No matter which one consumers use, changes to Reg E and other federal and state developments make payroll cards, gift cards, and check conversion a developing compliance challenge

After a long quiet period, the Federal Reserve Board has been busy this year making changes to Regulation E, the regulation that implements the Electronic Funds Transfer Act. This is only natural; the marketplace has been busy innovating lately. This has attracted not only the scrutiny of the Fed, but also the Comptroller’s Office and state legislatures.

Some of the changes impact the relatively new EFT functionality—Electronic Check Conversion (ECK). With an ECK, the paper check that the consumer writes to pay for goods and services at a merchant is converted by the merchant into a one-time electronic funds transfer. The paper check is returned to the consumer right away and an EFT transaction appears on the consumer’s next monthly account statement.

Under the regulatory revisions, merchants and others who accept ECKs will have to obtain a consumer’s authorization for each such transaction after providing the consumer with a notice that the transaction will be processed as an EFT instead of a normal paper check. The consumer must be alerted to the fact that with an ECK, the amount of the transaction may be debited from the consumer’s account much more quickly than with a paper check. The consumer’s continuance of the transaction is considered authorization for the transaction, assuming adequate notice has been given to the consumer.

 

When a merchant/payee also has a returned “check” fee that would be electronically debited from a consumer’s account, the amendments also require a notice to the consumer at the time of the transaction.

 

Additional changes to the regulation that impact financial institutions cover:

Investigation of an EFT dispute: The Federal Reserve says it’s not enough when conducting an investigation of an alleged EFT error for the bank to just review the payment instructions for that EFT. The institution must also review any additional information in the institution’s records to determine if an error did or did not occur.

 

Issuance of additional access devices at renewal: The Federal Reserve clarified that an institution may replace or substitute one access device with multiple access devices, only if the additional access devices are handled as an unsolicited access device. They must not be pre-validated and must be accompanied by the normal disclosures. 

Preauthorized EFTs: The Fed has added some clarifications regarding the handling of preauthorized EFTs, including handling the consumer’s authorization, stopping payments, and giving notice of varying amounts. 

ATM fee disclosure: The Fed has made it possible for an ATM operator to disclose at the ATM that a fee may be imposed rather than will be imposed, if there are circumstances under which the fee may not be charged.

A payroll card is typically a stored-value card that contains the value of a person’s salary or wages. Payroll cards can be used at ATMs and, often, at merchant locations. Paying an employee through a payroll card is less expensive than issuing a paper check; a paper check costs an employer between $1 and $2, with the additional cost of between $8 to $10 to replace a lost or stolen paper check, according to figures from the Comptroller’s Office. The cost of direct deposit is much lower (about 20 cents), but some employees do not have bank accounts, making direct deposit unavailable. With a payroll card, an employer can pay wages to an employee at less cost than a paper check and with greater safety than cash.

 

The Fed published the final rule, with some changes, placing payroll cards under Regulation E on Aug. 30, 2006. Payroll cards come under Regulation E coverage through the expanded definition of account. Regulation E now defines account to include:

 

“A payroll card account, which is an account that is directly or indirectly established through an employer and to which electronic fund transfers of the consumer’s wages, salary or other employee compensation are made on a recurring basis.”

 

Whether or not the funds are held in individual employee accounts or in a pooled employer account with subaccount tracking, is irrelevant for Regulation E coverage. Also, whether or not the card can be used only at ATMs to make withdrawals or at both ATMs and at merchants, like a debit card, is not a factor in the coverage. The new definition is not intended to cover nonrecurring payments such as travel expense reimbursement or annual bonus payments.

 

Payroll card specifics
Amendments to Regulation E and the Commentary make some adjustments in the normal disclosure, consumer liability, error resolution, and periodic statement provisions for payroll card accounts.

 

Periodic Statements for Payroll Card Accounts
Since most employees who are paid via a payroll card do not have bank accounts, the Regulation E requirement to provide monthly periodic statements had to be modified. Financial institutions have an alternative to providing the statement; they can choose to provide access to the consumer’s account balance through a readily available telephone number, along with the availability of a 60-day electronic history of the consumer’s account transactions (in a form the consumer can keep, such as a printable history accessed through an internet site).

 

In addition, a consumer has to be able to obtain a 60-day written history from the financial institution upon request. The 60-day account history that is available electronically or upon request would contain the same information as required for a periodic statement for other types of EFTs.

 

Consumer Liability for Payroll Card Accounts
The consumer’s liability for unauthorized use of a payroll card is similar to that of other EFTs under Regulation E. If a consumer notifies the institution within two business days of learning that a payroll card has been lost or stolen or used by someone who’s not authorized, the consumer’s liability is limited to the greater of $50 or the amount of the unauthorized use.

 

With a payroll card, however, the third tier of liability is triggered when the consumer either accesses the electronic account history or the date the institution sent the consumer a written account history, whichever is earlier. If the payroll card is a branded Visa or MasterCard, the consumer’s liability may be subject to different rules, although not greater than allowed under Regulation E.

 

Error Resolution for Payroll Card Accounts
Payroll card accounts are subject to error resolution procedures under Reg E, with some modifications. Instead of imposing a deadline for error notices from consumers that begins from the date the institution sends a periodic statement showing the alleged error, the 60-day period begins to run from either the date the consumer electronically accessed the account history showing the alleged error or the date the institution sent the relevant written account history at the consumer’s request. If an institution chooses, in place of the 60-day time frame, it can use a 120-day deadline that starts counting from the date the transfer that is being disputed was credited or debited to the account.

 

Disclosures for Payroll Card Accounts
Regulation E initial disclosures are required for payroll card accounts. Naturally, since some of the processes affecting payroll card accounts are modified the corresponding disclosures that are provided to consumers at the outset are also modified. The error resolution disclosure language must be modified to reflect the different timing requirements. The telephone number and the Internet web site address that the consumer can use to obtain account balance information also must be included in the initial disclosure.

 

New changes don’t answer everything
The recent amendments to Regulation E have settled many questions about payroll cards, but many more issues about them remain open for discussion.

 

State law concerns. One very big question is state law. Some states specify that employees must be paid by either paper check or direct deposit. Some state laws are silent on the subject. Eight states (Delaware, Maine, Maryland, Michigan, Minnesota, Nevada, North Dakota and Virginia) now have laws that do allow for payroll cards to be used to pay wages. More states are considering similar legislative moves. The Kansas state legislature is considering legislation that would prohibit any fees being charged to the employees for the use of payroll cards.

 

Maryland’s law requires that any fees associated with a payroll card be disclosed to the employee in at least 12-point type. Vermont has passed a law that prohibits the use of payroll cards. States may become more involved in regulating payroll cards if they see more complaints from consumers.

 

FDIC coverage. The issue of how payroll card accounts are treated for FDIC insurance coverage is still the subject of an FDIC proposed rulemaking from April 2004. As proposed, the funds in the underlying payroll card account at an insured institution are FDIC-insured and subject to FDIC assessment. The funds may be insurable to the employer or on a pass-through basis to the employees depending on the ownership agreement between the institution and the employer.

 

Money-laundering concerns. Highly important in today’s environment for any product or service a financial institution embarks upon is the consideration of the anti-money laundering risks of the activity (see the box on page 54). An institution must analyze the anti-money-laundering risks of payroll cards and how it will design controls and procedures to avoid their misuse for money laundering or terrorist financing purposes. If the account is held at the institution in the name of the employer, what kind of identifying information, if any, is needed about the individual employees who have cards? The Customer Identification Program (CIP) regulations do not address payroll cards specifically. Even if the employees are not “customers” of the institution, what do the regulators expect of an institution in the way of BSA/AML safeguards?

 

Community-related issues. The Community Reinvestment Act (CRA) may also play a role in the planning for payroll cards. Payroll cards are not credit products. However, it’s possible that payroll cards could be considered in the CRA Service Test. Payroll cards are often used to pay lower-wage employees who do not have bank accounts and who qualify as low-to-moderate income individuals. The CRA Service Test looks at the institution’s availability and effectiveness of alternative systems for delivering retail banking services in low-to-moderate income geographies and to low-to-moderate income individuals.

 

“UDAP” traps? Institutions must be ever-mindful of the unfair and deceptive acts or practices implications of any aspect of service, including payroll cards. The regulators’ scope of what might be considered an unfair or deceptive act or practice is very broad and ill defined. How they are imposed on employees, the fees that are charged, the limitations on how they can be used, etc., are all potential UDAP pitfalls. The consumer/employee must be clearly informed about all costs, uses, requirements, limitations, and obligations associated with the card.

 

What about gift cards?
Regulation E has not been expanded to include gift cards—at least not yet.

 

However, the Comptroller’s Office recently issued guidance to national banks concerning bank-issued gift cards (that typically can be used at many different merchants). Just in time for the holiday buying season, OCC Bulletin 2006-34 warns national banks that they should issue gift cards “in a manner in which both the purchasers and recipients {of gift cards} are fully informed of the terms and conditions of the product.”

 

The account-related concerns associated with payroll cards are not present with gift cards because there is no underlying account. The value of the gift card is stored in the card itself. However, the terms and conditions of the card and its usage do have to be carefully communicated to both the purchaser and the end user, or “giftee.” A growing number of banks, including community banks, issue these cards. Disclosures that they should make sure are contained right on the card include:

 

Any expiration date.
Amount of any monthly maintenance, usage, dormancy, or other fee.
How to obtain additional information about the card, such as a telephone number or website address.
 

Additional disclosures should come with the card so that they can be passed on to the recipient, including:

• Name of the issuing bank.
• Any other fees not already disclosed on the card.
• Whether and how the consumer can get a replacement card for lost or stolen cards.
• Where the card can be used.
• Any authorization that is needed and circumstances in which the issuing bank may refuse to authorize a transaction.
• Reminder to the consumer that it is important to track the remaining balance on the card after each use.
• Whether the card can be used for split payment transactions.
• How to resolve problems and get balance information.
• Any revocation or change in terms provisions that apply.

 

Payroll cards, gift cards, and check conversions are all new types of electronic or stored value financial products. Guidance and legislation are beginning to catch up to innovation. Who knows what type of service they’ll think up next. So, keeping the compliance as well as the safety and soundness considerations in mind if you’re thinking about offering these or other new products is the wisest move. BJ

 

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