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Thursday, September 3, 2015

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Update Newsletter: Spring 2009

The Laws, Regulations, Guidelines, and Industry Practices That Protect Consumers Who Use Gift Cards

Expanding on the center's prepaid card research, Philip Keitel discusses consumer protections available to gift-card users in his recent paper "The Laws, Regulations, Guidelines, and Industry Practices That Protect Consumers Who Use Gift Cards."* This paper specifically considers the protections for the two types of prepaid gift cards: "closed-loop" and "open-loop." Closed-loop cards are typically sold by individual retailers, serviced by those retailers (or their agents), and function only at that particular retailer's locations. Open-loop cards are issued by financial institutions, operate over debit or credit networks, carry a network logo, and can be used at any retail location that displays the payment network logo. In describing consumer protections for gift cards, Keitel cites several sources, including state statutes, Federal Trade Commission decisions, financial industry regulatory guidelines, and past interviews with payments industry experts.

Closed-loop cards account for both the majority of gift cards sold and the majority of dollars loaded onto gift cards. While there are presently no federal laws or regulations that protect consumers who buy and use these gift cards, approximately 40 states and the District of Columbia have enacted legislation designed to protect purchasers of gift cards. Although the specific laws vary, they generally deal with issues related to fees (issuance fees, service fees, dormancy charges for nonuse), the length of time before cards may expire, and the disclosures that must be made to consumers. A number of states also apply their abandoned property laws to unused balances on closed-loop gift cards, requiring that unclaimed balances revert to the state treasury after a defined period of time. The amounts involved are not trivial, with some estimates suggesting that unused gift card balances are in the multibillion-dollar range. While there are similarities among state laws, there are also important differences. For example, provisions that stipulate the amount of time that must pass before cards may expire were found to range from one to seven years.

In addition to state laws, state attorneys general have taken action against gift-card issuers and program operators. In 2002, for example, Home Depot changed its national policy regarding lost or stolen cards after then-Attorney General Eliot Spitzer questioned some of the retailer's gift-card program practices. As a result of this agreement, consumers who report lost or stolen Home Depot gift cards and provide proof of purchase can request deactivation and replacement of the original card. Today, virtually all gift-card programs offer similar protections.

The Federal Trade Commission (FTC) has also been active in protecting consumer gift cards. In two separate cases in 2007, the FTC ruled that Darden Restaurants Inc. and Kmart Corp. were guilty of "unfair or deceptive practices" involving their gift-card programs. Specifically, it was found that disclosures at the time of purchase did not adequately and clearly define dormancy fees that went into effect after the cards had not been used for some time. The gift-card issuers were ordered to make changes to their disclosure practices and take ameliorative actions. As a result, many gift-card programs now generally follow these FTC-ordered disclosure practices.

The other type of gift card discussed in Keitel's paper is the open-loop, or network- branded, gift card. While smaller in volume than closed-loop retail gift cards, open-loop cards represent an important and growing segment of the market. Unlike retail gift cards, open-loop cards are issued by financial institutions that are subject to federal regulations. These regulations are principally issued by the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS). Having generally issued similar rules related to disclosures and substantive practices for operating gift-card programs, the OCC and the OTS distinguish between the purposes behind particular types of disclosures — recognizing that certain information is relevant to the purchaser's decision making, while other information is essential to the user and should be "passed on from the gift card purchaser to the gift card recipient."

Another source of consumer protection for open-loop gift cards comes from rules established by the card networks whose brands adorn the cards. For example, in some instances, networks extend consumer protection policies developed for credit and debit card users to open-loop gift-card holders. Two such critical policy extensions relate to "zero liability" and chargebacks. Under the zero liability rule, networks require issuers of network-branded gift cards under certain circumstances to recredit consumers within five business days for any losses suffered as a result of reported unauthorized transactions. Under chargeback rules, issuers are able to charge back to retailers transactions deemed to have been faulty. While this protection is sometimes extended to open-loop gift-card holders, Keitel cites interviews in which card issuers suggest that there are differences in how aggressively chargeback remedies are extended — often depending on the nature of the cardholder relationship.

The applicability of state laws (including state gift-card laws, abandoned property laws, and various other state laws) to open-loop gift-card programs offered by nationally chartered financial institutions is characterized by Keitel as a dynamic and evolving area of law. While some state statutes specifically exempt gift-card products issued by these financial institutions from their purview, others specifically target these issuers. This general issue — whether state consumer protection laws aimed at gift-card consumers apply to open-loop cards issued by federally regulated financial institutions — has been at the heart of several actions brought by state attorneys general. While Keitel notes that appellate court decisions have helped clarify elements of the debate, including whether federal law preempts state law here, the general question has not been completely resolved.

Today's gift-card programs, both closed-loop and open-loop, often provide substantial consumer protections as a result of actions taken by state legislatures, state attorneys general, federal agencies, financial institutions, and payment networks. The increasing use and high consumer satisfaction levels associated with gift cards are likely to be, at least partly, the result of consumers' comfort with these protections. However, this minimal risk feature of gift cards may change as innovation in payments continues. Should new gift-card models expand beyond the original low-value, short-lifetime concept, the need to address new consumer protection issues will likely follow.