Group Asks Government To Protect Cardholders

The Consumers Union, the nonprofit publisher of Consumer Reports magazine, sent a letter to the Federal Trade Commission dated Sept. 11 asking it to protect consumers when gift card companies go bankrupt.
 In the letter, the Consumers Union asks the commission to require companies that sell gift cards to set the funds paid by consumers for the cards aside in a trust fund so consumers can get their funds back if the companies go out of business.
 It also asks the commission to require third-party distributors to stop selling gift cards for companies that file for bankruptcy.
 Currently, consumers who hold gift cards from companies that go bankrupt must try to recover their funds through court action like any other creditor, Michelle Jun, staff attorney for Consumers Union, tells Prepaid Trends.
 To protect consumers, the commission should require companies that sell gift cards to set aside funds to  back their face value, Jun says. "This money would be set aside and held in trust specifically for consumers," Jun says of funds used to pay for gift cards. "We hope the FTC will act before this holiday season."
 The commission does not comment on communications it receives, Frank Dorman, a commission spokesperson tells Prepaid Trends.
 The bankruptcy of Sharper Image Corp. has shown that a company's financial collapse can leave gift cardholders with worthless cards.
The San Francisco-based company filed for bankruptcy protection in February and shortly thereafter stopped accepting its gift cards. The company began accepting them again if consumers spent more than twice the value of the card in the store but rescinded that offer after the chain's purchase in May by a joint-venture group that included Gordon Brothers Retail Partners LLC, GB Brand LLC, Hilco Merchant Resources LLC and Hilco Consumer Capital LLC.
 The National Retail Federation had not seen the Consumers Union letter, but Craig Shearman, vice president for governmental affairs at the Washington D.C.-based retailers' trade group, says merchants, even those facing bankruptcy, want to honor gift cards.
"Retailers certainly do want to honor their gift cards for the sake of customer relations because they hope to come out of bankruptcy at some point, and they still want to have those people as customers," Shearman says.
 Retailers even have tried to use worthless cards from bankrupt stores to bring in new customers. For example, in March, Los Angeles-based PurePro LLC, a manufacturer of air purifiers, said in a press release it would give consumers a $50 credit toward the purchase of a PurePro professional air purifier in exchange for a Sharper Image gift card.
Retailer Brookstone Inc., which is based in Merrimack, N.H., announced Feb. 27 it would give consumers who bring in a Sharper Image gift card a 25% discount on their total purchase. Logan's Roadhouse Inc., which is based in Nashville, Tenn., announced Aug. 6 it would give customers a free entrée with the purchase of another entrée when they bring in unused gift cards from now-defunct Benningan's and Steak & Ale restaurants.
 But even though the Consumers Union proposal sounds reasonable, bankruptcy law might make it difficult to accomplish, Shearman says. Bankruptcy law treats gift cardholders the same as any other creditor, so they need to make their claims like anyone else, Shearman says.
 Consumers have been aware of problems with gift cards after bankruptcies because of the attention the issue has received in the past year, Shearman says, adding that they know to spend gift cards quickly.
 Whatever their habits regarding spending the value loaded onto gift cards, the cards remain popular. Based in Needham, Mass., Tower Group Inc. estimates the gift card market will reach $94 billion this year. 
 Brian Riley, TowerGroup senior analyst, tells Prepaid Trends an escrow account for gift card funds would offer consumers the best protection.  Although Riley takes no position on what the Federal Trade Commission should do, gift cards sold by bankrupt retailers raise a number of questions, he says.
 Consumers have the right to expect the full value of the gift cards they buy, Riley says, noting the cards will lose their appeal if consumers view them as risky. "When the consumer has to carry the risk of the business, that was never the spirit of the original transaction. That's where it gets cumbersome," Riley says.
 An added problem is that most people do not buy gift cards for themselves, Riley says. "It is not like you are getting burned yourself," he says. "You are giving it to somebody and, ultimately, they lose the value."
 The Consumers Union also sent a letter last month to the Federal Deposit Insurance Corp. asking the agency to create clear rules to govern deposit insurance for funds loaded onto prepaid cards. "We want to make sure that they are backed by the FDIC in the event of a bank failure," Jun says.
 She says the FDIC has left the question of insurance for cardholder funds unanswered. "It should be that all these prepaid cards are backed by the FDIC," Jun says. If an issuing bank fails, consumers could lose funds loaded onto payroll cards, general-purpose cards, tax-refund cards, flexible-spending cards and bank-issued gift cards, the Consumers Union says in its letter.
 Christopher Hencke, counsel in the legal division at the FDIC, says insurance coverage extends to individual accountholders if the records at a bank or company allow the FDIC to trace particular amounts to particular employees, such as with payroll cards, for example.
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.
 "If they don't satisfy our record-keeping, we're going to treat the named accountholder, the company, as the depositor, with the $100,000 limit applied to that company," Hencke says.