New Scrutiny for Remote Checks
he Federal Reserve Board issued a new rule that defines bank liabilities associated with remotely created checks (also known as remote drafts). The rules have been adopted as amendments to the two primary Fed regulations covering checks: Regulation CC and Regulation J.
Telemarketers and collection agents commonly use remote drafts, also known as pre-authorized drafts or paper drafts. Some Internet merchants, trying to avoid card-not-present interchange, also use them. Since these drafts do not bear authorizing signatures, but rather a statement that the accountholder approved the transaction, they are prone to fraud.
Bankers and consumer watchdogs say remote draft fraud became particularly acute beginning in 2002 when NACHA and the Federal Trade Commission began taking action against fraudsters using the automated clearing house to process fraudulent e-checks. That's why the Fed ruling on what party to these transactions bears responsibility when a payment goes south (the bank depositing the draft) is crucial.
"Remotely created checks are indistinguishable from other checks unless manually inspected," a NACHA spokesman said. "Another problem is that it is a simple matter for anyone to print their own stock of remotely created checks using inexpensive, off-the-shelf hardware and software."
Here's how the remote draft process works: Telesales agents offer buyers (perhaps those who can't or won't use cards) the option to pay for purchases from their checking account. They ask customers to provide information contained on their check's MICR line and to verbally authorize the transaction. Once printed, the remote check is deposited into the banking system and cleared like any other check.
Presently, remote drafts are covered by state law as set forth under Articles 3 and 4 of the Uniform Commercial Code (UCC), as adopted by each state. Under the UCC, generally the bank that pays a remote draft drawn on a customer account is obligated to re-credit the amount if the customer says the payment was not authorized.
If a paying bank believes that an item is unauthorized, it's up to that bank to take action; it has until midnight of the day following deposit to return the payment as unauthorized to the bank that first accepted the remote check.
Recently, the UCC was amended to place the burden of ensuring the legitimacy of remotely created checks on the banks initially accepting the deposits; these banks ostensibly are in the best position to identify fraudulent items. Once an amendment to the UCC is adopted, however, it can take years for individual states to make the changes to their commercial codes. According to the Fed, fewer than half of all states have adopted the UCC revisions.
"The state-by-state approach to the adoption of remote check warranties complicates the determination of liability for remotely created checks collected across state lines because the bank that presents the check may not be subject to the same rules as the paying bank," a Fed document detailing the Reg CC and Reg J amendments stated. Nearly everyone who commented on the amendments when proposed by the Fed earlier this year urged adoption.
As adopted, the amendments make it clear that a bank presenting a remotely created check to another bank and receiving settlement or other considerations, warrants to the paying bank and to all other parties to the collection process, that the transaction was properly authorized by the accountholder. The new rule takes effect July 1, 2006.
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