Financial Services Industry Outsourcing and Enforcement of Privacy Laws

Financial Services Industry Outsourcing and Enforcement of Privacy Laws

Order Code RS21809
Updated June 9, 2004
CRS Report for Congress
Received through the CRS Web
Financial Services Industry Outsourcing and
Enforcement of Privacy Laws
M. Maureen Murphy and Angie A. Welborn
Legislative Attorneys
American Law Division
Summary
Concerns about enforcement of customer privacy laws across international
boundaries have been raised as the perception grows that more U.S. financial service
companies are outsourcing to foreign service providers. This report addresses some
frequently asked questions about the enforcement of federal laws requiring the
safeguarding of customer financial information in the context of this outsourcing. This
report will be updated as events warrant.
What is Outsourcing? Outsourcing refers to a business practice of securing
outside providers for functions once performed internally or for new functions that
support or augment internal operations and otherwise would be performed inside the
business, itself. Retaining core functions and farming out peripheral operations is known
as strategic outsourcing and is usually a means of maintaining a “competitive edge.”1
What Functions May Be Outsourced? Unless a statute, regulatory mandate,
a company’s charter, or other legal constraint precludes it, outsourcing of any function or
operation is possible. Financial services companies, particularly depository institutions,
are accustomed to close regulatory scrutiny and have been provided with various forms
of regulatory guidance on outsourcing.2 Functions that are commonly outsourced are
“core processing; information and transaction processing and settlement and activities for
lending; deposit-taking, funds transfer, fiduciary, or trading activities; Internet related
services; security monitoring; systems development and maintenance; aggregation
services; digital certification services; and call centers.... [and] human resources
administration and internal audit.”3 Among the few functions that may not be outsourced
1 Ann H. Spiotto and James E. Spiotto, “The Ultimate Downside of Outsourcing: Bankruptcy of
the Service Provider,” 11 Am. Bankr. Inst. L. Rev. 47 (2003).
2 See, e.g., Federal Financial Institutions Examination Council (FFIEC), FFIEC TSP,
“Supervision of Technology Service Providers (March 2003).
3 Julie L. Williams and James. F. E. Gillespie, Jr., “The Impact of Technology on Banking: The
(continued...)
Congressional Research Service ˜ The Library of Congress

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are those which must be performed by officers or personnel of the institution (e.g.,
certification of the accuracy of annual reports, as required under the Sarbanes-Oxley Act
of 2002.)4
What Financial Institutions Outsource Customer Information? Virtually
any financial institution (e.g., any bank, thrift, credit union, securities firm, insurance
company, tax preparation service, credit bureau, accounting firm, money transmitting
business, and check cashing business) is likely to have some arrangement with outside
entities to process data, either in lieu of processing it in-house or as a back-up in
emergency situations. Banks, for example, rely on outside firms for printing checks,
issuing credit cards, processing transactions, preparing billing statements, operating call
centers and other customer service centers, and processing customer payments.
What Legal Arrangements Do Financial Institutions Make for
Outsourcing? Typically, a financial institution’s outsourcing arrangement will involve
a contract. The contract may be with a wholly independent company or a separately
incorporated subsidiary or a service company in which the institution maintains a capital
investment; or, it may take the form of a joint venture with another company. The contract
generally will specify the duties and rights of each of the parties, the remedies for any
breach, the law that is to be applied to interpret the contract, and any other agreements of
the parties.
What Foreign Entities Provide Services Outsourced By Financial
Institutions? Third-party5 foreign- or domestic- based businesses may perform
outsourced functions for financial institutions. They may be independent of the financial
institution or in some way subject to the oversight of the financial institution by way of
a capital investment, a joint venture partnership, a corporate affiliation, or other form of
arrangement.6 If the operations or services provided are performed in a foreign
jurisdiction, the third-party service provider is likely to be subject to the laws of that
jurisdiction, whether or not it is a subsidiary of a U.S. company or incorporated in the
foreign jurisdiction.7 India and other South Asian countries are emerging centers of
outsourced technology and services.8
3 (...continued)
Effect and Implications of ‘Deconstruction’ of Banking Functions,” 5 N.C. Banking Institute 135
140 (April 2001). [Hereinafter, Impact of Technology].
4 P.L. 107-204 § 302; 116 Stat.745, 777; 15 U.S.C. § 7241.
5 The customer and the institution are considered the primary parties in this context.
6 See Impact of Technology, at 142, indicating an emerging trend toward investing in technology
service providers, rather than merely contracting with them.
7 OCC Bulletin OCC 2002-16, “Bank Use of Foreign-Based Third-Party Service-Providers,”
(May 15, 2002), 2002 OCC CB LEXIS 36 (May 15, 2002).
8 A report by Chris Gentle for Deloitte Consulting Firm, predicted that “future offshore activity
will be spread around the Indian Ocean Rim, from South Africa through the Indian sub-continent
to China, Malaysia and down to Australia.” Gale Group, Inc., Financial Services Distribution
(June 1, 2003), LEXIS;BANKNG Library, CURNWS file, avail. Mar. 25, 2004.

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Where May the Outsourced Service Be Performed? Whether the provider
is a domestic or foreign, the service may be performed either in or outside the United
States, provided it is not performed in violation of existing terrorist or country sanctions
under programs administered by the Office of Foreign Assets Control9 or any applicable
export control law.

What Governs the Confidentiality of Financial Institution Customer
Information? Until the 1970's, confidentiality requirements for financial institutions
were generally imposed under state law. Since then, with the passage of the Fair Credit
Reporting Act (FCRA)10 and Title V of the Gramm-Leach-Bliley Act (GLBA),11 the
financial service industry is subject to broadly applicable federal confidentiality
requirements that may, to some extent, be supplemented by state law. FCRA sets forth
responsibilities for credit bureaus and the entities that furnish consumer information to
them. It preempts state law on, and sets standards for, sharing of customer information
among affiliated companies. GLBA sets the standards for sharing of nonpublic customer
information by financial institutions with nonaffiliated third parties. It does not preempt
state laws that provide more consumer protection.
What Safeguards Are in Place to Protect the Privacy of Customer
Information Outsourced by Financial Institutions? GLBA requires the regulators
of financial institutions12 to issue rules “relating to administrative, technical, and physical
safeguards ... to insure the security and confidentiality of customer records and
information ... and ... to protect against unauthorized access to or use of such records or
information which could result in substantial harm or inconvenience to any customer.”
Banking institutions, thrifts, and credit unions are required by law to notify their federal
regulator of any contract or arrangement with a third-party service provider.13 Each of the
federal financial institution regulators has issued a safeguards rule14 that addresses the
outsourcing of such information, emphasizing that the confidentiality obligation remains
with the financial institution. The federal banking regulators have issued guidance on
9 [http://www.treas.gov/offices/eotffc/ofac/sanctions/index.html].
10 15 U.S.S. §§ 1681 et seq.
11 P.L. 106-102, 113 Stat. 1338, 1436, 15 U.S.C. §§6801 et seq.
12 These are the: Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of
the Currency (OCC), Federal Reserve Board (FRB), Office of Thrift Supervision (OTS),
Securities and Exchange Commission (SEC), National Credit Union Administration (NCUA),
with respect to the depository institutions which they regulate, and the Federal Trade
Commission (FTC), with respect to all other entities coming under the definition of “financial
institution” in GLBA’s privacy title, except for insurance companies. The safeguards standards
for insurance companies are to be administered by state insurance authorities.
13 12 U.S.C. § 1867(c); 12 U.S.C.§ 1464(d)(7)(D)(ii).
14 Federal depository institution regulators’ documents can be found at the FFIEC Website.
[http://www.ffiec.gov/exam/InfoBase/toc_s/02-ffi-table_of_contents_select.html]. The SEC and
FTC safeguards rules are 17 C.F.R. § 248.30 and 16 C.F.R., Part 314. See also, 68 Fed. Reg.
47954 (Aug. 12, 2003), proposing “Interagency Guidance on Response Programs for
Unauthorized Access to Customer Information and Customer Notice.”

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third-party relationships or on outsourcing, particularly outsourcing technology.15
Generally, these guidelines require adequate due diligence and risk management
assessment, as well as contractual provisions, to assure that service providers are capable
of, take steps to, and actually implement safeguards to protect customer information.16
Examiners of depository institutions are required to evaluate the measures taken by the
institutions to oversee service providers.17
Is A Financial Institution Liable for Breaches of Security by Service
Providers? Any financial institution that is subject to a state or federal statutory duty
of maintaining confidentiality of customer information may not avoid that responsibility
by contracting out or otherwise shifting the operation to another entity. Not only does
GLBA18 require that any contractual or joint venture agreement with a third-party service
provider cover the confidentiality of nonpublic personal customer information, but the
actions of the contractor will be attributed to the financial institution under the law of
agency.
What Regulatory Tools Are Available To Monitor Service Providers?
There is a range of regulatory, criminal, and private enforcement options available
depending upon the particular situation. All third-party service providers of federally
regulated depository institutions may be examined by the appropriate federal banking
agencies,19 even in foreign countries.20 Federal regulators may police privacy
15 Id. The FFIEC Website assembles some of the guidelines applicable to depository institutions
by regulatory agency.
16 See, e.g., FRB, SR 00-4(SUP), “Outsourcing of Information and Transaction Processing” (Feb.
29, 2000). Among other things, such contracts must provide for compliance with regulatory
requirements and for access by federal regulators. OCC Bulletin OCC 2002-16 (May 15, 2002),
addresses “Bank Use of Foreign-Based Third-Party Service Providers.” It requires that the
contract “state that all information shared by the bank with a foreign-based third-party service
provider, regardless of how the service provider processes, stores, copies, or otherwise
reproduces it, remains solely the property of the bank.” Id., at 4. It provides that “[a] bank’s use
of a foreign-based service provider must not inhibit its ability to comply with all applicable U.S.
law and regulations. These include requirements concerning accessibility and retention of
records ... and other U.S. consumer protection laws and regulations.” Id., at 3. The guidance
suggests contract provisions protecting customer privacy and requires a provision authorizing
OCC examination of the third-party service provider. It also mandates provisions prohibiting the
redisclosure of bank data or information, compliance with OCC privacy regulations, and
implementation of security measures to maintain confidentiality.
17 “Examination Procedures to Evaluate Compliance With the Guidelines to Safeguard Customer
Information.” [http://www.ffiec.gov/exam/InfoBase/toc_s/02-ffi-table_of_contents_select.html].
18 15 U.S.C. § 6802(2).
19 12 U.S.C. § 1867(c).
20 OTS requires 30-day advance notice from thrifts contemplating third-party service
arrangements with foreign service providers and requires them to include in any contract a
provision that the services are subject to OTS examination. Thrift Bulletin TB 82, at 5 (March
18,2003). The OCC guidance has a similar requirement. OCC Bulletin OCC 2002-16, at 5-7.
It states that “a national bank should not outsource any of its information or transaction
processing to third-party service providers that are located in jurisdictions where the OCC’s full
and complete access to data or other information may be impeded by legal, regulatory, or
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requirements administratively with fines, cease and desist orders, prohibitions on further
dealings, and various other strictures on operations.21 Transgressions that involve
criminal activity such as computer or wire fraud or larceny may be prosecuted under
federal and state criminal laws.22 Victims may be able to resort to a federal or state law
that authorizes civil suits to recover damages.23 Contractors of federally regulated
depository institutions fall within the definition of “institution-affiliated parties” and may
be prosecuted for knowingly or recklessly participating in violating a law, regulation, or
fiduciary duty or contributing to an unsafe or unsound practice. 12 U.S.C. § 1813(u).
What Obstacles May Arise in Enforcement Actions Involving Foreign
Outsourcing? Foreign outsourcing involves risks that the foreign law will change or
that the foreign government will not cooperate in enforcement of U.S. laws, requests for
judicial process, or for extradition. These can be ameliorated by contractual provisions
and by treaty arrangements with the foreign governments. To discharge their privacy
obligations, U.S. financial institutions must require third party service providers to adhere
to the applicable provisions of GLBA, including those on redisclosure and security of
information.24 Before entering into contracts with service providers based in foreign
countries, financial institutions must assess the political, social and economic stability
of the foreign country and its legal framework, including the privacy regime and the
financial institution’s ability to enforce U.S. privacy laws. Contractual provisions that
address choice of law issues, such as which country’s law is to apply to the various
elements of the contract; which courts will have jurisdiction over any contract claim; and
alternative dispute resolution options are means by which the financial institution may
ameliorate some of the risks associated with conducting business with a party operating
20 (...continued)
adminstrative restrictions unless copies of all critical records also are maintained at the bank’s
U.S. offices....If circumstances warrant, the OCC may examine a national bank’s outsourcing
arrangement with a foreign-based service provider. If the provider is a regulated entity, then the
OCC may arrange through the appropriate foreign supervisor(s) to obtain information related to
the services provided to the bank and, if significant risk issues emerge, to examine those
services.”
21 Banking regulators have at their disposal a comprehensive array of administrative tools, most
of which are found in section eight of the Federal Deposit Insurance Act (FDIA) and range from
informal actions, formal cease and desist orders, and civil money penalties. 12 U.S.C. § 1818.
Among the administrative enforcement remedies available are: termination of deposit insurance;
cease and desist orders; temporary cease and desist orders; removal orders; and civil money
penalties. OCC has used this authority to enforce the GLBA privacy requirements. On April 7,
2003, the agency assessed civil money penalties of $20,000 and $10,000 against two former
national bank employees and issued an order requiring their permanent removal from banking
for unauthorized e-mailing of customer data, and electronic loan files.
22 Some offenses may involve federal mail fraud, 18 U.S.C. § 1342; wire fraud, 18 U.S.C.§ 1343;
or computer fraud, 18 U.S.C. § 1030 , and may act as predicate offenses for racketeering, 18
U.S.C. §§ 1961, et seq., or money laundering, 18 U.S.C. § 1956, prosecutions.
23 California’s financial privacy law imposes more requirements on joint marketing agreements
with third-party providers than does GLBA and provides for individual lawsuits to enforce its
provisions. See CRS Report RS21614, Comparison of California’s Financial Information
Privacy Act of 2003 With Federal Privacy Provisions.
24 15 U.S.C. §§ 6802(c) and 6801(b).

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in a foreign country. Nonetheless, since the activity is to be conducted on territory over
which a sovereign other than the United States has jurisdiction, there is always the
possibility that the laws of the other sovereign, including any changes in the foreign law,
may have an effect upon the performance or interpretation of the contract.25 Contracts,
thus, often include clauses indicating the allocation or assumption of the risks associated
with nonperformance in such situations.26 Enforcement of U.S. criminal laws
extraterritorially involves: (1) a valid basis of extraterritorial enforcement,27 (2 ) statutory
authority for extraterritorial enforcement,28 and (3) cooperation of the foreign government
through treaties or other agreements for assistance in law enforcement matters.29 For
further information, see FDIC’s Offshore Outsourcing of Data Services by Insured
Institutions and Associated Consumer Privacy Risks at [http://www.fdic.gov
/regulations/examinations/offshore/index.html] (June 2004).
What Remedies Are Available to Victims of Identity Theft Resulting
From Outsourcing? Victims of identity theft resulting from the outsourcing of
financial information would have the same remedies available to them as victims under
other circumstances. There are no laws specifically aimed at preventing identity theft or
assisting victims when financial information has been outsourced. Thus, victims would
need to use the generally applicable laws discussed in CRS Report RL31919, Remedies
Available to Victims of Identity Theft, to clear their credit records of inaccurate
information resulting from the theft and challenge unauthorized charges on credit and
debit cards.
25 According to Comment (a), relating to subsection (1) of § 441 of the Restatement (Third) of
the Foreign Relations Law of the U.S. (1986), which addresses foreign state compulsion,: “a
state may not, absent unusual circumstances, require a person, even one of its nationals, to do
abroad what the territorial state [foreign country] prohibits.”
26 See, Restatement (Second) Conflict of Laws § 201 (1971).
27 If the offense is committed outside the United States, jurisdiction may be predicated on the
occurrence of a significant effect within the United States. See, C. L. Blakesley, “Extraterritorial
Jurisdiction,” in M. Cherif Bassiouni, International Criminal Law 33, 50 (2d ed. 1999).
28 The federal money laundering statute provides jurisdiction, if conduct by a non-U.S. citizen
occurs in part in the U.S. and the transaction involves $10,000 or more. 18 U.S.C. § 1956(f). For
further information, see CRS Report RS21306, Terrorism and Extraterritorial Jurisdiction in
Criminal Cases: Recent Developments in Brief, at 4.
29 For further information about this topic, including lists of: (1) the jurisdictional bases for
extraterritorial application of a nation’s criminal laws, (2) federal criminal statutes that include
provisions for extraterritorial enforcement, see CRS Report 94-166A, Extraterritorial Application
of American Criminal Law.