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You may have noticed changes in your bank statement lately. You don’t find the canceled check for the $700 you paid the credit card company. Instead, the debits section of the statement has the cryptic entry “$700 Electronic/ACH Debit Ace Credit Card acct pymt 115.” You ask your banker about this. He yawns dismissively and says this is merely “lockbox check conversion.” Your check has been converted into a debit transaction. Although both the Federal Reserve Board and Federal Trade Commission approve, check conversion is a bad idea. It is a deceptive practice that spawns confusion and makes life more difficult for consumers, particularly for those who have trouble enough coping in a digital world. Check conversion is a recent phenomenon, but its origins are in the Electronic Fund Transfer Act of 1978 (EFTA), 15 U.S.C. §1693. That law provides “a basic framework establishing the rights, liabilities, and responsibilities of participants in electronic fund transfer systems.” The Fed oversees the banking aspects of the law through its Regulation E, 12 C.F.R. §205.01, while the FTC has certain other responsibilities. The EFTA was not supposed to apply to checks. It says, “The term ‘electronic fund transfer’ means any transfer of funds, other than a transaction originated by check, draft, or similar paper instrument, which is initiated through an electronic terminal.” 15 U.S.C. §1693a. Congress’ intent seemed clear. There was to be a bright line between the old world of paper checks and the new world of electronic fund transfers. The two worlds would operate under different rules. Paper checks would be governed by Article 4 of the Uniform Commercial Code (UCC) while electronic fund transfers would fall under the EFTA. Consumers would have the choice of deciding whether they wanted to stay with paper checks or move to new electronic fund transfers such as debit cards. Of course, some well-equipped consumers may carry the full arsenal of modern payment systems: cash, paper checks, credit cards, debit cards, and ATM cards. In recent years, though, pressure developed to blur the bright line that Congress drew and force consumers to use electronic fund transfers. The problem stemmed from a few pesky consumers who refused to carry plastic and wanted to pay for purchases with cash or paper checks. Merchants liked the cash, but not the paper checks. Checks bounce. Credit and debit cards are much better as far as merchants are concerned. Thus was born the idea of having an electronic reader that could use the coding of a paper check to launch an electronic fund transfer, just like a debit card. This was called point-of-sale, or POS, check conversion. Like a plastic debit card transaction, POS check conversion tells the merchant if there is enough money in the consumer’s account. By 2000, the idea of check conversion had worked its way up to the Fed. Conversion faced a legal problem though: the EFTA seemed to prohibit it. Still, the Fed proposed to change its interpretation of Regulation E in order to permit check conversion. The change that was initially proposed was a minor one. The Fed planned to approve check conversion only in the limited POS situation. If a customer wanted to pay by check, the merchant could run the check through a reader, then either return or destroy the check, and give the consumer a paper receipt for the transaction. Arguably, this didn’t run afoul of the EFTA because the consumer had not intended to originate a check transaction — although that is obviously what he had in mind. Arguably, the consumer consented to the electronic fund transfer when he gave the merchant his check. Yet in the course of the proceeding, the Fed began to look beyond POS check conversion and to consider applying Regulation E to all consumer payments by check, even those where the consumer paid a bill by mail and where the consumer’s consent was constructive rather than actual. The term lockbox is used for check conversion in these circumstances, apparently to connote that the transaction is somehow secure. In the final ruling, the Fed’s director of consumer and community affairs, acting under delegated authority, approved several forms of check conversion, including lockbox. 66 Federal Register 15,187 (March 16, 2001). Thus, the Fed ruled that if a consumer has received a notice that his check will be converted, then the mere act of writing a check to pay a bill is deemed consent to an electronic fund transfer. The ruling sidestepped the EFTA’s prohibition against check conversion by reasoning that the prohibition does not apply if the consumer constructively consents. Because it has taken time for the electronic fund transfer industry to gear up, businesses have only recently started to use lockbox check conversion. They send out notices to customers in special mailings or include them on bill statements. This one is typical: When you pay by check, we will present the check for payment by your bank electronically. Your bank account will be debited in the amount of the check and the transaction will appear on your bank statement. Your original check will be destroyed once processed, and you will not receive your cancelled check back. For additional information, please call. The benefits of lockbox check conversion to merchants and banks are obvious. An electronic transfer gets the money into the merchant’s account — and out of your account — faster than the paper check clearance process does. The merchant knows instantly if the check is good. And both merchants and banks save the considerable expenses associated with the process of physically moving paper checks through the clearance system. The consumer benefits not at all. A few consumer groups argue otherwise. They say that poor or unsophisticated consumers, who have no leverage with their banks, are better protected by the EFTA in the case of unauthorized electronic transfers than they are by the UCC for forged and altered checks. They point out that the EFTA requires a bank to investigate an unauthorized transfer within 10 business days of being requested to do so by its customer. This helps consumers who don’t know their substantive legal rights and can’t afford an attorney. The consumer groups say that while the consumer is not liable for a forged or altered check either, the UCC doesn’t give him the legal right to demand that his bank investigate his claim. Of course, by this logic, checks should simply be eliminated and replaced by debit cards. In fact, check conversion is a bad deal for consumers. The lockbox variation makes it hard for the consumer to prove forgery, alteration, or mistake. This is so because once the payee, e.g., the credit card company, gets your check, it swipes the check through a reader and then destroys it. The possibility that check conversions will result in unauthorized transactions is not a minor concern. Professor Mark Budnitz of Georgia State University Law School and a specialist in consumer banking law says that the industry itself worries that a single check will be processed multiple times either intentionally or by mistake. FROM BAD TO WORSE To make matters worse, the Fed ruling does not require the merchant to keep an image copy of the check nor does it give the consumer a right to get an image copy. In fact, the details of electronic fund transfers are governed not by Fed regulations at all but rather by rules established by a banking industry organization called the National Automated Clearing House Association. At the moment, NACHA rules provide that merchants should retain an image copy of the converted check for two years. However, the rules may be changed, and they do not in any event give the consumer a legal right to obtain a copy of the check from the merchant. Without an image copy, the consumer will have a difficult time proving something is amiss. One example illustrates the problems consumers will face without canceled checks. Suppose your bill from the credit card company is $700. It includes a $200 charge for defective merchandise, but you don’t want to pay that charge. Therefore, you write a check to the credit card company for only $500 and inform it by telephone that you are in a dispute with the merchant about the remaining $200. You have a legal right to do this. However, when your next bank statement arrives, you see a debit of $700 to the credit card company. (Since there is no canceled check for the transaction, you may not readily notice the error and you have only 60 days from the mailing of the statement to ask the bank to investigate the unauthorized transaction.) You are outraged. Someone has either altered your check or has otherwise made an unauthorized transaction, but your best proof, the check itself, has been destroyed. The credit card company may have an image copy, but that company presumably is the one at fault. Neither you nor your bank has a copy. You can ask your bank to investigate in the hopes that it can straighten the matter out. However, you would be in a far stronger position if you had the canceled check. Check conversion hurts consumers in instances besides forgery. Consumers rely on canceled checks as an easy way to prove payment. However, if a check has been converted, the consumer’s only proof is her bank statement with the date of payment, check number, payee, and amount. That bank statement will not show the date the check was written, the name of the person who signed or in what capacity he signed, any notations in the memo field of the check, nor indeed any other markings on the front or back of the check. Moreover, without a canceled check, the consumer faces the embarrassment and invasion of privacy of having to use her bank statement as proof of payment. To prove that she paid one item, she must hand over her entire statement. Her bank statement will show the deposits she made and the numbers, dates, and amounts for all the checks she wrote. It will have the beginning and ending balance and any overdrafts. For debit transactions, the statement will also show the name of the payee. Thus, just to prove she paid a bill, the consumer will have to disclose personal and financial information to strangers — indeed to strangers with whom she may be in a dispute. And, even though an image copy of the check may exist, the consumer has no legal right to it. The Fed made this radical change in check law and procedure, and the FTC acquiesced, with little, if any, consumer input. Although the Fed received 120 comments in its proceeding on check conversion, it apparently did not receive any comments from consumers. Neither of the two consumer groups that usually appear in Board proceedings, the National Consumer Law Center and Consumers Union, filed. WHAT THE EFTA SAYS Perhaps this explains why the Fed’s ruling is so anti-consumer. It adopted a scheme of constructive consent that runs counter to the consumer’s actual intent. Consumers know the difference between a check and a debit card. The presumption should be that consumers who pay by check intend a check transaction, not an electronic fund transfer. This is what the EFTA says. Under the circumstances, there is no reason to give legal effect to a notice appearing on the back of a billing statement that the consumer won’t read. As professor Budnitz laments, “The consumer is meaningfully consenting to less and less.” Indeed, under the Fed’s reasoning, the mere act of payment would bind consumers to whatever terms a merchant chooses to put on the bill. That is an absurd result. The EFTA itself rejects constructive consent in a related context. It permits merchants to launch electronic fund transfers for recurring transactions, such as monthly mortgage payments, but requires the merchant to obtain the consumer’s signed written consent. This requirement for written consent to recurring electronic transfers leads to the strange result that the consumers are receiving two, different, contradictory notices in billing statements. The first, quoted earlier, informs them that payment by check will become an electronic fund transfer. The second tells consumers about recurring payments. The billing statement, quoted earlier, also says this: REFT (Recurring Electronic Fund Transfer) To enroll: sign below, check the REFT box on the reverse side and remit with this month’s payment. Keep paying your bill until your statement indicates “Do Not Pay.” REFT Agreement: I authorize my financial institution to deduct the amount of my monthly wireless phone bill from the account associated with the enclosed check and remit payment to . . . . A consumer reading this second paragraph might fairly conclude that if he pays by check and does not sign the REFT agreement, he has not agreed to an electronic fund transfer. But the consumer would be wrong because the first paragraph said that payment by check would be converted to an electronic funds transfer. It is truly a Catch-22. The Fed ruling did not address such potential problems. It made no mention of the impact on the consumer. And the FTC has said nothing about constructive consent and these incomprehensible notices. Check conversion is meeting consumer resistance, though. In March 2004, the banking industry group NACHA announced that by June 2004, merchants will have to give consumers the right to opt out of check conversion. The press release minimized the significance of this ruling, saying that a survey showed 93 percent of merchants already did this and yet only 1 percent of consumers opted out. Still, this self-help mechanism is important. You can call merchants and opt out. Indeed, check conversion might fail if a significant percentage of consumers opted out. Nonetheless, the NACHA ruling underscores two of the faults of check conversion. First, neither the Fed nor the FTC acted to protect the consumer in these matters. Second, even though the NACHA gave the consumer the right to avoid check conversion, it chose an opt-out mechanism rather than one whereby the consumer would have to opt in. Opt-in procedures are widely recognized as more consumer-friendly, and it is not surprising that NACHA’s survey showed only 1 percent of consumers were opting out. The billing statement quoted above illustrates the difference between opt in and opt out. If the consumer wants to make recurring payments by electronic fund transfer, he must op in, but if he pays by check, he must opt out. Regrettably, the current rules for check conversion are anti-consumer. Few consumers are sophisticated enough to know they can opt out and have the time to do that. Many, especially the poor, the unsophisticated, and the elderly, do not understand modern payment systems and how to protect themselves. Most count on their bankers, the Fed, and the FTC to protect their interests in such matters. In this instance, however, all three institutions have failed to do that. D.C. lawyer James H. Johnston is a frequent contributor to Legal Times. He may be contacted at [email protected].

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