An article by Thomas Vartanian on the multiple and disparate state laws on digital signatures ("Multiple Legal Setups Imperil Electronic Commerce," July 9, page 11) posed a question that has arisen in other banking environments for decades: What is the most effective relationship between federal and state regulation?

Should federal regulation defer to the states? Or should federal regulation preempt the state or permit only certain types of state regulation, for example, that which provides greater protection for consumers?

These questions require careful study. Electronic commerce is not restricted by any border. The potential costs of complying with a balkanized set of state statutes seem foreboding. And different regulatory requirements will create confusion for businesses and consumers alike.

While states may regulate in an attempt to protect local business interests, they may also be able to respond more quickly than federal regulators and be more sensitive and responsive to certain consumer protection issues.

Two decades ago an emerging form of electronic commerce-automated teller machine networks-was the focus of regulators and Congress. In response to questions about the impact of new technology on banking and consumers, Congress created the National Commission on Electronic Fund Transfers in 1974 and asked it to advise what form of regulation, if any, was necessary to assure a safe, fair, and predictable EFT world.

Many of the issues arising in the current electronic commerce debates- consumer protection, liability limits, privacy-were addressed by the EFT Commission.

Based on its recommendations, Congress enacted the Electronic Funds Transfer Act of 1978. Some members of Congress and the commission believed federal regulation was unnecessary because the states were beginning to regulate. Others believed only federal law was appropriate and it should preempt the states.

Neither view was adopted. State laws that offered less protection that the EFT Act would be preempted; those that exceeded the federal consumer protection safeguards would not be preempted.

In practice, state regulation of ATM networks has not been particularly helpful for consumers. Some of it harmed them-and the competitive process.

When ATMs were first deployed, many states tried to protect their small banks by enacting mandatory sharing statutes, requiring an ATM owner to share it with any other bank. This was one of the most contentious EFT Commission issues. The Federal Reserve proposed mandatory sharing. The Justice Department opposed it, warning of "free riding" (banks would be deterred from creating networks because they would have to let others in) and potential monopolies.

The debate was between two views of competition:

ATM networks should be treated like regulated public utilities, with open-access obligations.

Numerous networks should compete amid no or light regulation.

The EFT Commission concluded ATM networks were not natural monopolies and that individual markets could support several competing systems. Congress considered legislation to preempt the state sharing statutes but did not enact it.

The Justice Department continued, unsuccessfully, to argue against sharing. Its prediction about the anticompetitive effects of these laws seems to have been borne out. In states with mandatory sharing laws, ATM deployments and card usage are lower than in states that do not require sharing. And by requiring networks to admit any bank as a member, the laws dampened network competition.

If the state sharing laws were the spark that created monopoly networks, the lax merger enforcement of federal regulators fueled the firestorm of ATM network mergers that resulted in regional monopolies. Regulators' stance was fundamentally that bigger is better-a proposition that has brought scrutiny from Sen. Alfonse D'Amato and the Senate Banking Committee.

Then came ATM surcharges, an example of the law of unintended consequences and regulatory misadventure.

Surcharges were unknown until the late 1980s. In 1988 First Texas, a savings and loan, wanting to deploy hundreds of ATMs away from its own premises, challenged an effort by the Pulse network to reduce the interchange fees paid by participating institutions. An arbitrator ruled that the interchange fee system constituted illegal price fixing-unless surcharges were permitted.

Within months Valley Bank of Nevada, which had deployed ATMs at Las Vegas casinos, saw in them an opportunity to profit by charging gamblers extra for the convenience of cash. The nationwide Plus network, not yet controlled by Visa, had explicitly prohibited surcharges, and Valley sued it for engaging in a price-fixing conspiracy violating antitrust laws. The treble-damage provision of the antitrust laws made the suit a significant revenue opportunity for Valley and a threat to thinly capitalized Plus.

The surcharge provision probably would have been upheld. It resulted in lower prices, Plus did not have a huge market share, and cardholders traveling away from home needed to be protected from price gouging.

Given that likelihood, Valley Bank astutely took its plea to the Nevada Legislature, which in a midnight session quickly passed a bill prohibiting any ATM network from restricting surcharging. This ostensibly enhanced consumer welfare by promoting more deployments of ATMs, especially at off- premises and rural sites, while benefiting the state's gaming industry and promoting competition among ATMs.

Valley asked a federal court for a declaratory judgment that the legislation was legitimate, giving it the right to surcharge. Plus argued that the statute violated the U.S. Constitution's commerce clause and warned that other states would pass similar but inconsistent legislation. But the Ninth Circuit appellate court dismissed the claim as "speculation" and Plus had to let Valley surcharge.

The "speculation" was right on the mark. Surcharge-hungry institutions supported similar bills in other states. Plus opposed them, but the local banks trumped consumers' interests by saying the only adversely affected parties would be people from out of state. By late 1995, 15 states allowed surcharging.

Plus prevailed in a 1995 Alabama case challenging its surcharge policy, where a judge ruled it was pro-competition and pro-consumer. The disappointed plaintiffs merely returned to the Legislature seeking a pro- surcharge bill.

With so many states opposing them, Plus and MasterCard, owners of the Cirrus network, faced the inevitable and rescinded their surcharge bans. Their officials then returned to the legislative front, this time defending the elimination of the surcharge ban before Congress. They testified that fighting the battle in many state legislatures and attempting to comply with various and inconsistent laws was simply too great a burden.

Ironically, the states never acted to prohibit or restrict surcharges. Rather several states forced the ATM networks to permit surcharges, by invalidating their anti-surcharge rules.

Do consumers really benefit from surcharges? The jury is still out, but the initial indications are not promising. Surcharging may have led to additional ATM deployment, but its impact on consumer convenience is questionable. A great number of consumers probably find their lives considerably less convenient as they search for ATMs that don't surcharge-a quixotic quest in many places.

The state inconsistency problem has not gone away. While 15 states arguably helped create the surcharge problem, another dozen or so are moving in the opposite direction and, in response to a consumer and small- bank outcry, are considering surcharge prohibitions. The networks may ultimately face a completely balkanized regulatory environment as some states permit the charges, others don't, and still others remain neutral.

Federal regulators, meanwhile, have not been responsive. While the state battles were raging in the early 1990s, the federal regulators could have taken action preempting the states, advocating surcharge prohibitions on the state level, or requiring stiffer federal consumer protection provisions. But they were silent.

Ironically, only now are federal regulators considering using their ability to preempt-but in an effort to stop the states that are considering pro-consumer rules to prohibit surcharges. As the national ATM networks were rolling back their anti-surcharge rules, the Federal Reserve actually weakened the consumer protection provisions of Regulation E that require disclosures of surcharges at ATMs. The networks have actually established more rigorous disclosure requirements.

This suggests preemption may be only part of the equation. Where the federal regulators can preempt, they should use the power judiciously to protect consumers and not just the firms they regulate.

A uniform system of regulation is only half the goal. It must effectively protect both consumers and the competitive process. The ATM experience is a lesson in what to avoid.

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