Supreme Court Declines to Hear Case Involving Virginia Credit Union Payments Liability

“This case involves a question of national importance in which the courts of appeal have diverged: When does a financial institution bear responsibility for the loss when it allows scammers to use a custodial account to abscond with stolen funds?” SBS argued in its petition to the Supreme Court. The company argued that Virginia’s Uniform Commercial Code imposes liability when a financial institution "knows" a deposit is misdirected but fails to act.

SBS asked the justices to decide whether "know" implies a duty of due diligence, as held by the 11th Circuit Court of Appeals and several district courts, or whether it requires “actual knowledge” by an employee, as the Fourth Circuit Court of Appeals concluded.

In its response to SBS’s petition, 1st Advantage argued the Fourth Circuit Appeals Court decision was “precisely faithful to the language of the state statute” and that there are no federal-law issues in the case. The credit union also argued that there is “no cognizable circuit (court) split involving the interpretation of analogous state-law statutes from other jurisdictions,” and that a decision contrary to the ruling of the Fourth Circuit Appeals Court would threaten grave harm to the national financial system.

The Fourth Circuit Court’s ruling reversed a January 2023 judgment by a Virginia district court judge, which found the Yorktown-based credit union was liable for fraudulent fund transfers. The judge ruled in favor of SBS’s lawsuit that 1st Advantage failed to act on anti-money laundering alerts and suspicious activity involving a member's account and payments made on that account by SBS, a Webster, N.Y., manufacturer of steel framing systems.

The dispute traced back to August 2018, when a member identified as L.T. opened a personal account at 1st Advantage and told the credit union it would be used for real estate transactions. In October, SBS received a spoofed email purporting to be from its client Olympic Steel, instructing it to update payment information. Studco made four ACH deposits totaling $558,868 to L.T.’s account between Oct. 1 and Nov. 13, 2018.

Although the credit union system flagged the Olympic Steel transactions due to the name mismatch, the reports were stored automatically and never reviewed by credit union staff.

The appellate court noted that reviewing hundreds or thousands of such alerts daily would not have been practical or customary. Instead, 1st Advantage processed the transactions based on the account number provided, in accordance with state law.

In legal terms, "actual knowledge" means that a credit union employee is consciously aware that the account number and name in a payment order do not match.

The appellate judges found it erroneous for the district court to interpret “actual knowledge” as knowledge that could have been discovered through “due diligence,” as 1st Advantage had no duty to proactively search for mismatches.

While the lower court agreed that 1st Advantage had no duty to proactively discover a misdescription of the account information, the evidence showed that the credit union did not maintain reasonable routines for communicating significant information to the person conducting the transaction. If 1st Advantage had exercised due diligence, the misdescription would have been discovered during the first ACH transfer, according to the lower court’s ruling.

However, the appellate court emphasized that state law allows financial institutions to rely on automated systems. Requiring them to verify every name mismatch would hinder efficiency.

“And this makes good sense. Countless discrepancies can arise inadvertently and harmlessly,” the appellate panel wrote. “For instance, the inclusion or omission of a suffix such as Jr. or a middle initial could trigger an alert, as could listing a surname before a first name. Requiring individualized review for meaningless differences such as these would be most impractical, time-consuming, and expensive and would impede the efficient transfer of funds, imposing gridlock on the financial system.”

Peter Strozniak can be reached at pstrozniak@cutimes.com.