Consumer Compliance Outlook: Fourth Quarter 2009

Current Issues in Payroll Cards

In July 2007, payroll cards became subject to the consumer protections of Regulation E, the implementing regulation for the Electronic Fund Transfer Act. Since then, as the functionality of payroll cards has expanded to include services provided by traditional deposit accounts, the number of consumer protection regulations with which payroll card issuers must comply has also increased. This article recaps the requirements of the 2007 rule, reviews the consumer compliance implications of payroll cards, summarizes consumer complaints related to payroll cards received at the Federal Reserve's consumer complaint center, and discusses the favorable implications under the Community Reinvestment Act (CRA) for issuing payroll cards.

A payroll card is a type of stored-value card that provides employers with an alternative to traditional paper checks or direct deposit to pay employees. Unlike gift cards and other stored-value cards, which are typically closed-end cards accepted only at the issuer's locations, payroll cards are designed to transfer compensation on a recurring basis and are typically open loop, meaning they are accepted beyond the issuer's locations because the issuer participates in a wide network such as STAR for pin-based transactions or Visa for signature-based transactions. The popularity of payroll cards has increased in recent years as a cost-effective alternative to paying workers with cash and payroll checks, particularly for employees who lack traditional deposit accounts. Benefits of payroll cards include enabling employees to avoid or minimize check cashing fees, lowering employers' payroll costs, and providing access to banking services to individuals who historically have maintained few or no established banking relationships.

RECAP OF FINAL RULE

In August 2006, the Board of Governors of the Federal Reserve System (Board) amended Regulation E's definition of "account" in 12 C.F.R. §205.2(b) to include a "payroll card account."1 As a result, the regulation's substantive and disclosure protections apply to payroll cards, with one significant modification. The final rule extends the regulation's unauthorized use and error resolution protections to payroll cardholders and requires financial institutions offering payroll cards to provide all initial and subsequent disclosures.2 However, the rule allows financial institutions, as an alternative to complying with the regulation's periodic statement requirement, to provide specific account information such as account balance and transaction history by telephone, electronically, or in writing upon the cardholder's request.3 The final rule also clarified that for banks using this alternative method, the 60-day notice period for unauthorized use begins the earlier of the date the cardholder accesses the account information electronically or the date on which the bank sends a written account history, as requested by the consumer.4

The Board, after conducting detailed focus group testing with payroll card users in the fall of 2005, permitted the alternative provision of periodic statement information because of the specific needs and behaviors of typical users. Although most focus group participants retained periodic statements for their records, the majority monitored their payroll cards by telephone or through the website of the payroll card provider. In the preamble to the final rule, the Board stated that information provided electronically and via telephone was timelier and could assist consumers in avoiding overdrawing their accounts.5

COMPLIANCE IMPLICATIONS

The compliance requirements for payroll cards are expanding. For example, on November 12, 2009, the Board announced a final rule under Regulation E to provide consumer protections for overdrafts.6 Because payroll cards are now subject to Regulation E, as discussed earlier, the new rule will apply to payroll cards with an overdraft feature. Under the final rule, financial institutions can only enroll consumers in a program covering overdrafts for automated teller machine (ATM) and one-time point-of-sale transactions if the consumers have opted in to the program. The rule does not apply to checks, recurring transactions, or automated clearinghouse transactions. Financial institutions must complete four steps for the opt-in procedure before they may assess any fees for an ATM or one-time debit card overdraft: (1) provide the consumer with an opt-in notice explaining the overdraft service for ATM withdrawals and one-time debit card transactions segregated from all other information, including other account disclosures; (2) provide the consumer with a reasonable opportunity to consent to the service; (3) obtain the consumer's affirmative consent to the service; and (4) provide the consumer with written confirmation of the consent7 and a statement of the right to revoke it.

Financial institutions may not assess overdraft fees for existing accounts on consumers who have not opted in by August 15, 2010. For accounts opened on or after July 1, 2010, financial institutions must provide notices to their customers and obtain their opt-in before fees may be assessed.

In addition, the recent final Red Flags regulations jointly issued by the Federal Trade Commission (FTC) and the five federal banking agencies (Agencies) to implement the Fair and Accurate Credit Transactions Act of 2003 contain rules that apply to payroll card issuers. The final rule specifies that financial institutions offering "covered accounts" must develop and implement a written identity theft prevention program to combat identity theft for new and existing covered accounts. The FTC and the Agencies recently issued a "frequently asked questions" specifically stating that a payroll card is a "covered account."8 The identity theft program must satisfy four requirements: (1) identify forms of activity that are red flags for possible identity theft and include those red flags in the program; (2) detect red flags incorporated in the program; (3) respond appropriately to any red flags that are detected to prevent and mitigate identity theft; and (4) ensure that the program is updated periodically to reflect changes in risks from identity theft.9

The final rule also specifies that if a debit or credit card issuer receives an address change notification and subsequently receives a request for an additional or replacement card within 30 days, the issuer cannot send the additional or replacement card until it has notified the cardholder or otherwise assessed the validity of the change of address in accordance with the rule's requirements.

CRA CREDIT

Under the "Interagency Questions and Answers Regarding Community Reinvestment," financial institutions offering payroll cards may be eligible for credit under CRA if the cards are free or low cost and increase access to financial services for low- and moderate-income individuals.10 A review of CRA public evaluations identified numerous examinations in which financial institutions received CRA credit for offering payroll cards. Large institutions (assets greater than $1.1 billion) received credit for offering payroll cards under the retail services component of the services test, while banks evaluated under the intermediate small bank procedures (assets between $277 million and $1.1 billion) received credit under the community development test for their payroll cards.

CONSUMER COMPLAINT ACTIVITY

Federal Reserve Consumer Help (FRCH) is the Federal Reserve System's central office for consumer complaints. Analyzing consumer complaint data is an important tool the Federal Reserve System uses to identify emerging consumer protection issues with financial products and services. An analysis of FRCH's consumer complaint data revealed a low level of complaints or inquiries involving payroll cards, especially when compared with the volume of complaints received regarding payroll checks.

Some of the payroll card complaints received at FRCH concerned whether employers could require employees to accept wages via payroll cards. Regulation E prohibits employers (and banks) from requiring employees to establish an account to receive electronic fund transfers as a condition of employment; however, employers can avoid this compulsory-use protection by giving employees the option of having their salary deposited at a bank or by another means such as check or cash. Several states have also addressed the degree to which employers can require the use of payroll cards.11 Financial institutions should review state law regarding employee compensation to ensure compliance.

FRCH has also received inquiries about which entity is responsible for investigating and resolving alleged errors. Regulation E requires financial institutions that provide electronic fund services to investigate whether an error occurred, report the results to the consumer, and correct any error within established time frames.12 Consequently, banks that offer and service payroll cards are responsible for investigating and resolving any errors alleged by payroll card holders.

Other consumers complained that banks were either unwilling to cash payroll checks unless the consumer had an account with the institution or that banks charged a fee for cashing noncustomer payroll checks. Payroll card holders are not required to maintain a deposit account to access their compensation. Some states have restrictions on the levels and types of fees that may be imposed to access wages,13 which should also be reviewed by compliance staff.

CONCLUSION

As the functionality of payroll cards continues to increase, the number of consumer protection regulations with which financial institutions must comply increases, too. Banks should conduct appropriate reviews of federal and state laws, including those related to customer identification, state employee compensation restrictions, and federal consumer financial protection laws, before implementing a payroll card product. Compliance professionals should also monitor the evolving marketplace and regulatory environment to ensure payroll cards' continued compliance. Specific issues and questions should be raised with the consumer compliance contact at your Reserve Bank or with your primary regulator.

  • 1 Section 205.2(b)(2) External Site of Regulation E defines "payroll card account"' as "an account that is directly or indirectly established through an employer and to which electronic fund transfers of the consumer's wages, salary, or other employee compensation (such as commissions) are made on a recurring basis, whether the account is operated or managed by the employer, a third-party payroll processor, a depository institution, or any other person."
  • 2 The commentary to §205.18(a)-2 of Regulation E External Site states that "typically, employers and third-party service providers do not meet the definition of a financial institution subject to the regulation because they neither hold payroll card accounts nor issue payroll cards and agree with consumers to provide EFT services in connection with payroll card accounts. However, to the extent an employer or a service provider undertakes either of these functions, it would be deemed a financial institution under the regulation."
  • 3 12 C.F.R. §205.18(b) External Site
  • 4 12 C.F.R. §205.18(c)(3) External Site
  • 5 71 Fed. Reg. 51437, 51443 (August 30, 2006) External Site
  • 6 74 Fed. Reg. 59033 (November 17, 2009) External Site
  • 7 Electronic documentation is permissible if the consumer consents.
  • 8 Question 4, page 6 External Site
  • 9 12 C.F.R. §222.90 (d)(2) External Site
  • 10 See Interagency Questions and Answers Regarding Community Reinvestment, §228.12(i)-3 External Site ("Examples of community development services include… providing other financial services with the primary purpose of community development, such as…free or low-cost…payroll, or other check cashing services, that increase access to financial services for low- or moderate-income individuals.").
  • 11 Beth S. DeSimone, Jeremy W. Hochberg, and Olayemi Y. Abayomi. "State Law Developments in the Regulation of Payroll Cards." Review of Banking and Financial Services External Site, 24:8, August 2008, pp. 96-97.
  • 12 12 C.F.R. §205.11 External Site
  • 13 "State Law Developments in the Regulation of Payroll Cards," pp. 98-100.