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92–704 PDF 2004

S. HRG. 108–397

THE FEDERAL RESERVE BOARD’S PROPOSAL

ON CHECK TRUNCATION

HEARING

BEFORE THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

ON

LEGISLATION TO INCREASE THE EFFICIENCY OF CHECK COLLECTION

AND TO ELIMINATE UNNECESSARY STEPS THAT WILL HELP IMPROVE

OUR FINANCIAL SYSTEM

APRIL 3, 2003

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN E. SUNUNU, New Hampshire

ELIZABETH DOLE, North Carolina

LINCOLN D. CHAFEE, Rhode Island

PAUL S. SARBANES, Maryland

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

JON S. CORZINE, New Jersey

KATHLEEN L. CASEY, Staff Director and Counsel

STEVEN B. HARRIS, Democratic Staff Director and Chief Counsel

PEGGY R. KUHN, Senior Financial Economist

PATIENCE SINGLETON, Democratic Counsel

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator

GEORGE E. WHITTLE, Editor

(II)

CONTENTS

THURSDAY, APRIL 3, 2003

Page

Opening statement of Chairman Shelby ................................................................ 1

Opening statements, comments, or prepared statements of:

Senator Bennett ................................................................................................ 2

Senator Johnson ............................................................................................... 3

Senator Bunning ............................................................................................... 4

Senator Miller ................................................................................................... 4

Senator Hagel ................................................................................................... 5

Senator Chafee ................................................................................................. 5

Senator Sununu ................................................................................................ 15

Senator Allard ................................................................................................... 16

Prepared statement ................................................................................... 41

Senator Sarbanes .............................................................................................. 30

Senator Carper ................................................................................................. 34

Senator Dole ...................................................................................................... 41

Senator Schumer .............................................................................................. 41

WITNESSES

Roger W. Ferguson, Jr., Vice Chairman, Board of Governors of the Federal

Reserve System .................................................................................................... 5

Prepared statement .......................................................................................... 42

Response to written questions of:

Senator Sarbanes ...................................................................................... 58

Senator Reed .............................................................................................. 65

Senator Schumer ....................................................................................... 65

Lindsay A. Alexander, President & CEO, National Institutes of Health Federal Credit Union; on behalf of the Credit Union National Association .......... 17

Prepared statement .......................................................................................... 46

Response to written questions of:

Senator Shelby ........................................................................................... 66

Senator Reed .............................................................................................. 67

Janell Mayo Duncan, Legislative and Regulatory Counsel, Consumers Union . 19

Prepared statement .......................................................................................... 48

Response to written question of Senator Reed ............................................... 68

Danne L. Buchanan, Executive Vice President, Zions Bancorporation; on behalf of the American Bankers Association, America’s Community Bankers,

Consumer Bankers Association, Financial Services Roundtable, and Independent Community Bankers of America .......................................................... 21

Prepared statement .......................................................................................... 52

Response to written questions of:

Senator Sarbanes ...................................................................................... 69

Senator Reed .............................................................................................. 74

Senator Schumer ....................................................................................... 75

Senator Bennett ........................................................................................ 77

(III)

(1)

THE FEDERAL RESERVE BOARD’S PROPOSAL

ON CHECK TRUNCATION

THURSDAY, APRIL 3, 2003

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

Washington, DC.

The Committee met at 10:05 a.m. in room SD–538 of the Dirksen

Senate Office Building, Senator Richard C. Shelby (Chairman of

the Committee) presiding.

OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

Chairman SHELBY. The Committee will come to order.

We have some pending nominations and if we get a quorum,

Governor Ferguson, we will probably interrupt the proceedings and

move to the nominations and then go back to where we are, so if

you will be patient with us. We appreciate that you are here today.

This morning the Committee meets to consider the Federal Reserve Board’s proposal on check truncation. We are very pleased to

have as our first witness Vice Chairman Roger W. Ferguson of the

Federal Reserve System, who will discuss their proposal and its

benefits in some detail.

For our second panel today, we will welcome three witnesses: Ms.

Lindsay Alexander, President and Chief Executive Officer of the

NIH Federal Credit Union, representing the Credit Union National

Association; Ms. Janell Mayo Duncan, Legislative and Regulatory

Counsel from Consumers Union; and Mr. Danne L. Buchanan, Executive Vice President from the Zions Bancorporation, testifying on

behalf of several banking trade associations.

Long before credit cards and debit cards came along, the paper

check served as a convenient and a safe means for consumers to

make purchases and pay bills. Despite the growing popularity of

these newer payment instruments, checks remain a significant part

of the American payment system. The Federal Reserve System estimates that over 40 billion checks are written annually, accounting

for $39.3 trillion in payments.

I doubt that many of us have given any great thought to what

happens when we write a check to a merchant or put one in the

mail to pay a bill. Today’s hearing provides us an opportunity to

highlight how the existing check clearing process works and how

little that process has changed to fully incorporate advances in

technology. I truly believe that most Americans would be surprised

at how dependent our system remains on the physical transportation of paper checks.

2

Under current law, banks must physically present and return

original checks to receive payment unless the bank has an agreement with another bank to do so by electronic means. Some banks

have such agreements and have been able to take advantage of

electronic processing using advanced imaging technology. However,

since there are over 15,000 banks, thrifts, and credit unions, negotiating such agreements with each individual institution would be

impossible. As a result, we continue to have billions of checks, literally tons of checks, either trucked or flown across the country

every night. Given the availability of inexpensive electronic transmissions media, this enormous dependence on ground and air

transportation systems makes very little sense. Truncation could be

used to make the process less expensive over the long-term.

The Fed’s proposal would end the requirement to move paper by

allowing banks to transfer electronic images of checks rather than

the originals. In cases where a hard copy of a check was needed,

a legally equivalent substitute could be downloaded from the electronic image and delivered to the bank. The end result is considerable savings in time and money through the elimination of an

outdated law. We can learn from the experience of the credit union

industry, which has used the truncation process for many years.

We will hear more about that later this morning.

I look forward to hearing the testimony of the witnesses today.

Governor Ferguson, we are pleased to have you with us this morning. Modernizing the check clearing process would provide benefits

to consumers and financial institutions and I believe to our economy as a whole. I intend to work with my colleagues on both sides

of the aisle to develop legislation that accomplishes this task.

Senator Bennett, do you have a statement?

COMMENTS OF SENATOR ROBERT F. BENNETT

Senator BENNETT. Yes, thank you, Mr. Chairman. I very much

appreciate your holding this hearing. I will get into it more when

we get into the second panel, but I have seen this process at work.

I have seen the software. I have seen the product. And once you

have seen it actually happen, you wonder, why in the world would

anybody want to continue the present system?

We should remind ourselves that on September 11, the entire

airline system was shut down for security purposes. It was the prudent thing to do. It was the essential thing to do. We did not know

where the attacks were coming from, and the only way that we

could find out was to get all of the airplanes out of the sky and

then any that were still flying, we knew were under control by

someone other than by the FAA.

That was the homeland security requirement. No one questioned

it at the time and no one would question it if it were to be required

again. But it completely brought to a halt all transfer of funds in

the United States because there was no physical transfer of checks

outside of individual communities. And the economic cost of that

physical transfer was highlighted in that situation.

So in the new world in which we live, where terrorists can interrupt economic activity with physical acts, we should have an electronic work-around that can resolve that and keep the economy

going smoothly in the face of such an attack. And that is why, in

3

addition to all of the economic reasons, this makes sense, there are

security reasons why it makes sense as well.

I thank you again for holding the hearing.

Chairman SHELBY. Senator Johnson.

STATEMENT OF SENATOR TIM JOHNSON

Senator JOHNSON. Thank you, Chairman Shelby, for holding today’s hearing on check truncation. While we may not spend a lot

of time thinking about how our checks get processed, it is clear

that electronic presentment of checks is an important step forward

in modernizing our Nation’s payment system.

In the days, as Senator Bennett has noted, following September

11, when planes across the country remain grounded, banks were

forced to take drastic steps to ensure the shipment of checks from

bank to bank. Check payments across the country were delayed,

which opened up possibilities for processing errors and fraud.

Electronic payments, on the other hand, continued to be processed in a safe and timely fashion during that crisis. But even absent a crisis, processing challenges confront banks in my State of

South Dakota every winter. Deep snowfalls and vast distances between small town banks and processing centers add significant

costs to physical transportation of checks. These costs trickle down

to consumers and everyone ends up paying the price of our outdated system.

Last year, I introduced a Check Truncation Act, together with

my colleagues, Senator Carper and Senator Miller. Our bill would

improve America’s check payment system by allowing banks to exchange checks electronically. Current law requires banks to physically present and return original checks, a tedious, antiquated,

and expensive process. Our bill would also reduce infrastructure

costs for banks, allowing for more flexibility and great cost savings

for the consumer.

Our bill would not, however, prevent banks from returning

checks to consumers who still like getting their physical checks

returned. Banks would continue to have the discretion to provide

returned check services. The only difference would be that some of

those checks might be legal substitutes rather than the original

payment instrument, and this is an example of that legal substitute [indicating].

The Federal Reserve Board has spent a greater deal of time analyzing the potential benefits of check truncation. I want to commend Mr. Ferguson and the Fed for their exhaustive efforts in this

area. They have put together a comprehensive working group that

included a diversity of viewpoints, ranging from members of the industry to consumer representatives. Our bill closely mirrors their

proposal. Some of the Fed’s recommendations have evolved over

time and I would urge the Committee to pay attention to some of

these changes as we proceed with any legislation.

I also wanted to note that Senator Bennett, who is now Chairman of our Financial Institutions Subcommittee, has spent a great

deal of time on this issue and our staff has been working closely

together with his on check truncation.

I look forward to working with Senator Bennett on this and a

number of issues that affect America’s financial institutions and

4

Mr. Chairman, I am pleased that you are working so quickly to

focus the Committee’s attention on the potential for check truncation to increase the stability and efficiency of our financial system.

It is the right time to give electronic versions of checks the same

legal validity as paper checks, so America’s financial institutions

can provide customers with faster check clearing and better access

to liquid funds in both good times and times of crisis.

Thank you, Mr. Chairman.

Chairman SHELBY. Senator Bunning.

STATEMENT OF SENATOR JIM BUNNING

Senator BUNNING. Thank you, Mr. Chairman. I want to thank

you for holding this hearing, and I would like to thank all of our

witnesses for appearing today.

I am very familiar with check truncation. My bank in Kentucky

has been truncating checks for a number of years. There have been

no problems, and I think it has added a good service I receive by

being able to have my checks cleared faster. At my bank, we have

seen none of the problems that at least one of our witnesses will

speak to today. Of course, not every bank is as well run as the

bank I have in Kentucky.

[Laughter.]

I certainly understand the concerns of opponents of the Federal

Reserve proposal. They are valid. But I believe that they are being

addressed. Nobody wants consumers to be charged twice for a

check-cashing service. We have to do what we can in this legislation to make sure that it does not happen. We also must make sure

that criminals are not able to get their hands on the original or

truncated checks and do everything we can to prevent fraud. I

think the banks understand this. If one of their customers is a victim of a double charge or fraud. It is very likely that the consumer

will vote with their feet and probably take their family and friends

with them. In this highly competitive financial service environment, not very many banks can afford that.

I would especially like to welcome Governor Ferguson today. I

am probably one of the Fed’s strongest critics when I think they

have done something outside of their mandate, and I make no

apologies for that. But if I am going to criticize the Fed when I believe they are wrongfully exceeding their mandate, it is only fair

that I compliment them when I think they are doing a job well

done. I believe the Fed should be commended for moving this issue

forward and trying to promote the use of technology to clear checks

faster. Clearing checks faster is pro-consumer.

Once again, Mr. Chairman, I thank you for holding this hearing

and I look forward to hearing from our witnesses.

Chairman SHELBY. Thank you.

Senator Miller.

COMMENTS OF SENATOR ZELL MILLLER

Senator MILLER. Thank you, Mr. Chairman, for holding today’s

hearing, and I thank all of the witnesses for being here.

I have no opening statement.

Chairman SHELBY. Senator Hagel.

5

COMMENTS OF SENATOR CHUCK HAGEL

Senator HAGEL. No, I do not have an opening statement, Mr.

Chairman. Thank you.

Chairman SHELBY. Senator Chafee.

COMMENTS OF SENATOR LINCOLN CHAFEE

Senator CHAFEE. I have no opening statement. Thank you.

Chairman SHELBY. Thank you.

Governor Ferguson, you proceed as you wish.

STATEMENT OF ROGER W. FERGUSON, JR.

VICE CHAIRMAN, BOARD OF GOVERNORS

OF THE FEDERAL RESERVE SYSTEM

Governor FERGUSON. Thank you very much, Mr. Chairman. I

would also like to thank the Committee for inviting me to discuss

the proposed Check Truncation Act and for holding hearings on

this very important legislative initiative.

The proposal that the Board forwarded to Congress in December

2001, is designed to remove the legal barriers to the use of new

technology in check processing. It accomplishes this essentially by

allowing banks to replace one piece of paper during the check collection or return process, the original check, with another piece of

paper that contains exactly the same payment information, a substitute check. This simple change holds the promise of a more efficient check collection system.

Today, consumers, businesses, and the Government write about

40 billion checks annually. And over the years, banks, thrifts, and

credit unions, which going forward I will refer to collectively as

banks, have applied a variety of electronic technologies to automate

check processing, which involves handling and sorting checks so

that they can be physically shipped to their destinations.

A typical check is processed several times before it is eventually

paid. First, it is processed by the bank in which it is deposited.

Then it may be shipped for processing to one or more intermediaries. And finally, it is shipped for processing and payment to the

bank on which it is drawn.

While most checks are currently processed in this fashion, some

checks are removed from the collection process and the payment

information on the checks is captured and delivered electronically

to the banks on which they are drawn. This process, which is commonly referred to as check truncation, as Senator Bunning has

indicated, reduces the number of times that each check must be

physically processed and shipped. As a result, check truncation is

generally more efficient, more cost-effective, and less prone to processing errors.

The check system’s legal framework, however, has not kept pace

with technological advances and is now constraining the efforts of

many banks to use new electronic technologies, such as digital

check imaging, to improve check processing efficiency and to provide improved services to customers.

Today, check truncation can only occur by agreement of the

banks involved because existing law requires the original paper

checks to be physically presented or returned in the absence of an

agreement to the contrary. Given the thousands of banks in the

6

United States, it is not feasible for any one bank to obtain check

truncation agreements from all other banks, or even a large proportion of them. Therefore, legal changes are needed to foster the use

of new electronic technologies to improve check processing and to

reduce the need for physical transportation in the check collection

process.

The proposed legislation facilitates check truncation early in the

check collection or return process, without mandating that banks

accept checks in electronic form. The proposed legislation accomplishes this by creating a new negotiable instrument called a ‘‘substitute check,’’ and this, as you have already seen, is an example

of a substitute check. That is a check that banks could use in place

of an original check.

Under the proposed legislation, banks would be able to truncate

original checks, process check information electronically, and deliver substitute checks to other banks and bank customers that

want to continue receiving paper checks. As a result, banks could

handle much of their check processing electronically without needing to obtain legal agreements from thousands of other banks to

truncate checks.

A substitute check would be the legal equivalent of the original

check, and could be used by both banks and their customers just

as if it were the original check. It would look like a regular check,

as you have seen, would carry an image of the original check on

the front and the back, as you can tell, and could be processed on

existing check processing equipment.

Under the proposed legislation, a bank could still demand to receive paper checks, although it would be likely to receive a mix of

both original checks and substitute checks. Because substitute

checks could be processed just like original checks, the bank would

not need to invest in any new technology or otherwise change its

current check processing operations.

Further, bank customers that receive cancelled checks with their

monthly statements would continue to receive cancelled checks.

Only some would be the original checks and some would be substitute checks. Bank customers would be able to use the substitute

checks in exactly the same way that they would use the originals.

While allowing banks to replace one piece of paper with another

might seem like a small change, eliminating the need to deliver

original checks would allow banks to speed up a process of technological transformation in check clearing that is already under way.

By adopting a market-based approach that permits each bank to

decide when and how to use substitute checks, the proposed legislation should result in the use of technology to provide a more efficient and flexible check collection system.

The proposed legislation would also help address the risks to the

check collection system from its extensive reliance on air transportation that was highlighted immediately after the September 11

tragedy. One effect of air transportation being grounded was that

the flow of checks slowed dramatically. During the week of the

attacks, the Federal Reserve Bank’s daily check float ballooned

to over $47 billion, which is more than one hundred times its normal level.

7

Had the proposed legislation been in effect at that time, and had

the banks been using a more robust electronic infrastructure for

check collection, banks would have been able to collect many more

checks by transmitting electronic check information across the

country and presenting the substitute checks to paying banks that

desired them.

The proposed legislation might also enable banks to provide new

and improved services to their customers. For example, banks

might allow some corporate customers to transmit their deposits

electronically.

Further, if banks begin to transmit check images from the point

of deposit to their operation centers for processing, they might be

able to establish branches or ATM’s in more remote locations and

provide later deposit cut-off hours for their customers. Later deposit cut-off times could result in some checks being credited one

day earlier and interest accruing one day earlier for some checks

deposited in interest-bearing accounts.

Because the proposed legislation will likely encourage greater investments in image technology, banks might also be able to expand

their customers’ access to enhanced account information and check

images through the Internet. In addition, banks might be able to

resolve customer inquiries more easily and quickly than today by

accessing check images.

Further, as the banks reduce their operating costs, the savings

will be passed on through a combination of lower fees to their customers and higher returns to their shareholders. After all, the

banking industry, as Senator Bunning has already noted, is quite

competitive. And banks have indicated that they expect cost savings to be substantial.

While there is a fairly broad consensus on the desirability of the

underlying concepts of the proposed legislation to permit the use of

substitute checks, the issue of customer protections has been the

subject of much debate. Since we forwarded the proposed legislation to Congress in late 2001, the Board has had an opportunity

to further reflect on the views that have been expressed by both

consumer advocates and the banking industry.

The Board originally included the expedited recredit provisions

in an attempt to balance the interests of consumers and banks.

Given that existing check law already protects customers from

check processing problems, and there does not appear to be a pattern of problems suggesting these protections are inadequate, the

Board has now concluded that these provisions are not necessary

for the successful implementation of the proposed legislation.

Congress, however, may arrive at a different conclusion as it considers the need for customer protections, and I would like to briefly

discuss why we believe the expedited recredit provisions are not

necessary.

The Board’s proposed legislation extended the protections of the

existing check law, including the Uniform Commercial Code, or

UCC, and the Federal Reserve Board’s Regulation CC, to substitute

checks as though they were original checks.

Long-established check law protects bank customers if checks are

improperly charged to their accounts. If a bank charges a customer’s account for a check that is not properly payable, the bank

8

could be liable to its customer not only for the amount of the unauthorized charge, but also for interest on that amount and consequential damages for the wrongful dishonor of any subsequently

presented checks.

While it is true that the UCC does not provide a specific time

frame within which a bank must act, the UCC’s provisions give the

bank a significant financial incentive to resolve problems on a

timely basis.

Specifically, the longer a bank takes to research and resolve a

customer’s claim, the longer the bank is exposed to the liability for

consequential damages arising from the wrongful dishonor of subsequently presented checks.

These existing protections appear to have worked well for many

decades.

In addition to the protections provided in current check law, the

proposed legislation requires banks to provide new warranties for

substitute checks and to indemnify customers for losses resulting

from the receipt of a substitute check instead of the original check.

Specifically, banks must warrant that substitute checks that they

handle are legally equivalent to the original checks and that the

check will not be paid more than once from a customer’s account.

Banks must also indemnify customers for losses they incur due

to the receipt of substitute checks rather than the original checks.

And taken together, these warranties and the indemnity provisions

provide customers with, I think, additional protections against

losses related to the use of substitute checks.

The use of substitute checks is not expected to result in problems

different from those that are routinely addressed in today’s environment. And existing law already encourages the prompt redress

of consumer complaints.

Therefore, the Board believes that the significant compliance

burdens imposed by the expedited recredit provisions on banks that

receive substitute checks would outweigh the small incremental

benefits that the provisions would provide to consumers.

Nonetheless, Congress may conclude that the expedited recredit

provisions for consumers should be included in the legislation. In

that case, we believe any expedited recredit provisions should be

consistent with the proposed legislation’s basic purposes and

should not go beyond the provisions proposed by the Board. In the

unlikely event that additional consumer protections are needed for

substitute checks, the proposed legislation grants the Board the

authority to adopt such protections by regulation.

In conclusion, although an increasing number of payments are

being made electronically, it is clear that checks will continue to

play an important role in the Nation’s payment systems for the

foreseeable future.

The Board believes that over the long run, the concepts embodied

in the Check Truncation Act will spur the use of new technologies

to improve the efficiency and the flexibility of the Nation’s check

collection system, and provide better services to bank customers.

The proposed legislation accomplishes this by simply permitting

banks to replace one piece of paper, the original check, with another piece of paper, the substitute check, and both of which contain the same payment information. Because the proposed legislaVerDate 11-MAY-2000 13:23 Apr 01, 2004 Jkt 000000 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 92704.TXT SBANK4 PsN: SBANK4
9

tion should result in substantial cost savings, it would also be desirable to begin obtaining these savings as quickly as possible.

We look forward to working with the Committee as it further

considers this legislation. I thank you gentlemen for your time and

I would be happy to answer your questions.

Thank you.

Chairman SHELBY. Governor Ferguson, I believe this is a copy of

a check that the Fed has given us.

Governor FERGUSON. Yes. This is what a substitute check would

look like. As you can see, it is very much the same size as a regular

check and it includes notification.

Chairman SHELBY. It is very clear, the imaging on it.

Governor FERGUSON. Yes, it is quite clear. The technology for

imaging is good.

Chairman SHELBY. I think most of the Members have seen that

up here. I do not know about the press.

The use of imaging technology is an additional cost to banks and

may be a larger consideration for smaller community banks. Is

there any reason, Governor Ferguson, to believe that up-front costs

could impede the small banks from moving toward more electronic

processing?

Governor FERGUSON. No, I have no reason to believe that the upfront costs will impede the small banks from moving. The cost of

the imaging equipment has come down quite dramatically. And

there also are a number of service providers that are willing to provide that kind of service to small banks. So, I think there is no

competitive disadvantage that could emerge from this legislation.

Chairman SHELBY. Wouldn’t electronic processing be particularly

attractive to banks which are more remotely located and are thus,

sensitive to transportation disruptions or paper checks?

Governor FERGUSON. Absolutely. It would be both beneficial to

the banks and as Senator Johnson has indicated, potentially beneficial to those customers, as well as time speeds up.

Chairman SHELBY. Rural areas?

Governor FERGUSON. Rural areas, mountainous areas, areas with

bad weather that impedes transportation. There are a number of

parts of the country where this is clearly a net plus.

Chairman SHELBY. The Fed is required, as I understand it, to

monitor funds available under the Expedited Funds Availability

Act. Greater use of electronic images will likely mean that checks

will clear through the system faster, as you have indicated. Assuming that truncation legislation is passed, would it be appropriate to

phase in truncation prior to making decisions regarding expedited

funds availability? In other words, how long a trial period of observation would be appropriate here?

Governor FERGUSON. Well, I think, as I have tried to suggest,

that since there are some savings and benefits here, it is appropriate to move expeditiously, as you intend, and to make sure that

the effective date is as near to passage as you think reasonable.

I do not see a reason to phase in truncation per se. I do think

it is appropriate to let truncation and this Act develop over some

time and give us plenty of opportunity to see what does, in fact,

happen with respect to presentment times and when that funds

availability becomes sooner.

10

We will be monitoring that extremely closely and will be prepared to act under the Expedited Funds Availability Act as soon as

the facts do become clear.

So, I think that there would be nothing that we would do that

would slow down the benefits at all. We would be quite aware of

the question that you just raised and our need under the Act to

track very closely when funds become available to make sure that

the regulations reflect reality.

Chairman SHELBY. You went into this earlier, the truncation at

the point of sale.

Some merchants have implemented programs to truncate checks

at the point of sale in stores already. In some of these cases, the

consumer actually gets to keep a copy of the cancelled check. This

type of system also has some appeal as it permits customers to continue to use checks that they are familiar with while also eliminating transportation of paper checks. Has the Fed been involved

in these types of initiatives?

Governor FERGUSON. We have been watching them and monitoring them closely. We spend a great deal of time—I personally,

and the staff even more so—talking to the institutions that have

been doing this, including some of the larger retailers.

Many of the benefits that you observed have come forward. And

what we have seen, particularly in grocery stores and others that

have a heavy dependence on cash and checks, is that for many of

them, this has been a real plus. It has been important, obviously,

to explain to customers that they will get their check back and

what that implies. But there seem to be no major problems that

have emerged as we have watched this closely.

Chairman SHELBY. As I understand it, these transactions are

handled through an automated clearinghouse and are not governed

by check law. Can you confirm that?

Governor FERGUSON. That is true. In those cases, the check is

being used as the initiating document for electronic funds transfer

and it is not governed by the usual check law.

Chairman SHELBY. What about the customer acceptance of that?

Governor FERGUSON. There appears to be no problem with customer acceptance. Many customers already are familiar with electronic deposits, electronic debits, et cetera, and they understand in

many cases what is happening. The only thing that needs to be explained is that they will be getting their check back and that it is

just being used in some cases to start an electronic funds transfer.

Chairman SHELBY. As we move toward greater use of electronic

images, there will have to be some type of standard format or data

requirements for the substitute checks. Could you elaborate as to

what set of standards there would be and how detailed those standards are likely to be?

Governor FERGUSON. There is a private-sector group called ANSI,

I believe, that is already working with respect to the question of

standards. The standards would have to do with things such as the

placement and size of the image on the substitute check. There

would also have to be standards in the image archives themselves

to make them work together, to make them more interconnected.

But the good news is that there is already progress underway

there and that there are many standards that the private sector is

11

developing that are responding to the questions that I have just

identified, such as what the contrast should be, for example.

Chairman SHELBY. Governor, the privacy of electronic checks,

that has been raised. What protections govern how financial institutions and other processors use these images and the information

on them?

Governor FERGUSON. Well, the check activity would be governed

by the usual rules that cover privacy and financial privacy, and you

are obviously well aware of what those rules are. There is nothing

here that would in any sense change that one way or the other.

I would also hasten to add that there is nothing in the ability

to use images that creates new incentives for banks to change or

violate privacy of their customers. So the preexisting privacy laws

would obviously continue to apply for the substitute checks in images, as well as the existing approaches to paper checks.

Chairman SHELBY. Senator Bennett.

Senator BENNETT. Governor Ferguson, are you familiar with the

1996 study published by the Michigan Federal Reserve Bank’s

quarterly review?

Governor FERGUSON. I think I am, yes. You may have to remind

me of some of the details. But go ahead.

Senator BENNETT. In that study, they said that the social cost of clearing a check is currently $3, and it would be $1.25 for an electronic transfer. Do those numbers sound about right to you?

Governor FERGUSON. Those numbers sound about right, but let

me be cautious.

It has always been hard for us to get a very good fix on the social

cost. I have seen numbers that size. I have seen numbers somewhat smaller, to be fair. I have seen numbers on the scale of $20

billion, for example. But there is a significant cost in the check

clearing process. And as I have said, I believe, and based on talking

to bankers, that there would be significant cost savings.

I would encourage you, Senator, to talk to the second panel

where there are some bankers to talk about their experience and

what the cost savings may look like. It has been very hard for us

to really get the kind of Fed quality numbers on cost savings, but

I am quite convinced that there would be significant cost savings

that would occur.

Senator BENNETT. I picked on that one because it is connected

to the Fed. It is the Minneapolis Federal Reserve Bank.

Governor FERGUSON. Right. I realize that. And as I said, that

study is certainly a valid one. We have had many other studies as

well and the numbers do change somewhat.

The reason I suggest that you talk to the banks in particular is

that the Act deals with permission to do something. Part of the

question of how much cost savings comes depends on how fully the

banks use it. That is the linkage there.

Senator BENNETT. My own assumption—my own experience, I

should say—says that as it becomes more widespread, the cost savings would become even greater.

Governor FERGUSON. I agree.

Senator BENNETT. So, you do not know the assumptions that are

built into this as to what level of use it has. But simply doing the

math, that is $73 billion a year, if you take the 42 billion checks.

12

Governor FERGUSON. There are significant savings, potentially

significant savings. The question of how much of those savings we

capture and how quickly depends on business decisions and how

quickly banks continue to go down this path.

Senator BENNETT. Now can you address or do you know of any

studies that address the issue of the increased profits to the banks

that come as a result of the reduced float time?

Governor FERGUSON. I have not seen any studies that address

that specifically. I would again encourage you to talk to some of the

bankers that are on your second panel.

But one of the things that one has to recognize is, as I have indicated as an economist, and others here know, the banking industry

is extremely competitive. And one of the things that I have seen

in a number of advances in payment systems, including creation of

ATM’s and other things, is that because of the competitive nature

of the industry, the cost savings that occur to banks are quickly

transmitted in terms of better products and services for customers,

because, indeed, customers get a number of mailings as you know

with respect to bank services almost on a daily basis.

It is also the case that we have found many of these advances

with respect to payment systems, if they have led to greater profitability, have obviously then been returned to bank shareholders.

So, I am not in any sense concerned about how our financial system works from a competitive standpoint, and insofar as there are

cost savings. I think they will accrue to consumers in one form or

another over time because we have a very competitive banking system. And that has been borne out with almost every advance with

respect to payment systems, that, ultimately, the banks make the

investments and the consumers reap the rewards in one form or

the other—lower costs, better services.

Senator BENNETT. That is the point I was hoping the question

would make, and I thank you for that explanation because it is

very clear that if we can bring the costs of doing business down in

the economy wherever, the net result is more economic efficiency.

More economic efficiency means lower prices, and it ultimately

means better economic activity.

One of the challenges that we have in the Congress right now is

that we are in a sluggish economy and we are trying to find ways

to make it revive. And if we could do something that puts $73 billion a year, plus whatever additional economic advantage would

come from the improvement of the float, into the economy, at least

during the budget debate, we would say that was a good day’s

work, if we could find $73 billion of stimulus one way or the other.

[Laughter.]

The only other comment I would make, echoing what Senator

Johnson has said, is there are plenty of rural people in Utah. And

to do something that would improve services to the customers who

live in those rural towns is something that clearly we need to do.

However, we should be careful not to get carried away with concerns that apply theoretically that cause us to deny benefits that

are there in reality for a lot of people who do not happen to live

in big cities.

Thank you, Mr. Chairman.

Chairman SHELBY. Senator Johnson.

13

Senator JOHNSON. I will waive questioning, Mr. Chairman.

Thank you.

Chairman SHELBY. Senator Bunning.

Senator BUNNING. Thank you, Mr. Chairman.

I don’t know whether you read Ms. Duncan’s testimony or not.

Governor FERGUSON. I am aware of some of it. I have been told

some of it.

Senator BUNNING. Would you like to respond or comment on

some of her concerns? Particularly the recommendations that she

has made on the final page.

Governor FERGUSON. I do not have the recommendations per se.

Senator BUNNING. Because all consumers are equally susceptible

to harm from processing errors, the recredit loophole in the proposed ETA should be closed——

Chairman SHELBY. Senator Bunning, could you suspend? We

have a quorum now where we can move——

Senator BUNNING. Absolutely.

[Laughter.]

Chairman SHELBY. Thank you. We will now move into Executive

Session and deal with some nominations.

We have: Alfred Plamman, to be a Member of the National Consumer Cooperative Bank; Thomas Waters Grant, Noe Hinojosa,

and William Robert Timken, all of whom were nominated to be

Directors of the Securities Investor Protection Corporation.

All of these nominees appeared before this Committee at a hearing held on March 25. So, I would ask now, is there any comment

or debate on the nominations?

[No response.]

Hearing no objection, it is so ordered.

All in favor of the nominations, say aye.

[A chorus of ayes.]

Chairman SHELBY. Those opposed, no?

[No response.]

Chairman SHELBY. The ayes appear to have it. And the four

nominations will be favorably reported to the Full Senate.

Thank you, Senator Bunning.

Senator BUNNING. Thank you.

Chairman SHELBY. Senator Bunning is recognized again.

Senator BUNNING. Mr. Ferguson, would you like to comment?

Governor FERGUSON. Yes, I would like to comment on them. I

would also observe that, having been a nominee before this Committee, I am pleased to see the Committee move so expeditiously

with nominations.

[Laughter.]

To a more serious point, because I take it very seriously, the concerns that have been raised in this testimony, particularly the recommendations, are ones that, frankly, I do not share. And it is not

from any lack of concern about consumers whatsoever on my part.

It is rather based on analysis of the current situation and what the

likely new situation would be under the Check Truncation Act.

The current situation is one in which we have a number of laws

that emerged out of common law because people have been drawing

drafts on banks for hundreds of years. It has been codified in the

UCC and also in some Federal Reserve regulations, in which the

14

banks, if they do, inadvertently do a double debit, have the legal

responsibility to fix that problem so that the consumers are not at

risk there and there are a number of incentives that are built in

to encourage the banks, incent the banks, to fix any of those problems early on.

I would also observe, as others have, that we have a system that

has 40 billion checks or so every year. And as we have looked at

our databases, we see very, very few problems across all of the regulatory agencies that deal with consumer complaints, that deal

with the kinds of concerns that are raised here in terms of double

debits or a calculation error or an error in simply transmitting the

correct information. So, we have a system that works very well.

All we are doing here under this proposal is creating a new form

of paper in lieu of the old form of paper. But the same protections

would be there and we have proposed some new protections in

terms of a warranty and an indemnity.

Now to the specifics. That is the background, of a system that

works well, common law that is codified that has worked well, plus

some new protections here to really give the right kind of teeth to

this legislation.

Now to go to these two comments.

First, on the question of processing errors and the right of recredit to be expanded, I have said to you, while we would have no

objection if you wanted to put in a right to recredit, we do not

think it is necessary. We do believe that if you choose to put in,

the right to recredit, it should not be expanded beyond the case in

which consumers get back a substitute check. The reason is that

if we expand it more broadly than that, you are going to find that

we have two different types of legal regimes that could potentially,

as you were indicating, come into conflict with each other.

We would be building a system in which we are trying to protect

against potential risks that I think are really fairly remote. And so,

if one were to have a recredit, I would encourage it to be a fairly

narrow and focused recredit because otherwise, you are opening up

a case in which consumers do not know which rights they really

have and you are creating, I think, more confusion than you are

clarity.

With respect to the second point here regarding the comparative

negligence standard as an inappropriate way to resolve harm suffered by consumers due to processing errors, again, we have very,

very few processing errors as far as we can tell. But this question

of comparative negligence already exists in many of the common

law standards for tort and particularly as embodied in a variety of

different ways, sometimes using the words, comparative negligence,

sometimes not, in the UCC. And it has withstood the test of time.

I would argue that comparative negligence is a standard that is

well understood in common law, well understood in business tort,

well understood in check law, and I think that is appropriately

maintained by the Check Truncation Act as we have proposed it.

So in both cases, while I am always sympathetic to consumer

interests as part of what I am asked to do, I think that these two

recommendations really do not find a useful place in the kind of

proposal that is being put forward here, and they are indeed presuming a greater degree of risk than we think is likely to occur,

15

and are creating, if you will, a set of check law that is in some

sense, in the case of recredit, not a necessary addition to a check

law that we have had for many years that works very well and

that would not be undercut—in fact, would be reinforced—by what

we have in the proposed Act.

Therefore, I am not supportive of these two recommendations.

Senator BUNNING. Thank you very much.

Chairman SHELBY. Senator Miller.

Senator MILLER. I guess following up a little bit more on that,

Governor Ferguson, you do not have a great concern, then, of the

possibility of the customer getting debited twice, once for the original check and once for the substitute check?

Governor FERGUSON. No, I do not because there are a number of

incentives already built in that stop that from happening.

We have, as I said, 40 billion checks a year that are written now

and we have very little evidence of this as a major problem whatsoever. And partially, I think it has to do with the incentives that

Senator Bunning talked about in the competitive environment.

Banks have created a number of systems to minimize the risk of

a double debit, and I do not think that creating an opportunity to

use more electronics is going to increase that risk or change those

incentives.

Senator MILLER. Thank you.

Thank you, Mr. Chairman.

Chairman SHELBY. Senator Sununu.

COMMENTS OF SENATOR JOHN E. SUNUNU

Senator SUNUNU. Thank you, Mr. Chairman.

Governor Ferguson, could you be more specific? Very little evidence, 40 billion checks. For what percentage does the double debit

problem exist?

Governor FERGUSON. We have gone back and looked at the databases of all the consumer complaints that we have had. I believe

that we have absolutely none where I have heard anything of a

double debit.

[Pause.]

And the staffers are shaking their heads in agreement. There

may be the rare case out there, but it has not emerged through the

complaint process.

Senator, I am not going to be facetious at all. I get a large number of letters with a variety of complaints about things that banks

do. I have gone back and looked at my files and the things that

I have responded to. And over the 7 years that I have been on the

Board, the 6-plus years that I have been on the Board, I haven’t

received one complaint of this nature.

So, I would have thought since there is something at stake here,

that either the formal complaint process or others would suggest

an issue here.

Senator SUNUNU. And other than the interpretation based on correspondence or complaints that you are receiving through formal

channels, there is no statistical database of the 40 billion checks

and what kind of problems——

16

Governor FERGUSON. No. We have a statistical database for all

complaints. There is not a statistical database of what happens to

the 40 billion checks.

Senator SUNUNU. Okay.

Governor FERGUSON. But since we are responsible for consumer

complaints in part, we have looked across all the FFIEC agencies

and we see nothing there.

Senator SUNUNU. No evidence that consumers are reluctant to

call you and complain?

[Laughter.]

Governor FERGUSON. I am not encouraging more of that.

[Laughter.]

But, no, there is no evidence of reluctance of their part to let me

know if things are not going well.

Senator SUNUNU. You say that you do not recommend or advocate necessarily for a credit provision. Correct?

Governor FERGUSON. That is correct.

Senator SUNUNU. Why not? And I apologize, it may have been at

least touched on in your testimony, which I missed. But could you

elaborate on the reason that recredit, you do not see it as being

necessary?

Governor FERGUSON. We do not see it as being necessary because

current check law gives the right set of incentives to fix any problems that might emerge. Banks have effective problem-solving resolution processes already for these kinds of problems insofar as they

emerge. And we have proposed in this Act an additional warranty

and an indemnity that gives even a little more strength there.

We do not see that there is a hole in current existing law that

needs to be filled because of this new proposed approach to dealing

with paper checks. And so, it is just simply an analysis based on

reflection, the passage of time, and a better understanding.

Senator SUNUNU. Thank you.

Thank you, Mr. Chairman.

Chairman SHELBY. Senator Allard.

COMMENTS OF SENATOR WAYNE ALLARD

Senator ALLARD. Thank you, Mr. Chairman. I have a couple of

questions concerning the point of sale of the merchandise.

Will it be possible at some point to eliminate the paper check at

the point of sale or purchase instead of at the point of first deposit,

further reducing the paper requirements?

Governor FERGUSON. It is quite possible that other institutions

may decide that they want to truncate the checks and pass that

information on electronically and use that to start an EFT, an electronic funds transfer.

Some of that already does occur. And obviously, we have a large

number of nonpaper-driven retail payments through the form of

debit cards and credit cards already.

So, indeed, we are getting assistance and becoming gradually

more electronic and less paper-based. But when you start with a

system that has 40 billion checks, we still have a very large critical

mass of checks. Even though they are not increasing, other things

are, and we will I think over time see fewer checks being written.

17

But, still, when you are counting things in the billions, it is important to deal with that problem as well.

Senator ALLARD. Well, when a consumer gets used to a certain

format, they tend to like to stick with it, particularly as they get

older. They do not like to change.

Governor FERGUSON. Right.

Senator ALLARD. My understanding is the retailers generally

support your effort on check truncation. There has been some that

have expressed concerns with the logistics of the warranty provisions in the draft legislation from the standpoint that a retailer

would like to process a check electronically from the point of sale.

If the warranty to process a check electronically with legal protections came from individual banks, a clerk would have to examine each check to determine whether it was written on the bank

providing the retailer with a warranty. Do you see the need for revisions or expansions in that area?

Governor FERGUSON. No, I do not. I think it is not as onerous a

problem as perhaps some believe—we thought through this balance

issue and are pretty comfortable with where we came out in the

proposed legislation. I do not see any reason for changes there.

Senator ALLARD. Thank you, Mr. Chairman. I ask unanimous

consent that my opening remarks be made a part of the record.

Chairman SHELBY. Without objection, your statement will be

made part of the record.

Governor Ferguson, we appreciate your appearance here today.

We might have some other questions for the record and we will

expedite them to you.

Governor FERGUSON. Sure.

Chairman SHELBY. Our second panel will consist of: Ms. Lindsay

Alexander. She is President and Chief Executive Officer of the NIH

Federal Credit Union in Rockville, Maryland. She will be representing the Credit Union National Association. Ms. Janell Mayo

Duncan, Legislative and Regulatory Counsel, Consumers Union.

And Mr. Danne Buchanan, Executive Vice President, Zions Bancorporation, on behalf of the American Bankers Association, the

Financial Services Roundtable, America’s Community Bankers,

Independent Community Bankers of America, and the Consumer

Bankers Association.

We welcome all of you here today. Your written statements will

be made part of the record in their entirety and if you would sum

up the points of what you want to touch on, it would be appreciated

and it would give us some time to ask questions.

Ms. Alexander, we will start with you.

STATEMENT OF LINDSAY A. ALEXANDER

PRESIDENT & CHIEF EXECUTIVE OFFICER

NATIONAL INSTITUTES OF HEALTH FEDERAL CREDIT UNION

ON BEHALF OF THE

CREDIT UNION NATIONAL ASSOCIATION

Ms. ALEXANDER. Chairman Shelby and Members of the Committee, thank you for the opportunity to provide comments on how

check truncation has been working at credit unions for the past

three decades. I am Lindsay Alexander, President and CEO of the

National Institutes of Health Federal Credit Union in Rockville,

18

Maryland. I am testifying before you today on behalf of the Credit

Union National Association, CUNA.

I would like to provide you with information regarding how check

truncation works at credit unions and insight into our views on

proposals to facilitate check truncation.

Most credit unions that offer checking accounts truncate. Sixtyfour percent of credit unions offer checking accounts, and of those

credit unions, 91 percent truncate share drafts or checks.

Credit unions tends to truncate checks at the last step in the

check collection process by not distributing share drafts to their

credit union members by not giving the checks back.

Credit unions do not usually truncate the checks drawn on other

financial institutions that their members deposit or use to make

loan payments at the credit union.

Credit unions have found that check truncation, under existing

check law, allows credit unions to serve their members very well.

The experience of credit unions is that our members rarely request

or need originals from truncated share drafts or checks.

We found in an informal survey in 2001, that of 1.1 billion

checks, only about 480,000 requests, or 0.04 percent, were made for

the original check. In almost all cases, a good quality, clear image

of the check satisfied the member’s needs.

I would like to now describe the experience of my credit union.

Like most credit unions, we do not return checks to members and

never have. We image all the checks that we receive, both the

checks drawn on our members’ accounts and the deposited checks

from other institutions. This imaging service reduces the time it

takes to retrieve checks from approximately 2 to 3 days to almost

instantaneous.

In my 14 years at NIH Federal Credit Union, we have never had

a member that has complained about not getting an original check.

In those cases where the member does request a copy, the most

common reasons are because the member needs it for proof of payment or for an audit. At my credit union, about 90 percent of those

that request a copy need it as proof of payment and about 10 percent request it for audits such as IRS audits. In a very few, isolated

cases, members need it for a court case or some other reason.

The Federal Reserve initially presented to Congress a proposal

allowing financial institutions to voluntarily decide to present an

item totally electronically without the need for previously adopted

agreements. The Federal Reserve proposal would have allowed

existing truncation programs, such as those in credit unions, to

co-exist, without imposing new requirements from the proposal on

existing credit union programs.

We strongly support that provision in the Federal Reserve proposal. And we strongly oppose any expansion of the scope of the

Act that would impose requirements on check truncation programs

that already exist and do not use a substitute check. Expanding the

scope of this Act is unnecessary and would interfere with credit

union check truncation programs that already seem to be working

very well.

We support changes that have been made to the Federal Reserve

proposal that appear in the Check Clearing for the 21st Century

Act, that was recently introduced by Representatives Hart and

19

Ford in the House. These changes would allow the financial institutions to truncate all types of checks. Moreover, the House bill

allows an indemnifying financial institution to produce a copy to

resolve a consumer’s complaint or claim when a copy is sufficient

for that purpose.

The experience of credit unions is that at nearly all times a copy

is indeed sufficient, so there should not be a requirement to reproduce anything more than a good quality copy.

We are also supportive of consumer protections in the House bill

that mirror those of existing laws and give credit unions more time

to investigate complaints. The recredit procedure in Section 6 gives

the member’s credit unions 10 business days to investigate the

claim before being required to recredit the member and 45 calendar

days in certain unique circumstances.

The credit union’s ability to investigate a consumer’s claim prior

to being required to recredit the consumer’s account is essential for

the credit union to avoid fraud losses from the new expedited recredit procedure.

In conclusion, most credit unions truncate their share drafts or

checks and have done so for decades. We remain supportive of the

current attempts to voluntarily facilitate check truncation and we

look forward to working with the Committee, the Federal Reserve,

and consumers in further strengthening this proposal.

I thank you for this opportunity to comment and I would be

happy to answer any questions.

Chairman SHELBY. Ms. Duncan.

STATEMENT OF JANELL MAYO DUNCAN

LEGISLATIVE AND REGULATORY COUNSEL

CONSUMERS UNION

Ms. DUNCAN. Good morning, Chairman Shelby and Members of

the Committee. Thank you for providing me the opportunity to

come before you today. I am Janell Mayo Duncan, Legislative and

Regulatory Counsel at Consumers Union. And my testimony today

on the proposed CTA is supported by the Consumer Federation of

America, the U.S. Public Interest Research Group, and the National Consumer Law Center.

We believe that in its current form the proposed CTA would be

bad for consumers for three important reasons. First, the proposed

legislation would eliminate the ability of an estimated 45 million

consumers to receive their original cancelled paper checks each

month. Second, the recredit provisions in the proposed CTA would

not protect all consumers whose check information is processed

electronically. Third, if enacted into law, the proposed comparative

negligence provisions would give banks an unfair ability to deter,

delay, or reduce claims for damages resulting from processes errors

by alleging that a consumer was somehow at fault.

Although we recognize the value of the advances in technology,

and we recognize what they could provide to consumers, we are

concerned that the proposed CTA would take a system that works

relatively well and change it in a way that imposes new risks on

consumers.

Those risks include: The inability to get original checks back in

order to prove payment or forgery. Potential improper account debVerDate 11-MAY-2000 13:23 Apr 01, 2004 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 92704.TXT SBANK4 PsN: SBANK4
20

its resulting from the double processing of a single check. Errors

in reading the amount of, or account number on, a check.

This proposal contains a loophole. Recredit is limited to consumers who receive substitute checks back from their banks. However, issuance of substitute checks is at the discretion of each back.

Although Section 6 of the proposed legislation requires a bank to put $2,500 in disputed funds back into a consumer’s account if the

matter is not settled in one business day, it would allow consumers

to seek recredit of disputed funds only if they receive a substitute

check from their banks.

Banks could prevent consumers from having the right to recredit

simply by not issuing them a substitute check. We believe that the

recredit provision should be mandatory and extend to all consumers, regardless of whether or not he or she receives a substitute

check.

Consumers unable to seek recredit would not be similarly and

adequately protected. They would have to seek redress under the

UCC provisions and State law that do not require a bank to redeposit disputed funds in consumer accounts and would require a

consumer to sue his or her bank over disputes. This is too expensive and time-consuming for consumers for most amounts likely to

be in dispute.

Although the proposed CTA has added warranty and indemnity

provisions, they also require a lawsuit to enforce. Because all consumers are equally susceptible to harm from processing errors, the

recredit loophole in the CTA should be closed and the right expanded to apply in every case.

The recredit provision is critical. Until a recent reversal, the

importance of the recredit provision has been recognized by the

Federal Reserve Board. The initial summary documents that were

included in the transmittal letter sent in December 2001, by Chairman Greenspan to then-Banking Committee Chairman Sarbanes

with the proposed CTA stated: ‘‘The expedited recredit procedure is

intended to mitigate the effects on consumers of any potential problems associated with the receipt of substitute checks.’’ It also

states: ‘‘These expedited recredit provisions of the proposed Act are

limited to consumers who are generally not in a position to negotiate with their banks the terms of their deposit accounts that affect the consumer’s rights and liabilities, such as how payments are

processed and charged to their accounts.’’

We, therefore, would strongly oppose any CTA without recredit

for consumers.

The proposed CTA contains comparative negligence provisions

that would allow banks to reduce the amount of damages a consumer can recovery by asserting the consumer was somehow at

fault. It is unlikely that a consumer could contribute to improper

check processing, but this provision could unfairly allow a bank to

deter or delay a consumer’s claim by asserting that a consumer was

partly responsible. The comparative negligence standard is inappropriate to resolve harm suffered by consumers and should be

removed from the proposed CTA.

I thank the Chairman and the Members of the Committee and

I look forward to any questions that you may have.

Chairman SHELBY. Mr. Buchanan.

21

STATEMENT OF DANNE L. BUCHANAN

EXECUTIVE VICE PRESIDENT

ZIONS BANCORPORATION

ON BEHALF OF THE

AMERICAN BANKERS ASSOCIATION

AMERICA’S COMMUNITY BANKERS

CONSUMER BANKERS ASSOCIATION

FINANCIAL SERVICES ROUNDTABLE AND THE

INDEPENDENT COMMUNITY BANKERS OF AMERICA

Mr. BUCHANAN. Good morning. My name is Danne Buchanan. I

am the Executive Vice President of E–Business Solutions at Zions

Bancorporation in Salt Lake City, Utah.

I am here today representing the six major banking and financial

services trade associations—the American Bankers Association, the

America’s Community Bankers, the Consumer Bankers Association, the Electronic Funds Transfer Association, the Financial Services Roundtable, and the Independent Community Bankers of

America. I am pleased to present the associations views on the concept of check truncation as envisioned by the Federal Reserve

Board’s proposal.

The associations believe that legislation to sanction substitute

checks will facilitate electronic check processing that will produce

significant cost savings, efficiencies, and new consumer conveniences, to the great benefit of both the consumers and the financial

institutions.

On behalf of the associations, I would like to extend our appreciation to Senator Shelby for holding this hearing. We also commend the staffs of the Senate Banking Committee and the Board,

who have worked tirelessly to address the concerns of the banking

industry, consumer groups, and others in moving this important

concept forward.

Check processing is a very expensive and labor-intensive process

that requires checks to be handled, sorted, and physically transported to the paying bank. Because of current law, paper checks

generally must physically move from the bank of first deposit to

the paying bank. The primary impediment to elimination of this

route is the fact that customers have the right to receive back their

original paper checks. The only exceptions when checks do not have

to be returned are unusual cases where the very largest banks with

the largest check volumes have reached private agreements. Such

arrangements and check truncation are out of reach for small institutions, rendering the technology largely unusable for them.

At our bank, over the last 2 years, we have been truncating original items for payments and creating substitute checks. We have accomplished this with two-party agreements between Zion’s Bank

and its customers. I am pleased to let you know that this process

works. We have had few customer inquiries and have successfully

dealt with every issue or question posed by a paying bank.

Keep in mind that many customers today do not receive their

checks back with their statements. Informal industry assessments

indicate that more than 30 percent of all checks drawn by bank

customers, and nearly all checks drawn by credit union customers

are not returned to the check writer.

22

It is important to note that these are sufficient for consumers.

For example, images are routinely used and accepted as proof of

payment for tax records. Original items are rarely requested or

needed. This fact is critical because many of the objections raised

by consumer advocates about the broader check imaging envisioned

under the Board’s proposal exists today, but in fact present few, if

any, problems.

Electronic check processing has the potential to streamline the

collection of checks, reducing processing costs, and minimize the

effect of unexpected disruptions to air and ground transportation

systems. No longer would a bank in California have to ship a check

drawn on a New York bank across the country.

Improving the check clearing process may also allow banks to develop new banking services. For example, image-capable ATM’s

that can forward deposits electronically will allow banks to deploy

more ATM’s in remote locations as the cost and frequency of physically retrieving deposits and servicing ATM’s could be reduced.

Consumers may be able to use these ATM’s to cash payroll checks

at their place of employment, which may be particularly attractive

for those without bank accounts.

The proposal would also serve to promote check imaging technology by adding another positive weight to the business case for

adopting check imaging generally.

For example, a more recent application of check imaging allows

their customers to view check images online. Customers who do not

bank online also benefit from imaging because customer service

representatives can quickly bring up for view images to verify

transactions for the customer. This requires a fraction of the time

typically required to research microfilm or physical archives and

transmit copies.

Finally, the proposal could provide real benefits to rural community banks and their customers. This proposal would allow rural

community banks to transmit electronic images of checks that can

be used for clearing and settlement with their existing systems,

regardless of weather, transportation constraints, or distances to

processing centers.

The associations support the concepts outlined in the Board’s

proposal. However, we strongly believe that the provisions related

to expedited recrediting for consumers are unnecessary and will not

only facilitate, but also, indeed, encourage fraud. We believe that

existing check law provides appropriate and adequate protection to

consumers with respect to substitute checks.

The banking industry and consumers have an established history

with truncated checks and imaged documents. Indeed, millions of

consumers have been receiving either images or a notation in their

statement for years, without complaint that disputes are not addressed satisfactorily. The current check law works in a truncated

and image environment. There is simply no evidence to justify deviation from existing check law.

Consumer representatives complain that consumers need protections above and beyond what is provided today because they will

be at a disadvantage if they receive substitute checks rather than

originals. However, the situations they cite have existed for many

years in the truncated environment without adverse consequence to

23

consumers. For example, consumer groups express concern that it

will be up to the consumer to persuade a landlord or another person to accept a substitute check as proof of payment.

Again, today, by the time consumers request a check, it is likely

to have already been destroyed in a truncated environment, as was

mentioned earlier by the credit unions. Moreover, under the proposal, substitute checks will bear the legend, ‘‘This is a legal copy

of your check. You can use it the same way you would the original

check.’’ We believe that this will convince landlords and others of

the legal equivalence of the check.

In addition, consumer groups also demand that the expedited recrediting provisions of the proposal extend to all truncated checks,

including those provided today. They argue that consumers will be

confused because the rules for dispute resolution for those who receive images voluntarily, as they do today, will be different from

those who insist on substitute checks. The need for consistency argues for retaining current check law. Since existing check law has

a long, proven record of success in the truncated environment, if

a single consistent rule is adopted, it should be based on proven

check law, not a new law that, arguably, will promote fraud.

The trade associations support the general principle outlined in

the Board’s proposal to facilitate innovation in the check collection

system. We believe, however, that existing law and regulations are

both effective in protecting consumers and minimizing the banking

industry’s exposure to fraud.

We hope that Members will also take this opportunity to improve

the efficiency of the U.S. payments system by quick passage of this

proposal.

Thank you.

Chairman SHELBY. Ms. Alexander, you have indicated that most

customers who do request copies need them as proof of payment.

Ms. ALEXANDER. That is correct.

Chairman SHELBY. Have your customers ever run into any problems using the copies for this purpose?

Ms. ALEXANDER. No, Mr. Chairman, not that I am aware of. Although I do not get the volume of complaints that Mr. Ferguson

does, I get a lot of complaints that reach me. I have never had a

complaint from a member that they could not get an original.

Courts accept good images. The IRS accepts good images. We have

never had a problem with that.

Chairman SHELBY. You have answered my question. The next

one was the IRS audits and other reasons.

Ms. ALEXANDER. Yes, they do.

Chairman SHELBY. They accept the images?

Ms. ALEXANDER. Yes, they do.

Chairman SHELBY. Mr. Buchanan, today, among other things, we

have discussed how some banks, which have agreements with other

banks, already use electronic transmissions to clear checks. What

happens to the original checks in these cases?

Mr. BUCHANAN. In the current environment, the physical documents still follow in these environments. But then the checks, if

the checks are not returned to the consumer, they are truncated

and destroyed after a period of time.

24

Chairman SHELBY. What can you tell us about consumers’ desires to get copies of these checks? You alluded to it earlier.

Mr. BUCHANAN. Well, within our own bank, we still receive requests for copies of checks, some that the consumer may have even

lost, for record of payment. We think that the banking industry has

always responded efficiently to those requests and rarely receive

problems around those issues.

Chairman SHELBY. Are you aware of any problems associated

with consumers having to use copies of the checks rather than the

original checks?

Mr. BUCHANAN. No, sir. I am unaware of any problems with that.

Chairman SHELBY. Ms. Alexander, how many customer complaints does your credit union receive regarding their checks? Just

your judgment.

Ms. ALEXANDER. Regarding copies or just checks in general?

Chairman SHELBY. Yes.

Ms. ALEXANDER. I have not seen one in 14 years. I have not had

a specific——

Chairman SHELBY. In 14 years?

Ms. ALEXANDER. Yes. Not a specific complaint about receiving a

check copy.

Chairman SHELBY. So, you do not have any complaints at all

about them that you know of?

Ms. ALEXANDER. I may, that have not reached me. I think that

earlier on, when we did not image, it took longer to get a copy of

a check and I did have some complaints about that. Now it is immediate.

Chairman SHELBY. Do you have any other complaints about

checks other than just trying to get a copy?

Ms. ALEXANDER. I would say that, on the whole, the complaints

about our checking-account services are very low.

Chairman SHELBY. Okay.

Ms. ALEXANDER. We have very good services.

Chairman SHELBY. Does the use of imaging enable you to resolve

just basic complaints more quickly than a paper-based system?

Ms. ALEXANDER. Absolutely.

Chairman SHELBY. It is quicker, is it not?

Ms. ALEXANDER. Absolutely. Very quick.

Chairman SHELBY. Ms. Duncan, you have testified that the right

of recredit should be expanded to apply in every case where the

original check is not returned to the customer. This would affect

even those customers who have already agreed with their bank to

not receive paper checks back. What information, what data can

you provide us here at the Committee regarding consumer complaints involving their checks?

For the record. In other words, I will ask it again. What information can you provide to the Banking Committee here regarding consumer complaints involving their checks?

Ms. DUNCAN. Well, I think quite a bit of your focus already has

been on image quality. And certainly, consumers do not have problems when they receive checks, as long as the image quality is

good. If they need proof of payment, if the image quality is good,

oftentimes——

25

Chairman SHELBY. Have you seen this, that the Fed gave us just

awhile ago [indicating]?

Ms. DUNCAN. I have not yet seen that.

Chairman SHELBY. I do not know what the other image is. This

is real clear, and I guess it depends on——

Ms. DUNCAN. What we are concerned about is those case where

a check image is not clear. Actually, I have a copy of a letter here

that I was cc:ed on, that was sent to the Chairman and to Senator

Sarbanes yesterday. It is from a lawyer in San Francisco who represents low-income clients who experienced a great deal of harm

and stress based on the fact that the best copy they could get of

a mortgage payment they claimed to have made was a microfiche

and was unreadable.

Basically, just in summary, they paid their mortgage. Their bank

destroyed the original check, as was the practice. They told the

mortgage company that they had paid it, got a copy of the microfiche, presented it to the mortgage company. The mortgage company said that this was not acceptable because it was not legible.

Then the mortgage company turned the case over to a collection

company and foreclosure proceedings were initiated.

We are concerned that this may be the tip of the iceberg. This

is just a microfiche copy and the way that it is done now. The system that we are talking about would have images converted in and

out of electronic form. So, yes, that is one of our concerns.

Chairman SHELBY. I would agree with you that the imaging

should be legible. You should be able to read it. But there has been

tremendous breakthroughs in imagery technology. The digitization

of images would replace what you are talking about, the microfiche,

and would be much better, I believe.

I am just looking at what the Fed gave us up here.

Ms. DUNCAN. We welcome improvements in technology.

Chairman SHELBY. You are right in this regard. The technology,

the imaging has to be clear.

Ms. DUNCAN. Yes.

Chairman SHELBY. You have to be able to read it. Otherwise, I

do not guess you can have proof of anything.

Ms. DUNCAN. Right.

Chairman SHELBY. But if you have some other information regarding, other than this one instance, furnish it to the Committee.

Will you do that?

Ms. DUNCAN. We will furnish any additional information that we

receive.

Chairman SHELBY. Do you know how common these complaints

are? I guess that is what——

Ms. DUNCAN. Our main concern here is there is a consumer protection provision within the proposed legislation, and it anticipates

certain events.

We just think that if you were going to anticipate consumers

having a double processing—and it is more likely when you have

an electronic image and a substitute check going through the system, it is more likely than you would have today with just a paper

check going through the system. We would just like to see it applied to all.

Chairman SHELBY. But you cannot hold back technology.

26

Ms. DUNCAN. And that is not what we are suggesting.

Chairman SHELBY. I know. Okay.

Ms. DUNCAN. We are just suggesting that consumers receive adequate protection.

Chairman SHELBY. Sure.

Ms. DUNCAN. Somewhat similar to the Regulation E that governs

debit card transactions and electronic transactions today.

Chairman SHELBY. Sure.

Mr. Buchanan, are you aware of consumers having difficulty getting access to their checks, digital images of checks?

Mr. BUCHANAN. No. In fact, if I could comment about the earlier

message around microfilm.

I think that what we are talking about here is looking at an old

medium and we can actually improve upon that. I think things like

microfilm and microfiche potentially have more problems than

what the imagining technology is.

Chairman SHELBY. But these are dated technologies.

Mr. BUCHANAN. Exactly. We think that this is a dramatic improvement and that the quality of those images in terms of storage

and retrieval would be far better. We are unaware of any issues or

problems around that.

Chairman SHELBY. How do we get the banks to get up to the digital world on imaging? That is important, too, for uniformity.

Mr. BUCHANAN. Well, I think that there are a couple of beneficial

things with this Act.

One is that if a bank chooses not to have to adopt image technology, the process still works with a substitute check. I would say,

though, that the way our system works, those who do not adopt

would be forced to through the competitive environment because

people will clear checks against those banks quicker, which we

think the marketplace will force adoption.

Chairman SHELBY. Ms. Alexander, your written testimony indicates that your credit union currently receives checks back from

the Federal Reserve Bank, but that you are undergoing a process

to convert to an all-electronic system. What made you decide to

make that conversion? What will that conversion cost your institution? And do you expect to save money over the long run?

Ms. ALEXANDER. We are constantly looking for ways to expedite

the process and to also reduce our costs. I do not have an actual

figure on what it will cost us. We know that doing transactions

electronically is less expensive than actually handling the paper.

Chairman SHELBY. But do you know how much less expensive?

Can you furnish that to the Committee?

Ms. ALEXANDER. I can furnish that later, yes.

Chairman SHELBY. Just give us a benchmark.

Ms. ALEXANDER. I could. I am sorry I do not have those figures

with me.

Chairman SHELBY. Okay.

Ms. ALEXANDER. We know it will be less expensive and we are

looking for ways to not have to handle the paper checks.

Right now, we do actually, once we receive the checks back from

the Fed, we have to process them through our equipment. We are

trying not to do that and looking to the Fed for ways to facilitate

27

not doing that. And we know that it will be faster and it will also

be less expensive for us in terms of staff.

Chairman SHELBY. Mr. Buchanan, one last question. How many

smaller or community banks pursue the alternative of savings from

the electronic process? And what are the potential savings from

moving away from the paper system?

Mr. BUCHANAN. We think that the savings are substantial, and

let me give you some examples within our banking system in Utah.

As Senator Bennett mentioned, we have many rural communities. Many of those communities we cut off at 1:00 in the afternoon

to be able to make deliveries to get them to our item processing

centers to clear checks.

Chairman SHELBY. And you wouldn’t have to do that.

Mr. BUCHANAN. We wouldn’t have to do that any longer. We

would be able to provide our customers longer time frames to be

able to conduct their banking, make their deposits, make their payments, and at the same time improve the process dramatically by

not having to physically transport these items around the Nation

and deal with them on a manual basis. So, we think the savings

will be substantial.

Chairman SHELBY. Senator Bennett.

Senator BENNETT. Thank you very much, Mr. Chairman.

Ms. Duncan, I would get a hold of the lawyer and say, microfiche

technology is 30 to 40 years old. And I do not anticipate any bank

or credit union utilizing that under this legislation. Any bank that

would try to use microfiche to take advantage of check truncation

is living in the Dark Ages. It is just incredible to me that anybody

would even bring it up as a possible way of handling this right

now. I mean, I am sure the incident occurred.

Ms. DUNCAN. It is old technology. And our concerns really are

making sure that consumers have adequate protections. Speaking

of actually things that have been around for a while, the UCC was

created quite a while ago. There are protections that were created

today with the types of issues that we are concerned about in mind.

And as I mentioned, Regulation E has a 10-day right of recredit,

and it has an unlimited amount. It is unlimited in a dollar amount.

So, we would like to move forward. We would like to look at things

considering the technology of today. We would like consumers to

have protections, taking current technology into account.

Senator BENNETT. Let me just state a general thought that has

occurred to me.

Mr. Buchanan, of course, the hometown excitement is here. You

come from Utah, so, automatically, we are very proud of you.

[Laughter.]

But I do not recall any time in the history of this Committee that

the ABA, the ACB, the CBA, the Roundtable, and the ICBA—those

alphabets do not mean anything to most of you—but this is virtually every banking organization in the world, have been satisfied

by a single witness.

They always insist on coming in, each with a slightly different

take on things. I think this is the first time in the history of this

Committee that we have had that kind of unanimity. And then to

have the credit unions sitting at the same table with the same

view, maybe we should declare peace in our time.

28

[Laughter.]

And to move forward on this. I think it is extraordinary that we

have had this kind of unity here.

So, we come back to you, Ms. Duncan. You have heard the testimony here this morning from Governor Ferguson and then from

Ms. Alexander that says that there is virtually no double charging

going on and that this problem simply does not exist.

It would seem to me that the burden would fall upon your organization to tell us, A, their figures are wrong and give us surveys

that demonstrate that there is a fairly high level of problem here.

Or B, how the adoption of the kind of technology that Mr.

Buchanan’s bank is using would suddenly create problems that

aren’t there.

Now is that an unfair question on my part? I want to be as fair

to you as I possibly can. But it seems to me, listening to this, that

the burden falls on you to say either, A, they are wrong and there

are a lot of problems, or, B, okay, there aren’t any problems, but

there will be if we go in this direction.

Ms. DUNCAN. Well, it is my understanding that the organization

that Ms. Alexander is here to represent also supports the recredit

provisions as they stand.

I think what we are talking about here is the fact that this will

be a new system. The way credit unions do what they do today, a

check is truncated at your bank. At the credit union, you can walk

right into your credit union and say, I would like to see a copy of

my check, the best copy you have.

What we are talking about here is, a consumer’s original check

will be stopped somewhere back in the process where, with a bank

or an institution, the consumer may not have a relationship with.

And so the recredit provisions that we would like to have to apply

to everyone will just incentivize their own bank to do whatever investigation is necessary to find out what happened if there has

been some error.

We are talking about just incentives. We are talking about consumers and the real-life obstacles that they face. Bureaucracy in a

financial institution may well be one of them.

So this is what we are talking about. It is just an incentive to

balance this legislation so that consumers will have more of an

ease to resolve any disputes.

Senator BENNETT. My only problem with what you are saying is

that the testimony we have heard says that those problems now do

not exist, that there are—Governor Ferguson said zero. He did not

say a small percentage. He said zero. And Ms. Alexander said, at

the beginning, she remembered a few instances where the image

wasn’t good, which would recall microfiche; but that in the last 14

years, it is zero.

Mr. Buchanan, as I understand the technology, a customer could

do exactly what Ms. Duncan just said, could walk into your bank,

even if the truncation occurred some place else, and your bank

would have electronically the ability to generate the image and say

to the customer, here is a substitute copy of your check. Isn’t that

correct?

Mr. BUCHANAN. That is correct, Senator.

29

Senator BENNETT. So it doesn’t matter where in the system the

truncation occurs. The fact that the information is being shared

electronically means that the customer has more control than they

do now because if you depend entirely on the printed check now,

the chances of that printed check getting lost somewhere in the

system are much higher than the chances of the electronic check

getting lost.

We have had hearings in this Committee about identity theft.

And one of the main ways people get a hold of your identity is by

simply stealing your mail. And there is a check, there is a credit

card application, and so on, and they just go out and steal mail

without regard to what is in it, hoping as they go through it that

they will find a financial document which they can then use.

This says, you cannot steal it. You can steal all the mail you

want, but the image of your check, wherever it got truncated, is

available at your bank.

It would seem to me that consumers would like that because it

would reduce the chances of fraud. It would increase their opportunity to control their accounts, for the circumstances you are appropriately concerned about, rather than going the other direction.

I am having a hard time understanding why Consumers Union

is against this because everything that I see in the real world says,

this is going to make security of consumer information substantially higher than it is today, and it is going to lower costs, which

can only benefit consumers in the long run as well.

Now help me understand where I am off base here because I am

trying to do the right thing for the consumer.

Ms. DUNCAN. Right. Our concern is to ensure that consumers are

adequately protected, and we would like to have the protections

available to all consumers. That is our concern. This will be a new

system. And the system as it stands right now poses different problems and has different risks and benefits for consumers.

As I said earlier, you walk into your bank. You can get a copy.

In the truncated system, in this new system, the copy at your bank

may not be the best copy available. They might have to trace back

up through the system to find the best copy available, which may

be——

Senator BENNETT. There is no evidence that that is the case.

Isn’t that true, Mr. Buchanan, that the copy that you get from the

bank in many ways might be better because it hasn’t been handled

and crinkled?

Mr. BUCHANAN. Again, I think I would go back and say in the

current environment, you would be relying on microfilm or microfiche instead of an image document. In any case, an image is going

to be better than those alternatives.

Senator BENNETT. Thank you.

My time is up. However, I really have a problem understanding

why there is a problem because, as I see it, the consumer would

have access at more places to the information. The information

would be protected from intrusion. It would be protected from physical deterioration.

I have 6 kids and 17 grandkids and the checks can disappear.

My 2-year-old grandson can go through the house and all kinds of

things disappear.

30

[Laughter.]

And I have a sense of comfort knowing that it is preserved electronically in the bank and that I can go there at any time and get

whatever I need.

Thank you, Mr. Chairman.

Chairman SHELBY. Senator Allard.

Senator ALLARD. I have a question for Mr. Buchanan.

Obviously, the proposal would involve new systems and equipment. I have some bankers in my State of Colorado that provide

services in communities that are pretty small. They operate more

on the lower margin. Will this pose a burden for small independent

community banks? And how can we assure a smooth transition?

Mr. BUCHANAN. Yes. Let me address that a couple of ways.

One of the great things about this bill is it does not force banks

to adopt imaging technology. As I have mentioned, I think the marketplace will force that, for them to remain competitive.

But let me go to your question about——

Senator ALLARD. Before you move on, I would like to pursue that

question a little further.

Mr. BUCHANAN. Sure.

Senator ALLARD. We may not have a mandate in the bill, but

where these gets centrally cleared, they may say, well, you have to

bring your system up to standards. We are not going to take these

unless they are electronically checked. So, we are not going to accept it. Do you see what I am saying? In effect, it becomes a mandate because somebody at the central clearing point may refuse to

accept it unless the individual banks adopt that technology.

Mr. BUCHANAN. The item would look exactly as an original.

Senator ALLARD. Yes.

Mr. BUCHANAN. So there is no way to really force that without

stopping any original check from coming through the system, which

I think is unlikely.

But with that being said, let me move to your other question

about the cost for small banks.

One of the great things with technology right now is that it is

very affordable. We have scanning devices that we can implement

for branches that start at $700, moving to the low couple of thousand dollars, and then on up. And so, there is no evidence that we

can see that only large banks can participate in this. In fact, I

would say that small banks have a competitive advantage in being

able to move quicker than a large bank will be able to move. And

cost will not be an issue for them.

Senator ALLARD. Thank you, Mr. Chairman.

Chairman SHELBY. Senator Sarbanes.

COMMENTS OF SENATOR PAUL S. SARBANES

Senator SARBANES. Thank you very much, Mr. Chairman.

Ms. Duncan, I am interested, first of all, in whether, under the

proposed legislation, consumers would lose protections they now

have under the UCC?

Ms. DUNCAN. The proposed legislation does not necessarily—well,

yes, it would. And the concern actually is—the proposed legislation

has a comparative negligence provision which is actually broader

31

than what the UCC is. It would establish—somehow, if the consumer is at fault, that their damages could be reduced.

Under the UCC, as it stands for checks, the comparative negligence provisions really apply to areas that a consumer has control

over, such as paying attention and making sure that there are not

a series of fraudulent or forged signatures on their checks. So it

would expand comparative negligence in a way that is not in current law.

Senator SARBANES. So the proposal, as I understand it, would in

fact diminish consumer protections on the comparative negligence

issue. Is that correct?

Ms. DUNCAN. That is correct.

Senator SARBANES. Does anyone at the panel disagree with that?

Mr. BUCHANAN. I am not sure that I have a comment about that,

knowing it well enough to comment.

Senator SARBANES. All right. Now, of course, it is not necessarily

the case that the existing protections for consumers are adequate.

So, I do not know that that is necessarily the baseline that one

should operate from. That leads me to my next question. And that

is the question of expedited recredit for consumers. What is your

view of the provision in the legislation on that issue?

Ms. DUNCAN. We believe that the recredit provision is inadequate

because it does not apply to all consumers whose check information

is processed electronically. And we also believe that consumers are

not adequately protected. Those consumers that do not have the

ability to benefit from recredit are not adequately protected because recredit is a simple nonlitigation remedy, and consumers who

are not protected would be required to sue their banks, which

would be a very big burden on consumers for the amounts we are

talking about.

Senator SARBANES. Ms. Alexander, Mr. Buchanan, do you want

to comment on that issue?

Mr. BUCHANAN. Our belief, from an industry standpoint, is that

it is unnecessary. It does create fraud risk in that if you have an

immediate recredit provision, that what it does is promotes the

ability for fraudsters to take advantage of the system. It also creates a regulatory burden for the banks that we believe is unnecessary and is covered very well and handles all the consumer issues

with current UCC law.

Ms. DUNCAN. May I respond?

Senator SARBANES. Certainly.

Ms. DUNCAN. Our concern is that the UCC—I am sorry. I lost my

train of thought.

Senator SARBANES. Well, let me go to Ms. Alexander and see if

she wants to add anything to Mr. Buchanan’s comments?

Ms. ALEXANDER. Actually, I would echo Mr. Buchanan’s comments. We believe that the recredit provisions are sufficient as they

now stand.

In our own credit union, we have experienced a 256 percent incident increase of check fraud in the last 5 years. Two days, which

was the original proposal, is simply not enough time to be able to

determine whether or not that check is legitimate. We believe, as

it stands now, is what we would support.

Ms. DUNCAN. I have regained my thought, if I may.

32

Senator SARBANES. All right. I thought you might.

[Laughter.]

Ms. DUNCAN. Thank you. We believe that banks are adequately

protected, if not overly protected, in the legislation. Banks are not

required to recredit in instances where they believe that fraud is

an issue. They are not required to recredit in areas where there is

a new account, where there has been a negative balance. And a

bank is also able to reverse a recredit where they believe that there

is a problem.

So, we do think that that particular issue is well-addressed in

the legislation and it balances the consumer’s need for recredit.

And to remove recredit would just be a negative impact on consumers and that provision should apply to all.

Senator SARBANES. Now to what extent has the privacy question

been addressed in terms of this new technology? We are seeing new

technology being developed all the time. And every time it happens,

we seem to have another potential serious incursion into people’s

privacy.

Of course, electronic documents have the advantage of being

easily transmitted. I understand some of the benefits of that. But,

presumably, this is going to result in the creation of a large electronic database, which will have a lot of information in it about the

consumer and his check writing habits. That is a valuable store of

information. How is that privacy going to be protected?

Mr. Buchanan.

Mr. BUCHANAN. I would say that the current process has all of

the information you are talking about anyway, and I am not aware

of problems around that. And I would also suggest that the new

process would eliminate manual steps and handling that, in fact,

would enhance privacy, not diminish it.

Senator SARBANES. How in the current system do you create a

database which can be either sold or exploited for other purposes

which fully identifies the consumer’s spending practices?

Mr. BUCHANAN. Well, banks today currently are able to retain

images. And so many banks already retain those images, as we

have discussed. For instance, there is a company by the name of

U–Point that stores images for banks like Bank of America, Chase,

Zions, First Tennessee, and others. The data is currently available.

I am not aware of any consumer privacy issues around that, or

banks using that inappropriately.

Senator SARBANES. So what do the banks do with this stored

information?

Mr. BUCHANAN. Primarily, it is used for a couple of things.

One is for customer service aspects. If a customer calls up and

says, I would like to see what this check was from 3 months ago,

it can be easily retrieved. Going back to the comment about being

able to go into a branch and request a copy of a check, those images are retrieved from those types of devices.

Senator SARBANES. And what other purposes?

Mr. BUCHANAN. The other purpose would be for Internet usage.

So if I am a consumer at home, I may want to be able to look at

my last 30 days’ checks and retrieve those images online.

Senator SARBANES. Are the banks currently using these checks

to identify consumer spending patterns and then to use that inforVerDate 11-MAY-2000 13:23 Apr 01, 2004 Jkt 000000 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 92704.TXT SBANK4 PsN: SBANK4
33

mation either themselves or—to either sell or convey it to others

to be used for various marketing purposes?

Mr. BUCHANAN. I could not speak for all banks. I can tell you

that at our bank, we do not use it that way.

Senator SARBANES. But you do not know if other banks do so?

Mr. BUCHANAN. No, sir, I do not.

Senator SARBANES. Would it be easier to engage in that activity

if this material was being stored electronically?

Mr. BUCHANAN. I would suggest again that if a bank wanted to

do that, they could currently do it, and have had that ability for

quite some time.

Senator SARBANES. But they would have to add another step.

Whereas, you are now going to substitute or introduce this technology, so it will be done not for that purpose, but for the purpose

of the truncation, to gain the advantages that are sought in this

legislation, which we recognize.

Then, having done it for that purpose, they will have this database then available for other purposes. They do not have to go

through the extra step. Isn’t that correct?

Mr. BUCHANAN. Let me try and address it. I think there is——

Senator SARBANES. Let me first just make sure I am correct.

Then they would not have to go through the extra step. Correct?

Mr. BUCHANAN. I think that there is confusion between storage

and clearing. And what this Act primarily relates to is creating efficiencies in the clearing system not relating to storage of data.

Banks currently store vast amounts of data that could be used

in that way. This Act really is related to making efficiencies in our

clearing system with the use of substitute checks so that those

physical items never need to flow through to the paying banks.

So, I do not believe that it changes the dynamics from a privacy

standpoint, and I do not think that it even requires additional

steps from a privacy standpoint. This is really related to clearing

and not storage.

Senator SARBANES. Would the industry support check truncation

if there was a very strong rule that check images could not be used

for any purpose other than check processing, dispute resolution,

and consumer requests?

Mr. BUCHANAN. I would like to address that with the industry

and not speak for them off the cuff. So, I would like to get back

to you on that question.

Senator SARBANES. I take it that that means that giving a simple

yes to its limitation for those purposes, that would create problems.

You are not comfortable with that. Is that correct?

Mr. BUCHANAN. I am not saying it would create problems. I am

just saying that if I were to speak for my institution, I would answer one way. I do not know if I would feel comfortable answering

for the entire institution.

Senator SARBANES. Presumably, for your institution, the answer

would be yes. Am I correct?

Mr. BUCHANAN. I think that from our institution’s standpoint, we

would like to use the data in the same ways that we currently do,

which falls within——

Senator SARBANES. Which goes beyond these objectives that I discussed, that I mentioned?

34

Mr. BUCHANAN. No, no.

Senator SARBANES. It stays within them?

Mr. BUCHANAN. It stays within them.

Senator SARBANES. Okay. Thank you, Mr. Chairman.

Chairman SHELBY. Senator Carper.

COMMENTS OF SENATOR THOMAS R. CARPER

Senator CARPER. Good morning. Thanks for joining us this morning. I apologize for missing your testimony, but I will have a

chance to read it later, and I actually will. I know that some people

find this subject boring, I am told; but I really find it actually

pretty interesting.

When I was a pup of a Congressman back in the House of Representatives serving with then-Congressman Shelby, I think the

first bill I ever introduced was legislation dealing with the availability of funds. When we deposit checks into our accounts, how

quickly can we have access to those monies.

I have a question. Mr. Buchanan, I will start with you, but I

want to ask the others to respond as well.

I am pleased that today, people have quicker access, quicker

availability of funds when they deposit checks than used to be the

case, say 20 years ago. I want to make sure that if this legislation

were enacted, that we do not somehow set the clock back and, if

anything, that we could actually make availability of funds maybe

expedited even further for people who deposit checks into their accounts. Can you tell me how this legislation relates to the availability of funds and our ability to make use of the funds when we

have deposited a check?

Mr. BUCHANAN. Yes, I can. I think if you go back to my earlier

example about rural communities within Utah and Nevada, for instance, as I mentioned earlier, the way that the process works is

that a branch needs to be cut off at a certain time to be able to

make the physical transportation deadlines. That can be, say, 1:00

in the afternoon for some of our branches.

With this technology, we believe, and we would implement within our environments the ability for consumers to make deposits up

until the branch closure, which could be 8:00 at night for some of

our banking centers, which would then provide them the ability to

earn interest on those funds a day earlier, to have their payments

posted sooner and their deposits made the same day, instead of

being held over for the following banking day.

Senator CARPER. Let me say to Ms. Duncan and Ms. Alexander,

in considering this legislation, I am interested in how this legislation is not just going to help financial institutions. I think it is

pretty clear how it would help or be advantageous to the industry.

But I am looking for ways that this legislation could actually be of

benefit to consumers. And this would appear to me, at least at first

blush, to be a plus for consumers. Am I missing something there,

or do you see it that way, too, at least this aspect of it?

Ms. DUNCAN. The faster the availability of funds would certainly

be a potential benefit of the legislation. It certainly is not included

as a requirement for part of this legislation. So, we would definitely

want to make sure that if this does become a possibility, that it becomes a reality.

35

Senator CARPER. How might that happen?

Ms. DUNCAN. Well, there are two possibilities.

The banks would—it is within their purview whether to make

the funds available faster. We would want to see that happen. In

addition, if it becomes possible for funds to become available faster,

then the Fed can take a look at this. And we want them to take

a hard look at it if the legislation were to become law, to see if

there is an ability to make the funds available faster and possibly

change the regulations governing funds’ availability to make sure

that consumers are benefiting from this.

Senator CARPER. Thank you.

Ms. Alexander, any comments?

Ms. ALEXANDER. Well, I would agree certainly that the funds’

availability to consumers is certainly going to be a benefit, a side

benefit of this legislation and other legislation that may follow.

We would be able to make funds available to our members much

more quickly. I also think in the longer term, that overall expense

of offering checking accounts may come down as well. It is less expensive to offer electronic transactions than over-the-counter teller

transactions and other types of transactions that require human

beings.

Senator CARPER. Can you quantify that at all in terms of the

order of magnitude?

Ms. ALEXANDER. We offer online banking to our members and

they are able to transfer funds, create a check, access check images, do any number of things in the online banking environment. It costs us approximately a little over $3 to serve a member at

a teller counter. It costs us about 45 cents for a member to actually

access his account and do a transaction with online banking. So as

a not-for-profit institution, credit unions look for ways to reduce

costs and ultimately return those back to the members. We see this

as being able to ultimately offer something along those lines because we will be able to restructure pricing.

Senator CARPER. Let me just ask the others, are there other

examples in this legislative proposal that would also inure to the

benefit of consumers, or at least have the potential of inuring to

the benefit of consumers?

Mr. BUCHANAN. Yes, I could give a couple more.

Another example would be ATM usage, which I mentioned in my

testimony, where consumers would be able to make deposits in

ATM’s, which have again the same type of cut-off time frames in

making a deposit. And we believe that those capabilities would be

far expanded again over the current availability for consumers.

Another example would be where, again, rural commercial customers that need to drive to the bank every day to make their

check deposits would no longer be required to do so. They could actually truncate those checks at those commercial enterprises and

move the images through the clearing system.

Senator CARPER. How would that work?

Mr. BUCHANAN. We actually have a system that Senator Bennett

has seen that provides for the scanning of the image and the voiding and making the image, the actual original item, nonnegotiable,

and then moving the image through the clearing system and providing significant benefits to commercial customers.

36

Senator CARPER. Ms. Alexander, as I understand it, the credit

unions have had for some time the ability to truncate checks. What

have you learned from that experience with your industry that we

should put to use in this instance?

Ms. ALEXANDER. Well, credit unions truncate the checks at the

very end of the process. We do not return checks to members as

most banks do. In fact, when we were permitted in 1977 to offer

checking accounts, we weren’t allowed to return them. That has

since changed.

But we have done a very good job of educating our members that

in most cases, they do not really need the paper checks back. If

they do, we are able to provide them a very clear and legible copy.

In the early days, we actually did provide them back with the

original if they needed it. Now, we provide them an imaged copy.

My members, they do need to request copies once in a while. It is

not frequent. When they do, we can provide it immediately, which

is faster than we could have if we gave them the paper check.

We feel that the service has actually improved. Our members do

not see the need to have the checks returned and we have not been

returning them. We never returned them. And we have been offering checking accounts at my credit union since about 1978.

Chairman SHELBY. Senator Bennett, any other questions?

Senator BENNETT. Yes. But just a comment to Senator Carper.

I made reference to a study that was done by the Minneapolis

Federal Reserve Bank that indicated that this would save $1.75

per transaction. I did the math and that is $73 billion a year. And

given the conversations that we are having around here, if you

multiply that by ten, that is $730 billion, which, by coincidence,

just happens to be the size of the President’s proposed tax cut to

stimulate the economy.

[Laughter.]

So if we could have the same kick on the economy by passing

this legislation that we could have by passing the President’s tax

bill and not have to worry about the deficit, I think it is a legitimate thing that we should do.

Senator CARPER. I thought you were going to say, we wouldn’t

need the President’s tax cut.

Senator BENNETT. No.

[Laughter.]

Close, but no cigar.

[Laughter.]

I want to come back to what I was doing in the previous round,

and I do not want to beat this to death, but Senator Sarbanes’

questions raised it once again: The issue of privacy.

Hearings before this Committee have indicated that identity

theft and concern about privacy comes from the present situation,

where there is access to a physical financial institution, that people

steal mail in order to get a financial instrument.

And just to nail this down, is it not true, and my understanding

of it, is it not true that exposure to identity theft from those who

would move into the area of privacy would be eliminated by the

kind of system that Mr. Buchanan has indicated. I have seen it operate. I have seen it work. My understanding of it is that consumer

37

privacy would go up very substantially as a result of application of

this system.

Now that is as soft a ball as I can give you, Mr. Buchanan, but

I think it is an important one for everybody to understand. Could

you expand on that?

Mr. BUCHANAN. Yes, I would agree. Again, I think that by eliminating the need to move these items around in the system, and

being able to truncate checks, we would enhance privacy, not diminish it. And so, I would echo your views.

Senator BENNETT. Ms. Alexander.

Ms. ALEXANDER. I would just like to comment. I would tend to

agree. In fact, at my credit union, it is much harder for my staff

to get an image of a check. It is a two-password system on a separate server and much more secure than the paper checks that are

put in with the daily work and locked in a drawer. And to me, it

seems that the overall privacy issue is strengthened by this kind

of a system. It is just harder to get those images than it is anything on paper.

Senator BENNETT. Ms. Duncan, do you have a reaction to that?

Ms. DUNCAN. I would just be concerned that we take a close look

at the storage of this information. To the extent that the information might be aggregated, might be potentially mined for information, that would be available for somebody who had a nefarious

intent. The identify theft type——

Senator BENNETT. In what way would it be available that it is

not available now?

Ms. DUNCAN. Actually, you make a good point. There is a lot of

electronically stored data as it stands right now. This would just

increase the amount and possibly increase the risk for consumers.

Senator BENNETT. I do not want to be argumentative, but I do

not understand how it would increase the available data. Let me

walk through what I have seen because maybe we are talking past

each other here.

A merchant in a Delaware town——

Senator CARPER. Where we have no sales tax.

[Laughter.]

Senator BENNETT. Yes. Okay.

[Laughter.]

A merchant in a Delaware town at the end of the day has a series of checks. And under the present situation, he adds all those

checks up, makes a handwritten deposit slip, puts them in a bag,

and carries it to the bank and deposits it in an overnight depository and it gets opened the next day.

Under this system, the merchant sits there, he has a little black

box. He runs the check through the black box and then he locks

the check up.

It is transmitted instantly and electronically to the bank, which

means it is in the merchant’s account that night. It doesn’t get

there the next morning. The availability of funds is there. The

bank then has that electronic information, which then goes back to

the various customers and is taken out of their banks electronically

and instantly.

How is that creating a database that can be mined for nefarious

purposes that is any different from the present situation where the

38

bank makes a microfiche or an electronic whatever, or the credit

union keeps track of it?

How is the transmission efficiency created by this system creating a new database that doesn’t exist, that is more vulnerable than

what we have now?

Ms. DUNCAN. If we are talking about the increased opportunities

for ID theft or underneath this proposed legislation, then we would

want to wait to have more information on how the banks would intend to use this information because increased storage, collection,

and dissemination of information does lend to ID theft. We would

just continue to pay close attention as this moves along to how the

data may be used for other purposes.

Senator BENNETT. Ms. Alexander and Mr. Buchanan, just very

quickly, does the system increase the database that could be used

for ID theft?

Mr. BUCHANAN. No. Maybe just a final comment around this.

The data is already stored. I think what you described, Senator,

is very good in that the way the new process will work is that it

will eliminate a number of manual steps that I think could create

more problems around privacy and the vulnerability of dealing

with physical items moving through the various points versus just

moving it electronically, storing it as it currently is stored—I do not

think, and I think it is important to understand that we are not

talking about storing anything differently than it is already being

stored, and then being able to clear these items. We see this system improving significantly, not diminishing.

Senator BENNETT. Ms. Alexander.

Ms. ALEXANDER. I agree that the database exists now. If someone

wishes to use it for nefarious reasons, they could do it this day. I

do not see that this process exacerbates that. It simply uses it

much more efficiently and for the benefit of the consumer.

Senator BENNETT. If I understand your previous testimony, actually, this system could make the current database more secure. Is

that—am I——

Ms. ALEXANDER. That has been my experience, yes, it does.

Senator BENNETT. I see.

Thank you very much, Mr. Chairman.

Chairman SHELBY. Any other questions?

Senator CARPER. Just one, if I could.

Margaret Simmons, my staff member here, was good enough to

share with me a copy of—this is a legal copy of your check. You

can use it the same way you would use the original check.

I am one of those people who actually balances his checkbook. I

still reconcile my checking account every month.

My kids—my boys are now 13 and 14. And as they get older,

they actually watch what I am doing and they say, what are you

doing? Why do you do that every month? I tell them, I just want

to make sure that I know how much money is in our checking account. Well, don’t you get those statements? And I say, yes, but I

sometimes make mistakes and I just like to check the math and

make sure that I know exactly what is in the account.

And I save, religiously save my checks, and I have them like

stacked up in our basement and they are in their boxes in the right

39

order and everything. My wife says, it is a disease. I am not sure

if it is or not.

[Laughter.]

But I have been into this for a long time. I think I am beyond

redemption. So, I face the prospect of not having my checks coming

in my statement every month. But if I actually need a copy of my

check, I guess I can get something like this. And my question is,

how quickly can I get it? Do you have to go through a lot of hoops?

Do you have to submit something in writing? How does it work?

Ms. Alexander, I guess you all have been doing this for a while.

Ms. ALEXANDER. We have. In fact, members can give us a call on

the telephone. They can walk into a branch. If they are an online

branching user, they can access it themselves and print it out. It

is absolutely instantaneous. It takes very little effort to produce. It

is right there. It is as good as that copy you have.

Senator CARPER. So online, I can get it right away?

Ms. ALEXANDER. Yes.

Senator CARPER. If I telephone, what are we talking about?

Ms. ALEXANDER. Well, we will mail it to you, or you could stop

in and pick it up. I can fax it, but, of course, faxing denigrates the

printing a little bit. But there are a number of ways that you can

get that. We encourage our online banking users to obtain their

checks themselves, which they do, in large numbers.

Senator CARPER. The complaints from consumers that you hear

most about the kind of check truncation that you have at your

credit unions, what are the complaints that you hear?

Ms. ALEXANDER. We really do not hear complaints now about

truncation. In the early days, members did complain. They wanted

their checks back. It did take a while to get a copy. You had to go

retrieve the physical check. You had to make a copy of it or give

them the original and keep a copy yourself if they needed it for an

audit or for a court case. But that was 20-some years ago.

The credit union where I am at now and where I was previously

have offered checking accounts from the beginning. And after the

first couple of years, members accepted it, we became better at retrieving copies for them, and we tried to do our best to give them

excellent service.

Now, they consider it to be a very normal part of their checking

account process. I have had no complaints about truncation.

Senator CARPER. Ms. Duncan, a closing word from you on this?

Ms. DUNCAN. Our main concern is just to make sure that consumers are well-protected. In this situation, what we are talking

about is taking a consumer’s check and turning it virtually into an

electronic transmission of information.

There is a scheme out there, Regulation E, which gives consumers protection, which is taking into account electronic processing of information and potential errors that can occur. And that

regulation includes a 10-day write of recredit and an unlimited

amount. So that is the thing that we would like to see on a broad

application.

When we look at the CTA, we would like to take the current recredit system and apply it broadly to protect consumers.

Senator CARPER. One last one. Mr. Buchanan and Ms. Duncan

and Ms. Alexander, do you see some way to resolve some of the difVerDate 11-MAY-2000 13:23 Apr 01, 2004 Jkt 000000 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 92704.TXT SBANK4 PsN: SBANK4
40

ferences that we have heard here today? You talk about issues

about which reasonable people can disagree. Is this an issue that

we can resolve if we give it our best?

Mr. BUCHANAN. Well, my impression is that anything can be resolved. I think that change is difficult, although I would say that

our position is that we are not taking anything away. In fact, going

back to your example about wanting to retain your checks, I think

it is important to know that you would not necessarily not get

those checks back. You would receive a substitute document instead of the original check.

But from a consumer’s standpoint, they would still receive the

items. You would still be able to take comfort in storing those for

as long as you would like. We do not see take-aways here. We see

value-adds. And therefore, we believe it is unnecessary to add any

additional regulation around that.

Senator CARPER. That wasn’t my question.

Mr. BUCHANAN. I understand.

Senator CARPER. Are these differences resolvable?

Mr. BUCHANAN. Excuse me?

Senator CARPER. In your view, are the differences that you have

heard here today resolvable?

Mr. BUCHANAN. I believe they are.

Senator CARPER. Ms. Duncan.

Ms. DUNCAN. I believe they are resolvable, yes.

Senator CARPER. Ms. Alexander.

Ms. ALEXANDER. I would believe so.

Senator CARPER. Good. All right. Well, let’s try to do that.

Thank you.

Chairman SHELBY. I want to thank all of you—Ms. Alexander,

Ms. Duncan, Mr. Buchanan—for your appearance here today. I

think it has been a good hearing.

The hearing is adjourned.

[Whereupon, at 12:10 p.m., the hearing was adjourned.]

[Prepared statements and response to written questions supplied

for the record follow:]

41

PREPARED STATEMENT OF SENATOR WAYNE ALLARD

I want to thank Chairman Shelby for holding this hearing to discuss legislation

that will ultimately improve the check collection system and eliminate unnecessary

steps in the process. I look forward to the discussion today and am hopeful that we

can work together to develop legislation that will contribute to the overall improvement of our financial system.

The Federal Reserve Board first sent its proposed Check Truncation Act to the

Congress in December 2001, with the goal of increasing the efficiency of the check

collection system. Their proposal recognizes the existing legal barriers preventing

the possibilities new technology could bring to enhance the current system, and improvements that would save time, money, energy, and resources.

Thank you to all of our witnesses for agreeing to appear before the Committee

today to discuss an important procedure that could change the way our banks,

thrifts, and credit unions handle check processing, a major component of the moneyhandling system. I look forward to your testimony.

—————

PREPARED STATEMENT OF SENATOR ELIZABETH DOLE

Thank you, Mr. Chairman, I would like to express my appreciation to you and

to Ranking Member Sarbanes for agreeing to hold this hearing on the Federal Reserve’s proposed Check Truncation Act. Checks have long served a critical function

in the U.S. payments system. In 2001, consumers made approximately 41 billion

payments by check. However, most checks continue to process as they did 50 years

ago, requiring physical presentation of the check at the bank at which the account

is held.

This requirement necessitates the physical transportation of millions of checks

across the country on a daily basis. According to the Federal Reserve, an estimated

37 million checks were transported every day in 2001. In order to accomplish this

tremendous task, the Fed contracts with independent air freight services to fly these

checks around the country. After the tragic events of September 11, 2001 halted all

air traffic, this critical function of our system of payments ground to a halt and further compounded the crisis which ensued after the attacks.

Because of this weakness in the payment system, and as an effort to improve its

efficiency, the Fed has presented Congress with a legislative proposal to transform

our check processing system from a physical to an electronic system. These improvements to the system would result in considerable savings throughout the financial

system and would also reduce check clearing time for consumers and businesses.

As with any such fundamental change to our system of payments, however, some

questions will need to be answered as we move ahead with reform of the process.

In particular, the anticipated changes in the system may open the door to fraud

unless all necessary precautions are taken. It is my understanding that this proposal would require the destruction of the physical check at the bank the check is

deposited. Currently, checks contain security devices such as microprinting and

watermarks which would be lost in a digital image. I would be very interested in

gaining a better understanding of the new security features which would replace the

traditional ones.

I look forward to discussing this issue and others with our distinguished panel

of witnesses today. I want to thank you all for taking the time out of your busy

schedules to join us here today to share your considerable knowledge on this issue.

Thank you.

—————

PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER

Thank you, Mr. Chairman. I want to commend both you and Senator Sarbanes

for putting together such a distinguished panel. I also want to thank our panelists

for taking the time to meet with us.

Several days ago, I had the pleasure of meeting with a small group of community

bankers from New York, and we discussed this check truncation proposal. These

individuals represented community banks who, as we all know, have a strong dependence on the support and patronage of the individuals and businesses in their

area. Efficiency is important, but doing the right thing to maintain the customer

relationship is critical.

42

These bankers support the Fed’s proposal on check truncation. Many have already

moved to electronic statements in their operations. They told me that not a single

customer had objected to the modernization of the banking processes.

I have long been an advocate of consumer protection in our banking systems. To

me, the consumers can be the real beneficiaries if we decide to make this change.

While there are no guarantees in this proposed legislation, experience tells us that

lower operating costs enable businesses to offer lower costs or better services to

their customers. Things like broader deposit options, later deposit cut-off hours,

more timely access to account information, and faster deposit clearance. If one bank

doesn’t do it, another will. That is the nature of our market system. And in the end

the consumer wins.

‘‘The check is in the mail,’’ is an old expression. Today, despite the tremendous

advances in data systems, networks, and technology, the check is still in the mail.

It is time we updated our banking processes so that the check doesn’t have to be

in the mail for banks.

The Federal Reserve has provided a thoughtful proposal. There is some work to

be done to ensure that the interests of consumers and bankers are safeguarded and

balanced. And much progress has already been made. But it is time we moved forward with this legislation.

Thank you, Mr. Chairman.

—————

PREPARED STATEMENT OF ROGER W. FERGUSON, JR.

VICE CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

APRIL 3, 2003

I would like to thank the Committee for inviting me to discuss the proposed

Check Truncation Act (CTA) that the Board sent to Congress for its consideration

in December 2001. The proposed CTA removes existing legal barriers to the use of

new technology in check processing and holds the promise of a more efficient check

collection system. The Board commends the Committee for holding hearings on this

very important legislative initiative.

Technological Advances in Check Processing

Check processing is far more efficient than it once was. Less than 50 years ago,

clerks hand-sorted millions of checks each day. In the 1960’s, the banking industry

began to use mechanical high-speed check processing equipment to read and sort

checks, which had been redesigned for automated processing. Today, banks, thrifts,

and credit unions, which I will collectively refer to as banks, process about 40 billion

checks that consumers, businesses, and the Government write each year.

Typically, after a check has been deposited at a bank’s branch or ATM, the bank

transports the check to a central operations center. The check is then usually sent

to one or more intermediaries—such as a Federal Reserve Bank or a correspondent

bank—or a clearinghouse for collection before it is ultimately delivered for payment

to the bank on which it is drawn. At each step, the check must be physically processed and then shipped to its destination by air or ground transportation. Some

of the checks, however, are removed from the collection or return process, and the

payment information on the checks is captured and delivered electronically. This

process, which is commonly referred to as check truncation, reduces the number of

times that the checks must be physically processed and shipped. As a result, check

truncation is generally more efficient, more cost-effective, and less prone to processing errors.

Today, however, check truncation can only occur by agreement of the banks involved because existing law requires that, in the absence of an agreement, the original paper checks be presented or returned. Further, given the thousands of banks

in the United States, it is infeasible for any one bank to obtain check truncation

agreements from all other banks or even a large proportion of them. As a result,

the check system’s legal framework, which has not kept up with technological advances, has constrained the efforts of many banks to use new electronic technologies, such as digital check imaging, to improve check processing efficiency and

to provide improved services to customers. Therefore, legal changes are needed to

facilitate the use of technologies that could improve check processing efficiency and

lead to substantial reductions in transportation and other check processing costs.

The proposed CTA makes such changes.

43

Proposed Check Truncation Act

The proposed Check Truncation Act solves a long-standing dilemma—how to foster check truncation early in the check collection or return process without mandating that banks accept checks in electronic form. Currently, under typical check

truncation arrangements, electronic information about a truncated check, rather

than the original paper check, is presented to the bank on which the check is drawn.

The proposed legislation facilitates check truncation by creating a new negotiable

instrument called a ‘‘substitute check,’’ which would permit banks to truncate the

original checks, to process the check information electronically, and to print and deliver substitute checks to banks and bank customers that want to continue receiving

paper checks.

A substitute check, which would be the legal equivalent of the original check,

would include all the information contained on the original check—that is, an image

of the front and back of the original check, as well as the machine-readable numbers

that appear on the bottom of the check. Under this proposed legislation, while a

bank could no longer demand to receive the original check, it could still demand to

receive a paper check. Banks would likely receive a mix of original checks and substitute checks. Because substitute checks could be processed just like original

checks, a bank would not need to invest in any new technology or otherwise change

its current check processing operations.

Banks could use the new authority provided in this legislation in a number of different ways. For example, a bank would no longer need to send couriers every afternoon to each of its branches and ATM’s to pick up checks that customers have

deposited. Instead, digital images of checks could be transmitted electronically from

those locations to the bank’s operations center, where substitute checks could be created and forwarded for collection. Not only would this be quicker and more efficient,

but it could also permit banks to establish branches or ATM’s in remote locations

more cost effectively and to provide their customers with later deposit cut-off hours.

Moreover, the proposed legislation would give a bank the flexibility to transmit

checks electronically over long distances, and create substitute checks at locations

near their ultimate destination, for example, near to the bank on which the checks

are drawn, substantially reducing the time and cost associated with physical transportation. By enabling the banking industry to reduce its reliance on physical transportation, the proposed legislation would also reduce the risk that checks may be

lost or delayed in transit. Today, bad weather routinely delays check shipments and

check shipments have been destroyed in plane crashes. The banking industry’s

extensive reliance on air transportation was underscored in the aftermath of the

September 11 tragedy, when air transportation came to a standstill and the flow

of checks slowed dramatically. During the week of the attacks, the Federal Reserve

Banks’ daily check float, which is normally a few hundred million dollars, ballooned

to over $47 billion, or more than a hundred times its normal level. Had the proposed

legislation been in effect at that time and had banks been using a robust electronic

infrastructure for check collection, banks would have been able to collect many more

checks by transmitting electronic check information across the country and presenting substitute checks to paying banks.

Finally, many banks hope to use the authority provided by this legislation to

streamline the processing of checks that they must return unpaid. Today, after a

bank processes its incoming checks and determines which checks to return, it has

to reprocess all of the incoming checks to pull out the less than 1 percent of checks

that are to be returned unpaid. Many banks have indicated to us that they would

find it more cost-effective to use their image systems to generate substitute checks

for return rather than having to reprocess all of their physical checks.

Both individual and corporate bank customers would also benefit from the proposed legislation. As I noted earlier, as banks restructure their branch and ATM

networks, they could offer customers broader deposit options or extended deposit

cut-off hours. Such changes could result in some checks being credited one day earlier and interest accruing one day earlier for some checks deposited in interest-bearing accounts. In addition, banks might allow some corporate customers to transmit

their deposits electronically. Because the proposed legislation will likely encourage

greater investments in image technology, banks might also be able offer their customers new and improved services. For example, banks might be able to provide

customers with access to online images of deposits and payments before the delivery

of paper statements or provide printed copies of checks deposited at ATM’s on ATM

receipts. The same investment in image technology might also enable banks to provide better customer service by using check images to resolve customer inquiries

more easily and quickly than today. Further, as banks reduce their operating costs,

the savings will be passed on through a combination of lower fees to their customers

44

1The extent to which banks that receive substitute checks incur additional administrative and

compliance costs will depend largely on whether the legislation, as enacted, includes expedited

recredit and disclosure requirements and, if so, the form of these requirements. 2 U.C.C. § 4–401(a).

and higher returns to their shareholders. Banks have indicated that they expect cost

savings to be substantial.

The proposed legislation is designed to provide banks with additional flexibility

in processing checks by requiring banks to accept substitute checks in place of original checks. The proposed legislation does not, however, require banks to accept

checks in electronic form nor does it require banks to use the new authority granted

by the proposed legislation to create substitute checks. This market-based approach

permits each bank to decide whether to make use of this new authority based on

its business judgment about the costs and benefits of doing so.

We believe the market changes arising from these revisions to the check law will

result in substantial cost savings. Clearly, because substitute checks can be processed in the same manner as original checks, recipients of substitute checks should

incur little or no additional processing costs.1 It is difficult, however, to estimate the

overall cost savings. Different banks will take different approaches toward using the

new authority granted by the proposed legislation. Each bank’s use of the new

authority will depend on its technology infrastructure and strategy, its physical

infrastructure, and its customer and business profiles. Thus, the magnitude of the

cost savings, which will depend on the rate at which banks begin using the new authority, is difficult to determine.

Customer Protection Provisions

While there is a fairly broad consensus on the desirability of the underlying concepts of the proposed legislation to permit the use of substitute checks, the issue

of customer protections has been the subject of much debate. We recognize that this

issue is the most challenging policy issue in the proposed law, and Congress will

have a number of alternative approaches to consider as it contemplates the need for

additional customer protections. We would not object to any approach that does not

go beyond the protections included in our original proposal.

Modified Position On Customer Protections

The Board’s proposed legislation extended the protections of existing check law to

substitute checks and included new warranty and indemnity provisions that were

designed to address losses resulting from the receipt of a substitute check instead

of the original check. In addition, the proposed legislation included consumer and

interbank expedited recredit provisions. Since we forwarded the proposed legislation

to the Congress in late 2001, the Board has had an opportunity to further reflect

on the views that have been expressed by both consumer advocates and the banking industry and has concluded that the expedited recredit provisions originally

suggested by the Board are not necessary for the successful implementation of the

proposed legislation. I would like to discuss briefly why we believe that expedited

recredit provisions are not necessary.

Existing Customer Protections

Long-established check law protects bank customers if checks are improperly

charged to their accounts. The proposed legislation would apply existing check law,

including the Uniform Commercial Code (UCC) and the Federal Reserve Board’s

Regulation CC, to substitute checks as though they were the original checks, to the

extent such law is not inconsistent with the proposed legislation.

Specifically, a bank may only charge a check that is properly payable to a customer’s account.2 A check is properly payable if it has been authorized by the bank’s

customer and complies with any agreement between the customer and the bank.

Thus, if a bank charges a customer’s account for a check that is not properly payable, such as when a check has been forged, altered, or duplicated, the customer

has a claim against the bank for an unauthorized charge to the customer’s account.

For example, if a bank pays a counterfeit check, the bank could be liable to its customer for the amount of the unauthorized charge, interest on that amount, and consequential damages for the wrongful dishonor of any subsequently presented checks.

This potentially large liability provides a strong incentive for the bank to resolve

a claim for an unauthorized charge as expeditiously as possible.

Over the years, no pattern of problems has emerged to suggest that existing check

law is inadequate in protecting bank customers against unauthorized charges. As

part of its analysis, Board staff has reviewed the consumer complaint databases of

the five agencies of the Federal Financial Institution Examination Council and

had found no pattern of problems associated with the timely resolution of check

45

3 In contrast, there was no established body of law governing the rights and liability of consumers regarding unauthorized electronic funds transfers when Congress was considering the

Electronic Fund Transfer Act in 1978. Therefore, Congress decided to address consumer rights

and liability in that Act.

problems, including problems related to accounts where the checks are not returned

with the monthly statements.

Additional Customer Protections Under The Proposed Legislation

In addition to the protections provided in current check law, the proposed legislation requires banks to provide new warranties for substitute checks and to indemnify customers for losses resulting from the receipt of a substitute check instead of

the original check. Specifically, banks must warrant that the substitute checks they

provide to their customers are legally equivalent to the original checks and that a

check will not be paid more than once from a customer’s account. Banks must also

indemnify their customers for losses they incur due to the receipt of substitute

checks rather than the original checks. Taken together, these warranty and indemnity provisions provide customers with additional protections against losses related

to the use of substitute checks.

Are Expedited Recredit Provisions Needed?

The Board’s original proposal to Congress also included expedited recredit provisions for consumers. (A companion section of the proposal included interbank expedited recredit rules.) The expedited recredit provisions required a bank to recredit

a consumer’s account, within a specified time frame, if a substitute check was not

properly charged to the consumer’s account. Upon further reflection, the Board has

now concluded that the significant compliance burdens imposed by these provisions

on banks that receive substitute checks outweigh the small incremental benefits

that the provisions would provide to consumers. These compliance burdens would

run counter to one of the Board’s guiding principles when drafting the proposed legislation: Minimization of the operational and the administrative costs that would be

borne by banks receiving substitute checks, because these banks would have no

choice but to accept the substitute checks.

Further, the Board believes the expedited recredit provisions are unnecessary

given the protections provided by existing check law and by the proposed legislation’s new warranties and indemnity, which provide additional customer protections.

As discussed above, existing check law provides substantive protections against unauthorized charges to customer accounts. Further, while it is true that the UCC

does not provide a specified time frame within which a bank must act, its provisions

give the bank a significant financial incentive to resolve problems on a timely basis.

Specifically, the longer a bank takes to research and resolve a customer’s claim, the

longer the bank is exposed to liability for consequential damages arising from the

wrongful dishonor of subsequently presented checks. These protections, in existing

check law, appear to have worked well for many decades.3

In summary, substitute checks are not expected to result in problems different

from those that are routinely addressed in today’s environment. Therefore, we believe that the costs associated with the expedited recredit provisions will substantially outweigh the small incremental benefit of these requirements to consumers.

To address the possibility that additional consumer protections may become necessary in the future, the proposed legislation grants the Board authority to adopt

such protections by regulation, if needed. Nonetheless, Congress may conclude that

expedited recredit provisions for consumers should be included in the legislation. In

that case, we believe any expedited recredit provisions should be consistent with the

proposed legislation’s basic purposes and should not go beyond the provisions proposed by the Board.

Conclusion

In conclusion, although an increasing number of payments are being made electronically, it is clear that checks will continue to play an important role in the Nation’s payments system for the foreseeable future. The Board believes that, over the

long run, the concepts embodied in the proposed Check Truncation Act will spur the

use of new technologies to improve the efficiency and reduce the cost of the Nation’s

check collection system and provide better services to bank customers. The proposed

legislation accomplishes this by simply permitting banks to replace one piece of

paper, the original check, with another piece of paper, the substitute check, both of

which contain the same payment information. Because the proposed legislation

should result in substantial cost savings, it would also be desirable to begin obtaining these savings as quickly as possible.

46

1Share draft accounts at credit unions are equivalent to checking accounts at banks.

2Share drafts are checks.

We look forward to working with the Committee as it further considers this legislation. Thank you for your time and I would be happy to answer your questions.

—————

PREPARED STATEMENT OF LINDSAY A. ALEXANDER

PRESIDENT & CEO, NATIONAL INSTITUTES OF HEALTH FEDERAL CREDIT UNION

ON BEHALF OF THE

CREDIT UNION NATIONAL ASSOCIATION

APRIL 3, 2003

Chairman Shelby, Senator Sarbanes, and Members of the Committee, thank you

for the opportunity to provide comments on how check truncation has been working

at credit unions for the past three decades. I am Lindsay Alexander, President and

CEO of National Institutes of Health Federal Credit Union in Rockville, Maryland.

I am testifying before you today on behalf of the Credit Union National Association

(CUNA), which represents more than 90 percent of the Nation’s 10,000 State and

Federal credit unions. As you know, credit unions are cooperative, nonprofit financial institutions organized to provide individuals associated by a common bond with

a place to save and a source of loans at reasonable rates.

I would like to provide you with information regarding:

• The frequency of check truncation at credit unions. • How check truncation works in the credit union movement. • The benefits to credit unions and consumers of check truncation. • The Federal Reserve Board proposal and other proposals to facilitate

check truncation.

The Frequency of Check Truncation at Credit Unions

Credit unions have had extensive experience with check truncation for nearly

three decades. When the National Credit Union Administration (NCUA) authorized

all credit unions to provide share draft accounts in 1977, NCUA initially required

truncation.1 This followed a pilot program underway since 1974. As a result, most

credit unions that offer checking accounts truncate. Sixty-four percent of credit

unions offer checking accounts, and of those credit unions 91 percent truncate share

drafts or checks.2 Among the credit unions that offer checking accounts, 7.1 percent

include images of all checks within the statements that their members receive. Although only two-thirds of credit unions truncate, nearly all credit union members

have access to checking accounts. In fact, 96.1 percent of credit unions members are

in credit unions that offer checks.

How Check Truncation Works in the Credit Union Movement

Initially, the NCUA required all credit unions offering share draft accounts to

truncate and NCUA defined truncation as when the original share draft was not returned to the credit union member. As a result, in the past and now, credit unions

tend to truncate checks at the last step in the check collection process by not distributing share drafts to their credit union members. Under this system, there are two

processes. In the first case, a credit union may receive the checks that a member

writes against his or her account at the credit union, but the credit union does not

pass those checks onto the member. In the second case, a credit union may have

their members’ checks truncated by a Federal Reserve Bank or a third-party processor, and the essential share draft information is transmitted electronically to the

credit union for payment or dishonor. In this scenario, neither the credit union nor

the member receives the original paper check. For all credit unions, each share draft

or check is itemized on the statement that the member receives.

Credit unions do not usually truncate all of the checks that they process. For

example, credit unions do not usually truncate the checks drawn on other financial

institutions that their members deposit or use to make loan payments at the

credit union.

The Benefits to Credit Unions and Consumers of Check Truncation

Credit unions have found that check truncation, under existing check law, allows

credit unions to serve credit unions members well. Check truncation has allowed

credit unions to provide members with lower fees and still provide members with

outstanding service. The experience of credit unions is that our members rarely

47

request or need originals from truncated share drafts or checks. In fact, some credit

unions never provide originals because they destroy the originals within 2–3 business days. In 2001, an informal survey of corporate credit unions, credit unions that

provide services for other credit unions, confirmed this. In 2001, corporate credit

unions processed over 1.1 billion items in total check volume. Of those 1.1 billion

checks, only about 480,000 requests were made for the original check, representing

.04 percent of all checks. In almost all cases, the corporate credit union could make

a good quality, clear image of the check that satisfied the member’s needs.

I would like to now describe the experience of my credit union, which is a $350

million asset institution. We have 48,000 members with 26,800 checking accounts.

Like most credit unions, we truncate the share drafts drawn on our members’

accounts at the end of the check process. We do not return checks to members and

never have. Although we currently receive checks back from our Federal Reserve

Bank, we are undergoing a process to convert to an all-electronic system. We still

use the paper collection system for checks drawn on other financial institutions that

are deposited by our members.

In addition, at National Institutes of Health Federal Credit Union we image all

checks that we receive (both checks drawn on our accounts and deposited checks

from other institutions). After we image checks drawn on other institutions, we keep

copies onsite for 30 days and retain copies offsite for 7 years. Our credit union processed about 2 million of our own checks that were worth approximately $649 million

and 461,532 checks drawn on other financial institutions worth approximately $340

million.

In my 14 years at National Institutes of Health Federal Credit Union, we have

never had a member that has complained about not getting an original. Members

do not request originals anymore. A copy of the share draft seems to satisfy members’ needs as long as the share draft or the check is clear and legible. In those

cases where the member does request a copy, the most common reasons are because

the member needs it for proof of payment or for an audit. At my credit union, 90

percent request a copy of the check as proof of payment and 10 percent request it

for Internal Revenue Service audits. Only a few members need it for court cases or

other reasons.

Truncation has helped us meet our members’ needs and our members are extremely complimentary of the services that we can provide along with truncation.

In mid-February, we implemented a new service to complement our truncation program whereby members who are registered with our online banking service can

obtain a copy of a share draft or check free by accessing the image through their

online account. Since we introduced the service we have had an extraordinary response, with several members a week spontaneously sending complimentary e-mails

to the credit union praising this service. This imaging service reduces the time it

takes to retrieve checks from 2–3 days to making it nearly instantaneous.

The Federal Reserve Board Proposal and other Proposals to

Facilitate Check Truncation

The Federal Reserve initially presented to Congress a proposal that would have

permitted depository institutions to convert original checks into electronic items and

send those electronic checks to other depository institutions that agree to accept

electronic checks. The proposal did not mandate check truncation, however. For

instance, if a depository institution did not agree to accept electronic checks, then

the presenting financial institution would send that institution a substitute, papermachine-readable copy of the check (a substitute check). During the collection and

return process, checks would be converted into electronic and paper versions as necessary. This proposal represented a step forward by allowing financial institutions

to voluntarily decide to present an item totally electronically without the need for

previously adopted agreements.

The Federal Reserve proposal would have allowed existing truncation programs,

such as those at credit unions, to coexist, without imposing new requirements from

the proposal on existing credit union programs. We strongly support that provision

in the Federal Reserve proposal. And we strongly oppose any expansion of the scope

of the Act that would impose requirements on check truncation programs that

already exist and do not use a substitute check. The Act is designed to address situations where a customer is forced to accept a substitute check and the special provisions for substitute checks in the Act should only apply to situations where the

credit union member or bank customer actually receives a substitute check. In the

case of credit unions, members have already agreed not to accept the check, and our

experience suggests that our members are doing well with this approach. Therefore,

expanding the scope of this Act is unnecessary and would interfere with credit union

48

check truncation programs that already seem to be working. We hope the Senate,

like the Federal Reserve, limits the scope of its bill.

We support changes that have been made to the Federal Reserve proposal that

appear in the Check Clearing for the 21st Century Act that was recently introduced

by Representative Hart and Representative Ford in the House. These changes would

allow financial institutions to truncate all types of checks, including checks drawn

on the Department of the Treasury, without unique processing streams. Moreover,

the consumer provisions found in the Act appear to reflect the experience that credit

unions have had with check truncation. The Act allows an indemnifying financial

institution to produce a copy to resolve a consumer’s claim when a copy is sufficient

for that purpose. The experience of credit unions is that at nearly all times a copy

is sufficient, so being able to reproduce a good quality copy should be sufficient. The

change is especially important because frequently the original will be destroyed

within a few days and might not be available anyway.

We are also supportive of consumer protections in the House bill that mirror those

of existing laws. Section 6 of the bill would provide a consumer who receives a substitute check with certain recredit rights. If the member suffered a loss because of

the substitute check, the member’s credit union under certain circumstances would

be required to recredit the account of the member up to $2,500 by the end of the

tenth business day following receipt of the member’s notice that a substitute check

was not properly charged to the account. The approach appears reasonable. The recredit procedure in Section 6 gives the member’s credit union 10 business days to

investigate the claim before being required to recredit the member and 45 calendar

days in certain unique circumstances. The credit union’s ability to investigate a consumer’s claim prior to being required to recredit the consumer’s account is essential

for the credit union to avoid fraud losses from the new expedited recredit procedure.

Similarly, the Section 6 expedited recredit procedure does not require the credit

union to provide notice to the member before reversing a claim that is not substantiated. Requiring a credit union to give notice before reversal would have

undermined the credit union’s ability to protect itself from fraud, because it gives

the person a chance to withdraw funds even when the credit union has discovered

that there is a fraud in progress.

We also support Section 7 in the House bill that provides ground rules regarding

when a financial institution that has suffered a loss from a substitute check must

be recredited by an indemnifying bank. Under Section 7, a claimant financial institution has 120 days to make a claim that it suffered a loss as a result of a substitute

check. After that, the indemnifying bank must respond by giving the appropriate

recredit, or a copy of the check showing that the claim is unfounded, or information

why the bank does not need to provide either of those two responses. Placing a time

limit on responses to claims among financial institutions protects smaller institutions and ensures that paying financial institutions do not disproportionately bear

the burden for substitute checks that may have been mishandled earlier in the collection process by an indemnifying bank.

Conclusion

In conclusion, most credit unions throughout the country in addition to National

Institutes of Health Federal Credit Union truncate their share drafts or checks, and

have done so for decades. The experience of these credit unions is that members like

this service, and in particular, seem to find imaging helpful. Members find that in

cases where they need a copy of the share draft a good copy is sufficient. We remain

supportive of the current attempts to voluntarily facilitate check truncation. And we

look forward to working with the Committee, the Federal Reserve, and consumers

in further strengthening this proposal.

We thank the Committee for this opportunity to comment and I will be glad to

answer any questions.

—————

PREPARED STATEMENT OF JANELL MAYO DUNCAN

LEGISLATIVE AND REGULATORY COUNSEL, CONSUMERS UNION

APRIL 3, 2003

Good morning, Chairman Shelby, Senator Sarbanes, and Members of the Committee. Thank you for providing me the opportunity to come before you today. I am

49

1 Consumers Union is a nonprofit membership organization chartered in 1936 under the laws

of the State of New York to provide consumers with information, education, and counsel about

goods, services, health, and personal finance. Consumers Union’s income is solely derived from

the sale of Consumer Reports, its other publications, and from noncommercial contributions,

grants, and fees. In addition to reports on Consumers Union’s own product testing, Consumer

Reports with approximately 4.5 million paid circulation, regularly carries articles on health,

product safety, marketplace economics and legislative, judicial, and regulatory actions that affect consumer welfare. Consumers Union’s publications carry no advertising and receive no commercial support. 2 Consumer Federation of America is a nonprofit association of almost 300 pro-consumer organizations, founded in 1967 to advance the consumer interest.

U.S. Public Interest Research Group (U.S. PIRG) serves as the national lobbying office for

State PIRG’s, which are nonprofit, nonpartisan public interest advocacy groups with 400,000

members in States around the country.

The National Consumer Law Center is a nonprofit organization specializing in consumer

issues on behalf of low-income people. The Center’s experienced attorneys work with thousands

of legal services, Government and private attorneys, as well as community groups and organizations, from all States who represent low-income and elderly individuals on consumer issues. 3 At an August 2002 meeting, bank representatives stated that approximately 60 percent of

consumers east of the Mississippi River, and 30 percent of consumers in the West receive their

original checks back. Since approximately 90 percent of the 105 million U.S. households have

a bank account, usually a checking account, this means that approximately 45.8 million U.S.

households get back their paper checks. 4Today many bank and credit union customers do not receive their checks back in the mail

monthly; however, a credit union creates an image of the customer’s check at the end of the

process, after the check has made its way through the check clearing process. In contrast, a

‘‘substitute check’’ is a reconstituted version of the consumer’s check. Because not all financial

institutions will transmit the check in electronic form, the substitute check may contain errors

arising during the transmission process. In addition, if the consumer needs the original check

due to a claim of improper amount, forgery, or alteration (which may require handwriting evidence) the original check will now be in the custody of someone other than the consumer’s own

bank, and so it would take longer to find and retrieve.

Janell Mayo Duncan, Legislative and Regulatory Counsel for Consumers Union.1

Consumers Union is the nonprofit publisher of Consumer Reports magazine. Our

mission at Consumers Union is to test products, inform the public, and protect the

consumers. Today, I offer this testimony on the proposed Check Truncation Act as

part of our consumer protection function. My testimony today is supported by the

Consumer Federation of America, U.S. Public Interest Research Group, and the

National Consumer Law Center.2

If the proposed Check Truncation Act (CTA) is enacted into law, it would have

a significant impact on an estimated 45 million consumers who receive their original

paper checks in the mail every month.3 The proposed CTA would enable banks,

thrifts, and credit unions (collectively referred to in this testimony as banks) to convert original paper checks written by consumers into electronic form so they can be

sent by banks to other banks that agree to accept them. Consequently, original

paper checks would be ‘‘truncated,’’ or stopped by one of the first banks in the system to process a consumer’s check. Banks refusing or unable to accept electronic

check information would receive a paper ‘‘substitute check.’’ During the check return

process under the proposed CTA, a consumer’s check could be transferred in and

out of electronic and paper substitute form. Thus, the consumer’s bank would receive either an electronic image or a ‘‘substitute check,’’ but would not receive back

the consumer’s original paper check. Likewise, the consumer could only get back a

‘‘substitute check’’ but not the original.4

We believe the proposed CTA would be a bad deal for consumers for three main

reasons. First, the proposed legislation would eliminate the choice preferred by millions of consumers who receive their original paper checks each month. Second, the

provisions in the proposed CTA meant to protect consumers from processing errors

will not be available to all consumers whose check information is processed electronically. Third, if enacted into law, the proposed CTA would give banks an unfair

ability to deter, delay, or reduce consumers’ claims for damages resulting from processing errors by alleging that a consumer was somehow at fault.

Potential Impact of Federal Reserve Board Proposal

We recognize the value that advances in technology can provide to consumers in

terms of enhanced banking and customer services. However, our concern is not with

the technology—but the resulting removal of consumer choice. The proposed CTA

would take a system that works relatively well and change it in a way that imposes

new risks and inconveniences on consumers. Today, some consumers prefer online

banking, some receive no checks with their monthly statement, and some receive

checks back every month, like clockwork. The proposed CTA would tell millions of

consumers that they can no longer get their original paper checks back with their

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5We believe that this amount should not be limited to $2,500. Recredit amounts are not limited for consumers who conduct electronic transfers. 6 12 CFR Part 205.

statements to double-check what a bank has done with their funds, to make sure

a payee has not changed the amount, or to prove payment where this is an issue.

In addition to eliminating this consumer option, the proposed legislation creates a

system of electronic transmission of checks that could expose consumers to new

risks including double processing of a single check, or errors in reading the amount

of or account number on a check—resulting in losses to consumers.

It is virtually certain that the largest banks will save money from the efficiencies

achieved from increased electronic processing of checks. In contrast, there is no

guarantee that consumers will benefit from mandatory check truncation. In return

for changing their banking practices and being subjected to potential errors related

to electronic processing, the consumer is offered vague and unenforceable promises

that they will be sufficiently protected, promises of increased flexibilty to view account information, and promises that in the future funds from checks they deposit

into their account may be available sooner. None of these promises are certainties

under the proposed CTA.

Loophole in Legislation Relating to ‘‘Recredit’’ of Disputed Funds

If the proposed CTA were enacted into law, consumers would need additional protections to address any errors or disputes that occur when their check information

is processed electronically. In an effort to provide protections, Section 6 of the proposed legislation, among other duties, would require a bank to put up to $2,500 in

disputed funds back into a consumer’s account if the matter is not settled in one

business day—called ‘‘recredit.’’ 5 However, the proposed language would allow consumers to seek recredit of disputed funds only if they receive a ‘‘substitute check’’

from their bank.

This is a significant loophole because a bank could avoid giving account-holders

these rights simply by refusing return substitute checks to them. If a bank does not

give a substitute check to its account-holder, the customer loses the right to recredit,

and is left with weaker UCC remedies found under State law. Consumers unable

to seek recredit would have to seek redress under State law—UCC Articles 3 and

4—which governs negotiable instruments, including checks. UCC liability provisions

are not comparable to recredit because, although they provide rules for liability,

they lack a nonlitigation remedy. In addition, UCC provisions do not set a specific

time period to resolve disputes, and do not require a bank to redeposit disputed

funds. If a bank delays or declines to solve the problem, the only way for the consumer to get his or her money back under the UCC is to sue, which is too expensive

and time consuming for most disputes relating to modest amounts.

Although consumers would benefit from additional warranty and indemnity provisions under the proposed CTA, in order to obtain damages for losses due to an

improperly paid check under either the UCC or the proposed CTA’s warranty and

indemnity provisions, a consumer would be forced to sue his or her bank. And as

discussed earlier, this is an expensive and cost-prohibitive prospect for most

amounts likely to be in dispute. We, therefore, believe that the recredit provision

should be extended to all consumers, regardless of whether or not he or she receives

a ‘‘substitute check.’’

Although Inadequate in Current Form—The Recredit Provision is

Critical to Ensure Consumer Protections

Currently, consumers engaging in other electronic funds transfers (for example,

using debit or ATM cards or allowing funds to be debited directly from their accounts) are protected by Regulation E,6 which includes a 10-day right of recredit,

and has no dollar limit. Because the proposed CTA would allow banks to turn consumer paper check processing into electronic transmissions of check information, the

recredit section essentially gives consumers protections that are similar to those

governing other types of electronic funds transfers.

In the absence of any recredit provision in the CTA, banks would lack an incentive to expedite their investigations of possible errors. During the delay, consumers

could be denied access to rightful and necessary funds. The recredit provision properly places the burden of delay on the bank rather than the consumer. As described

above, in the absence of recredit, for unresolved disputes, consumers would be required to sue their banks in order to pursue claims for improperly debited funds.

The importance of a recredit provision cannot be over-emphasized, and has been

recognized by its authors. In a letter dated December 17, 2001, Federal Reserve

Board Chairman Alan Greenspan presented the proposed CTA to then-Senate BankVerDate 11-MAY-2000 13:23 Apr 01, 2004 Jkt 000000 PO 00000 Frm 00054 Fmt 6621 Sfmt 6621 92704.TXT SBANK4 PsN: SBANK4
51

7 Under Section 8(b) of the CTA, a bank could raise a comparative negligence defense with

respect to every claim by a consumer that his or her account had been improperly debited (that

is, a ‘‘warranty claim’’). See CTA Section 8(b). Similarly, the CTA also would allow banks to

raise a comparative negligence defense if a consumer seeks indemnity for harm caused by the

unavailability of the original check. See CTA Section 5(c). 8The first instance relates to fictitious payees or imposters [3–404(d)], the second involves

where a consumer’s negligence contributes to a loss due to a forged signature or alteration [3–

406(c)]. Finally, under the UCC, an account-holder has a duty to be diligent in reviewing his

or her monthly statement, and report any item paid that was improperly altered or contains

an unauthorized signature. If the consumer fails to examine his or her statement and discover

and report such indications of fraud, then he or she may lose the ability to assert a claim

against the bank for wrongful payment [4–406].

ing Committee Chairman Sarbanes, along with an overview of the proposed legislation, and a section-by-section analysis. The ‘‘Highlights’’ section of the overview of

the proposed legislation states that: ‘‘The expedited recredit procedure is intended

to mitigate the effects on consumers of any potential problems associated with the

receipt of substitute checks.’’ In addition, the section-by-section analysis of proposed

CTA Section 6 states: ‘‘These expedited recredit provisions of the proposed Act are

limited to consumers, who are generally not in a position to negotiate with their

banks the terms of their deposit accounts that affect the consumers’ rights and

liabilities, such as how payments are processed and charged to their accounts.’’

As recognized by the Federal Reserve Board, recredit is an essential consumer

protection element of the proposed CTA. The alternative—requiring consumers to

seek redress by suing their bank over a disputed check processing error—is an unacceptably unfair, time consuming, and potentially expensive alternative. We would,

therefore, oppose any CTA legislation that allows banks to treat checks like an

electronic funds transfer, without giving consumers the right to recredit—a legal

protection they need and deserve.

Comparative Negligence Provisions

The proposed CTA contains provisions that would make it harder for consumers

to seek damages from banks for improperly paid checks.7 These comparative negligence standards in Sections 5(b) and 8(c) of the proposed legislation would allow

banks to reduce the amount of damages a consumer can recover by asserting that

the consumer was somehow at fault (that is, comparatively negligent). Despite the

creation of this defense, it is highly unlikely that a consumer could contribute in

any way to the double processing of his or her checks, or to a processing error. This

provision would unfairly enable a bank to deter a consumer’s claim, or make any

litigation longer and more expensive by asserting that the consumer was somehow

partly responsible for check processing errors.

The proposed CTA’s comparative negligence provisions are much broader than

those currently governing consumer check transactions under the UCC. Although

the UCC imposes a comparative negligence standard, it does so only relating to

fraud.8 The proposed CTA, therefore, gives banks greater protections than exist

under current law by extending a bank’s ability to claim a defense of comparative

negligence beyond situations where there has been a loss to the consumer due to

fraud or forgery. This expansion would make it harder for consumers to collect judgments against banks responsible for processing errors. We, therefore, believe that

the comparative negligence standards in Sections 5(b) and 8(c) of the proposed CTA

are inappropriate to resolve harms suffered by consumers due to processing errors,

and should be removed.

Recommendations

We recommend the following changes to the proposed CTA to more properly balance the benefit of increased check processing efficiencies with necessary consumer

protections:

• Because all consumers are equally susceptible to harm from processing errors, the

recredit loophole in the proposed CTA should be closed. The right of recredit

should be expanded to apply in every case where the original check is not returned to the consumer and a check may have been improperly charged to the

consumer’s account.

• A comparative negligence standard is inappropriate to resolve harms suffered by

consumers due to processing errors. Banks should not be able to use this standard

to avoid liability, or to delay a consumer’s action for improperly paid checks that

result from processing errors. Therefore, as it relates to consumers, the language

relating to a comparative negligence standard should be removed from the proposed CTA.

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We also have other concerns about the proposal, but we believe that these two

elements are among the most important.

I thank the Chairman, Senator Sarbanes, and the Committee for the opportunity

to testify, and I look forward to any questions you may have.

—————

PREPARED STATEMENT OF DANNE L. BUCHANAN

EXECUTIVE VICE PRESIDENT, ZIONS BANCORPORATION

ON BEHALF OF THE

AMERICAN BANKERS ASSOCIATION, AMERICA’S COMMUNITY BANKERS

CONSUMER BANKERS ASSOCIATION, FINANCIAL SERVICES ROUNDTABLE

AND INDEPENDENT COMMUNITY BANKERS OF AMERICA

APRIL 3, 2003

Good morning. My name is Danne Buchanan. I am the Executive Vice President

of the E-Business Solutions Group at Zions Bancorporation, Salt Lake City, Utah.

I also serve as the CEO of NetDeposit, a subsidiary of Zions Bancorporation that

provides processing and clearing technology which allows organizations to move to

electronic presentment of paper checks.

I am here today representing the five major banking and financial services trade

associations—the American Bankers Association, America’s Community Bankers,

the Consumer Bankers Association, the Financial Services Roundtable, and the

Independent Community Bankers of America (the associations). I am pleased to

present the banking and financial services trade associations views on the concept

of check truncation as envisioned in the Federal Reserve Board’s (Board) proposal

(proposal).

Although the associations sometimes have divergent views on issues, on this

issue, we are unequivocally united in supporting efforts to increase the efficiency of

the Nation’s payments system. We believe that legislation to sanction ‘‘substitute

checks’’ will facilitate electronic check processing that will produce significant cost

savings, efficiencies, and new consumer conveniences, to the great benefit of both

consumers and financial institutions.

On behalf of the associations, I would like to extend our appreciation to Senator

Shelby for holding this hearing. We also commend the staffs of the Senate Banking

Committee and the Board who have worked tirelessly to address the concerns of the

banking industry, consumer groups, and others in moving this concept forward.

Consumer Payment Alternatives and the Check Clearing Process

Consumers today have a variety of alternatives at their disposal to make noncash

retail payments. These include debit cards, credit cards, automated clearinghouse

(ACH) debit payments in addition to traditional checks. According to the Board,

American consumers make more than 70 million of these noncash retail payments

each year. While electronic payments represent an increasing number of these

noncash payments, paper checks remain the dominant form of noncash payment in

the United States today. Despite repeated predictions of their demise, checks play

a significant role in the U.S. payments system and will continue to do so for years

to come.

Check processing is an enormously expensive and labor-intensive process that requires checks to be handled, sorted, and physically transported to the paying bank.

Because of current law, paper checks generally must physically move, by train,

plane, and automobile, from the bank of first deposit to the paying bank. The primary impediment to elimination of this paper check travel route and adoption of

electronic check processing is the fact that customers have the right to receive their

original paper checks back. Of course, checks today can be truncated at the paying

bank site because paying banks and their customers can agree to the arrangement.

However, the bank of first deposit usually does not have a relationship with the

paying bank’s customer and cannot know whether the check writer will insist on

receipt of the paper check. Therefore, checks generally cannot be truncated at the

point of deposit, necessitating the long trip to the paying bank. The only exceptions

are unusual cases where very largest banks with large check volumes have reached

private agreements.

At our bank we have, over the last 2 years, been truncating original items for payments and creating Image Replacement Documents that have been processed by

every major financial institution in the United States for thousands of customers.

We have accomplished this with two-party agreements between Zion’s Bank and its

customers even though the customer’s deposit account may be held with another

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financial institution. I am pleased to let you know that the process works. After we

disclosed the process, we had few customer inquiries and have successfully dealt

with every issue or question posed by a paying bank. We have also proven the value

propositions by streamlining our internal operations and reducing costs in float,

clearing fees, and transportation.

We also have a pilot program for our imaging product with a large New York

bank and one of its customers and their results are equally positive. The benefits

have gone beyond banking as we are finding our commercial customers anxious to

begin truncating their payments utilizing this same technology. We have several in

production now, with a large number awaiting implementation. The benefits for

these customers are improved availability, integration to back office systems, and

elimination of the daily bank delivery, along with the extension of operating time

frames. We are currently processing approximately a million dollars per day with

this process and expect it to ramp significantly in the coming months.

Keep in mind that many customers today do not receive their checks back with

their statements. Informal industry assessments indicate that more than 30 percent

of all checks drawn by bank customers, and nearly all checks drawn by credit union

customers, are not returned to the check writer. Depending on the bank’s check

safekeeping strategy, many consumers receive convenient images of cancelled checks

or detailed information about their check transactions on their monthly account

statement. Those who receive notations on their check statements may obtain copies

of checks upon request. In addition, some customers also have the ability to review

check images online.

It is important to note that the detailed check transaction information and check

images satisfy virtually all customer needs today. For example, images are routinely

used and accepted as proof of payment, for tax records, etc. Original items are rarely

requested or needed. This fact is critical because many of the objections raised by

consumer advocates about the broader check imaging envisioned under the Board’s

proposal exist today, but in fact present few, if any, problems.

The removal, or truncation, of paper checks from clearing, processing, and settlement activities is growing and will continue to proceed regardless of whether legislation is enacted. However, passage of legislation will facilitate electronic processing

so it progresses in a more orderly, efficient fashion, to the benefit of all participants.

The Board’s Proposal Will Improve the Efficiency of the Check System

Responding to the massive costs and inefficiencies associated with check processing, the Board’s Payments System Development Committee over 3 years ago began

actively seeking input from the banking industry, consumer groups, check clearinghouses, processors, and others in developing a proposed legal framework that would

remove the barriers to the wide scale use of electronic check processing. The Board’s

diligent review of comments, resolution of issues, and creative thinking produced its

draft legislation. We applaud those efforts and the ultimate product.

The Board’s proposal would allow a collecting bank to remove, or truncate, the

original paper check from the check collection and return process. Checks could then

be processed as images that are transmitted electronically. Any bank in the process,

as well as the check writer could demand that items be reconverted from electronic

form into a ‘‘substitute check,’’ complete with back and front images and the magnetic ink character recognition (MICR). The proposal would establish that substitute

checks are the legal equivalent of the original check. The proposal provides that

substitute checks must adhere to rigorous standards that ensure the document accurately represents the original check and can be processed in the same manner as

the original check. As noted earlier in my testimony, we have proven that the concept works in the real world without adverse impact to banks or customers.

No longer would a California bank have to ship a check drawn on a New York

bank across the country for clearing, processing, and settlement. Checks could be

processed and transmitted electronically without the original paper check. Moreover,

the proposal does not require the banking industry to adopt wholesale electronic

check clearing; rather it provides flexibility to adapt to electronic check clearing over

time without interfering with the existing paper check process.

The banking and financial services trade associations believe that removing the

legal impediments to electronic check processing will improve the efficiency of our

Nation’s payment system and provide benefits to both consumers and depository institutions. Electronic check processing has the potential to streamline the collection

and return of checks, reduce processing costs, and minimize the effect of unexpected

disruptions to air and ground transportation systems. Reducing the dependency on

the physical presentment of original items will result in faster check collection,

which will allow consumers sooner access to their funds. Consumers will also have

faster, more convenient access to information about check transactions.

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Improving the check clearing process may also allow banks to develop new and

more flexible banking services. For example, image-capable ATM’s that can forward

deposits electronically will allow banks to deploy more ATM’s in remote locations

as the cost and frequency of physically retrieving deposits and servicing ATM’s

could be reduced. Consumers may be able to use these ATM’s to cash payroll checks

at their place of employment, which may be particularly attractive for those without

bank accounts. It will also be possible for banks to offer extended deposit cut-off at

remote locations since the need for physical same-day pick up could be eliminated.

Check Truncation and Imaging Will Benefit Banks and Their Customers

In addition to the direct impact on costs, the proposal would serve to promote

check imaging technology by adding another positive weight to the business case for

adopting check imaging generally. This broader adoption of check imaging will help

provide benefits beyond those attributable to the electronic processing facilitated by

the proposal. New applications, services, and benefits will emerge and existing ones

expand if check imaging is boosted by the electronic processing aspect envisioned

under the proposal.

For example, today many consumers receive compendious and convenient image

statements of checks rather than disorganized, loose checks. In addition, a more

recent application of check imaging allows customers to view check images online.

This helps consumers to quickly and to conveniently review transactions, identify

potential errors, and detect fraudulent transactions sooner. Customers who do

not bank online also benefit from imaging because customer service representatives

can quickly bring up for view images to verify transactions for the customer. This

requires a fraction of the time typically required to research microfilm or to physical

archives and transmit copies. Identifying errors and potential fraud as soon as possible also helps banks minimize customer inconvenience, control potential losses,

and gives law enforcement an advantage in tracking down the perpetrators. Such

current imaging applications will expand with the additional application of check

truncation.

Finally, the proposal could provide real benefits to rural community banks and

their customers. In remote areas, banks are constantly challenged to meet the Federally mandated funds availability deadlines due to adverse weather conditions and

limited access to air courier services. In some places, it can take hours via ground

transportation to reach a processing facility. Air couriers are often not available.

With the Board reducing check processing services and closing facilities, such physical challenges and complications will only increase. Banks in these situations struggle to process checks before they must make funds available pursuant to the schedules mandated under the Expedited Funds Availability Act. The proposal would

allow rural community banks to transmit electronic images of checks that can be

used for clearing and settlement with their existing systems, regardless of weather,

transportation constraints, or distances to processing centers.

Existing Consumer Protections for Checks are Adequate

The associations support the concepts outlined in the Board’s proposal. The legislation removes the need to transport and present original checks. However, we

strongly believe that the provisions of Section 6 of the proposal related to expedited

recrediting for consumers are unnecessary and will not only facilitate, but also indeed encourage fraud. We believe that existing check law provides appropriate and

adequate protection to consumers with respect to substitute checks as envisioned

under the proposal.

The banking industry and consumers have an established history with truncated

checks and image documents. Indeed, millions of consumers have been receiving

either images or a notation in their statements for years, without complaint that

disputes are not addressed satisfactorily. The current check law works in the truncated and image environment. There simply is no evidence to justify deviation from

existing check law.

In fact, the Board’s staff has indicated that an informal review of the consumer

complaints filed with all the banking regulatory agencies reveal no significant consumer issues relating to existing check protections. Banks report the same dearth

of complaints on these matters. Complicated new recredit procedures would only

serve to confuse customers, create compliance headaches for banks, and expose

banks to potential new sophisticated fraud schemes.

Under the Uniform Commercial Code, a bank is liable to its customer if it charges

its customer’s account for a check that is not ‘‘properly payable.’’ This includes

checks that are not authorized by the consumer, checks containing a fraudulent

endorsement or signature, and other erroneously posted checks. A bank that improperly debits a customer’s account is liable to the customer not only for the

55

amount of the improper debit, but also for the amount of any damages that are

caused by any checks that are returned due to insufficient funds resulting from the

improper debit. Additional protections and funds availability schedules are provided

under the Board’s Regulation CC. For example, under Regulation CC, returning

banks warrant to the bank customer to whom the check is being returned that they

have returned the check in accordance with the requirements of applicable law, that

they are authorized to return the check, and that the check has not been materially

altered. These laws ensure check related disputes are handled appropriately. They

work, whether the original check, an image, or a statement notation is involved.

Proposed Expedited Recredit Provisions are Unnecessary and

Will Promote Fraud

The proposal establishes a complicated expedited recredit and reversal of recredit

structure for consumers and banks that will promote fraud. Section 6 of the proposal provides that consumers may make claims for expedited recrediting if they assert that the bank charged the account for a substitute check that was not properly

charged and that production of the check is necessary to determine the validity of

the charge. The bank then must either produce the original check and show that

the account was properly charged or recredit the consumer account for the amount

of the check up to $2,500 no later than the business day following the banking day

of the claim. The remainder must be available not later than 20 business days following the banking day of the claim. Funds must be available the day after recrediting. Banks may delay recrediting under certain circumstances: The account is

‘‘new;’’ the account has been repeatedly overdrawn; the bank has reasonable cause

to believe that the claim is fraudulent; and emergencies.

Even with the exceptions, the expedited recrediting period is far too short and will

not only facilitate fraud, but also indeed encourage it. To illustrate:

• A fraudster sets up a bank account and writes a check drawn on the account for

$2,400 that is deposited into another account belonging to the same individual at

another institution.

• After the original item is truncated and a substitute check sent to the paying

bank, the fraudster disputes the item, claiming the original has been altered from

$240 to $2,400 and that the original is required to resolve the problem.

• Because in most cases, it will not be possible to obtain the original check within

2 days, the bank will be obliged to release the funds. The fraudster walks away

with $2,160 of the bank’s money.

Under the proposal, the paying bank must make funds available 2 days after the

claim, risking that the funds will be withdrawn before—and if—it can produce the

original check. In addition, the bank risks liability for wrongful dishonor of additional checks drawn on the account.

As a practical matter, under the proposal, the bank has no time to obtain the

check or investigate before it must release $2,500 per claim. (The Proposal does not

limit the number of claims an individual may make in a single day.) Multiply the

claims by multiple checks and multiple accounts and the sum can be significant reward for such little effort and time.

This is attractive not only for ‘‘true fraudsters,’’ but also for customers who may

be tempted to abuse the law on an occasional basis. Certainly, this is banks’ experience and complaint under Regulation E which governs electronic fund transfers

related to consumer accounts and generally permits a more generous 10 days to recredit the account. Banks complain that this current 10-day recrediting requirement

means that they must absorb losses due to fraudulent claims that cannot be resolved within the 10-day time frame. Accordingly, we strongly recommend retaining

current check law.

Consumer Groups’ Concerns are Unfounded Because Consumers’

Situation Will Be Unchanged

Consumer representatives complain that consumers need protections above and

beyond what is required today because they will be at a disadvantage if they receive

substitute checks rather than originals. However, the situations they cite have

existed for years in the truncated environment without adverse consequence to consumers. As noted earlier, millions of bank customers receive check images with their

statements. Generally, banks providing the images destroy the checks within 30 to

60 days. In many cases, by the time the consumer requests the check, it has already

been destroyed and only a copy is available. Thus, the environment under the proposal will differ little from the environment of today.

Testimony presented by Gail Hillebrand on behalf of Consumer Union and others

on September 25, 2002, before the House Financial Services Committee, asserted

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that the substitute check would not be able to ‘‘show things that cannot be copied

such as the pressure applied to the pen by a forger.’’ This is true today with the

ubiquitous image statements.

First, by the time consumers determine they want the original, it has usually already been destroyed. Second, examining pen pressure, which is expensive, would

typically only arise in rare cases, that is, high dollar checks. In such cases today,

the check may not have been destroyed. Similarly, if the proposal is adopted, the

bank may choose not to truncate large checks or retain the original if they are truncated, given the risk of loss in the event the item is disputed. Thus, in rare cases

when pen pressure might be examined, the check would probably be available for

examination as it is today.

In addition, consumer groups expressed concern that: ‘‘It will be up to the consumer to persuade a landlord or another person to accept the substitute check as

proof of payment.’’ Again, today, by the time consumers determine that they want

the check, it is likely to have already been destroyed. Moreover, under the proposal,

substitute checks will bear the legend, ‘‘This is a legal copy of your check. You can

use it the same way you would use the original check.’’ We believe that this will

be sufficient to quickly convince the landlords and others of the legal equivalence

of the check.

Finally, consumer groups also demand that the expedited recrediting provisions

of the proposal extend to all truncated checks, including those provided today with

the customers’ consent. They argue that consumers will be confused because the

rules for dispute resolution for those who receive images voluntarily, as they do

today, will be different from those who insist on substitute checks. The need for consistency argues for retaining current check law. Since existing check law has a long,

proven record of success in the truncated environment, if a single consistent rule

is adopted, it should be based on current proven law, not a new law that arguably

will promote fraud.

Conclusion

The banking and financial services trade associations support the general principle outlined in the Board’s proposal to facilitate innovation in the check collection

system without mandating receipt of checks in electronic form. We believe, however,

that the body of law and regulations that has developed around existing check clearing processes is both effective in protecting consumers and minimizing the banking

industry’s exposure to fraud. The banking industry and consumer experience with

existing check safekeeping and truncation programs demonstrate that existing law

and regulations work. The worries of consumer groups demanding additional consumer protections are unfounded. The examples they raise exist today without complaints of the harms or inconveniences they predict will accompany the legislation.

We urge Members of the Committee to consider changes to the Board’s proposal

that will preserve existing law with respect to substitute checks. We hope Members

will also take this opportunity to improve the efficiency of the U.S. payments system

by quick passage of the proposal, which has the broad support of the banking industry and the Federal Reserve Board.

REPRESENTED ORGANIZATIONS

American Bankers Association

The American Bankers Association brings together all categories of banking institutions, including mutually-chartered savings banks and savings associations, to

best represent the interests of the rapidly changing industry. Its membership—

which includes community, regional, and money center banks and holding companies, as well as savings associations, trust companies, and savings banks—makes

ABA the largest banking trade association in the country.

Consumer Bankers Association

The Consumer Bankers Association is the recognized voice on retail banking

issues in the Nation’s capital. Member institutions are the leaders in consumer finance (auto, home equity, and education), electronic retail delivery systems, bank

sales of investment products, small business services, and community development.

CBA was founded in 1919 and provides leadership and representation on retail

banking issues such as privacy, fair lending, and consumer protection legislation/

regulation. CBA members include 85 percent of the Nation’s largest 50 bank holding

companies and hold two-thirds of the industry’s total assets.

America’s Community Bankers

America’s Community Bankers represents the Nation’s community banks of all

charter types and sizes. ACB members, whose aggregate assets exceed $1 trillion,

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pursue progressive, entrepreneurial and service-oriented strategies in providing

financial services to benefit their customers and communities.

The Financial Services Roundtable

The mission of the Financial Services Roundtable is to unify the leadership of

large integrated financial services companies in pursuit of three primary objectives:

To be the premier forum in which leaders of the U.S. financial services industry determine and influence the most critical public policy issues that shape a vibrant,

competitive marketplace and a growing national economy; to promote the interests

of member companies in Federal legislative, regulatory, and judicial forums; and to

effectively communicate the benefits of competitive and integrated financial services

to the American public.

Independent Community Bankers of America

ICBA, ‘‘The Nation’s Leading Voice for Community Banks,’’ represents nearly

5,000 institutions at more than 17,000 locations nationwide. Community banks are

independently owned and operated and are characterized by attention to customer

service, lower fees, and small business agricultural and consumer lending. ICBA’s

members hold more than $526 billion in insured deposits, $643 billion in assets and

more than $405 billion in loans for consumers, small businesses, and farms. They

employ more than 231,000 citizens in the communities they serve.

58

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES

FROM ROGER W. FERGUSON, JR.

1. In your written testimony you stated that, ‘‘Check truncation is

generally more efficient, more cost effective, and less prone to processing errors.’’ Based in part on this assessment, you concluded

that, ‘‘The proposed legislation should result in substantial cost

savings.’’ In defining how these benefits would be distributed, you

stated that, ‘‘As banks reduce their operating costs, the savings will

be passed on through a combination of lower fees to their customers and higher returns to their shareholders. Banks have indicated

that they expect cost savings to be substantial.’’ Based on these

statements, I have two related questions.

Q.1.a. What is the Fed’s estimate of the size of these savings for

banks?

A.1.a. While we believe that the proposed legislation will result in

substantial cost savings, the magnitude of those savings is difficult

to estimate. The magnitude of the savings will depend on the rate

at which banks begin using the proposed legislation’s new authority. Each of the bank’s approach toward using the new authority

will depend on its technology infrastructure, physical infrastructure, business strategy, and customer profile. On the other hand,

banks receiving substitute checks will be able to process substitute

checks in the same manner as original checks, thereby incurring

little or no additional processing costs. Banks that receive substitute checks, however, will incur additional administrative and

compliance costs that will depend largely on whether the proposed

legislation, as enacted, includes expedited recredit and disclosure

requirements and, if so, the form of those requirements. Therefore,

while banks have indicated that they expect cost savings to be

substantial, the actual magnitude of the cost savings is difficult to

determine.

Q.1.b. What portion of these substantial savings do you expect to

go to customers as opposed to shareholders?

A.1.b. We are not able to forecast the relative amount of the cost

savings that might accrue to banks’ customers and shareholders

under the proposed CTA. Banks implement changes for a variety

of reasons. Banks might implement changes to improve profitability or to increase market share by attracting and retaining customers through improved services or fee reductions. Historically,

both banks and their customers have benefited from banks’ investment in technology. We expect that the proposed CTA will benefit

both banks’ customers and shareholders.

2. It is my understanding that the CTA reduces the amount of

damages that a consumer can recover under an indemnity loss

claim, breach of warranty, or failure of the bank to meet any requirement of the CTA, in proportion to the amount of negligence

or bad faith attributable to the customer. In your April 3 testimony, you stated that, ‘‘The question of comparative negligence

already exists in any of the common law standards for tort and

. . . in the UCC. And it has withstood the test of time.’’ Consumer

groups agree. However, they allege that the comparative negligence

standards in subsection 5(c) and 8(b) of the CTA are much broader

59

than the Uniform Commercial Code (UCC) standards governing

consumer check transactions and will make it more difficult for

consumers to recover damages from banks.

Q.2.a. Are consumer protections under the CTA weaker than

under the UCC as the consumer groups allege?

A.2.a. The CTA consumer protection provisions are generally consistent with, and would not weaken, consumers’ rights under the

UCC. The comparative negligence standard is included to ensure

that the doctrine of comparative negligence adheres to the newly

created rights under the warranties and indemnity that would

apply to substitute checks. The comparative negligence language is

also intended to negate any concern that the CTA preempts wellestablished State check law protections. Consumer protections

under the CTA are additional protections over and above current

UCC provisions. The CTA warranties and indemnity, as well as the

comparative negligence provisions, would overlay existing check

law and apply in cases where substitute checks are used.

Comparative negligence is a common law concept under which

courts apportion tort liability according to how much the actions of

each party contributed toward the loss. This concept has been incorporated into check law through the UCC, as well as the Board’s

Regulation CC (See 12 CFR § 229.38(c)). The UCC contains several

provisions that allocate liability based on fault. For example, the

UCC sets out a comparative negligence standard in cases of imposters and fictitious payees (Section 3–404(d)) and alterations and

forged signatures (Section 3–406). These cases often, but need not

always, involve fraud. Other UCC provisions reduce a person’s ability to recover losses based on that person’s negligent actions and

generally do not involve fraud. For example, Section 4–406(d) reduces a consumer’s ability to recover for unauthorized items if the

consumer does not make a timely examination of his or her statement. Also, under Section 3–407(c), a consumer could be held liable

for a check that was completed in an unauthorized manner if the

check was signed yet incomplete when it left the consumer’s hands.

The CTA comparative negligence provision would operate in a

manner similar to these UCC provisions: When a party to a check

(which could be a consumer, a nonconsumer, or a bank) acts negligently or in bad faith, that party’s ability to recover under the

CTA warranties or indemnity will be proportionally reduced.

Q.2.b. Please explain why there are comparative negligence provisions in the CTA when current law governing check processing

remedies already provides a comparative negligence standard?

A.2.b. Although State law already encompasses a concept of comparative negligence in the provisions of the UCC and as a common

law principle, a new Federal law that did not explicitly incorporate

such a concept may be deemed to preempt the State law. Therefore,

the proposed CTA includes a comparative negligence provision to

make it clear that the new liabilities created by the CTA warranties and indemnity could be reduced where the complaining party

acts negligently or in bad faith.

Q.2.c. What types of actions are anticipated that would make a

consumer somehow at fault for a bank’s processing error? Does the

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Board believe that a consumer could contribute in any way to the

double processing of a check or to a processing error such that the

amount they recover is reduced?

A.2.c. There are relatively few processing errors today, given the

40 billion checks written annually, and it is highly unlikely that

the CTA would change that very positive experience for those who

use checks for their payment needs. It is possible, although unlikely, that a consumer’s actions would result in a bank processing

error. A bank processing error could take many forms, including

misencoding and the creation of illegible or duplicate substitute

checks. Misencoding of checks seldom occurs today and there are

encoding warranties in the UCC and the Board’s Regulation CC

that address this issue. Consumer actions rarely contribute to such

errors. Similarly, we believe it would be a rare circumstance when

a consumer’s actions contributed to the creation of an illegible or

duplicate substitute check. For example, a consumer may have

taken some action with respect to the original check with the intent that the substitute check created from that original check

would be illegible. A bank that can prove such consumer intent

may be partially or fully absolved from liability.

Generally, a bank that is liable for damages because it has created an illegible or duplicate substitute check would not be able to

assert a comparative negligence defense against a consumer absent

unusual circumstances, such as those described above. It is our expectation that the comparative negligence provisions will apply in

most cases to disputes between banks.

Q.2.d. Consumer groups allege that under the UCC, a bank may

only raise a comparative negligence defense with respect to fraud

or forgery. Is this correct?

A.2.d. As indicated in more detail under the first question, there

are instances under the UCC where a consumer’s ability to recover

losses or to avoid liability is limited due to the consumer’s own

negligence or bad faith (see UCC 3–407(c) and 4–406(d)). Fraud or

forgery is not necessarily involved.

Q.2.e. Is it true that under the current law a bank could not

defend against processing errors on the grounds of comparative

negligence?

A.2.e. The legal defenses available to a bank depend on the nature

of the processing error and whether the consumer’s actions contributed to that error. As indicated above, we believe that a consumer’s

actions rarely contribute to errors such as misencoding. However,

in the event that a consumer intended to defraud a bank and took

actions intended to result in misencoding or misdirection of a

check, it appears that the bank could recover against that consumer under the UCC and common law. We note, however, that

the case law involving misencoded checks generally is between

banks and does not involve consumers.

3. In your written summary testimony you note that check imaging under the CTA could ‘‘provide their customers with later deposit cut-off hours. Such changes could result in some checks being

credited one day earlier and interest accruing one day earlier for

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some checks deposited in interest-bearing accounts.’’ Based on this

statement, I have three questions.

Q.3.a. It is my understanding that while the adoption of CTA will

likely allow banks to benefit from faster check clearing, the CTA

does not make changes in the Expedited Funds Availability Act

(EFAA) that would ensure that banks make customers’ funds available to them more quickly. Is this true?

A.3.a. The EFAA already requires that the Federal Reserve Board

shorten the maximum permissible hold periods that banks may

place on a category of checks if improvements in the check collection and return system enable banks to learn of the nonpayment

of most of those checks more quickly (see EFAA Section 603(d)(1)).

The Board will monitor improvements to the check system and reduce permissible holds as warranted. Because the Board complies

with current law and will continue to do so, there is no need to either repeat existing mandates or create new ones. It is important

to note that most institutions already make funds available to their

customers more promptly than required by law. In a 1996 report

to Congress on Funds Availability Schedules and Check Fraud at

Depository Institutions, the Federal Reserve Board reported that

over 70 percent of banks provide customers faster funds availability to customers than required by Regulation CC.

Q.3.b. In the absence of a change in the EFAA and its regulations,

how can we be certain that consumers will be able to access their

funds more quickly?

A.3.b. The EFAA already requires that the Federal Reserve Board

shorten the maximum hold that banks may place on a category of

checks if improvements in the check collection and return system

enable banks to learn of the nonpayment of most of those checks

more quickly. If the proposed CTA results in such improvements,

the Board will shorten maximum permissible holds as required by

the EFAA.

In addition to the general improvements that might result in the

shortening of the maximum permissible hold schedules, the proposed CTA might result in some consumers being able to access

their funds more quickly through the possible extension of deposit

cut-off hours at some banks. Every bank has a cut-off hour after

which check deposits are considered made on the next banking day.

Banks could use the proposed CTA to transmit check deposits to

central processing centers for collection faster than the deposits

could be physically shipped to the centers. Banks could use this

additional time to extend deposit cut-off hours, which could result

in some consumer checks being credited one day earlier and consumers potentially obtaining access to funds on those deposits one

day earlier.

Further, as was noted above, a large percentage of banks already

provide customers with faster funds availability than required

under regulation. This suggests that market forces provide banks

with incentives to improve funds availability where possible. It

seems likely that if technology and business processes change such

that banks are able to collect checks more quickly than they do

today, market forces may well lead banks to provide customers access to their funds more quickly.

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Q.3.c. What steps will the Board take under EFAA to ensure that

consumers receive most of the benefit from faster check clearing

under the CTA?

A.3.c. As required by the EFAA, the Board plans to monitor improvements to the check system and reduce the maximum permissible hold schedules as warranted.

Q.4. A recent American Banker article on check truncation reported that Mr. John Hodas, Chief Financial Officer for Florida

Gulf Bank, which uses check imaging, is concerned about the quality of these images. The story states that: ‘‘Mr. Hodas said the images are sometimes too faint to read, especially when checks are

written in light-colored ink.’’ Does the Fed proposal include any

standards for the quality of an electronic or substitute check? Why

or why not?

A.4. The proposed CTA requires that a substitute check conform to

generally applicable industry standards. There are two American

National Standards specifications that would be used in a future

CTA environment. The first is ANS X9.90—Specifications for

Image Replacement Documents. This standard outlines the design

or layout of a substitute check and incorporates other existing

standards, including standards that deal with paper dimensions

and quality, MICR line location and printing, check background design, and check endorsements. The second is ANS X9.37—Specifications for Electronic Exchange of Check and Image Data. This

standard has been revised to support the inclusion of images and

electronic endorsement records, which is critical to the implementation of the proposed CTA. These two standards have already been

released as Draft Standards for Trial Use (DSTU’s).

The proposed CTA also requires that a substitute check include

an image of the front and back of the original check. Further, to

be the legal equivalent of the original check, the proposed CTA requires that a substitute check accurately represent all the information on the front and back of the original check at the time the

original check was truncated. If the writing on a check is clear on

the original but not on the substitute, then the substitute check

would not be legally equivalent to the original check and the reconverting bank would be in breach of its legal equivalence warranty.

Q.5. It is my understanding that under the Fed proposal banks

will still be able to return substitute checks to customers if both

the bank and the consumer agree to that service. To do such would

require that at some point the image of the check be translated

into a substitute check and that that substitute check either be

sent to or printed at the customer’s bank. David Walker, Executive

Director of the Electronic Check Clearing House Organization

(ECCHO) is quoted in a recent American Banker article as estimating the cost of creating and processing substitute checks in the

range of 2 to 2.5 cents apiece, versus about 1 cent for regular

checks. As a result of this higher cost the article concludes that,

‘‘The industry’s hope, of course, is that substitute checks will not

be a concern for long.’’ Mr. Ferguson, should one be concerned that

the potential high costs involved in creating and handling substitute checks will make it increasingly less likely that banks will

even offer customers the ability to receive substitute checks?

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A.5. Under the proposed CTA, banks would have to weigh the

costs associated with creating substitute checks against the savings

from being able to handle more of the check collection process electronically. Mr. Walker’s statement simply suggests that using the

substitute checks may not be the most cost-effective approach for

processing all checks. A collecting bank will collect checks using the

most cost-effective approach for each type and category of check.

Therefore, some checks may be collected as original checks, some

as substitute checks, and some electronically under electronic exchange agreements. Regardless of how checks are collected, banks

will have the ability to provide their customers with accounts that

return cancelled checks with bank statements. Assuming there is

demand for accounts that return cancelled checks to customers,

competition in the banking industry should drive banks to offer

such accounts. Further, some States have laws that require banks

to offer accounts that return cancelled checks to customers.

Q.6. It is my understanding that banks are required by law to

maintain a copy of all checks for 7 years. As I have been informed,

the majority of these copies are kept using nonelectronic means

(generally microfiche), while some smaller percentage is stored

electronically. If check truncation were implemented under this

proposal would you expect this to change such that the vast majority of checks would be stored electronically?

A.6. Microfiche or microfilm technology is a relatively old technology. As the cost of digital imaging technology declines, banks

are increasingly using this technology to maintain copies of checks

that they handle. The proposed CTA would likely accelerate this

trend because there would be more business applications for the

technology, thereby making investments in the technology more

attractive.

7. One general advantage of electronic documents is that they are

easily transmitted and that large numbers of documents can be

sorted according to a wide variety of information. Thus, it is possible, perhaps likely, that this legislation could lead to the creation

of a large, electronic database containing the information of many

consumers’ check writing habits.

Q.7.a. Is it your opinion that the CTA would create new and expanded opportunities for banks to mine personal consumer information for commercial purposes?

A.7.a. A check is typically imaged several times in today’s environment. The check is imaged by the bank at which it is deposited,

it may be imaged by any intermediary handling the check, and it

is imaged by the paying bank. Therefore, there are already significant databases containing check images. Check images, however,

are simply pictures of checks. To mine information, extra steps are

required to extract information from check images and to enter

that information into a database. Given the 40 billion checks that

are written each year, mining information from check images

would likely be relatively expensive and labor intensive.

Q.7.b. Is there any provision in the proposed Act that would limit

a bank’s ability to search its database of electronic check informaVerDate 11-MAY-2000 13:23 Apr 01, 2004 Jkt 000000 PO 00000 Frm 00067 Fmt 6602 Sfmt 6602 92704.TXT SBANK4 PsN: SBANK4
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tion and use it to create and to share a detailed profile of the customer’s buying and spending habits?

A.7.b. There are no provisions in the proposed CTA that address

the privacy of financial information. The Congress has already

addressed the protection, disclosure, and use of consumer financial

information in Title 5 of the Gramm-Leach-Bliley Act. There are

many ways by which banks obtain financial information about

their customers other than through checks that they handle. If

Congress wishes to expand the privacy provisions of the GrammLeach-Bliley Act, it would be more effective to consider such expansions in separate, broadly applicable, legislation rather than in a

narrowly targeted bill such as the CTA.

Q.8. The Board’s section-by-section analysis of the CTA, accompanying Chairman Greenspan’s transmittal letter to the Committee

on December 17, 2001, includes the following sentences:

‘‘The Federal Reserve Board believes that a next day re- credit limit of $2,500 is a reasonable compromise between

banks and consumer interests’’ and ‘‘the expedited recredit

procedure is intended to mitigate the effects on consumers

of any potential problems associated with the receipt of

substitute checks.’’

You failed to endorse this provision in your April 3 testimony. Instead, your written testimony notes that, ‘‘Upon further reflection,

the Board has now concluded that the significant compliance burdens imposed by these provisions on banks that receive substitute

checks outweigh the small incremental benefits that the provisions

would provide consumers.’’ There may be some practical problems

with the expedited recredit provision contained in the Board’s CTA

proposal, but I am most interested in understanding what has

changed since December 17, 2001? What are some of the new compliance burdens? Was the Board staff unaware of the Uniform

Commercial Code’s protections when the proposal was sent to Congress? If so, why was the provision included?

A.8. The Board submitted a draft of the CTA to the Congress in

December 2001, with the understanding that it would serve as a

starting point for discussions among the Congress, banks, consumer groups, and other interested parties. The Board expected

that further revisions could and would likely take place as the interested parties, including the Board itself, continued to consider

the pros and cons of various provisions of the legislation. In particular, the Board expected further debate on the expedited recredit

provisions, which had been the subject of spirited discussions between banks and consumer groups well before December 2001.

Two of the Board’s guiding principles in developing the CTA

were that: (1) the burdens associated with the proposed law did not

outweigh the associated benefits for either banks in the aggregate

or their customers in the aggregate; and (2) banks that choose to

convert a check to, or receive a check in, electronic form should internalize, to the extent practicable, the costs and risks related to

the creation of the substitute check, because they receive most of

the associated benefits. The Board believed at that time (and continues to believe) that the risks of any serious consumer problems

under the proposed CTA would be low and was well aware in DeVerDate 11-MAY-2000 13:23 Apr 01, 2004 Jkt 000000 PO 00000 Frm 00068 Fmt 6602 Sfmt 6602 92704.TXT SBANK4 PsN: SBANK4
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cember 2001, that the UCC provided strong check-related protections to consumers. Nevertheless, our discussions with the banking

industry and consumer groups on this issue focused largely on how

to craft expedited recredit provisions rather than on the need for

such provisions.

Since that time, however, the Board has had further opportunity

to carefully consider the arguments on both sides of this debate.

The Board has also had the opportunity to consider the results of

ongoing experiments in the marketplace involving substitute

checks, which have raised virtually no consumer problems. In addition, as the draft CTA has evolved, additional burdens in the form

of notice requirements have been placed on banks that are passive

recipients of substitute checks. After further reflection, the Board

now believes that the compliance burdens imposed by the expedited

recredit provisions on banks that receive substitute checks would

outweigh the small incremental benefits that the provisions would

provide to consumers. Therefore, the Board does not believe that

the expedited recredit provisions are necessary to successfully implement the CTA. Nevertheless, if Congress concludes that expedited recredit provisions for consumers should be included in the

legislation, we believe that any expedited recredit provisions should

be consistent with the proposed legislation’s basic purposes and

should not go beyond the provisions proposed by the Board.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED

FROM ROGER W. FERGUSON, JR.

Q.1. Under the Fed proposal, if a hacker interferes with a check’s

electronic transmission (for example, the creation of electronic

counterfeit checks), who would ostensibly bear the sole liability for

lost assets? Does the indemnity provision of this proposal cover

incidences of electronic fraud?

A.1. Under existing law, a bank can only charge a customer’s account for transactions authorized by the customer. In the example

you cite, the bank’s customer has not authorized the fraudulent

transaction and is not responsible for the loss. The customer, of

course, has a duty to examine his or her bank statement and must

notify the bank of any unauthorized charges. Where the ultimate

liability falls depends on the facts of the particular case. Generally,

banks that have agreed to exchange checks electronically would include in their agreement provisions governing the responsibility for

data integrity at various points in the check collection process.

The proposed CTA’s indemnity provision only covers situations in

which the receipt of a substitute check results in a loss to a bank

customer or other party to the check. As I noted, existing law protects bank customers from electronic fraud.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER

FROM ROGER W. FERGUSON, JR.

Q.1.a. Please comment on the implications of this proposal on the

security of checks. My understanding is that today checks, like the

U.S. dollar, are actually quite sophisticated pieces of paper ‘‘technology’’ with various safeguards against fraud ‘‘wired’’ into the

check. Will the Fed proposal preserve that high degree of security?

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A.1.a. Today, some checks incorporate a variety of physical security features including microprinting, chemical sensitivity, security

fibers, watermarks, high-resolution border text, and latent images.

Many of these security features are lost when checks are imaged.

A number of vendors, however, have developed a variety of imagesurvivable security features to address check security issues in an

image environment. These features include two-dimensional bar

coding, seal encoding, and digital watermarking. Banks could use

these new features to protect against fraud. Also, we expect that,

as the use of substitute checks becomes more prevalent, other new

security features will be developed to help prevent fraud.

Q.1.b. Who will be responsible for authenticating a check?

A.1.b. Ultimately, the bank paying a check is responsible for ‘‘authenticating’’ a check that is written by its customer. The paying

bank has knowledge of the drawer’s signature and generally has

knowledge of check stock type, check serial number range, and so

forth. This knowledge is useful in identifying many fraudulent

checks. We also expect that over time the security features in

checks would evolve to accommodate the technological developments in check processing.

Q.1.c. And if the physical check does not end up back at the bank

that is on the hook for the funds—and presumably most motivated

to do a thorough security verification—how will you ensure a high

level of attention to security?

A.1.c. Today, most security verification is done at the paying bank.

This process will likely continue, albeit through the use of new

security features. Banks at which checks are deposited will have

access to the original checks and will be able to perform the same

verification they do today.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY

FROM LINDSAY A. ALEXANDER

Q.1. What is the difference in cost for clearing a check electronically versus paper?

A.1. Based on the volume of checks cleared at NIHFCU (a total of

2.5 million checks are cleared annually), our costs for clearing

checks electronically versus paper are $6,250 compared to $37,500.

The following figures showing the cost of each service are from the

Federal Reserve’s website, at www.frbservices.org. ACH origination—.25 cents per item ($0.0025). ACH receipt—.25 cents per item

($0.0025). Check Truncation @ Fed—1.5 cents per item ($0.0150).

Even without our labor and fixed costs factored in, it costs onesixth as much to move transactions electronically.

Q.2. Your testimony states NIHFCU will be undergoing a conversion to an entirely electronic system. What are the costs associated

with such a conversion?

A.2. The exact figures to convert to an entirely electronic system

are not available. However, we expect the costs to be minimal,

since NIHFCU already truncates its checks and offers imaging and

online services to its members. The fees associated with such a conversion would mostly stem from internal conversions needed as a

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credit union to use the new technologies, in addition to a one-time

fee from the Federal Reserve.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED

FROM LINDSAY A. ALEXANDER

Q.1. Under the Fed proposal, if a hacker interferes with a check’s

electronic transmission (for example, the creation of electronic

counterfeit checks), who would ostensibly bear the sole liability for

lost assets? Does the indemnity provision of this proposal cover

incidences of electronic fraud?

A.1. Under the Federal Reserve proposal, the liability for the lost

assets would not be covered by the proposal itself. According to the

section-by-section analysis of the Check Truncation Act, the indemnity section provides an indemnity for a loss incurred by the recipient of a substitute, if the loss is due to the receipt of the substitute

check, rather than the original check. Moreover, under this section,

if the loss would have occurred even if the original check had been

transferred or presented instead of the substitute check, the party

incurring the loss would not have an indemnity claim, because that

party is no worse off as a result of having received the substitute

check. In this case, the loss is not caused by the receipt of the substitute check. In fact, in your case, there is no mention of the substitute check. The consumer would be able to recover under the

Uniform Commercial Code Article 4.

What financial institution bears sole liability for this loss under

Article 4 of the Uniform Commercial Code would depend on how

the electronic check was altered to commit the fraud. For instance,

if the electronic counterfeit alters the check writer’s signature to

obtain the payment then the paying bank would cover the loss pursuant to Uniform Commercial Code 4–208(3). On the other hand,

if the payee’s endorsement is altered, then the presenting financial

institution would be in breach of its warranty and the presenting

bank would bear liability for the claim under Uniform Commercial

Code 4–208(a)(1). Under different scenarios, different parties would

be liable.

The indemnity provision would not cover incidences of electronic

fraud. As described above, the scope of this Act and the indemnities

and warranties are limited to substitute checks. For instance, the

indemnity only begins when a financial institution converts an

electronic check into a substitute check. From that point forward,

the indemnity runs with the substitute check or any subsequent

electronic version of the check. However, the loss must be suffered

because of receipt of the substitute check instead of the original

check. In order for that requirement to be fulfilled there would

have to be a loss caused by receiving the substitute check when it

was not good enough (for example, for forgeries where the original

was necessary to make a determination) or for having two substitute checks presented or other similar circumstances.

Q.2. If we move forward with this legislation, what assurances can

you give consumers that they will see lower costs or better services

in their banking experiences: I believe consumers will benefit from

this change, but perhaps you can outline some specifics for us?

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A.2. Consumers would see lower costs and better services because

the technology allows us to provide both. NIHFCU already truncates its checks and also offers imaging and online services to its

members. By combining truncation with imaging, NIHFCU offers

members greater access to their checks online. Members have used

these enhanced services to access their checks much more frequently than was possible before imaging. Also as stated in the answers above, at any point in the process check truncation is much

cheaper to NIHFCU than full manual processing of checks. Thus,

since NIHFCU as a credit union is a member-owned institution

these savings will be passed along to its members.

Q.3. In a dispute over check fraud, how will your policies change—

if they change at all—in investigating fraud and making the consumer whole in the event of fraud?

A.3. NIHFCU does not believe that there would be increased fraud

from electronic transactions. As a result, NIHFCU does not plan to

change its policies regarding check fraud if check truncation legislation passes because its current policies and procedures to handle

fraudulent items are more than sufficient to handle the fraud that

may arise. If a member alleges that they have been the victim of

check fraud, NIHFCU investigates the allegation and within time

frames prescribed by applicable laws, NIHFCU makes consumers

whole in cases of fraud.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED

FROM JANELL MAYO DUNCAN

Q.1. Under the Fed proposal, if a hacker interferes with a check’s

electronic transmission (for example, the creation of electronic

counterfeit checks), who would ostensibly bear the sole liability for

lost assets? Does the indemnity provision of this proposal cover

incidences of electronic fraud?

A.1. The Federal Reserve proposal doesn’t appear to assign liability for losses due to unauthorized access or fraudulent alteration of

a check during electronic transmission. In addition, the proposal

does not create any new protections for electronically transmitted

checks. Under the Fed proposal, the check must be transformed

into a substitute check to trigger any additional protections, such

as indemnity.

The indemnity provision of the Fed proposal does not clearly

address the issue of a fraudulently created substitute check. The

indemnity provision relates to damages resulting from the creation

of a substitute check, instead of the original check. However, it is

not clear that the indemnity provision would assign liability to a

bank, thrift, or credit union (hereinafter collectively referred to as

banks) where a substitute check is fraudulently created or altered

by a hacker.

Even if the indemnity section applies to fraudulently altered or

created checks, it would require a lawsuit to enforce, which would

be very time consuming and potentially expensive for a consumer

to pursue. Additionally, the indemnity section of the Fed proposal

contains a comparative negligence section that would not assign

‘‘sole liability,’’ and instead would require a fact intensive exploration of comparative fault between the bank and the consumer.

69

Presumably, common law negligence principles also would apply

to a bank that negligently failed to safeguard consumer check information, leading to a loss. However, if a court were to look to the

Uniform Commercial Code (UCC) to define negligence, a bank may

be able to avoid responsibility if it maintained a low standard of

care, but acted in compliance with industry standards. Under UCC

3–103(a)(7), ‘‘ordinary care’’ is defined only as ‘‘observance of reasonable commercial standards, prevailing in the area in which the

person is located. . . .’’ In addition, UCC 4–103(c) further provides

that, ‘‘Action or nonaction consistent with . . . a general banking

usage not disapproved by this Article, is prima facie the exercise

of ordinary care.’’ See also UCC 4–103, Comment 4. This standard

of ordinary care raises the concern that if no other banks have

taken sufficient security measures, it will provide prima facie evidence that a bank that has had its electronic check processing system breached is not negligent. This concern is heightened by the

fact that the Fed proposal fails to create any new obligations on

banks electronically transmitting consumer check information to

safeguard the information from security breaches.

Finally, under existing law, Section 4–401(a) of the UCC, a bank

may only charge against a customer’s account, ‘‘An item that is

properly payable from the account even though the charge creates

an overdraft.’’ The Section continues, ‘‘An item is properly payable

if it is authorized by the customer and is in accordance with any

agreement between the customer and the bank.’’ Under this Section of the UCC a bank may be liable for improperly paying a

fraudulently created, or improperly altered consumer check because

it is not a ‘‘properly payable’’ item. However, seeking a remedy

places a tremendous burden on the consumer because in order to

recover losses under the UCC, he or she must litigate the claim.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES

FROM DANNE L. BUCHANAN

1. As the representative of the American Bankers Association, the

Financial Services Roundtable, America’s Community Bankers,

Independent Community Bankers of America, and the Consumer

Bankers Association, please answer the following questions.

Q.1.a. Are banks, subsidiaries, or affiliates of banks or other entities that process bank checks, currently using information from

checks, such as payee or amount, to identify consumer spending

patterns? If so, do firms use this information themselves or do they

share it with or sell it to other firms or financial institutions?

A.1.a. Banks have always had the ability to extract information

from paper checks or check images to detect potential fraud and to

analyze customer spending habits and there are some depository

institutions which extract information on an ad hoc, sporadic basis

for internal purposes or for sharing with affiliates. However, this

practice of extracting information from checks is not prevalent.

First, extracting information from images is relatively difficult,

time-consuming, and labor intensive for both paper checks and

check images. We are aware that products may emerge that may

extract information more efficiently that rely on character recognition, but to our knowledge, such techniques are currently unreliVerDate 11-MAY-2000 13:23 Apr 01, 2004 Jkt 000000 PO 00000 Frm 00073 Fmt 6602 Sfmt 6602 92704.TXT SBANK4 PsN: SBANK4
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able. Second, public sensitivities inhibit use and sharing of such

information. Finally, the privacy provisions of the Gramm-LeachBliley Act significantly restrict how such information can be shared

outside of the bank.

Q.1.b. Would the industry support check truncation legislation if

it contained a provision that check images, or any data contained

on the check, could not be used for any purpose other than check

processing, dispute resolution, or responding to customer requests?

A.1.b. Any privacy issues related to the use of check information

should be addressed in the broader context of financial information

privacy and should not be included as part of any check truncation

legislation. The check truncation process as envisioned by the Federal Reserve Board’s proposal will have no impact one way or the

other on the type of check information collected by banks, how that

check information is or is not used for purposes outside of check

processing, dispute resolution, or responding to customer requests.

2. As you know, on March 26, the American Banker reported that

Viewpointe Archive Services shut down the JP Morgan and Bank

of America image exchange pilot at the end of February. Viewpointe’s Chairman and CEO, John Lettko, noted that the pilot was

discontinued because the banks had reached, ‘‘A point of diminishing returns.’’ According to Mr. Lettko, the banks concluded that,

to get further economic value from the exchanges, they needed to

install more image capability in their back-office processing shops.

The article further noted that only a small number of banks can

process images ‘‘from the front end of the office to the back.’’

Q.2.a. As we explore legislation facilitating widespread check imaging, what lessons can be learned from the Viewpointe experience

with image exchange?

A.2.a. To respond to the Committee’s question regarding Viewpointe and check image exchanges, I consulted with Grant Cole,

Senior Vice President at Bank of America, who has more direct information on the Viewpointe project. The response below is based

in part on information obtained from Bank of America.

In November 2001, JP Morgan Chase and Bank of America embarked on a research and development project to test assumptions

about check image exchange using a shared central archive. Both

banks are owners of Viewpointe Archive Services. The banks set

out to develop processes, rules, agreements, and logistics related to

the exchange of check images in a shared archive to facilitate the

collection and settlement of checks that traditionally had been

exchanged between the banks in paper form. The Federal Reserve

was invited to participate in the design of the process, but not to

exchange checks in this phase of the project. The Electronic Check

Clearing House Organization (ECCHO) was asked to join the

project as well, in the capacity of rules rationalization.

Through this exchange project, the banks developed the design

for exchanging images of checks within a central archive, the indices required, privacy requirements, and access capabilities. This

design was then tested by exchanging through the Viewpointe archive a small sample of check images from each bank. During this

test, the paper checks were still exchanged by the banks. The

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banks still needed the paper checks because they have not completely extended image technology to all aspects of the banks’ check

operations and so were needed to perform exceptions processing

such as return item processing. It is anticipated that prior to a full

rollout image exchange between two or more banks, the participating banks would extend the necessary technology throughout

the check processing systems at such banks.

The project to test image exchange through Viewpointe was a

complete success as the banks involved in the test were able to

prove an operational design that fulfilled all the objectives.

The article that was published in the American Banker regarding

the check image exchange through Viewpointe is misleading, as the

comments out of context left the wrong impression. The quote by

Mr. Lettko of ‘‘diminishing returns’’ is accurate, but only because

the objective of testing the image exchange process was met, and

as long as the original paper checks have to follow the exchanged

check images, there would not be much of an additive economic

benefit. Also, the banks recognized during the test that there is a

need for more automation to handle images efficiently in ‘‘the back

office’’ which will be accomplished prior to the full implementation

of check image exchange.

The comment in the American Banker article about a ‘‘small

number of banks being able to process images from the front end

of the process to the back’’ is also misleading. There are check

image projects underway today in almost all large banks, and

many smaller financial institutions are generally ahead of large

banks in deploying image technology. The 2002 ICBA and InFinet

Resources Community Bank survey results indicate that community banks’ use of check imaging technology outpaces that of larger

banks by a margin of 2 to 1, with 47 percent of the respondents

currently using the technology and another 41 percent planning to

evaluate the technology within the next 12–18 months. This corresponds to 88 percent of the respondents currently using or planning to evaluate imaging technology. Many small institutions have

responded that they are waiting for check truncation legislation

before investing in imaging. While not all banks are today implementing front-to-back exchange of images, the image programs

established by these banks are the first and necessary step toward

the day when banks can exchange images with any other bank in

the Nation.

We believe the Boards proposed check truncation legislation will

provide the impetus for the expansion of image exchange programs.

Lessons to be learned from the Viewpointe experience are that

the image exchange using a common shared archive can be accomplished efficiently and securely. It also illuminated that in order for

the real benefits of image exchange to be realized for the Nation’s

payment system, check images must be exchanged without the

need for the original paper checks to be transported. For the reasons discussed above, we believe that the substitute check process

contemplated in the Board’s proposal will provide the impetus

required for the furtherance of the business case for check image

exchange.

Q.2.b. As the President of NetDeposit, a company that provides

processing and clearing technology that facilitates the electronic

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presentment of paper checks, what are some of the problems you

have experienced with imaging?

A.2.b. We have experienced very few problems with the technology

or customer complaints. One reason is that paying banks are not

required to have image capability since they are provided substitute checks. Some banks and merchants have expressed concerns

about the lack of clarity with regard to the legal validity of substitute checks. The Board’s proposal would provide that clarity by

stating substitute checks are the legal equivalent of the original.

Q.2.c. Do the check images (substitute checks) contain securities

features? If not, what are some of the obstacles currently preventing banks from imaging security features onto substitute checks?

A.2.c. New image-survivable security features have been developed, and are under development, that should provide all check

issuers with superior security features for checks that are imaged

or converted to substitute checks. For example, we are aware of one

technology company that offers a security feature for checks that

are image-survivable, but also machine-readable, allowing for automatic processing. These image-based security features/processes

are superior to the paper-based security features currently in use

because check issuers can verify the security procedures carried on

each image on an automated basis, rather than upon physical inspection of the paper check.

Industry standards groups are also working on standards and

other operational issues for check image systems and substitute

checks. The standard defines a structure to properly identify security features. The standard enables the incorporation of standardized and proprietary security features into the original check by

providing a trigger and identification structure. The standards do

not specify requirements for the type of security features.

At the time the check is issued or printed a one- or two-dimensional bar code is printed on the check with information about the

check. For example, the dollar amount or check number could be

encoded. One of the benefits of this encoding process is that the

image of the check with the encoding can be authenticated anywhere in the check collection process. The validating encoded information is carried on both the paper check, the image of the paper

check, and a subsequent printed copy of the check image (such as

a substitute check).

See example below with a one-dimensional bar code.

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Q.3. In your written testimony, you note that, ‘‘Reducing the dependency on the physical presentment of original items will result

in faster check collection, which will allow consumers sooner access

to their funds.’’ Moreover, the Federal Reserve has noted that due

to check imaging under the CTA banks could, ‘‘Provide their customers with later deposit cut-off hours.’’ It is my understanding

that while the adoption of CTA will likely allow banks to benefit

from faster check clearing, the CTA does not make changes in the

Expedited Funds Availability Act (EFAA) that would ensure that

banks make customers’ funds available to them more quickly. In

the absence of a change in the EFAA, how can we be certain that

consumers will be able to access their funds more quickly? Would

the industry support a change in the EFAA requiring that funds

become available to customers more quickly?

A.3. No change is necessary as the Expedited Funds Availability

Act already anticipates a reduction in the funds availability schedules in the event checks are processed and returned more quickly.

Specifically, under Section 603(d) of that Act, the Board must, by

regulation, ‘‘Reduce the time periods . . . to as short a time as possible and equal to the period of time achievable under the improved

check clearing system for a receiving depository institution to reasonably expect to learn of the nonpayment of most items for each

category of checks.’’

Q.4. Is it my understanding that banks are required by law to

maintain a copy of all checks for 7 years. I have been informed that

the majority of these copies are kept using nonelectronic means

(generally microfiche), while some smaller percentage is stored

electronically. If check truncation were implemented under this

proposal, would you expect this to change such that the vast majority of checks would be stored electronically?

A.4. Over time, we would expect that most checks would be stored

electronically regardless of whether the proposal is enacted.

5. A general advantage of electronic documents is that they are

easily transmitted and many documents can be sorted according to

a wide variety of criteria. Thus, it is possible, perhaps likely, that

this legislation could lead to the creation of a large, electronic database containing the information of many consumers’ check writing

habits. In your written testimony, you stated that you are CEO of

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NetDeposit, ‘‘A subsidiary of Zions Bancorporation that provides

processing and clearing technology which allows organizations to

move to electronic presentment of paper checks.’’ The American

Banker has reported that, ‘‘Zions is selling the system [NetDeposit]

to other institutions and has one money-center bank testing it.’’ As

CEO of NetDeposit, please answer the following questions.

Q.5.a. Does NetDeposit currently, or plan in the future, to handle

electronic check processing for multiple banks?

A.5.a. NetDeposit will handle electronic check processing for multiple banks.

Q.5.b. What information is, or could be, kept electronically from an

imaged check as it goes through the NetDeposit system?

A.5.b. The only information held by the NetDeposit system will be

images that are stored for several days to ensure that if items are

not received or lost, we can recreate the cash letter. At the end of

5 days, these images are backed up to tape for record retention

only and stored offsite for 7 years.

Q.5.c. What restrictions regarding privacy exist for imaged checks?

A.5.c. The Gramm-Leach-Bliley Act (GLB Act) imposes significant

restrictions on the sharing and use of information from paper

checks or check images. Banks also could only use or disclose customer information from checks in compliance with their privacy

policies adopted pursuant to the GLB Act. In addition, the GLB Act

requires the banking agencies to establish appropriate standards

for financial institutions relating to administrative, technical, and

physical safeguards to protect: (1) the security and confidentiality

of customer information, (2) against unauthorized access, and (3)

against anticipated threats or hazards.

Q.5.d. Does the legislation proposed by the Federal Reserve provide any additional privacy protections?

A.5.d. No. The Federal Reserve Board proposal does not include

additional privacy provisions. For the reasons stated above, we believe additional privacy legal provisions are not needed for check

truncation programs. As a practical matter, customer privacy will

be enhanced by the proposal as access to checks and their information will be far more restricted when controlled in an electronic

check collection process. For instance, the current paper check

route offers opportunity to acquire information more easily than if

the check image were transmitted electronically. Today, paper

checks sit in airports, etc. awaiting transport and delivery. They

must also be physically handled along the various stops where the

information can be compromised. Electronic delivery eliminates

these physical stops and the opportunity to acquire the checks and

information.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED

FROM DANNE L. BUCHANAN

Q.1. Under the Fed proposal, if a hacker interferes with a check’s

electronic transmission (for example, the creation of electronic

counterfeit checks), who would ostensibly bear the sole liability for

lost assets? Does the indemnity provision of this proposal cover

incidences of electronic fraud?

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A.1. Both the Federal Reserve proposal and the Uniform Commercial Code protect consumers from liability for any check, electronic

or not, that is charged against their account and is not properly

payable. Thus, under no circumstances would the consumer be liable in this case. Depending on how and where the hacker intercepted the information and how the hacker used it, one of the

banks in the check process would bear the loss, based on warranties of the Uniform Commercial Code, the Federal Reserve proposal, and interbank agreements. If a hacker used the account

numbers in the electronic check image database to create an electronic funds transfer from the customer’s account, the consumer

would be protected from liability under the Electronic Fund Transfer Act and its implementing regulation, Regulation E. That law

protects consumers from liability for unauthorized electronic fund

transfers.

In addition, hacking would seem unlikely in this case. As currently envisioned and configured, banks use only secure data lines

to transmit the check image data to the database, and the databases themselves are protected with data encryption and other

security techniques.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER

FROM DANNE L. BUCHANAN

Q.1. A question for the bankers on the panel: If we move forward

with this legislation, what assurances can you give consumers that

they will see lower costs or better services in their banking experiences? I believe the consumers will benefit from this change, but

perhaps you can outline some specifics for us.

A.1. Generally, the potential benefits of the proposal derive from

the expected cost savings and quicker access to funds and account

information associated with the elimination of the need for paper

checks to physically travel from the bank of first deposit, through

various check processing participants, to reach the paying bank.

Consumers benefit from the potential cost savings in the form of

lower costs and better services. In a market as competitive as the

banking industry, competitive pressures will compel depository institutions to pass on to consumers savings from a more efficient

check collection system. In addition to the potential costs savings,

consumers will benefit from better service:

• Reducing the dependency on the physical presentment of original

items will result in faster check collection, which will allow consumers sooner access to their funds.

• Consumers will also have faster, more convenient access to information about check transactions.

• Improving the check clearing process may also allow banks to

develop new and more flexible banking services. For example,

image-capable ATM’s that can forward deposits electronically

will allow banks to deploy more ATM’s in remote locations as the

cost and frequency of physically retrieving deposits and servicing

ATM’s could be reduced. Consumers may be able to use these

ATM’s to cash their payroll checks at their place of employments,

which may be particularly attractive for those without bank

accounts.

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In addition to the direct impact on costs, the proposal would

serve to promote check imaging technology by adding another positive weight to the business case for adopting check imaging generally. This broader adoption of check imaging will help provide

benefits beyond those attributable to the electronic processing facilitated by the proposal. New applications, services, and benefits

will emerge and existing ones expand if check imaging is boosted

by the electronic processing envisioned under the proposal.

For example, today many consumers receive compendious and

convenient image statements of checks rather than disorganized,

loose checks. In addition, a more recent application of check imaging allows customers to view check images online. This helps consumers to quickly and conveniently review transactions, identify

potential errors, and detect fraudulent transactions sooner. In addition to the timely receipt of information, the customer might also

be able to print a copy of the check or send a copy of the check to

a party questioning payment.

Customers who do not bank online also benefit from imaging

because customer service representatives can quickly bring up for

view images to verify transactions for the customer. This requires

a fraction of the time typically required to research microfilm or

physical archives and transmit copies. Identifying the errors and

potential fraud as soon as possible helps banks minimize customer

inconvenience and control potential losses, and gives law enforcement an advantage in tracking down perpetrators. Such current

imaging applications will expand with the additional applications

contemplated in the Board’s proposal.

Q.2. A question for the bankers on the panel: In a dispute over

check fraud, how will your policies change—if they change at all—

in investigating fraud and making the consumer whole in the event

of fraud?

A.2. Generally, bank policies will remain unchanged with regard

to investigating fraud and making the consumer whole.

Today, depository institutions investigate and resolve claims as

soon as possible because of the potential liability under the Uniform Commercial Code (UCC) for consequential damages for failure

to properly pay items. The proposal preserves these UCC rights.

In addition, though the industry believes it unnecessary and dangerous from a fraud perspective, the proposal adds new ‘‘expedited

recrediting’’ provisions that basically guarantee consumers that

funds for unauthorized substitute check transactions will be available on the second day after the depository institution is notified

of a claim. We believe that this provision is unnecessary as existing

check law provides appropriate and adequate protection to consumers with respect to substitute checks as envisioned under the

proposal.

The banking industry and consumers have an established history

with truncated checks and image documents. Indeed, millions of

consumers have been receiving either images or a notation in their

statements for years, without complaint that disputes are not

addressed satisfactorily. The current check law works in the truncated and image environment. There simply is no evidence to justify deviation from existing check law.

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In fact, Board staff has indicated that an informal review of the

consumer complaints filed with all the banking regulatory agencies

reveal no significant consumer issues relating to the existing check

protections. Banks report the same dearth of complaints on these

matters. Complicated new recredit procedures would only serve to

confuse customers, create compliance headaches for banks, and expose banks to potential new sophisticated fraud schemes.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BENNETT

FROM DANNE L. BUCHANAN

Q.1. What is the effect of the provisions of Sections 5 and 8 in the

Federal Reserve’s proposed Check Truncation Act that provide a

comparative negligence standard for indemnification and other

claims under the Act? Would this comparative negligence standard

alter the current customer protections under check law?

A.1. The comparative negligence provision of Sections 5 and 8 of

the Federal Reserve proposal provides that the potential liability of

a bank to another person under the proposal’s indemnity relating

to a substitute check or for other failures to comply with the proposal is limited to the extent that the resulting losses are caused

in part by the negligence of the person making the claim. As an

initial matter, it should be pointed out that the person making the

claim against a bank could be a consumer, a business customer, or

even another bank. The comparative negligence provision would

apply the same way in all cases.

This comparative negligence provision was included in the proposal to provide a similar defense to full liability that is available

under common law in most States, as well as under the Federal

Reserve’s Regulation CC and the State law Uniform Commercial

Code (UCC) provisions that currently regulate check operations.

This comparative negligence standard does not change check law

liabilities as they work today, but rather makes the application

of the new warranties provided under the proposal similar to the

liability structure established under the UCC, and Regulation CC

for checks today.

Under the Federal Reserve Board Regulation CC, the damages a

person is entitled to as a result of a failure to comply with that

Regulation are diminished in proportion to the amount of the negligence or bad faith attributable to that person. (See Regulation

CC, Section 229.38(c).)

The UCC similarly includes the concept of comparative negligence. For example, Section 4–406 of the UCC requires that a customer must exercise reasonable promptness to examine a statement of checks to determine if any unauthorized checks have been

paid. If the customer fails to comply with this duty, the customer

may be precluded from recovering the amount of the unauthorized

checks. Furthermore, if the customer can establish that the bank’s

negligence contributed to the customer’s loss under this UCC section, the loss is allocated between the bank and the customer on

the basis of the relative comparative negligence of the parties.

This comparative negligence approach in the proposal (as well as

the UCC and Regulation CC) reflects the policy of fundamental

fairness—if both parties acted wrongly and each contributed to the

loss, they should share the loss accordingly.

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The comparative negligence provision of Sections 5 and 8 of the

proposal only applies in the event of a claim made under the Section 5 indemnity or for a failure to comply with the Act. The comparative negligence provisions of the proposal do not alter or preempt any other State or Federal law rights or claims the customer

may already have under existing law relating to a check payments.

Finally, as a related matter, whenever one is discussing claims

between a bank and its customer, it should be highlighted that the

vast majority of customer complaints or disputes regarding a check

transaction are resolved by the bank to the customer’s satisfaction

through the normal customer service process. Very few disputes between customers and banks actually go to arbitration or litigation.

Accordingly, while this comparative negligence standard is very

important for a large dollar dispute that results in litigation, in the

typical consumer allegation of error in a check transaction, this

comparative negligence standard would likely not be relevant or

applied.