Early Feedback Tepid on Check Truncation Plan

Lobbyists, consumer groups, and other constituencies have begun weighing in on proposed legislation that would make printed images of checks the legal equivalent of the real things.

The Federal Reserve Board drafted the proposal, and, when it was submitted to the House and Senate banking committees on Dec. 17, Fed Chairman Alan Greenspan urged legislators that it be turned into law.

But despite his powerful imprimatur, opponents of the proposal — which has yet to be drafted into a bill or introduced in Congress — are expressing a variety of concerns that could translate into a long and acrimonious debate on the matter.

Consumer groups are concerned that by putting multiple images of checks in circulation — as the Fed suggests — there would be a greater likelihood of an account being debited twice for the same transaction, and that it would be harder for people to get their bank to correct the problem. Other constituencies say that in replacing the current system, the Fed’s proposal would create a whole new set of problems.

The Federal Reserve Board says that the proposal it calls the Check Truncation Act would streamline the process of moving funds from one bank to another, and that it would save time and money, and ultimately reduce risk. Since a check image would bear the same check number as the original, there would be no confusion over double debits, the Fed says.

The Fed has been working on its proposal for two years, but Sept. 11 and its aftermath sped the process along. For the three to four days that most commercial airlines were grounded, hundreds of thousands of paper checks could not reach their destinations.

To keep the economy functioning as normally as possible, the Fed oversaw an unprecedented $45 billion of processing float during those days. Generally the Fed permits between $600 million to $800 million of float a day.

“Had the provisions of this proposed Act been in effect when air traffic came to a standstill due to the terrorist attacks on September 11, banks would have been able to reduce the impact of the disruption in air transportation on the check collection system,” Fed Chairman Alan Greenspan wrote in letters to the ranking members of the House and Senate banking committees.

The proposed legislation would create a new legal entity called a “substitute check” that could be created from an electronic check image and would have the same legal status as the original check. It would supersede existing laws that require banks to present and return original paper checks unless a customer agrees to receive them electronically.

The Fed’s proposed legislation would also let banks truncate checks without getting permission from other parties. Customers — or other banks — who wanted paper checks could get substitute paper checks rather than originals. The proposed law would not mandate that anyone receive checks electronically.

Check truncation, the conversion of a paper check payment to an electronic one at the point of sale or an automated teller machine, takes place today, but on a small scale. Few U.S. banks are ready to roll out a comprehensive truncation system.

During the two years the Fed has worked on the proposal, it has gotten input from the banking industry, trade associations, payment law experts, and consumer groups.

“We tried to cover the waterfront in terms of interested parties,” said Jack Walton, an assistant director at the Fed. “We spent time with all these various groups, and we came out with what we felt the best approach would be to each side.”

But some consumer groups say they still have problems with the proposed legislation, specifically Section 6, which addresses the way that deposit accounts would be recredited in the case of a wrongful debit.

A system in which original checks, substitute checks, and electronic check images exist simultaneously would improve the chances that an account could accidentally (or fraudulently) be debited more than once for the same transaction, the consumer groups say.

Section 6 of the Fed’s proposal states that if a consumer claims that something has gone wrong, the bank “shall either produce the original check and show that the substitute check was properly charged to the consumer’s account, or recredit the consumer’s account for the amount of the claim, up to the amount of the substitute check or $2,500, whichever is less, no later than the business day following the banking day the consumer makes the claim.”

It further states: “The bank shall credit the consumer’s account for the remainder of the amount of the claim, up to the amount of the check, plus interest, on the business day following the banking day on which the bank determines that the consumer’s claim is valid, but no later than 20 business days following the banking day the consumer makes the claim.”

The proposal contains some exceptions to those rules. For example, if an account was opened less than 30 days before a claim is made, the bank can delay the recrediting for up to 20 days. Other clauses are meant to give extra powers to the bank if the account has a history of insufficient funds, or if there is a reasonable suspicion the claim is fraudulent.

Gail Hillebrand, a senior attorney for the West Coast regional office of the Consumers Union in San Francisco, said the narrowness of the “recredit right” — the circumstances under which an account can be made whole if an error is made or fraud occurs — is a sticking point for her group.

“We don’t want [the legislation] unless we can make the recredit right broader so it can be real and effective for all consumers,” she said. “Who is holding onto the money while you’re sorting out the problem?”

Another concern is that, since substitute checks would necessarily lack some of the properties of original checks, some doors to abuse could open.

The Fed’s Mr. Walton acknowledged that “some things do not survive the image process,” such as the watermark on check stock and pen pressure from the customer’s signature.

However, he said that the indemnity section of the proposed legislation says that the bank that prints the check would be responsible for making the consumer’s account whole in the event of a dispute, and that the industry is working to “come up with image-survivable features.”

Consumer groups are not the only ones with worries. Companies that transport paper checks from bank to bank say they see the writing on the wall, and they are trying to move quickly into other lines of business.

For example, AirNet Systems Inc. of Columbus, Ohio, is looking to use its 120 jets, which now transport thousands of checks a day, to deliver, among other things, organs for surgery.

“Actually, they’re not opposed to the Check Truncation Act,” said Stephen Brown, a lobbyist for the Washington-based Dutko Group who represents AirNet. “We’re opposed to this particular approach.”

The federal government could have easily overcome the post-Sept. 11 check transportation problems by designating a private contractor or public air fleet to fly the checks under an emergency provision, he said.

Another potential problem is that criminals might be able to break into the computers that house the check images, or physically attack the facilities that house them, Mr. Brown said. “If you don’t have a paper-based redundancy, then you’re creating a whole other set of vulnerabilities.”

Also, the substitute checks would have to be sent through the mail, he said. “How do they move the paper copies of these checks? They have to fly them. You’ve come up with a 20th-century solution to a 21st-century problem.”

While the Fed asserts that the Check Truncation Act would save the banks a lot of money, Mr. Brown said the Fed has not produced any studies to demonstrate cost savings, nor has it shown any risk/reward comparison.

“Because we are seeing migration, it may make sense to move to an electronic-based payment system,” but “the market should be able to work its will at its own pace,” he said

Mr. Walton of the Fed said that cost savings “is a pretty obvious conclusion” if a check, which “is nothing more than instructions to pay someone out of a bank,” is handled fewer times. By making the transaction electronic, banks eliminate many of the middlemen who handle the checks, such as AirNet, he said.

And banks have processes in place to resolve recredit issues, Mr. Walton said. If a bank sees that an account is hit with the same exact amount more than once with the same check number, it will recredit within a day, or sooner, he said.

The longer recrediting periods are meant to inhibit fraud, he said.

Redundancy would be an integral part of the system proposed by the Fed, Mr. Walton said. The bank of first deposit would take pictures of the check for its own files, and “if for some reason [the image] gets destroyed, you have to reconstruct it by going back to the original banks,” he said.

The Federal Reserve Board, with its national presence, could also be the intermediary between banks if one of the banks required a paper image of the checks, he said.

If the Check Truncation Act became law, most banks would “take baby steps rolling this out,” Mr. Walton predicted. “It would take some time after enactment before this would take hold.”

Mr. Brown, the AirNet lobbyist, predicted that the Fed’s proposal would face heavy opposition from large corporations that write a lot of checks, as well as from senior citizens who prefer the tried-and-true checkbook.

“I’m willing to bet that millions of grandmas not getting their checks back would be able to hold off this legislation,” he said.