The Federal Reserve Board's proposed expansion of Regulation E will probably fall harder on merchants than on banks, because merchants will have additional reporting requirements for transactions that involve electronic check conversions.
The Fed's proposal, released Sept. 13, includes two major changes. One, which has not generated much controversy, would officially classify payroll card accounts as commercial banking accounts covered under Reg E. This change is expected to clear up the nebulous status of payroll card products.
The other revision may well draw fire from the merchant community before Nov. 19, when the Fed's comment period ends. It would require merchants (and other payees) that use information from a check to initiate an electronic fund transfer from a consumer account to notify consumers and get authorization from them for each transaction.
Reg E does not cover merchants and other payees that conduct e-check conversions.
The latter change is particularly relevant in light of two developments: the trend toward converting checks to electronic payments at the point of sale, and the impending implementation of the Check Clearing for the 21st Century Act, which is expected to hasten the use of check images.
A lawyer for a merchant trade group said that putting retailers under the thumb of Reg E, which implements the Electronic Fund Transfer Act, will not sit well with his constituency.
"My sense is it will raise serious concerns for our members," said Mallory Duncan, a senior vice president and the general counsel for the National Retail Federation. "This appears to raise a number of troubling issues - but I am only just giving it a first going-over."
Notification can take the form of a sign at the point of sale or a written statement on a bill or invoice. Merchants are being asked to comment on whether a signed authorization should be obtained from the customer.
Autumn is about the worst possible time for merchants to have to deal with this, Mr. Duncan said. "They are trying to get ready for the holiday season. Anything that comes up in the fall is always much more problematic."
Del Tonguette, the debit card executive at ICBA Bancard, the Arlington, Va., e-payment services subsidiary of the Independent Community Bankers of America, said the notification and authorization requirements seem onerous.
"I'm puzzled how a payee can possibly comply with the customer notification and authorization requirements without a significant slowdown in the payment process," he said. "This is an unnecessary burden for the merchant and payee."
A 2001 Fed commentary on the issue of converting checks to EFT at the point of payment put responsibility for notifying customers on the merchant or payee, but it did not put merchants under Reg E, because they are not financial institutions. The Fed noted at the time that it had the authority to extend Reg E to merchants and might consider doing so.
The proposed changes announced last week are meant to clarify a long list of issues concerning payroll cards and e-payments that had been vague for years. The Fed's 40-page proposal covers payment procedures that were left out of earlier regulations mostly because they were too new or unusual to require set rules until more recently.
In the case of payroll cards, Congress imposed a moratorium on any Fed action in 1996 and asked the agency to look into them.
"The board noted that given the limited experience at that time, it was difficult to predict whether the benefits to consumers from Regulation E would outweigh the corresponding costs of compliance," the proposal said. It did not say how long it will take to issue a final ruling but solicited comment on a 6-month phase-in for the new rules.
Payroll cards often substitute for checking accounts for unbanked employees. Each pay period, participating employers credit payroll funds to the cards, which sometimes carry a Visa or MasterCard logo. Workers can use the cards to withdraw cash at automated teller machines or to make purchases.
If the cards are classified as accounts under Regulation E, as the Fed has proposed, the issuers will have to make initial disclosures of terms, send periodic statements, establish error-resolution procedures, and offer other consumer protections.
Thomas P. Vartanian, a partner at the law firm of Fried, Frank, Harris, Shriver & Jacobson LLP in Washington, said the congressional moratorium had put the cards in a "regulatory netherworld."
Consumers Union, a Yonkers, N.Y., advocacy group that has addressed payroll cards and check conversion on its Web site and in its magazine, said that though the proposal included much-needed changes it did not go far enough.
"I am pleased to see it but think the Fed needs to act on other cards acting as account substitutes," such as reloadable stored-value cards typically marketed to college students, said Gail Hillebrand, a senior attorney with the group. The proposal covers only cards offered by employers.
Ms. Hillebrand expects little opposition to the payroll card portion of the proposal. "I would not think employers would have an interest in opposing this, though providers sometimes argue against their own best interest," she said. "This provides a level of confidence and certainty that can increase acceptance of these products."
The Fed notified bankers in May that the change was under consideration because of payroll cards' growing popularity. One industry insider called the changes a good idea.
"Consumer protection on payroll cards is a necessary thing for the market to survive," said Rob Drozdowski, the vice president for payments and technology policy at America's Community Bankers, in an interview Thursday.
In addition, anything that makes it clearer to consumers how checks may be processed "is beneficial," Mr. Drozdowski said.
Ms. Hillebrand said that some banks already comply with most of the Reg E terms. "They are all over the map," she said. Some promote the zero liability that Visa and MasterCard promise, though that is not the same as Reg E protection.
Bank of America Corp. already treats payroll cards as full accounts, and its cards are compliant with the rule, a spokeswoman said.
Mr. Tonguette at ICBA Bancard said the payroll card proposal was not surprising. "Banks in general will endorse payroll cards coming under Reg E," he said. "We have been expecting it and endorse such a decision."
But Rhonda Bentz, Visa U.S.A.'s director of public affairs, said the new rule could have "unintended consequences." One concern is whether the Federal Deposit Insurance Commission will decide that card deposits are covered under its rules and how that affects Regulation E coverage.
"It raises issues such as reserves for deposits and the know-your-customer part of the Patriot Act," Ms. Bentz said. The proposal does not address those concerns. Visa will be submitting comments, and many issuers are still weighing their response, she said.
Ms. Hillebrand of Consumers Union said the other significant part of the Fed's proposal, giving merchants new Reg E responsibilities, was a good idea.
It is the merchant who makes the choice to turn a paper check into an automated clearing house transaction, not the bank, she said. "You have to tell customers what will happen to a check before they write the check, otherwise it is meaningless."
The proposal, citing consumer confusion, requested comment on whether merchants and billers should help educate customers on the topic and offer them the option of specifying under which circumstances a check that could be converted to an EFT should instead be processed as a check. Sometimes the bank truncates the check into an ACH transaction at the lockbox, and the merchant does not have a say.
Mr. Duncan at the National Retail Federation said merchants should not have to bear the burden of educating consumers about financial transactions.
"The question is, is that an appropriate assignment for merchants, when it is to financial services' benefit?" he asked. "There is a concern about putting on responsibilities for notification for benefits that primarily go to financial services."
If the proposal stands, all parties engaged in electronic check conversion transactions will be subject to Reg E for the "limited purpose of obtaining authorizations," the Fed document said. Merchants will be required to warn customers that funds may be debited from their accounts more quickly than they are accustomed to, that their financial institution will not be returning their check, and that any insufficient funds fees will be debited electronically from their accounts.
The proposal also clarifies the rules on minicards or other devices sent to customers with their debit cards, saying that institutions may send more than one device as long as they are sent unactivated.
The Fed also proposes to loosen ATM fee notification requirements slightly to let banks include language that clarifies circumstances under which the charge will not be applied, such as for cardholders of foreign banks.
