I. INTRODUCTION
An electronic check conversion transaction takes place when a consumer authorizes the use of a check for initiating an electronic fund transfer (EFT). For example, a traditional paper check might be converted into an electronic item at the point-of-sale and processed through the Federal Reserve’s Automated Clearing House (ACH). The purpose of electronic check conversion is to save time through faster check processing and fewer deposit slip entries and reduce risks associated with check verification, lost or stolen checks and insufficient funds checks. Regulation E provides that where a consumer authorizes the use of a check for initiating an EFT, the transaction is not deemed to be originated by check and is subject to the regulation. As such, this type of transaction may have implications for a consumer’s financial institution in regard to Regulation E disclosure requirements (See, Paragraph III below).
II. CHECK CONVERSION PROCEDURES
A consumer desires to make payment with a check. The check may be blank, partially completed or fully completed and signed. The business runs the check through a reader in which the MICR (Magnetic Ink Character Recognition) information is captured. The transaction amount is entered on a terminal keypad and under most situations, the check is also verified against a negative check history database for acceptance. If approved, a receipt is printed for the consumer to sign or otherwise authorize an electronic conversion of the check. The receipt contains language authorizing an electronic check conversion for the amount of the transaction and may include language authorizing that any return fees be electronically debited from the consumer’s account should the transaction involve insufficient funds.
In many cases, the transaction will be electronically transferred through the ACH network where funds are debited directly from the consumer’s account and deposited automatically into the merchants’ account, usually within one or two days. In other cases, the check may be mailed to a merchant or other payee or a lockbox where it is later converted to an electronic fund transfer. The check may be retained by the consumer, the merchant or other payee or the payee’s financial institution.
An electronic check conversion differs from a debit transaction in that debit transactions are processed through ATM networks whereas a check conversion uses MICR data from the check and runs it through the ACH network. Unlike debit cards, funds are not automatically withdrawn from a consumer’s account, but are moved within 48 hours of the transaction.
If a consumer has a problem with his or her account statement, Regulation E provides that the consumer has up to 60 days from the statement date to notify a financial institution of the problem.
III. REGULATION E
Section 205.3(a) of Regulation E “applies to any electronic fund transfer that authorizes a financial institution to debit or credit a consumer’s account.” In the above discussion, a payee offering a check conversion service is providing an EFT service and therefore must obtain the consumer’s authorization to initiate an EFT. That authorization takes place if the consumer engages in the transaction after receiving notice that it will be treated as an EFT. The transaction is not deemed to be originated by check and is therefore subject to Regulation E. Section 904(d)(1) of the Electronic Fund Transfer Act (EFTA) provides:
[i]f electronic fund transfer services are made available to consumers by a person other than a financial institution holding a consumer’s account, the Board shall by regulation assure that the disclosures, protections, responsibilities, and remedies created by [the EFTA] are made applicable to such persons and services.
Regulation E, Supplement I to Part 205, Official Staff Interpretations, states:
The term “access device” does not include a check or draft used to capture the MICR (Magnetic Ink Character Recognition) encoding to initiate a one-time ACH debit. For example, if a consumer authorizes a one-time ACH debit from the consumer’s account using a blank, partially completed, or fully completed and signed check for the merchant to capture the routing, account, and serial numbers to initiate the debit, the check is not an access device. (Although the check is not an access device under Regulation E, the transaction is nonetheless covered by the regulation. See comment 3(b)-1(v).) Supra, at 2(a).
A POS terminal that captures data electronically, for debiting or crediting to a consumer’s asset account, is an electronic terminal for purposes of Regulation E even if no access device is used to initiate the transaction. (See, § 205.9 for receipt requirements.) Id.At 2(h).
A transfer via ACH where a consumer has provided a check to enable the merchant or other payee to capture the routing, account, and serial numbers to initiate the transfer, whether the check is blank, partially completed, or fully completed and signed; whether the check is presented at POS or is mailed to a merchant or other payee or lockbox and later converted to an EFT; or whether the check is retained by the consumer, the merchant or other payee, or the payee’s financial institution. Id.at 3(b) –1.- v.
A consumer authorizes a one-time EFT (in providing a check to a merchant or other payee for the MICR encoding), where the consumer receives notice that the transaction will be processed as an EFT and completes the transaction. Examples of notice include, but are not limited to, signage at POS and written statements. Id.at 3(b)-3.
The Official Staff Commentary goes on to state:
Where a consumer authorizes a third party to debit or credit the consumer’s account, an account-holding institution that has not received advance notice of the transfer or transfers must provide the required disclosures as soon as reasonably possible after the first debit or credit is made, unless the institution has previously given the disclosures. Id.at 7(a)-2 (Emphasis supplied).
Note that Regulation E generally requires that disclosures be provided at the time the consumer contracts for an EFT service or before the first transfer is made to or from the consumer’s account. Comment 7(a)-2, provides an exception to the disclosure timing rules when the consumer has authorized a third party to debit or credit the consumer’s account, on either a one-time or recurring basis and the financial institution has not received prior notice of the transfer. In these circumstances, the financial institution must provide the Regulation E disclosures as soon as reasonably possible after the first transfer. Prior to this revision, Comment 7(a)-2 provided this disclosure timing exception only for direct deposits.
Regulation E consumer protection procedures apply to electronic check conversion transactions. If there is a discrepancy on the consumer’s statement, a consumer has 60 days from the statement mailing date to report an unauthorized transfer that appears on the statement. As with other electronic transactions, the consumer is protected from assuming responsibility for unauthorized transfers. If the consumer notifies his or her financial institution within the 60-day time period, then the consumer should receive credit for the unauthorized amounts. Should a financial institution need more than ten business days to investigate and resolve the matter, the financial institution must return the amount in question to the consumer’s account during the investigation. The consumer may be asked to sign an Affidavit of Unauthorized Activity.
IV. APPLICATION OF REGULATION E TO MERCHANTS AND BILLERS
On January 10, 2006, the Federal Reserve Board (FRB) published its final rule amending Regulation E to cover electronic check conversion (ECK). Mandatory compliance with the final rule has been delayed until January 1, 2007. Under the final rule, merchants and other payees that initiate electronic check conversion transactions (POP or ARC) must obtain a consumer’s authorization for each transaction. Authorization is also required in order to impose a service fee, via EFT, due to a return based on insufficient or uncollected funds. Additional disclosure requirements are imposed to give consumers adequate warning that their paper checks will be converted electronically.
Up until now, Regulation E has imposed duties only on “financial institutions” that engage in electronic fund transfers. Since merchants and other payees are in a better position than payor banks to obtain authorization-by-notice from consumers for conversion of their checks to ACH debit entries at the point of purchase, the FRB has imposed new compliance requirements on merchants and other payees (and on financial institutions in their role as payees rather than payors).
When a consumer gives a merchant a paper check and the merchant uses the information from the MICR line of the check to initiate a one-time EFT (ACH debit entry) from the consumer’s account, the EFT Act and Regulation E now apply. However, the final rule makes it clear that merchants and other payees are subject to the regulation only for the limited purpose of obtaining a consumer’s authorization for the one-time transfer.
A. Consumer Authorization by Notice
Electronic check conversions are covered by Regulation E only if the consumer authorizes the transactions as an EFT. Under the final rule, in a POS transaction, authorization is obtained with the payee provides notice to the consumer that the transaction will or may be processed as an EFT, and the consumer proceeds with the transaction. The notice must be posted in a prominent and conspicuous location, and a copy of the notice must be provided to the consumer at the time of the receipt, for example, on a receipt. In an ARC transaction, the notice will typically be provided on a billing statement or invoice.
The regulation allows consumer authorization for the merchant to (1) convert the paper check to an ACH debit entry; or (2) deposit and collect the check as a paper item. This flexibility recognizes that, due to processing or technical errors, a transaction authorized as an ECK ultimately may not be processed electronically. In order to provide full flexibility for merchants, amended Regulation E sets forth alternative model clauses providing “Notice about Electronic Check Conversion”:
When you provide a check as payment, you authorize us either to use information from your check to make a one-time electronic fund transfer from your account or to process the payment as a check transaction. Model Clause A-6(a).
When you provide a check as payment, you authorize us to use information from your check to make a one-time electronic fund transfer from your account. In certain circumstances, such as for technical or processing reasons, we may process your payment as a check transaction. Model Clause A-6(b).
The final regulation incorporates the principal of “imputed notice.” Notice to the consumer listed on the billing account constitutes sufficient notice to convert all checks provided for payment in the billing cycle or invoice, whether the checks are received from the consumer or someone else for that account.
B. Additional Notice Regarding ECK Transactions
Amended Regulation E requires that a merchant using check conversion disclose two pieces of information:
C. Collection of Service Fees by EFT
Prior to imposing a service fee, for a “bounced” item, the merchant must have proper authorization. Under the amended regulation, a consumer authorizes a one-time EFT “from the consumer’s account to pay a fee for the return of an electronic fund transfer or check unpaid due to insufficient or uncollected funds in the consumer’s account, when the consumer receives a notice stating that the fee will be collected by an electronic fund transfer from the consumer’s account, along with a disclosure of the amount of the fee, and the consumer goes forward with the transaction.” Consistent with other authorization requirements, new Regulation E provides that, for POS transactions, the notice must be posted in a prominent and conspicuous location, and a copy of the notice must be provided to the consumer.
For ARC transactions, notice of a service fee collected by EFT will be found in the invoice or periodic billing statement, combined with the general authorization notice and the notice about ECK transactions.
The new regulation makes it clear that the rule does not apply to imposition of an NSF fee by the consumer’s bank. That fee is governed by bank regulations and state law, as supplemented by the terms and conditions of the deposit agreement. Conversely, if the consumer’s payor/receiving bank also occupies the role of payee, it must comply with Regulation E in order to impose a service fee for the returned item. The bank will normally give the notice in the periodic billing statement, for example, for credit card debt. There is nothing in amended Regulation E that would preclude the bank from charging two fees – (1) an NSF fee in its role as payor; and (2) a service fee in its role as payee – so long as it had proper authorization for both.
D. Addition of Electronic Check Conversion Services
When check conversion services are added to a consumer’s account, and are subject to terms and conditions different than previously disclosed, new disclosures are required. Amended Regulation E, Appendix A-2, provides new model clauses for initial disclosures. For example, in the clause dealing with consumer liability for unauthorized transfers, the new language asks the consumer to tell the bank at once if consumer believes that his or her card/code has been stolen, “or if you believe that an electronic fund transfer has been made without your permission using information from your check.” In the clause dealing with “transfer types and limitations” subject to Regulation E, the language adds a new reference “Electronic check conversion." You may authorize a merchant or other payee to make a one-time payment from your checking account using information from your check to: (i) Pay for purchases (ii) Pay bills.”
E. Timing of Compliance
Under the final rule, for customers opening accounts after January 1, 2007, banks must include in initial disclosures that ECK transactions are among the types of transfers that a consumer can make. Where banks have already amended their disclosures to notify their customers of the new development, they would not be required to make new initial disclosures to these customers. New disclosures to existing customers are required after January 1, 2007, however, if the bank has not disclosed to those customers that ECK transactions may be made, even if other terms of the underlying account agreement would equally apply to the new type of transfer. Banks were given until January 1, 2007, to revise their initial disclosure form to reflect ECK, and to provide new disclosures to existing customers if necessary. Institutions were not required to provide new disclosures reflecting ECK until the mandatory compliance date of January 1, 2007. Suggested language for this disclosure is found in Appendix-2 of amended Regulation E.