Compliance Corner: Fourth Quarter 2004

Checking In With Check 21

by Robert W. Snarr, Jr, Supervising Examiner

The Check Clearing for the 21st Century Act, commonly known as the Check 21 Act or Check 21, was enacted on October 28, 2003 and became effective a year later on October 28, 2004.¹ Initiatives that led to the enactment of Check 21 began during 2000 within a context of increasing electronic payments and available technology that would enable more efficient and cost effective check processing. In particular, the physical transport of paper checks could be eliminated and, instead, digital images of the original checks or, when necessary, substitute checks made from digital images of the originals, could facilitate check processing. Such initiatives were intensified and accelerated subsequent to the terrorist attacks of September 11, 2001, when all air traffic in the United States was grounded, resulting in a substantial delay in the processing of millions of checks.

On July 26, 2004, the Board of Governors of the Federal Reserve System released its final rule that amended Regulation CC, Availability of Funds and Collection of Checks, to implement Check 21. In essence, Check 21 facilitates electronic check exchange, and, where applicable, permits banks ² to create substitute checks for presentment and transfer to those banks that have not formally agreed to accept checks electronically. The provisions of Check 21 address various responsibilities and requirements on the part of banks regarding the operational aspects of check truncation and related consumer protections. Consumer protection provisions of Check 21 fall into two broad categories—consumer awareness disclosures and consumer expedited recrediting rights.

By now, all banks should have implemented the procedures and mechanisms necessary to effectively comply with all applicable provisions of Check 21. The purpose of this article is to provide guidance to help banks comply with the provisions of Check 21 that address consumer protections and to offer helpful tips to banks to mitigate related compliance, legal, and reputational risks.

Consumer Awareness Disclosure
The consumer awareness disclosure requirements of Check 21 under §229.57 of Regulation CC apply to consumer customer accounts only, and not to business customer accounts. ³ Further, when the consumer account is jointly held, a bank is not required to provide separate disclosures to each customer.

Section 229.57 requires banks to provide customers written disclosures that describe substitute checks and the rights of customers relative to such checks. The disclosures must be provided to customers who:

Routinely receive paid checks ⁴ with their respective account statements.
Receive a paid substitute check in response to a request for a paid check.
Receive returned substitute checks.
Receive a substitute check, irrespective of whether the customer was provided the disclosure earlier.

Customers that had an existing consumer account with a bank on or before October 28, 2004, should receive or should have received the requisite disclosures no later than the first statement cycle subsequent to October 28, 2004. Customers that established a consumer account relationship with a bank going forward should be provided disclosures at the date that the relationship is initiated.

For customers that receive substitute checks in response to a request or on an occasional basis, the written disclosures must be provided no later than the date on which the bank provides the substitute check. In the case of substitute checks that are provided in response to a customer's request, the disclosures should be provided at the time of the request, if feasible.

The content of the written disclosures must explain both of the following elements.

That a substitute check is the legal equivalent of the original check.
That a consumer has expedited recrediting rights, with a description of those rights, in the event that a consumer believes in good faith that a substitute check was improperly charged to his or her account.

Appendix C of Regulation CC contains a model disclosure (Model C-5A) to comply with the requisite consumer awareness disclosure requirements. A bank that uses Model C-5A will be deemed to be in compliance with the disclosure requirements provided that the model language accurately describes an institution's procedures.

Provisions for Expedited Recredits to Consumer Accounts Section 229.54 of Regulation CC addresses expedited recrediting rights for customers. The recrediting rights apply only to those customers who have received a substitute check. Moreover, the expedited recrediting rights apply only to checks charged to consumer deposit accounts. Generally, they do not apply to credit card checks, checks that are drawn on a home equity line of credit, or checks drawn on a brokerage clearing account. However, the recrediting rights would generally apply when a customer deposits such a check into a deposit account, and the check was returned unpaid to the customer as a substitute check.

To invoke the provisions which govern expedited recrediting under Â§229.54, a customer must make a claim in good faith, with supporting documentation, that addresses all of the following elements.

His or her account was charged for a substitute check.
His or her account was improperly charged or that he or she has a warranty claim related to the substitute check.
He or she suffered a loss.
He or she needs the original check or a sufficient copy to determine the validity of the claim.

A customer claim must be filed such that the bank receives it within 40 calendar days ⁵ from the date that the bank mailed, or delivered by a means agreed to by the customer, the account statement or the check that gave rise to the claim. Should a bank require that a claim be in writing, ⁶ and a customer attempts to submit a claim orally, the bank must inform the customer of the requirement for a written claim at the time that the customer attempts an oral claim. Under Regulation CC, a customer must submit a written claim such that the bank receives it within the later of (i) 10 business days of the date of notification by the bank of the written claim requirement or (ii) the aforementioned 40-calendar-day time period. ⁷

In responding to a customer's claim, a bank must take one of the following actions.

Approve the customer's claim and send a notice of recredit no later than the business day after the banking day on which the bank recredits the customer's account.
Deny the customer's claim and provide a notice to the customer that demonstrates why the claim is not valid. The notice must be sent no later than one business day after the banking day on which the bank made the determination.
Provisionally recredit the customer's account pending further investigation as to the validity of the claim and provide a notice of the provisional recredit. The notice must be sent no later than the business day on which the bank actually recredits the customer's account.

If a bank provisionally recredits a customer's account pending further investigation, the bank is required to recredit the amount of the customer's loss up to the amount of the substitute check or $2,500, whichever is less. If during its investigation the bank determines that the customer's claim is valid, the bank must recredit any remaining amount, plus any applicable interest, no later than the 45th day after receiving the claim.

If a bank determines that the claim was not valid, the bank may reverse the applicable provisional recredit. In so doing, the bank must provide a notice of reversal no later than the business day after the banking day on which the bank makes the reversal.

Similar to the consumer awareness disclosure requirements, Appendix C of Regulation CC contains various model disclosures to comply with the regulation's expedited re-credit rights provisions. However, unlike the consumer awareness disclosure model C-5A, the use of the expedited recredit model forms does not provide banks with a statutory safe harbor.

Guidance for Mitigating Compliance, Legal, and Reputational Risks
Most banks have likely provided customers with the consumer awareness disclosures regarding Check 21 and have implemented procedures to effectively address expedited recrediting rights of consumers. In fact, many banks provided their customers with multiple notifications of Check 21 and its ramifications several months prior to the October 28, 2004 effective date.

Despite such measures, Check 21 represents a major change to the nation's payments system as most consumers have known it. Although the overall effect of Check 21 will likely be gradual, it is probably safe to assume that many consumers will find it a challenge to adjust to the faster check clearing times. Some within the financial services industry have opined that Check 21 portends a substantial increase in the volume of bounced checks during the first months after Check 21 becomes effective. In particular, The Wall Street Journal reported one source as estimating that, by the middle of 2005, the number of bounced checks might increase by seven million each month, potentially resulting in an additional $175 million in penalty fees to consumers. ⁸

The following guidance should help reduce compliance, legal, and reputational risks regarding Check 21, particularly during the initial months of the law's inception.

Be aware of examination procedures that have been approved and issued by the Federal Financial Institutions Examination Council (FFIEC) to evaluate a bank's compliance with the consumer protection provisions of Regulation CC.

The procedures are available on the FFIEC's website. A bank's compliance or internal audit staff should be familiar with the procedures and its compliance program should include adequate coverage of the more recent revisions to Regulation CC.

As might be expected, the procedures focus on (i) determining a bank's compliance with the regulation's content and timing requirements regarding consumer awareness disclosures and (ii) ascertaining a bank's compliance with the requirements to address customer claims regarding substitute check expedited recredits.

Implement procedures to ensure that your bank effectively complies with consumer awareness disclosure requirements of Regulation CC on an ongoing basis. When opening new accounts and establishing new customer relationships, adequate resources should be allocated among the bank's branch office network and deposit operations, as applicable, to ensure that requisite notifications are provided to customers at the time that an account or relationship is initiated.

Implement adequate procedures or processes to address and resolve Check 21-related consumer inquiries, complaints, and claims in an effective and timely manner. Staff should be adequately trained and available to respond to complaints within the recredit timeframes established by Regulation CC.
The number of exceptions to the recredit time frames established by Regulation CC should be minimal, and the reason(s) for exceptions should be sufficiently documented.

If form letters or correspondence are used in the expedited recrediting process, language and terms used should be clear and understandable. Appendix C to Regulation CC contains model disclosures.

Any applicable time frames that the customer is expected to abide by should be clearly identified in any correspondence provided to the customer.

Customer complaint procedures should be effectively integrated with and coordinated among the bank's branch office network, deposit operations, and legal or compliance functions, as applicable.

Customer complaint procedures should include adequate tracking or reporting mechanisms to document a complaint or inquiry from the date received until the date resolved.

Tracking or reporting mechanisms should enable the identification of any inadequate, ineffective, or inefficient aspects of a bank's existing customer complaint procedures or patterns that might warrant management's attention.
Develop training procedures to effectively instruct current and new employees of the revisions to Regulation CC and any Check 21-related changes to the bank's deposit operations or other applicable operations. It is recommended that a bank document any initial and ongoing training efforts, including the dates and scope of training provided. It is also recommended that a bank ensure that training is provided to all staff who are responsible for compliance with Check 21 and Regulation CC, including staff in the branch office networks, deposit operations, and legal and marketing functions.

If a bank offers a non-contractual courtesy overdraft checking program, it may be prudent to monitor customer usage of the program for substantial increases in overdrafts and the imposition of overdraft fees during the remainder of 2004 and the early months of 2005. Depending upon the feedback of such monitoring, a bank may wish to provide a higher level of assistance to customers to avoid substantially increased overdrafts and resultant overdraft fees as they adjust to a more rapid check clearing process.

Final Thoughts
Check 21, which facilitates the nation's transition to electronic check processing, has arrived. Regulation CC, which implements many provisions of Check 21, does not, in any way, mandate check truncation or check destruction. Rather, the regulation governs a negotiable instrument known as a substitute check, which is the legal equivalent of an original check.

In addition to protecting recipients of substitute checks through expedited recrediting rights, Regulation CC also contains provisions regarding mandatory consumer awareness disclosures. Bankers and others within the financial services industry should be familiar with the provisions of Regulation CC that implement Check 21. In this regard, the FFIEC Check 21 Compliance Information for Examiners and Industry InfoBase should be a valuable resource. Additional information on this tool appears elsewhere in this issue of Compliance Corner.

If you have any questions about this article or the consumer compliance implications of Check 21, please contact either Supervising Examiner John D. Fields or Supervising Examiner Robert W. Snarr, Jr. through the Regulations Assistance Line at (215) 574-6568.

¹ Check Clearing for the 21st Century Act
² For purposes of this article, the term bank is used in context of Regulation CC's definition of banks and includes federally insured commercial banks, mutual savings banks, savings banks, credit unions, savings associations, agencies or branches of foreign banks, and members of a Federal Home Loan Bank. The term also includes any entity engaged in the business of banking, such as a Federal Reserve Bank, Federal Home Loan Bank, and to the extent that they act as a paying bank, the U.S. Treasury and the U.S. Postal Service.
³ Based on the definition of consumer account in Regulation CC, a consumer customer, for purposes of the regulation, means any natural person who deposits a check into, cashes a check against, or draws a check on a deposit account that he or she uses primarily for personal or household purposes.
⁴ The disclosure requirement does not apply if a bank provides with an account statement something other than paid original checks, paid substitute checks, or some combination of original and substitute checks. For example, the requirement does not apply to banks that provide customers with account statements together with only a document that contains multiple images of checks transacted during a given statement period.
⁵ Regulation CC requires banks to extend the time limit in extenuating circumstances. In addition, a bank may choose to extend the 40-day time period to parallel the 60-day claim period under Regulation E regarding claims for disputed electronic fund transfers. Also, Regulation CC holds that a complaint or inquiry from a customer is not a claim for purposes of expedited re-crediting until the claim is complete. As such, the time period for a bank to respond begins when a customer submits a "complete" claim. However, it is the duty of the bank to inform the customer that a complaint is incomplete and identify what information is necessary for a complete claim.
⁶ Applicable consumer awareness disclosures should inform customers of a bank's requirement for written claims.
⁷ If a customer makes an oral claim within the 40-calendar-day period, and the customer ultimately meets the 10-business-day written notification requirement, under Regulation CC, the customer's claim is deemed timely even if the written claim is received by the bank after the 40-calendar-day period.
⁸ Kathy Chu, "Identity Theft Could Impede Victims' Banking," The Wall Street Journal, October 26, 2004, p. D2.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.

Compliance Corner: Fourth Quarter 2004

Checking In With Check 21

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