[Federal Register Volume 70, Number 227 (Monday, November 28, 2005)]
[Rules and Regulations]
[Pages 71218-71226]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-23331]


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FEDERAL RESERVE SYSTEM

12 CFR Parts 210 and 229

[Regulations J and CC; Docket No. R-1226]


Collection of Checks and Other Items by Federal Reserve Banks and 
Funds Transfers Through Fedwire and Availability of Funds and 
Collection of Checks

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board of Governors is adopting a final rule amending 
Regulation CC to define ``remotely created checks'' and to create 
transfer and presentment warranties for such checks. The purpose of the 
amendments is to shift liability for unauthorized remotely created 
checks to the depositary bank, which is generally the bank for the 
person that initially created and deposited the remotely created check. 
The Board is also adopting conforming cross-references to the new 
warranties in Regulation J.

EFFECTIVE DATE: July 1, 2006.

FOR FURTHER INFORMATION CONTACT: Adrianne G. Threatt, Counsel (202-452-
3554), or Joshua H. Kaplan, Attorney, (202-452-2249), Legal Division; 
or Jack K. Walton, II, Associate Director (202-452-2660), or Joseph P. 
Baressi, Senior Financial Services Analyst (202-452-3959), Division of 
Reserve Bank Operations and Payment Systems; for users of 
Telecommunication Devices for the Deaf (TDD) only, contact 202-263-
4869.

SUPPLEMENTARY INFORMATION:

Background

Existing Law and the Board's Proposed Rule

    ``Remotely created checks'' typically are created when the holder 
of a checking account authorizes a payee to draw a check on that 
account but does not actually sign the check.\1\ In place of the 
signature of the account-holder, the remotely created check generally 
bears a statement that the customer authorized the check or bears the 
customer's printed or typed name. Remotely created checks can be useful 
payment devices. For example, a debtor can authorize a credit card 
company to create a remotely created check by telephone, which may 
enable the debtor to pay his credit card bill in a timely

[[Page 71219]]

manner and avoid late charges. Similarly, a person who does not have a 
credit card or debit card can purchase an item from a telemarketer by 
authorizing the seller to create a remotely created check.
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    \1\ There is no commonly accepted term for these items. The 
terms ``remotely created check,'' ``telecheck,'' ``preauthorized 
drafts,'' and ``paper draft'' are among the terms that describe 
these items.
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    On the other hand, remotely created checks are vulnerable to fraud 
because they do not bear the drawer's signature or other readily 
verifiable indication of authorization. Because remotely created checks 
are cleared in the same manner as other checks, it is difficult to 
measure the use of remotely created checks relative to other types of 
checks. However, there have been significant consumer and bank 
complaints identifying cases of alleged fraud using remotely created 
checks.

Existing Law on Remotely Created Checks

    A remotely created check is subject to state law on negotiable 
instruments, specifically Articles 3 and 4 of the Uniform Commercial 
Code (U.C.C.) as adopted in each state. Under the U.C.C., a bank that 
pays a check drawn on the account of one of its customers may charge a 
customer's account for a check only if the check is properly payable. A 
bank generally must recredit its customer's account for the amount of 
any unauthorized check it pays.\2\ This obligation is subject to 
limited defenses.\3\ In addition, the paying bank may obtain evidence 
that the depositor did in fact authorize the check and is seeking to 
reverse the authorization. Under such circumstances, the paying bank 
would not be obligated to recredit its customer for the amount of the 
check.\4\
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    \2\ U.C.C. 4-401.
    \3\ For example, the paying bank may be able to assert that the 
customer failed to notify the bank of the unauthorized item with 
``reasonable promptness'' (U.C.C. 4-406(c) and (d)).
    \4\ The FTC's Telemarketing Sales Rule prohibits a telemarketer 
from issuing a remotely created check on a consumer's deposit 
account without the consumer's express verifiable authorization. The 
authorization is deemed verifiable if it is in writing, tape 
recorded and made available to the consumer's bank upon request, or 
confirmed by a writing sent to the consumer prior to submitting the 
check for payment. 6 CFR part 310.
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    A paying bank may, until midnight of the banking day after a check 
has been presented to the bank, return the check to the bank at which 
the check was deposited if, among other things, the paying bank 
believes the check is unauthorized. Once its midnight deadline has 
passed, the paying bank generally cannot return an unauthorized check 
to the depositary bank.\5\
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    \5\ See U.C.C. 4-301 and 4-302. In limited cases, the paying 
bank may be able to recover from the presenting bank the amount of a 
check that it paid under the mistaken belief that the signature of 
the drawer of the draft was authorized. This remedy, however, may 
not be asserted against a person that took the check in good faith 
and for value or that in good faith changed position in reliance on 
the payment or acceptance. U.C.C. 3-418(a) and (c).
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    The provisions of the U.C.C. cited above implement the rule set 
forth in the seminal case of Price v. Neal,\6\ which held that drawees 
of checks and other drafts must bear the economic loss when the 
instruments they pay are not properly payable because the drawer did 
not authorize the item.\7\ Under the Price v. Neal rule, the paying 
bank must bear the economic loss of an unauthorized check with little 
recourse other than bringing an action against the person that created 
the unauthorized item. This rule currently applies to all checks, 
including remotely created checks, in a majority of states.
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    \6\ 97 Eng. Rep. 871 (K.B. 1762).
    \7\ See also Interbank of New York v. Fleet Bank, 730 NYS 2d 208 
(2001).
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    The policy rationale for the Price v. Neal rule is that the paying 
bank, rather than the depositary bank, is in the best position to judge 
whether the signature on a check is the authorized signature of its 
customer. Remotely created checks, however, do not bear a handwritten 
signature of the drawer that can be verified against a signature card. 
In most cases, the only means by which a paying bank could determine 
whether a remotely created check is unauthorized and return it in a 
timely manner would be to contact the customer before the midnight 
deadline passes. However, before a paying bank can verify the 
authenticity of remotely created checks, it first must identify 
remotely created checks drawn on its accounts. Because there is no code 
or feature on remotely created checks that would enable a paying bank 
to identify them reliably in an automated manner, remotely created 
checks rarely come to the attention of paying banks until a customer 
identifies the check as unauthorized, usually well after the midnight 
deadline.

Recent Legal Changes to Address Remotely Created Checks

Amendments to the U.C.C.

    In recognition of the particular problems presented by remotely 
created checks, the National Conference of Commissioners on Uniform 
State Laws and the American Law Institute in 2002 approved revisions to 
Articles 3 and 4 of the U.C.C. that specifically address remotely 
created checks. The U.C.C. revisions define a remotely created check 
(using the term ``remotely-created consumer item'') as ``an item drawn 
on a consumer account, which is not created by the paying bank and does 
not bear a hand written signature purporting to be the signature of the 
drawer.'' \8\ The U.C.C. revisions require a person that transfers a 
remotely-created consumer item to warrant that the person on whose 
account the item is drawn authorized the issuance of the item in the 
amount for which the item is drawn.\9\ Accordingly, the U.C.C. alters 
the Price v. Neal rule for remotely-created consumer items by shifting 
liability for those items to the transferors.\10\
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    \8\ U.C.C. 3-103(16).
    \9\ U.C.C. 3-416(a). A person that transfers a remotely-created 
consumer item for consideration warrants to the transferee and, if 
the transfer is by indorsement, to any subsequent transferee, that 
the person on whose account the item is drawn authorized the 
issuance of the item in the amount for which the item is drawn. See 
also U.C.C. 4-207(a)(6), 3-417(a)(4), 4-208(a)(4).
    \10\ For items other than remotely-created consumer items, the 
transferor must warrant only that it has ``no knowledge'' that the 
instrument is unauthorized. U.C.C. 3-417(a)(3).
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    These revisions rest on the premise that it is appropriate to shift 
the burden of ensuring authorization of a remotely created check to the 
bank whose customer deposited the remotely created check because this 
bank is in the best position to detect the fraud.\11\ The U.C.C. 
warranty provides an economic incentive for the depositary bank to 
monitor customers that deposit remotely created checks and, therefore, 
should have the effect of limiting the quantity of unauthorized 
remotely created checks that are introduced into the check collection 
system.
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    \11\ U.C.C. 3-416, Official Comment, paragraph 8. The Official 
Comment notes that the provision supplements the FTC's Telemarketing 
Sales Rule, which requires telemarketers to obtain the customer's 
``express verifiable authorization.''
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Amendments to State Laws

    Fewer than half the states in the U.S. have amended their Articles 
3 and 4 to include provisions to address remotely created checks.\12\ 
Among the states that have made such amendments, the definitions and 
warranties are not uniform in their scope or requirements. In addition 
to the state codes, some check clearinghouses have adopted warranties 
that apply to remotely created checks that are collected through these 
clearinghouses. The state-by-state approach to the adoption of remotely 
created check warranties complicates the determination of liability for 
remotely created checks collected across state lines, because the bank 
that presents a check may not be

[[Page 71220]]

subject to the same rules as the paying bank.
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    \12\ Those states include Arkansas, California, Colorado, 
Hawaii, Idaho, Iowa, Maine, Missouri, Minnesota, Nebraska, New 
Hampshire, North Dakota, Oregon, Tennessee, Texas, Utah, Vermont, 
West Virginia, and Wisconsin.
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Proposed Rule

    On March 4, 2005, the Board published for comment a proposal to 
amend Regulation CC to provide transfer and presentment warranties for 
remotely created checks.\13\ This proposal was issued pursuant to the 
Expedited Funds Availability Act (the EFA Act), Pub. L. 100-86, 101 
Stat. 635 (codified at 12 U.S.C. 4001 et seq.), which authorizes the 
Board to establish rules allocating losses and liability among 
depository institutions ``in connection with any aspect of the payment 
system.'' \14\ As noted above, the check collection and return system 
operates nationally. As a result, in order for the remotely created 
check warranties to be effective they must apply uniformly and 
nationwide.
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    \13\ 70 FR 10509.
    \14\ The Board is authorized to impose on or allocate among 
depository institutions the risks of loss and liability in 
connection with any aspect of the payment system, including the 
receipt, payment, collection, or clearing of checks, and any related 
function of the payment system with respect to checks. Such 
liability may not exceed the amount of the check giving rise to the 
loss or liability, and, where there is bad faith, other damages, if 
any, suffered as a proximate consequence of any act or omission 
giving rise to the loss or liability. 12 U.S.C. 4010(f).
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    The Board proposed to define a ``remotely created check'' as a 
check that is drawn on a customer account at a bank, is created by the 
payee, and does not bear a signature in the format agreed to by the 
paying bank and the customer. Unlike the U.C.C. amendments, the Board's 
proposed definition would apply to remotely created checks drawn on 
both consumer and non-consumer accounts.
    The Board proposed to create transfer and presentment warranties 
that would apply to remotely created checks that are transferred or 
presented by banks to other banks. Under the proposed warranties, any 
transferor bank, collecting bank, or presenting bank would warrant that 
the remotely created check that it is transferring or presenting is 
authorized according to all of its terms by the person on whose account 
the check is drawn. The proposed warranties would apply only to banks 
and ultimately would shift liability for the loss created by an 
unauthorized remotely created check to the depositary bank. A paying 
bank would not be able to assert a warranty claim under the Board's 
proposed rule directly against a nonbank payee that created or 
transferred an unauthorized remotely created check.

General Comments

    The Board received over 250 comments on the proposed rule from 
depository institutions of various sizes, trade associations that 
represent depository institutions, state attorneys general, 
individuals, academics, consumer representatives, the Permanent 
Editorial Board of the U.C.C., and Reserve Banks. This section presents 
an overview of the central points contained in the comments that the 
Board received. The section-by-section analysis of the final rule, set 
forth below, discusses the comments in greater detail and responds to 
specific concerns regarding the definition of remotely created check 
and the scope of the warranties.
    The commenters provided overwhelming support for the proposed rule, 
although many suggested that the Board make specific revisions in the 
final rule. The Board received many comments in favor of the proposal 
from small depository institutions, many of which noted that they 
regularly suffer losses as the result of unwittingly paying remotely 
created checks that customers later identify as unauthorized. Large 
depository institutions and their trade associations also strongly 
supported the proposal and specifically addressed a number of important 
issues discussed below.
    Only one depository institution opposed the proposal in its 
entirety, arguing that there is no factual predicate for the proposed 
rule because paying banks do not verify the authenticity of customer 
signatures on any checks. The Board believes that many banks do examine 
signatures on some subset of checks. Nevertheless, given that remotely 
created checks do not bear a verifiable mark of authentication, the 
depositary bank is in a better position to prevent the introduction of 
unauthorized remotely created checks into the check collection process 
by acquainting itself with the business practices of its customers who 
routinely deposit such checks. The purpose of the Board's rule is to 
create an economic incentive for depositary banks to perform the 
requisite due diligence on their customers by shifting liability for 
unauthorized remotely created checks to the depositary bank.
    Some commenters, including Attorneys General representing 35 
states, recommended that the Board prohibit the use of remotely created 
checks altogether, arguing principally that legitimate use of remotely 
created checks has significantly declined, largely as a result of new 
automated clearing house (ACH) payment applications that can be used in 
place of remotely created checks. Several commenters, however, reported 
an increase in the use of the remotely created checks (albeit some 
noting that this increase in use has been accompanied by a commensurate 
increase in unauthorized remotely created checks). The Board believes 
that substantial additional research would be required about the uses 
of remotely created checks and the commercial impact of an outright ban 
before a prohibition by statute or regulation could be justified. The 
Board believes its rule provides effective protections against 
unauthorized remotely created checks while still allowing for the 
legitimate use of those checks.
    Some commenters argued that remotely created checks also should be 
covered by the Board's Regulation E (12 CFR Part 205), because payments 
by remotely created check are in fact electronic fund transfers subject 
to the Electronic Funds Transfer Act (EFTA), which, among other things, 
requires certain disclosures related to transfers covered by the 
Act.\15\ Under the EFTA, the term ``electronic fund transfer'' includes 
any transfer of funds, other than a transaction originated by check, 
draft, or similar paper instrument.\16\ Therefore, as a general matter, 
the EFTA does not apply to funds transferred from a consumer's account 
by means of a check. The commenters argued that a remotely created 
check is initiated by an electronic communication between the consumer 
and a third party and not by a check or similar paper instrument. 
Further clarification of the applicability of the EFTA to check 
transactions that are authorized on-line or by telephone must be made 
within the context of Regulation E. The Board will continue to monitor 
developments to determine whether further action is appropriate.
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    \15\ 15 U.S.C. 1693 et seq.
    \16\ 15 U.S.C. 1693a(6).
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Extension of the Midnight Deadline

    The Board invited comment on whether a different approach to 
address the risks of remotely created checks would be appropriate. One 
alternative on which the Board requested comment was whether the Board 
should extend the U.C.C. midnight deadline for paying banks that return 
unauthorized remotely created checks to give the paying bank more time 
to determine whether a particular check was authorized. Some commenters 
favored the approach because it would mirror the ACH rules set forth by 
the National Automated Clearing House Association for unauthorized ACH 
debits, while others

[[Page 71221]]

opposed this approach arguing that it would delay finality of check 
payments. One commenter argued that if the Board adopted this approach, 
then it also should exempt remotely created checks from the funds 
availability schedule in Regulation CC because the availability 
schedules are generally related to the collection and return times for 
a check.
    Other commenters viewed the possible midnight deadline extension 
not as an alternative to creation of new warranties, but as a different 
enforcement mechanism for the new warranties. These commenters thought 
that instead of having to make a warranty claim outside of the check 
collection process when the paying bank seeks to recoup losses 
following a breach of the remotely created check warranty, extension of 
the midnight deadline would enable the paying bank to return the 
unauthorized remotely created through the check collection process. 
Many of the commenters in this group advocated handling the warranty 
claim on a ``with entry'' basis, which is a procedure that has been 
adopted by certain clearinghouses and which allows a warranty claim to 
be made through the procedures for returned checks.\17\ A few 
commenters suggested an additional nuance to this approach: 
unauthorized remotely created checks under $1000 should be handled on a 
``with entry'' basis and unauthorized remotely created checks over 
$1000 should be handled as a warranty claim outside of the check 
collection and return process.
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    \17\ Under the Electronic Check Clearing House Organization's 
Uniform Paper Check Exchange Rules, the paying bank ``may make a 
warranty claim'' by ``delivering such check to the clearinghouse or 
the depositary bank for settlement, in accordance with the 
clearinghouse's rules for returned checks.'' While the claim is 
processed through the return settlement process, the delivery of the 
check to the clearing house, and ultimately the depositary bank, is 
not a ``return'' of the check under the U.C.C. or Regulation CC.
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    Because the Board believes that finality of payment and the 
discharge of the underlying obligation are fundamental and valuable 
features of the check collection process, the final rule does not make 
any adjustments to the midnight deadline. Until otherwise established 
by agreement, banks must assert claims arising under transfer and 
presentment warranties for remotely created checks outside of the check 
collection process.

Action by State Governments

    The Board also requested comment on whether it should refrain from 
addressing remotely created checks in Regulation CC and await adoption 
of the U.C.C. warranties for remotely created checks, or some variation 
thereof, by all of the states. Numerous commenters expressed opposition 
to this approach. Generally, these commenters argued that states have 
been too slow to act on this issue and have not and will not 
necessarily act uniformly. However, one commenter urged the Board to 
refrain from usurping the U.C.C. process, arguing that hesitancy by 
state legislatures to adopt a uniform law may signal defects in the 
proposed amendment. In light of the comments favoring action by the 
Board from the Permanent Editorial Board of the U.C.C., as well as 
thirty-five state Attorneys General, the Board believes that there is 
broad support for amendments to Regulation CC to address remotely 
created checks on a nationwide basis and that such amendments are 
appropriate.

Section-by-Section Analysis

Section 229.2(fff) Definition

    The Board proposed the following definition: A remotely created 
check means a check that is drawn on a customer account at a bank, is 
created by the payee, and does not bear a signature in the format 
agreed to by the paying bank and the customer. Commenters had numerous 
concerns regarding the scope of the proposed definition.
    On the issue of whether the definition of remotely created checks 
should cover items drawn on both consumer and non-consumer accounts, 
all but one of the commenters addressing this issue supported covering 
remotely created checks drawn on both consumer and non-consumer 
accounts. These commenters stated that there is no reason to 
distinguish between fraud against consumers and fraud against 
businesses for purposes of this rule.\18\ Furthermore, one commenter 
noted that, as an operational matter, it would be more efficient for 
banks to treat remotely created checks drawn on both consumer and non-
consumer accounts the same. For these reasons, the final rule applies 
to remotely created checks drawn on both consumer and non-consumer 
accounts.
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    \18\ The one commenter that favored limiting the scope to 
consumer items argued that if the definition covers commercial 
accounts, it would weaken the ability of the bank to contract with 
its commercial customers for timely review of account activity. The 
Board does not believe this concern warrants a limitation on the 
scope of the definition. The Board's final rule creates transfer and 
presentment warranties among banks and is not intended to interfere 
with the contractual relationships between depository institutions 
and their customers. The legal relationship between the paying bank 
and its customer with respect to whether a check was authorized or 
whether a claim was made in a timely manner continues to be governed 
by state law.
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    With respect to the other elements of the definition, numerous 
commenters, particularly large depository institutions, preferred the 
following definition (or minor variations thereon): A remotely created 
check is a check that (i) Is drawn on a customer account at a bank, 
(ii) is not created by the paying bank, and (iii) does not bear a 
signature purporting to be the signature of the customer. In the 
alternative, several commenters favored the definition of demand draft 
in the commercial code of California, arguing that this definition has 
been adopted in a number of states and has been applied successfully 
over the past nine years.\19\
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    \19\ Under California U.C.C. Sec.  3104(k) a demand draft means 
a writing not signed by a customer that is created by a third party 
under the purported authority of the customer for the purpose of 
charging the customer's account with a bank. A demand draft shall 
contain the customer's account number and may contain any of the 
following: (1) The customer's printed or typewritten name. (2) A 
notation that the customer authorized the draft. (3) The statement 
``No Signature Required'' or words to that effect.
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    With respect to the proposal that a remotely created check must be 
created by the payee, numerous commenters noted that depository 
institutions have no physical means of distinguishing between a 
remotely created check created by a payee and a remotely created check 
created by, for example, a bill payment service on behalf of the 
drawer.
    The Board considered alternative ways of defining remotely created 
checks from the perspective of how they were created. Under one 
formulation, the definition could require that a check not be created 
by the paying bank in order to be a remotely created check. The 
advantage of that formulation is that the paying bank should be able to 
determine whether it created a check and whether the warranty applies. 
That requirement, however, would not exclude a check created by the 
customer (such as a check that a customer filled out but forgot to 
sign) or the customer's agent, such as a bill payment service. However, 
the Board believes that these checks do not present the same risk that 
the check was not actually authorized by the drawer as the typical 
telemarketer-created check that is made payable to the entity that 
created it.
    Under another formulation, the definition could exclude checks that 
are created by the paying bank as well as checks that are created by 
the customer or the customer's agent. This formulation, however, would 
exclude from the warranty checks created by telemarketers or other 
payees to the

[[Page 71222]]

extent they were acting as agent of the customer, as well as checks 
created on behalf of the customer by a bill payment service. At a 
minimum, this formulation would raise issues as to the scope of the 
creating entity's agency and would seem to cause as many evidentiary 
difficulties as the Board's original proposal.
    After considering the benefits and drawbacks of each formulation, 
the definition in the Board's final rule requires that a remotely 
created check must be created by a person other than the paying bank. 
This definition will be operationally efficient for paying banks 
because they easily can determine whether the warranty applies to a 
particular check. In addition, this formulation is consistent with the 
analogous definition in the U.C.C. Under this definition, the parties 
to the check will not have to distinguish checks that are created by 
the payee from checks that are created by a customer's bill-payment 
service in order to assert a warranty claim. As noted above, the 
definition will cover certain checks created remotely by bill-payment 
services, as well as checks that the drawer created but neglected to 
sign, where there is a less compelling reason for shifting liability 
for unauthorized checks to the depositor's bank. Including these 
checks, however, is unlikely to result in significantly greater 
liability for depositary banks. It appears that such checks are 
generally less prone to fraud, and, therefore, less prone to trigger a 
warranty claim than are payee-created checks.
    Numerous commenters objected to the requirement that a remotely 
created check not bear a signature ``in the format'' agreed to by the 
paying bank and the customer. Many commenters argued that litigation 
will ensue over the meaning of the phrase ``in the format,'' and that 
the language will sweep traditional forged checks into the warranty 
because a forged check may be deemed to not bear a signature in the 
format agreed to by the paying bank and its customer. Most commenters 
favored focusing simply on whether a signature was present or not. The 
language of the proposed definition was intended to introduce greater 
specificity around the term ``signature,'' which is very broadly 
defined under the U.C.C., to ensure that the definition does not 
include traditional forged checks in the warranties. However, in light 
of the persuasive criticism from numerous commenters, the final rule 
requires that a remotely created check not bear a signature ``applied 
by, or purported to be applied by, the person on whose account the 
check is drawn.'' The commentary to the final rule explains that the 
term ``applied by'' refers to the physical act of placing the signature 
on the check. This formulation should more clearly exclude traditional 
forged checks from the operation of the new warranties, but include 
checks created by telemarketers and similar payees.
    Several commenters noted that under the definition of customer 
account in Regulation CC, checks drawn on accounts such as money market 
accounts and credit accounts would be excluded from the definition of 
remotely created check, because the proposed definition is limited to 
checks drawn on a customer account, which under Regulation CC does not 
include all types of accounts on which checks can be drawn. These 
commenters pointed out that the U.C.C. definition of remotely created 
checks, which covers ``accounts'' as defined by the U.C.C., includes 
checks drawn on various types of consumer checking accounts and the 
Board should also expand its definition of customer account for 
purposes of the remotely created check warranties. The Board sees no 
reason to exclude these types of checks from the operation of the new 
warranties and the final rule expands the definition of account in the 
final rule, solely for the purposes of the new warranties, to include 
any credit or other arrangement that allows a person to draw checks on 
a bank.
    Commenters also argued that the definition of remotely created 
check should cover ``payable through'' or ``payable at'' checks. Many 
of these checks are drawn on a nonbank, such as a mutual fund, but 
payable through or at a bank. Under Regulation CC the term ``check'' 
means a negotiable demand draft drawn on or payable through or at an 
office of a bank.\20\ Therefore, the definition of remotely created 
check could include a ``payable through'' or ``payable at'' check if 
the other requirements of the regulation are met. With regard to the 
requirement that a remotely created check not bear the signature of the 
account-holder, the signature of the person on whose account the check 
is drawn would be the signature of the payor institution (e.g., a 
mutual fund) or the signatures of the customers who are authorized to 
draw checks on that account, depending on the arrangements between the 
``payable through'' or ``payable at'' bank, the payor institution, and 
the customers. The Board has added clarifying language to the 
commentary.
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    \20\ 12 CFR 229.2(k).
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    One commenter urged the Board to confirm that a substitute check 
created from a remotely created check benefits from the warranties for 
remotely created checks. The commentary to the final rule specifically 
states that the transfer and presentment warranties for remotely 
created checks would apply to a substitute check that represents a 
remotely created check.

Section 229.34 Warranties

    The Board proposed the following transfer and presentment 
warranties with respect to a remotely created check: A bank that 
transfers or presents a remotely created check and receives a 
settlement or other consideration warrants to the transferee bank, any 
subsequent collecting bank, and the paying bank that the person on 
whose account the remotely created check is drawn authorized the 
issuance of the check according to the terms stated on the check.
    Numerous commenters urged the Board to limit the warranty to the 
terms stated on the ``face of the check.'' Others urged the Board to 
adopt the U.C.C. approach, requiring only a warranty that ``the person 
on whose account the check is drawn authorized the issuance of the 
check in the amount for which it is drawn.'' \21\ Commenters argued 
that the proposed warranty could be construed to cover the indorsements 
on the back of the check and the date. The Board did not intend to 
create warranties that would cover the indorsements on a remotely 
created check because the U.C.C. already contains indorsement 
warranties. In addition, other information on the front of the check, 
such as the date, does not give rise to the risk of fraud as does the 
name of the payee and the amount. Accordingly, the final rule states 
with specificity that the transfer and presentment warranties apply 
only to the fact of authorization by the account holder, the amount 
stated on the check, and issuance to the payee stated on the check.
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    \21\ See e.g. U.C.C. 3-417(a)(4).
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    A few commenters suggested that the depositor of a remotely created 
check should also be required to make the new warranties, as is the 
case with the U.C.C. warranties relating to remotely created consumer 
items. One commenter suggested that the customer of the paying bank 
should be able to assert a Sec.  229.34(d) warranty claim directly 
against a transferring or presenting bank. The authority under which 
the Board is adopting this amendment is limited to establishing rules 
imposing or allocating losses and liability among depository 
institutions in connection with any aspect of the payment system.\22\ 
However, although these warranties do not extend to losses and

[[Page 71223]]

liability as between depository institutions and their nonbank 
customers, banks may choose to allocate liability to customers by 
agreement. The final rule also does not alter the rights or liabilities 
of customers of depository institutions under state law.
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    \22\ See footnote 14, supra.
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    Commenters also suggested that the commentary address the situation 
in which the customer authorizes that the check be made payable to the 
payee's trade name, but the check is instead made payable to the legal 
name of the payee. Under the new transfer and presentment warranties, 
banks will warrant that the customer authorized the issuance of the 
check to the payee stated on the check. Whether an alteration of the 
payee's name from the trade name to the legal name would result in a 
breach of warranty will depend on whether the change is within the 
scope of the customer's authorization. Because that determination would 
have to be made on a case-by-case basis, the Board has not added any 
general statement on such a situation to the commentary.
    A number of commenters urged the Board to state explicitly that the 
warranties would not cover the situation in which the initial 
authorization by the account-holder was subsequently disclaimed as the 
result of ``buyer's remorse'' by the account-holder. As noted in the 
proposed rule, the Board anticipates that the transfer and presentment 
warranties will supplement the FTC's Telemarketing Sales Rule (16 CFR 
310.3(a)(3)), which requires telemarketers that submit instruments for 
payment to obtain the customer's ``express verifiable authorization.'' 
A depositary bank could tender the authorization obtained by its 
telemarketer customer as a defense to a paying bank warranty claim. 
Therefore, the paying bank would not prevail on a warranty claim if the 
customer had, in fact, authorized the transaction but later suffered 
``buyer's remorse.'' If the paying bank can show that the check was 
properly payable from the customer's account, then it would be able to 
charge the account for the check in accordance with U.C.C. 4-401.

Defenses to Warranty Claims

    Several commenters argued that when a paying bank makes a claim 
under the remotely created check warranties a depositary bank should be 
able to assert certain defenses that the paying bank would have against 
its customer under the U.C.C. Specifically, the commenters noted that 
U.C.C. 4-406 places a duty on a customer to discover and report 
unauthorized checks with reasonable promptness and limits a paying 
bank's liability if the customer fails to perform that duty. The 
commenters suggested that a paying bank should be precluded from 
asserting a warranty claim against a depositary bank where the paying 
bank's liability to the customer would have been limited by U.C.C. 4-
406 had the paying bank asserted its own defenses. The commenters noted 
that the U.C.C. warranty provisions permit similar defenses by 
warranting banks.
    The U.C.C. provides that the warrantor may defend a warranty claim 
based on an unauthorized indorsement or alteration by proving that the 
drawer is precluded from asserting that claim because of his or her 
failure to discover the lack of authorization in a timely manner.\23\ 
The Official Comment explains the purpose of the provision: if the 
drawer's conduct contributed to a loss from a forged indorsement or 
alteration, the drawee should not be allowed to shift the loss from the 
drawer to the warrantor.\24\ While the drafters of the U.C.C. did not 
extend this defense to an unauthorized remotely-created consumer item, 
commenters argued that the stated purpose of the U.C.C. 3-417(c) 
defense should apply to a remotely created check warranty claim under 
Regulation CC. The Board believes that such a defense would be 
appropriate. Therefore, the regulation and the commentary to the final 
rule provide that the depositary bank may defend a remotely created 
check warranty claim by proving that customer is precluded under U.C.C. 
4-406 from asserting a claim against the paying bank for the 
unauthorized issuance of the check. This may be the case, for example, 
when the customer fails to discover the unauthorized remotely created 
check in a timely manner.
---------------------------------------------------------------------------

    \23\ U.C.C. 3-417(c).
    \24\ U.C.C. 3-417, Official Comment, 6.
---------------------------------------------------------------------------

    One commenter stated that the proposed warranty for remotely 
created checks should be limited in a way that is similar to the 
indemnification related to the creation and collection of substitute 
checks. The commenter argued that the indemnity provision of the Check 
Clearing for the 21st Century Act, as implemented by Regulation CC, 
shifts liability to the reconverting banks for losses due to the 
absence of security features that do not survive the imaging process, 
and, therefore, do not appear on substitute checks, only in those 
instances in which the paying bank's processes actually would have 
relied on the security features that were lost in the imaging process. 
These lost security features, it is argued, are analogous to the lack 
of an authorized signature on the remotely created check.\25\ The 
commenter argued that by analogy the warranty that the Board proposed 
with respect to remotely created checks should not apply under 
circumstances in which the paying bank would not have verified the 
signatures anyway, for example because the checks were under the dollar 
amount set by the paying bank for such purposes.
---------------------------------------------------------------------------

    \25\ 12 U.S.C. 5005, as implemented at 12 CFR 229.53(a) and the 
accompanying commentary.
---------------------------------------------------------------------------

    The Board's rule on remotely created checks is intended to reduce 
the fraudulent use of unauthorized remotely created checks by creating 
an incentive for depositary banks to be more vigilant when accepting 
such checks for deposit. This incentive would be seriously weakened if 
the regulation required the paying bank to make the showing suggested 
by the commenter. Therefore, the final rule does not adopt this 
suggestion.

Effective Date

    A number of commenters suggested that the final rule include an 
implementation period of not less than six months. The final rule is 
effective July 1, 2006.

Additional Considerations

MICR Line Identifier

    The Board requested comment on whether digits should be assigned in 
the External Processing Code (EPC) Field (commonly referred to as 
Position 44) of the magnetic ink character recognition (MICR) line to 
identify remotely created checks. Most commenters opposed this aspect 
of the proposal, arguing that the unassigned digits in the EPC Field 
could best serve other purposes and that enforcement of such a rule 
would be cumbersome at best. Ten commenters specifically expressed 
support for assigning digits in the EPC Field, arguing that it would 
facilitate the tracking of remotely created checks. However, without 
broad support for such a rule, and in light of the impracticalities of 
enforcement, the Board has determined not to pursue a MICR identifier 
for remotely created checks.

Relation to State Law

    Many commenters supported the proposed amendment to Regulation CC 
as a means to establish uniformity with respect to liability for 
unauthorized remotely created checks. Some of these commenters presumed 
that the amendment to Regulation CC would preempt state laws that 
address unauthorized remotely created checks or their equivalents. 
However, several

[[Page 71224]]

commenters raised the issue of preemption explicitly by stating that 
the warranties provided in Regulation CC should preempt state law 
warranties and that the one-year statute of limits for actions under 
subpart C of Regulation CC should preempt statute of limitations for 
breach of demand draft warranties under state law (generally 3 years). 
One commenter recommended that the Board's amendments explicitly 
preempt the field to eliminate confusion about the application of state 
laws that govern remotely created checks. Section 608(b) of the 
Expedited Funds Availability Act provides that Board rules prescribed 
under that Act shall supersede any provision of state law, including 
the UCC as in effect in such state, that is inconsistent with the Board 
rules. To the extent that the state law is inconsistent with the 
Board's rules on remotely created checks, the Board's rules would 
supersede such state law. The Board will monitor the interaction of 
state law and Regulation CC, and may take further action at a later 
time if necessary.

Price v. Neal

    One commenter suggested that the Board overrule the Price v. Neal 
doctrine for all checks. The Price v. Neal doctrine dates back to the 
1760s and is based on the assumption that the paying bank should bear 
the loss for unauthorized checks because it is in the best position to 
prevent fraud by comparing signatures on checks with signature cards on 
file with the bank. The commenter argued that, at present, automated 
check processing that relies on the MICR line means that signature 
verification of checks by back-room personnel no longer plays a 
meaningful role in stopping check fraud. However, other commenters 
argued that the depositary bank generally has no better means to detect 
unauthorized checks than the paying bank and, therefore, the argument 
would provide no logical basis for abandoning the Price v. Neal 
doctrine. Furthermore, as one commenter noted, the advent of signature 
recognition software may soon enable the paying bank to verify 
signatures on an automated basis. The final rule reverses the Price v. 
Neal rule for remotely created checks only. However, the Board would 
welcome a public dialogue on broader check law issues, such as the 
utility of and possible alternatives to the Price v. Neal rule in the 
modern check processing environment.

Conforming Amendments to Regulation J

    The Board is also amending Regulation J to make clear that the new 
remotely created check warranties apply to remotely created checks 
collected through the Federal Reserve Banks.

Regulatory Analysis

Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3506; 5 CFR 1320 Appendix A.1) and under authority delegated by the 
Office of Management and Budget, the Board has reviewed the final rule 
and determined that it contains no collections of information.

Regulatory Flexibility Act

    In accordance with the Regulatory Flexibility Act (RFA), an agency 
must publish a final regulatory flexibility analysis with its final 
rule, unless the agency certifies that the rule will not have a 
significant economic impact on a substantial number of small entities. 
(5 U.S.C. 601-612.) The Board certifies that the rule will not have a 
significant economic impact on a substantial number of small entities.
    The RFA requires agencies to examine the objectives, costs and 
other economic implications on the entities affected by the rule. (5 
U.S.C. 603.) Under section 3 of the Small Business Act, as implemented 
at 13 CFR part 121, subpart A, a bank is considered a ``small entity'' 
or ``small bank'' if it has $150 million or less in assets. Based on 
June 2005 call report data, the Board estimates that there are 
approximately 13,400 depository institutions with assets of $150 
million or less.
    The amendments to Regulation CC create a definition of a remotely 
created check and warranties that apply when a remotely created check 
is transferred or presented. The amendments require any bank that 
transfers or presents a remotely created check to warrant that the 
person on whose account the remotely created check is drawn authorized 
the issuance of the check in the amount stated on the check and to the 
payee stated on the check. The purpose of the amendments is to place 
the liability for an unauthorized remotely created check on the bank 
that is in the best position to prevent the loss. By shifting the 
liability to the bank in the best position to prevent the loss caused 
by the payment of an unauthorized remotely created check, the Board 
anticipates that the amendments will reduce costs for all banks that 
handle remotely created checks. Banks seeking to minimize the risk of 
liability for transferring remotely created checks will likely screen 
with greater scrutiny customers seeking to deposit remotely created 
checks. The Board believes that the controls that small institutions 
will develop and implement to minimize the risk of accepting 
unauthorized remotely created checks for deposit likely will pose a 
minimal negative economic impact on those entities. Furthermore, there 
was unanimous support for transfer and presentment warranties for 
remotely created checks from the small institutions that commented on 
the proposal. These institutions noted that the warranties will enable 
them to reduce losses they currently suffer when they inadvertently pay 
an unauthorized remotely created check.
    The RFA requires agencies to identify all relevant Federal rules 
which may duplicate, overlap or conflict with the proposed rule. As 
noted above, the Board's Regulation J includes cross-references to the 
warranties set forth in Regulation CC and the rule amends such cross-
references to include the warranties. As also noted above, the rule 
overlaps with at least 19 state codes that presently provide warranties 
for instruments that are similar to remotely created checks.

List of Subjects in 12 CFR Parts 210 and 229

    Banks, Banking, Federal Reserve System, Reporting and recordkeeping 
requirements.

Authority and Issuance

0
For the reasons set forth in the preamble, the Board is amending parts 
210 and 229 of chapter II of title 12 of the Code of Federal 
Regulations as set forth below:

PART 210--COLLECTION OF CHECKS AND OTHER ITEMS BY FEDERAL RESERVE 
BANKS AND FUNDS TRANSFERS THROUGH FEDWIRE (REGULATION J)

0
1. The authority citation for part 210 continues to read as follows:

    Authority: 12 U.S.C. 248(i) and (j), 12 U.S.C. 342, 12 U.S.C. 
464, 12 U.S.C. 4001 et seq., 12 U.S.C. 5001-5018.



0
2. In Sec.  210.5, revise paragraph (a)(3) to read as follows:


Sec.  210.5  Sender's agreement; recovery by Reserve Bank.

    (a) * * *
    (3) Warranties for all electronic items. The sender makes all the 
warranties set forth in and subject to the terms of 4-207 of the U.C.C. 
for an electronic item as if it were an item subject to the U.C.C.

[[Page 71225]]

and makes the warranties set forth in and subject to the terms of Sec.  
229.34(c) and (d) of this chapter for an electronic item as if it were 
a check subject to that section.
* * * * *

0
3. In Sec.  210.6, revise paragraph (b)(2) to read as follows:


Sec.  210.6  Status, warranties, and liability of Reserve Bank.

* * * * *
    (b) * * *
    (2) Warranties for all electronic items. The Reserve Bank makes all 
the warranties set forth in and subject to the terms of 4-207 of the 
U.C.C. for an electronic item as if it were an item subject to the 
U.C.C. and makes the warranties set forth in and subject to the terms 
of Sec.  229.34(c) and (d) of this chapter for an electronic item as if 
it were a check subject to that section.
* * * * *

0
4. In Sec.  210.9, revise paragraph (b)(5) to read as follows:


Sec.  210.9  Settlement and payment.

* * * * *
    (b) * * *
    (5) Manner of settlement. Settlement with a Reserve Bank under 
paragraphs (b)(1) through (4) of this section shall be made by debit to 
an account on the Reserve Bank's books, cash, or other form of 
settlement to which the Reserve Bank agrees, except that the Reserve 
Bank may, in its discretion, obtain settlement by charging the paying 
bank's account. A paying bank may not set off against the amount of a 
settlement under this section the amount of a claim with respect to 
another cash item, cash letter, or other claim under Sec.  229.34(c) 
and (d) of this chapter (Regulation CC) or other law.
* * * * *

PART 229--AVAILABILITY OF FUNDS AND COLLECTION OF CHECKS 
(REGULATION CC)

0
5. The authority citation for part 229 continues to read as follows:

    Authority: 12 U.S.C. 4001 et seq., 12 U.S.C. 5001-5018.


0
6. In section 229.2, add a new paragraph (fff) to read as follows:


Sec.  229.2  Definitions.

* * * * *
    (fff) Remotely created check means a check that is not created by 
the paying bank and that does not bear a signature applied, or 
purported to be applied, by the person on whose account the check is 
drawn. For purposes of this definition, ``account'' means an account as 
defined in paragraph (a) of this section as well as a credit or other 
arrangement that allows a person to draw checks that are payable by, 
through, or at a bank.
0
7. In Sec.  229.34, redesignate paragraphs (d), (e), and (f) as 
paragraphs (e), (f), and (g), and add a new paragraph (d) to read as 
follows:


Sec.  229.34  Warranties.

* * * * *
    (d) Transfer and presentment warranties with respect to a remotely 
created check. (1) A bank that transfers or presents a remotely created 
check and receives a settlement or other consideration warrants to the 
transferee bank, any subsequent collecting bank, and the paying bank 
that the person on whose account the remotely created check is drawn 
authorized the issuance of the check in the amount stated on the check 
and to the payee stated on the check. For purposes of this paragraph 
(d)(1), ``account'' includes an account as defined in Sec.  229.2(a) as 
well as a credit or other arrangement that allows a person to draw 
checks that are payable by, through, or at a bank.
    (2) If a paying bank asserts a claim for breach of warranty under 
paragraph (d)(1) of this section, the warranting bank may defend by 
proving that the customer of the paying bank is precluded under U.C.C. 
4-406, as applicable, from asserting against the paying bank the 
unauthorized issuance of the check.
* * * * *

0
8. In Sec.  229.43, revise paragraph (b)(3) to read as follows:


Sec.  229.43  Checks payable in Guam, American Samoa, and the Northern 
Mariana Islands.

* * * * *
    (b) Rules applicable to Pacific islands checks. * * *
    (3) Sec.  229.34(c)(2), (c)(3), (d), (e), and (f);
* * * * *

0
9. In Appendix E to part 229:
0
a. Under paragraph II., Sec.  229.2, paragraph (OO) is revised and a 
new paragraph (FFF) is added.
0
b. Under paragraph XX., Sec.  229.34, redesignate paragraphs D., E., 
and F. as paragraphs E., F., and G., and add a new paragraph D.

Appendix E to Part 229--Commentary

* * * * *

II. Section 229.2 Definitions

* * * * *

OO. 229.2(oo) Interest Compensation

    1. This calculation of interest compensation derives from U.C.C. 
4A-506(b). (See Sec. Sec.  229.34(e) and 229.36(f).)
* * * * *

FFF. 229.2(fff) Remotely Created Check

    1. A check authorized by a consumer over the telephone that is 
not created by the paying bank and bears a legend on the signature 
line, such as ``Authorized by Drawer,'' is an example of a remotely 
created check. A check that bears the signature applied, or 
purported to be applied, by the person on whose account the check is 
drawn is not a remotely created check. A typical forged check, such 
as a stolen personal check fraudulently signed by a person other 
than the drawer, is not covered by the definition of a remotely 
created check.
    2. The term signature as used in this definition has the meaning 
set forth at U.C.C. 3-401. The term ``applied by'' refers to the 
physical act of placing the signature on the check.
    3. The definition of a ``remotely created check'' differs from 
the definition of a ``remotely created consumer item'' under the 
U.C.C. A ``remotely created check'' may be drawn on an account held 
by a consumer, corporation, unincorporated company, partnership, 
government unit or instrumentality, trust, or any other entity or 
organization. A ``remotely created consumer item'' under the U.C.C., 
however, must be drawn on a consumer account.
    4. Under Regulation CC (12 CFR part 229), the term ``check'' 
includes a negotiable demand draft drawn on or payable through or at 
an office of a bank. In the case of a ``payable through'' or 
``payable at'' check, the signature of the person on whose account 
the check is drawn would include the signature of the payor 
institution or the signatures of the customers who are authorized to 
draw checks on that account, depending on the arrangements between 
the ``payable through'' or ``payable at'' bank, the payor 
institution, and the customers.
    5. The definition of a remotely created check includes a 
remotely created check that has been reconverted to a substitute 
check.
* * * * *

XX. Section 229.34 Warranties

* * * * *

D. 229.34(d) Transfer and Presentment Warranties

    1. A bank that transfers or presents a remotely created check 
and receives a settlement or other consideration warrants that the 
person on whose account the check is drawn authorized the issuance 
of the check in the amount stated on the check and to the payee 
stated on the check. The warranties are given only by banks and only 
to subsequent banks in the collection chain. The warranties 
ultimately shift liability for the loss created by an unauthorized 
remotely created check to the depositary bank. The depositary bank 
cannot assert the transfer and presentment warranties against a 
depositor. However, a depositary bank may, by agreement, allocate 
liability for such an item to the depositor and also may have a 
claim under other laws against that person.

[[Page 71226]]

    2. The transfer and presentment warranties for remotely created 
checks supplement the Federal Trade Commission's Telemarketing Sales 
Rule, which requires telemarketers that submit checks for payment to 
obtain the customer's ``express verifiable authorization'' (the 
authorization may be either in writing or tape recorded and must be 
made available upon request to the customer's bank). 16 CFR 
310.3(a)(3). The transfer and presentment warranties shift liability 
to the depositary bank only when the remotely created check is 
unauthorized, and would not apply when the customer initially 
authorizes a check but then experiences ``buyer's remorse'' and 
subsequently tries to revoke the authorization by asserting a claim 
against the paying bank under U.C.C. 4-401. If the depositary bank 
suspects ``buyer's remorse,'' it may obtain from its customer the 
express verifiable authorization of the check by the paying bank's 
customer, required under the Federal Trade Commission's 
Telemarketing Sales Rule, and use that authorization as a defense to 
the warranty claim.
    3. The scope of the transfer and presentment warranties for 
remotely created checks differs from that of the corresponding 
U.C.C. warranty provisions in two respects. The U.C.C. warranties 
differ from the Sec.  229.34(d) warranties in that they are given by 
any person, including a nonbank depositor, that transfers a remotely 
created check and not just to a bank, as is the case under Sec.  
229.34(d). In addition, the U.C.C. warranties state that the person 
on whose account the item is drawn authorized the issuance of the 
item in the amount for which the item is drawn. The Sec.  229.34(d) 
warranties specifically cover the amount as well as the payee stated 
on the check. Neither the U.C.C. warranties, nor the Sec.  229.34(d) 
warranties apply to the date stated on the remotely created check.
    4. A bank making the Sec.  229.34(d) warranties may defend a 
claim asserting violation of the warranties by proving that the 
customer of the paying bank is precluded by U.C.C. 4-406 from making 
a claim against the paying bank. This may be the case, for example, 
if the customer failed to discover the unauthorized remotely created 
check in a timely manner.
    5. The transfer and presentment warranties for a remotely 
created check apply to a remotely created check that has been 
reconverted to a substitute check.
* * * * *

    By order of the Board of Governors of the Federal Reserve 
System, November 21, 2005.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 05-23331 Filed 11-25-05; 8:45 am]
BILLING CODE 6210-01-P