AL 2001-3
OCC Advisory Letter
Subject: Internet-Initiated ACH Debits/ACH Risks
Date:  January 29, 2001

TO: Chief Executive Officers of All National Banks,
Service Providers and Software Vendors, Department
and Division Heads, and All Examining Personnel

PURPOSE

This advisory alerts national bank management and
boards of directors to specific Automated Clearing
House (ACH) risks and emphasizes the importance of
sound ACH risk management practices.  In particular,
this advisory describes a recently approved amendment
to the operating rules of the National Automated
Clearing House Association (NACHA).  The amendment
is designed to enhance security for ACH debits
initiated through the Internet and mandates the use of
security measures that meet minimum standards.
National banks that transmit certain Internet-initiated
ACH debits will be deemed to warrant that their
customers who originate the entries have met these
standards.  The banks can be held liable for losses
that result from a failure of their customers to meet
these standards.  In order to fulfill their
responsibilities, management and boards of directors
of national banks must understand the nature of ACH
risks, ensure the bank has procedures in place to
comply with the NACHA operating rules, and ensure
appropriate risk controls exist within the bank.

BACKGROUND

The ACH network through which electronic payments are
distributed and settled has existed since the early
1970s.  ACH debit entries transfer funds from another
party (receiver) to the originator of the entry
(originator).  For example, for a mortgage payment
made through ACH debit, the receiver is the mortgage
payor and the originator is the mortgage creditor.
On the other hand, ACH credit entries transfer funds
from the originator to the receiver.  For example,
for employee payroll distributions made through ACH
credit, the employer is the originator and the
employees are the receivers.

As the industry develops new and innovative uses for
ACH, and as both ACH activity and the number of
participants in the network (including third parties)
[See NACHA Operations Bulletin (June 2, 2000)
discussing the risks involved with third-party direct
access to the ACH Network and with Internet-initiated
ACH payments at
http://www.nacha.org/ACHNetwork/2000_bulletins
___2.doc.] grow, the Office of the Comptroller of the
Currency (OCC) believes that there is an increased
need for ACH risk management.  The volume and dollar
amount of ACH originations have been increasing
significantly and in particular with regard to
transactions initiated through the Internet.

DISCUSSION

As with other electronic payment mechanisms, there are
inherent risks in using the ACH, most notably strategic,
reputation, transaction, credit, and compliance risk.
Federal banking agencies have encouraged sound ACH risk
management practices for a number of years. [See,
e.g., FFIEC Information Systems Examination Handbook,
chapter 21 (1996).] The risks are particularly acute
concerning ACH entries initiated through the Internet
in light of the anonymity of that medium and the volume
and velocity of transactions that can be originated.
The recently approved amendment to NACHA's operating
rules with respect to Internet-initiated payments [Banks
may purchase from the NACHA a copy of the 2001
operating rules incorporating the amendment.  Purchase
requests may be made at http://www.nacha.org or at
(703) 561-1100.] presents management and boards of
directors with new challenges.  The amendment,
effective on March 16, 2001, is designed to enhance
security for ACH debits initiated through the Internet.
It increases the warranties that accompany the
transmission of certain Internet-initiated ACH entries
by an originating depository financial institution
(ODFI) to a receiver's account with a receiving
depository financial institution (RDFI).

Management and boards of directors should review the
amendment with legal counsel.  In addition, management
should review agreements with originators and third
parties, including clauses that may provide for
indemnification of the bank, in light of the new
warranty liability imposed on ODFIs by the amendment
and described below.

The most important changes introduced by the amendment
are as follows:

* A new Standard Entry Class (SEC) Code, WEB, has been
created to uniquely identify a debit entry initiated
pursuant to an authorization obtained through the
Internet to effect a transfer of funds from a consumer
account.  WEB entries will be further identified as
either recurring entries or nonrecurring entries; [The
amendment does not impose additional requirements on
RDFIs.  We note, however, that the new SEC Code permits
RDFIs to identify Internet-initiated entries for
appropriate treatment.]

* Originators of WEB entries (e.g., merchant customers
of national banks) are required to

- Employ commercially reasonable [Banks should refer to
NACHA guidance on the "commercially reasonable"
standard.] fraudulent-transaction detection systems
to screen the entries in order to
minimize the risk of fraud related to
Internet-initiated payments. [Originators'
authentication of receivers is critical to decreasing
the risk of fraud.]

* Use commercially reasonable procedures to verify that
routing numbers are valid.

* Establish a secure Internet session with each receiver
prior to the key entry by the receiver of any banking
information.  Originators are required to use a
commercially reasonable security technology providing
a level of security that, at a minimum, is equivalent
to 128-bit encryption technology.

* Conduct an annual audit to ensure that the financial
information obtained from receivers is protected by
security practices and procedures that include, at a
minimum, adequate levels of (1) physical security
to protect against theft, tampering, or damage;
(2) personnel and access controls to protect against
unauthorized access and use; and (3) network security
to ensure capture, storage, and distribution of
financial information.  The first audit must be
completed by December 31, 2001.

* ODFIs are required [The annual audit requirement
under the NACHA operating rules has also been amended
to include verification that the ODFI is meeting these
new requirements.] to

* Ensure that originators are in compliance with the
above requirements on a continuing basis.  Under the
amendment, ODFIs that transmit WEB entries warrant
that originators have conformed to those new
requirements.

* Conform with an additional warranty, in the case of a
WEB entry initiated by an originator that is not a
natural person, that the ODFI has

* Used a commercially reasonable method to establish
the identity of the originator;

* Established procedures to monitor the
creditworthiness of the originator on an ongoing basis;

* Established an exposure limit for the originator and
implemented procedures to review that exposure limit
periodically;

* Implemented procedures to monitor entries initiated
by the originator relative to its exposure limit across
multiple settlement dates.

SUMMARY

The OCC recognizes that ACH-related products and
services provide national banks an opportunity to
retain customers and attract new business.  ACH
transactions, especially Internet-initiated
transactions, present important risk management and
legal liability challenges to management and boards of
directors.  OCC examiners will continue to assess
whether ACH risk management practices are commensurate
with ACH activities and risks and conform to the NACHA
operating rules.  As the ACH network develops further,
the OCC may provide further guidance on ACH-related
risks and controls.

Questions concerning this advisory may be directed to
the OCC's Core Policy unit at (202) 874-5490.

_________________________
Mark L. O'Dell
Deputy Comptroller
Core Policy