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[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]

                 IS THE PAYROLL INDUSTRY AT RISK DUE TO

                  ACH SYSTEM USED FOR DIRECT DEPOSIT?

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                       TAX, FINANCE, AND EXPORTS

                                 OF THE

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                     WASHINGTON, DC, APRIL 9, 2002

                               __________

                           Serial No. 107-52

                               __________

         Printed for the use of the Committee on Small Business

79-639              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2002
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpr.gov  Phone: toll free (866) 512-1800; (202) 512�091800  
Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001

                      COMMITTEE ON SMALL BUSINESS

                  DONALD MANZULLO, Illinois, Chairman
LARRY COMBEST, Texas                 NYDIA M. VELAZQUEZ, New York
JOEL HEFLEY, Colorado                JUANITA MILLENDER-McDONALD, 
ROSCOE G. BARTLETT, Maryland             California
FRANK A. LoBIONDO, New Jersey        DANNY K. DAVIS, Illinois
SUE W. KELLY, New York               BILL PASCRELL, Jr., New Jersey
STEVE CHABOT, Ohio                   DONNA M. CHRISTENSEN, Virgin 
PATRICK J. TOOMEY, Pennsylvania          Islands
JIM DeMINT, South Carolina           ROBERT A. BRADY, Pennsylvania
JOHN R. THUNE, South Dakota          TOM UDALL, New Mexico
MICHAEL PENCE, Indiana               STEPHANIE TUBBS JONES, Ohio
MIKE FERGUSON, New Jersey            CHARLES A. GONZALEZ, Texas
DARRELL E. ISSA, California          DAVID D. PHELPS, Illinois
SAM GRAVES, Missouri                 GRACE F. NAPOLITANO, California
EDWARD L. SCHROCK, Virginia          BRIAN BAIRD, Washington
FELIX J. GRUCCI, Jr., New York       MARK UDALL, Colorado
TODD W. AKIN, Missouri               JAMES R. LANGEVIN, Rhode Island
SHELLEY MOORE CAPITO, West Virginia  MIKE ROSS, Arkansas
BILL SHUSTER, Pennsylvania           BRAD CARSON, Oklahoma
                                     ANIBAL ACEVEDO-VILA, Puerto Rico
                      Doug Thomas, Staff Director
                  Phil Eskeland, Deputy Staff Director
                  Michael Day, Minority Staff Director
                                 ------                                

               Subcommittee on Tax, Finance, and Exports

                   PAT TOOMEY, Pennsylvania, Chairman
STEVEN J. CHABOT, Ohio               JAMES LANGEVIN, Rhode Island
DARRELL ISSA, California             GRACE F. NAPOLITANO, California
EDWARD SCHROCK, Virginia             ANIBAL ACEVEDO-VILA, Puerto Rico
TODD AKIN, Missouri                  DANNY K. DAVIS, Illinois
FRANK LoBIONDO, New Jersey           ROBERT A. BRADY, Pennsylvania
JIM DeMINT, South Carolina           MIKE ROSS, Arkansas
JOHN THUNE, South Dakota
                     Sean M. McGraw, Staff Director

                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on April 9, 2002....................................     1

                               WITNESSES

Dawson, Chip, Co-Founder & Chairman, Payroll 1, Royal Oak, 
  Michigan.......................................................     3
Antich, Nick, AD Computer, President, Center Valley, Pennsyvlania     5
Brunskill, Dena, President, IPPA, Palm Desert, California........     7
Krause, Gene, ACH Direct, Director of Business Development, 
  Cathedral City, California.....................................     9
Zeidner, Rita, Manager, Government Relations, American Payroll 
  Association, Washington, DC....................................    11

                                APPENDIX

Opening statements:
    Toomey, Hon. Patrick.........................................    19
Prepared statements:
    Dawson, Chip.................................................    25
    Antich, Nick.................................................    31
    Brunskill, Dena..............................................    37
    Krause, Gene.................................................    45
    Zeidner, Rita................................................    67
Additional Information:
    Written Testimony of Elliott McEntee, President & CEO, 
      NACHA--The Electronic Payments Association.................    73

 
   IS THE PAYROLL INDUSTRY AT RISK DUE TO ACH SYSTEM USED FOR DIRECT 
                                DEPOSIT?

                              ----------                              

                         TUESDAY, APRIL 9, 2002

                  House of Representatives,
                       Committee on Small Business,
                  Subcommittee on Tax, Finance and Exports,
                                                    Washington, DC.
    The committee met, pursuant to call, at 2:04 p.m. in room 
2360, Rayburn House Office Building, Hon. Pat Toomey (chairman 
of the committee) presiding.
    Chairman Toomey. At this time I would like to call the 
hearing to order and ask the witnesses to take their seats at 
the witness table, please, if they would.
    [Pause.]
    Thank you. This afternoon the Small Business Committee on 
Tax, Finance and Exports convenes to hear from some of our 
nation's small payroll processing providers and third-party 
vendors about the problems they are encountering with the 
automated clearinghouse system that is used for direct 
deposits. The purpose of this hearing is to learn about the 
concerns of small payroll processing companies as they endure 
often significant financial liabilities as a result, in part, 
of the existing ACH system.
    The ACH system, and that stands for the automated 
clearinghouses, began operating about 30 years ago in response 
to the increased complications associated with a large volume 
of paper checks. In an effort to reduce both the number and 
cost of paper checks, banks in California began experimenting 
with ACHs. After much success, banks in different regions 
across the country began similar programs, and in 1974, the 
regional ACHs coordinated nationally under the National 
Automated Clearinghouse Association, which goes by the acronym 
NACHA. NACHA is now the private regulatory organization that 
oversees ACHs and the direct deposit payroll system.
    It should be noted that NACHA was offered an opportunity to 
testify today, but due to previous commitments they are not 
able to participate. They have, however, submitted testimony 
for the record.
    A quick description of the ACH system I think is in order 
here. ACH is basically a batch processing system. A payroll 
processing company will calculate and develop a file with all 
the relevant payroll information each pay period for each 
employee that they process.
    These files are forwarded to the company's bank, which will 
initially sort of any internal accounts to identify employees 
that use the same bank as the company. The remaining files are 
then forwarded to the ACH, sorted by destination, and then 
forwarded to the appropriate bank.
    As a result of federal banking regulations, should there be 
an occasion of nonsufficient funds in an employer's account on 
payday the payroll company, which is often held liable for 
these situations, is not allowed to do a reversal transaction 
to collect the funds back from the employee's account, and 
herein lies a major part of the problem.
    If a client of a payroll processing company, namely, an 
employer, has insufficient funds to cover a payroll, the 
payroll processing company can be made to cover the shortfall.
    The subcommittee will hear several small payroll providers 
and third-party vendors who are experiencing problems with the 
existing system, and I trust any corrections if my account of 
how the systems works is in any way in error.
    But I want to specifically thank a number of folks, 
starting with Mr. Nick Antich from AD Computer; Ms. Dena 
Brunskill, the president of Independent Payroll Processors 
Association; Mr. Chip Dawson from Payroll 1; Mr. Gene Krause 
with ACH Direct; and Ms. Rita Zeidner with the American Payroll 
Association for their participation in this hearing.
    I look forward to the testimony of the witnesses before us 
today, and I want to particularly thank my constituent and a 
member of the panel, Mr. Nick Antich, for bringing this concern 
about this issue to my attention.
    At this time I will be happy to yield to my good friend, 
the subcommittee's ranking member, Mr. Bill Pascrell, for his 
opening comments.
    Mr. Pascrell. Thank you, Chairman Toomey, and good 
afternoon.
    Today, no one can doubt the wide saturation of computers 
and information technology in business. Small businesses led 
the way during the 1990 economic boom. The numbers speak for 
themselves. Contributed new technology, software and services 
that capitalized on emerging information super highway we call 
the internet.
    Even outside the technology sector computers are pervasive. 
Our one recent survey said 80 percent of small firms use 
computers for business purposes. Offices today have moved away 
from paper toward completely electronic business communications 
and transactions from e-mail to e-commerce, and we persuaded 
them, we have encouraged that. All the subcommittees of small 
business have encouraged that movement away from massive 
paperwork that we still are swimming in.
    One survey reported that 27 percent of small firms use the 
internet for sales, and 44 percent of small firms used the 
internet for purchasing. Employees too are becoming more 
computer savvy. More than half of all employees regularly use a 
PC, and they are frequently taking advantage of electronic 
services such as internet banking, online bill payments, and 
shopping on the web. Clearly, we are living through a 
revolution in the basics of how we do business.
    One of the paperless transaction systems that evolved 
steadily during the last 15 years is direct deposit. It has 
evolved during the eighties as a novelty, and then flourished 
during the nineties when the mantra of better, faster and 
cheaper pushed information technology to new limits and 
capabilities.
    Capitalizing on the new revolution in electronic commerce 
direct deposit systems now offer substantial savings and money 
and time by cutting bank processing fees, paper costs, check 
replacement charges and delays in a time that employees once 
wasted in line just to deposit their own checks.
    However, as useful as direct deposit is to thousands of 
corporations and millions of their employees, there are 
significant barriers to these time and cost saving systems. 
Small businesses often simply do not have the resources to take 
full advantage of direct deposit, and as a consequence they 
waste more time and waste more money with older methods of 
paying their employees.
    One of the barriers they face is the prefunding requirement 
that many direct deposit automated clearinghouse services 
require. This is a demand that small businesses keep their 
payroll account flush with cash prior to payday. Unfortunately, 
many small business simply cannot spare that kind of seat saver 
money. So they don't take advantage of the service.
    Another problem is the fees for direct deposit services. 
Many of those fees are outlandish. Many banks charge more for 
their service than small businesses can afford, and if the 
small businesses cannot fulfill the prefunding requirement the 
fees charged by the clearinghouses to cover the risk usually 
push the cost even higher out of range, so that is why we are 
having this hearing.
    When transaction systems are automated and paperless, small 
businesses can concentrate on what they do best. This constant 
push for new ways of doing things is one of the reasons 
American workers are the most productive in the world.
    I look forward to hearing from our witnesses today, Mr. 
Chairman, and I thank you for bringing this problem to our 
attention.
    Chairman Toomey. I thank the gentleman from New Jersey.
    At this time let me just explain very briefly the way the 
process will work from here. I will recognize each of the five 
panelists. If you could please keep your remarks to five 
minutes. There will be a light system which will be green at 
the beginning, it will go to yellow when there is one minute 
left, and go to red when your time has expired.
    And after each of the panelists have had a chance to make 
their presentation, then I will ask a series of questions, 
followed by ranking member Pascrell, and then any other members 
of the committee who join us will get their chance at that 
point.
    So at this time I would like to welcome and invite to share 
with us his testimony, Mr. Chip Dawson.

 STATEMENT OF CHIP DAWSON, CO-FOUNDER AND CHAIRMAN, PAYROLL 1, 
                              INC.

    Mr. Dawson. Good afternoon, Chairman Toomey and Mr. 
Pascrell.
    Chairman Toomey. If you could take the microphone and bring 
it right up to your mouth, please, that will enable us all to 
hear you.
    Mr. Dawson. How is that?
    Chairman Toomey. I think that is going to work.
    Mr. Dawson. Okay. Good afternoon. My name is Chip Dawson. I 
am co-founder and chairman of Payroll 1. I would like to do 
three things today: Provide a brief background, frame the 
problem, and conclude by offering two solutions, one short term 
and one long term.
    Our firm is headquartered in Michigan. We provide payroll 
processing for 10,000 businesses across the country. We operate 
from eight states. A few among them are Pennsylvania, Illinois, 
Missouri, and California.
    Payroll 1 serves small businesses from one to several 
hundred employees, and our average size payroll is 15 to 20 
people. Among our services is direct deposit, and we do that 
utilizing NACHA.
    We are testifying today on behalf of our clients and the 
hundreds of thousands of clients of other payroll processors 
across the country for whom this system of moving money 
presents potential hardship.
    Direct deposit is a smart way to get paid. It is safe, it 
is confidential, it is convenient, and we continually look for 
the most cost-effective and efficient way to provide that 
service to our clients. NACHA statistics indicate that more 
than 80 percent of large companies offer direct deposit, but 
100 plus employee companies represent a mere fraction, less 
than two percent in fact, of American businesses.
    Among smaller businesses direct deposit has not grown 
significantly until recently despite being available for many 
years. That is changing as demand for direct deposit picks up 
momentum in our ever-expanding electronic age.
    But the fees many banks charge for originating direct 
deposit transactions have increased over the years, to the 
point that they are just too high for small businesses to bear. 
These high bank fees have compelled payroll companies to search 
out alternatives for direct deposit processing.
    Now, one method we found is to consolidate direct deposits 
for multiple employers through a single ACH originator, such as 
one bank. That way a payroll company is able to create enough 
volume to attract third-party vendors to provide services at 
substantially lower fees than banks will offer. However, the 
single source is not the employer's bank, and therefore will 
not bear the risk of insufficient payroll funds, so it is up to 
the payroll company to make that choice.
    The ACH system of today is a batch processing system that 
relies on overnight transmissions, and consequently the payroll 
company, the way we operate, is the initial receiver of the 
funds and cannot be certain in some cases that sufficient funds 
were transmitted until after employees have already been paid 
and receive their monies.
    As a result of this uncertainty, small businesses are 
frequently disadvantaged in obtaining direct deposit services 
because they must choose from a series of unattractive options. 
A small business has three basic choices:
    It can have its payroll company send direct deposit files 
directly to the employer's bank. As I have said, that results 
often in high bank fees and likely diminished use of direct 
deposit by small businesses.
    It can have its payroll company use a third-party vendor to 
send direct deposit files. This alternative is unacceptable to 
a responsible payroll company because it puts them at risk of 
NSFs.
    Now, this risk can be mitigated by the employer either by 
prefunding the account well in advance of payday or executing a 
letter of credit in favor of the payroll company, but arguably 
neither is the most efficient use of capital in a small 
business.
    It can choose one of the largest payroll processors who may 
accept the NSF risk, but then the employer is losing the 
individualized attention and personal service that is often the 
fundamental reason for choosing the smaller payroll company in 
the first place.
    I would conclude by offering two possible solutions. For 
the short term, change the NACHA rules to permit payroll 
companies to reverse entries from employee bank accounts in the 
event that the employer does not fund the payroll. And for the 
long term, to utilize a different system. Take advantage of 
newer technology as the funding source for direct deposit in 
the ACH network.
    For example, automated teller machine or point of sale 
network operates in real time, and thus could enable an ACH 
originator to verify funds at the time a transaction is 
initiated rather than finding out later that the funds are 
insufficient.
    I thank you for the opportunity to testify here today on 
this important issue, and I will be glad to try and answer any 
questions you might have.
    [Mr. Dawson's statement may be found in appendix.]
    Chairman Toomey. Thank you very much, Mr. Dawson.
    At this time I would like to welcome and recognize Mr. Nick 
Antich, AD Computer in Center Valley, Pennsylvania. Welcome.

    STATEMENT OF C. NICHOLAS ANTICH, PRESIDENT, AD COMPUTER 
                          CORPORATION

    Mr. Antich. Good afternoon, Chairman Toomey, and members of 
the subcommittee.
    My name is Nick Antich. I am president of AD Computer 
Corporation in the Lehigh Valley, Pennsylvania. We are a 
payroll processing company.
    I am here today to alert you to the fact that when the 
automatic clearinghouse is used for payroll direct deposits, 
the small independent payroll computer company is put in peril 
and at great risk when there is a nonsufficient funds 
situation.
    With the advent of automated electronic bill payments, ATM 
machines, the internet, and debit cards, the public has become 
accustomed to electronic funds transfer. This has resulted in a 
great increased demand for payroll direct deposit over the last 
few years. There has been a switch from just the largest 
companies offering direct deposit to their employees to the 
very smallest companies. We are talking about companies with 
two to three to five to ten employees.
    Small companies want to have the same efficiencies as the 
larger businesses. In addition, they have to offer similar 
options to their employees to retain them.
    In the U.S., there are three major public national payroll 
companies, and there are several behind them, and then there 
are approximately 3300 small independent payroll computer 
processors.
    The problem I am bringing to light is really a problem for 
the small, independent payroll computer processors. As was 
already stated, when direct deposit is offered, the small 
payroll processor must offer direct deposit to be competitive 
with the large payroll companies, a file is created of which 
there are multiple transactions. There is one debit from the 
employer's account and a credit to each of the employee's 
account.
    This file is then sent to an originator that originates or 
sends it through the ACH system. In the past that has always 
been the bank that the employer dealt with, that he had his 
accounts with. And if there were multiple companies dealing 
with the same bank, the payroll company would put all of the 
companies on one file, send that to the bank once a day, and 
then those transactions would be processed.
    The bank had determined particular limits that the direct 
deposit file could have for each customer based on their risk 
assessment and their relationship with the customer. Therefore, 
there was very, very minimal risk of an NSF. Should that direct 
deposit exceed their limit, they would not originate the funds 
until they contacted their customer to make sure there would be 
funds or made other arrangements.
    Third-party ACH vendors were established. This has 
eliminated the sending of the files to the banks, and therefore 
have put the small payroll companies on a level playing field 
with the large national public payroll companies.
    The big problem is that banks are more dependent on fee 
income today than they ever have been for their earnings, and 
they are charging sometimes five and ten times what they charge 
for the exact very same service that we had in the eighties and 
early nineties, and some of the consolidation in the banking 
industry is responsible for this.
    That is the bottom line of the problem. The fees are too 
high. The small companies cannot afford to go that route. 
Therefore, we had to use the third-party ACH vendors in order 
to offer an affordable direct deposit system for small 
companies which eliminate bank fees.
    The problem is we do not have any financial relationship 
with that customer, neither does the third-party vendor. 
Therefore, if there is a nonsufficient funds, it is the payroll 
company who by default is looked to to make good for the funds.
    In summary, the ACH system has not been updated to utilize 
today's technology. It was developed in the seventies when 
Richard Nixon was president, before PCs, before companies had 
fax machines, when typewriters were used instead of word 
processing. Can you imagine doing today's business with the 
tools of the seventies?
    There is a solution, and that can be automatic electronic 
authorization prior to originating the file, and those tools 
can be developed with the software companies who develop the 
ACH and the electronic authorization today, for example, with 
debit cards.
    Thank you very much for the opportunity to testify here 
today, and I will be very happy to answer any questions you may 
have for me regarding this important issue affecting all small 
business.
    [Mr. Antich's statement may be found in appendix.]
    Chairman Toomey. Thank you very much, Mr. Antich.
    Next, I would like to welcome and invite Ms. Dena 
Brunskill, the president of IPPA from Palm Desert, California.

STATEMENT OF DENA L. BRUNSKILL, PRESIDENT, INDEPENDENT PAYROLL 
      PROVIDERS ASSOCIATION; CEO, COMPUTER PAYROLL COMPANY

    Ms. Brunskill. Thank you. Good afternoon, Chairman Toomey, 
and to your committee.
    My name is Dena Brunskill, and I am president of the 
Independent Payroll Providers Association.
    Chairman Toomey. Excuse me, Ms. Brunskill. Could you bring 
the microphone closer?
    Ms. Brunskill. It will not go.
    Chairman Toomey. That is all it will go. Okay. Well, then 
we will just listen carefully.
    Ms. Brunskill. Sorry.
    [Pause.]
    Ms. Brunskill. How is that?
    Thank you. Would you like me to start over?
    Chairman Toomey. If you could, please.
    Ms. Brunskill. Okay. Good afternoon, Chairman Toomey, and 
to your committee.
    My name is Dena Brunskill.
    Chairman Toomey. A little closer still. Sorry. We are going 
to get this just exactly right.
    Ms. Brunskill. My name is Dena Brunskill, and I am 
president of the Independent Payroll Providers Association, 
IPPA.
    Our organization represents 107 independent payroll service 
bureaus across the United States. Our members service 
approximately 50,000 small, medium and large employers, with an 
estimate of two million employees nationwide.
    IPPA's primary focus is to provide forms and resources to 
assist our members in advancing their respective organizations 
by facilitating the exchange of best practices and top business 
resources. IPPA's board of directors come from Kansas, 
Virginia, California, and Minnesota. Our executive offices are 
located in Kansas City, Kansas.
    My comments today will focus on how our members provide 
direct deposit service to their clients and the liability to 
which they are exposed to. For some members that exposure 
occurs 200 times plus a day. We are here before you to seek 
your guidance and support in creating a solution to this 
crisis, both short term and long term.
    Many of our members have been directly impacted by this 
exposure and all feel as if this is aland mine waiting to be 
stepped on.
    There are several different software packages our members 
use to send their direct deposit files for input into the fed 
line. The software is dictated by the automated clearinghouse, 
ACH originator they have chose to do business with.
    Banks are the more prevalent choice for an ACH provider. 
However, third-party vendors are becoming a viable 
consideration when our members reevaluate their current 
vendors.
    Regardless of the software they use, the ACH originator 
converts and/or transmits the files into a format required by 
the National Automated Clearinghouse Association, NACHA, for 
ACH to the fed line. It appears every region and every ACH 
originator have differing windows of time in which the payroll 
provider has to transmit its data. Fees for these services are 
just as regional.
    Our members have implemented in-house procedures and 
processing steps along with checks and balances to ensure the 
accuracy of these transactions. Believe me, in our business it 
really does pay to do it right the first time.
    Because this is a repetitive set of steps, it is fairly 
easy to perfect the procedure as long as the audits are 
performed within the prescribed time frame. Audits need to be 
performed by the ACH provider, the payroll provider and the 
employer. It is the ethical obligation of each to inform the 
other parties of any problem that would hinder the successful 
completion of this task.
    The most crucial element of the whole equation is timing. 
Each party has a different timing requirement.
    The employer has to know how much and when to make certain 
the funds are in his account to cover his payroll obligations. 
He also needs to notify his payroll provider within 24 hours if 
there is a problem with his service.
    The payroll provider has to create schedules based on the 
client's check dates and the ACH originator's windows to ensure 
that all the necessary calculations are done by all parties in 
time to fund the employee's account. The providers are totally 
dependent upon the employer for the accuracy of the input dates 
they agreed to during the start-up process. They are also 
responsible for correctly inputting the employer's information 
into their software, calculating the data, and completing all 
segments of the payroll process.
    The ACH originator must follow its mandated procedures to 
ensure all of its checks and balances for its outside auditors 
and to fulfill the features of its service contract with the 
payroll provider. They have total control of the NSF 
information. The timing of furnishing this information to the 
provider varies. It can be anywhere from 24 hours to seven 
days. I have been told by my ACH originator a dispute can be 
submitted up to 30 days after settlement date. In reality, 
anything longer than four hours is too late.
    Payroll providers and ACH originators need to know if the 
employer has enough money to fund the employees' pay checks 
electronically before the credit is sent to the employee, 
bottom line.
    The real significance of the situation is who really has 
control of this process. The employer dictates which employees 
to pay, how much to pay, when to pay, and what to do with the 
pay. The ACH originator dictates when the transactions go into 
the system and when the payroll provider is notified of a 
problem. The only responsibilities of the payroll provider are 
the accuracy of the data and to complete the steps of the 
process.
    We believe the technology is available today in some 
already proven format for a real time solution.
    My time is over so I will go ahead and sum up.
    Chairman Toomey. Finish your thought if you would like, 
sure.
    Ms. Brunskill. As my colleagues have stated, payroll 
providers need to offer direct deposits to their clients in 
order to compete with the big guys--end of the story. We have 
lost hundreds of thousands of dollars paying someone else's 
employees, not to mention the time and effort expended to 
collect those losses.
    I would like to thank you for this opportunity to present 
the views of our membership and we look forward to working 
together to solve this most urgent problem.
    Thank you.
    [Ms. Brunskill's statement may be found in appendix.]
    Chairman Toomey. Thank you very much.
    At this time I would like to welcome and introduce Mr. Gene 
Krause from ACH Direct.
    Mr. Krause.

STATEMENT OF GENE P. KRAUSE, DIRECTOR OF BUSINESS DEVELOPMENT, 
                    ACH DIRECT, INCORPORATED

    Mr. Krause. Mr. Chairman, Congressman Pascrell, good 
afternoon, and thank you for granting the opportunity to appear 
before this subcommittee, hearing recommendations pertaining to 
the ACH network as it relates to credit transactions, 
specifically the impact on companies performing payroll 
processing and those that process the direct deposit payroll 
transactions.
    My name is Gene Krause, and I am the director of business 
development for ACH Direct, Incorporated, a California-based 
company.
    My profession and the company I work for evolves centrally 
around the Federal Reserve's ACH system. We are a company that 
is commonly referred to as a third-party ACH processor, a 
company that develops value-added technologies and services for 
the users of the ACH network, as well as performing ACH 
transaction processing.
    Approximately one month ago, I received correspondence from 
a company who performs payroll processing, in turn, providing 
direct deposit via the AHC network for their clients' 
employees. This correspondence came at an interesting point in 
time as this topic has been central to our company focus in 
recent time.
    Relayed in the correspondence were frustrations and 
limitations pertaining to the ACH system as well as thought of 
alternative solutions to the issues they were faced with. We 
have known for some time that many share those same 
frustrations as they are voiced regularly to our staff.
    As many end-user companies view it, the electronic 
distribution or deposit of their company's payroll should not 
be a difficult task. On the surface, most anyone would draw the 
same conclusion. These personal theories are borne from the 
basic principal of thought that because funds must first be 
debited from the client company's account before being credited 
to the employees' accounts, there should be no risk or problem 
in doing so.
    Unfortunately, for this industry the ACH network does not 
provide for real time settlement finality. This operating 
limitation of a 72-hour risk of return window is then made 
significant because it requires various levels of collateral or 
risk alleviation measures to be utilized.
    Additionally, the industry or the payroll processing 
service providers have time constraints brought about by their 
clients, most of which cannot provide data four days in advance 
of the deposit credits to employees or for one reason or 
another do not want their company's operating account debited 
four days before deposit credits are issued.
    The ACH network operates effectively and efficiently under 
most operating environments.Unfortunately, in the case of 
credit transactions for the purpose of direct deposit payroll it does 
not provide the ultimate solution. The central limiting factor, being 
the lack of real time settlement finality for the debit or funding 
transaction from where the credit dispersements come from. This 
limitation creates a severely unbalanced risk-to-reward scenario for 
any company performing ACH transactions assuming a 72-hour hold of 
funds has not been imposed.
    Without a 72-hour hold of funds, our company would be 
exposed to a potential loss that is 14,000 times greater than 
the profit received.
    While the ACH network does have operating limitations, the 
alteration of any rules governing its use would most probably 
not alleviate the issue of settlement finality. Any alteration 
to or adaptation for the ACH network that might provide for 
real time settlement would, in essence, be the creation of a 
new transaction network.
    It is most probable that a solution be found from one of 
the following areas: One, adaptation of a merging technology 
that can provide for funding settlement finality; or two, 
integrated use of additional transaction methodologies for 
funding settlement with the ACH network being used for credit 
dispersement transactions.
    Either one refers to the use of ATM networks and recent 
advancements made to them. Over the past year our company has 
dedicated a good percentage of resources towards the 
integration to ATM networks which would provide for company 
growth in the area of debit transactions. To utilize these 
systems for direct deposit purposes, a few things are still 
needed:
    One, rules adaptation for business account debits; two, 
increased participation from financial institutions which 
currently is growing.
    Item two refers to the supplemental use of other existing 
transaction methods such as wire transfers which could 
eliminate the processor's risk for funding, ideally reverse 
wires would be used with the origination notification provided 
by the transaction processor, leading to a more automated 
solution. This potential solution also has limitations, 
including the availability. Not all financial institutions are 
capable of handling reverse wires, (b) increased costs. Wire 
transfers are much more expensive than ACH transactions. Risk 
exposure, with reverse wire risk exposure is not eliminated, 
but rather is transferred to the funding party.
    In summary, the current system makes for an unfavorable 
risk-to-reward scenario which, in turn, makes it difficult for 
payroll service providers, particularly small companies, to 
acquire a transaction processing that is flexible enough to 
meet their needs, and in turn, their clients' needs. There is 
no doubt that the larger of the payroll processing companies 
have less difficulty in acquiring and providing for this 
service, but no matter who is the company or how large they are 
the risk of exposure is a constant. Only the management thereof 
can be an effective variable.
    And in an effort to be efficient with time, I have limited 
my oral testimony. I welcome your questions pertaining to it or 
to my more detailed written testimony.
    I thank this subcommittee for allowing our voice to be 
heard. Thank you.
    [Mr. Krause's statement may be found in appendix.]
    Chairman Toomey. Thank you, Mr. Krause.
    At this time I would like to welcome and introduce Ms. Rita 
Zeidner from the American Payroll Association here in 
Washington.

   STATEMENT OF RITA ZEIDNER, MANAGER, GOVERNMENT RELATIONS, 
                  AMERICAN PAYROLL ASSOCIATION

    Ms. Zeidner. Thank you so much for having me, and I 
apologize for coming up here and squirming. I injured my knee 
in a ski accident about a month ago, and I am anxiously 
awaiting surgery which will speed up the recovery. So if you 
see me a little squirmy up here, I apologize.
    On behalf of the American Payroll Association, I am pleased 
to address the issues related to the automated clearinghouse 
system.
    The APA is a nonprofit professional association 
representing nearly 21,000 companies and payroll professionals 
in all 50 states and Canada. Our membership includes all 
employees as well as large firms and spans virtually ever 
sector of the economy, including financial services, retail 
manufacturing, restaurants, educational institutions, and state 
and local government. We represent payroll software developers 
and several hundred third-party payers, including all of the 
large firms, and hundreds of small and independently owned 
payroll service providers.
    As an organization, we represent our members' interests in 
a broad range of areas, including the administration of federal 
and state wage and hour laws, employment tax withholding, 
remittance reporting and garnishment administration, and 
needless to say the efficient and cost effective running of the 
electronic banking system is an integral part of our members' 
success.
    The overwhelming--the majority of our members favor direct 
deposit as a method of paying workers. In general, they find 
the system eliminates many of the administrative problems 
associated with traditional paychecks.
    While the savings that can be directly attributed to direct 
deposit vary from company to company, and are often difficult 
to quantify, respondents to a 1999 APA direct deposit survey 
reported that they could save as much as $5 per payment.
    Because most states don't allow employers to require their 
workers to be paid by direct deposit, many of our members 
conduct elaborate direct deposit campaigns during the workday 
offering prizes and other incentives to induce their workers to 
abandon their allegiance to paper checks.
    When all other direct deposit marketing efforts fail, some 
employers adopt policies that make it cumbersome for workers to 
receive a paper check. For instance, they might insist that 
paper checks be mailed to the workers' homes with the 
accompanying risk of late or lost payment, or they may charge 
an employee for a replacement check, or they may refuse to 
issue advance payments to workers who will be away on business 
or on vacation on payday.
    Some employers have even looked into the legality of making 
direct deposit a condition of employment for new hires. 
Employers in 16 states have succeeded in convincing their state 
lawmakers to allow mandatory direct deposit. In all of these 16 
states the employer can require workers to receive their pay 
via direct deposit so long as the worker is permitted to choose 
the financial institution.
    And I give you that introduction just to give you an idea 
of how popular direct deposit is among our members.
    My detailed testimony gives some explanation about how 
employers work with the ACH system, and I think most of the 
witnesses have already given that presentation, so I will skip 
over that. But I wanted to talk a little bit about the 
relationship of employers with payroll processors.
    Information circulated by this subcommittee suggests that 
there are more than 3,000 independent payroll processors 
handling payroll for U.S. employers. Many of these processors, 
along with the larger public companies, are members of the 
American Payroll Association. Both the independents and the 
large processors vie aggressively for business among APA's 
21,000 employer members. These payroll processors market to our 
members by buying advertising in our magazines, exhibiting in 
our conferences, and sponsoring payroll-related events, such as 
National Payroll Week.
    In fact, several hundred of these vendors will be leasing 
space in our exhibit hall during our annual meeting next month 
in San Antonio.
    The active marketing presence of so many payroll processors 
suggests that competition is stiff, and the fact that about 
half of our members use a payroll processor to assist in all or 
part of the payroll administration suggests that business in 
this industry is thriving.
    An informal survey we conducted of our membership in 
preparation for this hearing supported that premise. As part of 
this informal survey, we sent an e-mail to several hundred 
American payroll association members, asking about the fees 
they pay to originated direct deposit.
    And I see I am running a little bit long to. Should I 
summarize our may I continue?
    Chairman Toomey. Finish the thought you are on. You have a 
little time left.
    Ms. Zeidner. Okay. I received a broad array of answers, and 
in some instances the banker service bureau processing the 
payroll charge to flat fee. In other arrangements the employer 
was charged a flat fee per transmission, plus a fee per direct 
deposit transaction.
    Responses to our informal survey suggested that fees 
generally range from about three cents to 10 cents per 
transaction. Some companies paid only per transaction, and in 
these instances the fee seemed slightly higher, around 15 cents 
per transaction.
    I asked our members whether loss of float figured into 
their decision to offer direct deposit or not. Information 
circulated by this subcommittee suggests that at least one 
smaller payroll processor believes--he or she believes she is 
at a disadvantage because he or she must ask employer clients 
to prefund their payroll to ensure that the employer has the 
funds on hand on payday.
    The vendor suggested that the larger service bureaus 
generally do not have the prefunding requirement. The majority 
of respondents, including APA's own payroll director, said that 
prefunding was not an issue for them. Rather, they understood 
it to be part of the cost of doing business. Companies that 
were concerned with lose of float took that into consideration 
when negotiating other fees with their service provider and/or 
their bank.
    And what I would like to do is quickly summarize. I was 
asked to respond to three proposals, and I would like to 
quickly go over those.
    May I have the time?
    Chairman Toomey. Okay, if we could do that briefly.
    Ms. Zeidner. Okay. You asked us how we felt about 
regulating the fees that banks can charge for direct deposit or 
via the fed wire system. We do strongly oppose this proposal. 
Regulation is generally seen as a way to correct market 
imbalances or stop abuses, and our members don't feel that 
that's taking place. If they felt that they were being abused, 
then I think we wouldn't see direct deposit as popular as we 
see it today.
    You also asked us to comment about proposal to allow 
payroll companies to do reversals from employee accounts when 
an employer doesn't fund its accounts.
    I think it's important to note that NACHA has very specific 
rules spelling out when an electronic payment can be reversed, 
and an employer's failure to fund the payroll doesn't seem to 
fit in with this rule. Reversals for ACH items can be only 
carried out within five days of the originating settlement date 
for the item, and they are allowed for only two reason: 
duplicate payments or erroneous payments.
    Some of the service bureau members we interviewed suggested 
that reversals wouldn't even help them solve the problems they 
face by underfunded employers. These respondents noted that by 
the time the service bureau would attempt to recoup the 
misappropriated funds it's likely that the payee would already 
have withdrawn the money and therefore the funds would no 
longer be available to debit.
    Because of the problems inherent in initiating a proposal, 
including the questionable legality under the NACHA rules, and 
the fact that the money wouldn't be available anyway, several 
of the service bureaus that responded stressed that risk 
management was a far more effective means of limiting exposure.
    And lastly, regarding the ATM debit network, we don't 
necessarily have any position on this proposal, but we do 
support innovative ways of administering payroll, and have been 
positively impressed by the rollout of payment card systems 
such as the Visa Payroll Card, and I think Mr. Dawson spoke a 
little bit about the expansion and use of ATM debit systems as 
a means of paying folks, so I won't go over that.
    I would like to thank you so much for the opportunity to 
testify here and for your interest in this interesting issue.
    [Ms. Zeidner's statement may be found in appendix.]
    Chairman Toomey. Thank you very much, and I will begin with 
some questions. I have a number of questions. I would like to 
first make sure I understand the nature of the problem a little 
bit better.
    First of all, it strikes me that a business model that is 
all about providing the service of computing the payroll and 
administering and preparing the payroll need not necessarily 
also have with it the credit risk component of whether or not 
an employer has sufficient funds on hand. I do not see why 
those two features need to go together.
    And I guess I want to make sure I understand exactly why 
they do, so correct me if I am wrong here. But prior to the 
advent of ACHs, this really was not a problem; is that correct?
    Mr. Antich. [Nodding.]
    Mr. Dawson. [Nodding.]
    Chairman Toomey. But since the advent of the ACH system the 
problem occurs. Now, perhaps Mr. Antich could address this. 
Others feel free to as well.
    Does the problem occur because the payments actually are 
run through your accounts of your company, and you have an 
obligation, you have made a credit, and you are waiting for a 
credit on the other side?
    Can you help us with mechanically how is it that you are 
out of cash when there is nonsufficient funds?
    Mr. Antich. Well, first of all, we have been doing direct 
deposits since 1980, and in many cases, and we still do also 
send files to the bank where the customer has their accounts. 
There is not a problem in that scenario because the bank has a 
financial interest with their customer. The bank has the credit 
limit that they have ascertained because of their risk 
management and so forth, and they electronically check that 
file. They know what the funds are for the company that has 
their account with that bank, so that is not where the issue 
is.
    The issue is really when, because of the extremely higher 
fees, and as I mentioned, five to ten times as much now as they 
were in the eighties for the exact same service, when you have 
a small company with two to five employees they can be charged 
$100 a month to $125 in order for them to just electronically 
send this file through the system. That is as much or more than 
our entire service.
    The problem is that there is no real time authorization. 
The file is now sent to a third party ACH vendor. Neither one 
of us has any knowledge whatsoever of what the employer has, 
whether he has funds or not.
    There is a date for the credits to hit the employees 
accounts. This is sent through. Now,sometimes you might debit 
the account a day or two ahead of time, but still you may not find out 
for three days after that that there were nonsufficient funds.
    So since it is not real time, it is just done, the credits 
are just sent out. You then find out there is a nonsufficient 
funds, and if it is after the fact, even if it is the same day 
as the credits, they are already there, and that is where the 
transaction has to be made whole. Somebody has got to make good 
for those credits that went into those accounts.
    Chairman Toomey. So who is the enforcer on this? Is it one 
of the banks? Is it a bank employee or is it the bank for the 
employer, and when they come to you, and they call you up and 
say this is how much we were short, write us a check? Is that 
what happens?
    Mr. Antich. Well, it is going to be in this case the third-
party ACH vendor, and Gene might be able to add on to this, 
they are going to be looking to the company who sent that file, 
which is the payroll company.
    The payroll company is certainly going to try to get the 
money from the employer, but they may be belly-up. They might 
be out of business. And if the payroll company goes out of 
business, then it seems to me it's the third-party ACH vendor 
who is going to have to make good.
    Chairman Toomey. So Mr. Krause, in this scenario the first, 
in the information that there is insufficient funds comes to 
your firm, and then you, in turn, turn to the payroll 
processing company; is that what your company does?
    Mr. Krause. Correct. In our model of business, ultimately 
the risk lies with us. However, I mean, if we cannot get the 
money from Nick's company, we are assuming the risk, and so 
whatever payroll has not been funded that comes out of our 
pocket.
    Really the whole issues lies around one central point, and 
that is the lack of settlement finality from the funding of the 
client company's payroll. The RDFIs have by law 72 hours to 
respond.
    Chairman Toomey. Excuse me. What is an RDFI?
    Mr. Krause. Receiving financial institution.
    Chairman Toomey. Okay.
    Mr. Krause. In this case the client company's bank is an 
RDFI because the funding for the payroll is actually a debit 
from their account. Then we in turn send out credits to the 
employees.
    Chairman Toomey. Right.
    Mr. Krause. So theoretically, and I will refer you to page 
4 of my written testimony, theoretically a company could 
deposit a paper check on Friday, which is when they send off a 
file for the ACH transactions to us. They fund their bank 
account with a paper check. It shows up on the ledger as there 
being money in there.
    We go on Monday and debit that account, send the funds out. 
We are able to do that because the ledger says there is money 
there. A day later they come back to us and say, hey, there is 
no money there. Well, that company all of a sudden is out of 
business or for whatever reason we cannot get the money. That 
is where the risk lies and that is why these companies are 
having a hard time.
    Chairman Toomey. And given the technology that we have and 
we talked briefly about other kinds of electronic transfers, 
ATM, debit cards, mechanism that are in widespread use, seem to 
work very well as far as I can see, what is preventing a more 
modern way of solving this problem so that you can look in real 
time and know that there is money there or there is not, and 
you have that finality you are talking about? What is the 
obstacle here?
    Mr. Krause. We need a few more good programmers and a 
little bit more money.
    Chairman Toomey. I do not understand.
    Mr. Krause. We are working on a solution.
    Chairman Toomey. I mean, the technology exists, right?
    Mr. Krause. Yes, it does.
    Chairman Toomey. Has it not been adopted by this network? 
Is that the problem?
    Mr. Krause. Exactly. We are the first company in the 
country that is integrated with the Star ATM network which may 
be a solution to this problem. There are a couple of limiting 
factors in that the rules are yet to be clarified as to what 
you can do with this network.
    At this moment we are able to look into a DDA or a bank 
account and find out if there is money there. We are able to do 
that right now. By the end of this year we will be able to 
debit in real time, or actually capture or freeze funds, and 
then the account will be funded the next day. So that is real 
close to being accomplished.
    We have got a couple of issues. Number one, how many 
participating financial institutions are there to make this 
worthwhile for this particular industry; and number two--I lost 
my train of thought here. Oh, the rules pertaining to the 
business debits. The network essentially was set up for 
business to consumer, yes, business to consumer transactions.
    Chairman Toomey. Well, I am going to yield to my colleague, 
Mr. Pascrell, but then I am going to go back and ask some more 
questions, and I am going to try to follow up with a question 
about whether there is existing legislation that in any way 
impedes the development of this network that would be more 
efficient or whether there is a need for new legislation to 
facilitate it, but at this time I will yield to the gentleman 
from New Jersey.
    Mr. Pascrell. I just have a quick question, Mr. Chairman. I 
have to run to the other end of the campus for another meeting.
    My question to Mr. Dawson is, I mean, we're talking about a 
lot of money here. Last year, I am looking at the, there was 
eight billion ACH payments worth over $22 trillion. That is 
pretty mind-boggling, so we are not talking about nickel and 
dime stuff here. We are talking about something very critical. 
And assessing risk is not an easy task. You know, I understand 
that.
    What exactly--I mean, we know that processing a check 
actually cost the originating bank more than processing any ACH 
transaction. Just very briefly, how do we assess risk in terms 
of trying to answer what the Chairman just concluded with?
    In order to answer his questions, we are going to have to 
decide how to assess this risk. How do you assess it?
    Mr. Dawson. Someone might have a better answer than this, 
but we assess it as we do not want it at all.
    Mr. Pascrell. That is the bottom line, is it not?
    Mr. Dawson. We are not a banker.
    Mr. Pascrell. Right.
    Mr. Dawson. We are not a lender. We are not a credit 
provider. We are a transaction processor. We get a small fee, 
six-seven dollars----
    Mr. Pascrell. Right.
    Mr. Dawson [continuing]. For initiating a file, and I think 
someone made the mention that the risk associated with that, if 
we choose to accept it, is 14,000 times or something the 
rewards, that six or seven dollars.
    In our case at our company we choose not to accept that 
risk. We require prefunding, which is an obstacle to ask a 
small company four or five days ahead of its payroll to fund 
its entire payroll.
    Mr. Pascrell. So then how would you react, what is your 
response, what is the answer in your mind?
    Mr. Dawson. The answer to which question? I am sorry.
    Mr. Pascrell. The one you just very--you clarified, you 
crystallized. I mean, what is our response? Is it legislation? 
Is it something we need that is already on the books to 
enforce? What are you suggesting? Less regulation? More 
regulation?
    Mr. Dawson. You know, actually, I am not certain with the 
technology being where it is today, that is, it looks like it 
could provide the solution, I am not really sure what the 
obstacle is, but it appears to be somewhere embedded in either 
NACHA or the banking system, or there is a lot of resistance to 
this occurring, and I really do not know where it is.
    Mr. Pascrell. Yes, sir.
    Mr. Dawson. Nick does.
    Mr. Pascrell. Mr. Antich?
    Mr. Antich. No, I do not.
    Again, just a possible solution, and I know Gene mentioned 
they are working on something. But number one, we have gotten 
feedback that banks are not interested whatsoever in making any 
change because they do not see the risk, and that is number 
one. So this is really like a problem of moving mountains here.
    But I do believe that the technology is available with the 
software vendors today to come up with a solution. There are 
various payment types in the ACH NACHA format, and there could 
be, and this is just an idea, a new payment type, that if that 
payment type is used, it would automatically interface into a 
yet undesigned, electronic authorization system designed for 
commercial accounts. If the account has the funds, the company 
still has the use of those funds for earnings credit until 
settlement date, which might be two-three days later, the 
electronic authorization system would put a memo hold or a 
reserve on those funds with the date of settlement, knowing 
that this electronic debit is coming through on that date. To 
me, that is certainly a potential solution, but we would have 
to get the banking industry to embrace this. I know we could 
get the software vendors to do it, and there would have to be 
some changes in the NACHA rules as well, and formats and 
payments.
    Chairman Toomey. Thank you. I have a bill that is on the 
House floor momentarily, and I am going to have to run down and 
manage the floor debate on my bill. But I wanted to wrap up 
with a couple of maybe questions and thoughts.
    The changes that we have discussed, the potential solution 
that Mr. Antich just referred to, and the idea of an 
alternative, which is real time ability to evaluate whether the 
money is here or not, is anyone of the opinion that that 
requires actual legislation to make that happen, or is there a 
legislative obstacle?
    Mr. Krause. Depends on the rules that will come about. This 
is new, this is new technology.
    Chairman Toomey. Okay. At the moment is it fair to say that 
the existing system and methodology and the rules for 
participating in this network are designed by NACHA and they 
are within the authority of NACHA, which is, I assume, a 
voluntary association of members? Is that correct? Is it 
really?
    Mr. Krause. For the AMT networks, I am not sure that all 
the rules reside within NACHA's operating.
    Chairman Toomey. I am not referring for the ATMs. I am 
talking about for payroll processing and settlements, current 
system.
    Mr. Krause. For the current system, yes, correct.
    Chairman Toomey. Yes. Okay. And there is nothing that--
there is no legislation that anyone is aware of that governs or 
regulates NACHA? I mean it is not--even the reversibility of 
credits, for instance.
    Mr. Krause. There are some FCC rules that----
    Chairman Toomey. Okay.
    Mr. Krause [continuing]. Taken into account, yes.
    Chairman Toomey. Okay. Is there legislation that precludes 
reversing out a credit to an account in the event that there is 
insufficient funds, or is that just a rule of NACHA?
    Mr. Krause. I believe that is just a rule of NACHA.
    Chairman Toomey. Okay. Okay. All right, did anybody have 
any closing thoughts, if they could be brief, that are 
important that we have not touched on yet?
    Okay, I would like to actually continue for some time with 
questions, but I have to--unfortunately, leave and get down to 
the House floor. But I want to thank you all very much for your 
testimony. This has been very informative, and you have raised 
some very interesting issues. And if you have any further 
thoughts on this, please submit them to the committee. We will 
take them under consideration.
    Thank you very much. The hearing is adjourned.
    Mr. Krause. Thank you.
    [Whereupon, at 3:00 p.m., the hearing was adjourned.]

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    [GRAPHIC] [TIFF OMITTED] T9639A.077
    

```