CUNA Regulatory Comment Call


December 6, 2004

Indorsement and Payment of Treasury Checks

EXECUTIVE SUMMARY

Please feel free to fax your responses to CUNA at 202-638-7052; or e-mail them to Associate General Counsel Mary Dunn at mdunn@cuna.com or to Assistant General Counsel Lilly Thomas at lthomas@cuna.com; or mail them to Mary or Lilly c/o CUNA’s Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, South Building, Suite 600, Washington, D.C. 20004. You may also access the proposed rule at http://www.fms.treas.gov/checkclaims/regulations.html.

DISCUSSION

Since the Check Clearing for the 21st Century Act (Check 21) has been in effect, financial institutions can present substitute checks to Treasury for payment in lieu of original Treasury checks. Check 21 makes it unnecessary for the physical transfer of original checks, but does not make electronic check images legally equivalent to original checks. Therefore, financial institutions may not exchange checks electronically unless they have an agreement with the paying bank to do so.

The Financial Management Service (FMS) is therefore creating in this interim rule the rights and obligations of financial institutions that present electronic images to Treasury and a legal framework to support the presentment of electronic images of Treasury checks without the need for the delivery of original or substitute checks. A financial institution will be able to present a Treasury check as an electronic check without subsequent delivery of the original check or a substitute check. Financial institutions are not required to present electronic images of Treasury checks, but this rule makes it possible for those institutions that would like to do so.

The legal framework in the rule mirrors the terms and conditions established by the Check 21 Act regarding which substitute checks are treated as the legal equivalent of original checks. However, the interim rule establishes the legal equivalence of electronic checks only between Treasury and the financial institution that presents an electronic image of a Treasury check to Treasury for payment. Financial institutions would not have the right to transfer, return or present an electronic image of a Treasury check to any other person. This is narrower than the Check 21 Act, which establishes the legal equivalence of substitute checks for all persons and all purposes.

Financial institutions can either retain or destroy paper checks that are truncated to create electronic checks. However, credit unions may want to consider retaining the original checks because Treasury may decline payment if it cannot determine whether a check contains a material defect or alteration without examining the original check or a better quality image of the check. Treasury may also decline payment on a check if it has already been paid as a substitute, electronic or original check. Additionally, if Treasury returns a check to a presenting bank in the form of an electronic check, the presenting bank does not have the right, absent an agreement, to return the check to the depositor using an electronic image. Therefore the presenting bank will need to return either the original check or a substitute check.

Currently, Treasury stores the Treasury checks that have been negotiated securely until they are destroyed. Since Treasury will not have possession of the Treasury checks that are truncated, financial institutions that create substitute checks or electronic checks must prevent unauthorized access to the truncated paper checks. In order to address concerns such as identity theft, financial institutions must store the checks in a way that is consistent with the guidelines that are issued by NCUA and other federal banking agencies for safeguarding customer information. NCUA issued Guidelines for Safeguarding Member Information in January 2001. (66 FR 8152-01) These Guidelines can be found at http://www.cuna.org/compliance/member/download/eguide_security_reg.pdf

This rule frames the Check 21 warranty and indemnity provisions as presentment guarantees in the current rule so that the procedure for invoking a substitute check becomes part of the declination or reclamation process. This will establish the process by which Treasury will invoke the substitute check indemnity provided by Regulation CC. Additionally, Treasury will follow certain procedures if there is a breach of one of the warranties a financial institution makes when transferring, presenting, or returning a substitute check under Check 21. Procedures are also established if the Federal government incurs a loss because it received a substitute check rather than the original check.

Certain definitions in this rule have been changed to incorporate these changes. The interim rule makes clear that in addition to an original paper check issued by Treasury, the definition of "check" includes a substitute check or an electronic check relating to an original check. Additionally, "electronic check" is defined as "an electronic image of a [Treasury check], together with information describing the check, that meets the technical requirements for sending electronic items to a Federal Reserve Bank as set forth in the Federal Reserve Banks’ operating circulars." The electronic image does not have to be created directly from the original check but can be created from a substitute check to qualify as an electronic check. Additionally, the definition of "reasonable efforts" is revised. Currently, §240.7(c) requires a reclamation debtor1 to make all reasonable efforts to ensure that a check is an authentic check before Treasury reclaims on a counterfeit check. "Reasonable efforts" is defined as verifying at a minimum the existence of the U.S. Treasury watermark. This interim rule revises the definition of "reasonable efforts" so as not to extend a reclamation debtor’s obligation to verify the existence of the U.S. Treasury watermark on a substitute check or electronic check presented to the reclamation debtor. This is to address that the Treasury watermark may not appear on a substitute check or electronic check.

1The definition of a reclamation debtor is a presenting bank or other indorser of a check from whom the Treasury has demanded a refund.

QUESTIONS TO CONSIDER

  1. The rule provides that checks that are truncated and retained must be stored in a manner consistent with federal banking agency guidelines for safeguarding member information. Do you believe that this provision is necessary? Please explain.
















  2. Do you believe the requirement in Question #1 will be burdensome for financial institutions, or in any way interfere with or add costs to the creation of substitute checks? Please explain.
















  3. The FMS is concerned with potential fraudulent use of check information as well as inappropriate use of check information by financial institutions, such as for marketing or other commercial purposes. Although privacy laws generally restrict the use and disclosure of consumer information, there are exceptions that may permit using check information for marketing or other purposes. FMS is specifically requesting comment on whether there is a need to prohibit financial institutions from making truncated paper checks available to third parties, and from disclosing or using information on the checks for commercial or business purposes.
















  4. Do you have any additional comments?
















Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com
Mary Mitchell Dunn • SVP & Associate General Counsel • (202) 508-6736 • mdunn@cuna.com
Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com
Lilly Thomast • Assistant General Counsel • (202) 508-6733 • lthomas@cuna.com