Some Legal Implications of the Use of Computers in the

Banking Business
Roy N. Freed
Philadelphia, Pennsylvaniat

The introduction of computers into the banking business has is introducing new entities whose rights and duties are just being
a wide variety of legal implications that merit careful attention defined. This is an ideal time to make this study, before many
at this very early stage. The industry is highly regulated by policies have been formulated and legal rules adopted. Conclu-
government and, hence, is subject to many statutes and regu- sions reached can help greatly in achieving controlling policies
lations. It also is affected by important common law rules and laws that reflect the peculiar needs of the new technology
and of persons affected by its use in banking.
established by courts. The legal ramifications involve not only
This article undertakes to provide a broad review of the many
the mechanization itself, but also the very significant, economi-
legal implications that might flow from the introduction of com-
cally attractive phenomenon of off premises processing. It is puters into the banking business [1]. Although oriented primarily
essential to identify and provide for many legal aspects for the layman who is involved in either banking or data process-
right now, before systems and practices crystallize, in order to ing, the discussion also should provide much assistance to lawyers
avoid the later impact of unanticipated physical complications unversed in the new electronic information processing tech-
and expense. nology. The primary purpose of this presentation is to help lay-
The legal aspects of computerization in the banking business men concerned with the use of the machines in the banking busi-
are especially diverse. In some states, there might be the basic ness identify factual aspects of potential legal significance for
question whether banks are authorized by law to invest in the further study by legal specialists. It is essential that those lay-
new facilities, either directly or through cooperatives. More men be able to serve as problem finders and perform that rune-
tion at the earliest possible stage in the adoption of computers in
challenging are questions relating to off-premises processors,
specific applications, while solutions are the easiest and least ex-
particularly with respect to the obligation not to disclose infor-
pensive to accomplish and while contracts are being negotiated.
mation concerning a bank's customers, the adequacy of fidelity However, this article is not intended to make lawyers out of
bond coverage, the extent of liability for improper refusal to bankers and computer specialists or even to give definitive an-
pay a check, and susceptibility to regulation by government swers to many of the possible legal problems identified. As usual,
agencies. Also pertinent is the propriety of data processing by legal generalities can provide only clues. Meaningful answers to
banks for nonbank entities and particularly of the rendering problems must be formulated with respect to specific fact situa-
of that service without charge for bank depositors. tions and in terms of applicable laws. Laws frequently vary
among states, for example, and the proper ones must be applied
in each instance. To give the general treatment greatest value,
How much may a bank spend to buy computers outright? M a y however, as many factual examples as possible will be used.
a bank use an outside computer processor? How much in money To provide laymen with a feeling for legal problems lurking in
damages might an outside computer processor have to pay a de- the mechanization of banking, the subject will be approached
positor if it caused his bank to refuse improperly to honor his here from a number of different points of view, some legal, some
check? M a y a bank do data processing for customers that are factual. Essentially, considerations underlying and eharacteriz-
not banks? More generally, how are the traditional legal liabili- ing the pertinent legal rules and requirements will be identified.
ties and obligations of banks affected by their use of outside data Knowing them, it should be possible to spot many legal problems
processors? And are the liabilities of outside data processors any not previously recognized and not covered here. At the outset,
greater than those of the banks for whom they work? These are successively, the sources of legal rules and requirements will be
just a few of the many important legal questions that arise when pointed out, the nature of legal implications that should be an-
banks turn to computers. The answers to applicable questions like ticipated will be indicated, the types of interests in the banking
these disclose factors for which provision should be made in cost area that legal rules exist to protect will be explained, and ac-
estimates, contracts, fidelity bonds, systems designs, and other ac- tivities that appear to require particular attention will be sug-
tivities relating to computer use in banking. Those factors are of gested. Thereafter, a series of examples of legal questions will be
direct concern not only to banks and outside data processors, but presented, drawn from the activities in mechanized banking con-
also to customers of banks, bonding companies and governmental sidered to warrant special study. Finally, recommendations will
regulatory authorities. be offered of programs for avoiding or at least minimizing legal
Consideration of legal topics like those mentioned is essential problems in the banking business.
because the adoption of the new technology in banking is making
major changes in many critical operations in that business and Sources of Legal Rights and Obligations
* Presented at a Symposium on Banking Automation, Prince- Legal rights and obligations pertinent to the mechanization
ton, N. J., June 1963, sponsored by the Association for Computing of the banking business, like such rights and obligations generally,
Machinery and National Computer Analysts, Ine. have a variety of different sources. However, none is of greater
"t 1660 Suburban Station Bldg., Phila. 3. significance than the others. Each must be considered and re-

Volume 6 / N u m b e r 12 / December, 1963 C o m m u n i c a t i o n s of t h e ACM 713

spected with equal care. All have to be examined in searching out parties. Those contracts constitute, for the parties to each trans-
potential legal considerations in banking mechanization. action separately, a body of special and frequently very im-
Statutes. Statutes enacted by Congress and state legislatures portant rules of law. They might, for example, define the extent
probably are the first source of legal rules normally thought of. to which each of the parties will suffer any losses, either by paying
The banking business is highly regulated because of its im- out damages or by foregoing the receipt of damages as compensa-
portance to society and the grave dangers inherent in the tion, where economic harm flows from improper acts in the course
possible abuses that might be practiced. Hence, statutory enact- of the relationship. I t should be borne in mind that contracts
ments pertinent to banking are extensive and cover a wide range normally cannot limit liability that exists to other persons. In a
of its aspects, and many of them are relevant in this discussion. few types of situations, parties may not alter their liabilities by
For example, Congress forbids member banks of the Federal contract. For example, under Pennsylvania's version of the Uni-
Reserve System to pay interest on demand deposits, directly or form Commercial Code, a bank may not escape liability, in con-
indirectly [2]. Similarly, many States limit the portions of the nection with its handling of bank deposits and collections, for
capital of banks that may be invested in data processing facili- its own lack of good faith or failure to exercise ordinary care, or
ties [3]. limit the amount of damages it must pay for harm resulting from
Common-law rules. Exercising their inherent powers under our such conduct [5].
Anglo-American system of law, courts formulate legal rules in
areas not covered by statutes, as they decide specific cases. These Nature of Legal Implications Possible
cases generally involve suits relating to contracts or suits for The kinds of different legal implications that might flow from
damages because of harmful conduct, the latter commonly known banking mechanization are as varied as the sources of legal ..
as tort suits. A substantial body of legal rules has been built up rules out of which they might arise. Circumstances are considered
in this fashion. Like statutes, they cover a very wide range of to constitute legal implications because, as indicated in the ex-
subjects and situations. Although, in the main, common law rules amples detailed below, by virtue of the authority or coercive
apply generally and are, in that respect, relevant to banking power of a government body, a person enjoys a benefit or suffers
operations, some few have peculiar application to situations in a burden. The natures of the possible burdens differ widely. Some
that business [4]. For example, in this fashion, it has been es- probably are not usually identified as legal penalties. Their prac-
tablished that a bank that discloses information about a cus- tical effects, however, are similar, and a l l warrant careful con-
tomer, without legal privilege, is liable to him for damages sideration to their avoidance wherever possible.
suffered and also that a bank that refuses improperly to honor a Lawsuits for damages. The type of legal entanglements most
business depositor's check must pay substantial damages to him commonly thought of is a civil suit in the courts for damages.
for slander of credit. As will be explained later, the rigors of the These suits can seek to enforce rights created by contracts or to
latter rule have been mitigated substantially for banks by statute. secure money damages for harm resulting from an act made im-
Requirements of administrative agencies. Requirements estab- proper by statute or by the common law rulings of judges. En-
lished by government regulatory agencies with jurisdiction over forcement of these rights is left entirely to the private person who
banks constitute a very important source of rules with the force suffers injury. Suit is brought at his discretion and at his expense.
of law. Those requirements might be formalized as published No civil penalty is suffered for a transgression unless injury is
regulations. They might, however, also stem from less formally suffered and a claim is pressed. Reference already has been made
determined ways of performing administrative functions, like to the obligations of banks to pay damages to customers harmed
bank examinations or audits. Normally, administrative agencies by the improper disclosure of information about them or by the
are given merely general responsibilities by the legislative bodies wrongful dishonor of their checks. Such damages would be sought
that set them up and are expected, by means of their rules and by a civil suit.
regulations, to furnish the details that give meaning to the under- Criminal prosecutions. Many legal rules make particular con-
lying policies and to apply them to specific fact situations. A duct improper and impose criminal penalties for indulging in it.
unique characteristic of administrative agencies is their power to Although criminal prosecutions in the banking business are not
decide specific cases involving the application of their regulations, common, the possibility always is present and cannot be ignored.
as well as to promulgate those regulations in the first instance. Criminal penalties particularly pertinent to the introduction of
Hence, agency decisions and rulings relating to particular fact computers into banking are found in laws relating to the preser-
situations also disclose important legal rules. As stated, the bank- vation of records [6] and to the falsification of records [7]. M a n y
ing business is highly regulated. This is indicated at least super- of these criminal penalties for acts of the banks themselves, like
ficially, by the number of agencies involved in the process, ~11 of the failure to preserve records, are applicable to their officers per-
whose regulations are pertinent. They include, for example, the sonally.
Board of Governors of the Federal Reserve System, the Comp- Remedial action to comply with rules. Frequently, a person
troller of the Currency, the various state departments of banking, found to be in violation of a legal requirement will have to take
and the Federal Internal Revenue Service. The regulations of steps to remedy the deficiency. For example, a bank might fail to
those agencies most pertinent to this discussion probably are provide, in a computer system, for records deemed necessary by
those relating to examinations and audits of banks. its state banking department for the conduct of examinations.
Private contracts. The specific agreements and understandings The need to suffer expense in order to achieve compliance, al-
that banks enter into with their customers or with outside data though not ordinarily thought of as a penalty, can be a legal im-
processors also reflect legal considerations highly pertinent in plication as significant as, if not even more burdensome than, a
connection with bank mechanization. Although such contracts judgment for damages.
usually are in writing, and always should be, they might be oral. Drafting contracts. Transactions between banks and their
And written contracts might consist of an exchange of corre- customers or their outside data processors involving data process-
spondence as well as a single formal document executed by both ing, in and of themselves, have impportant legal imlications. For

714 C o m m u n i c a t i o n s of t h e ACM Volume 6 / N u m b e r 12 / December, 1963

example, the tdlocation between the parties of the losses resulting to off-premises processing, and performance by a bank of data
from improper conduct, like carelessness or intentional acts, processing for its customers.
should be decided upon in advance and stated in a contract. The It should be recognized that the discussion and illustrations
parties have many opportunities, in this manner, to establish below are not exhaustive. As stated at the outset, they are fur-
special, but very important, legal rules applicable only to their nished to provide an overview or perspective on the subject, from
own dealings [8]. Full use should be made of these opportunities which other legal implications can be identified by persons in-
to adopt provisions that will help resolve conflicts, which in- timately acquainted with the operations involved.
evitably arise. Of a similar nature, are arrangements between To a certain extent, however, because numerous examples will
banks or data processors and their bonding companies, by which be provided, this segment of the discussion actually will serve as
the burdens of legal liability are spread through insurance. a check list of many legal implications of computerized banking
that are recognized readily and should be considered by banks,
Interests Legal Rules Exist to Protect data processors, supervisory agencies, bonding companies, and
customers of banks. To achieve the completeness appropriate to a
Obviously, legal rules do not exist for their own sake, however check list, necessarily many of the examples referred to previously
unreasonable or unnecessary, on a rare occasion, they might ap- will be repeated, but generally with elaboration.
pear to laymen to be. They always are adopted to protect or foster The following review of legal considerations will provide the
very specific interests in society. With a knowledge of the reasons basis for the recommendations that conclude this article.
why legal rules were adopted, of the interests they aim to protect,
it might be possible to anticipate how existing rules will be ap-
Use o f C o m p u t e r s i n B a n k i n g
plied to new types of situations and what new rules might be ex-
pected for novel circumstances. Various interests intended to There are a number of very different legal considerations that
benefit from laws applicable to banking are treated below. flow directly from the phenomenon of using computers in the
Right of bank customers to recover damages. Customers of banking business. As might be expected, they concern banks
banks have the right not to be subjected to economic loss be- primarily, rather than the other persons involved. However, the
cause of the careless or intentional improper acts of employees of others, especially users of bank services, are affected in some in-
banks. Legal rules provide that they are entitled to receive dam- stances and should find the discussion pertinent to themselves.
ages for any injury they suffer in that way. The right of a cus- Use of computer systems by banks. Ordinarily, it would be un-
tomer to sue for damages resulting from the improper disclosure usual to question whether a bank may use computers in its own
of information about him or from the unwarranted refusal to pay operations. That would seem to be the prerogative of any busi-
his check are examples of legal protections of this type. ness. However, the extremely highly regulated nature of the
Supervision of bank operations. To protect depositors from banking business gives that inquiry substance. Conceivably, the
losses due to improper bank management, governmental super- supervising agencies that maintain close watch over bank opera-
visory agencies reserve extensive examination privileges. To make tions might object, in a mood of extreme conservatism, to the
certain that banks are economically stable, examiners regularly radical change in records and operations that sophisticated com-
check on the sufficiency of assets on hand and on the existence of purer systems have in store, if not to less substantial alterations
adequate protections, like fidelity bonds and insurance, to cover already being experienced. Those agencies probably have con-
losses that might result from thefts, damage suits by customers, siderable power to dictate operating methods of banks, if they
and similar misfortunes. choose to exercise it.
Restriction of banks to banking functions. Generally, statutes Of course, viewed rationally, there should be no question about
and supervisory authorities will not permit banks to engage in the privilege of banks to adopt the new technology. In doing so,
nonbanking activities and businesses, in order to protect deposi- they should be able to satisfy conveniently all reasonable docu-
mentation requirements of their supervising agencies. In fact,
tors from the resulting risks of loss. The economic hazards in-
in many situations, banks probably have an obligation to com-
herent in banking are known and can be provided for to a reason-
puterize. Only in that way, for example, will commercial banks
able extent. Foreign risks are variable and frequently are of un- be able to cope with the tremendous volume of check transac-
known magnitudes and, hence, cannot safely be taken. In this tions. Manual operations prove quite inadequate for the task.
respect, is it economically safe for a bank to engage in the data Furthermore, the new machines are making it possible to achieve
processing business? significant economies and to reduce bank service charges, re-
versing the upward trend of many years.
Activities i n B a n k C o m p u t e r i z a t i o n R e q u i r i n g A t t e n t i o n If any direct legal authority is needed for the use of computers
by banks, it can be found in the many state statutes that permit
The last way to approach the legal implications of the use of
banks to invest in the devices [9], and the Federal law covering
computers in the banking business is to examine the particular bank service corporations [10]. Such authorization is implicit
activities or operations that seem to have such implications. Not in those statutes.
all aspects of banking have special legal considerations be- Distribution of losses from encoding errors. Considerable atten-
cause of automation. The few that do should be scrutinized tion has been given to the way to allocate among banks possible
closely to determine the facts involved. Since most readers will be losses resulting from errors in inscribing in M I C R the dollar
operation-oriented, this approach will be developed in greater amounts of checks on their lower margins so that they can be
depth than the previous three, and its various facets will be illus- processed by computers. This is a highly technical subject of the
trated with numerous examples. This topic will be broken down law of negotiable instruments, covered by the Negotiable Instru-
into the following four categories: the use of computers to conduct ments Law and the newer Uniform Commercial Code. For present
banking operations, the acquisition of computers by banks, resort purposes, and to avoid duplication, it should suffice to refer

V o l u m e 6 / Number 12 / December, 1963 C o m m u n i c a t i o n s of t h e ACM 715

 readers to well considered articles appearing elsewhere [11]. If situation completely. Operations are entirely dependent upon
laymen have any question concerning this aspect, they should its sustained functioning. Governmental authorities will not
recognize, as undoubtedly they expect, that every effort will be brook such vulnerability, even if a bank might be cavalier about
made to impose liability on the bank whose employee made the it. Contractual arrangements will have to be made for standby
mistake. equipment conveniently available.
Misuse of checks with M I C R account numbers. The inscription Protection secured by fidelity bond. Although a fidelity bond
on checks of bank and customer account numbers in M I C R does not cover the expense to compute the amount of the loss in-
probably will alter practices, and eventually legal rules, volved, it will provide reimbursement for the cost of repairing
respecting the proper care and safeguarding of cheek blanks. the harm done to an accounting system by a disloyal employee.
Where old style cheeks are used and the myth of careful bank This cost can be required to untangle an accounting system that
examination of all signatures, to detect forgeries, is prevalent, has been snarled in the course of a scheme to defalcate. Where
depositors have no obligation to safeguard their blank cheeks. computer systems are used for bank accounting, it is entirely
Apart from any names imprinted with regular ink, all cheeks of possible that greater expense will be required to straighten out
a bank are the same and, presumably, are equally useless to un- the records than in the case of a manual system.
authorized persons. Review of system documentation. There may be legal situations
The situation respecting blank checks is very different where in which it is essential to determine whether a bank used reason-
M I C R inscribing is present and computers are used to sort and able care in taking action. If such action is carried out by a ma-
process checks [12]. Signature checking and filing of checks by chine system, all the ingredients making up reasonable care are
customers are the only manual operations that remain. When reflected in the system documentation. This includes, par-
machine filing is achieved, every effort will be made to eliminate ticularly, precautions to avoid error. I t should be recalled that, in
signature checking overtly. Under those circumstances, the cheek litigation, legal adversaries frequently can secure evidence from
inscribed with an account number in M I C R becomes, for all the files of the other side. Hence, system documentation would
practical purposes, the equivalent of a cheek signed in blank to- be readily accessible, in that manner, for examination and use in
day or a credit card. Looking forward to that development, one evidence. Under the circumstances, computer users--and banks
very reasonable to expect, it probably is safe to forecast that are no exception--should be careful that their system documen-
customers will be required increasingly, from now on, to safe- tation does not contain incriminating or harmful information.
guard their own inscribed checks and to notify their banks in the Since notions of the propriety and sufficiency of precautions fre-
event of loss. In addition, it probably also will become necessary quently change, such documentation should be reviewed peri-
to enact laws making it a crime to use a cheek bearing another's odically.
account number in M I C R with intent to defraud, to forge an ac-
count number in M I C R , and to engage in similar practices. Acquisition of Computers by Banks
Anachronism of check certification. In automated systems, Because banks are so highly regulated, the extent to which
processing certified cheeks becomes an unnecessarily expensive
they may invest in computers and in the capital stock of com-
procedure, for which cashier's checks seem to provide an entirely
panies providing data processing service is provided for by law.
satisfactory substitute. Certified cheeks are demanded because
Statutes specify the percentages of their capital that banks may
they signify that funds are on hand at the bank. To accomplish
devote to those purposes. In Pennsylvania, for example, they
this, when a cheek is certified, the bank earmarks funds in the
may not invest more than 25 per cent of their capital and surplus
depositor's account to cover it. If certified checks were processed
in real estate and data processing facilities combined [14]. Simi-
by machine systems in the normal manner, when they were pre-
larly, no bank may invest more than 10 per cent of its capital
sented for payment, they would make deductions from the de-
and surplus in a bank service corporation authorized by Federal
positor's accounts without being associated with the earmark-
law [15].
ings. This would be tantamount to a second deduction for the
Closely allied to the acquisition of computers by banks is their
same cheek. To avoid this, certified checks nmst be handled man-
ownership of stock in outside processors. M a n y states and the
ually, as exceptions to the machine system. To accomplish this
Federal government have enacted laws to authorize this step [16].
treatment, many banks multilate the customer's M I C R number
when making the certification. As indicated, cashier's cheeks, in
sharp contrast, flow smoothly and normally through the new Off-Premises Processing
systems. The legal implications of off-premises processing probably are
As desirable as it might be to eliminate check certification, the most interesting of all those resulting from the introduction
that step is not yet possible. Many statutes and official regula- of computers into the banking business. The phenomenon of off-
tions provide for the acceptance of such checks but not cashier's premises processing is entirely unique. I t represents the first time
cheeks [13]. Efforts probably should be initiated to secure official that traditional bank operations have been entrusted to out-
acceptance of cashiers' checks routinely and to discourage the siders. The practice was entirely unanticipated when existing
use of certified checks. legal rules applicable to banks were established by legislatures
Availability of substitute equipment. Undoubtedly, banks using and courts.
Before considering the possible legal considerations of off-
computers, either on or off premises, will have to satisfy their
premises processing, it is important to recognize the role of the
supervisory agencies that substitute equipment is available if
practice in the banking business. Like in other areas of the econ-
the primary machines are knocked out by power failure, break- omy, it is an important practical means for providing banks with
down or other catastrophe. Where accounting, check processing data processing services at lower costs or with greater efficiencies
and other functions are done manuMly by a large staff, a complete made possible by specialization and a high volume of business.
cessation is extremely rare. Reliance upon a machine alters the In many situations, lower processing costs are achieved by that

716 Communications of the ACM Volume 6 / N u m b e r 12 / December, 1963

practice because, apart from any minimum charge, payment is significantly, it could be argued that the processor does not en-
made only for actual services utilized and varies directly with joy the special protection provided by statutes to banks. In this
need and use. Consequently, there are sound economic reasons respect, there is a legal principle that statutes enacted in deroga-
for achieving solutions to legal questions involving off-premises tion of the common law are construed strictly. Applied here, tile
processing favorable to the practice. word "bank" would mean bank and not also data processing
Examination of outside processor. It must be recognized that company.
an outside processor will be subject to the same examination by Of course, persuasive contrary arguments can be made. For
supervisory agencies as is the bank for which it does work [17]. example, the data processor is not an entirely separate and dis-
Banks could not possibly minimize examination of their activi- tinct entity, but, for practical purposes, occupies the position of
ties by farming out their clerical and accounting operations, and a bank in the new scheme of things. Similarly, it might be in-
none expects that. Methods for providing for examination of sisted that if the legislature were to enact the law now, it un-
outside processors are being formulated now. Under the Bank doubtedly would include the data processor within it scope.
Service Corporation Law, banks subject to examination by a Hence, it should not be deprived of the bank's protections arbi-
Federal supervisory agency must make arrangements with their trarily and without good reason. Approached differently, it
outside processors for examination and must submit written might be contended that the common-law rule arises solely from
assurances to that effect [18]. All state banking departments un- an implied contractual obligation of the bank to its customers
doubtedly will have similar requirements. and that there is no equivalent contract tie between the data
Many, if not all, banks must pay a fee to the supervisory processor and the bank's depositors.
agencies to cover examination costs [19]. Consideration should If the data processor is susceptible to greater liability than its
be given to how the portion of the expense covering the outside bank, depositors suffering wrongful dishonor because of its acts
processor will be handled. This probably is merely a matter of undoubtedly will try to sue it rather than the bank. When two
mechanics since the bank will pay it in the end, one way distinct entities have different degrees of legal liability for the
or another, or at least an amount that is reasonable for such same harm, the one from whom the greater amount can be col-
an operation. Banks have had long experience with examinations, lected generally is sued. I n the case of industrial accidents, for
but outside processors will find it a new experience. Undoubtedly, example, an injured employee usually tries to recover from the
they will be expected to facilitate the periodic step in order to machinery manufacturer for negligence, where verdicts are not
keel) the costs for it to a minimum. limited, rather than from his employer under the much less mu-
Where the outside processor is located in a State different from nificent fixed schedules of workmen's compensation laws.
that of the bank, it is important to make certain that the Where statutes limiting liability of banks already are on the
bank's examiners will cross state lines to visit the data processor. books, their amendment to cover data processors as well should
It is most likely that the state authorities will cooperate in that be considered in states in which data processors might have com-
respect. Informal inquiry corroborates this expectation. How- mon law liability. There probably is no sound reason for dis-
ever, this important point should not be assumed. tinguishing between the two. Similarly, when such statutes are
Outside processor's liability to depositor for wrongful dishonor of henceforth enacted, such as by the adoption of the Uniform Com-
check. It already has been pointed out that the courts feel that mercial Code, inclusion of data processors should be provided
the improper refusal to pay a businessman's cheek constitutes where appropriate. Unless this latter action is taken, it can be
slander of credit and entitles the customer to substantial dam- argued persuasively that the adoption of such a law after the
ages as a matter of course, without proof of specific harm suffered problem has been recognized shows that the legislature intended
or negligence on the part of the bank. If the customer has enough to give the protection only to banks.
nmney on deposit, the bank simply nmst pay his cheeks. This is Liability for disclosure of information about a bank's customer.
the common-law rule. I n considering the scope of this rule, it Courts also hold, under the common law, that the disclosure by a
should be recognized that the important factor behind it probably bank, without legal privilege, of information about a customer
is the harm suffered by the customer and not the causation of that makes it liable for damages for any harm caused. The classic case
harm by a bank. on this point is Tournier v. National Provincial and Union Bank
In recent years, banks have persuaded state legislatures to of England, [1924] 1 K.B. 461, decided in England in 1923. It
mitigate the penalty for wrongful dishonor, and now damages held that the nondisclosure obligation was implied in the contract
generally can be collected for that act only to the extent that between the customer and the bank. This rule raises at least three
they can be proved specifically. For obvious reasons, in light of interesting questions. Does it apply to the tactic of using an out-
the enactment of those laws in the pre-computer era, the protec- side data processor? Does it apply to the outside processor as well
tion appears to be accorded only to banks, at least the statutes so as to the bank? What steps should a bank take to protect itself,
state if they are to be taken literally [20]. How do outside proc- under the rule, when it uses an outside processor? These ques-
essors fit into the picture? tions are considered in the succeeding paragraphs.
Although, in most situations, it is unlikely that an outside Undoubtedly, the rule against unprivileged disclosure of in-
processor would perform an operation that would be the cause formation about a customer will not, in itself, prevent resort to
of an improper dishonor of a check, conceivably it could. If so, outside processors [21]. In the first place, generally, the rule
especially if it is considered to be a matter of tort law rather than penalizes a bank only where harm is suffered by a customer.
Where that approach prevails, mere disclosure, without accom-
contract law, the outside processor might, under the common
panying injury, does not expose the bank to any penalty. Since
law rule, be held liable to a business depositor for damages. There
the outside processor normally will observe strict secrecy, no in-
probably would be adequate legal basis for imposing that liability jury will be suffered by the bank's customers. In this regard, how-
on the processor even though it was doing work for a bank and ever, it has been held that a depositor can secure an injunction
had no overt relationship with the customer affected. But most to prevent his bank from disclosing information about him to out-

Volume 6 / N u m b e r 12 / December, 1963 C o m m u n i c a t i o n s of t h e ACM 717

 siders, specifically a district attorney [22]. That ruling tends to than a mere promise of reimbursement. I t wants to be certain of
undermine the rationale suggested, but probably will not in- actual payment. Probably, the best assurance of the financial
validate the practice under consideration. Secondly, resort by responsibility of the outside processor in the event of the bank's
banks to outside processing is a legally sanctioned step and might liability for its acts is a fidelity bond covering the processor's em-
be regarded as a privileged act. As pointed out, a Federal law and ployees. If such a bond covers losses suffered by the processor as
many state statutes authorize banks to use the services of data a result of the wrongful or dishonest acts of its personnel, it
processing cooperatives and so-called bank service corporations, should encompass legal obligations stemming from improper
although they do not cover ordinary data processors. While it disclosures, in the normal situation.
might be argued that those special entities are bank-dominated Fidelity bond considerations. Banks themselves must carry
and, hence, most likely will observe all of the cautions of a bank, fidelity bonds to provide financial protection in the event of losses
a genuinely valid distinction between them and data processing resulting from the dishonesty of their own employees and to main-
companies not owned by banks might be hard to demonstrate. tain their stability. As indicated, the outside processor should
Finally, and probably most conclusively, the bank utilizing an carry similar coverage not only for its own protection but also
outside data processor undoubtedly remains liable to its cus- for the banks it serves. In relying on the fidelity bond of an out-
tomers for harm suffered from improper disclosure by the side processor, however, the bank should recognize the precarious-
processor. Hence, if it is willing to risk the penalties, it is free to ness of that protection. Coverage of a specific employee generally
take the step. Utilizing an outside processor cannot give a bank is lost if he is retained with knowledge of his commission of an
immunity under the rule. Customers generally are unaware of the act to which the bond applies, without notifying the bonding com-
use of outside facilities when they deal with a bank. But, in any pany. As unlikely as such a situation might seem, the numerous
event, they have every reason and right to expect that the bank cases involving just that indicate that the risk should not be over-
will do nothing to disclose information about them to others or to looked. Hence, a bank could lose an important economic bulwark
make that disclosure possible. Of course, a bank might try to through no fault of its own and without even knowing about it.
eliminate its liability by using elaborate precautions in selecting As time goes on, some protective measures probably will
and dealing with its outside processor. Certainly, no bank should be worked out. Possibly, banks will be able to secure bonding
go outside, in any case, without taking such measures. However, coverage directly oIr persons who are not their employees but
they probably will not insulate the bank. whose acts can subject them to loss.
The common-law rule on improper disclosure probably will be Even where a bank secures full protection for itself through
applied to outside data processors for banks. D a t a processors bonds, the outside processor also must carry its own bonds as we]l.
would be foolhardy to assume that it will not. Bank customers A bonding company that paid a loss to a bank because of an im-
should not be deprived of their legal right to the preservation of proper act of a processor's employee would be subrogated to the
the privacy of their affairs by the fiat of the bank in going outside bank's claim against the processor and probably would press it.
for data processing. They probably will have the choice of suing Its own bond would cushion the processor against such a loss.
the bank or the outside processor. If a bank is forced to pay dam- Effect of outside processing on obligations of prior parties
ages for the improper disclosure of its outside processor, it should to checks. A question has been raised whether use of an outside
have no difficulty in securing at least reimbursement if not addi- processor, with delivery of checks directly to it rather than to the
tional damages for any provable tarnished reputation. In any bank itself, affects, in any way, the obligations of prior parties to
event, data processors would be hardput to deny liability for the check in the event of its dishonor. This question also involves
improper disclosure. Every one assures its customers of the secret interpretations of the Negotiable Instruments Law and the Uni-
treatment of information entrusted to it. form Commercial Code. I t has been the subject of a number of
What protective measures must a bank take when using an articles and it will not be treated here [23].
outside processor to satisfy its obligation under the rule? Restriction on branch banking. In some states that forbid banks
Actually, there are none, because its legal duty is an absolute to have branch offices, the question has arisen whether resort to
one under contract law and does not arise from its failure to take outside processing breaches that restriction. That probably is a
reasonable care. As indicated, a bank probably cannot shield itself concern born of excessive conservatism. When subjected to close
from liability by using an outside processor and will remain liable study in a number of instances, the possible handicap was felt
to an injured customer, possibly along with the guilty processor. not, to be real.
Nevertheless, the bank should take some precautions designed
to prevent improper disclosures by the outside processor, at least P e r f o r m a n c e by B a n k of Data Processing for Its C u s t o m e r s
to minimize its exposure to suit. Along these lines, it probably
would be unreasonable to ask the outside processor to warrant Many banks are offering to perform data processing service
for their customers. This novel step raises a number of legal ques-
that no improper disclosure will occur. After all, no liability at-
tions, some of which are considered at this point. The factual
taches until injury measurable in nmney damages is proven by
variations pertinent to those questions are numerous. Some of
the customer. However, it would seem to be reasonable to insist these banks have computers on their own premises; others rely
that the outside processor's personnel be reminded, on a con- upon outside processors entirely. Some of the customers are
tinuing basis, of the secrecy obligation. other banks; others are engaged in various other businesses. Some
The bank's main legitimate personal concern is to secure in- of the work is identical to that done by the bank for itself; other
demnification from a guilty outside processor for damages that work runs the entire gamut of data processing, business, indus-
have to be paid to an injured customer. Although a right to this trial, statistical and scientific.
indemnification very likely exists under the common law, prefer- Performance of data processing for customers that are not banks.
ably it should be provided for specifically in the contract between I t is not entirely clear that banks may render data processing
the bank and its processor. But the bank wants and needs more service for their customers that arc not other banks. Such serv-

718 C o m m u n i c a t i o n s of t h e ACM Volume 6 / N u m b e r 12 / December, 1963

 ices might involve, for example, payroll processing, inventory The practice of allowing credit to data processing customers
control, sales forecasting, or engineering calculations. As already for demand deposits maintained apparently is proving to be less
stated, banks are restricted to performing banking functions. desirable to the banks offering it than was anticipated. If that
They may not engage in other businesses whose risks are variable is the case, the problem will solve itself. However, if the practice
and unknown and hence might jeopardize the assets of their de- becomes prevalent, Federal regulatory agencies will be forced to
positors. Is rendering data processing service generally such a rule on its legality under the statute cited.
proscribed business? Power of bank service corporations to do data processing for
For some time, banks have been providing services that a lay- customers of banks they serve. Bank service corporations covered
man would not readily identify with banking. For example, by the Federal statute might be authorized to do data processing
many serve as travel agents, an activity that originated as an ad- for nonbank customers of banks they serve, if they so desire, al-
junct of their foreign operations. Undoubtedly, this involves a though this is not positive. That desire is not remote, because
nominal investment and entails minimal risks. Similarly, banks banks well might sell data processing to be performed by outside
perform investigatory services of various sorts, usually on an in- processors, which could include such corporations. Under the law,
formal, irregular and uncompensated basis, largely as an accom- bank service corporations may not do such work directly for
modation to good customers. Again, such services probably are customers that are not banks. They may perform only "bank
not extensive enough to be significant. Do such services provide services" for banks. However, the definition of "bank services"
an adequate precedent for full blown commercial data processing might be construed to authorize them to do general data process-
operations by banks? ing indirectly through the banks they serve. Permissible services
A consideration that might be pertinent in determining the are defined there to mean not only a series of specified activities
propriety of banks engaging in the data processing business ap- ordinarily associated primarily with banking, like check and de-
peared in the recent curbstone opinion of a state banking depart- posit sorting and posting, but also "any other clerical, bookkeep-
ment official. He felt that that activity might be proper if a bank ing, accounting, statistical, or similar functions performed for a
had genuine open machine time on computers suited and ac- bank." In accordance with the earlier discussion, if general data
quired primarily for its own needs but not if it secured computers processing is considered to be a banking function when sold by a
specifically for that purpose or greatly in excess of its own reason- bank, then bank service corporations might be authorized on that
able requirements. This presents an extremely difficult yardstick, basis to do the work when so sold.
if it were to be adopted officially. The very fact that it was men-
tioned, however, seems to indicate the persistence of the restric- Recommendations
tion of banks to the performance of banking functions. At the outset, it was stated that study of the legal implications
I t is argued that banks should be permitted to sell data of the use of computers in the banking business is timely because,
processing service as a means of securing customers for traditional with the adoption of the new technology, unique but important
banking services. Presumably, that ancillary benefit gives com- fact situations are coming into existence, for which applicable
mercial data processing an aura of a banking function. This argu- legal principles have not been formulated yet. The number of
ment probably is most persuasive when payroll processing is in- legal questions left unanswered in the preceding discussion indi-
volved, although largely on an emotional rather than a rational cates how very much legal work along these lines lies ahead. Fur-
basis. It seems to be extremely tenuous when engineering calcula- thermore, additional legal implications can be expected to arise
tions are to be made. as substantially more sophisticated use is made of computers in
As the situation is developing, it seems likely that data process- banking. This general situation presents a challenge and an op-
ing service will become a normal banking function by default. portunity to computer users to participate in the development of
Regulatory agencies do not appear to be facing the problem di- the legal rules they will have to live with.
rectly and ruling on the propriety of the activity. If that is so The paucity of laws pertaining specifically to computer use in
and if they procrastinate much longer, the amazing rapidity of banking is understandable. The technology itself is so very new.
current technological change will produce a longstanding cus- In addition, the process of law-making also contributes to the
tomary practice to validate the activity. Even customs are easier dearth of specifically designed rules.
to create with computers. Thus far, legislatures have failed to act in many areas because
Credit to data processing customers for demand deposits main- persons concerned with deficiencies in the law have failed to press
tained. Some banks are reported to be granting reductions in the for legislation. In highly specialized areas, like banking, sugges-
charges for data processing service to the extent that the customer tions for legislation normally come from the persons involved.
maintains demand deposits with them. That practice on the part Usually, legislators do not act spontaneously. Supervisory agen-
of banks that are members of the Federal Reserve System appears cies still are becoming acquainted with the technology. They
to violate the law against paying interest on demand deposits, probably have not yet commenced to study the many legal ques-
directly or indirectly, by any device whatsoever [24]. tions in earnest. Their regulations lie ahead. Similarly, courts
Of course, commercial banks generally allow checking account have not started to mold the common law on the subject because
depositors credit, against service charges, for the amount of specific cases involving the technology have not been brought be-
money kept on deposit. Although the customer never can get a fore them.
net payment in this way, he can reduce the cost of his checking Computer users can and should participate in all aspects of
account. However, this reduction seems to bear a direct relation- the law-making process described. Since law is a means for mini-
ship to the charge against which it applies since it is measured by mizing severe frictions in society and grows out of the environ-
the benefit to the bank from the bank account it handles. This ment in which it operates, its content frequently can be influ-
probably is the basis on which the practice escapes collision with enced substantially by the persons affected by it. The
the law. present situation is no exception. There are a number of practical

Volume 6 / N u m b e r 12 / December, 1963 Communications o f t h e AC~I 719

steps persons eoffeerned with the use of computers in banking can specialists. A constructive and important task confronts bankers
take now to mold the legal rules applicable to that phenomenon. and computer specialists working with them. It is hoped that
Those steps fall into two general categories. One is the formula- they will acquit their responsibilities promptly and with vigor.
tion and presentation of specific recommendations for legislation
and administrative regulations. The other is the creation among REFERENCES
makers of law, who include legislators, regulatory agency per- 1. For a discussion of more general legal implications of the use
sonnel, judges, and potential jurors, of an understanding of the of computers in business and industry, see FREED, ROY N.
nature of computer technology used in banking and its role in Legal implications of computer use. Comm. A C M 5, 12 (Dec.
that business. 1962), 607 et seq.
In undertaking to formulate recommendations for legislatures 2. Title 12 United States Code §371a.
and supervising agencies, careful study should be made of present 3. Title 7 Purdon's Penna. Stats. §819--1012.
and potential unnecessary frictions and impediments to the use 4. For probably the first reported litigation, however imaginary,
of the new technology that exist in current rules of law. Already, arising from the use of computers in banking, see Haddock v.
The Generous Bank Ltd., Computer 1578/32/W1, The Magi-
we have some good examples. These include the frequent legal
cal Electronic Contrivances Ltd., and the Central Elec-
requirement that certified cheeks be used and the possibility that tricity Board, reported in HERBERT,A. P. The computer in
outside data processors might be subject to greater liability than court. Punch (Feb. 13, 1963), 239-41.
banks if they cause the improper dishonor of a business cus- 5. Title 12A Purdon's Penna. Stats. §4--103.
tomer's check. The recommendations should include both changes 6. Title 7 Purdon's Penna. Stats. §321b.
in existing laws and entirely new legal rules, if any appear to be 7. Title 18 United States Code §1005.
necessary. 8. Topics suggested for possible inclusion in contracts between
Anticipating legal requirements is a very constructive ap- banks and outside processors are contained in Examination
proach, i t is an exercise in preventive law. It is far superior to of Automation of National Banks, pp. 39--40, Office of the
permitting legal problems to be solved by means of rules designed Comptroller of the Currency, 1962.
for entirely different situations. It spares the courts and super- 9. Title 7 Purdon's Penna. Stats. §819--1015.
10. Title 12 United States Code §§1861-1862.
visory agencies the need to stretch and contort legal rules de-
lla. CLARKE,JOHN J. Mechanized check collection. The Business
signed for other purposes. Lawyer 14, 3 (July 1959), 989-1007.
The suggested program to win friends for computers is less llb. The law of payment and settlement of checks. Banking Law
tangible than making eonerete recommendations of legal rules, Journal 79, 2 (Feb. 1962), 128-140.
but is no less important. Legal rules applicable to the use of 12. JOHNSON, KENNETH ~VL Automation, forged checks and the
computers in banking inevitably will be made by legislators, N. I. L. The Business Lawyer 17, 3 (July 1959), 1008-1015.
banking departments, judges and jurors. The attitudes with 13. Title 19 United States Code §198.
which they approach that task will determine, in large measure, 14. Title 7 Purdon's Penna. Stats. §§819--1015 and 819--1213.
the bias their legal products will reflect. If they feel that the new 15. Title 12 United States Code §1862.
technology represents a substantial bonanza to its users, espe- 16. CLARKE,JOHN J. Electronic brains for banks. The Business
Lawyer 17, 3 (April 1962), 532, 541-544.
cially one whose benefits are not shared with customers by
17. For a valuable discussion of the scope of examinations, see
means of reduced charges, they will tend to resolve doubts against Examination of Automation of National Banks. Office of the
users and shift legal burdens to them. They will suspect that the Comptroller of the Currency, 1962.
banks' customers are being subjected to new, unnecessary risks 18. For provisions governing the securing and submission of assur-
of economic loss in the rush to automate [25]. However, if the ances, see Bank service arrangements. Board of Governors
law makers see the new technology as a necessity to carry on ac- of the Federal Reserve System. Regulation S. Title 12 Code
tivities important to society, like the use of commercial cheeks, of Federal Regulations, Part 219. Effective April 3, 1963.
for example, and as a benefit enjoyed not only by users but by 19. See, for example, Title 7 Purdon's Penna. Stats. §754.
their customers as well, they will be more temperate in allocating 20. Title 12A Purdon's Penna. Stats. §4---402, which is Pennsyl-
legal burdens among the various types of persons involved. Then, vania's version of the Uniform Commercial Code that proba-
bly will be adopted in many States. The prior law, Title 7
all will be expected to share the risks as it seems appropriate.
Purdon's Penna. Stats. §211, applied only to a "bank, trust
By means of the suggested educational program, law makers company, or banker."
should be informed, through all media and on all occasions possi- 21. CLARKE,JOHN J. Electronic brains for banks. The Business
ible, of the accuracy levels achieved in computer systems, econo- Lawyer 17, 3 (April 1962), 532, 544-7.
mies in prospect through their use, and the essentiality of using 22. Brex v. Smith, 104 N. J. Eq. 386, 146 Atl. 34 (1929).
them to maintain, if not even improve, important banking serv- 23a. CLARKE,JOHN J. Electronic brains for banks. The Business
ices. Speeches, articles, demonstrations and similar devices can Lawyer 17, 3 (April 1962), 532-541.
23b. FUNK, CARLW. Presentment under the Uniform Commercial
make an important contribution in this respect.
Code--a reply to Mr. Clarke. The Business Lawyer 17,
These recommendations are offered in the belief that they con- 3 (April 1962), 548-551.
tribute to the widest use of computer technology in the banking 24. Title 12 United States Code §371a.
business with an absolute minimum of legal friction. Lawyers 25. For a judicial verbalization of this mentM reaction, see
stand ready to aid in this program to the extent that they are Colonial Life and Accident Insurance Company v. Wilson,
246 F.2d 922 (5 Cir. 1957). Subsequently, the author of that
called upon by persons concerned with the operational aspects.
decision recanted, probably after he became better ac-
Guided by the review of the types of legal implications flowing quainted with the role of computers in society. See BROWN,
from the introduction of the new machines in the banking busi- JOHN R. Electronic brains and the legal mind : computing the
ness, technically oriented personnel should be better equipped to data computers collision with law. Yale Law J. 71, (Dec.
identify situations that might benefit from the attention of legal 1961), 239-254.

720 C o m m u n i c a t i o n s of t h e ACM Volume 6 / N u m b e r 12 / December, 1963