CUNA Comment Letter

Remotely Created Checks

May 3, 2005

Jennifer J. Johnson
Secretary
Board of Governors of the Federal Reserve System
20th Street and Constitution Ave, NW
Washington, DC 20551

Re: Docket No. R-1226; Remotely Created Checks

Dear Ms. Johnson,

The Credit Union National Association (CUNA) and the Association of Corporate Credit Unions (ACCU) is pleased to respond to the Federal Reserve Board’s request for comments to amend Regulations CC and J to set forth rules governing remotely created checks and to conform cross- references to the warranties that are proposed. The proposed amendments to Regulation CC would create transfer and presentment warranties under which the depositary financial institution would warrant that the person on whose account the check is drawn authorizes the remotely created check.

By way of background, CUNA is the largest natural credit union trade association representing over 90 percent of the 9,400 state and federal credit unions in this country. This letter was prepared under the auspices of CUNA’s Payment Systems Subcommittee, which is chaired by Ralph Jones, Executive Vice President of the Georgia Credit Union Affiliates, Duluth, Georgia. The Association of Corporate Credit Unions ("ACCU") is the trade association representing the Nation’s 30 corporate credit unions.

Summary of CUNA’s and ACCU’s Position

Discussion

The Federal Reserve Board (Board) is requesting comment on proposed amendments that would impose transfer and presentment warranties on depository financial institutions for remotely created checks. Remotely created checks are typically created when a checking account owner authorizes a payee to draw a check on that account, but does not sign the check. Although useful for consumers when paying a bill by telephone or purchasing an item from a telemarketer, remotely created checks may be vulnerable to fraud because they do not bear a signature or other readily verifiable indication of authorization and are cleared in the same manner as other checks.

We support the Board’s proposal to impose warranties on the financial institution that transfers or presents a remotely created check. Under the proposed warranties, a depository financial institution would warrant that the account owner authorizes all of the terms of the remotely created check that it is transferring or presenting. Currently, a paying financial institution must recredit a member’s account if an unauthorized check is paid. The paying financial institution can return the unauthorized check to the depositary financial institution, but must do so before midnight of the banking day after a check has been presented. This places the burden of verifying authenticity on paying financial institutions, which works for most checks because they are in the best position to verify their account-holder’s signature.

However, because remotely created checks do not bear handwritten signatures, paying financial institutions are limited to contacting the account-holder before the midnight deadline to verify authenticity. Additionally, there is no method for the paying financial institution to automatically distinguish between remotely created checks and those signed by the account-holder. The depository financial institution that has a relationship with the payee of the remotely created check is in a better position to verify the authenticity of the check. For this reason, we support creating transfer and presentment warranties on depository financial institutions.

The National Conference of Commissioners on Uniform State Laws and the American Law Institute in 2002 approved revisions to Articles 3 and 4 of the UCC to address problems regarding remotely created checks. Fourteen states have amended their Articles 3 and 4 to include provisions similar to those in the UCC, and these states’ provisions differ. We appreciate the Board’s attempt to provide consistency in the liability for remotely created checks across state lines by imposing transfer and presentment warranties at the Federal level. If states do not act in this area, Federal warranties could help ensure that the paying financial institution would be subject to the same rules as the paying financial institution.

Definition of "Remotely Created Check"

The Board is seeking comment on its proposed definition of remotely created checks. The proposed definition is different than the UCC’s definition in that the Board’s proposed definition would apply to remotely created checks drawn on either a consumer or a non-consumer account. We support including checks drawn on non-consumer accounts, such as business accounts, in the Board’s definition. Although remotely created checks are typically drawn on consumer accounts, they can be drawn on business accounts or lines of credit and depository institutions are in the best position to determine their authenticity. Extending the definition of remotely created checks to include these accounts will enable credit unions to operate more efficiently for claims and adjustment processing.

We request that the Board consider additional language in the Commentary to clarify that remotely created checks include checks drawn on various types of accounts, such as business accounts and credit accounts. A remotely created check could be created when a consumer provides the numbers from the bottom of a paper draft that accesses a credit card account or line of credit for a telephone purchase. Providing additional language in the Commentary would ensure that the remotely created check warranty applies to the full range of possible remotely created checks.

The proposed definition also states that a remotely created check is created by the payee. This omits remotely created checks that are authorized by the account-holder through "bill-payer" services, which are created not by the payee but by a third party, to pay the account-holder’s bills. Since these types of remotely created checks are cleared in the same manner as other checks, with no identifiers to automatically distinguish them from checks created by the payee the payee will not easily meet the midnight deadline to return an unauthorized check. Additionally, it is not clear how a paying financial institution could determine from examining the remotely created check, or from contacting the drawer, whether the check was created by the payee, its agent, or a third party. This could potentially result in disputes between the paying institution and depositary institution as to whether or not the remotely created check warranty would apply. We believe modifying the definition to add the phrase "...and is not created by the paying financial institution," will include all remotely created checks, including those created by bill-payer services and other third parties.

The Board’s proposal currently states that a remotely created check "does not bear a signature in the format agreed to by the paying bank and the customer." A remotely created check can bear a statement of authorization in place of a signature, have the account-holder’s printed or typed name, or bear the signature of an employee of the payee that created the check. The UCC definition states in part that a remotely created check... "does not bear a handwritten signature purporting to be the signature of the drawer."1 We believe modifying the Board’s proposed definition to be consistent with the UCC definition without the requirement of a ‘handwritten’ signature will ensure that all remotely created checks will be included in the proposal, yet will more clearly exclude checks with forged drawers’ signatures. Omitting the requirement that a signature be handwritten will include business checks in the definition of remotely created checks, since other types of signatures are typically used by businesses, such as stamped or facsimiled signatures. We propose the following definition of a remotely created check:

"Remotely created check" means a check that is drawn on an customer account at a financial institution, is not cleared by the paying financial institution, and does not bear a signature purporting to be the signature of the customer.

It is not clear whether the definition of a remotely created check includes those remotely created checks that are payable-through a financial institution and drawn on another financial institution or a non-bank payor. We believe that remotely created checks that are payable- through checks should come within the definition of a remotely created check and should have the benefits of the remotely created check warranty.

1 UCC 3-103(16)

Alternatives to Remotely Created Check Warranties

The Board is seeking comment on whether to extend the midnight deadline to 60 days to allow a paying bank to recover its losses when an unauthorized remotely created check is paid. Extension of the midnight deadline could potentially reduce losses to the paying bank by giving additional time to account-holders to discover the unauthorized payment; however, this would not benefit the consumer. Under existing check law, a paying bank is generally required to recredit its account- holder’s account for the amount of any unauthorized check it pays, protecting the consumer from suffering a loss. If the right to return a remotely created check is extended to 60 days, the payee may withhold sending its product or performing its services until payment is finalized. Imposing warranties on the depository financial institution would provide recourse to the paying financial institution. Extending the midnight deadline to 60 days; however, would penalize the consumer while minimally benefiting the paying financial institution.

To provide an efficient process to handle these remotely created check warranty claims, we recommend developing procedures under the clearinghouse rules and Operating Circular 3 for the Federal Reserve Banks that would allow all or some of these warranty claims to be handled as claims but through return-like processes and with settlement entry. An example of this is Rule 8 of the Uniform Paper Check Exchange Rules, which states that the paying bank "may make a warranty claim" by "delivering such check to the clearinghouse or the depositary bank for settlement, in accordance with the clearinghouse’s rules for returned checks." While the claim is processed through the return settlement process, the delivery of the check to the clearinghouse, and ultimately the depositary bank, is not a "return" of the check under the UCC or Regulation C.

We understand that the Board is considering identifying remotely created checks by assigning digits in Position 44 of the MICR line. We believe that Position 44 is more useful for other check products and services that have a greater need for MICR line identification, for example identifying checks that are drawn on credit lines, such as from credit cards and home equity lines. Credit card convenience checks and checks used to access home equity lines are ineligible for ACH conversions under the ACH rules. However, these checks are not distinguishable from other checks and are being converted to ACH items at the point of purchase and in accounts receivable transactions. Receiving Depository Financial Institutions will typically return these transactions according to the ACH Rules, which inconveniences the consumer. We encourage the Board to work with the National Automated Clearinghouse Association (NACHA) to use Position 44 as identifiers for checks used to access lines of credit rather than for remotely created checks.

Conclusion

CUNA and ACCU generally support the proposed definition of remotely created checks, and believe that the midnight deadline should not be extended to 60 days as this has the potential to penalize the consumer who uses remotely created checks to pay bills or purchase products over the telephone. If you have any further questions, please contact CUNA’s Senior Vice President and Associate General Counsel Mary Dunn or me at (202) 638-5777.

Sincerely,

Lilly Thomas
Assistant General Counsel