How Could the Changes in Regulation CC Affect You? Angie Smith, AAP, NCP VP, Professional Development Events April 24, 2014

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1 How Could the Changes in Regulation CC Affect You? Angie Smith, AAP, NCP VP, Professional Development Events April 24, 2014

2 WesPay, as a Direct Member of NACHA, is a specially recognized and licensed provider of ACH education, publications and support. Regional Payments Associations are directly engaged in the NACHA rulemaking process and the Accredited ACH Professional (AAP) program. This material is derived from collaborative work product developed by NACHA The Electronic Payments Association and its member Regional Payments Associations. This material is not intended to provide any warranties or legal advice, and is intended for educational purposes only Western Payments Alliance (WesPay). All rights reserved. NACHA owns the copyright for the NACHA Operating Rules & Guidelines. The Accredited ACH Professional (AAP) is a registered service mark of NACHA. 2

3 REGULATION CC:

4 Notice of Nonpayment Requirement» Current Rule: If a paying bank determines not to pay a check in the amount of $2,500 or more, it shall provide notice of nonpayment such that the notice is received by the depositary bank by 4:00 p.m. (local time) on the second business day following the banking day on which the check was presented to the paying bank. If the day the paying bank is required to provide notice is not a banking day for the depositary bank, receipt of notice on the depositary bank's next banking day constitutes timely notice. Notice may be provided by any reasonable means, including the returned check, a writing (including a copy of the check), telephone, Fedwire, telex, or other form of telegraph.» Proposed Rule: Eliminate the notice of nonpayment requirement» Comments received: Mixed. Some support, but also some credit unions and their associations opposed 4

5 Same-Day Settlement Rule» Current Rule: Banks must provide same-day settlement for checks presented in accordance with regulatory requirements» Proposed Rule: Permit a paying bank to require checks presented under the rule to be delivered electronically» Comments received: Many commenters found the proposal to be unclear, and requested re-proposal Others supported the proposal, but recommended clarifications 5

6 Expeditious Return Requirement» Current Rule: A paying bank must return unpaid checks expeditiously to the bank of first deposit» Proposed Rule: A paying bank would have the duty of expeditious return only if the bank of first deposit agrees to accept return checks electronically» Comments received: Numerous commenters expressed concerns with FIs holding out of electronic exchanges Provided specific recommendations for how to clarify this provision, as well as suggestions for possible alternative formulations 6

7 Electronic Items» Current Rule: Regulation CC does not address electronic items Definition of electronic items o o Electronic image of the front and back of a paper check with electronic information that derived from a paper check Electronic image of the front and back of a check with electronic information, but no paper check ever existed» Proposed Rule: Electronic items that derived from paper would be treated as checks for purposes of Regulation CC s collection and return provisions. Regulation CC s presentment and transfer warranties would apply to electronic items derived from paper and those where paper never existed (electronically created items) 7

8 Definition of Electronic Collection Item (ECI)» Comments received: Paying bank has agreed to receive o Commenters found this prong of the definition to be too limiting Is sufficient to create a substitute check o General support - Some commenters requested clarification that banks can agree to collect electronic check images or data, notwithstanding that the image/data is not an ECI, and that the provisions of the regulation would not apply to exchanges of such image/data o One commenter expressed opposition to the possibility of such an arrangement Conforms with X and its UCD, unless parties otherwise agree o Comments mixed 8

9 Return Reason: Refer to Maker» Current: Refer to Maker is a valid return reason code by itself» Proposed: Eliminate refer to maker as a single return reason; must be accompanied with another return reason» Comments received: Almost all expressed concern or opposition o For positive-pay items, the drawer may want the payee to contact it, and the paying o o bank may not know the factual basis for the drawer s refer to maker instruction Because refer to maker is used in positive-pay and RDC systems, banks and their customers would need at least 2 years to make the necessary changes Question what prompted the proposed change at this time One commenter supported the proposal 9

10 Funds Availability» Current Rule: Local and nonlocal checks must be made available for withdrawal within 2 and 5 business days» Proposed Rule: Eliminate references to nonlocal checks and the nonlocal check hold schedule» Comments Received: Supportive 10

11 Funds Availability» Current Rule: A bank may apply a longer exception hold to a check deposit in certain circumstances where there is higher risk the check will be returned unpaid. The safe harbor period for the exception hold is 7 business days» Proposed Rule: Shorten this safe harbor to 4 business days» Comments Received: Very few comments in support Many stated that, if shortened, the safe harbor should be no less than 5 business days Many credit unions and associations opposed any shortening of the safe harbor 11

12 The Proposal for Non-Checks» Apply Regulation CC s current warranty of authorization for an RCC to a non-check e-check.» Apply the proposed new Check-21-like warranties to any item that banks handle electronically, whether or not it was properly derived from a truncated original check. The proposal would protect a bank that receives an electronic item against potential liability resulting from creating a substitute check for which there was no prior original check 12

13 The Proposal for Non-Checks» Comments Received: Generally Supportive Some commenters thought the proposal should go farther o o Make paperless RCCs subject to all provisions of subpart C Modify the regulation s original check definition to include paperless RCCs, such that they would be checks for all purposes of the regulation Suggestions that the rule clarify that banks exchanging electronic items may agree to vary or waive the application of (e) Differing views as to whether an electronic payment order should be addressed by the regulation 13

14 Model Disclosures and Notices» Current forms: Contains language to local and nonlocal checks» Proposed forms: Remove obsolete language to nonlocal and reflect the proposed, simplified funds-availability schedule (proposed new forms reflect recent consumer testing)» Bank will have 12 months to switch to the new forms» Current rule: Various sections of subpart B contain provisions applicable to a bank s disclosure of its funds-availability policy. Appendix C provides model disclosures» Proposal: Change disclosures format and content» Comments received: Mixed Concern with 8.5 x 11 paper size Some general support for the tabular format and revised, briefer language But, in the context of this general support, many voiced specific concerns. E.g., the wording of the proposed disclosures new language related to a bank s charge back of a check that is returned unpaid 14

15 REGULATION CC:

16 Regulation CC» Return rules: two alternative proposals» Same Day Settlement» Three new rules governing image exchanges New terms with new definitions These do not match your bank s existing agreements with other banks or depositors» ECI s, EPO s and Check Law» Remote Deposit Capture rule 16

17 Return Rule» Current: Paying Banks have two obligations that» are specifically creations of Reg. CC Expeditious return Notice of non-payment» Proposed Alternative 1: Eliminate expeditious return requirement, retain LDRN requirement on PB that returns paper, with 2 PM deadline» Proposed Alternative 2: Keep expeditious return requirement but not if the PB is unable to send returns to the BOFD electronically 17

18 Why and How» Why: Incentives to move banks from receiving» paper check returns, to electronics» How: Alternative 1 removes the regulatory burden on paying banks and would let the market move all the banks toward electronics» How: Alternative 2 leaves the burden on the paying bank to return expeditiously, but only if there is a path through which the PB s return items can reach the BOFD electronically. Direct incentive for BOFDs to accept electronics 18

19 Return Alternative 1» Eliminates expeditious return for both Paying Bank and Returning Bank (229.31(b) and (a))» Paying Bank remains subject to UCC midnight deadline for return Returning Bank subject to requirement of ordinary care under UCC in handling return» Imposes Notice of Non-Payment requirement for any check returned by Paying Bank in paper form, regardless of dollar amount of returned paper check (229.31(d)) Notice must be received by Depositary Bank by 2:00 pm (local time of the Depositary Bank) on the second business day after presentment o Current Regulation has delivery time of 4:00 pm No notice of non-payment requirement for Returning Bank even if it creates substitute check for return to BOFD 19

20 Return Alternative 1 Notification of Non-Payment Image Return Substitute Check Return or Substitute Check Return Depositary Bank (BOFD) Returning Bank Paying Bank No expeditious return requirement for return of paper check/check image 20

21 Return Alternative 2» Permits Paying Bank and Returning Bank to send returned check, subject to expeditious return obligation (229.31(a) and (a)) To Depositary Bank, or To any other bank agreeing to handle returned check» Expeditious-return requirement on Paying Bank and Returning Bank for all items (paper and electronic check returns): Would apply current 2-day expeditious return test Move cutoff hour for Depositary Bank s receipt of returned check from current 4:00 p.m. deadline to 2:00 p.m. deadline Eliminates current 4 day and forward collection test 21

22 Return Alternative 2» Exception to Expeditious Return for Paying Bank:» No expeditious return obligation on Paying Bank, if Paying Bank does not have agreement to send electronic returned checks: (229.31(c)) Directly to Depositary Bank, or To Returning Bank that is subject to expeditious return requirement under Section » If Paying Bank is subject to expeditious return obligation, it can choose to meet obligation by returning either paper or electronic returned check Paying Bank not obligated to use electronic returned check in all cases, so long as return is expeditious Depositary Bank not be entitled to expeditious return from any paying banks unless it has agreed to accept electronic returns from at least one Returning Bank The more agreements for electronic return that Depositary Bank has, the greater the likelihood that it will receive expeditious return of most/all items 22

23 Return Alternative 2» Exception to Expeditious Return for Returning Bank» No expeditious return obligation on Returning Bank, if Returning Bank does not have agreement to send electronic returned checks: (229.32(c)) Directly to Depositary Bank, or To another Returning Bank that is subject to expeditious return requirement, and The Returning Bank has not otherwise agreed to handle returned check expeditiously» Eliminates Current Notice of Non-Payment for items of $2500 or more» Notice in Lieu of Return retained for both Alternatives Must include information contained in check s MICR line 23

24 Return Alternative 2 Electronic Return Agreement Electronic Return Agreement Substitute Check Return or Substitute Check Return or Image Return Image Return Depositary Bank (BOFD) Image Return Returning Bank or Electronic Return Agreement o r Substitute Check Return Paying Bank 24 Expeditious return requirement for return of paper check/check image No notification of non-payment required

25 Return Alternative 2 Electronic Return Agreement (No Electronic Return Agreement) Depositary Bank (BOFD) Substitute Check Return Image Return Substitute Check Return or Electronic Return Agreement Returning Bank A (No Electronic Return Agreement) Returning Bank B Image Return Substitute Check Return Image Return o r Substitute Check Return or or Electronic Return Agreement Paying Bank Expeditious return requirement for return of paper check/check image No notification of non-payment required

26 Same Day Settlement Rule» Current: A presenting bank can impose SDS obligations on a paying bank by delivering a separately sorted, specifically labelled SDS cash letter of paper checks to the PB s presentment point by 8 AM local time» Proposed: The Fed considered changing the SDS rule but is proposing no change SDS would still be a paper only rule. 26

27 Rules for Image Exchange» Current: Reg. CC has no rules regarding images except for images captured from substitute checks. Reg. CC applies to checks and substitute checks. Images are exchanged by agreement» Proposed: New definitions of electronic check, electronic returned check, and electronically created item; three new layers of rules 27

28 New Rules: Layer 1 and 2» Electronic check/returned check is subject to subpart C of Reg. CC as if it is a check» When banks exchange electronic check/returned check for value, the transferring bank makes C21 like warranties» Why: Fed is partially plugging a hole that existed in check law after C21. This gives electronic items captured from paper checks essentially the same legal status under Reg. CC (not UCC) as a check 28

29 New Rules: Layer 3 Electronically Created Item» Proposed: a bank that transfers an electronic image or electronic information that is not derived from a paper check (i.e., an electronically-created item) indemnifies each transferee bank, any subsequent collecting bank, the paying bank, and any subsequent returning bank against any loss, claim, or damage that results from the fact that the image or information was not derived from a paper check 29

30 New Rule for Remote Deposit Capture (RDC)» Current: No rule for duplicate deposits» Problem: BOFD accepts image deposit via RDC. Depositor then deposits original check at BOFD 2. BOFD2 receives a return and has no place to obtain recourse» Proposal: A BOFD that transfers an item that it accepted for deposit via RDC indemnifies all transferees of the original check against loss if the original check is deposited 30

31 Indemnity Truncating Bank IMAGE RDC Agreement Bank A (BOFD A) IMAGE Indemnity Claim Agreement IMAGE Remote Deposit Customer Bank B (BOFD B) Return as Duplicate Paying Bank 31

32 Comments: Does the Proposed Solution for ECIs Work?» No bank to bank warranties. This is a big change. Consequences?» The indemnity protects only banks, not the account holder at the paying bank» The indemnity does not run back to the depositor» The proposal does not address issuance, authentication, or authorization of an ECI» Invitation to fraud? 32

33 Comments: Other Proposed Changes» Fed seeks comment on which alternative works the best: One or Two» Fed seeks comment on whether SDS should be extended to electronic items» Fed seeks comment on whether the new RDC indemnification imposes more risk 33

34 Other Issues» Definition of RCC Requesting comment on whether to narrow scope of definition to include only checks created by payee (or payee s agent)» Refer to Maker (229.31(e)) In 2011 Fed proposed elimination of this return reason, stating it was not a reason but an instruction Current Proposal would limit use o Permissible when drawer with positive pay arrangement instructs bank to return check o Not permissible when check is being returned due to paying bank having already paid item» Same Day Settlement (229.36(f)) Retains current SDS rule and only applies to paper presentment Settlement of presentment of electronic checks governed by agreement of parties 34

35 Other Issues» Indorsements (229.35) Eliminate Appendix D Indorsement, Reconverting-Bank Identification and Truncation Bank Identification Standards Refer to X9 industry standards for indorsement for paper check, substitute check and electronic check» Presumption of Alteration Requests comment whether Regulation CC should adopt an evidentiary presumption as to whether, in cases of doubt, check should be presumed to be altered or forged» Rejected Deposit ( and ) Bank that rejects check submitted for deposit and sends customer substitute check makes Check 21 warranties and provides indemnification, regardless of whether bank received consideration for substitute check 35

36 Resources» FRB Operating Circular 3» Regulation CC Availability of Funds and Collection of Checks» Federal Reserve Account Executives 36

37 QUESTIONS 37

38 Thank You