A LIVING POWERPOINT. March 25, Jenny Johnson ECCHO Phyllis Meyerson ECCHO

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1 March 25, 2015 A LIVING POWERPOINT Phyllis Meyerson ECCHO pmeyerson@eccho.org Jenny Johnson ECCHO jjohnson@eccho.org Copyright 2015 by the Electronic Check Clearing House Organization

2 Disclaimer This session provides an overview of various aspects of the check payments systems including legal and rules framework for check image exchange. Responsibility for compliance with image exchange rules and/or legal, operational and regulatory requirements applicable to check image exchange remains at all times with the financial institution participating in check image exchange and/or the individual or company using a check image exchange service. This presentation and the information contained herein is not intended as legal or compliance advice or recommendation to any person or company. This document could include technical inaccuracies or typographical errors and individual users are responsible for verifying any information found in this presentation. Financial institutions should consult with their legal counsel regarding legal and operational requirements applicable to any check image exchange program they may offer or in which they participate. 2

3 Session Overview ECCHO Overview Duplicates Overview/Resolving Duplicates Holder in Due Course Living PowerPoints: Duplicates Simple Sammy Scenario Hounding Holder in Due Course BOFD B Bounces Playing Nice in the Sandbox To Return or To Adjust Man in the Middle: Talking Check 3 Conclusions

4 ECCHO Overview

5 ECCHO: Who We Are Electronic Check Clearing House Organization Created in 1990 to facilitate check electronification Owned by membership of approx. 3,000 FIs All depositary financial institutions are eligible for membership For more info: 5

6 ECCHO: What We Do Electronic Check Clearing House Organization Provide private sector image check exchange rules Make image exchange fair among all members Advocate for the check industry: Reg CC changes, not to ban RCCs, Check 21, etc. Seek to make check payment system as electronic, effective and efficient as possible Provide check education for the industry Provide NCP certification for the industry ECCHO works for its members Not for profit. 6

7 NCP National Check Professional April 18 May 9, 2015 Exam Window 120 multiple choice questions Training through partners like WACHA Just about to test fifth exam class Currently 416 NCPs; about 800 registered since inception 7

8 Duplicates Overview

9 About Duplicates Have duplicates thrown you a curve ball? Do you wonder about the best way to handle duplicates? Today, suggested solutions will come to life but first a brief overview 9

10 Current Environment In 2012, 17% of checks were deposited via image Increasing in the last few years with mobile deposit going mainstream Now mainly RDC duplicates consumer and corporate Often outside control of banks Industry issue and concern particularly holder in due course claims 10

11 Two Causes of Dupes Errors (Staff Stupid, Sammy Stupid and Spouse Stupid) Image cash letter file sent 2nd time Accidental reimaging of physical checks Accidental depositing of physical check after RDC Imaged check erroneously included in physical cash letter Fraud (Sammy Shyster) Intentional deposit of original item after RDC deposit 11

12 Duplicate Warranty Reg CC, ECCHO Rules, Reg J (OC3 uses Reg J) have similar duplicate (already paid) warranties Excerpt from ECCHO Rules (Section XIX(L)(7)) Sending Bank warrants to Receiving Bank with respect to each Electronic Image will not. be asked to make a payment based on an item that it already paid; Word duplicate not there Intended to protect Receiving Bank regardless of form of duplicate item (e.g., image, IRD, ACH conversion, etc.) 12

13 Duplicate Warranty No duplicate warranty exists on original paper item Warranty limited to situation where Receiving Bank pays item already paid Duplicate warranty does not apply to represented items that were not paid the first time 13 NACHA rules have similar provisions for check conversion

14 Represented Duplicate Warranty Warranty limited to situation where Receiving Bank pays item already paid Not applicable where Receiving Bank returned and reversed settlement of first item, then receives second item Receiving Bank only paid single item Deposit Chk Sub Chk Return NSF Image Return Original Chk Representment Representment 14 BOFD A Adjust as Duplicate NOT A Duplicate Paying Bank

15 Understanding Duplicates Early on ECCHO was asked if different indorsements indicate a duplicate? From same original check = Yes, a duplicate From two different checks = Not a duplicate Two different indorsements not necessarily indicative of a duplicate Additional review and investigation needed Reconstruct what happened What are the facts? Consult legal 15

16 BOFDs Subject to Claim BOFD A Return/Adjust as Duplicate Either/Or Return/Adjust as Duplicate BOFD B Paying Bank C Paying Bank can go back to either BOFD A or BOFD B 16

17 No Claim Between BOFDs Currently, BOFD B does not have a claim against BOFD A BOFD A BOFD B Return/Adjust as Duplicate Paying Bank C 17

18 Claim Between BOFDs Since no image exchange between BOFDs, no warranty is made Warranties arise from exchange Consult legal counsel to understand situation Gentlemen s Agreements Form relationships with FIs with which you regularly exchange images Communicate issues, compromise, play nice in the sand box Fed proposing changes to Reg CC 18

19 Proposed Reg CC Change Truncating Bank Indemnity RDC Agreement BOFD A Indemnity Claim Agreement Remote Deposit Customer BOFD B Return as Duplicate Paying Bank 19

20 Proposed Reg CC Change 20 Truncating Bank Indemnity would permit BOFD B, that deposits original paper check, to make claim against BOFD A Claim made to any truncating bank Claim only exists if check returned to BOFD B due to already paid Language currently doesn t say adjusted Allows BOFD A to allocate loss to its depositing customer by agreement Fed s Rationale BOFD A permitted customer truncation, receives benefit from customer RDC, and is in best position to correct situation It should bear risk or cost to other banks

21 Resolving Duplicates

22 Returns vs. Adjustments Duplicate Deposit Ck Sub Ck Depositing Customer Sub Ck Return or Image Adjustment Drawer Customer BOFD Image Return Paying Bank Known operational duplicates may be resolved as adjustments During initial work on duplicates industry felt adjusting duplicates was best Made sense for errors caused within banking system Can minimize customer impact 22 22

23 Returns vs. Adjustments Duplicate and Deposit Ck Sub Ck Depositing Customer Sub Ck Return RDC duplicates Cause usually outside banking system Return may reach customer faster when funds still available When cause unknown, fraud may be involved Return would protect legal rights Timing is key BOFD Before midnight return deadline, option to return or adjust After midnight return deadline, not eligible for return Only option is to adjust or Image Adjustment Image Return Paying Bank Drawer Customer 23 23

24 Holder in Due Course (HIDC)

25 What is HIDC? Holder: Person that comes into possession of negotiable instrument Holder in Due Course (HIDC): Holder that takes check for value, in good faith and without notice check is overdue or been dishonored Not every holder qualifies as HIDC Depends on facts and circumstances HIDC may make claim against drawer regardless of certain defenses 25

26 New Issue: HIDC Claims Recently HIDC claims have arisen from customer RDC duplicates More challenging duplicate issue because: Caused from outside banking system by customer not a depositary FI Potentially harder to make right HIDC may have original check and may demand payment from drawer Duplicate warranty covers HIDC duplicate warranty claims 26

27 Review: Steps of HIDC Scenario 27 Check Casher took check in good faith without knowledge of issue with check Is Holder of item Has original item Not all check cashers or other claimants have HIDC status or have valid claim Paying Bank returns or adjusts item back to BOFD B, who charges check casher Paying Bank could make claim to either BOFD B or BOFD A Check Casher makes claim directly to Drawer as allowed under UCC With demand letter outside banking system Can only make to drawer Drawer already paid item when posted to its account at Paying Bank Drawer pays Check Casher due to fear of potential bad credit Drawer requests reimbursement from Paying Bank for item it already paid Paying Bank can make claim to BOFD A under duplicate warranty

28 HIDC Scenario Agreement (ICL) Adjust Duplicate Statement BOFD A (ICL) Statement Customer Check Casher HIDC Charge Account BOFD B Return or Adjust Duplicate Paying Bank $$$ Bank Reimburse Drawer Drawer Drawer Pays HIDC Claim 28 HIDC Claim

29 HIDC Summary HIDC is unique challenge because the problem lies outside the banking system 29 Introduced by remote deposit capture ECCHO Rules and Reg J/OC3 do not provide warranty directly to drawer Duplicate warranty made only to Paying Bank Check 21/Reg CC have protections for paying bank and the drawer Truncating bank introduces risk by allowing customer to engage in RDC so appropriate to bear risk of loss Do not pay HIDC claims if suspect holder of fraud

30 Addressing HIDC Issues

31 ECCHO Membership With all check issues, ECCHO meets/facilitates calls with its members to discuss solutions Industry experts share their ideas on how to address the issue Some recommendations result in Rules or commentary changes Following are procedural suggestions from industry experts in ECCHO membership 31

32 Subcommittee Action Subcommittee developed Improving Duplicate Payment Adjustment Resolution An ECCHO Suggestion Document Originally, banks went to BOFD B on duplicates Now banks making claims to BOFD A, depending on scenario: Following alternatives Avoid HIDC claims to Drawer Exceptions are still being worked on: Stale dated Stolen checks Represented checks 32 Altered/Counterfeit 32

33 HIDC Scenario Suggestion 1 Paying Bank makes preemptive claim to BOFD A upon suggestion from BOFD B BOFD B informs Paying Bank that it/its customer has original item and is HIDC BOFD B suggests Paying Bank make claim to BOFD A to short cut the long process that will end up at BOFD A anyway 33

34 HIDC Scenario 1 (ICL) Agreement BOFD A Return or Adjust Duplicate Statement (ICL) Return or Adjust Duplicate Statement Customer Check Casher - HIDC BOFD B Reject Claim Paying Bank Drawer 34

35 Reminder of HIDC Complexity (1) (1) (ICL) (7) Agreement Adjust Duplicate (1) Statement BOFD A (2) (2) (2) Customer (2) Check Casher HIDC (3) Charge Account BOFD B (3) (ICL) Return or Adjust Duplicate (3) Paying Bank (6) Statement $$$ Bank Reimburse Drawer Drawer (5) Drawer Pays HIDC Claim 35 (4) HIDC Claim

36 HIDC Scenario Suggestion 2 BOFD B makes request to BOFD A BOFD B informs BOFD A, it/its customer has original item, is HIDC and will make claim Legally there is no claim between BOFD B and BOFD A With gentleman s agreement the process can be simplified and end up with same result 36

37 HIDC Scenario 2 (ICL) Agreement BOFD A Statement (ICL) Return or Adjust Duplicate Statement Customer Check Casher - HIDC BOFD B Paying Bank Drawer 37

38 Advantages to Suggestions 38 Avoids complications of HIDC claims and subsequent warranty claims Eliminates drawer/customer receiving direct claim from HIDC Handles within banking system Speeds claims process Seems fair for BOFD A to bear risk of loss from double payments BOFD A introduced risk by allowing customer to engage in remote deposit capture Their customer did not secure original paper BOFD A in best position to collect on claim from customer based on customers agreement

39 Living Power Point An Original Play Welcome our Radically Duplicate Check (RDC) Players

40 Disclaimer The events, characters and organizations depicted in this skit are purely fictional. Any resemblance or similarity to any actual events, organizations or persons living or dead is entirely coincidental. 40

41 Starring 41 Sammy: Andy Barlow/WACHA Check 1: Kai Catlin/WACHA Check 2: Becky Miller/Gateway Community Bank BOFD A and Sally: Luanne Kohlmann/WACHA BOFD B: Alan McAfee/First Business Bank Paying Bank: Kevin Busker/Blackhawk Bank Check Casher: Jenny Muche/Horicon Bank Drawer: Cheryl Becker/WACHA Return and Talking Check Host: Phyllis Meyerson/ECCHO Adjust and Intermediary Bank: Jenny Johnson/ECCHO Understudy and Prop Master: Michelle Barlow/ WACHA Announcer: Jenny Johnson/ECCHO Written and Directed: Phyllis Meyerson/ECCHO

42 Simple Sammy Scenario

43 Intermission

44 Act 1: Simple Sammy Duplicate BOFD A Return/Adjust as Duplicate Sammy BOFD B Paying Bank 44 44

45 Hounding Holder in Due Course

46 Intermission

47 Act 2: Hounding HIDC Adjust Duplicate Statement Agreement BOFD A $$$ Charge Account Return or Adjust as Duplicate Bank Reimburse Drawer Sammy Check Casher HIDC BOFD B Paying Bank Drawer Drawer Pays HIDC Claim HIDC Claim 47

48 BOFD B Bounces

49 Intermission

50 Act 3: BOFD B Bounces Agreement BOFD A Return or Adjust Duplicate Statement Charge Account Return or Adjust as Duplicate Sammy Check Casher - HIDC Informs Bank is HIDC BOFD B Reject Claim Paying Bank 50 50

51 Playing Nice in the Sandbox

52 Intermission

53 Act 4: Nice in the Sandbox Agreement BOFD A Statement Check Return or Adjust as Duplicate Sammy Check Casher BOFD B - HIDC Paying Bank 53 53

54 To Return or To Adjust (To Be or Not to Be)

55 Intermission

56 Act 5 - Returns vs Adjustments Duplicate Depositing Customer Deposit Ck Sub Chk Return BOFD or Image Adjustment Image Return Paying Bank Known operational duplicates may be resolved as adjustments Can minimize customer impact Sub Ck Drawer Customer Duplicate and Deposit Ck Sub Ck 56 Depositing Customer Sub Chk Return BOFD or Image Adjustment Image Return Paying Bank Drawer Customer RDC duplicates Cause usually outside banking system When cause unknown, fraud may be involved, Return would protect legal rights Timing is key - Before midnight return deadline, option to return or adjust After deadline only adjust

57 To Return Duplicates typically affect innocent parties Decision to return or adjust at discretion of bank Bank performs its own risk analysis Encouraged to seek legal counsel on potential legal risks Returns Benefit - Do not lose right of return Significant issue if item is counterfeit or forged and not duplicate Benefit - Faster Timely Settlement May have negative impact on innocent parties (depositing customer and drawer customer) May have personnel not familiar with process Note: Use correct return reason code for Duplicate May avoid some negative impact 57

58 To Adjust 58 Adjustments Made to appropriate party Minimum negative impact to customers Handled within banking system Personnel familiar with process Historically resolve these issues Less efficient than returns Slower - Less timely settlement More paperwork May have dollar limits, fees associated with adjustments Due to timing may lose right to return item Waived right to return within midnight deadline Significant issue if item is counterfeit or forged and not duplicate

59 Man in the Middle (Talking Check)

60 Act 6 Man in the Middle Deposit Ck Image Intermediary Bank Image Sub Ck Return NSF Image Return Original Ck Representment Image Representment Sally Stupid Adjust as Duplicate BOFD Intermediary Bank Paying Bank

61 Welcome to Talking Check Welcome our Guests tonight Sally Stupid (wife of Sammy Stupid) Intermediary Bank 61

62 Intermission

63

64 Conclusions

65 Protecting Against Dupes Integrate RDC and duplicate detection systems Proof items Know your customer Sound, updated customer agreements Secure the paper, timing of destruction Restrictive indorsements: For Deposit Only RDC Daily/monthly deposit limits Increasing limits over time for good customers Customer education and training treat phone like a computer Repeat info to customer throughout the process 65

66 Summary 66 Increasing issue with duplicates originating from remote deposit - mainly from consumer customers Some errors; some fraud Duplicate warranties protect against paying an item that has already been paid Sending bank warrants to receiving bank that it won t be asked to make a payment on item already paid Paying Bank can make claim to BOFD A or BOFD B (from our example) Duplicates can be equitably handled within the banking system

67 Summary Recent HIDC claims are different because they are outside of the banking system (not depositary institutions) Therefore generally handled with demand letter (sent directly to drawer customers address on check) Fed has issued proposed changes to Reg CC Proposal is Truncating Bank Indemnity which would permit BOFD B, that deposits original paper check, to make claim against BOFD A in case of duplicate return This is currently not law Use communication and gentleman s agreement to accomplish similar result 67

68 Additional Information For additional information please see the following ECCHO Operating Rules and Commentary Regulation J Regulation CC Joint Comment Letter FIs offering RDC should review and implement FFIEC guidance on RDC which addresses FI responsibility to identify and control risks White Papers Currently Available: A Guideline Document on Duplicate Image/IRD Prevention and Detection Additional Issues Regarding Possible Duplicate Payment of Check items Avoid Duplicates! Improving Duplicate Payment Adjustment Resolution An ECCHO Suggestion Document Resolving Duplicates as Adjustments versus Returns 68

69 Thank You March 25, 2015 Phyllis Meyerson Jenny Johnson Electronic Check Clearing House Organization