Neiman
Marcus, stating a “critical distinction” was that thousands of Neiman
Marcus customers had suffered fraudulent charges.

In her appellate brief, the plaintiff argued that the district court
misapplied Clapper, given that her credit card information had
unquestionably been targeted and subsequently used, thus avoiding the
speculative chain of events that plagued the Clapper plaintiffs. She
further argued that her case fell squarely within Neiman Marcus and P.F.
Chang’s, two cases decided by the 7th Circuit, both of which generally held
that the theft of customers’ credit card information was enough to satisfy
Article III standing, and that the 7th Circuit’s rationale in those cases
should be followed.

The oral argument

The 2nd Circuit panel was active from the very outset of oral argument.
Judge Guido Calabresi was quite vocal in his belief that standing was
satisfied because the plaintiff was subject to up to $50 of liability for
fraudulent charges under 15 U.S.C. § 1643 at the very moment her credit
card information was compromised. To him, the fact that no such liability
was ever imposed was immaterial.

The other judges on the 2nd Circuit panel, however, expressed considerable
skepticism at the plaintiff’s contention that every cardholder of a
targeted data breach (as opposed to an inadvertent breach, such as a lost
laptop containing the same data) enjoyed Article III standing.

In an attempt to bolster her argument of actual harm, the plaintiff invoked
the costs the putative class incurred in obtaining credit monitoring
services. The Court, though, reminded the plaintiff that unless she bore
those expenses herself, they were immaterial to her standing.

The Court returned to the issue of the plaintiff’s liability for fraudulent
charges and whether American Express was contractually obligated to absolve
the plaintiff or whether it was simply its voluntary policy to do so. In
light of the plaintiff’s uncertainty, the Court asked for supplemental
briefing on the issue. In that briefing, the plaintiff conceded she had not
alleged she was subject to $50 in liability for fraudulent charges, but
argued the American Express policy was outside the pleadings and should not
have been considered by the district court. Whether the resolution of the
Court’s question will carry the day for either party remains to be seen.

Key takeaways

While we await the 2nd Circuit’s decision, there are a couple of immediate
takeaways on the issue of standing in data breach class actions to be
gleaned from the oral argument in Whalen:

1. Focus the court’s attention on the harm allegedly suffered by the class
representatives. Harm suffered solely by absent class members cannot be
used to manufacture Article III standing for class representatives.

2. Educate the court on what is — and, more importantly — is not possible
to do with compromised credit card data. “Identity theft” can be an
amorphous term. Care should be taken to explain the varying risk factors
accompanying a loss of payment card data (including the distinctions
between debit and credit cards) versus the loss of personally identifiable
information such as Social Security numbers.
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