[Federal Register Volume 64, Number 212 (Wednesday, November 3, 1999)]
[Rules and Regulations]
[Pages 59607-59613]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-28580]
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FEDERAL RESERVE SYSTEM
12 CFR Part 229
[Regulation CC; Docket No. R-1034]
Availability of Funds and Collection of Checks
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Final rule.
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SUMMARY: The Board is adopting amendments to Subpart C of Regulation
CC, which contains rules governing the collection and return of checks.
The amendments to the regulation and Commentary are intended to provide
further clarification as to the extent to which depository institutions
and others may vary the terms of the regulation by agreement for the
purpose of instituting electronic return systems.
EFFECTIVE DATE: December 15, 1999.
FOR FURTHER INFORMATION CONTACT: Louise Roseman, Director, Division of
Reserve Bank Operations and Payment Systems (202/452-2789); Oliver I.
Ireland, Associate General Counsel (202/452-3625), Stephanie Martin,
Managing Senior Counsel (202/452-3198), Legal Division. For the hearing
impaired only, contact Diane Jenkins, Telecommunications Device for the
Deaf (TDD) (202/452-3544), Board of Governors of the Federal Reserve
System, 20th and C Streets, NW, Washington, D.C. 20551.
SUPPLEMENTARY INFORMATION:
Background
In February 1999, the Board requested comment on options for
amending provisions in Regulation CC governing when paying or returning
banks may send notices instead of returning the original
checks.1 The purpose of the proposal was to explore whether
more flexibility is needed to enable check system participants to
experiment with methods to return checks electronically.
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\1\ 64 FR 9105, Feb. 24, 1999.
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The collection and return of checks is governed by both Regulation
CC and state law (Articles 3 and 4 of the Uniform Commercial Code
(U.C.C.)). When a paying bank decides to return a check, the U.C.C. and
Regulation CC require it to send the check or a notice within certain
deadlines.2 The U.C.C. and Regulation CC differ on when a
bank can return a notice rather than the check itself. If a check is
``unavailable for return,'' U.C.C. 4-301(a) allows a paying bank to
charge back the check by revoking its provisional settlement with the
presenting bank based on a notice of dishonor or nonpayment. The
Official Comment to U.C.C. 4-301 states that a check may be considered
unavailable for return if, under a collecting bank check retention
plan, presentment is made by a presentment notice and the check is
retained by the collecting bank. Presumably, therefore, the U.C.C.
would allow a paying bank to return a notice when a check has been
truncated. (It is not clear whether a check would be deemed unavailable
for return under the U.C.C. if the paying bank, rather than the
collecting bank, retains it.)
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\2\ The paying bank must initiate the return by midnight of the
banking day following the day the check was presented (U.C.C. 4-
301). The paying bank must return the check so that it reaches the
depositary bank expeditiously, in accordance with Sec. 229.30(a) of
Regulation CC.
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Regulation CC (Secs. 229.30(f) and 229.31(f)) establishes a
``notice in lieu of return,'' which substitutes for the original check
and carries value. The notice-in-lieu provisions of Regulation CC
provide that the paying (or returning) bank must return the original
check unless the check is unavailable, in which case the bank may
return a notice that meets certain information requirements. The
Regulation CC Commentary states that notice is permitted in lieu of
return only when a bank does not have and cannot obtain possession of
the check or must retain possession of the check for protest. The
Commentary explains that a check is not unavailable for return if it is
merely
[[Page 59608]]
difficult to retrieve from a filing system or from storage by a keeper
of checks in a truncation system.
The primary reason for the difference between the U.C.C.''s and
Regulation CC's treatment of notices is that there is likely to be less
risk for a depositary bank in accepting a notice (instead of the
original check) from a bank it knows than from a bank it doesn't know.
Under the U.C.C., the paying bank returns a check to the presenting
bank, which in turn charges back the check against the prior collecting
bank, and so on back up the forward collection chain until the check
reaches the depositary bank. Therefore, under the U.C.C., the
depositary bank receives returns from the bank to which it had sent the
check for collection and with which it has a previously established
relationship. One of the purposes of Regulation CC was to speed up the
check return system that existed under the U.C.C. Regulation CC
eliminated the requirement that returned checks follow the forward
collection chain. Under Regulation CC, the paying bank may send the
returned check directly to the depositary bank or to any returning
bank, even if that bank did not handle the check for forward
collection. Therefore, under Regulation CC, depositary banks may
receive returned checks from banks with which they have no previous
relationship.
Some check system participants asked the Board to clarify the
interrelationship between the U.C.C. and Regulation CC in order to
provide additional legal certainty for institutions that wish to
experiment with electronic return systems, under which they would
return images or other notices rather than the checks. These
participants were concerned about their ability to bind all relevant
parties to an electronic return arrangement under the variation-by-
agreement provisions of Regulation CC. Regulation CC (Sec. 229.37)
permits the parties to a check to vary the notice-in-lieu provisions;
however, an agreement under Regulation CC cannot affect banks,
customers, or others that are not party to the agreement or otherwise
bound by it. The Regulation CC variation-by-agreement provision differs
from the corresponding language in U.C.C. 4-103 in that the U.C.C.
allows clearinghouse rules (as well as Federal Reserve regulations and
operating circulars) to be effective as agreements whether or not
specifically assented to by all interested parties.3
Regulation CC does not incorporate the U.C.C.''s special treatment for
clearinghouse rules (or for Federal Reserve rules and circulars) but
does not affect the status of such under the U.C.C.
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\3\ The Official Comment to U.C.C. 4-103 (note 3) indicates,
however, that there are limitations on the scope of clearinghouse
rules. The Comment notes that clearinghouses are not authorized to
rewrite the basic law generally and that clearinghouse rules should
be understood in the light of functions the clearinghouses have
exercised in the past.
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This difference in variation-by-agreement provisions exists because
Regulation CC does not govern the relationship between banks, their
customers, and remote parties to the extent that the U.C.C. does. While
Board rules can bind depository institutions, the Board does not appear
to have the authority under the Expedited Funds Availability Act to
bind depositors or payees to an electronic check return system. Section
611(f) of the Act, which authorizes the Board to establish rules
allocating loss and liability in the payments system, applies to loss
and liability among depository institutions only. The Act does not
authorize such allocations to customers of depository institutions.
Although banks would be able to obtain agreement to the terms of an
electronic return arrangement from their customers through account
agreements, under Regulation CC they would not be able to bind remote
parties to the check, such as non-depositor payees. Some check system
participants sought an amendment to Regulation CC that would eliminate
the risk that these remote third parties would bring a claim under
Regulation CC in the event they suffered losses due to the fact that a
check was returned electronically rather than in physical form. A claim
could potentially arise under the following circumstances:
Drawer A writes and delivers a check payable to Payee B. Payee B
negotiates the check to Depositor C, who deposits the check in his
bank. Depositor C's bank presents the check to Drawer A's bank. Both
banks are participating in an electronic return system, and Drawer A's
bank returns an image of the check to Depositor C's bank, which, in
turn, charges Depositor C's account. Depositor C would have to attempt
to collect the funds from Payee B or Drawer A without the physical
check. Assuming that Depositor C has agreed to the electronic return
system through an account agreement, Depositor C would bear the risk
that Payee B or Drawer A would not pay without the original check.
(Payee B or Drawer A may be concerned about the risk of double payment
if the original check is not returned.) If Payee B pays Depositor C in
return for the check image or similar notice, Payee B may still be
unable to collect from Drawer A without the check and could suffer
losses (although Payee B may still have recourse against Drawer A under
the U.C.C. even without the original check). Presumably, an electronic
return arrangement would allow banks or customers to request the
original check within a certain amount of time. If Drawer A becomes
insolvent before the original check is retrieved, Payee B would suffer
losses. If Payee B would have been able to collect from Drawer A had
Payee B originally received the check rather than the notice, then
Payee B's losses would likely be attributable to the electronic return
system.
Regulation CC imposes a duty on banks to exercise ordinary care and
act in good faith in handling checks under Regulation CC. This duty
runs to the depositary bank, the depositary bank's customer, the owner
of a check, or another party to the check. If a bank violates these
duties, resulting in harm to one of these parties, the party may have a
claim against the bank for damages. Therefore, if a bank returned a
notice-in-lieu when the physical check was deemed ``available'' under
Regulation CC, and the return of the notice rather than the physical
check caused a party to the check to incur a loss, the bank potentially
could be liable for damages. The bank sending the notice could be
liable even if it had agreed with the receiving bank to use notices in
lieu of return. The injured party would have to show lack of good faith
or failure to exercise ordinary care.
The risk of a bank becoming liable to a remote third party under
the circumstances described above appears to be low. Nevertheless, some
check system participants stated that they were reluctant to begin
experimenting with electronic check return systems without additional
protection. To flesh out the pros and cons of making regulatory changes
in this area, in February 1999 the Board sought commenters' input on
two options.4
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\4\ 64 FR 9105, Feb. 24, 1999.
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The first option was to amend the Commentary to Regulation CC to
state that banks could send a notice of dishonor or nonpayment in
accordance with the provisions of U.C.C. 4-301 when they return the
notice through the forward collection chain, as contemplated in the
U.C.C. The U.C.C. notices would be subject to the Regulation CC
expeditious return rules. This proposal would clarify that banks could
avail themselves of the U.C.C. rules regarding return of notices to the
same extent that they could before Regulation CC was adopted. The Board
noted, however, that this proposal may
[[Page 59609]]
not provide relief for check truncation or image systems if returns do
not follow the forward collection chain and that it could have
consequences for the depositors or payees of the checks, who may have
difficulty recovering from the drawers without the original checks.
The second option was to delete the Regulation CC Commentary
language that explains when a check is unavailable for return. Instead
of this language, the Commentary would indicate that notices in lieu of
return are permissible whenever they would be permissible under the
U.C.C. The Board noted that this option would liberalize the
circumstances under which banks could use notices in lieu of return and
potentially make it easier for banks to establish electronic check
return mechanisms that feature check truncation, but would force
depositary banks to accept notices from banks with whom they may have
no established relationships. This option could also have consequences
for the depositors or payees of the checks as discussed above under
option one.
The Board also proposed to delete Sec. 229.36(c) of Regulation CC
and its associated Commentary, which states that a bank may present a
check electronically under an agreement with the paying bank and that
the agreement may not extend return times or otherwise vary the
provisions of Regulation CC with respect to persons not party to the
agreement. This provision of the regulation is subsumed by the
variation-by-agreement provisions in Sec. 229.37, and it may be
unnecessary and potentially confusing to retain special provisions
regarding a particular type of variation by agreement. The Board
proposed to add an example to the Commentary to Sec. 229.37, listing an
electronic check presentment agreement as a permissible variation by
agreement under Regulation CC. The Board noted that eliminating
Sec. 229.36(c) and its Commentary would result in no substantive change
to the regulation regarding the validity of electronic presentment
agreements.
Summary of Comments
The Board received 72 comments on its proposed options, classified
as follows:
Banks/Bank holding cos: 32
Thrifts/Thrift holding cos: 2
Credit unions/Corporate credit unions: 9
Trade associations representing--
Banks: 5
Credit unions: 5
Clearing houses: 2
Non-banks: 2
Clearing houses/organizations: 9
Federal Reserve Banks: 2
Non-bank service providers: 4
Problems Raised by Notices in Lieu of Returns
Overall, the commenters were supportive of changes that would
improve efficiency and reduce risk in the check collection and return
system, but were reluctant to support changes that would impose costs
on depositary banks, their customers, and other parties to the check
without their consent. Thirty-five commenters specifically discussed
the problems that would arise if depositors received notices of
returned checks instead of the physical checks. Many of these
commenters echoed the problems stated by the Board in its proposal,
i.e. that customers generally expect checks to be returned to them when
their accounts are charged back and that customers have ownership
rights in the physical checks. Commenters were concerned about whether
their customers would be able to collect from drawers without the
original checks and some noted that the drawer's risk of double payment
needs to be addressed. Some of these commenters stated that the U.C.C.
limits a holder's rights to enforce a check without possession of the
physical item. Several commenters raised concerns about whether a
notice of a returned check would be sufficient evidence of the return
in court, and others noted that law enforcement authorities often
require the original check in order to lift fingerprints from the check
or examine the handwriting. Four commenters, however, stated that even
though the customer, as the legal owner, may have a right to the
original check, there may be no practical consequence if an image or
other electronic return has legal equivalence under the U.C.C. or the
Uniform Electronic Transactions Act.5
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\5\ The Uniform Electronic Transactions Act is a model law
drafted and approved by the National Conference of Commissioners on
Uniform State Laws and recently adopted in California. It does not
provide that a check image or other electronic returned check is
legally equivalent to the original check, except for limited record-
keeping purposes.
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Twenty-one commenters raised concerns about whether the information
provided on a notice-in-lieu-of-return would be sufficient to allow the
depositary bank to charge back its customer's account. The commenters
listed such necessary information as the indorsement (especially on
third-party checks), the check date, the payee, the amount, the reason
for return, the teller stamp, trace numbers, and the account number.
Some commenters noted that missing information is already a problem for
notices-in-lieu under the current regulation. Some of these comments
were related to concerns about the quality of the photocopy or image
that depositary banks would receive, and others were related to the
sufficiency of information in an electronic notice that did not include
an image of the check. One commenter suggested that if notices-in-lieu
become more permissible, then all of the information requirements of
Sec. 229.33(b) should be mandatory and no questions marks allowed.
Costs and Benefits of Electronic Returns
Thirty-one commenters specifically mentioned the benefits of an
electronic return system. These commenters generally believe that
electronic returns will enable checks to be returned faster and will
allow depositary banks and their customers to protect themselves better
against check fraud. They stated that an electronic return system would
lead to operational savings and make forward check truncation feasible.
On the other hand, eight commenters believed that the costs of an
electronic return system could likely outweigh the benefits. The
commenters noted that costs could take the form of incomplete
information to the depositary bank, potentially resulting in delays in
charging back the customer's account, as well as the expense of
hardware and software to operate an electronic return system.
Six commenters discussed the potential competitive effects of
establishing an electronic return system. These commenters were
generally concerned that community banks and other small depository
institutions may not be technologically prepared for electronic returns
and should not be placed at a disadvantage by any regulatory change.
Option One
Only one commenter expressed a preference for option one. Thirty-
two commenters pointed out specific problems that would arise if the
Board were to adopt option one. Many stated that application of option
one would be too limited in scope to provide sufficient incentive for
experimentation in electronic returns. Several commenters believed that
certain checks may be impossible to return through the forward
collection chain within the expeditious return deadlines. Others
commented that the U.C.C. standards are not clear as to what
information must be included in a U.C.C. notice of nonpayment and were
concerned that the depositary bank would not receive information
sufficient to charge the check back to its customer's account.
[[Page 59610]]
Some commenters believed that adoption of option one would lead to
confusion as to when the U.C.C. applied to a returned check rather than
Regulation CC, and one commenter noted that state-to-state variation in
the meaning of ``unavailable for return'' could lead to confusion with
respect to interstate transactions. Commenters raised other questions
as to the implementation of option one, such as (1) whether the
presenting bank that receives a U.C.C. notice of nonpayment, but holds
the truncated physical check, has the option to either send a notice or
the check to depositary bank and (2) whether the physical check must be
made available to the depositary bank or its customer upon request.
Option Two
Eighteen commenters supported proposed option two, although nearly
all of those commenters raised additional issues that they believed
should be addressed. The Electronic Check Clearing House Organization
(ECCHO) and seventeen other commenters supported option two so long as
the regulation made clear that the depositary bank would have to agree
to receive electronic notices in lieu of return. These commenters
stated that experimentation with electronic notices should be conducted
on a voluntary basis, governed by bilateral or multilateral agreements.
The commenters stated that the depositary bank would need to know from
whom it would be receiving electronic returns and would have to work
out such issues as who would own the returns/images, acceptable quality
standards, who to contact in case of problems, and what procedures to
follow. One supporter of option two, however, did not expect that the
receipt of unexpected electronic returns from unfamiliar banks would be
widespread. This commenter stated that the issue of the quality of
electronic returns from unfamiliar banks would be an operational matter
that would likely be self-regulated between paying banks and depositary
banks and should be left for the banks to police.
Eleven commenters discussed specific problems regarding option two.
Some of these commenters raised issues related to dealing with an
unknown returning bank. They stated that accepting notices from banks
with which the depositary bank has no relationship could pose
significant financial or customer service risk exposure. They also said
that handling returned items could become more complex and time-
consuming if images are received from multiple sources, and the amount
of manual sorting could outweigh the advantages of new technology.
Another concern raised by the commenters was that option two could
increase the use of notices in lieu of returns, placing the burden on
the depositary bank in providing the depositor with the information on
the return item when a charge-back occurs without the physical check.
The commenters also raised other matters that would need to be
addressed under option two, such as (1) Whether the presenting bank
that receives a notice but holds the physical check has the option to
send either the notice or the check to the depositary bank and (2)
whether the physical check must be made available to the depositary
bank or its customer on request.
Other Comments on Options.
Seventeen commenters opposed both options. Most of these commenters
stated that the proposals would make the return process more
complicated, particularly in connection with reconcilement, without a
comprehensive all-electronic approach. They stated that the Board
should address other issues related to electronic returns before
adopting either option. One commenter favored either option, stating
that either would accomplish the goal of reconciling Regulation CC with
the U.C.C. as to when a check is available for return.
Most of the commenters suggested additions or enhancements to the
two options proposed by the Board:
Variation by Agreement.
Nine commenters stated that the Board should permit clearing house
rules to vary Regulation CC in same way as they vary the U.C.C. The
commenters stated that this would avoid the need to change Regulation
CC to accommodate innovations and would put private-sector banks on a
more equal footing with non-banks and Federal Reserve Banks.
The Federal Reserve Bank of Atlanta (FRB Atlanta) believed that the
concern as to whether Sec. 229.37 of Regulation CC limits the ability
of an agreement to bind remote parties is ameliorated by at least two
factors: (1) FRB Atlanta stated that the only remote party right under
Regulation CC is the right to receive a notice of return, which can be
met by an image of sufficient quality to permit the depositary bank to
identify its customer; other remote party rights arise under the U.C.C.
and can be addressed in the context of agreements under the U.C.C.; and
(2) At least one court decision 6 held that the depositary
bank, as the collection agent for its customer, can enter into
agreements on behalf of the customer without prior consent as long as
agreement is reasonable. FRB Atlanta stated that accepting an image
return (with the paper check to follow) seems to be reasonable. FRB
Atlanta suggested, as an alternative to the proposed options, that the
Board revise the Commentary to Sec. 229.37 to provide that depositary
bank may agree with paying or returning banks to accept images or other
notices of dishonored checks as notices in lieu of return and that
those banks may be responsible under other applicable law to parties
interested in the check for any losses caused by the handling of check
returns under such agreements (except to the extent addressed in
effective agreements with those other parties).
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\6\ Graubert v. Bank Leumi, 399 N.E. 2d 930 (Ct. App. N.Y.
1979).
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U.C.C. Availability Requirement.
Three commenters stated that the proposal's reference to U.C.C. 4-
301 is not sufficient because it is not clear what types of check
programs are encompassed by the U.C.C.'s Official Comment to 4-301
regarding ``availability'' of checks for return. The commenters
suggested that the Regulation CC Commentary should specifically permit
notice in lieu of return when a check is difficult to retrieve from a
filing system or from storage pursuant to a truncation, image or other
check electronification program, provided the receiving bank has agreed
to accept notices in lieu of return in such circumstances.
Two commenters raised other questions concerning what sorts of
truncation arrangements are contemplated by U.C.C. 4-301(a). These
comments reflected the uncertainty as to whether it matters which bank
in the collection or return chain is the truncating bank in determining
if a check is unavailable for return under the U.C.C.
Three commenters suggested that the Board allow a bank to provide a
notice-in-lieu at will, rather than only when the original check is
unavailable for return. These commenters noted that such returns may
not be permissible under the U.C.C., but they anticipated that the
U.C.C. or its state variations may become less restrictive in the
future as technology changes.
Address Legal Status of Images.
Five commenters requested that the Board address the legal status
of images to provide comfort that an image or electronic notice legally
replaces the original check. Some of these commenters suggested that
the
[[Page 59611]]
Commentary should explicitly state that images are acceptable in the
U.S. check collection and return system to bolster banks' ability to
convince customers to accept images in lieu of the original check.
Establish Standards.
Fifteen commenters asked the Board to establish standards for an
electronic return system. The commenters expressed a need for standards
in areas such as image quality, standardized return reason codes, data
communication, procedures to verify system integrity and compatibility,
and indorsements. Some of these commenters stated that the Board should
set time limits for the returning bank to provide the depositary bank
with the paper check and procedures for request and retrieval. One
commenter stated that the Board should provide for migration to more
image-friendly check stock. Another commenter stated that a new
regulatory infrastructure is necessary to address detailed issues, even
more specifically than the Board's same-day settlement provisions in
Regulation CC.
Address Return Deadlines.
Seven commenters stated that the Board should clarify how an
electronic return system would affect return deadlines. For example,
one commenter suggested that the Board should clarify when the return
clock starts if checks are presented electronically and the physical
item is necessary to create a return. Other commenters suggested that
the Board amend Regulation CC to provide that, if a bank sends image
returns under a truncation arrangement where the check was presented
electronically, it would not be required to meet the U.C.C. return
deadline. The commenters stated that this rule would nurture the
development of electronic check presentment and would enable the paying
bank to examine the physical check and create an image return without
violating the U.C.C. midnight deadline.
Representment.
Eleven commenters stated that the Board should address how a
depositary bank could represent a check that had been returned
electronically. They said that representment of checks returned
electronically would pose technical and operational challenges,
including the form of the represented check and what would replace the
indorsement audit trail. One commenter suggested that the Board
establish redeposit rules allowing for prompt representment of
electronic returns to protect consumers from the potential loss from
dishonored checks.
Depositary Bank Protections.
Thirteen commenters requested that the Board take steps to protect
depositary banks under electronic return systems. Several commenters
suggested that the depositary bank should be able to send back an
electronic return and require return of the physical check instead.
Other commenters suggested providing warranty protection for the
depositary bank by requiring the bank that sends an electronic return
to indemnify a depositary bank that charges back its customer based on
the electronic return. One commenter also stated that the depositary
bank and its customers should receive guarantees that the original
check will not be returned.
Allow Images Only.
Ten commenters suggested that the Board limit electronic return to
images only. One of these commenters stated that the regulation should
reflect a preference in favor of check imaging rather than the
transmission of a detailed accounting of the check. Another commenter
stated that the regulation should discourage the proliferation of
written notices, which are often incomplete and expose the depositary
bank to undue risk.
Address Coordination Issues.
Two commenters suggested that the Board should address various
issues related to the interaction of an electronic return system with
other electronic payment initiatives. One commenter asked for
clarification as to how a paying bank could return an image if it is
receiving check presentment electronically. This commenter also asked
how a depositary bank could create ACH returned-check entries (RCKs)
without the physical checks. Another commenter suggested that the Board
should provide a statement authorizing use of a notice in lieu of
return when the check has been processed electronically and returned to
its owner at the point of sale. The commenter stated that this would
encourage increased experimentation with electronic check truncation at
the point of sale.
Comprehensive Approach.
Seven commenters believed that the Board should take the lead in
working with the industry on a comprehensive approach to structuring an
all-electronic return process. One commenter stated that electronic
returns need to be part of a new regulatory approach for overall check
electronification. Another commenter stated that the Board should
express its willingness to consider and act on appropriate regulatory
changes on an ongoing basis during the transition to electronics in
check processing. Another commenter suggested that the Board fund a
nationwide education and marketing campaign to ensure consumer and
corporate acceptance of images in lieu of checks. Finally, one
commenter stated that the current return rules hold the check system
hostage to the needs of a few payees, and the Board should endorse the
notice-in-lieu process more enthusiastically rather than merely
condoning it.
Implementation Date.
Seven commenters made statements regarding the implementation date
of any rule change. Most of these commenters favored implementation as
quickly as possible, but one commenter asked for at least one year lead
time to allow for updating of internal systems.
Amendments to Secs. 229.36 and 229.37.
Seven commenters explicitly supported the proposed amendments to
Secs. 229.36 and 229.37 regarding electronic presentment agreements.
One commenter suggested that the restriction on the expansion of check
return deadlines should be retained explicitly.
Board staff invited all of the public commenters to participate in
a meeting on July 26 to discuss issues related to the proposed
amendments. Twenty-eight commenters attended the meeting.
Discussion
As indicated in the comment summary, overall, most commenters were
open to the idea of an electronic return system but were very concerned
about the effects of such a system on depositary banks and their
customers. Many commenters were reluctant to support regulatory changes
without knowing the details of how an electronic return system would
work and how they and their customers would be protected. This concern
prompted many commenters to suggest that the Board, in cooperation with
banks, establish more detailed rules and standards that would govern
such a system. The Board continues to believe that practices and
standards would be developed most efficiently through commercial
practice and market experimentation rather than by regulation. The
Board believes that its appropriate role is to facilitate
experimentation by determining whether its rules create barriers to
experimentation and if so, whether
[[Page 59612]]
those rules can be changed without creating undue adverse affects.
As noted above, under Regulation CC, the inability to bind remote
parties to an interbank agreement could lead to liability on the part
of banks for relying on electronic returns. Some participants in the
July 26 meeting reiterated that it is this potential liability they
would like to avoid. ECCHO and various others suggested in their
comment letters that the Board adopt option two but permit an
electronic return only if the depositary bank agrees to accept it.
ECCHO restated its proposal at the July 26 meeting, laying out a 3-part
plan for revising option two: (1) All of the banks involved, including
the depositary bank, would have to agree to participate in any
electronic check return program, (2) a notice in lieu of return,
whether specifically permitted under Regulation CC or permitted as part
of an interbank agreement on electronic check returns, would satisfy
the requirements of Regulation CC to the same extent as the return of
the original paper check for all bank and non-bank parties to the
check, and (3) banks that are parties to an electronic return agreement
may be liable under other law to non-bank parties unless that liability
is covered by other agreements.
Most of the discussion at the July 26 meeting focused on the cut-
off of rights under ECCHO's point (2), which would shield participating
banks against claims by remote parties under Regulation CC but would
not operate as a shield against claims under other law. (Presumably,
ECCHO and others would rely on their ability to bind remote parties by
clearinghouse rules under the U.C.C. to address these potential
claims.) The Board's proposed option two would have cut off Regulation
CC rights, but those rights would have been cut off for both banks and
non-banks. The ECCHO proposal would allow banks to opt out of the
electronic return arrangement but would not allow their customers or
other parties to the check to do so. Supporters of the ECCHO proposal
reasoned that this distinction was justified because depositary banks
would have to make operational changes to be able to accept electronic
returns, but depositors and others would not necessarily need to make
such changes.
Meeting participants were unable to quantify the risk presented by
the possibility that non-assenting parties may assert Regulation CC
rights if an electronic return program caused them to incur losses. In
general, participants agreed that, because banks can generally obtain
assent from their customers through deposit agreements, the most
serious risks would be from potential claims by remote third parties,
such as non-depositor payees, unless those rights are cut off. ECCHO
and some of the bank representatives stated that the uncertainty as to
the size of this risk was preventing banks from investing in pilot
electronic return programs. Without quantifying this risk, some banks
stated that they are unable to judge whether the benefits of an
electronic return system outweigh the risks, although some bank
representatives said that they had not made a focused attempt to
determine the magnitude of the risk. At the close of the meeting
representatives from ECCHO and certain banks stated that they would
take a closer look at the risks of claims from non-assenting parties
under Regulation CC to determine whether those risks are actually
outweighed by the perceived benefits to banks of electronic returns.
In a subsequent letter to the Board, ECCHO reiterated its support
for a Regulation CC amendment that would incorporate its proposal as
outlined at the meeting.7 In its letter, ECCHO argued that
its proposal would result in increased efficiency in the check return
system that would benefit banks as well as depositors in terms of
protection against check fraud. ECCHO believes that customer service
incentives will lead banks to make the original paper checks available
to customers within a reasonable window of time and that banks that are
not comfortable with the arrangement can opt out.
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\7\ The Board received five other follow-up letters from
organizations that attended the July 26 meeting. The letters
supported the ECCHO proposal in general, but some stated that the
Board should seek additional comment before adopting the ECCHO
proposal.
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ECCHO's proposal would eliminate the risks of potential Regulation
CC claims against banks that participate in electronic check return
systems. The risk would, in effect, be shifted from depositary banks to
their customers and remote third parties. Those who favor this proposal
have not demonstrated the magnitude of this risk. They state that the
risk is significant enough to prevent banks from experimenting with
electronic returns. On the other hand, they state that shifting the
risk to non-bank parties is justified by the efficiencies and cost-
savings that an electronic return system would bring. The Board's
proposed option 2 would also, in effect, shift this risk to non-bank
parties to the check, as well as to depositary banks. The Board
believes that the risk of Regulation CC claims by remote third parties
is quite low and finds it difficult to justify shifting that risk to
the remote third parties to benefit banks that have agreed among
themselves to return checks electronically. The barrier that the
current regulation presents to electronic check return does not appear
to be significant enough to warrant shifting risks to non-assenting
parties. Further, the commenters indicated that proposed option one
would not be useful in many situations where checks are not returned
back through the forward collection chain.
Instead, the Board has taken a different approach, similar to that
suggested by FRB Atlanta. The Board has revised the Commentary to
Sec. 229.37 to clarify that depositary banks may agree with paying or
returning banks to accept images or other notices in lieu of returned
checks even when the checks are available for return under Regulation
CC. Except to the extent that other parties interested in the checks
assent to or are bound by the banks' agreements, banks entering into
such agreements may be liable under Regulation CC or other applicable
law to other interested parties for any losses caused by the handling
of returned checks under such agreements. This revision leaves the
rights of depositary banks, depositors, and remote parties intact under
both Regulation CC and the U.C.C., avoiding the potential consumer
issues of the proposed options and the ECCHO proposal.
Given the Board's action, the final analysis of any electronic
return system will be driven by a cost decision on the part of the
banks involved. If the cost savings of an electronic return system will
be as great as some check system participants expect, then the risk of
Regulation CC claims by non-assenting remote third parties may be
outweighed by those savings and could be absorbed by participating
banks. The Board notes that banks have taken on these risks in other
contexts. For example, the banks that are participating in the Federal
Reserve electronic return pilot in Montana have agreed to assume the
risk of claims by non-assenting parties.8
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\8\ In other electronic payment experimental programs, banks
have been willing to assume risks that appear to be more significant
than the risk presented in this instance. For example, under
recently adopted National Automated Clearing House Association rules
that allow check payees to collect the funds from the checks through
the automated clearing house (ACH) under certain circumstances, the
bank that originates the ACH transaction warrants that all
signatures on the check are genuine and that the underlying paper
check will not be presented, even though the bank itself may not
have possession of or control over the check.
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The Board believes that the best long-term solution to this
particular electronic return issue, as well as other
[[Page 59613]]
issues related to the electronic collection and return of checks, would
best be addressed in a coordinated effort to bring subpart C of
Regulation CC and the U.C.C. into conformance. The Board is pursuing
this solution with the National Conference of Commissioners on Uniform
State Laws.
In addition, as proposed, the Board has removed the electronic
presentment agreement provisions from Sec. 229.36(c) and its related
Commentary and added a corresponding example to the Commentary to
Sec. 229.37. These amendments will not have any substantive effect.
Regulatory Flexibility Act Certification
In accordance with section 605 of the Regulatory Flexibility Act,
(12 U.S.C. 605), the Board certifies that the amendments to Regulation
CC and its Commentary will not have a significant economic impact on a
substantial number of small entities. The amendments will clarify the
extent to which banks may agree to vary the terms of Regulation CC by
agreement to experiment with electronic return systems, but will not
affect any entities who have not agreed.
List of Subjects in 12 CFR Part 229
Banks, banking, Federal Reserve System, Reporting and recordkeeping
requirements.
For the reasons set forth in the preamble, 12 CFR Part 229 is
amended as set forth below:
PART 229--AVAILABILITY OF FUNDS AND COLLECTION OF CHECKS
(REGULATION CC)
1. The authority citation for part 229 continues to read as
follows:
Authority: 12 U.S.C. 4001 et seq.
Sec. 229.36 [Amended]
2. In Sec. 229.36, paragraph (c) is removed and reserved.
3. In Appendix E, under section XXII, paragraph C. is removed and
reserved.
4. In Appendix E, under section XXIII, new paragraphs C.9. and
C.10. are added to read as follows:
Appendix E to Part 229--Commentary
* * * * *
XXIII. Section 229.37 Variations by Agreement
* * * * *
C. * * *
9. A presenting bank and a paying bank may agree that
presentment takes place when the paying bank receives an electronic
transmission of information describing the check rather than upon
delivery of the physical check. (See Sec. 229.36(b).)
10. A depositary bank may agree with a paying or returning bank
to accept an image or other notice in lieu of a returned check even
when the check is available for return under this part. Except to
the extent that other parties interested in the check assent to or
are bound by the variation of the notice-in-lieu provisions of this
part, banks entering into such an agreement may be responsible under
this part or other applicable law to other interested parties for
any losses caused by the handling of a returned check under the
agreement. (See Secs. 229.30(f), 229.31(f), 229.38(a).)
* * * * *
By order of the Board of Governors of the Federal Reserve
System, October 27, 1999.
Robert deV. Frierson,
Associate Secretary of the Board.
[FR Doc. 99-28580 Filed 11-2-99; 8:15 am]
BILLING CODE 6210-01-P
