The rules governing accounts receivable conversion are clear - only consumer checks can be converted into automated clearing house payments, not business ones.
However, with about a billion checks expected to be converted this year, it should not come as a surprise that some business checks are accidentally being sent through the ARC process. Some observers say the problem is only going to get worse, but National City Corp. says it has a solution. And Nacha, the electronic payments association, says that solution could prompt it to permit ARC for business checks.
Mary Ann Francis, National City's senior vice president of global trade and treasury product management, said business customers depend on paper checks for bookkeeping purposes.
Banks and billers have enthusiastically adopted ARC for processing consumer checks more efficiently. Under the current rules, a check converted under ARC disappears from the payment stream and is replaced by a new transaction, an ACH payment.
But when business checks are mistakenly converted into ACH payments, it becomes very difficult for the customer to reconcile accounts. The new transactions show up on bank statements as electronic debits and often seem to have no relationship to the original check.
Accidental conversions also make certain for-fee services - such as positive pay, in which a bank monitors a corporate customer's incoming checks against a list of valid checks provided by the customer - less effective. A check that arrives at the bank as an ACH payment bypasses this gatekeeper service and increases the risk of fraud.
In many cases, a business transaction is "born as a piece of paper" but dies as an ACH transaction, Ms. Francis said.
Mike Herd, a spokesman for Nacha, the Herndon, Va., trade group, confirmed that despite the rules, "business checks are being converted."
One of the reasons this happens is that most business checks are bigger (in area) than consumer ones. But many businesses still use small checks that "look like anybody else's checks - they look like consumer checks" and, as a result, are often treated like consumer checks, he said.
Small businesses are particularly vulnerable, because they are more likely than others to use consumer-size checks, Mr. Herd said.
Susan Feinberg, a senior analyst with the wholesale banking practice at MasterCard International's TowerGroup Inc. unit, said that business customers oppose allowing the ARC process for their checks, because it hinders their record keeping. If a check is converted to an ACH transaction, the customer "can never reconcile that - it looks like a check hasn't cleared," she said.
Ms. Francis said that at National City, "literally thousands of [business] items a day come in that are converted." Though that is a small percentage of the Cleveland company's check processing volume, thousands of customers are affected, she said. And with ARC volume growing significantly (Nacha has said next year's total could exceed 1.25 billion), the problem is going to get worse, she said. This is "the writing on the wall." Soon "hundreds of thousands" of customers will be affected.
Her team has polled all of the top 15 banks, and all of them reported similar problems, she said.
Art Hilgert, a vice president at Wachovia Corp., said its lockbox operation identifies business checks by their auxiliary on-us codes, which are stored in the magnetic ink character recognition data but are not used in consumer checks. However, "the fact of the matter is the database doesn't always catch those, and the auxiliary on-us isn't always on a corporate check, so they do slip through" when the Charlotte company converts checks.
If issuing banks complain, Wachovia has to update its database by hand so checks on those accounts are not mistakenly converted a second time.
And when the Charlotte company receives mistakenly converted business checks from other banks, it returns them to the institution that originally converted the check. This forces customers to wait for the check to be re-sent in order for it to be processed properly.
On Oct. 18, National City started using a system that monitors inbound ACH transactions to spot payments that had originated as checks. By reading the account numbers and coding on these payments, the system (which Ms. Francis proposed in September 2003) discerns which ones are mistakenly converted business checks. When the customers get their statements, they see the transactions represented as checks, not as electronic debits.
Ms. Francis said the system works for all converted business checks. She also said that all of the 15 banks she had surveyed said they are interested in implementing it.
Nacha has also endorsed the idea of making check conversion compatible with business banking services.
Though the concept is not complicated, the process was difficult to engineer, because the ACH and check-processing departments are housed in different areas of National City, and "those systems don't talk to each other," she said. "We're the ones who built the silos in the first place; it's up to us to fix it."
David Bouffard, a spokesman for Sterling Jewelers Inc., one of National City's business customers, said accidental conversion was eroding the effectiveness of his Akron company's positive pay and reconciliation systems. The new system for linking ACH and check records is alleviating this problem and helping Sterling "manage our treasury needs."
Gwenn Bezard, a senior analyst for the Boston market research firm Celent Communications LLC, said that only a small portion of business checks are mistakenly converted, but the problem has hit a large number of companies.
"I would say it was definitely widespread," he said.
National City's system would never be needed in a perfect world, but "it's opening the door to more check conversion, and potentially it's opening the door to a change with Nacha," Mr. Bezard said.
Mr. Herd said that the development of National City's system has encouraged Nacha to revisit its guidelines next year and consider letting business checks be converted into ACH transactions.
Ms. Feinberg said businesses that have been unwilling to let their checks go through the ARC process might reconsider when they see the new system.
"What National City is doing is a huge step forward," she said.
Ms. Francis said that whether or not Nacha permits ARC for business checks, banks need to develop a way to spot accidental conversions, because "rule or no rule, it's going to happen."
