CBA Regulatory Compliance Bulletin

Transcription

1 CBA Regulatory Compliance Bulletin April 13, 2015 Identifying a Remotely Created Check Through the External Processing Code Field by Ted Teruo Kitada. 1 I. Introduction As commonly used by, among others, debt collectors and telemarketers, remotely created checks have generated federal and state regulatory scrutiny and concern. These instruments have been subject to misuse because they may be created to debit a deposit account without the authorization of the account owner; a creator of a remotely created check may be able to debit a deposit account merely armed with the routing number and account number associated with the account. The American National Standards Institute ( ANSI ) addressed the difficulty of identifying remotely created checks by adopting a new standard on the MICR line of a check where the character 6 is exhibited as an identifier for remotely created checks. II. Background A remotely created check is defined in Regulation CC 2 section 229.2(fff) as follows: (fff) Remotely created check means a check that is not created by the paying bank and that does not bear a signature applied, or purported to be applied, by the person on whose account the check is drawn. For purposes of this definition, account means an account as defined in paragraph (a) of this section as well as a credit or other arrangement that allows a person to draw checks that are payable by, through, or at a bank. A remotely created check is sometimes also called a demand draft, 3 a preauthorized draft, a MICR draft, or a telecheck. Under a proposal recently issued by the Federal Trade Commission, 4 the Telemarketing Sales Rule would be amended to prohibit the acceptance of remotely created checks as payment in both inbound and outbound telemarketing transactions. While the FTC has not acted on this proposal to date, the tone and content of this proposal reflect the grave reservations regulators have about this payment instrument. Further, the Board of 1 Senior Vice President & Senior Company Counsel, Wells Fargo Bank, and Chairman of CBA s Legal Affairs Committee C.F.R. Part California Uniform Commercial Code section 3104(k) Fed.Reg (July 9, 2013).

2 2 April 13, 2015 Governors of the Federal Reserve System deems a remotely created check such a risky payment instrument that it created a special transfer and presentment warranty under Regulation CC. 5 One difficult challenge in identifying misusers of remotely created checks is the inability to isolate such checks in the payment process. Currently, the only practical method to identify misusers is to detect remotely created checks through inspections of returned deposited checks, by examining the face of such checks manually. Remotely created checks have no distinct identifier in the MICR line. III. American National Standards Institute solution A. External Processing Code field. The American National Standards Institute ( ANSI ) issues industry standards for, among other things, payment instruments, such as for paper checks. 6 On November 24, 2014, ANSI approved an ANSI standard for the External Processing Code ( EPC ) field of the MICR line: ANSI X , Magnetic Ink Printing (MICR), Part 2: EPC Field Use. This voluntary ANSI standard is effective November 24, 2015, albeit it may be adopted immediately. On a business check, the EPC field is between the Auxiliary On Us Field and the Routing Number Field. This new standard replaces X New Clause assigns a character 6 in the EPC field, called position 44, as an identifier for remotely created checks. Below is an example: For a regular remotely created check, the following is an example: 5 Regulation CC section (d) 6 ANSI X Clause 5.6 provides: 5.6 Character 6 Status: Assigned for usage as an identifier of Remotely Created Checks (RCCs). RCCs are not signed by the drawer.

3 3 April 13, 2015 Note the character 6 in the EPC field of this check. B. Substitute checks. 8 While most checks are collected electronically, prior to collection some checks must be converted to a substitute check for various reasons, e.g., the check may be difficult to image. In such instances, to facilitate forward collection, a depository bank may create a substitute check. Additionally, when a deposited check is returned by a paying bank, a depository bank may also create a substitute check to deliver to its customer originally depositing the check, as the originally deposited check would have been truncated in the ordinary course. Normally, such substitute checks have a character 4 in the EPC field, as established under ANSI standards. 9 When a reconverting bank (the bank creating a substitute check) 10 creates a substitute check from a remotely created check for forward collection or return of a deposited check to its customer, the EPC field will continue to have a 4 despite the original imaged remotely created check possibly 8 Regulation CC section 229.2(aaa) provides: (aaa) Substitute check means a paper reproduction of an original check that (1) Contains an image of the front and back of the original check; (2) Bears a MICR line that, except as provided under ANS X (unless the Board by rule or order determines that a different standard applies), contains all the information appearing on the MICR line of the original check at the time that the original check was issued and any additional information that was encoded on the original check's MICR line before an image of the original check was captured; (3) Conforms in paper stock, dimension, and otherwise with ANS X (unless the Board by rule or order determines that a different standard applies); and (4) Is suitable for automated processing in the same manner as the original check. 9 ANSI X (2013) and ANSI X (2014), Clause 5.3. For a qualified return (see Regulation CC, comment (a)-7) of a substitute check, the character 5 is used. ANSI X (2014), Clause Regulation CC section 229.2(zz).

4 4 April 13, 2015 having a 6 in the EPC field (for those remotely created checks complying with the new ANSI standard): 11 For a substitute check created from a regular check, the following is an example: In order for a bank to identify and isolate substitute checks created from remotely created checks by automated means using the new EPC field s character 6, the bank would need to scan not only the MICR line of the substitute check (identified with the character 4 for forward collection) but also the MICR line of the imaged remotely created check bearing the character 6 in the EPC field. This process may involve key enhancements to check processing. 11 ANSI X , Clause 6.4

5 5 April 13, 2015 IV. Use of the new EPC character 6. This new EPC character presents the following opportunities and raises the following issues for the banking industry. A. Customer generating remotely created checks. For those banks providing banking services to a customer regularly creating remotely created checks (such as a debt collector), by agreement consider having the customer include the character 6 in the EPC field. By enhancing check processing software or hardware to interrogate the EPC field for this character, a bank may monitor the volume of remotely created checks deposited in the ordinary course (as remotely created checks could be commingled with other deposited checks). Further, as and when that customer has returned deposited checks, the bank may again monitor by automated means the return velocity of remotely created checks previously deposited by that customer by scanning the EPC field (as remotely created checks could be commingled with other returned checks). The bank will not be required to manually inspect returned checks to identify and isolate remotely created checks as deposited or as returned checks. B. Account agreement term. Through its account agreement, to mitigate payment risks, a bank may consider requiring firstly that any customer creating a remotely created check have the bank s consent prior to depositing such checks. Secondly, in the event such consent is granted, the bank should require the customer to include the character 6 in the EPC field. In the event the bank determines that the customer is creating remotely created checks inconsistent with the account agreement terms, the violation of this agreement s requirement may provide the bank with a contractual basis to exit a risky relationship. C. Creation of substitute checks from remotely created checks for returned remotely created deposited checks. As discussed above, a depository bank frequently creates a substitute check from a returned deposited check. That check normally has a character 4 in the EPC field, denoting forward collection. In the event the returned deposited check is a remotely created check and that check originally bears a character 6 in the EPC field, the substitute check created by the depository bank to deliver to its customer would have a 4 in the EPC field, as shown in the figure above. Again, to the extent a depository bank enhances its system to isolate and identify remotely created checks, in the event this returned check is redeposited, it will be able to track these checks (to the extent the depository bank is able to scan the EPC field of the originally deposited check displayed as an image in the substitute check). D. Creation of substitute checks from remotely created checks for forward collection. While 99% of checks are collected electronically, from time to time a check may not be subject to conversion to an electronic item. This inability may be due to the quality of the image of the check under collection. Under such circumstances, a depository bank may elect to convert the check to a substitute check for collection purposes. In this regard, in instances where the check for collection is a remotely created check again the substitute check will have a 4 in the EPC field. Again, in order to isolate and identify remotely created checks using this new character 6 in the EPC field, a paying bank may need to enhance its check processing methods in order to scan the MICR line

6 6 April 13, 2015 field of the originally imaged remotely created check in order to read the character 6 (in addition to the MICR line of the substitute check. E. MICR drafts. As a treasury management service, a depository bank may create a remotely created check (or MICR draft) on behalf of a merchant to collect a returned check fee on behalf of merchant. In such instances, the bank will generate a remotely created check, commonly called a MICR draft. In light of the new EPC field character 6, the bank may entertain voluntarily including this character in the MICR draft to foster sound banking practices. V. Conclusion. Because misused remotely created checks have created mischief in the payment system, by requiring the use of the character 6 by its customers a bank may be able to some extent to monitor and police by automated means the deposit and return velocities of such checks by its customers. This opportunity is a risk mitigation consideration, particularly for banks providing services to payment processors generating such checks in the ordinary course. Additionally, the new ANSI standard presents issues and questions for a bank creating remotely created checks or similar instruments for the benefit of its customers. The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.