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The evolution of prepaid cards took another step last month when the Federal Deposit Insurance Corp. published an opinion in the Federal Register clarifying that its insurance covers individuals' funds in open-loop prepaid card accounts.
But that clarification raised a whole new set of questions about the status of reloadable cards.
In clarifying that the funds on open-loop prepaid cards are deposits insured under the Federal Deposit Insurance Act, the FDIC has raised the question of whether reloadable open-loop cards are accounts that require banks to comply with certain rules and regulations. These include the Bank Secrecy Act, USA Patriot Act know-your-customer requirements and Regulation E of the Electronic Funds Transfer Act, John L. Douglas, a partner with Atlanta-based law firm Paul, Hastings, Janofsky & Walker LLP, tells Prepaid Trends.
"It is one thing to say there is a deposit and there is insurance. That in and of itself is not all that big of deal," Douglas says. "The other issue that banks and program managers need to start worrying about really is, if you are going to create an insured-deposit relationship with a customer, what other regulatory requirements do you need to be worrying about as well? I don't know the answer."
The FDIC published it general counsel's opinion Nov. 13, saying it will provide insurance for funds held at insured depository institutions for network-branded, stored-value cards. Prepaid card managers often store the funds for those cards in pooled accounts, so each cardholder does not have a separate account.
This year, 22 banks had failed as of Nov. 21, according to the FDIC. So having FDIC insurance for prepaid card funds may boost consumer confidence in open-loop cards by alleviating fears funds will be inaccessible if the bank holding them fails, Douglas says.
"If your bank goes under, you are not out of luck," Douglas says. "In these times every little bit of assurance helps."
In the opinion, Sara A. Kelsey, FDIC general counsel, says deposit-insurance coverage would pass through to cardholders if the pooled account is identified as a custodial account and the identities of and the amounts held by individual cardholders are available either from the bank or program manager.
The opinion says the FDIC still does not insure merchants' proprietary gift cards because consumers pay the retailers for the cards, and insured financial institutions do not hold the fund accounts.
"The principles they set forth in the opinion are pretty well understood," Douglas says. "The much harder question is, what baggage comes with it?"
That baggage could include responsibilities for banks to have files on cardholders they may not previously have kept to satisfy Patriot Act know-your-customer rules or requirements that they have an anti-money laundering program in place that covers prepaid cards, Douglas says.
The FDIC opinion came almost two months after the Consumers Union, the nonprofit publisher of Consumers Reports magazine, and several other consumer-advocacy groups sent the FDIC a letter asking it to clarify deposit-insurance coverage for prepaid cards.
The advocates wanted the FDIC to clearly say FDIC insurance would cover open-loop prepaid cardholders in the event of a bank failure. In their letter, dated Aug. 25, the groups said clarifying the coverage for prepaid card funds was necessary to increase public confidence and because many consumers and their families tie their wages and other funds to some of these cards, such as payroll cards.
The opinion does the job of making it clear that the funds for prepaid cards are backed by FDIC insurance, says Michelle Jun, a staff attorney for Consumers Union.
"It is covering folks who rely upon these prepaid cards like anybody would for a bank account: maintaining their payroll, their benefits, their savings, etc.," Jun says.
In September, Christopher Hencke, counsel in the legal division at the FDIC, told Prepaid Trends insurance coverage extends to individual account holders if the records at a bank or company allow the FDIC to trace particular amounts to particular employees, such as with payroll cards (Prepaid Trends, 9/23).
The FDIC can insure funds for cardholders in an account that pools funds for a number of cardholders if the account records show the cardholders as being owners of the funds in the account, Hencke says. However if those records aren't available then the manager of the account would be insured to the standard limits.
"If they don't satisfy our record-keeping, we're going to treat the named account holder, the company, as the depositor, with the $100,000 insurance limit applied to that company," he says.
The rules Hencke describes are the same as those laid out in the general counsel opinion.
Issuers and program managers should set up their record keeping to comply with the FDIC conditions to make sure that all cardholders are covered by deposit insurance, Jun says.
Those cards would be more attractive to consumers than cards where FDIC insurance is uncertain, she says.
"It would be to the benefit of issuers to hop on the bandwagon and make sure these products are FDIC-backed," Jun says.
Having insurance on the cards makes reloadable prepaid cards more like a general checking account. As the prepaid industry continues to evolve, problems will arise; consumers, regulators and industry members will ask questions; and new regulations will result, Douglas says.
