[Senate Hearing 108-397]
[From the U.S. Government Publishing Office]



                                                      S. Hrg. 108-397


                  THE FEDERAL RESERVE BOARD'S PROPOSAL
                          ON CHECK TRUNCATION

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING, HOUSING, AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                                   ON

   LEGISLATION TO INCREASE THE EFFICIENCY OF CHECK COLLECTION AND TO 
ELIMINATE UNNECESSARY STEPS THAT WILL HELP IMPROVE OUR FINANCIAL SYSTEM

                               __________

                             APRIL 3, 2003

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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                            WASHINGTON : 2003
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire        THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina       DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island      JON S. CORZINE, New Jersey

             Kathleen L. Casey, Staff Director and Counsel

     Steven B. Harris, Democratic Staff Director and Chief Counsel

               Peggy R. Kuhn, Senior Financial Economist

                 Patience Singleton, Democratic Counsel

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)


                            C O N T E N T S

                               ----------                              

                        THURSDAY, APRIL 3, 2003

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Bennett..............................................     2
    Senator Johnson..............................................     3
    Senator Bunning..............................................     4
    Senator Miller...............................................     4
    Senator Hagel................................................     5
    Senator Chafee...............................................     5
    Senator Sununu...............................................    15
    Senator Allard...............................................    16
        Prepared statement.......................................    41
    Senator Sarbanes.............................................    30
    Senator Carper...............................................    34
    Senator Dole.................................................    41
    Senator Schumer..............................................    41

                               WITNESSES

Roger W. Ferguson, Jr., Vice Chairman, Board of Governors of the 
  Federal Reserve System.........................................     5
    Prepared statement...........................................    42
    Response to written questions of:
        Senator Sarbanes.........................................    58
        Senator Reed.............................................    65
        Senator Schumer..........................................    65

Lindsay A. Alexander, President & CEO, National Institutes of 
  Health Federal Credit Union; on behalf of the Credit Union 
  National Association...........................................    17
    Prepared statement...........................................    46
    Response to written questions of:
        Senator Shelby...........................................    66
        Senator Reed.............................................    67

Janell Mayo Duncan, Legislative and Regulatory Counsel, Consumers 
  Union..........................................................    19
    Prepared statement...........................................    48
    Response to written question of Senator Reed.................    68

Danne L. Buchanan, Executive Vice President, Zions 
  Bancorporation; on behalf of the American Bankers Association, 
  America's Community Bankers, Consumer Bankers Association, 
  Financial Services Roundtable, and Independent Community 
  Bankers of America.............................................    21
    Prepared statement...........................................    52
    Response to written questions of:
        Senator Sarbanes.........................................    69
        Senator Reed.............................................    74
        Senator Schumer..........................................    75
        Senator Bennett..........................................    77

                                 (iii)

 
                  THE FEDERAL RESERVE BOARD'S PROPOSAL
                          ON CHECK TRUNCATION

                              ----------                              


                        THURSDAY, APRIL 3, 2003

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:05 a.m. in room SD-538 of the 
Dirksen Senate Office Building, Senator Richard C. Shelby 
(Chairman of the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The Committee will come to order.
    We have some pending nominations and if we get a quorum, 
Governor Ferguson, we will probably interrupt the proceedings 
and move to the nominations and then go back to where we are, 
so if you will be patient with us. We appreciate that you are 
here today.
    This morning the Committee meets to consider the Federal 
Reserve Board's proposal on check truncation. We are very 
pleased to have as our first witness Vice Chairman Roger W. 
Ferguson of the Federal Reserve System, who will discuss their 
proposal and its benefits in some detail.
    For our second panel today, we will welcome three 
witnesses: Ms. Lindsay Alexander, President and Chief Executive 
Officer of the NIH Federal Credit Union, representing the 
Credit Union National Association; Ms. Janell Mayo Duncan, 
Legislative and Regulatory Counsel from Consumers Union; and 
Mr. Danne L. Buchanan, Executive Vice President from the Zions 
Bancorporation, testifying on behalf of several banking trade 
associations.
    Long before credit cards and debit cards came along, the 
paper check served as a convenient and a safe means for 
consumers to make purchases and pay bills. Despite the growing 
popularity of these newer payment instruments, checks remain a 
significant part of the American payment system. The Federal 
Reserve System estimates that over 40 billion checks are 
written annually, accounting for $39.3 trillion in payments.
    I doubt that many of us have given any great thought to 
what happens when we write a check to a merchant or put one in 
the mail to pay a bill. Today's hearing provides us an 
opportunity to highlight how the existing check clearing 
process works and how little that process has changed to fully 
incorporate advances in technology. I truly believe that most 
Americans would be surprised at how dependent our system 
remains on the physical transportation of paper checks.
    Under current law, banks must physically present and return 
original checks to receive payment unless the bank has an 
agreement with another bank to do so by electronic means. Some 
banks have such agreements and have been able to take advantage 
of electronic processing using advanced imaging technology. 
However, since there are over 15,000 banks, thrifts, and credit 
unions, negotiating such agreements with each individual 
institution would be impossible. As a result, we continue to 
have billions of checks, literally tons of checks, either 
trucked or flown across the country every night. Given the 
availability of inexpensive electronic transmissions media, 
this enormous dependence on ground and air transportation 
systems makes very little sense. Truncation could be used to 
make the process less expensive over the long-term.
    The Fed's proposal would end the requirement to move paper 
by allowing banks to transfer electronic images of checks 
rather than the originals. In cases where a hard copy of a 
check was needed, a legally equivalent substitute could be 
downloaded from the electronic image and delivered to the bank. 
The end result is considerable savings in time and money 
through the elimination of an 
outdated law. We can learn from the experience of the credit 
union 
industry, which has used the truncation process for many years. 
We will hear more about that later this morning.
    I look forward to hearing the testimony of the witnesses 
today. Governor Ferguson, we are pleased to have you with us 
this morning. Modernizing the check clearing process would 
provide benefits to consumers and financial institutions and I 
believe to our economy as a whole. I intend to work with my 
colleagues on both sides of the aisle to develop legislation 
that accomplishes this task.
    Senator Bennett, do you have a statement?

             COMMENTS OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Yes, thank you, Mr. Chairman. I very much 
appreciate your holding this hearing. I will get into it more 
when we get into the second panel, but I have seen this process 
at work. I have seen the software. I have seen the product. And 
once you have seen it actually happen, you wonder, why in the 
world would anybody want to continue the present system?
    We should remind ourselves that on September 11, the entire 
airline system was shut down for security purposes. It was the 
prudent thing to do. It was the essential thing to do. We did 
not know where the attacks were coming from, and the only way 
that we could find out was to get all of the airplanes out of 
the sky and then any that were still flying, we knew were under 
control by someone other than by the FAA.
    That was the homeland security requirement. No one 
questioned it at the time and no one would question it if it 
were to be required again. But it completely brought to a halt 
all transfer of funds in the United States because there was no 
physical transfer of checks outside of individual communities. 
And the economic cost of that physical transfer was highlighted 
in that situation.
    So in the new world in which we live, where terrorists can 
interrupt economic activity with physical acts, we should have 
an electronic work-around that can resolve that and keep the 
economy going smoothly in the face of such an attack. And that 
is why, in addition to all of the economic reasons, this makes 
sense, there are security reasons why it makes sense as well.
    I thank you again for holding the hearing.
    Chairman Shelby. Senator Johnson.

                STATEMENT OF SENATOR TIM JOHNSON

    Senator Johnson. Thank you, Chairman Shelby, for holding 
today's hearing on check truncation. While we may not spend a 
lot of time thinking about how our checks get processed, it is 
clear that electronic presentment of checks is an important 
step forward in modernizing our Nation's payment system.
    In the days, as Senator Bennett has noted, following 
September 11, when planes across the country remain grounded, 
banks were forced to take drastic steps to ensure the shipment 
of checks from bank to bank. Check payments across the country 
were delayed, which opened up possibilities for processing 
errors and fraud.
    Electronic payments, on the other hand, continued to be 
processed in a safe and timely fashion during that crisis. But 
even absent a crisis, processing challenges confront banks in 
my State of South Dakota every winter. Deep snowfalls and vast 
distances between small town banks and processing centers add 
significant costs to physical transportation of checks. These 
costs trickle down to consumers and everyone ends up paying the 
price of our outdated system.
    Last year, I introduced a Check Truncation Act, together 
with my colleagues, Senator Carper and Senator Miller. Our bill 
would improve America's check payment system by allowing banks 
to exchange checks electronically. Current law requires banks 
to physically present and return original checks, a tedious, 
antiquated, and expensive process. Our bill would also reduce 
infrastructure costs for banks, allowing for more flexibility 
and great cost savings for the consumer.
    Our bill would not, however, prevent banks from returning 
checks to consumers who still like getting their physical 
checks 
returned. Banks would continue to have the discretion to 
provide 
returned check services. The only difference would be that some 
of those checks might be legal substitutes rather than the 
original payment instrument, and this is an example of that 
legal substitute [indicating].
    The Federal Reserve Board has spent a greater deal of time 
analyzing the potential benefits of check truncation. I want to 
commend Mr. Ferguson and the Fed for their exhaustive efforts 
in this area. They have put together a comprehensive working 
group that included a diversity of viewpoints, ranging from 
members of the industry to consumer representatives. Our bill 
closely mirrors their proposal. Some of the Fed's 
recommendations have evolved over time and I would urge the 
Committee to pay attention to some of these changes as we 
proceed with any legislation.
    I also wanted to note that Senator Bennett, who is now 
Chairman of our Financial Institutions Subcommittee, has spent 
a great deal of time on this issue and our staff has been 
working closely together with his on check truncation.
    I look forward to working with Senator Bennett on this and 
a number of issues that affect America's financial institutions 
and Mr. Chairman, I am pleased that you are working so quickly 
to focus the Committee's attention on the potential for check 
truncation to increase the stability and efficiency of our 
financial system.
    It is the right time to give electronic versions of checks 
the same legal validity as paper checks, so America's financial 
institutions can provide customers with faster check clearing 
and better access to liquid funds in both good times and times 
of crisis.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman. I want to thank 
you for holding this hearing, and I would like to thank all of 
our witnesses for appearing today.
    I am very familiar with check truncation. My bank in 
Kentucky has been truncating checks for a number of years. 
There have been no problems, and I think it has added a good 
service I receive by being able to have my checks cleared 
faster. At my bank, we have seen none of the problems that at 
least one of our witnesses will speak to today. Of course, not 
every bank is as well run as the bank I have in Kentucky.
    [Laughter.]
    I certainly understand the concerns of opponents of the 
Federal Reserve proposal. They are valid. But I believe that 
they are being addressed. Nobody wants consumers to be charged 
twice for a check-cashing service. We have to do what we can in 
this legislation to make sure that it does not happen. We also 
must make sure that criminals are not able to get their hands 
on the original or truncated checks and do everything we can to 
prevent fraud. I think the banks understand this. If one of 
their customers is a victim of a double charge or fraud. It is 
very likely that the consumer will vote with their feet and 
probably take their family and friends with them. In this 
highly competitive financial service environment, not very many 
banks can afford that.
    I would especially like to welcome Governor Ferguson today. 
I am probably one of the Fed's strongest critics when I think 
they have done something outside of their mandate, and I make 
no apologies for that. But if I am going to criticize the Fed 
when I believe they are wrongfully exceeding their mandate, it 
is only fair that I compliment them when I think they are doing 
a job well done. I believe the Fed should be commended for 
moving this issue forward and trying to promote the use of 
technology to clear checks faster. Clearing checks faster is 
pro-consumer.
    Once again, Mr. Chairman, I thank you for holding this 
hearing and I look forward to hearing from our witnesses.
    Chairman Shelby. Thank you.
    Senator Miller.

                COMMENTS OF SENATOR ZELL MILLLER

    Senator Miller. Thank you, Mr. Chairman, for holding 
today's hearing, and I thank all of the witnesses for being 
here.
    I have no opening statement.
    Chairman Shelby. Senator Hagel.

                COMMENTS OF SENATOR CHUCK HAGEL

    Senator Hagel. No, I do not have an opening statement, Mr. 
Chairman. Thank you.
    Chairman Shelby. Senator Chafee.

               COMMENTS OF SENATOR LINCOLN CHAFEE

    Senator Chafee. I have no opening statement. Thank you.
    Chairman Shelby. Thank you.
    Governor Ferguson, you proceed as you wish.

              STATEMENT OF ROGER W. FERGUSON, JR.
               VICE CHAIRMAN, BOARD OF GOVERNORS
                 OF THE FEDERAL RESERVE SYSTEM

    Governor Ferguson. Thank you very much, Mr. Chairman. I 
would also like to thank the Committee for inviting me to 
discuss the proposed Check Truncation Act and for holding 
hearings on this very important legislative initiative.
    The proposal that the Board forwarded to Congress in 
December 2001, is designed to remove the legal barriers to the 
use of new technology in check processing. It accomplishes this 
essentially by allowing banks to replace one piece of paper 
during the check collection or return process, the original 
check, with another piece of paper that contains exactly the 
same payment information, a substitute check. This simple 
change holds the promise of a more efficient check collection 
system.
    Today, consumers, businesses, and the Government write 
about 40 billion checks annually. And over the years, banks, 
thrifts, and credit unions, which going forward I will refer to 
collectively as banks, have applied a variety of electronic 
technologies to automate check processing, which involves 
handling and sorting checks so that they can be physically 
shipped to their destinations.
    A typical check is processed several times before it is 
eventually paid. First, it is processed by the bank in which it 
is deposited. Then it may be shipped for processing to one or 
more intermediaries. And finally, it is shipped for processing 
and payment to the bank on which it is drawn.
    While most checks are currently processed in this fashion, 
some checks are removed from the collection process and the 
payment information on the checks is captured and delivered 
electronically to the banks on which they are drawn. This 
process, which is commonly referred to as check truncation, as 
Senator Bunning has 
indicated, reduces the number of times that each check must be 
physically processed and shipped. As a result, check truncation 
is generally more efficient, more cost-effective, and less 
prone to processing errors.
    The check system's legal framework, however, has not kept 
pace with technological advances and is now constraining the 
efforts of many banks to use new electronic technologies, such 
as digital check imaging, to improve check processing 
efficiency and to provide improved services to customers.
    Today, check truncation can only occur by agreement of the 
banks involved because existing law requires the original paper 
checks to be physically presented or returned in the absence of 
an agreement to the contrary. Given the thousands of banks in 
the United States, it is not feasible for any one bank to 
obtain check truncation agreements from all other banks, or 
even a large proportion of them. Therefore, legal changes are 
needed to foster the use of new electronic technologies to 
improve check processing and to reduce the need for physical 
transportation in the check collection process.
    The proposed legislation facilitates check truncation early 
in the check collection or return process, without mandating 
that banks accept checks in electronic form. The proposed 
legislation accomplishes this by creating a new negotiable 
instrument called a ``substitute check,'' and this, as you have 
already seen, is an example of a substitute check. That is a 
check that banks could use in place of an original check.
    Under the proposed legislation, banks would be able to 
truncate original checks, process check information 
electronically, and deliver substitute checks to other banks 
and bank customers that want to continue receiving paper 
checks. As a result, banks could handle much of their check 
processing electronically without needing to obtain legal 
agreements from thousands of other banks to truncate checks.
    A substitute check would be the legal equivalent of the 
original check, and could be used by both banks and their 
customers just as if it were the original check. It would look 
like a regular check, as you have seen, would carry an image of 
the original check on the front and the back, as you can tell, 
and could be processed on existing check processing equipment.
    Under the proposed legislation, a bank could still demand 
to receive paper checks, although it would be likely to receive 
a mix of both original checks and substitute checks. Because 
substitute checks could be processed just like original checks, 
the bank would not need to invest in any new technology or 
otherwise change its current check processing operations.
    Further, bank customers that receive cancelled checks with 
their monthly statements would continue to receive cancelled 
checks. Only some would be the original checks and some would 
be substitute checks. Bank customers would be able to use the 
substitute checks in exactly the same way that they would use 
the originals.
    While allowing banks to replace one piece of paper with 
another might seem like a small change, eliminating the need to 
deliver original checks would allow banks to speed up a process 
of technological transformation in check clearing that is 
already under way. By adopting a market-based approach that 
permits each bank to decide when and how to use substitute 
checks, the proposed legislation should result in the use of 
technology to provide a more efficient and flexible check 
collection system.
    The proposed legislation would also help address the risks 
to the check collection system from its extensive reliance on 
air transportation that was highlighted immediately after the 
September 11 tragedy. One effect of air transportation being 
grounded was that the flow of checks slowed dramatically. 
During the week of the 
attacks, the Federal Reserve Bank's daily check float ballooned 

to over $47 billion, which is more than one hundred times its 
normal level.
    Had the proposed legislation been in effect at that time, 
and had the banks been using a more robust electronic 
infrastructure for check collection, banks would have been able 
to collect many more checks by transmitting electronic check 
information across the country and presenting the substitute 
checks to paying banks that desired them.
    The proposed legislation might also enable banks to provide 
new and improved services to their customers. For example, 
banks might allow some corporate customers to transmit their 
deposits electronically.
    Further, if banks begin to transmit check images from the 
point of deposit to their operation centers for processing, 
they might be able to establish branches or ATM's in more 
remote locations and provide later deposit cut-off hours for 
their customers. Later deposit cut-off times could result in 
some checks being credited one day earlier and interest 
accruing one day earlier for some checks deposited in interest-
bearing accounts.
    Because the proposed legislation will likely encourage 
greater investments in image technology, banks might also be 
able to expand their customers' access to enhanced account 
information and check images through the Internet. In addition, 
banks might be able to resolve customer inquiries more easily 
and quickly than today by accessing check images.
    Further, as the banks reduce their operating costs, the 
savings will be passed on through a combination of lower fees 
to their customers and higher returns to their shareholders. 
After all, the banking industry, as Senator Bunning has already 
noted, is quite competitive. And banks have indicated that they 
expect cost savings to be substantial.
    While there is a fairly broad consensus on the desirability 
of the underlying concepts of the proposed legislation to 
permit the use of substitute checks, the issue of customer 
protections has been the subject of much debate. Since we 
forwarded the proposed legislation to Congress in late 2001, 
the Board has had an opportunity to further reflect on the 
views that have been expressed by both consumer advocates and 
the banking industry.
    The Board originally included the expedited recredit 
provisions in an attempt to balance the interests of consumers 
and banks. Given that existing check law already protects 
customers from check processing problems, and there does not 
appear to be a pattern of problems suggesting these protections 
are inadequate, the Board has now concluded that these 
provisions are not necessary for the successful implementation 
of the proposed legislation.
    Congress, however, may arrive at a different conclusion as 
it considers the need for customer protections, and I would 
like to briefly discuss why we believe the expedited recredit 
provisions are not necessary.
    The Board's proposed legislation extended the protections 
of the existing check law, including the Uniform Commercial 
Code, or UCC, and the Federal Reserve Board's Regulation CC, to 
substitute checks as though they were original checks.
    Long-established check law protects bank customers if 
checks are improperly charged to their accounts. If a bank 
charges a customer's account for a check that is not properly 
payable, the bank could be liable to its customer not only for 
the amount of the unauthorized charge, but also for interest on 
that amount and consequential damages for the wrongful dishonor 
of any subsequently presented checks.
    While it is true that the UCC does not provide a specific 
time frame within which a bank must act, the UCC's provisions 
give the bank a significant financial incentive to resolve 
problems on a timely basis.
    Specifically, the longer a bank takes to research and 
resolve a customer's claim, the longer the bank is exposed to 
the liability for consequential damages arising from the 
wrongful dishonor of subsequently presented checks.
    These existing protections appear to have worked well for 
many decades.
    In addition to the protections provided in current check 
law, the proposed legislation requires banks to provide new 
warranties for substitute checks and to indemnify customers for 
losses resulting from the receipt of a substitute check instead 
of the original check. Specifically, banks must warrant that 
substitute checks that they handle are legally equivalent to 
the original checks and that the check will not be paid more 
than once from a customer's account.
    Banks must also indemnify customers for losses they incur 
due to the receipt of substitute checks rather than the 
original checks. And taken together, these warranties and the 
indemnity provisions provide customers with, I think, 
additional protections against losses related to the use of 
substitute checks.
    The use of substitute checks is not expected to result in 
problems different from those that are routinely addressed in 
today's environment. And existing law already encourages the 
prompt redress of consumer complaints.
    Therefore, the Board believes that the significant 
compliance burdens imposed by the expedited recredit provisions 
on banks that receive substitute checks would outweigh the 
small incremental benefits that the provisions would provide to 
consumers.
    Nonetheless, Congress may conclude that the expedited 
recredit provisions for consumers should be included in the 
legislation. In that case, we believe any expedited recredit 
provisions should be consistent with the proposed legislation's 
basic purposes and should not go beyond the provisions proposed 
by the Board. In the unlikely event that additional consumer 
protections are needed for substitute checks, the proposed 
legislation grants the Board the authority to adopt such 
protections by regulation.
    In conclusion, although an increasing number of payments 
are being made electronically, it is clear that checks will 
continue to play an important role in the Nation's payment 
systems for the foreseeable future.
    The Board believes that over the long run, the concepts 
embodied in the Check Truncation Act will spur the use of new 
technologies to improve the efficiency and the flexibility of 
the Nation's check collection system, and provide better 
services to bank customers.
    The proposed legislation accomplishes this by simply 
permitting banks to replace one piece of paper, the original 
check, with another piece of paper, the substitute check, and 
both of which contain the same payment information. Because the 
proposed legislation should result in substantial cost savings, 
it would also be desirable to begin obtaining these savings as 
quickly as possible.
    We look forward to working with the Committee as it further 
considers this legislation. I thank you gentlemen for your time 
and I would be happy to answer your questions.
    Thank you.
    Chairman Shelby. Governor Ferguson, I believe this is a 
copy of a check that the Fed has given us.
    Governor Ferguson. Yes. This is what a substitute check 
would look like. As you can see, it is very much the same size 
as a regular check and it includes notification.
    Chairman Shelby. It is very clear, the imaging on it.
    Governor Ferguson. Yes, it is quite clear. The technology 
for imaging is good.
    Chairman Shelby. I think most of the Members have seen that 
up here. I do not know about the press.
    The use of imaging technology is an additional cost to 
banks and may be a larger consideration for smaller community 
banks. Is there any reason, Governor Ferguson, to believe that 
up-front costs could impede the small banks from moving toward 
more electronic processing?
    Governor Ferguson. No, I have no reason to believe that the 
up-front costs will impede the small banks from moving. The 
cost of the imaging equipment has come down quite dramatically. 
And there also are a number of service providers that are 
willing to provide that kind of service to small banks. So, I 
think there is no competitive disadvantage that could emerge 
from this legislation.
    Chairman Shelby. Wouldn't electronic processing be 
particularly attractive to banks which are more remotely 
located and are thus, sensitive to transportation disruptions 
or paper checks?
    Governor Ferguson. Absolutely. It would be both beneficial 
to the banks and as Senator Johnson has indicated, potentially 
beneficial to those customers, as well as time speeds up.
    Chairman Shelby. Rural areas?
    Governor Ferguson. Rural areas, mountainous areas, areas 
with bad weather that impedes transportation. There are a 
number of parts of the country where this is clearly a net 
plus.
    Chairman Shelby. The Fed is required, as I understand it, 
to monitor funds available under the Expedited Funds 
Availability Act. Greater use of electronic images will likely 
mean that checks will clear through the system faster, as you 
have indicated. Assuming that truncation legislation is passed, 
would it be appropriate to phase in truncation prior to making 
decisions regarding expedited funds availability? In other 
words, how long a trial period of observation would be 
appropriate here?
    Governor Ferguson. Well, I think, as I have tried to 
suggest, that since there are some savings and benefits here, 
it is appropriate to move expeditiously, as you intend, and to 
make sure that the effective date is as near to passage as you 
think reasonable.
    I do not see a reason to phase in truncation per se. I do 
think it is appropriate to let truncation and this Act develop 
over some time and give us plenty of opportunity to see what 
does, in fact, happen with respect to presentment times and 
when that funds availability becomes sooner.
    We will be monitoring that extremely closely and will be 
prepared to act under the Expedited Funds Availability Act as 
soon as the facts do become clear.
    So, I think that there would be nothing that we would do 
that would slow down the benefits at all. We would be quite 
aware of the question that you just raised and our need under 
the Act to track very closely when funds become available to 
make sure that the regulations reflect reality.
    Chairman Shelby. You went into this earlier, the truncation 
at the point of sale.
    Some merchants have implemented programs to truncate checks 
at the point of sale in stores already. In some of these cases, 
the consumer actually gets to keep a copy of the cancelled 
check. This type of system also has some appeal as it permits 
customers to continue to use checks that they are familiar with 
while also eliminating transportation of paper checks. Has the 
Fed been involved in these types of initiatives?
    Governor Ferguson. We have been watching them and 
monitoring them closely. We spend a great deal of time--I 
personally, and the staff even more so--talking to the 
institutions that have been doing this, including some of the 
larger retailers.
    Many of the benefits that you observed have come forward. 
And what we have seen, particularly in grocery stores and 
others that have a heavy dependence on cash and checks, is that 
for many of them, this has been a real plus. It has been 
important, obviously, to explain to customers that they will 
get their check back and what that implies. But there seem to 
be no major problems that have emerged as we have watched this 
closely.
    Chairman Shelby. As I understand it, these transactions are 
handled through an automated clearinghouse and are not governed 
by check law. Can you confirm that?
    Governor Ferguson. That is true. In those cases, the check 
is being used as the initiating document for electronic funds 
transfer and it is not governed by the usual check law.
    Chairman Shelby. What about the customer acceptance of 
that?
    Governor Ferguson. There appears to be no problem with 
customer acceptance. Many customers already are familiar with 
electronic deposits, electronic debits, et cetera, and they 
understand in many cases what is happening. The only thing that 
needs to be explained is that they will be getting their check 
back and that it is just being used in some cases to start an 
electronic funds transfer.
    Chairman Shelby. As we move toward greater use of 
electronic images, there will have to be some type of standard 
format or data requirements for the substitute checks. Could 
you elaborate as to what set of standards there would be and 
how detailed those standards are likely to be?
    Governor Ferguson. There is a private-sector group called 
ANSI, I believe, that is already working with respect to the 
question of standards. The standards would have to do with 
things such as the placement and size of the image on the 
substitute check. There would also have to be standards in the 
image archives themselves to make them work together, to make 
them more interconnected.
    But the good news is that there is already progress 
underway there and that there are many standards that the 
private sector is developing that are responding to the 
questions that I have just identified, such as what the 
contrast should be, for example.
    Chairman Shelby. Governor, the privacy of electronic 
checks, that has been raised. What protections govern how 
financial institutions and other processors use these images 
and the information on them?
    Governor Ferguson. Well, the check activity would be 
governed by the usual rules that cover privacy and financial 
privacy, and you are obviously well aware of what those rules 
are. There is nothing here that would in any sense change that 
one way or the other.
    I would also hasten to add that there is nothing in the 
ability to use images that creates new incentives for banks to 
change or violate privacy of their customers. So the 
preexisting privacy laws would obviously continue to apply for 
the substitute checks in images, as well as the existing 
approaches to paper checks.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Governor Ferguson, are you familiar with 
the 1996 study published by the Michigan Federal Reserve Bank's 
quarterly review?
    Governor Ferguson. I think I am, yes. You may have to 
remind me of some of the details. But go ahead.
    Senator Bennett. In that study, they said that the social 
cost of clearing a check is currently $3, and it would be $1.25 
for an electronic transfer. Do those numbers sound about right 
to you?
    Governor Ferguson. Those numbers sound about right, but let 
me be cautious.
    It has always been hard for us to get a very good fix on 
the social cost. I have seen numbers that size. I have seen 
numbers somewhat smaller, to be fair. I have seen numbers on 
the scale of $20 billion, for example. But there is a 
significant cost in the check clearing process. And as I have 
said, I believe, and based on talking to bankers, that there 
would be significant cost savings.
    I would encourage you, Senator, to talk to the second panel 
where there are some bankers to talk about their experience and 
what the cost savings may look like. It has been very hard for 
us to really get the kind of Fed quality numbers on cost 
savings, but I am quite convinced that there would be 
significant cost savings that would occur.
    Senator Bennett. I picked on that one because it is 
connected to the Fed. It is the Minneapolis Federal Reserve 
Bank.
    Governor Ferguson. Right. I realize that. And as I said, 
that study is certainly a valid one. We have had many other 
studies as well and the numbers do change somewhat.
    The reason I suggest that you talk to the banks in 
particular is that the Act deals with permission to do 
something. Part of the question of how much cost savings comes 
depends on how fully the banks use it. That is the linkage 
there.
    Senator Bennett. My own assumption--my own experience, I 
should say--says that as it becomes more widespread, the cost 
savings would become even greater.
    Governor Ferguson. I agree.
    Senator Bennett. So, you do not know the assumptions that 
are built into this as to what level of use it has. But simply 
doing the math, that is $73 billion a year, if you take the 42 
billion checks.
    Governor Ferguson. There are significant savings, 
potentially significant savings. The question of how much of 
those savings we capture and how quickly depends on business 
decisions and how quickly banks continue to go down this path.
    Senator Bennett. Now can you address or do you know of any 
studies that address the issue of the increased profits to the 
banks that come as a result of the reduced float time?
    Governor Ferguson. I have not seen any studies that address 
that specifically. I would again encourage you to talk to some 
of the bankers that are on your second panel.
    But one of the things that one has to recognize is, as I 
have indicated as an economist, and others here know, the 
banking industry is extremely competitive. And one of the 
things that I have seen in a number of advances in payment 
systems, including creation of ATM's and other things, is that 
because of the competitive nature of the industry, the cost 
savings that occur to banks are quickly transmitted in terms of 
better products and services for customers, because, indeed, 
customers get a number of mailings as you know with respect to 
bank services almost on a daily basis.
    It is also the case that we have found many of these 
advances with respect to payment systems, if they have led to 
greater profitability, have obviously then been returned to 
bank shareholders.
    So, I am not in any sense concerned about how our financial 
system works from a competitive standpoint, and insofar as 
there are cost savings. I think they will accrue to consumers 
in one form or another over time because we have a very 
competitive banking system. And that has been borne out with 
almost every advance with respect to payment systems, that, 
ultimately, the banks make the investments and the consumers 
reap the rewards in one form or the other--lower costs, better 
services.
    Senator Bennett. That is the point I was hoping the 
question would make, and I thank you for that explanation 
because it is very clear that if we can bring the costs of 
doing business down in the economy wherever, the net result is 
more economic efficiency. More economic efficiency means lower 
prices, and it ultimately means better economic activity.
    One of the challenges that we have in the Congress right 
now is that we are in a sluggish economy and we are trying to 
find ways to make it revive. And if we could do something that 
puts $73 billion a year, plus whatever additional economic 
advantage would come from the improvement of the float, into 
the economy, at least during the budget debate, we would say 
that was a good day's work, if we could find $73 billion of 
stimulus one way or the other.
    [Laughter.]
    The only other comment I would make, echoing what Senator 
Johnson has said, is there are plenty of rural people in Utah. 
And to do something that would improve services to the 
customers who live in those rural towns is something that 
clearly we need to do.
    However, we should be careful not to get carried away with 
concerns that apply theoretically that cause us to deny 
benefits that are there in reality for a lot of people who do 
not happen to live in big cities.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Johnson.
    Senator Johnson. I will waive questioning, Mr. Chairman.
    Thank you.
    Chairman Shelby. Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    I don't know whether you read Ms. Duncan's testimony or 
not.
    Governor Ferguson. I am aware of some of it. I have been 
told some of it.
    Senator Bunning. Would you like to respond or comment on 
some of her concerns? Particularly the recommendations that she 
has made on the final page.
    Governor Ferguson. I do not have the recommendations per 
se.
    Senator Bunning. Because all consumers are equally 
susceptible to harm from processing errors, the recredit 
loophole in the proposed ETA should be closed----
    Chairman Shelby. Senator Bunning, could you suspend? We 
have a quorum now where we can move----
    Senator Bunning. Absolutely.
    [Laughter.]
    Chairman Shelby. Thank you. We will now move into Executive 
Session and deal with some nominations.
    We have: Alfred Plamman, to be a Member of the National 
Consumer Cooperative Bank; Thomas Waters Grant, Noe Hinojosa, 
and William Robert Timken, all of whom were nominated to be 
Directors of the Securities Investor Protection Corporation.
    All of these nominees appeared before this Committee at a 
hearing held on March 25. So, I would ask now, is there any 
comment or debate on the nominations?
    [No response.]
    Hearing no objection, it is so ordered.
    All in favor of the nominations, say aye.
    [A chorus of ayes.]
    Chairman Shelby. Those opposed, no?
    [No response.]
    Chairman Shelby. The ayes appear to have it. And the four 
nominations will be favorably reported to the Full Senate.
    Thank you, Senator Bunning.
    Senator Bunning. Thank you.
    Chairman Shelby. Senator Bunning is recognized again.
    Senator Bunning. Mr. Ferguson, would you like to comment?
    Governor Ferguson. Yes, I would like to comment on them. I 
would also observe that, having been a nominee before this 
Committee, I am pleased to see the Committee move so 
expeditiously with nominations.
    [Laughter.]
    To a more serious point, because I take it very seriously, 
the concerns that have been raised in this testimony, 
particularly the recommendations, are ones that, frankly, I do 
not share. And it is not from any lack of concern about 
consumers whatsoever on my part. It is rather based on analysis 
of the current situation and what the likely new situation 
would be under the Check Truncation Act.
    The current situation is one in which we have a number of 
laws that emerged out of common law because people have been 
drawing drafts on banks for hundreds of years. It has been 
codified in the UCC and also in some Federal Reserve 
regulations, in which the banks, if they do, inadvertently do a 
double debit, have the legal responsibility to fix that problem 
so that the consumers are not at risk there and there are a 
number of incentives that are built in to encourage the banks, 
incent the banks, to fix any of those problems early on.
    I would also observe, as others have, that we have a system 
that has 40 billion checks or so every year. And as we have 
looked at our databases, we see very, very few problems across 
all of the regulatory agencies that deal with consumer 
complaints, that deal with the kinds of concerns that are 
raised here in terms of double debits or a calculation error or 
an error in simply transmitting the correct information. So, we 
have a system that works very well.
    All we are doing here under this proposal is creating a new 
form of paper in lieu of the old form of paper. But the same 
protections would be there and we have proposed some new 
protections in terms of a warranty and an indemnity.
    Now to the specifics. That is the background, of a system 
that works well, common law that is codified that has worked 
well, plus some new protections here to really give the right 
kind of teeth to this legislation.
    Now to go to these two comments.
    First, on the question of processing errors and the right 
of recredit to be expanded, I have said to you, while we would 
have no objection if you wanted to put in a right to recredit, 
we do not think it is necessary. We do believe that if you 
choose to put in, the right to recredit, it should not be 
expanded beyond the case in which consumers get back a 
substitute check. The reason is that if we expand it more 
broadly than that, you are going to find that we have two 
different types of legal regimes that could potentially, as you 
were indicating, come into conflict with each other.
    We would be building a system in which we are trying to 
protect against potential risks that I think are really fairly 
remote. And so, if one were to have a recredit, I would 
encourage it to be a fairly narrow and focused recredit because 
otherwise, you are opening up a case in which consumers do not 
know which rights they really have and you are creating, I 
think, more confusion than you are clarity.
    With respect to the second point here regarding the 
comparative negligence standard as an inappropriate way to 
resolve harm suffered by consumers due to processing errors, 
again, we have very, very few processing errors as far as we 
can tell. But this question of comparative negligence already 
exists in many of the common law standards for tort and 
particularly as embodied in a variety of different ways, 
sometimes using the words, comparative negligence, sometimes 
not, in the UCC. And it has withstood the test of time.
    I would argue that comparative negligence is a standard 
that is well understood in common law, well understood in 
business tort, well understood in check law, and I think that 
is appropriately maintained by the Check Truncation Act as we 
have proposed it.
    So in both cases, while I am always sympathetic to consumer 

interests as part of what I am asked to do, I think that these 
two recommendations really do not find a useful place in the 
kind of proposal that is being put forward here, and they are 
indeed presuming a greater degree of risk than we think is 
likely to occur, and are creating, if you will, a set of check 
law that is in some sense, in the case of recredit, not a 
necessary addition to a check law that we have had for many 
years that works very well and that would not be undercut--in 
fact, would be reinforced--by what we have in the proposed Act.
    Therefore, I am not supportive of these two 
recommendations.
    Senator Bunning. Thank you very much.
    Chairman Shelby. Senator Miller.
    Senator Miller. I guess following up a little bit more on 
that, Governor Ferguson, you do not have a great concern, then, 
of the possibility of the customer getting debited twice, once 
for the original check and once for the substitute check?
    Governor Ferguson. No, I do not because there are a number 
of incentives already built in that stop that from happening.
    We have, as I said, 40 billion checks a year that are 
written now and we have very little evidence of this as a major 
problem whatsoever. And partially, I think it has to do with 
the incentives that Senator Bunning talked about in the 
competitive environment.
    Banks have created a number of systems to minimize the risk 
of a double debit, and I do not think that creating an 
opportunity to use more electronics is going to increase that 
risk or change those incentives.
    Senator Miller. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sununu.

               COMMENTS OF SENATOR JOHN E. SUNUNU

    Senator Sununu. Thank you, Mr. Chairman.
    Governor Ferguson, could you be more specific? Very little 
evidence, 40 billion checks. For what percentage does the 
double debit problem exist?
    Governor Ferguson. We have gone back and looked at the 
databases of all the consumer complaints that we have had. I 
believe that we have absolutely none where I have heard 
anything of a double debit.
    [Pause.]
    And the staffers are shaking their heads in agreement. 
There may be the rare case out there, but it has not emerged 
through the complaint process.
    Senator, I am not going to be facetious at all. I get a 
large number of letters with a variety of complaints about 
things that banks do. I have gone back and looked at my files 
and the things that I have responded to. And over the 7 years 
that I have been on the Board, the 6-plus years that I have 
been on the Board, I haven't received one complaint of this 
nature.
    So, I would have thought since there is something at stake 
here, that either the formal complaint process or others would 
suggest an issue here.
    Senator Sununu. And other than the interpretation based on 
correspondence or complaints that you are receiving through 
formal channels, there is no statistical database of the 40 
billion checks and what kind of problems----
    Governor Ferguson. No. We have a statistical database for 
all complaints. There is not a statistical database of what 
happens to the 40 billion checks.
    Senator Sununu. Okay.
    Governor Ferguson. But since we are responsible for 
consumer complaints in part, we have looked across all the 
FFIEC agencies and we see nothing there.
    Senator Sununu. No evidence that consumers are reluctant to 
call you and complain?
    [Laughter.]
    Governor Ferguson. I am not encouraging more of that.
    [Laughter.]
    But, no, there is no evidence of reluctance of their part 
to let me know if things are not going well.
    Senator Sununu. You say that you do not recommend or 
advocate necessarily for a credit provision. Correct?
    Governor Ferguson. That is correct.
    Senator Sununu. Why not? And I apologize, it may have been 
at least touched on in your testimony, which I missed. But 
could you elaborate on the reason that recredit, you do not see 
it as being necessary?
    Governor Ferguson. We do not see it as being necessary 
because current check law gives the right set of incentives to 
fix any problems that might emerge. Banks have effective 
problem-solving resolution processes already for these kinds of 
problems insofar as they emerge. And we have proposed in this 
Act an additional warranty and an indemnity that gives even a 
little more strength there.
    We do not see that there is a hole in current existing law 
that needs to be filled because of this new proposed approach 
to dealing with paper checks. And so, it is just simply an 
analysis based on reflection, the passage of time, and a better 
understanding.
    Senator Sununu. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Allard.

                COMMENTS OF SENATOR WAYNE ALLARD

    Senator Allard. Thank you, Mr. Chairman. I have a couple of 
questions concerning the point of sale of the merchandise.
    Will it be possible at some point to eliminate the paper 
check at the point of sale or purchase instead of at the point 
of first deposit, further reducing the paper requirements?
    Governor Ferguson. It is quite possible that other 
institutions may decide that they want to truncate the checks 
and pass that 
information on electronically and use that to start an EFT, an 
electronic funds transfer.
    Some of that already does occur. And obviously, we have a 
large number of nonpaper-driven retail payments through the 
form of debit cards and credit cards already.
    So, indeed, we are getting assistance and becoming 
gradually more electronic and less paper-based. But when you 
start with a system that has 40 billion checks, we still have a 
very large critical mass of checks. Even though they are not 
increasing, other things are, and we will I think over time see 
fewer checks being written. But, still, when you are counting 
things in the billions, it is important to deal with that 
problem as well.
    Senator Allard. Well, when a consumer gets used to a 
certain format, they tend to like to stick with it, 
particularly as they get older. They do not like to change.
    Governor Ferguson. Right.
    Senator Allard. My understanding is the retailers generally 
support your effort on check truncation. There has been some 
that have expressed concerns with the logistics of the warranty 
provisions in the draft legislation from the standpoint that a 
retailer would like to process a check electronically from the 
point of sale.
    If the warranty to process a check electronically with 
legal protections came from individual banks, a clerk would 
have to examine each check to determine whether it was written 
on the bank providing the retailer with a warranty. Do you see 
the need for revisions or expansions in that area?
    Governor Ferguson. No, I do not. I think it is not as 
onerous a problem as perhaps some believe--we thought through 
this balance issue and are pretty comfortable with where we 
came out in the proposed legislation. I do not see any reason 
for changes there.
    Senator Allard. Thank you, Mr. Chairman. I ask unanimous 
consent that my opening remarks be made a part of the record.
    Chairman Shelby. Without objection, your statement will be 
made part of the record.
    Governor Ferguson, we appreciate your appearance here 
today. We might have some other questions for the record and we 
will 
expedite them to you.
    Governor Ferguson. Sure.
    Chairman Shelby. Our second panel will consist of: Ms. 
Lindsay Alexander. She is President and Chief Executive Officer 
of the NIH Federal Credit Union in Rockville, Maryland. She 
will be representing the Credit Union National Association. Ms. 
Janell Mayo Duncan, Legislative and Regulatory Counsel, 
Consumers Union. And Mr. Danne Buchanan, Executive Vice 
President, Zions Bancorporation, on behalf of the American 
Bankers Association, the 
Financial Services Roundtable, America's Community Bankers, 
Independent Community Bankers of America, and the Consumer 
Bankers Association.
    We welcome all of you here today. Your written statements 
will be made part of the record in their entirety and if you 
would sum up the points of what you want to touch on, it would 
be appreciated and it would give us some time to ask questions.
    Ms. Alexander, we will start with you.

               STATEMENT OF LINDSAY A. ALEXANDER
              PRESIDENT & CHIEF EXECUTIVE OFFICER
       NATIONAL INSTITUTES OF HEALTH FEDERAL CREDIT UNION
                        ON BEHALF OF THE
               CREDIT UNION NATIONAL ASSOCIATION

    Ms. Alexander. Chairman Shelby and Members of the 
Committee, thank you for the opportunity to provide comments on 
how check truncation has been working at credit unions for the 
past three decades. I am Lindsay Alexander, President and CEO 
of the National Institutes of Health Federal Credit Union in 
Rockville, Maryland. I am testifying before you today on behalf 
of the Credit Union National Association, CUNA.
    I would like to provide you with information regarding how 
check truncation works at credit unions and insight into our 
views on proposals to facilitate check truncation.
    Most credit unions that offer checking accounts truncate. 
Sixty-four percent of credit unions offer checking accounts, 
and of those credit unions, 91 percent truncate share drafts or 
checks.
    Credit unions tends to truncate checks at the last step in 
the check collection process by not distributing share drafts 
to their credit union members by not giving the checks back.
    Credit unions do not usually truncate the checks drawn on 
other financial institutions that their members deposit or use 
to make loan payments at the credit union.
    Credit unions have found that check truncation, under 
existing check law, allows credit unions to serve their members 
very well. The experience of credit unions is that our members 
rarely request or need originals from truncated share drafts or 
checks.
    We found in an informal survey in 2001, that of 1.1 billion 
checks, only about 480,000 requests, or 0.04 percent, were made 
for the original check. In almost all cases, a good quality, 
clear image of the check satisfied the member's needs.
    I would like to now describe the experience of my credit 
union.
    Like most credit unions, we do not return checks to members 
and never have. We image all the checks that we receive, both 
the checks drawn on our members' accounts and the deposited 
checks from other institutions. This imaging service reduces 
the time it takes to retrieve checks from approximately 2 to 3 
days to almost instantaneous.
    In my 14 years at NIH Federal Credit Union, we have never 
had a member that has complained about not getting an original 
check. In those cases where the member does request a copy, the 
most common reasons are because the member needs it for proof 
of payment or for an audit. At my credit union, about 90 
percent of those that request a copy need it as proof of 
payment and about 10 percent request it for audits such as IRS 
audits. In a very few, isolated cases, members need it for a 
court case or some other reason.
    The Federal Reserve initially presented to Congress a 
proposal allowing financial institutions to voluntarily decide 
to present an item totally electronically without the need for 
previously adopted agreements. The Federal Reserve proposal 
would have allowed existing truncation programs, such as those 
in credit unions, to 
co-exist, without imposing new requirements from the proposal 
on existing credit union programs.
    We strongly support that provision in the Federal Reserve 
proposal. And we strongly oppose any expansion of the scope of 
the Act that would impose requirements on check truncation 
programs that already exist and do not use a substitute check. 
Expanding the scope of this Act is unnecessary and would 
interfere with credit union check truncation programs that 
already seem to be working very well.
    We support changes that have been made to the Federal 
Reserve proposal that appear in the Check Clearing for the 21st 
Century Act, that was recently introduced by Representatives 
Hart and Ford in the House. These changes would allow the 
financial institutions to truncate all types of checks. 
Moreover, the House bill 
allows an indemnifying financial institution to produce a copy 
to 
resolve a consumer's complaint or claim when a copy is 
sufficient for that purpose.
    The experience of credit unions is that at nearly all times 
a copy is indeed sufficient, so there should not be a 
requirement to reproduce anything more than a good quality 
copy.
    We are also supportive of consumer protections in the House 
bill that mirror those of existing laws and give credit unions 
more time to investigate complaints. The recredit procedure in 
Section 6 gives the member's credit unions 10 business days to 
investigate the claim before being required to recredit the 
member and 45 calendar days in certain unique circumstances.
    The credit union's ability to investigate a consumer's 
claim prior to being required to recredit the consumer's 
account is essential for the credit union to avoid fraud losses 
from the new expedited recredit procedure.
    In conclusion, most credit unions truncate their share 
drafts or checks and have done so for decades. We remain 
supportive of the current attempts to voluntarily facilitate 
check truncation and we look forward to working with the 
Committee, the Federal Reserve, and consumers in further 
strengthening this proposal.
    I thank you for this opportunity to comment and I would be 
happy to answer any questions.
    Chairman Shelby. Ms. Duncan.

                STATEMENT OF JANELL MAYO DUNCAN
               LEGISLATIVE AND REGULATORY COUNSEL
                        CONSUMERS UNION

    Ms. Duncan. Good morning, Chairman Shelby and Members of 
the Committee. Thank you for providing me the opportunity to 
come before you today. I am Janell Mayo Duncan, Legislative and 
Regulatory Counsel at Consumers Union. And my testimony today 
on the proposed CTA is supported by the Consumer Federation of 
America, the U.S. Public Interest Research Group, and the 
National Consumer Law Center.
    We believe that in its current form the proposed CTA would 
be bad for consumers for three important reasons. First, the 
proposed legislation would eliminate the ability of an 
estimated 45 million consumers to receive their original 
cancelled paper checks each month. Second, the recredit 
provisions in the proposed CTA would not protect all consumers 
whose check information is processed electronically. Third, if 
enacted into law, the proposed comparative negligence 
provisions would give banks an unfair ability to deter, delay, 
or reduce claims for damages resulting from processes errors by 
alleging that a consumer was somehow at fault.
    Although we recognize the value of the advances in 
technology, and we recognize what they could provide to 
consumers, we are concerned that the proposed CTA would take a 
system that works relatively well and change it in a way that 
imposes new risks on consumers.
    Those risks include: The inability to get original checks 
back in order to prove payment or forgery. Potential improper 
account debits resulting from the double processing of a single 
check. Errors in reading the amount of, or account number on, a 
check.
    This proposal contains a loophole. Recredit is limited to 
consumers who receive substitute checks back from their banks. 
However, issuance of substitute checks is at the discretion of 
each back.
    Although Section 6 of the proposed legislation requires a 
bank to put $2,500 in disputed funds back into a consumer's 
account if the matter is not settled in one business day, it 
would allow consumers to seek recredit of disputed funds only 
if they receive a substitute check from their banks.
    Banks could prevent consumers from having the right to 
recredit simply by not issuing them a substitute check. We 
believe that the recredit provision should be mandatory and 
extend to all consumers, regardless of whether or not he or she 
receives a substitute check.
    Consumers unable to seek recredit would not be similarly 
and adequately protected. They would have to seek redress under 
the UCC provisions and State law that do not require a bank to 
redeposit disputed funds in consumer accounts and would require 
a consumer to sue his or her bank over disputes. This is too 
expensive and time-consuming for consumers for most amounts 
likely to be in dispute.
    Although the proposed CTA has added warranty and indemnity 
provisions, they also require a lawsuit to enforce. Because all 
consumers are equally susceptible to harm from processing 
errors, the recredit loophole in the CTA should be closed and 
the right expanded to apply in every case.
    The recredit provision is critical. Until a recent 
reversal, the 
importance of the recredit provision has been recognized by the 
Federal Reserve Board. The initial summary documents that were 
included in the transmittal letter sent in December 2001, by 
Chairman Greenspan to then-Banking Committee Chairman Sarbanes 
with the proposed CTA stated: ``The expedited recredit 
procedure is intended to mitigate the effects on consumers of 
any potential problems associated with the receipt of 
substitute checks.'' It also states: ``These expedited recredit 
provisions of the proposed Act are limited to consumers who are 
generally not in a position to negotiate with their banks the 
terms of their deposit accounts that affect the consumer's 
rights and liabilities, such as how payments are processed and 
charged to their accounts.''
    We, therefore, would strongly oppose any CTA without 
recredit for consumers.
    The proposed CTA contains comparative negligence provisions 
that would allow banks to reduce the amount of damages a 
consumer can recovery by asserting the consumer was somehow at 
fault. It is unlikely that a consumer could contribute to 
improper check processing, but this provision could unfairly 
allow a bank to deter or delay a consumer's claim by asserting 
that a consumer was partly responsible. The comparative 
negligence standard is inappropriate to resolve harm suffered 
by consumers and should be 
removed from the proposed CTA.
    I thank the Chairman and the Members of the Committee and I 
look forward to any questions that you may have.
    Chairman Shelby. Mr. Buchanan.

                 STATEMENT OF DANNE L. BUCHANAN
                    EXECUTIVE VICE PRESIDENT
                      ZIONS BANCORPORATION
                        ON BEHALF OF THE
                  AMERICAN BANKERS ASSOCIATION
                  AMERICA'S COMMUNITY BANKERS
                  CONSUMER BANKERS ASSOCIATION
             FINANCIAL SERVICES ROUNDTABLE AND THE
            INDEPENDENT COMMUNITY BANKERS OF AMERICA

    Mr. Buchanan. Good morning. My name is Danne Buchanan. I am 
the Executive Vice President of E-Business Solutions at Zions 
Bancorporation in Salt Lake City, Utah.
    I am here today representing the six major banking and 
financial services trade associations--the American Bankers 
Association, the America's Community Bankers, the Consumer 
Bankers Association, the Electronic Funds Transfer Association, 
the Financial Services Roundtable, and the Independent 
Community Bankers of America. I am pleased to present the 
associations views on the concept of check truncation as 
envisioned by the Federal Reserve Board's proposal.
    The associations believe that legislation to sanction 
substitute checks will facilitate electronic check processing 
that will produce significant cost savings, efficiencies, and 
new consumer conveniences, to the great benefit of both the 
consumers and the financial institutions.
    On behalf of the associations, I would like to extend our 
appreciation to Senator Shelby for holding this hearing. We 
also commend the staffs of the Senate Banking Committee and the 
Board, who have worked tirelessly to address the concerns of 
the banking industry, consumer groups, and others in moving 
this important concept forward.
    Check processing is a very expensive and labor-intensive 
process that requires checks to be handled, sorted, and 
physically transported to the paying bank. Because of current 
law, paper checks generally must physically move from the bank 
of first deposit to the paying bank. The primary impediment to 
elimination of this route is the fact that customers have the 
right to receive back their original paper checks. The only 
exceptions when checks do not have to be returned are unusual 
cases where the very largest banks with the largest check 
volumes have reached private agreements. Such arrangements and 
check truncation are out of reach for small institutions, 
rendering the technology largely unusable for them.
    At our bank, over the last 2 years, we have been truncating 
original items for payments and creating substitute checks. We 
have accomplished this with two-party agreements between Zion's 
Bank and its customers. I am pleased to let you know that this 
process works. We have had few customer inquiries and have 
successfully dealt with every issue or question posed by a 
paying bank.
    Keep in mind that many customers today do not receive their 
checks back with their statements. Informal industry 
assessments indicate that more than 30 percent of all checks 
drawn by bank customers, and nearly all checks drawn by credit 
union customers are not returned to the check writer.
    It is important to note that these are sufficient for 
consumers. For example, images are routinely used and accepted 
as proof of payment for tax records. Original items are rarely 
requested or needed. This fact is critical because many of the 
objections raised by consumer advocates about the broader check 
imaging envisioned under the Board's proposal exists today, but 
in fact present few, if any, problems.
    Electronic check processing has the potential to streamline 
the collection of checks, reducing processing costs, and 
minimize the 
effect of unexpected disruptions to air and ground 
transportation systems. No longer would a bank in California 
have to ship a check drawn on a New York bank across the 
country.
    Improving the check clearing process may also allow banks 
to develop new banking services. For example, image-capable 
ATM's that can forward deposits electronically will allow banks 
to deploy more ATM's in remote locations as the cost and 
frequency of physically retrieving deposits and servicing ATM's 
could be reduced. Consumers may be able to use these ATM's to 
cash payroll checks at their place of employment, which may be 
particularly attractive for those without bank accounts.
    The proposal would also serve to promote check imaging 
technology by adding another positive weight to the business 
case for adopting check imaging generally.
    For example, a more recent application of check imaging 
allows their customers to view check images online. Customers 
who do not bank online also benefit from imaging because 
customer service representatives can quickly bring up for view 
images to verify transactions for the customer. This requires a 
fraction of the time typically required to research microfilm 
or physical archives and transmit copies.
    Finally, the proposal could provide real benefits to rural 
community banks and their customers. This proposal would allow 
rural community banks to transmit electronic images of checks 
that can be used for clearing and settlement with their 
existing systems, regardless of weather, transportation 
constraints, or distances to processing centers.
    The associations support the concepts outlined in the 
Board's proposal. However, we strongly believe that the 
provisions related to expedited recrediting for consumers are 
unnecessary and will not only facilitate, but also, indeed, 
encourage fraud. We believe that existing check law provides 
appropriate and adequate protection to consumers with respect 
to substitute checks.
    The banking industry and consumers have an established 
history with truncated checks and imaged documents. Indeed, 
millions of consumers have been receiving either images or a 
notation in their statement for years, without complaint that 
disputes are not addressed satisfactorily. The current check 
law works in a truncated and image environment. There is simply 
no evidence to justify deviation from existing check law.
    Consumer representatives complain that consumers need 
protections above and beyond what is provided today because 
they will be at a disadvantage if they receive substitute 
checks rather than originals. However, the situations they cite 
have existed for many years in the truncated environment 
without adverse consequence to consumers. For example, consumer 
groups express concern that it will be up to the consumer to 
persuade a landlord or another person to accept a substitute 
check as proof of payment.
    Again, today, by the time consumers request a check, it is 
likely to have already been destroyed in a truncated 
environment, as was mentioned earlier by the credit unions. 
Moreover, under the proposal, substitute checks will bear the 
legend, ``This is a legal copy of your check. You can use it 
the same way you would the original check.'' We believe that 
this will convince landlords and others of the legal 
equivalence of the check.
    In addition, consumer groups also demand that the expedited 
recrediting provisions of the proposal extend to all truncated 
checks, including those provided today. They argue that 
consumers will be confused because the rules for dispute 
resolution for those who receive images voluntarily, as they do 
today, will be different from those who insist on substitute 
checks. The need for consistency argues for retaining current 
check law. Since existing check law has a long, proven record 
of success in the truncated environment, if a single consistent 
rule is adopted, it should be based on proven check law, not a 
new law that, arguably, will promote fraud.
    The trade associations support the general principle 
outlined in the Board's proposal to facilitate innovation in 
the check collection system. We believe, however, that existing 
law and regulations are both effective in protecting consumers 
and minimizing the banking industry's exposure to fraud.
    We hope that Members will also take this opportunity to 
improve the efficiency of the U.S. payments system by quick 
passage of this proposal.
    Thank you.
    Chairman Shelby. Ms. Alexander, you have indicated that 
most customers who do request copies need them as proof of 
payment.
    Ms. Alexander. That is correct.
    Chairman Shelby. Have your customers ever run into any 
problems using the copies for this purpose?
    Ms. Alexander. No, Mr. Chairman, not that I am aware of. 
Although I do not get the volume of complaints that Mr. 
Ferguson does, I get a lot of complaints that reach me. I have 
never had a complaint from a member that they could not get an 
original. Courts accept good images. The IRS accepts good 
images. We have never had a problem with that.
    Chairman Shelby. You have answered my question. The next 
one was the IRS audits and other reasons.
    Ms. Alexander. Yes, they do.
    Chairman Shelby. They accept the images?
    Ms. Alexander. Yes, they do.
    Chairman Shelby. Mr. Buchanan, today, among other things, 
we have discussed how some banks, which have agreements with 
other banks, already use electronic transmissions to clear 
checks. What happens to the original checks in these cases?
    Mr. Buchanan. In the current environment, the physical 
documents still follow in these environments. But then the 
checks, if the checks are not returned to the consumer, they 
are truncated and destroyed after a period of time.
    Chairman Shelby. What can you tell us about consumers' 
desires to get copies of these checks? You alluded to it 
earlier.
    Mr. Buchanan. Well, within our own bank, we still receive 
requests for copies of checks, some that the consumer may have 
even lost, for record of payment. We think that the banking 
industry has always responded efficiently to those requests and 
rarely receive problems around those issues.
    Chairman Shelby. Are you aware of any problems associated 
with consumers having to use copies of the checks rather than 
the original checks?
    Mr. Buchanan. No, sir. I am unaware of any problems with 
that.
    Chairman Shelby. Ms. Alexander, how many customer 
complaints does your credit union receive regarding their 
checks? Just your judgment.
    Ms. Alexander. Regarding copies or just checks in general?
    Chairman Shelby. Yes.
    Ms. Alexander. I have not seen one in 14 years. I have not 
had a specific----
    Chairman Shelby. In 14 years?
    Ms. Alexander. Yes. Not a specific complaint about 
receiving a check copy.
    Chairman Shelby. So, you do not have any complaints at all 
about them that you know of ?
    Ms. Alexander. I may, that have not reached me. I think 
that earlier on, when we did not image, it took longer to get a 
copy of a check and I did have some complaints about that. Now 
it is immediate.
    Chairman Shelby. Do you have any other complaints about 
checks other than just trying to get a copy?
    Ms. Alexander. I would say that, on the whole, the 
complaints about our checking-account services are very low.
    Chairman Shelby. Okay.
    Ms. Alexander. We have very good services.
    Chairman Shelby. Does the use of imaging enable you to 
resolve just basic complaints more quickly than a paper-based 
system?
    Ms. Alexander. Absolutely.
    Chairman Shelby. It is quicker, is it not?
    Ms. Alexander. Absolutely. Very quick.
    Chairman Shelby. Ms. Duncan, you have testified that the 
right of recredit should be expanded to apply in every case 
where the original check is not returned to the customer. This 
would affect even those customers who have already agreed with 
their bank to not receive paper checks back. What information, 
what data can you provide us here at the Committee regarding 
consumer complaints involving their checks?
    For the record. In other words, I will ask it again. What 
information can you provide to the Banking Committee here 
regarding consumer complaints involving their checks?
    Ms. Duncan. Well, I think quite a bit of your focus already 
has been on image quality. And certainly, consumers do not have 
problems when they receive checks, as long as the image quality 
is good. If they need proof of payment, if the image quality is 
good, oftentimes----
    Chairman Shelby. Have you seen this, that the Fed gave us 
just awhile ago [indicating] ?
    Ms. Duncan. I have not yet seen that.
    Chairman Shelby. I do not know what the other image is. 
This is real clear, and I guess it depends on----
    Ms. Duncan. What we are concerned about is those case where 
a check image is not clear. Actually, I have a copy of a letter 
here that I was cc:ed on, that was sent to the Chairman and to 
Senator Sarbanes yesterday. It is from a lawyer in San 
Francisco who represents low-income clients who experienced a 
great deal of harm and stress based on the fact that the best 
copy they could get of a mortgage payment they claimed to have 
made was a microfiche and was unreadable.
    Basically, just in summary, they paid their mortgage. Their 
bank destroyed the original check, as was the practice. They 
told the mortgage company that they had paid it, got a copy of 
the microfiche, presented it to the mortgage company. The 
mortgage company said that this was not acceptable because it 
was not legible. Then the mortgage company turned the case over 
to a collection company and foreclosure proceedings were 
initiated.
    We are concerned that this may be the tip of the iceberg. 
This is just a microfiche copy and the way that it is done now. 
The system that we are talking about would have images 
converted in and out of electronic form. So, yes, that is one 
of our concerns.
    Chairman Shelby. I would agree with you that the imaging 
should be legible. You should be able to read it. But there has 
been tremendous breakthroughs in imagery technology. The 
digitization of images would replace what you are talking 
about, the microfiche, and would be much better, I believe.
    I am just looking at what the Fed gave us up here.
    Ms. Duncan. We welcome improvements in technology.
    Chairman Shelby. You are right in this regard. The 
technology, the imaging has to be clear.
    Ms. Duncan. Yes.
    Chairman Shelby. You have to be able to read it. Otherwise, 
I do not guess you can have proof of anything.
    Ms. Duncan. Right.
    Chairman Shelby. But if you have some other information 
regarding, other than this one instance, furnish it to the 
Committee. Will you do that?
    Ms. Duncan. We will furnish any additional information that 
we receive.
    Chairman Shelby. Do you know how common these complaints 
are? I guess that is what----
    Ms. Duncan. Our main concern here is there is a consumer 
protection provision within the proposed legislation, and it 
anticipates certain events.
    We just think that if you were going to anticipate 
consumers having a double processing--and it is more likely 
when you have an electronic image and a substitute check going 
through the system, it is more likely than you would have today 
with just a paper check going through the system. We would just 
like to see it applied to all.
    Chairman Shelby. But you cannot hold back technology.
    Ms. Duncan. And that is not what we are suggesting.
    Chairman Shelby. I know. Okay.
    Ms. Duncan. We are just suggesting that consumers receive 
adequate protection.
    Chairman Shelby. Sure.
    Ms. Duncan. Somewhat similar to the Regulation E that 
governs debit card transactions and electronic transactions 
today.
    Chairman Shelby. Sure.
    Mr. Buchanan, are you aware of consumers having difficulty 
getting access to their checks, digital images of checks?
    Mr. Buchanan. No. In fact, if I could comment about the 
earlier message around microfilm.
    I think that what we are talking about here is looking at 
an old medium and we can actually improve upon that. I think 
things like microfilm and microfiche potentially have more 
problems than what the imagining technology is.
    Chairman Shelby. But these are dated technologies.
    Mr. Buchanan. Exactly. We think that this is a dramatic 
improvement and that the quality of those images in terms of 
storage and retrieval would be far better. We are unaware of 
any issues or problems around that.
    Chairman Shelby. How do we get the banks to get up to the 
digital world on imaging? That is important, too, for 
uniformity.
    Mr. Buchanan. Well, I think that there are a couple of 
beneficial things with this Act.
    One is that if a bank chooses not to have to adopt image 
technology, the process still works with a substitute check. I 
would say, though, that the way our system works, those who do 
not adopt would be forced to through the competitive 
environment because people will clear checks against those 
banks quicker, which we think the marketplace will force 
adoption.
    Chairman Shelby. Ms. Alexander, your written testimony 
indicates that your credit union currently receives checks back 
from the Federal Reserve Bank, but that you are undergoing a 
process to convert to an all-electronic system. What made you 
decide to make that conversion? What will that conversion cost 
your institution? And do you expect to save money over the long 
run?
    Ms. Alexander. We are constantly looking for ways to 
expedite the process and to also reduce our costs. I do not 
have an actual figure on what it will cost us. We know that 
doing transactions electronically is less expensive than 
actually handling the paper.
    Chairman Shelby. But do you know how much less expensive? 
Can you furnish that to the Committee?
    Ms. Alexander. I can furnish that later, yes.
    Chairman Shelby. Just give us a benchmark.
    Ms. Alexander. I could. I am sorry I do not have those 
figures with me.
    Chairman Shelby. Okay.
    Ms. Alexander. We know it will be less expensive and we are 
looking for ways to not have to handle the paper checks.
    Right now, we do actually, once we receive the checks back 
from the Fed, we have to process them through our equipment. We 
are trying not to do that and looking to the Fed for ways to 
facilitate not doing that. And we know that it will be faster 
and it will also be less expensive for us in terms of staff.
    Chairman Shelby. Mr. Buchanan, one last question. How many 
smaller or community banks pursue the alternative of savings 
from the electronic process? And what are the potential savings 
from moving away from the paper system?
    Mr. Buchanan. We think that the savings are substantial, 
and let me give you some examples within our banking system in 
Utah.
    As Senator Bennett mentioned, we have many rural 
communities. Many of those communities we cut off at 1:00 in 
the afternoon to be able to make deliveries to get them to our 
item processing centers to clear checks.
    Chairman Shelby. And you wouldn't have to do that.
    Mr. Buchanan. We wouldn't have to do that any longer. We 
would be able to provide our customers longer time frames to be 
able to conduct their banking, make their deposits, make their 
payments, and at the same time improve the process dramatically 
by not having to physically transport these items around the 
Nation and deal with them on a manual basis. So, we think the 
savings will be substantial.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman.
    Ms. Duncan, I would get a hold of the lawyer and say, 
microfiche technology is 30 to 40 years old. And I do not 
anticipate any bank or credit union utilizing that under this 
legislation. Any bank that would try to use microfiche to take 
advantage of check truncation is living in the Dark Ages. It is 
just incredible to me that anybody would even bring it up as a 
possible way of handling this right now. I mean, I am sure the 
incident occurred.
    Ms. Duncan. It is old technology. And our concerns really 
are making sure that consumers have adequate protections. 
Speaking of actually things that have been around for a while, 
the UCC was created quite a while ago. There are protections 
that were created today with the types of issues that we are 
concerned about in mind.
    And as I mentioned, Regulation E has a 10-day right of 
recredit, and it has an unlimited amount. It is unlimited in a 
dollar amount. So, we would like to move forward. We would like 
to look at things considering the technology of today. We would 
like consumers to have protections, taking current technology 
into account.
    Senator Bennett. Let me just state a general thought that 
has occurred to me.
    Mr. Buchanan, of course, the hometown excitement is here. 
You come from Utah, so, automatically, we are very proud of 
you.
    [Laughter.]
    But I do not recall any time in the history of this 
Committee that the ABA, the ACB, the CBA, the Roundtable, and 
the ICBA--those alphabets do not mean anything to most of you--
but this is virtually every banking organization in the world, 
have been satisfied by a single witness.
    They always insist on coming in, each with a slightly 
different take on things. I think this is the first time in the 
history of this Committee that we have had that kind of 
unanimity. And then to have the credit unions sitting at the 
same table with the same view, maybe we should declare peace in 
our time.
    [Laughter.]
    And to move forward on this. I think it is extraordinary 
that we have had this kind of unity here.
    So, we come back to you, Ms. Duncan. You have heard the 
testimony here this morning from Governor Ferguson and then 
from Ms. Alexander that says that there is virtually no double 
charging going on and that this problem simply does not exist.
    It would seem to me that the burden would fall upon your 
organization to tell us, A, their figures are wrong and give us 
surveys that demonstrate that there is a fairly high level of 
problem here. Or B, how the adoption of the kind of technology 
that Mr. Buchanan's bank is using would suddenly create 
problems that aren't there.
    Now is that an unfair question on my part? I want to be as 
fair to you as I possibly can. But it seems to me, listening to 
this, that the burden falls on you to say either, A, they are 
wrong and there are a lot of problems, or, B, okay, there 
aren't any problems, but there will be if we go in this 
direction.
    Ms. Duncan. Well, it is my understanding that the 
organization that Ms. Alexander is here to represent also 
supports the recredit provisions as they stand.
    I think what we are talking about here is the fact that 
this will be a new system. The way credit unions do what they 
do today, a check is truncated at your bank. At the credit 
union, you can walk right into your credit union and say, I 
would like to see a copy of my check, the best copy you have.
    What we are talking about here is, a consumer's original 
check will be stopped somewhere back in the process where, with 
a bank or an institution, the consumer may not have a 
relationship with. And so the recredit provisions that we would 
like to have to apply to everyone will just incentivize their 
own bank to do whatever investigation is necessary to find out 
what happened if there has been some error.
    We are talking about just incentives. We are talking about 
consumers and the real-life obstacles that they face. 
Bureaucracy in a financial institution may well be one of them.
    So this is what we are talking about. It is just an 
incentive to balance this legislation so that consumers will 
have more of an ease to resolve any disputes.
    Senator Bennett. My only problem with what you are saying 
is that the testimony we have heard says that those problems 
now do not exist, that there are--Governor Ferguson said zero. 
He did not say a small percentage. He said zero. And Ms. 
Alexander said, at the beginning, she remembered a few 
instances where the image wasn't good, which would recall 
microfiche; but that in the last 14 years, it is zero.
    Mr. Buchanan, as I understand the technology, a customer 
could do exactly what Ms. Duncan just said, could walk into 
your bank, even if the truncation occurred some place else, and 
your bank would have electronically the ability to generate the 
image and say to the customer, here is a substitute copy of 
your check. Isn't that correct?
    Mr. Buchanan. That is correct, Senator.
    Senator Bennett. So it doesn't matter where in the system 
the truncation occurs. The fact that the information is being 
shared electronically means that the customer has more control 
than they do now because if you depend entirely on the printed 
check now, the chances of that printed check getting lost 
somewhere in the system are much higher than the chances of the 
electronic check getting lost.
    We have had hearings in this Committee about identity 
theft. And one of the main ways people get a hold of your 
identity is by simply stealing your mail. And there is a check, 
there is a credit card application, and so on, and they just go 
out and steal mail without regard to what is in it, hoping as 
they go through it that they will find a financial document 
which they can then use.
    This says, you cannot steal it. You can steal all the mail 
you want, but the image of your check, wherever it got 
truncated, is available at your bank.
    It would seem to me that consumers would like that because 
it would reduce the chances of fraud. It would increase their 
opportunity to control their accounts, for the circumstances 
you are appropriately concerned about, rather than going the 
other direction.
    I am having a hard time understanding why Consumers Union 
is against this because everything that I see in the real world 
says, this is going to make security of consumer information 
substantially higher than it is today, and it is going to lower 
costs, which can only benefit consumers in the long run as 
well.
    Now help me understand where I am off base here because I 
am trying to do the right thing for the consumer.
    Ms. Duncan. Right. Our concern is to ensure that consumers 
are adequately protected, and we would like to have the 
protections available to all consumers. That is our concern. 
This will be a new system. And the system as it stands right 
now poses different problems and has different risks and 
benefits for consumers.
    As I said earlier, you walk into your bank. You can get a 
copy. In the truncated system, in this new system, the copy at 
your bank may not be the best copy available. They might have 
to trace back up through the system to find the best copy 
available, which may be----
    Senator Bennett. There is no evidence that that is the 
case. Isn't that true, Mr. Buchanan, that the copy that you get 
from the bank in many ways might be better because it hasn't 
been handled and crinkled?
    Mr. Buchanan. Again, I think I would go back and say in the 
current environment, you would be relying on microfilm or 
microfiche instead of an image document. In any case, an image 
is going to be better than those alternatives.
    Senator Bennett. Thank you.
    My time is up. However, I really have a problem 
understanding why there is a problem because, as I see it, the 
consumer would have access at more places to the information. 
The information would be protected from intrusion. It would be 
protected from physical deterioration.
    I have 6 kids and 17 grandkids and the checks can 
disappear. My 2-year-old grandson can go through the house and 
all kinds of things disappear.
    [Laughter.]
    And I have a sense of comfort knowing that it is preserved 
electronically in the bank and that I can go there at any time 
and get whatever I need.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Allard.
    Senator Allard. I have a question for Mr. Buchanan.
    Obviously, the proposal would involve new systems and 
equipment. I have some bankers in my State of Colorado that 
provide services in communities that are pretty small. They 
operate more on the lower margin. Will this pose a burden for 
small independent community banks? And how can we assure a 
smooth transition?
    Mr. Buchanan. Yes. Let me address that a couple of ways.
    One of the great things about this bill is it does not 
force banks to adopt imaging technology. As I have mentioned, I 
think the marketplace will force that, for them to remain 
competitive.
    But let me go to your question about----
    Senator Allard. Before you move on, I would like to pursue 
that question a little further.
    Mr. Buchanan. Sure.
    Senator Allard. We may not have a mandate in the bill, but 
where these gets centrally cleared, they may say, well, you 
have to bring your system up to standards. We are not going to 
take these unless they are electronically checked. So, we are 
not going to accept it. Do you see what I am saying? In effect, 
it becomes a mandate because somebody at the central clearing 
point may refuse to accept it unless the individual banks adopt 
that technology.
    Mr. Buchanan. The item would look exactly as an original.
    Senator Allard. Yes.
    Mr. Buchanan. So there is no way to really force that 
without stopping any original check from coming through the 
system, which I think is unlikely.
    But with that being said, let me move to your other 
question about the cost for small banks.
    One of the great things with technology right now is that 
it is very affordable. We have scanning devices that we can 
implement for branches that start at $700, moving to the low 
couple of thousand dollars, and then on up. And so, there is no 
evidence that we can see that only large banks can participate 
in this. In fact, I would say that small banks have a 
competitive advantage in being able to move quicker than a 
large bank will be able to move. And cost will not be an issue 
for them.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sarbanes.

              COMMENTS OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Ms. Duncan, I am interested, first of all, in whether, 
under the proposed legislation, consumers would lose 
protections they now have under the UCC?
    Ms. Duncan. The proposed legislation does not necessarily--
well, yes, it would. And the concern actually is--the proposed 
legislation has a comparative negligence provision which is 
actually broader than what the UCC is. It would establish--
somehow, if the consumer is at fault, that their damages could 
be reduced.
    Under the UCC, as it stands for checks, the comparative 
negligence provisions really apply to areas that a consumer has 
control over, such as paying attention and making sure that 
there are not a series of fraudulent or forged signatures on 
their checks. So it would expand comparative negligence in a 
way that is not in current law.
    Senator Sarbanes. So the proposal, as I understand it, 
would in fact diminish consumer protections on the comparative 
negligence issue. Is that correct?
    Ms. Duncan. That is correct.
    Senator Sarbanes. Does anyone at the panel disagree with 
that?
    Mr. Buchanan. I am not sure that I have a comment about 
that, knowing it well enough to comment.
    Senator Sarbanes. All right. Now, of course, it is not 
necessarily the case that the existing protections for 
consumers are adequate. So, I do not know that that is 
necessarily the baseline that one should operate from. That 
leads me to my next question. And that is the question of 
expedited recredit for consumers. What is your view of the 
provision in the legislation on that issue?
    Ms. Duncan. We believe that the recredit provision is 
inadequate because it does not apply to all consumers whose 
check information is processed electronically. And we also 
believe that consumers are not adequately protected. Those 
consumers that do not have the ability to benefit from recredit 
are not adequately protected because recredit is a simple 
nonlitigation remedy, and consumers who are not protected would 
be required to sue their banks, which would be a very big 
burden on consumers for the amounts we are talking about.
    Senator Sarbanes. Ms. Alexander, Mr. Buchanan, do you want 
to comment on that issue?
    Mr. Buchanan. Our belief, from an industry standpoint, is 
that it is unnecessary. It does create fraud risk in that if 
you have an immediate recredit provision, that what it does is 
promotes the ability for fraudsters to take advantage of the 
system. It also creates a regulatory burden for the banks that 
we believe is unnecessary and is covered very well and handles 
all the consumer issues with current UCC law.
    Ms. Duncan. May I respond?
    Senator Sarbanes. Certainly.
    Ms. Duncan. Our concern is that the UCC--I am sorry. I lost 
my train of thought.
    Senator Sarbanes. Well, let me go to Ms. Alexander and see 
if she wants to add anything to Mr. Buchanan's comments?
    Ms. Alexander. Actually, I would echo Mr. Buchanan's 
comments. We believe that the recredit provisions are 
sufficient as they now stand.
    In our own credit union, we have experienced a 256 percent 
incident increase of check fraud in the last 5 years. Two days, 
which was the original proposal, is simply not enough time to 
be able to determine whether or not that check is legitimate. 
We believe, as it stands now, is what we would support.
    Ms. Duncan. I have regained my thought, if I may.
    Senator Sarbanes. All right. I thought you might.
    [Laughter.]
    Ms. Duncan. Thank you. We believe that banks are adequately 
protected, if not overly protected, in the legislation. Banks 
are not required to recredit in instances where they believe 
that fraud is an issue. They are not required to recredit in 
areas where there is a new account, where there has been a 
negative balance. And a bank is also able to reverse a recredit 
where they believe that there is a problem.
    So, we do think that that particular issue is well-
addressed in the legislation and it balances the consumer's 
need for recredit. And to remove recredit would just be a 
negative impact on consumers and that provision should apply to 
all.
    Senator Sarbanes. Now to what extent has the privacy 
question been addressed in terms of this new technology? We are 
seeing new technology being developed all the time. And every 
time it happens, we seem to have another potential serious 
incursion into people's privacy.
    Of course, electronic documents have the advantage of being 

easily transmitted. I understand some of the benefits of that. 
But, presumably, this is going to result in the creation of a 
large electronic database, which will have a lot of information 
in it about the consumer and his check writing habits. That is 
a valuable store of information. How is that privacy going to 
be protected?
    Mr. Buchanan.
    Mr. Buchanan. I would say that the current process has all 
of the information you are talking about anyway, and I am not 
aware of problems around that. And I would also suggest that 
the new process would eliminate manual steps and handling that, 
in fact, would enhance privacy, not diminish it.
    Senator Sarbanes. How in the current system do you create a 
database which can be either sold or exploited for other 
purposes which fully identifies the consumer's spending 
practices?
    Mr. Buchanan. Well, banks today currently are able to 
retain images. And so many banks already retain those images, 
as we have discussed. For instance, there is a company by the 
name of U-Point that stores images for banks like Bank of 
America, Chase, Zions, First Tennessee, and others. The data is 
currently available. I am not aware of any consumer privacy 
issues around that, or banks using that inappropriately.
    Senator Sarbanes. So what do the banks do with this stored 
information?
    Mr. Buchanan. Primarily, it is used for a couple of things.
    One is for customer service aspects. If a customer calls up 
and says, I would like to see what this check was from 3 months 
ago, it can be easily retrieved. Going back to the comment 
about being able to go into a branch and request a copy of a 
check, those images are retrieved from those types of devices.
    Senator Sarbanes. And what other purposes?
    Mr. Buchanan. The other purpose would be for Internet 
usage. So if I am a consumer at home, I may want to be able to 
look at my last 30 days' checks and retrieve those images 
online.
    Senator Sarbanes. Are the banks currently using these 
checks to identify consumer spending patterns and then to use 
that information either themselves or--to either sell or convey 
it to others to be used for various marketing purposes?
    Mr. Buchanan. I could not speak for all banks. I can tell 
you that at our bank, we do not use it that way.
    Senator Sarbanes. But you do not know if other banks do so?
    Mr. Buchanan. No, sir, I do not.
    Senator Sarbanes. Would it be easier to engage in that 
activity if this material was being stored electronically?
    Mr. Buchanan. I would suggest again that if a bank wanted 
to do that, they could currently do it, and have had that 
ability for quite some time.
    Senator Sarbanes. But they would have to add another step. 
Whereas, you are now going to substitute or introduce this 
technology, so it will be done not for that purpose, but for 
the purpose of the truncation, to gain the advantages that are 
sought in this legislation, which we recognize.
    Then, having done it for that purpose, they will have this 
database then available for other purposes. They do not have to 
go through the extra step. Isn't that correct?
    Mr. Buchanan. Let me try and address it. I think there is--
--
    Senator Sarbanes. Let me first just make sure I am correct. 
Then they would not have to go through the extra step. Correct?
    Mr. Buchanan. I think that there is confusion between 
storage and clearing. And what this Act primarily relates to is 
creating efficiencies in the clearing system not relating to 
storage of data.
    Banks currently store vast amounts of data that could be 
used in that way. This Act really is related to making 
efficiencies in our clearing system with the use of substitute 
checks so that those physical items never need to flow through 
to the paying banks.
    So, I do not believe that it changes the dynamics from a 
privacy standpoint, and I do not think that it even requires 
additional steps from a privacy standpoint. This is really 
related to clearing and not storage.
    Senator Sarbanes. Would the industry support check 
truncation if there was a very strong rule that check images 
could not be used for any purpose other than check processing, 
dispute resolution, and consumer requests?
    Mr. Buchanan. I would like to address that with the 
industry and not speak for them off the cuff. So, I would like 
to get back to you on that question.
    Senator Sarbanes. I take it that that means that giving a 
simple yes to its limitation for those purposes, that would 
create problems. You are not comfortable with that. Is that 
correct?
    Mr. Buchanan. I am not saying it would create problems. I 
am just saying that if I were to speak for my institution, I 
would answer one way. I do not know if I would feel comfortable 
answering for the entire institution.
    Senator Sarbanes. Presumably, for your institution, the 
answer would be yes. Am I correct?
    Mr. Buchanan. I think that from our institution's 
standpoint, we would like to use the data in the same ways that 
we currently do, which falls within----
    Senator Sarbanes. Which goes beyond these objectives that I 
discussed, that I mentioned?
    Mr. Buchanan. No, no.
    Senator Sarbanes. It stays within them?
    Mr. Buchanan. It stays within them.
    Senator Sarbanes. Okay. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Carper.

              COMMENTS OF SENATOR THOMAS R. CARPER

    Senator Carper. Good morning. Thanks for joining us this 
morning. I apologize for missing your testimony, but I will 
have a chance to read it later, and I actually will. I know 
that some people find this subject boring, I am told; but I 
really find it actually 
pretty interesting.
    When I was a pup of a Congressman back in the House of 
Representatives serving with then-Congressman Shelby, I think 
the first bill I ever introduced was legislation dealing with 
the availability of funds. When we deposit checks into our 
accounts, how quickly can we have access to those monies.
    I have a question. Mr. Buchanan, I will start with you, but 
I want to ask the others to respond as well.
    I am pleased that today, people have quicker access, 
quicker availability of funds when they deposit checks than 
used to be the case, say 20 years ago. I want to make sure that 
if this legislation were enacted, that we do not somehow set 
the clock back and, if anything, that we could actually make 
availability of funds maybe expedited even further for people 
who deposit checks into their accounts. Can you tell me how 
this legislation relates to the availability of funds and our 
ability to make use of the funds when we have deposited a 
check?
    Mr. Buchanan. Yes, I can. I think if you go back to my 
earlier example about rural communities within Utah and Nevada, 
for instance, as I mentioned earlier, the way that the process 
works is that a branch needs to be cut off at a certain time to 
be able to make the physical transportation deadlines. That can 
be, say, 1:00 in the afternoon for some of our branches.
    With this technology, we believe, and we would implement 
within our environments the ability for consumers to make 
deposits up until the branch closure, which could be 8:00 at 
night for some of our banking centers, which would then provide 
them the ability to earn interest on those funds a day earlier, 
to have their payments posted sooner and their deposits made 
the same day, instead of being held over for the following 
banking day.
    Senator Carper. Let me say to Ms. Duncan and Ms. Alexander, 
in considering this legislation, I am interested in how this 
legislation is not just going to help financial institutions. I 
think it is pretty clear how it would help or be advantageous 
to the industry. But I am looking for ways that this 
legislation could actually be of benefit to consumers. And this 
would appear to me, at least at first blush, to be a plus for 
consumers. Am I missing something there, or do you see it that 
way, too, at least this aspect of it?
    Ms. Duncan. The faster the availability of funds would 
certainly be a potential benefit of the legislation. It 
certainly is not included as a requirement for part of this 
legislation. So, we would definitely want to make sure that if 
this does become a possibility, that it becomes a reality.
    Senator Carper. How might that happen?
    Ms. Duncan. Well, there are two possibilities.
    The banks would--it is within their purview whether to make 
the funds available faster. We would want to see that happen. 
In addition, if it becomes possible for funds to become 
available faster, then the Fed can take a look at this. And we 
want them to take a hard look at it if the legislation were to 
become law, to see if there is an ability to make the funds 
available faster and possibly change the regulations governing 
funds' availability to make sure that consumers are benefiting 
from this.
    Senator Carper. Thank you.
    Ms. Alexander, any comments?
    Ms. Alexander. Well, I would agree certainly that the 
funds' availability to consumers is certainly going to be a 
benefit, a side benefit of this legislation and other 
legislation that may follow.
    We would be able to make funds available to our members 
much more quickly. I also think in the longer term, that 
overall expense of offering checking accounts may come down as 
well. It is less expensive to offer electronic transactions 
than over-the-counter teller transactions and other types of 
transactions that require human beings.
    Senator Carper. Can you quantify that at all in terms of 
the order of magnitude?
    Ms. Alexander. We offer online banking to our members and 
they are able to transfer funds, create a check, access check 
images, do any number of things in the online banking 
environment.
    It costs us approximately a little over $3 to serve a 
member at a teller counter. It costs us about 45 cents for a 
member to actually access his account and do a transaction with 
online banking. So as a not-for-profit institution, credit 
unions look for ways to reduce costs and ultimately return 
those back to the members. We see this as being able to 
ultimately offer something along those lines because we will be 
able to restructure pricing.
    Senator Carper. Let me just ask the others, are there other 

examples in this legislative proposal that would also inure to 
the benefit of consumers, or at least have the potential of 
inuring to the benefit of consumers?
    Mr. Buchanan. Yes, I could give a couple more.
    Another example would be ATM usage, which I mentioned in my 
testimony, where consumers would be able to make deposits in 
ATM's, which have again the same type of cut-off time frames in 
making a deposit. And we believe that those capabilities would 
be far expanded again over the current availability for 
consumers.
    Another example would be where, again, rural commercial 
customers that need to drive to the bank every day to make 
their check deposits would no longer be required to do so. They 
could actually truncate those checks at those commercial 
enterprises and move the images through the clearing system.
    Senator Carper. How would that work?
    Mr. Buchanan. We actually have a system that Senator 
Bennett has seen that provides for the scanning of the image 
and the voiding and making the image, the actual original item, 
nonnegotiable, and then moving the image through the clearing 
system and providing significant benefits to commercial 
customers.
    Senator Carper. Ms. Alexander, as I understand it, the 
credit unions have had for some time the ability to truncate 
checks. What have you learned from that experience with your 
industry that we should put to use in this instance?
    Ms. Alexander. Well, credit unions truncate the checks at 
the very end of the process. We do not return checks to members 
as most banks do. In fact, when we were permitted in 1977 to 
offer checking accounts, we weren't allowed to return them. 
That has since changed.
    But we have done a very good job of educating our members 
that in most cases, they do not really need the paper checks 
back. If they do, we are able to provide them a very clear and 
legible copy.
    In the early days, we actually did provide them back with 
the original if they needed it. Now, we provide them an imaged 
copy. My members, they do need to request copies once in a 
while. It is not frequent. When they do, we can provide it 
immediately, which is faster than we could have if we gave them 
the paper check.
    We feel that the service has actually improved. Our members 
do not see the need to have the checks returned and we have not 
been returning them. We never returned them. And we have been 
offering checking accounts at my credit union since about 1978.
    Chairman Shelby. Senator Bennett, any other questions?
    Senator Bennett. Yes. But just a comment to Senator Carper.
    I made reference to a study that was done by the 
Minneapolis Federal Reserve Bank that indicated that this would 
save $1.75 per transaction. I did the math and that is $73 
billion a year. And given the conversations that we are having 
around here, if you multiply that by ten, that is $730 billion, 
which, by coincidence, just happens to be the size of the 
President's proposed tax cut to stimulate the economy.
    [Laughter.]
    So if we could have the same kick on the economy by passing 
this legislation that we could have by passing the President's 
tax bill and not have to worry about the deficit, I think it is 
a legitimate thing that we should do.
    Senator Carper. I thought you were going to say, we 
wouldn't need the President's tax cut.
    Senator Bennett. No.
    [Laughter.]
    Close, but no cigar.
    [Laughter.]
    I want to come back to what I was doing in the previous 
round, and I do not want to beat this to death, but Senator 
Sarbanes' questions raised it once again: The issue of privacy.
    Hearings before this Committee have indicated that identity 
theft and concern about privacy comes from the present 
situation, where there is access to a physical financial 
institution, that people steal mail in order to get a financial 
instrument.
    And just to nail this down, is it not true, and my 
understanding of it, is it not true that exposure to identity 
theft from those who would move into the area of privacy would 
be eliminated by the kind of system that Mr. Buchanan has 
indicated. I have seen it operate. I have seen it work. My 
understanding of it is that consumer privacy would go up very 
substantially as a result of application of this system.
    Now that is as soft a ball as I can give you, Mr. Buchanan, 
but I think it is an important one for everybody to understand. 
Could you expand on that?
    Mr. Buchanan. Yes, I would agree. Again, I think that by 
eliminating the need to move these items around in the system, 
and being able to truncate checks, we would enhance privacy, 
not diminish it. And so, I would echo your views.
    Senator Bennett. Ms. Alexander.
    Ms. Alexander. I would just like to comment. I would tend 
to agree. In fact, at my credit union, it is much harder for my 
staff to get an image of a check. It is a two-password system 
on a separate server and much more secure than the paper checks 
that are put in with the daily work and locked in a drawer. And 
to me, it seems that the overall privacy issue is strengthened 
by this kind of a system. It is just harder to get those images 
than it is anything on paper.
    Senator Bennett. Ms. Duncan, do you have a reaction to 
that?
    Ms. Duncan. I would just be concerned that we take a close 
look at the storage of this information. To the extent that the 
information might be aggregated, might be potentially mined for 
information, that would be available for somebody who had a 
nefarious 
intent. The identify theft type----
    Senator Bennett. In what way would it be available that it 
is not available now?
    Ms. Duncan. Actually, you make a good point. There is a lot 
of electronically stored data as it stands right now. This 
would just increase the amount and possibly increase the risk 
for consumers.
    Senator Bennett. I do not want to be argumentative, but I 
do not understand how it would increase the available data. Let 
me walk through what I have seen because maybe we are talking 
past each other here.
    A merchant in a Delaware town----
    Senator Carper. Where we have no sales tax.
    [Laughter.]
    Senator Bennett. Yes. Okay.
    [Laughter.]
    A merchant in a Delaware town at the end of the day has a 
series of checks. And under the present situation, he adds all 
those checks up, makes a handwritten deposit slip, puts them in 
a bag, and carries it to the bank and deposits it in an 
overnight depository and it gets opened the next day.
    Under this system, the merchant sits there, he has a little 
black box. He runs the check through the black box and then he 
locks the check up.
    It is transmitted instantly and electronically to the bank, 
which means it is in the merchant's account that night. It 
doesn't get there the next morning. The availability of funds 
is there. The bank then has that electronic information, which 
then goes back to the various customers and is taken out of 
their banks electronically and instantly.
    How is that creating a database that can be mined for 
nefarious purposes that is any different from the present 
situation where the bank makes a microfiche or an electronic 
whatever, or the credit union keeps track of it?
    How is the transmission efficiency created by this system 
creating a new database that doesn't exist, that is more 
vulnerable than what we have now?
    Ms. Duncan. If we are talking about the increased 
opportunities for ID theft or underneath this proposed 
legislation, then we would want to wait to have more 
information on how the banks would intend to use this 
information because increased storage, collection, and 
dissemination of information does lend to ID theft. We would 
just continue to pay close attention as this moves along to how 
the data may be used for other purposes.
    Senator Bennett. Ms. Alexander and Mr. Buchanan, just very 
quickly, does the system increase the database that could be 
used for ID theft?
    Mr. Buchanan. No. Maybe just a final comment around this.
    The data is already stored. I think what you described, 
Senator, is very good in that the way the new process will work 
is that it will eliminate a number of manual steps that I think 
could create more problems around privacy and the vulnerability 
of dealing with physical items moving through the various 
points versus just moving it electronically, storing it as it 
currently is stored--I do not think, and I think it is 
important to understand that we are not talking about storing 
anything differently than it is already being stored, and then 
being able to clear these items. We see this system improving 
significantly, not diminishing.
    Senator Bennett. Ms. Alexander.
    Ms. Alexander. I agree that the database exists now. If 
someone wishes to use it for nefarious reasons, they could do 
it this day. I do not see that this process exacerbates that. 
It simply uses it much more efficiently and for the benefit of 
the consumer.
    Senator Bennett. If I understand your previous testimony, 
actually, this system could make the current database more 
secure. Is that--am I----
    Ms. Alexander. That has been my experience, yes, it does.
    Senator Bennett. I see.
    Thank you very much, Mr. Chairman.
    Chairman Shelby. Any other questions?
    Senator Carper. Just one, if I could.
    Margaret Simmons, my staff member here, was good enough to 
share with me a copy of--this is a legal copy of your check. 
You can use it the same way you would use the original check.
    I am one of those people who actually balances his 
checkbook. I still reconcile my checking account every month.
    My kids--my boys are now 13 and 14. And as they get older, 
they actually watch what I am doing and they say, what are you 
doing? Why do you do that every month? I tell them, I just want 
to make sure that I know how much money is in our checking 
account. Well, don't you get those statements? And I say, yes, 
but I sometimes make mistakes and I just like to check the math 
and make sure that I know exactly what is in the account.
    And I save, religiously save my checks, and I have them 
like stacked up in our basement and they are in their boxes in 
the right order and everything. My wife says, it is a disease. 
I am not sure if it is or not.
    [Laughter.]
    But I have been into this for a long time. I think I am 
beyond redemption. So, I face the prospect of not having my 
checks coming in my statement every month. But if I actually 
need a copy of my check, I guess I can get something like this. 
And my question is, how quickly can I get it? Do you have to go 
through a lot of hoops? Do you have to submit something in 
writing? How does it work? Ms. Alexander, I guess you all have 
been doing this for a while.
    Ms. Alexander. We have. In fact, members can give us a call 
on the telephone. They can walk into a branch. If they are an 
online branching user, they can access it themselves and print 
it out. It is absolutely instantaneous. It takes very little 
effort to produce. It is right there. It is as good as that 
copy you have.
    Senator Carper. So online, I can get it right away?
    Ms. Alexander. Yes.
    Senator Carper. If I telephone, what are we talking about?
    Ms. Alexander. Well, we will mail it to you, or you could 
stop in and pick it up. I can fax it, but, of course, faxing 
denigrates the printing a little bit. But there are a number of 
ways that you can get that. We encourage our online banking 
users to obtain their checks themselves, which they do, in 
large numbers.
    Senator Carper. The complaints from consumers that you hear 
most about the kind of check truncation that you have at your 
credit unions, what are the complaints that you hear?
    Ms. Alexander. We really do not hear complaints now about 
truncation. In the early days, members did complain. They 
wanted their checks back. It did take a while to get a copy. 
You had to go retrieve the physical check. You had to make a 
copy of it or give them the original and keep a copy yourself 
if they needed it for an audit or for a court case. But that 
was 20-some years ago.
    The credit union where I am at now and where I was 
previously have offered checking accounts from the beginning. 
And after the first couple of years, members accepted it, we 
became better at retrieving copies for them, and we tried to do 
our best to give them excellent service.
    Now, they consider it to be a very normal part of their 
checking account process. I have had no complaints about 
truncation.
    Senator Carper. Ms. Duncan, a closing word from you on 
this?
    Ms. Duncan. Our main concern is just to make sure that 
consumers are well-protected. In this situation, what we are 
talking about is taking a consumer's check and turning it 
virtually into an electronic transmission of information.
    There is a scheme out there, Regulation E, which gives 
consumers protection, which is taking into account electronic 
processing of information and potential errors that can occur. 
And that regulation includes a 10-day write of recredit and an 
unlimited amount. So that is the thing that we would like to 
see on a broad application.
    When we look at the CTA, we would like to take the current 
recredit system and apply it broadly to protect consumers.
    Senator Carper. One last one. Mr. Buchanan and Ms. Duncan 
and Ms. Alexander, do you see some way to resolve some of the 
differences that we have heard here today? You talk about 
issues about which reasonable people can disagree. Is this an 
issue that we can resolve if we give it our best?
    Mr. Buchanan. Well, my impression is that anything can be 
resolved. I think that change is difficult, although I would 
say that our position is that we are not taking anything away. 
In fact, going back to your example about wanting to retain 
your checks, I think it is important to know that you would not 
necessarily not get those checks back. You would receive a 
substitute document instead of the original check.
    But from a consumer's standpoint, they would still receive 
the items. You would still be able to take comfort in storing 
those for as long as you would like. We do not see take-aways 
here. We see value-adds. And therefore, we believe it is 
unnecessary to add any additional regulation around that.
    Senator Carper. That wasn't my question.
    Mr. Buchanan. I understand.
    Senator Carper. Are these differences resolvable?
    Mr. Buchanan. Excuse me?
    Senator Carper. In your view, are the differences that you 
have heard here today resolvable?
    Mr. Buchanan. I believe they are.
    Senator Carper. Ms. Duncan.
    Ms. Duncan. I believe they are resolvable, yes.
    Senator Carper. Ms. Alexander.
    Ms. Alexander. I would believe so.
    Senator Carper. Good. All right. Well, let's try to do 
that.
    Thank you.
    Chairman Shelby. I want to thank all of you--Ms. Alexander, 
Ms. Duncan, Mr. Buchanan--for your appearance here today. I 
think it has been a good hearing.
    The hearing is adjourned.
    [Whereupon, at 12:10 p.m., the hearing was adjourned.]
    [Prepared statements and response to written questions 
supplied for the record follow:]
               PREPARED STATEMENT OF SENATOR WAYNE ALLARD
    I want to thank Chairman Shelby for holding this hearing to discuss 
legislation that will ultimately improve the check collection system 
and eliminate unnecessary steps in the process. I look forward to the 
discussion today and am hopeful that we can work together to develop 
legislation that will contribute to the overall improvement of our 
financial system.
    The Federal Reserve Board first sent its proposed Check Truncation 
Act to the Congress in December 2001, with the goal of increasing the 
efficiency of the check collection system. Their proposal recognizes 
the existing legal barriers preventing the possibilities new technology 
could bring to enhance the current system, and improvements that would 
save time, money, energy, and resources.
    Thank you to all of our witnesses for agreeing to appear before the 
Committee today to discuss an important procedure that could change the 
way our banks, thrifts, and credit unions handle check processing, a 
major component of the money-handling system. I look forward to your 
testimony.

                               ----------
              PREPARED STATEMENT OF SENATOR ELIZABETH DOLE

    Thank you, Mr. Chairman, I would like to express my appreciation to 
you and to Ranking Member Sarbanes for agreeing to hold this hearing on 
the Federal Reserve's proposed Check Truncation Act. Checks have long 
served a critical function in the U.S. payments system. In 2001, 
consumers made approximately 41 billion payments by check. However, 
most checks continue to process as they did 50 years ago, requiring 
physical presentation of the check at the bank at which the account is 
held.
    This requirement necessitates the physical transportation of 
millions of checks across the country on a daily basis. According to 
the Federal Reserve, an estimated 37 million checks were transported 
every day in 2001. In order to accomplish this tremendous task, the Fed 
contracts with independent air freight services to fly these checks 
around the country. After the tragic events of September 11, 2001 
halted all air traffic, this critical function of our system of 
payments ground to a halt and further compounded the crisis which 
ensued after the attacks.
    Because of this weakness in the payment system, and as an effort to 
improve its efficiency, the Fed has presented Congress with a 
legislative proposal to transform our check processing system from a 
physical to an electronic system. These improvements to the system 
would result in considerable savings throughout the financial system 
and would also reduce check clearing time for consumers and businesses.
    As with any such fundamental change to our system of payments, 
however, some questions will need to be answered as we move ahead with 
reform of the process. In particular, the anticipated changes in the 
system may open the door to fraud 
unless all necessary precautions are taken. It is my understanding that 
this proposal would require the destruction of the physical check at 
the bank the check is deposited. Currently, checks contain security 
devices such as microprinting and 
watermarks which would be lost in a digital image. I would be very 
interested in gaining a better understanding of the new security 
features which would replace the traditional ones.
    I look forward to discussing this issue and others with our 
distinguished panel of witnesses today. I want to thank you all for 
taking the time out of your busy schedules to join us here today to 
share your considerable knowledge on this issue.
    Thank you.

                               ----------
            PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER

    Thank you, Mr. Chairman. I want to commend both you and Senator 
Sarbanes for putting together such a distinguished panel. I also want 
to thank our panelists for taking the time to meet with us.
    Several days ago, I had the pleasure of meeting with a small group 
of community bankers from New York, and we discussed this check 
truncation proposal. These 
individuals represented community banks who, as we all know, have a 
strong dependence on the support and patronage of the individuals and 
businesses in their area. Efficiency is important, but doing the right 
thing to maintain the customer relationship is critical.
    These bankers support the Fed's proposal on check truncation. Many 
have already moved to electronic statements in their operations. They 
told me that not a single customer had objected to the modernization of 
the banking processes.
    I have long been an advocate of consumer protection in our banking 
systems. To me, the consumers can be the real beneficiaries if we 
decide to make this change. While there are no guarantees in this 
proposed legislation, experience tells us that lower operating costs 
enable businesses to offer lower costs or better services to their 
customers. Things like broader deposit options, later deposit cut-off 
hours, more timely access to account information, and faster deposit 
clearance. If one bank doesn't do it, another will. That is the nature 
of our market system. And in the end the consumer wins.
    ``The check is in the mail,'' is an old expression. Today, despite 
the tremendous advances in data systems, networks, and technology, the 
check is still in the mail. It is time we updated our banking processes 
so that the check doesn't have to be in the mail for banks.
    The Federal Reserve has provided a thoughtful proposal. There is 
some work to be done to ensure that the interests of consumers and 
bankers are safeguarded and balanced. And much progress has already 
been made. But it is time we moved forward with this legislation.
    Thank you, Mr. Chairman.

                               ----------
              PREPARED STATEMENT OF ROGER W. FERGUSON, JR.
    Vice Chairman, Board of Governors of the Federal Reserve System
                             April 3, 2003

    I would like to thank the Committee for inviting me to discuss the 
proposed Check Truncation Act (CTA) that the Board sent to Congress for 
its consideration in December 2001. The proposed CTA removes existing 
legal barriers to the use of new technology in check processing and 
holds the promise of a more efficient check collection system. The 
Board commends the Committee for holding hearings on this very 
important legislative initiative.

Technological Advances in Check Processing
    Check processing is far more efficient than it once was. Less than 
50 years ago, clerks hand-sorted millions of checks each day. In the 
1960's, the banking industry began to use mechanical high-speed check 
processing equipment to read and sort checks, which had been redesigned 
for automated processing. Today, banks, thrifts, and credit unions, 
which I will collectively refer to as banks, process about 40 billion 
checks that consumers, businesses, and the Government write each year.
    Typically, after a check has been deposited at a bank's branch or 
ATM, the bank transports the check to a central operations center. The 
check is then usually sent to one or more intermediaries--such as a 
Federal Reserve Bank or a correspondent bank--or a clearinghouse for 
collection before it is ultimately delivered for payment to the bank on 
which it is drawn. At each step, the check must be physically processed 
and then shipped to its destination by air or ground transportation. 
Some of the checks, however, are removed from the collection or return 
process, and the payment information on the checks is captured and 
delivered electronically. This process, which is commonly referred to 
as check truncation, reduces the number of times that the checks must 
be physically processed and shipped. As a result, check truncation is 
generally more efficient, more cost-effective, and less prone to 
processing errors.
    Today, however, check truncation can only occur by agreement of the 
banks involved because existing law requires that, in the absence of an 
agreement, the original paper checks be presented or returned. Further, 
given the thousands of banks in the United States, it is infeasible for 
any one bank to obtain check truncation agreements from all other banks 
or even a large proportion of them. As a result, the check system's 
legal framework, which has not kept up with technological advances, has 
constrained the efforts of many banks to use new electronic 
technologies, such as digital check imaging, to improve check 
processing efficiency and to provide improved services to customers. 
Therefore, legal changes are needed to facilitate the use of 
technologies that could improve check processing efficiency and lead to 
substantial reductions in transportation and other check processing 
costs. The proposed CTA makes such changes.

Proposed Check Truncation Act
    The proposed Check Truncation Act solves a long-standing dilemma--
how to foster check truncation early in the check collection or return 
process without mandating that banks accept checks in electronic form. 
Currently, under typical check truncation arrangements, electronic 
information about a truncated check, rather than the original paper 
check, is presented to the bank on which the check is drawn. The 
proposed legislation facilitates check truncation by creating a new 
negotiable instrument called a ``substitute check,'' which would permit 
banks to truncate the original checks, to process the check information 
electronically, and to print and deliver substitute checks to banks and 
bank customers that want to continue receiving paper checks.
    A substitute check, which would be the legal equivalent of the 
original check, would include all the information contained on the 
original check--that is, an image of the front and back of the original 
check, as well as the machine-readable numbers that appear on the 
bottom of the check. Under this proposed legislation, while a bank 
could no longer demand to receive the original check, it could still 
demand to receive a paper check. Banks would likely receive a mix of 
original checks and substitute checks. Because substitute checks could 
be processed just like original checks, a bank would not need to invest 
in any new technology or otherwise change its current check processing 
operations.
    Banks could use the new authority provided in this legislation in a 
number of different ways. For example, a bank would no longer need to 
send couriers every afternoon to each of its branches and ATM's to pick 
up checks that customers have deposited. Instead, digital images of checks could be transmitted electronically from those locations to the bank's operations center, where substitute checks could be created and forwarded 
for collection. Not only would this be quicker and more efficient, but it could also permit banks to establish branches or ATM's in remote locations more cost effectively and to provide their customers with later deposit 
cut-off hours.
    Moreover, the proposed legislation would give a bank the 
flexibility to transmit checks electronically over long distances, and 
create substitute checks at locations near their ultimate destination, 
for example, near to the bank on which the checks are drawn, 
substantially reducing the time and cost associated with physical 
transportation. By enabling the banking industry to reduce its reliance 
on physical transportation, the proposed legislation would also reduce 
the risk that checks may be lost or delayed in transit. Today, bad 
weather routinely delays check shipments and check shipments have been 
destroyed in plane crashes. The banking industry's 
extensive reliance on air transportation was underscored in the 
aftermath of the September 11 tragedy, when air transportation came to 
a standstill and the flow of checks slowed dramatically. During the 
week of the attacks, the Federal Reserve Banks' daily check float, 
which is normally a few hundred million dollars, ballooned to over $47 
billion, or more than a hundred times its normal level. Had the 
proposed legislation been in effect at that time and had banks been 
using a robust electronic infrastructure for check collection, banks 
would have been able to collect many more checks by transmitting 
electronic check information across the country and presenting 
substitute checks to paying banks.
    Finally, many banks hope to use the authority provided by this 
legislation to streamline the processing of checks that they must 
return unpaid. Today, after a bank processes its incoming checks and 
determines which checks to return, it has to reprocess all of the 
incoming checks to pull out the less than 1 percent of checks that are 
to be returned unpaid. Many banks have indicated to us that they would 
find it more cost-effective to use their image systems to generate 
substitute checks for return rather than having to reprocess all of 
their physical checks.
    Both individual and corporate bank customers would also benefit 
from the proposed legislation. As I noted earlier, as banks restructure 
their branch and ATM networks, they could offer customers broader 
deposit options or extended deposit cut-off hours. Such changes could 
result in some checks being credited one day earlier and interest 
accruing one day earlier for some checks deposited in interest-bearing 
accounts. In addition, banks might allow some corporate customers to 
transmit their deposits electronically. Because the proposed 
legislation will likely encourage greater investments in image 
technology, banks might also be able offer their customers new and 
improved services. For example, banks might be able to provide 
customers with access to online images of deposits and payments before 
the delivery of paper statements or provide printed copies of checks 
deposited at ATM's on ATM receipts. The same investment in image 
technology might also enable banks to provide better customer service 
by using check images to resolve customer inquiries more easily and 
quickly than today. Further, as banks reduce their operating costs, the 
savings will be passed on through a combination of lower fees to their 
customers and higher returns to their shareholders. Banks have 
indicated that they expect cost savings to be substantial.
    The proposed legislation is designed to provide banks with 
additional flexibility in processing checks by requiring banks to 
accept substitute checks in place of original checks. The proposed 
legislation does not, however, require banks to accept checks in 
electronic form nor does it require banks to use the new authority 
granted by the proposed legislation to create substitute checks. This 
market-based approach permits each bank to decide whether to make use 
of this new authority based on its business judgment about the costs 
and benefits of doing so.
    We believe the market changes arising from these revisions to the 
check law will result in substantial cost savings. Clearly, because 
substitute checks can be processed in the same manner as original 
checks, recipients of substitute checks should incur little or no 
additional processing costs.\1\ It is difficult, however, to estimate 
the overall cost savings. Different banks will take different 
approaches toward using the new authority granted by the proposed 
legislation. Each bank's use of the new 
authority will depend on its technology infrastructure and strategy, 
its physical 
infrastructure, and its customer and business profiles. Thus, the 
magnitude of the cost savings, which will depend on the rate at which 
banks begin using the new authority, is difficult to determine.
---------------------------------------------------------------------------
    \1\ The extent to which banks that receive substitute checks incur 
additional administrative and compliance costs will depend largely on 
whether the legislation, as enacted, includes expedited recredit and 
disclosure requirements and, if so, the form of these requirements.
---------------------------------------------------------------------------
Customer Protection Provisions
    While there is a fairly broad consensus on the desirability of the 
underlying concepts of the proposed legislation to permit the use of 
substitute checks, the issue of customer protections has been the 
subject of much debate. We recognize that this issue is the most 
challenging policy issue in the proposed law, and Congress will have a 
number of alternative approaches to consider as it contemplates the 
need for additional customer protections. We would not object to any 
approach that does not go beyond the protections included in our 
original proposal.

Modified Position On Customer Protections
    The Board's proposed legislation extended the protections of 
existing check law to substitute checks and included new warranty and 
indemnity provisions that were designed to address losses resulting 
from the receipt of a substitute check instead of the original check. 
In addition, the proposed legislation included consumer and interbank 
expedited recredit provisions. Since we forwarded the proposed 
legislation to the Congress in late 2001, the Board has had an 
opportunity to further reflect on the views that have been expressed by 
both consumer advocates and the banking industry and has concluded that 
the expedited recredit provisions originally suggested by the Board are 
not necessary for the successful implementation of the proposed 
legislation. I would like to discuss briefly why we believe that 
expedited recredit provisions are not necessary.

Existing Customer Protections
    Long-established check law protects bank customers if checks are 
improperly charged to their accounts. The proposed legislation would 
apply existing check law, including the Uniform Commercial Code (UCC) 
and the Federal Reserve Board's Regulation CC, to substitute checks as 
though they were the original checks, to the extent such law is not 
inconsistent with the proposed legislation.
    Specifically, a bank may only charge a check that is properly 
payable to a customer's account.\2\ A check is properly payable if it 
has been authorized by the bank's customer and complies with any 
agreement between the customer and the bank. Thus, if a bank charges a 
customer's account for a check that is not properly payable, such as 
when a check has been forged, altered, or duplicated, the customer has 
a claim against the bank for an unauthorized charge to the customer's 
account. For example, if a bank pays a counterfeit check, the bank 
could be liable to its customer for the amount of the unauthorized 
charge, interest on that amount, and consequential damages for the 
wrongful dishonor of any subsequently presented checks. This 
potentially large liability provides a strong incentive for the bank to 
resolve a claim for an unauthorized charge as expeditiously as 
possible.
---------------------------------------------------------------------------
    \2\ U.C.C. Sec. 4 - 401(a).
---------------------------------------------------------------------------
    Over the years, no pattern of problems has emerged to suggest that 
existing check law is inadequate in protecting bank customers against 
unauthorized charges. As part of its analysis, Board staff has reviewed 
the consumer complaint databases of the five agencies of the Federal 
Financial Institution Examination Council and 
had found no pattern of problems associated with the timely resolution 
of check problems, including problems related to accounts where the 
checks are not returned with the monthly statements.

Additional Customer Protections Under The Proposed Legislation
    In addition to the protections provided in current check law, the 
proposed legislation requires banks to provide new warranties for 
substitute checks and to indemnify customers for losses resulting from 
the receipt of a substitute check instead of the original check. 
Specifically, banks must warrant that the substitute checks they 
provide to their customers are legally equivalent to the original 
checks and that a check will not be paid more than once from a 
customer's account. Banks must also indemnify their customers for 
losses they incur due to the receipt of substitute checks rather than 
the original checks. Taken together, these warranty and indemnity 
provisions provide customers with additional protections against losses 
related to the use of substitute checks.

Are Expedited Recredit Provisions Needed?
    The Board's original proposal to Congress also included expedited 
recredit provisions for consumers. (A companion section of the proposal 
included interbank expedited recredit rules.) The expedited recredit 
provisions required a bank to recredit a consumer's account, within a 
specified time frame, if a substitute check was not properly charged to 
the consumer's account. Upon further reflection, the Board has now 
concluded that the significant compliance burdens imposed by these 
provisions on banks that receive substitute checks outweigh the small 
incremental benefits that the provisions would provide to consumers. 
These compliance burdens would run counter to one of the Board's 
guiding principles when drafting the proposed legislation: Minimization 
of the operational and the administrative costs that would be borne by 
banks receiving substitute checks, because these banks would have no 
choice but to accept the substitute checks.
    Further, the Board believes the expedited recredit provisions are 
unnecessary given the protections provided by existing check law and by 
the proposed legislation's new warranties and indemnity, which provide 
additional customer protections. As discussed above, existing check law 
provides substantive protections against unauthorized charges to 
customer accounts. Further, while it is true that the UCC does not 
provide a specified time frame within which a bank must act, its 
provisions give the bank a significant financial incentive to resolve 
problems on a timely basis. Specifically, the longer a bank takes to 
research and resolve a customer's claim, the longer the bank is exposed 
to liability for consequential damages arising from the wrongful 
dishonor of subsequently presented checks. These protections, in 
existing check law, appear to have worked well for many decades.\3\
---------------------------------------------------------------------------
    \3\ In contrast, there was no established body of law governing the 
rights and liability of consumers regarding unauthorized electronic 
funds transfers when Congress was considering the Electronic Fund 
Transfer Act in 1978. Therefore, Congress decided to address consumer 
rights and liability in that Act.
---------------------------------------------------------------------------
    In summary, substitute checks are not expected to result in 
problems different from those that are routinely addressed in today's 
environment. Therefore, we believe that the costs associated with the 
expedited recredit provisions will substantially outweigh the small 
incremental benefit of these requirements to consumers. To address the 
possibility that additional consumer protections may become necessary 
in the future, the proposed legislation grants the Board authority to 
adopt such protections by regulation, if needed. Nonetheless, Congress 
may conclude that expedited recredit provisions for consumers should be 
included in the legislation. In that case, we believe any expedited 
recredit provisions should be consistent with the proposed 
legislation's basic purposes and should not go beyond the provisions 
proposed by the Board.

Conclusion
    In conclusion, although an increasing number of payments are being 
made electronically, it is clear that checks will continue to play an 
important role in the Nation's payments system for the foreseeable 
future. The Board believes that, over the long run, the concepts 
embodied in the proposed Check Truncation Act will spur the use of new 
technologies to improve the efficiency and reduce the cost of the 
Nation's check collection system and provide better services to bank 
customers. The proposed legislation accomplishes this by simply 
permitting banks to replace one piece of paper, the original check, 
with another piece of paper, the substitute check, both of which 
contain the same payment information. Because the proposed legislation 
should result in substantial cost savings, it would also be desirable 
to begin obtaining these savings as quickly as possible.
    We look forward to working with the Committee as it further 
considers this legislation. Thank you for your time and I would be 
happy to answer your questions.

                               ----------
               PREPARED STATEMENT OF LINDSAY A. ALEXANDER
  President & CEO, National Institutes of Health Federal Credit Union
                            on behalf of the
                   Credit Union National Association
                             April 3, 2003

    Chairman Shelby, Senator Sarbanes, and Members of the Committee, 
thank you for the opportunity to provide comments on how check 
truncation has been working at credit unions for the past three 
decades. I am Lindsay Alexander, President and CEO of National 
Institutes of Health Federal Credit Union in Rockville, Maryland. I am 
testifying before you today on behalf of the Credit Union National 
Association (CUNA), which represents more than 90 percent of the 
Nation's 10,000 State and Federal credit unions. As you know, credit 
unions are cooperative, nonprofit financial institutions organized to 
provide individuals associated by a common bond with a place to save 
and a source of loans at reasonable rates.
    I would like to provide you with information regarding:

     The frequency of check truncation at credit unions.
     How check truncation works in the credit union movement.
     The benefits to credit unions and consumers of check 
            truncation.
     The Federal Reserve Board proposal and other proposals to 
            facilitate
      check truncation.

The Frequency of Check Truncation at Credit Unions
    Credit unions have had extensive experience with check truncation 
for nearly three decades. When the National Credit Union Administration 
(NCUA) authorized all credit unions to provide share draft accounts in 
1977, NCUA initially required truncation.\1\ This followed a pilot 
program underway since 1974. As a result, most credit unions that offer 
checking accounts truncate. Sixty-four percent of credit unions offer 
checking accounts, and of those credit unions 91 percent truncate share 
drafts or checks.\2\ Among the credit unions that offer checking 
accounts, 7.1 percent include images of all checks within the 
statements that their members receive. Although only two-thirds of 
credit unions truncate, nearly all credit union members have access to 
checking accounts. In fact, 96.1 percent of credit unions members are 
in credit unions that offer checks.
---------------------------------------------------------------------------
    \1\ Share draft accounts at credit unions are equivalent to 
checking accounts at banks.
    \2\ Share drafts are checks.
---------------------------------------------------------------------------
How Check Truncation Works in the Credit Union Movement
    Initially, the NCUA required all credit unions offering share draft 
accounts to truncate and NCUA defined truncation as when the original 
share draft was not returned to the credit union member. As a result, 
in the past and now, credit unions tend to truncate checks at the last 
step in the check collection process by not distributing share drafts 
to their credit union members. Under this system, there are two 
processes. In the first case, a credit union may receive the checks 
that a member writes against his or her account at the credit union, 
but the credit union does not pass those checks onto the member. In the 
second case, a credit union may have their members' checks truncated by 
a Federal Reserve Bank or a third-party processor, and the essential 
share draft information is transmitted electronically to the credit 
union for payment or dishonor. In this scenario, neither the credit 
union nor the member receives the original paper check. For all credit 
unions, each share draft or check is itemized on the statement that the 
member receives.
    Credit unions do not usually truncate all of the checks that they 
process. For example, credit unions do not usually truncate the checks 
drawn on other financial institutions that their members deposit or use 
to make loan payments at the credit union.

The Benefits to Credit Unions and Consumers of Check Truncation
    Credit unions have found that check truncation, under existing 
check law, allows credit unions to serve credit unions members well. 
Check truncation has allowed credit unions to provide members with 
lower fees and still provide members with outstanding service. The 
experience of credit unions is that our members rarely 
request or need originals from truncated share drafts or checks. In 
fact, some credit unions never provide originals because they destroy 
the originals within 2-3 business days. In 2001, an informal survey of 
corporate credit unions, credit unions that provide services for other 
credit unions, confirmed this. In 2001, corporate credit unions 
processed over 1.1 billion items in total check volume. Of those 1.1 
billion checks, only about 480,000 requests were made for the original 
check, representing .04 percent of all checks. In almost all cases, the 
corporate credit union could make a good quality, clear image of the 
check that satisfied the member's needs.
    I would like to now describe the experience of my credit union, 
which is a $350 million asset institution. We have 48,000 members with 
26,800 checking accounts.
    Like most credit unions, we truncate the share drafts drawn on our 
members' accounts at the end of the check process. We do not return 
checks to members and never have. Although we currently receive checks 
back from our Federal Reserve Bank, we are undergoing a process to convert 
to an all-electronic system. We still use the paper collection system for 
checks drawn on other financial institutions that are deposited by our 
members.
    In addition, at National Institutes of Health Federal Credit Union 
we image all checks that we receive (both checks drawn on our accounts 
and deposited checks from other institutions). After we image checks 
drawn on other institutions, we keep copies onsite for 30 days and 
retain copies offsite for 7 years. Our credit union processed about 2 
million of our own checks that were worth approximately $649 million 
and 461,532 checks drawn on other financial institutions worth 
approximately $340 million.
    In my 14 years at National Institutes of Health Federal Credit 
Union, we have never had a member that has complained about not getting 
an original. Members do not request originals anymore. A copy of the 
share draft seems to satisfy members' needs as long as the share draft 
or the check is clear and legible. In those cases where the member does 
request a copy, the most common reasons are because the member needs it 
for proof of payment or for an audit. At my credit union, 90 percent 
request a copy of the check as proof of payment and 10 percent request 
it for Internal Revenue Service audits. Only a few members need it for 
court cases or other reasons.
    Truncation has helped us meet our members' needs and our members 
are extremely complimentary of the services that we can provide along 
with truncation. In mid-February, we implemented a new service to 
complement our truncation program whereby members who are registered 
with our online banking service can obtain a copy of a share draft or 
check free by accessing the image through their online account. Since we introduced the service we have had an extraordinary response, with 
several members a week spontaneously sending complimentary e-mails to 
the credit union praising this service. This imaging service reduces the 
time it takes to retrieve checks from 2-3 days to making it nearly instantaneous.

The Federal Reserve Board Proposal and other Proposals to
Facilitate Check Truncation
    The Federal Reserve initially presented to Congress a proposal that 
would have permitted depository institutions to convert original checks 
into electronic items and send those electronic checks to other 
depository institutions that agree to accept electronic checks. The 
proposal did not mandate check truncation, however. For 
instance, if a depository institution did not agree to accept 
electronic checks, then the presenting financial institution would send 
that institution a substitute, paper-machine-readable copy of the check 
(a substitute check). During the collection and return process, checks 
would be converted into electronic and paper versions as necessary. 
This proposal represented a step forward by allowing financial 
institutions to voluntarily decide to present an item totally 
electronically without the need for previously adopted agreements.
    The Federal Reserve proposal would have allowed existing truncation 
programs, such as those at credit unions, to coexist, without imposing 
new requirements from the proposal on existing credit union programs. 
We strongly support that provision in the Federal Reserve proposal. And 
we strongly oppose any expansion of the scope of the Act that would 
impose requirements on check truncation programs that 
already exist and do not use a substitute check. The Act is designed to 
address situations where a customer is forced to accept a substitute 
check and the special provisions for substitute checks in the Act 
should only apply to situations where the credit union member or bank 
customer actually receives a substitute check. In the case of credit 
unions, members have already agreed not to accept the check, and our 
experience suggests that our members are doing well with this approach. 
Therefore, expanding the scope of this Act is unnecessary and would 
interfere with credit union check truncation programs that already seem 
to be working. We hope the Senate, like the Federal Reserve, limits the 
scope of its bill.
    We support changes that have been made to the Federal Reserve 
proposal that appear in the Check Clearing for the 21st Century Act 
that was recently introduced by Representative Hart and Representative 
Ford in the House. These changes would allow financial institutions to 
truncate all types of checks, including checks drawn on the Department 
of the Treasury, without unique processing streams. Moreover, the 
consumer provisions found in the Act appear to reflect the experience 
that credit unions have had with check truncation. The Act allows an 
indemnifying financial institution to produce a copy to resolve a 
consumer's claim when a copy is sufficient for that purpose. The 
experience of credit unions is that at nearly all times a copy is 
sufficient, so being able to reproduce a good quality copy should be 
sufficient. The change is especially important because frequently the 
original will be destroyed within a few days and might not be available 
anyway.
    We are also supportive of consumer protections in the House bill 
that mirror those of existing laws. Section 6 of the bill would provide 
a consumer who receives a substitute check with certain recredit 
rights. If the member suffered a loss because of the substitute check, 
the member's credit union under certain circumstances would be required 
to recredit the account of the member up to $2,500 by the end of the 
tenth business day following receipt of the member's notice that a 
substitute check was not properly charged to the account. The approach 
appears reasonable. The recredit procedure in Section 6 gives the 
member's credit union 10 business days to investigate the claim before 
being required to recredit the member and 45 calendar days in certain 
unique circumstances. The credit union's ability to investigate a 
consumer's claim prior to being required to recredit the consumer's 
account is essential for the credit union to avoid fraud losses from 
the new expedited recredit procedure. Similarly, the Section 6 
expedited recredit procedure does not require the credit union to 
provide notice to the member before reversing a claim that is not 
substantiated. Requiring a credit union to give notice before reversal 
would have 
undermined the credit union's ability to protect itself from fraud, 
because it gives the person a chance to withdraw funds even when the 
credit union has discovered that there is a fraud in progress.
    We also support Section 7 in the House bill that provides ground 
rules regarding when a financial institution that has suffered a loss 
from a substitute check must be recredited by an indemnifying bank. 
Under Section 7, a claimant financial institution has 120 days to make 
a claim that it suffered a loss as a result of a substitute check. 
After that, the indemnifying bank must respond by giving the 
appropriate recredit, or a copy of the check showing that the claim is 
unfounded, or information why the bank does not need to provide either 
of those two responses. Placing a time limit on responses to claims 
among financial institutions protects smaller institutions and ensures 
that paying financial institutions do not disproportionately bear the 
burden for substitute checks that may have been mishandled earlier in 
the collection process by an indemnifying bank.
Conclusion
    In conclusion, most credit unions throughout the country in 
addition to National Institutes of Health Federal Credit Union truncate 
their share drafts or checks, and have done so for decades. The 
experience of these credit unions is that members like this service, 
and in particular, seem to find imaging helpful. Members find that in 
cases where they need a copy of the share draft a good copy is 
sufficient. We remain supportive of the current attempts to voluntarily 
facilitate check truncation. And we look forward to working with the 
Committee, the Federal Reserve, and consumers in further strengthening 
this proposal.
    We thank the Committee for this opportunity to comment and I will 
be glad to answer any questions.

                               ----------
                PREPARED STATEMENT OF JANELL MAYO DUNCAN
          Legislative and Regulatory Counsel, Consumers Union
                             April 3, 2003

    Good morning, Chairman Shelby, Senator Sarbanes, and Members of the 
Committee. Thank you for providing me the opportunity to come before 
you today. I am Janell Mayo Duncan, Legislative and Regulatory Counsel 
for Consumers Union.\1\ Consumers Union is the nonprofit publisher of 
Consumer Reports magazine. Our mission at Consumers Union is to test 
products, inform the public, and protect the consumers. Today, I offer 
this testimony on the proposed Check Truncation Act as part of our 
consumer protection function. My testimony today is supported by the 
Consumer Federation of America, U.S. Public Interest Research Group, 
and the 
National Consumer Law Center.\2\
---------------------------------------------------------------------------
    \1\ Consumers Union is a nonprofit membership organization 
chartered in 1936 under the laws of the State of New York to provide 
consumers with information, education, and counsel about goods, 
services, health, and personal finance. Consumers Union's income is 
solely derived from the sale of Consumer Reports, its other 
publications, and from noncommercial contributions, grants, and fees. 
In addition to reports on Consumers Union's own product testing, 
Consumer Reports with approximately 4.5 million paid circulation, 
regularly carries articles on health, product safety, marketplace 
economics and legislative, judicial, and regulatory actions that affect 
consumer welfare. Consumers Union's publications carry no advertising 
and receive no commercial support.
    \2\ Consumer Federation of America is a nonprofit association of 
almost 300 pro-consumer organizations, founded in 1967 to advance the 
consumer interest.
    U.S. Public Interest Research Group (U.S. PIRG) serves as the 
national lobbying office for State PIRG's, which are nonprofit, 
nonpartisan public interest advocacy groups with 400,000 members in 
States around the country.
    The National Consumer Law Center is a nonprofit organization 
specializing in consumer issues on behalf of low-income people. The 
Center's experienced attorneys work with thousands of legal services, 
Government and private attorneys, as well as community groups and 
organizations, from all States who represent low-income and elderly 
individuals on consumer issues.
---------------------------------------------------------------------------
    If the proposed Check Truncation Act (CTA) is enacted into law, it 
would have a significant impact on an estimated 45 million consumers 
who receive their original paper checks in the mail every month.\3\ The 
proposed CTA would enable banks, thrifts, and credit unions 
(collectively referred to in this testimony as banks) to convert 
original paper checks written by consumers into electronic form so they 
can be sent by banks to other banks that agree to accept them. 
Consequently, original paper checks would be ``truncated,'' or stopped 
by one of the first banks in the system to process a consumer's check. 
Banks refusing or unable to accept electronic check information would 
receive a paper ``substitute check.'' During the check return process 
under the proposed CTA, a consumer's check could be transferred in and 
out of electronic and paper substitute form. Thus, the consumer's bank 
would receive either an electronic image or a ``substitute check,'' but 
would not receive back the consumer's original paper check. Likewise, 
the consumer could only get back a ``substitute check'' but not the 
original.\4\
---------------------------------------------------------------------------
    \3\ At an August 2002 meeting, bank representatives stated that 
approximately 60 percent of consumers east of the Mississippi River, 
and 30 percent of consumers in the West receive their original checks 
back. Since approximately 90 percent of the 105 million U.S. households 
have a bank account, usually a checking account, this means that 
approximately 45.8 million U.S. households get back their paper checks.
    \4\ Today many bank and credit union customers do not receive their 
checks back in the mail monthly; however, a credit union creates an 
image of the customer's check at the end of the process, after the 
check has made its way through the check clearing process. In contrast, 
a ``substitute check'' is a reconstituted version of the consumer's 
check. Because not all financial institutions will transmit the check 
in electronic form, the substitute check may contain errors arising 
during the transmission process. In addition, if the consumer needs the 
original check due to a claim of improper amount, forgery, or 
alteration (which may require handwriting evidence) the original check 
will now be in the custody of someone other than the consumer's own 
bank, and so it would take longer to find and retrieve.
---------------------------------------------------------------------------
    We believe the proposed CTA would be a bad deal for consumers for 
three main reasons. First, the proposed legislation would eliminate the 
choice preferred by millions of consumers who receive their original 
paper checks each month. Second, the provisions in the proposed CTA 
meant to protect consumers from processing errors will not be available 
to all consumers whose check information is processed electronically. 
Third, if enacted into law, the proposed CTA would give banks an unfair 
ability to deter, delay, or reduce consumers' claims for damages 
resulting from processing errors by alleging that a consumer was 
somehow at fault.

Potential Impact of Federal Reserve Board Proposal
    We recognize the value that advances in technology can provide to 
consumers in terms of enhanced banking and customer services. However, 
our concern is not with the technology--but the resulting removal of 
consumer choice. The proposed CTA would take a system that works 
relatively well and change it in a way that imposes new risks and 
inconveniences on consumers. Today, some consumers prefer online 
banking, some receive no checks with their monthly statement, and some 
receive checks back every month, like clockwork. The proposed CTA would 
tell millions of consumers that they can no longer get their original 
paper checks back with their statements to double-check what a bank has 
done with their funds, to make sure a payee has not changed the amount, 
or to prove payment where this is an issue. In addition to eliminating 
this consumer option, the proposed legislation creates a system of 
electronic transmission of checks that could expose consumers to new 
risks including double processing of a single check, or errors in 
reading the amount of or account number on a check--resulting in losses 
to consumers.
    It is virtually certain that the largest banks will save money from 
the efficiencies achieved from increased electronic processing of 
checks. In contrast, there is no guarantee that consumers will benefit 
from mandatory check truncation. In return for changing their banking 
practices and being subjected to potential errors related to electronic 
processing, the consumer is offered vague and unenforceable promises 
that they will be sufficiently protected, promises of increased 
flexibilty to view account information, and promises that in the future 
funds from checks they deposit into their account may be available 
sooner. None of these promises are certainties under the proposed CTA.
Loophole in Legislation Relating to ``Recredit'' of Disputed Funds
    If the proposed CTA were enacted into law, consumers would need 
additional protections to address any errors or disputes that occur 
when their check information is processed electronically. In an effort 
to provide protections, Section 6 of the proposed legislation, among 
other duties, would require a bank to put up to $2,500 in disputed 
funds back into a consumer's account if the matter is not settled in 
one business day--called ``recredit.'' \5\ However, the proposed 
language would allow consumers to seek recredit of disputed funds only 
if they receive a ``substitute check'' from their bank.
---------------------------------------------------------------------------
    \5\ We believe that this amount should not be limited to $2,500. 
Recredit amounts are not limited for consumers who conduct electronic 
transfers.
---------------------------------------------------------------------------
    This is a significant loophole because a bank could avoid giving 
account-holders these rights simply by refusing return substitute 
checks to them. If a bank does not give a substitute check to its 
account-holder, the customer loses the right to recredit, and is left 
with weaker UCC remedies found under State law. Consumers unable to 
seek recredit would have to seek redress under State law--UCC Articles 
3 and 4--which governs negotiable instruments, including checks. UCC 
liability provisions are not comparable to recredit because, although 
they provide rules for liability, they lack a nonlitigation remedy. In 
addition, UCC provisions do not set a specific time period to resolve 
disputes, and do not require a bank to redeposit disputed funds. If a 
bank delays or declines to solve the problem, the only way for the 
consumer to get his or her money back under the UCC is to sue, which is 
too expensive and time consuming for most disputes relating to modest 
amounts.
    Although consumers would benefit from additional warranty and 
indemnity provisions under the proposed CTA, in order to obtain damages 
for losses due to an improperly paid check under either the UCC or the proposed CTA's warranty and indemnity provisions, a consumer would be 
forced to sue his or her bank. And as discussed earlier, this is an 
expensive and cost-prohibitive prospect for most amounts likely to be in dispute. We, therefore, believe that the recredit provision should be 
extended to all consumers, regardless of whether or not he or she 
receives a ``substitute check.''

 Although Inadequate in Current Form--The Recredit Provision is
Critical to Ensure Consumer Protections
    Currently, consumers engaging in other electronic funds transfers 
(for example, using debit or ATM cards or allowing funds to be debited 
directly from their accounts) are protected by Regulation E,\6\ which 
includes a 10-day right of recredit, and has no dollar limit. Because 
the proposed CTA would allow banks to turn consumer paper check 
processing into electronic transmissions of check information, the 
recredit section essentially gives consumers protections that are 
similar to those governing other types of electronic funds transfers.
---------------------------------------------------------------------------
    \6\ 12 CFR Part 205.
---------------------------------------------------------------------------
    In the absence of any recredit provision in the CTA, banks would 
lack an incentive to expedite their investigations of possible errors. 
During the delay, consumers could be denied access to rightful and 
necessary funds. The recredit provision properly places the burden of 
delay on the bank rather than the consumer. As described above, in the 
absence of recredit, for unresolved disputes, consumers would be 
required to sue their banks in order to pursue claims for improperly 
debited funds.
    The importance of a recredit provision cannot be over-emphasized, 
and has been recognized by its authors. In a letter dated December 17, 
2001, Federal Reserve Board Chairman Alan Greenspan presented the 
proposed CTA to then-Senate Banking Committee Chairman Sarbanes, along 
with an overview of the proposed legislation, and a section-by-section 
analysis. The ``Highlights'' section of the overview of the proposed 
legislation states that: ``The expedited recredit procedure is intended 
to mitigate the effects on consumers of any potential problems 
associated with the receipt of substitute checks.'' In addition, the 
section-by-section analysis of proposed CTA Section 6 states: ``These 
expedited recredit provisions of the proposed Act are limited to 
consumers, who are generally not in a position to negotiate with their 
banks the terms of their deposit accounts that affect the consumers' 
rights and liabilities, such as how payments are processed and charged to their accounts.''
    As recognized by the Federal Reserve Board, recredit is an 
essential consumer protection element of the proposed CTA. The 
alternative--requiring consumers to seek redress by suing their bank 
over a disputed check processing error--is an unacceptably unfair, time 
consuming, and potentially expensive alternative. We would, therefore, 
oppose any CTA legislation that allows banks to treat checks like an 
electronic funds transfer, without giving consumers the right to 
recredit--a legal protection they need and deserve.

Comparative Negligence Provisions
    The proposed CTA contains provisions that would make it harder for 
consumers to seek damages from banks for improperly paid checks.\7\ 
These comparative negligence standards in Sections 5(b) and 8(c) of the 
proposed legislation would allow banks to reduce the amount of damages 
a consumer can recover by asserting that the consumer was somehow at 
fault (that is, comparatively negligent). Despite the creation of this 
defense, it is highly unlikely that a consumer could contribute in any 
way to the double processing of his or her checks, or to a processing 
error. This provision would unfairly enable a bank to deter a 
consumer's claim, or make any litigation longer and more expensive by 
asserting that the consumer was somehow partly responsible for check 
processing errors.
---------------------------------------------------------------------------
    \7\ Under Section 8(b) of the CTA, a bank could raise a comparative 
negligence defense with respect to every claim by a consumer that his 
or her account had been improperly debited (that is, a ``warranty 
claim''). See CTA Section 8(b). Similarly, the CTA also would allow 
banks to raise a comparative negligence defense if a consumer seeks 
indemnity for harm caused by the unavailability of the original check. 
See CTA Section 5(c).
---------------------------------------------------------------------------
    The proposed CTA's comparative negligence provisions are much 
broader than those currently governing consumer check transactions 
under the UCC. Although the UCC imposes a comparative negligence 
standard, it does so only relating to fraud.\8\ The proposed CTA, 
therefore, gives banks greater protections than exist under current law 
by extending a bank's ability to claim a defense of comparative 
negligence beyond situations where there has been a loss to the 
consumer due to fraud or forgery. This expansion would make it harder 
for consumers to collect judgments against banks responsible for 
processing errors. We, therefore, believe that the comparative 
negligence standards in Sections 5(b) and 8(c) of the proposed CTA are 
inappropriate to resolve harms suffered by consumers due to processing 
errors, and should be removed.
---------------------------------------------------------------------------
    \8\ The first instance relates to fictitious payees or imposters 
[3- 404(d)], the second involves where a consumer's negligence 
contributes to a loss due to a forged signature or alteration [3- 
406(c)]. Finally, under the UCC, an account-holder has a duty to be 
diligent in reviewing his or her monthly statement, and report any item 
paid that was improperly altered or contains an unauthorized signature. 
If the consumer fails to examine his or her statement and discover and 
report such indications of fraud, then he or she may lose the ability 
to assert a claim against the bank for wrongful payment [4- 406].
---------------------------------------------------------------------------
Recommendations
    We recommend the following changes to the proposed CTA to more 
properly balance the benefit of increased check processing efficiencies 
with necessary consumer protections:

 Because all consumers are equally susceptible to harm from 
    processing errors, the recredit loophole in the proposed CTA should 
    be closed. The right of recredit should be expanded to apply in 
    every case where the original check is not returned to the consumer 
    and a check may have been improperly charged to the consumer's 
    account.

 A comparative negligence standard is inappropriate to resolve 
    harms suffered by consumers due to processing errors. Banks should 
    not be able to use this standard to avoid liability, or to delay a 
    consumer's action for improperly paid checks that result from 
    processing errors. Therefore, as it relates to consumers, the 
    language relating to a comparative negligence standard should be 
    removed from the proposed CTA.

    We also have other concerns about the proposal, but we believe that 
these two elements are among the most important.
    I thank the Chairman, Senator Sarbanes, and the Committee for the 
opportunity to testify, and I look forward to any questions you may 
have.

                               ----------
                PREPARED STATEMENT OF DANNE L. BUCHANAN
             Executive Vice President, Zions Bancorporation
                            on behalf of the
       American Bankers Association, America's Community Bankers
      Consumer Bankers Association, Financial Services Roundtable
              and Independent Community Bankers of America
                             April 3, 2003

    Good morning. My name is Danne Buchanan. I am the Executive Vice 
President of the E-Business Solutions Group at Zions Bancorporation, 
Salt Lake City, Utah. I also serve as the CEO of NetDeposit, a 
subsidiary of Zions Bancorporation that provides processing and 
clearing technology which allows organizations to move to electronic 
presentment of paper checks.
    I am here today representing the five major banking and financial 
services trade associations--the American Bankers Association, 
America's Community Bankers, the Consumer Bankers Association, the 
Financial Services Roundtable, and the Independent Community Bankers of 
America (the associations). I am pleased to present the banking and 
financial services trade associations views on the concept of check 
truncation as envisioned in the Federal Reserve Board's (Board) 
proposal (proposal).
    Although the associations sometimes have divergent views on issues, 
on this issue, we are unequivocally united in supporting efforts to 
increase the efficiency of the Nation's payments system. We believe 
that legislation to sanction ``substitute checks'' will facilitate 
electronic check processing that will produce significant cost savings, 
efficiencies, and new consumer conveniences, to the great benefit of 
both consumers and financial institutions.
    On behalf of the associations, I would like to extend our 
appreciation to Senator Shelby for holding this hearing. We also 
commend the staffs of the Senate Banking Committee and the Board who 
have worked tirelessly to address the concerns of the banking industry, 
consumer groups, and others in moving this concept forward.
Consumer Payment Alternatives and the Check Clearing Process
    Consumers today have a variety of alternatives at their disposal to 
make noncash retail payments. These include debit cards, credit cards, 
automated clearinghouse (ACH) debit payments in addition to traditional 
checks. According to the Board, American consumers make more than 70 
million of these noncash retail payments each year. While electronic 
payments represent an increasing number of these noncash payments, 
paper checks remain the dominant form of noncash payment in the United 
States today. Despite repeated predictions of their demise, checks play 
a significant role in the U.S. payments system and will continue to do 
so for years to come.
    Check processing is an enormously expensive and labor-intensive 
process that requires checks to be handled, sorted, and physically 
transported to the paying bank. Because of current law, paper checks 
generally must physically move, by train, plane, and automobile, from 
the bank of first deposit to the paying bank. The primary impediment to 
elimination of this paper check travel route and adoption of electronic 
check processing is the fact that customers have the right to receive 
their original paper checks back. Of course, checks today can be 
truncated at the paying bank site because paying banks and their 
customers can agree to the arrangement. However, the bank of first 
deposit usually does not have a relationship with the paying bank's 
customer and cannot know whether the check writer will insist on 
receipt of the paper check. Therefore, checks generally cannot be 
truncated at the point of deposit, necessitating the long trip to the 
paying bank. The only exceptions are unusual cases where very largest 
banks with large check volumes have reached private agreements.
    At our bank we have, over the last 2 years, been truncating 
original items for payments and creating Image Replacement Documents 
that have been processed by every major financial institution in the 
United States for thousands of customers. We have accomplished this 
with two-party agreements between Zion's Bank and its customers even 
though the customer's deposit account may be held with another 
financial institution. I am pleased to let you know that the process 
works. After we disclosed the process, we had few customer inquiries 
and have successfully dealt with every issue or question posed by a 
paying bank. We have also proven the value propositions by streamlining 
our internal operations and reducing costs in float, clearing fees, and 
transportation.
    We also have a pilot program for our imaging product with a large 
New York bank and one of its customers and their results are equally 
positive. The benefits have gone beyond banking as we are finding our 
commercial customers anxious to begin truncating their payments 
utilizing this same technology. We have several in production now, with 
a large number awaiting implementation. The benefits for these 
customers are improved availability, integration to back office 
systems, and elimination of the daily bank delivery, along with the 
extension of operating time frames. We are currently processing 
approximately a million dollars per day with this process and expect it 
to ramp significantly in the coming months.
    Keep in mind that many customers today do not receive their checks 
back with their statements. Informal industry assessments indicate that 
more than 30 percent of all checks drawn by bank customers, and nearly 
all checks drawn by credit union customers, are not returned to the 
check writer. Depending on the bank's check safekeeping strategy, many 
consumers receive convenient images of cancelled checks or detailed 
information about their check transactions on their monthly account 
statement. Those who receive notations on their check statements may 
obtain copies of checks upon request. In addition, some customers also 
have the ability to review check images online.
    It is important to note that the detailed check transaction 
information and check images satisfy virtually all customer needs 
today. For example, images are routinely used and accepted as proof of 
payment, for tax records, etc. Original items are rarely requested or 
needed. This fact is critical because many of the objections raised by 
consumer advocates about the broader check imaging envisioned under the 
Board's proposal exist today, but in fact present few, if any, 
problems.
    The removal, or truncation, of paper checks from clearing, 
processing, and settlement activities is growing and will continue to 
proceed regardless of whether legislation is enacted. However, passage 
of legislation will facilitate electronic processing so it progresses 
in a more orderly, efficient fashion, to the benefit of all 
participants.

The Board's Proposal Will Improve the Efficiency of the Check System
    Responding to the massive costs and inefficiencies associated with 
check processing, the Board's Payments System Development Committee 
over 3 years ago began actively seeking input from the banking 
industry, consumer groups, check clearinghouses, processors, and others 
in developing a proposed legal framework that would remove the barriers 
to the wide scale use of electronic check processing. The Board's 
diligent review of comments, resolution of issues, and creative 
thinking produced its draft legislation. We applaud those efforts and 
the ultimate product.
    The Board's proposal would allow a collecting bank to remove, or 
truncate, the original paper check from the check collection and return 
process. Checks could then be processed as images that are transmitted 
electronically. Any bank in the process, as well as the check writer 
could demand that items be reconverted from electronic form into a 
``substitute check,'' complete with back and front images and the 
magnetic ink character recognition (MICR). The proposal would establish 
that substitute checks are the legal equivalent of the original check. 
The proposal provides that substitute checks must adhere to rigorous 
standards that ensure the document accurately represents the original 
check and can be processed in the same manner as the original check. As 
noted earlier in my testimony, we have proven that the concept works in 
the real world without adverse impact to banks or customers.
    No longer would a California bank have to ship a check drawn on a 
New York bank across the country for clearing, processing, and 
settlement. Checks could be processed and transmitted electronically 
without the original paper check. Moreover, the proposal does not 
require the banking industry to adopt wholesale electronic check 
clearing; rather it provides flexibility to adapt to electronic check 
clearing over time without interfering with the existing paper check 
process.
    The banking and financial services trade associations believe that 
removing the legal impediments to electronic check processing will 
improve the efficiency of our Nation's payment system and provide 
benefits to both consumers and depository institutions. Electronic 
check processing has the potential to streamline the collection and 
return of checks, reduce processing costs, and minimize the effect of 
unexpected disruptions to air and ground transportation systems. 
Reducing the dependency on the physical presentment of original items 
will result in faster check collection, which will allow consumers 
sooner access to their funds. Consumers will also have faster, more 
convenient access to information about check transactions.
    Improving the check clearing process may also allow banks to 
develop new and more flexible banking services. For example, image-
capable ATM's that can forward deposits electronically will allow banks 
to deploy more ATM's in remote locations as the cost and frequency of 
physically retrieving deposits and servicing ATM's could be reduced. 
Consumers may be able to use these ATM's to cash payroll checks at 
their place of employment, which may be particularly attractive for 
those without bank accounts. It will also be possible for banks to 
offer extended deposit cut-off at remote locations since the need for 
physical same-day pick up could be eliminated.

Check Truncation and Imaging Will Benefit Banks and Their Customers
    In addition to the direct impact on costs, the proposal would serve 
to promote check imaging technology by adding another positive weight 
to the business case for adopting check imaging generally. This broader 
adoption of check imaging will help provide benefits beyond those 
attributable to the electronic processing facilitated by the proposal. 
New applications, services, and benefits will emerge and existing ones 
expand if check imaging is boosted by the electronic processing aspect 
envisioned under the proposal.
    For example, today many consumers receive compendious and 
convenient image statements of checks rather than disorganized, loose 
checks. In addition, a more recent application of check imaging allows customers to view check images online. This helps consumers to quickly 
and to conveniently review transactions, identify potential errors, and 
detect fraudulent transactions sooner. Customers who do 
not bank online also benefit from imaging because customer service 
representatives can quickly bring up for view images to verify 
transactions for the customer. This requires a fraction of the time 
typically required to research microfilm or to physical archives and 
transmit copies. Identifying errors and potential fraud as soon as 
possible also helps banks minimize customer inconvenience, control 
potential losses, and gives law enforcement an advantage in tracking 
down the perpetrators. Such current imaging applications will expand 
with the additional application of check truncation.
    Finally, the proposal could provide real benefits to rural 
community banks and their customers. In remote areas, banks are 
constantly challenged to meet the Federally mandated funds availability 
deadlines due to adverse weather conditions and limited access to air 
courier services. In some places, it can take hours via ground 
transportation to reach a processing facility. Air couriers are often 
not available. With the Board reducing check processing services and 
closing facilities, such physical challenges and complications will 
only increase. Banks in these situations struggle to process checks 
before they must make funds available pursuant to the schedules 
mandated under the Expedited Funds Availability Act. The proposal would 
allow rural community banks to transmit electronic images of checks 
that can be used for clearing and settlement with their existing 
systems, regardless of weather, transportation constraints, or 
distances to processing centers.

Existing Consumer Protections for Checks are Adequate
    The associations support the concepts outlined in the Board's 
proposal. The legislation removes the need to transport and present 
original checks. However, we strongly believe that the provisions of 
Section 6 of the proposal related to expedited recrediting for 
consumers are unnecessary and will not only facilitate, but also indeed 
encourage fraud. We believe that existing check law provides 
appropriate and adequate protection to consumers with respect to 
substitute checks as envisioned under the proposal.
    The banking industry and consumers have an established history with 
truncated checks and image documents. Indeed, millions of consumers 
have been receiving either images or a notation in their statements for 
years, without complaint that disputes are not addressed satisfactorily. 
The current check law works in the truncated and image environment. There simply is no evidence to justify deviation from existing check law.
    In fact, the Board's staff has indicated that an informal review of 
the consumer complaints filed with all the banking regulatory agencies 
reveal no significant consumer issues relating to existing check 
protections. Banks report the same dearth of complaints on these 
matters. Complicated new recredit procedures would only serve to 
confuse customers, create compliance headaches for banks, and expose 
banks to potential new sophisticated fraud schemes.
    Under the Uniform Commercial Code, a bank is liable to its customer 
if it charges its customer's account for a check that is not ``properly 
payable.'' This includes checks that are not authorized by the 
consumer, checks containing a fraudulent endorsement or signature, and 
other erroneously posted checks. A bank that improperly debits a 
customer's account is liable to the customer not only for the 
amount of the improper debit, but also for the amount of any damages 
that are caused by any checks that are returned due to insufficient 
funds resulting from the improper debit. Additional protections and 
funds availability schedules are provided under the Board's Regulation 
CC. For example, under Regulation CC, returning banks warrant to the 
bank customer to whom the check is being returned that they have 
returned the check in accordance with the requirements of applicable 
law, that they are authorized to return the check, and that the check 
has not been materially altered. These laws ensure check related 
disputes are handled appropriately. They work, whether the original 
check, an image, or a statement notation is involved.

Proposed Expedited Recredit Provisions are Unnecessary and
Will Promote Fraud
    The proposal establishes a complicated expedited recredit and 
reversal of recredit structure for consumers and banks that will 
promote fraud. Section 6 of the proposal provides that consumers may 
make claims for expedited recrediting if they assert that the bank 
charged the account for a substitute check that was not properly 
charged and that production of the check is necessary to determine the 
validity of the charge. The bank then must either produce the original 
check and show that the account was properly charged or recredit the 
consumer account for the amount of the check up to $2,500 no later than 
the business day following the banking day of the claim. The remainder 
must be available not later than 20 business days following the banking 
day of the claim. Funds must be available the day after recrediting. 
Banks may delay recrediting under certain circumstances: The account is 
``new;'' the account has been repeatedly overdrawn; the bank has 
reasonable cause to believe that the claim is fraudulent; and 
emergencies.
    Even with the exceptions, the expedited recrediting period is far 
too short and will not only facilitate fraud, but also indeed encourage 
it. To illustrate:

 A fraudster sets up a bank account and writes a check drawn on 
    the account for $2,400 that is deposited into another account 
    belonging to the same individual at another institution.
 After the original item is truncated and a substitute check 
    sent to the paying bank, the fraudster disputes the item, claiming 
    the original has been altered from $240 to $2,400 and that the 
    original is required to resolve the problem.
 Because in most cases, it will not be possible to obtain the 
    original check within 2 days, the bank will be obliged to release 
    the funds. The fraudster walks away with $2,160 of the bank's 
    money.

    Under the proposal, the paying bank must make funds available 2 
days after the claim, risking that the funds will be withdrawn before--
and if--it can produce the original check. In addition, the bank risks 
liability for wrongful dishonor of additional checks drawn on the 
account.
    As a practical matter, under the proposal, the bank has no time to 
obtain the check or investigate before it must release $2,500 per 
claim. (The Proposal does not limit the number of claims an individual 
may make in a single day.) Multiply the claims by multiple checks and 
multiple accounts and the sum can be significant reward for such little 
effort and time.
    This is attractive not only for ``true fraudsters,'' but also for 
customers who may be tempted to abuse the law on an occasional basis. 
Certainly, this is banks' experience and complaint under Regulation E 
which governs electronic fund transfers 
related to consumer accounts and generally permits a more generous 10 
days to recredit the account. Banks complain that this current 10-day 
recrediting requirement means that they must absorb losses due to 
fraudulent claims that cannot be resolved within the 10-day time frame. 
Accordingly, we strongly recommend retaining current check law.

Consumer Groups' Concerns are Unfounded Because Consumers'
Situation Will Be Unchanged
    Consumer representatives complain that consumers need protections 
above and beyond what is required today because they will be at a 
disadvantage if they receive substitute checks rather than originals. 
However, the situations they cite have 
existed for years in the truncated environment without adverse 
consequence to consumers. As noted earlier, millions of bank customers 
receive check images with their statements. Generally, banks providing 
the images destroy the checks within 30 to 60 days. In many cases, by 
the time the consumer requests the check, it has already been destroyed 
and only a copy is available. Thus, the environment under the proposal 
will differ little from the environment of today.
    Testimony presented by Gail Hillebrand on behalf of Consumer Union 
and others on September 25, 2002, before the House Financial Services 
Committee, asserted that the substitute check would not be able to 
``show things that cannot be copied such as the pressure applied to the 
pen by a forger.'' This is true today with the ubiquitous image 
statements.
    First, by the time consumers determine they want the original, it 
has usually already been destroyed. Second, examining pen pressure, 
which is expensive, would typically only arise in rare cases, that is, 
high dollar checks. In such cases today, the check may not have been 
destroyed. Similarly, if the proposal is adopted, the bank may choose 
not to truncate large checks or retain the original if they are 
truncated, given the risk of loss in the event the item is disputed. 
Thus, in rare cases when pen pressure might be examined, the check 
would probably be available for examination as it is today.
    In addition, consumer groups expressed concern that: ``It will be 
up to the consumer to persuade a landlord or another person to accept 
the substitute check as proof of payment.'' Again, today, by the time 
consumers determine that they want the check, it is likely to have 
already been destroyed. Moreover, under the proposal, substitute checks 
will bear the legend, ``This is a legal copy of your check. You can use 
it the same way you would use the original check.'' We believe that 
this will be sufficient to quickly convince the landlords and others of 
the legal equivalence of the check.
    Finally, consumer groups also demand that the expedited recrediting 
provisions of the proposal extend to all truncated checks, including 
those provided today with the customers' consent. They argue that 
consumers will be confused because the rules for dispute resolution for 
those who receive images voluntarily, as they do today, will be 
different from those who insist on substitute checks. The need for 
consistency argues for retaining current check law. Since existing 
check law has a long, proven record of success in the truncated 
environment, if a single consistent rule is adopted, it should be based 
on current proven law, not a new law that arguably will promote fraud.

Conclusion
    The banking and financial services trade associations support the 
general principle outlined in the Board's proposal to facilitate 
innovation in the check collection system without mandating receipt of 
checks in electronic form. We believe, however, that the body of law 
and regulations that has developed around existing check clearing 
processes is both effective in protecting consumers and minimizing the 
banking industry's exposure to fraud. The banking industry and consumer 
experience with existing check safekeeping and truncation programs 
demonstrate that existing law and regulations work. The worries of 
consumer groups demanding additional consumer protections are 
unfounded. The examples they raise exist today without complaints of 
the harms or inconveniences they predict will accompany the 
legislation.
    We urge Members of the Committee to consider changes to the Board's 
proposal that will preserve existing law with respect to substitute 
checks. We hope Members will also take this opportunity to improve the 
efficiency of the U.S. payments system by quick passage of the 
proposal, which has the broad support of the banking industry and the 
Federal Reserve Board.

Represented Organizations
American Bankers Association
    The American Bankers Association brings together all categories of 
banking institutions, including mutually-chartered savings banks and 
savings associations, to best represent the interests of the rapidly 
changing industry. Its membership--which includes community, regional, 
and money center banks and holding companies, as well as savings 
associations, trust companies, and savings banks--makes ABA the largest 
banking trade association in the country.

Consumer Bankers Association
    The Consumer Bankers Association is the recognized voice on retail 
banking issues in the Nation's capital. Member institutions are the 
leaders in consumer finance (auto, home equity, and education), 
electronic retail delivery systems, bank sales of investment products, 
small business services, and community development. CBA was founded in 
1919 and provides leadership and representation on retail banking 
issues such as privacy, fair lending, and consumer protection 
legislation/regulation. CBA members include 85 percent of the Nation's 
largest 50 bank holding companies and hold two-thirds of the industry's 
total assets.

America's Community Bankers
    America's Community Bankers represents the Nation's community banks 
of all charter types and sizes. ACB members, whose aggregate assets 
exceed $1 trillion, pursue progressive, entrepreneurial and service-
oriented strategies in providing 
financial services to benefit their customers and communities.

The Financial Services Roundtable
    The mission of the Financial Services Roundtable is to unify the 
leadership of large integrated financial services companies in pursuit 
of three primary objectives: To be the premier forum in which leaders 
of the U.S. financial services industry determine and influence the 
most critical public policy issues that shape a vibrant, competitive 
marketplace and a growing national economy; to promote the interests of 
member companies in Federal legislative, regulatory, and judicial 
forums; and to effectively communicate the benefits of competitive and 
integrated financial services to the American public.
Independent Community Bankers of America
    ICBA, ``The Nation's Leading Voice for Community Banks,'' 
represents nearly 5,000 institutions at more than 17,000 locations 
nationwide. Community banks are independently owned and operated and 
are characterized by attention to customer service, lower fees, and 
small business agricultural and consumer lending. ICBA's members hold 
more than $526 billion in insured deposits, $643 billion in assets and 
more than $405 billion in loans for consumers, small businesses, and 
farms. They employ more than 231,000 citizens in the communities they 
serve.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES FROM ROGER W. 
                         FERGUSON, JR.

1. In your written testimony you stated that, ``Check 
truncation is generally more efficient, more cost effective, 
and less prone to processing errors.'' Based in part on this 
assessment, you concluded that, ``The proposed legislation 
should result in substantial cost savings.'' In defining how 
these benefits would be distributed, you stated that, ``As 
banks reduce their operating costs, the savings will be passed 
on through a combination of lower fees to their customers and 
higher returns to their shareholders. Banks have indicated that 
they expect cost savings to be substantial.'' Based on these 
statements, I have two related questions.

Q.1.a. What is the Fed's estimate of the size of these savings 
for banks?

A.1.a. While we believe that the proposed legislation will 
result in substantial cost savings, the magnitude of those 
savings is difficult to estimate. The magnitude of the savings 
will depend on the rate at which banks begin using the proposed 
legislation's new authority. Each of the bank's approach toward 
using the new authority will depend on its technology 
infrastructure, physical infrastructure, business strategy, and 
customer profile. On the other hand, banks receiving substitute 
checks will be able to process substitute checks in the same 
manner as original checks, thereby incurring little or no 
additional processing costs. Banks that receive substitute 
checks, however, will incur additional administrative and 
compliance costs that will depend largely on whether the 
proposed legislation, as enacted, includes expedited recredit 
and disclosure requirements and, if so, the form of those 
requirements. Therefore, while banks have indicated that they 
expect cost savings to be 
substantial, the actual magnitude of the cost savings is 
difficult to 
determine.

Q.1.b. What portion of these substantial savings do you expect 
to go to customers as opposed to shareholders?

A.1.b. We are not able to forecast the relative amount of the 
cost savings that might accrue to banks' customers and 
shareholders under the proposed CTA. Banks implement changes 
for a variety of reasons. Banks might implement changes to 
improve profitability or to increase market share by attracting 
and retaining customers through improved services or fee 
reductions. Historically, both banks and their customers have 
benefited from banks' investment in technology. We expect that 
the proposed CTA will benefit both banks' customers and 
shareholders.

2. It is my understanding that the CTA reduces the amount of 
damages that a consumer can recover under an indemnity loss 
claim, breach of warranty, or failure of the bank to meet any 
requirement of the CTA, in proportion to the amount of 
negligence or bad faith attributable to the customer. In your 
April 3 testimony, you stated that, ``The question of 
comparative negligence 
already exists in any of the common law standards for tort and 
. . . in the UCC. And it has withstood the test of time.'' 
Consumer groups agree. However, they allege that the 
comparative negligence standards in subsection 5(c) and 8(b) of 
the CTA are much broader than the Uniform Commercial Code (UCC) 
standards governing consumer check transactions and will make 
it more difficult for consumers to recover damages from banks.

Q.2.a. Are consumer protections under the CTA weaker than under 
the UCC as the consumer groups allege?

A.2.a. The CTA consumer protection provisions are generally 
consistent with, and would not weaken, consumers' rights under 
the UCC. The comparative negligence standard is included to 
ensure that the doctrine of comparative negligence adheres to 
the newly created rights under the warranties and indemnity 
that would apply to substitute checks. The comparative 
negligence language is also intended to negate any concern that 
the CTA preempts well-established State check law protections. 
Consumer protections under the CTA are additional protections 
over and above current UCC provisions. The CTA warranties and 
indemnity, as well as the comparative negligence provisions, 
would overlay existing check law and apply in cases where 
substitute checks are used.
    Comparative negligence is a common law concept under which 
courts apportion tort liability according to how much the 
actions of each party contributed toward the loss. This concept 
has been incorporated into check law through the UCC, as well 
as the Board's Regulation CC (See 12 CFR Sec. 229.38(c)). The 
UCC contains several provisions that allocate liability based 
on fault. For example, the UCC sets out a comparative 
negligence standard in cases of imposters and fictitious payees 
(Section 3- 404(d)) and alterations and forged signatures 
(Section 3- 406). These cases often, but need not always, 
involve fraud. Other UCC provisions reduce a person's ability 
to recover losses based on that person's negligent actions and 
generally do not involve fraud. For example, Section 4 - 406(d) 
reduces a consumer's ability to recover for unauthorized items 
if the consumer does not make a timely examination of his or 
her statement. Also, under Section 3- 407(c), a consumer could 
be held liable for a check that was completed in an 
unauthorized manner if the check was signed yet incomplete when 
it left the consumer's hands.
    The CTA comparative negligence provision would operate in a 
manner similar to these UCC provisions: When a party to a check 
(which could be a consumer, a nonconsumer, or a bank) acts 
negligently or in bad faith, that party's ability to recover 
under the CTA warranties or indemnity will be proportionally 
reduced.

Q.2.b. Please explain why there are comparative negligence 
provisions in the CTA when current law governing check 
processing remedies already provides a comparative negligence 
standard?

A.2.b. Although State law already encompasses a concept of 
comparative negligence in the provisions of the UCC and as a 
common law principle, a new Federal law that did not explicitly 
incorporate such a concept may be deemed to preempt the State 
law. Therefore, the proposed CTA includes a comparative 
negligence provision to make it clear that the new liabilities 
created by the CTA warranties and indemnity could be reduced 
where the complaining party acts negligently or in bad faith.

Q.2.c. What types of actions are anticipated that would make a 
consumer somehow at fault for a bank's processing error? Does 
the Board believe that a consumer could contribute in any way 
to the double processing of a check or to a processing error 
such that the amount they recover is reduced?

A.2.c. There are relatively few processing errors today, given 
the 40 billion checks written annually, and it is highly 
unlikely that the CTA would change that very positive 
experience for those who use checks for their payment needs. It 
is possible, although unlikely, that a consumer's actions would 
result in a bank processing error. A bank processing error 
could take many forms, including misencoding and the creation 
of illegible or duplicate substitute checks. Misencoding of 
checks seldom occurs today and there are encoding warranties in 
the UCC and the Board's Regulation CC that address this issue. 
Consumer actions rarely contribute to such errors. Similarly, 
we believe it would be a rare circumstance when a consumer's 
actions contributed to the creation of an illegible or 
duplicate substitute check. For example, a consumer may have 
taken some action with respect to the original check with the 
intent that the substitute check created from that original 
check would be illegible. A bank that can prove such consumer 
intent may be partially or fully absolved from liability.
    Generally, a bank that is liable for damages because it has 
created an illegible or duplicate substitute check would not be 
able to assert a comparative negligence defense against a 
consumer absent unusual circumstances, such as those described 
above. It is our expectation that the comparative negligence 
provisions will apply in most cases to disputes between banks.

Q.2.d. Consumer groups allege that under the UCC, a bank may 
only raise a comparative negligence defense with respect to 
fraud or forgery. Is this correct?

A.2.d. As indicated in more detail under the first question, 
there are instances under the UCC where a consumer's ability to 
recover losses or to avoid liability is limited due to the 
consumer's own 
negligence or bad faith (see UCC 3- 407(c) and 4 - 406(d)). 
Fraud or forgery is not necessarily involved.

Q.2.e. Is it true that under the current law a bank could not 
defend against processing errors on the grounds of comparative 
negligence?

A.2.e. The legal defenses available to a bank depend on the 
nature of the processing error and whether the consumer's 
actions contributed to that error. As indicated above, we 
believe that a consumer's actions rarely contribute to errors 
such as misencoding. However, in the event that a consumer 
intended to defraud a bank and took actions intended to result 
in misencoding or misdirection of a check, it appears that the 
bank could recover against that consumer under the UCC and 
common law. We note, however, that the case law involving 
misencoded checks generally is between banks and does not 
involve consumers.

3. In your written summary testimony you note that check 
imaging under the CTA could ``provide their customers with 
later deposit cut-off hours. Such changes could result in some 
checks being credited one day earlier and interest accruing one 
day earlier for some checks deposited in interest-bearing 
accounts.'' Based on this statement, I have three questions.

Q.3.a. It is my understanding that while the adoption of CTA 
will likely allow banks to benefit from faster check clearing, 
the CTA does not make changes in the Expedited Funds 
Availability Act (EFAA) that would ensure that banks make 
customers' funds available to them more quickly. Is this true?

A.3.a. The EFAA already requires that the Federal Reserve Board 
shorten the maximum permissible hold periods that banks may 
place on a category of checks if improvements in the check 
collection and return system enable banks to learn of the 
nonpayment of most of those checks more quickly (see EFAA 
Section 603(d)(1)). The Board will monitor improvements to the 
check system and reduce permissible holds as warranted. Because 
the Board complies with current law and will continue to do so, 
there is no need to either repeat existing mandates or create 
new ones. It is important to note that most institutions 
already make funds available to their customers more promptly 
than required by law. In a 1996 report to Congress on Funds 
Availability Schedules and Check Fraud at Depository 
Institutions, the Federal Reserve Board reported that over 70 
percent of banks provide customers faster funds availability to 
customers than required by Regulation CC.

Q.3.b. In the absence of a change in the EFAA and its 
regulations, how can we be certain that consumers will be able 
to access their funds more quickly?

A.3.b. The EFAA already requires that the Federal Reserve Board 
shorten the maximum hold that banks may place on a category of 
checks if improvements in the check collection and return 
system enable banks to learn of the nonpayment of most of those 
checks more quickly. If the proposed CTA results in such 
improvements, the Board will shorten maximum permissible holds 
as required by the EFAA.
    In addition to the general improvements that might result 
in the shortening of the maximum permissible hold schedules, 
the proposed CTA might result in some consumers being able to 
access their funds more quickly through the possible extension 
of deposit cut-off hours at some banks. Every bank has a cut-
off hour after which check deposits are considered made on the 
next banking day. Banks could use the proposed CTA to transmit 
check deposits to central processing centers for collection 
faster than the deposits could be physically shipped to the 
centers. Banks could use this additional time to extend deposit 
cut-off hours, which could result in some consumer checks being 
credited one day earlier and consumers potentially obtaining 
access to funds on those deposits one day earlier.
    Further, as was noted above, a large percentage of banks 
already provide customers with faster funds availability than 
required under regulation. This suggests that market forces 
provide banks with incentives to improve funds availability 
where possible. It seems likely that if technology and business 
processes change such that banks are able to collect checks 
more quickly than they do today, market forces may well lead 
banks to provide customers access to their funds more quickly.

Q.3.c. What steps will the Board take under EFAA to ensure that 
consumers receive most of the benefit from faster check 
clearing under the CTA?

A.3.c. As required by the EFAA, the Board plans to monitor 
improvements to the check system and reduce the maximum 
permissible hold schedules as warranted.

Q.4. A recent American Banker article on check truncation 
reported that Mr. John Hodas, Chief Financial Officer for 
Florida Gulf Bank, which uses check imaging, is concerned about 
the quality of these images. The story states that: ``Mr. Hodas 
said the images are sometimes too faint to read, especially 
when checks are written in light-colored ink.'' Does the Fed 
proposal include any standards for the quality of an electronic 
or substitute check? Why or why not?

A.4. The proposed CTA requires that a substitute check conform 
to generally applicable industry standards. There are two 
American National Standards specifications that would be used 
in a future CTA environment. The first is ANS X9.90--
Specifications for Image Replacement Documents. This standard 
outlines the design or layout of a substitute check and 
incorporates other existing standards, including standards that 
deal with paper dimensions and quality, MICR line location and 
printing, check background design, and check endorsements. The 
second is ANS X9.37--Specifications for Electronic Exchange of 
Check and Image Data. This standard has been revised to support 
the inclusion of images and electronic endorsement records, 
which is critical to the implementation of the proposed CTA. 
These two standards have already been released as Draft 
Standards for Trial Use (DSTU's).
    The proposed CTA also requires that a substitute check 
include an image of the front and back of the original check. 
Further, to be the legal equivalent of the original check, the 
proposed CTA requires that a substitute check accurately 
represent all the information on the front and back of the 
original check at the time the original check was truncated. If 
the writing on a check is clear on the original but not on the 
substitute, then the substitute check would not be legally 
equivalent to the original check and the reconverting bank 
would be in breach of its legal equivalence warranty.

Q.5. It is my understanding that under the Fed proposal banks 
will still be able to return substitute checks to customers if 
both the bank and the consumer agree to that service. To do 
such would require that at some point the image of the check be 
translated into a substitute check and that that substitute 
check either be sent to or printed at the customer's bank. 
David Walker, Executive Director of the Electronic Check 
Clearing House Organization (ECCHO) is quoted in a recent 
American Banker article as estimating the cost of creating and 
processing substitute checks in the range of 2 to 2.5 cents 
apiece, versus about 1 cent for regular checks. As a result of 
this higher cost the article concludes that, ``The industry's 
hope, of course, is that substitute checks will not be a 
concern for long.'' Mr. Ferguson, should one be concerned that 
the potential high costs involved in creating and handling 
substitute checks will make it increasingly less likely that 
banks will even offer customers the ability to receive 
substitute checks?

A.5. Under the proposed CTA, banks would have to weigh the 
costs associated with creating substitute checks against the 
savings from being able to handle more of the check collection 
process electronically. Mr. Walker's statement simply suggests 
that using the substitute checks may not be the most cost-
effective approach for processing all checks. A collecting bank 
will collect checks using the most cost-effective approach for 
each type and category of check. Therefore, some checks may be 
collected as original checks, some as substitute checks, and 
some electronically under electronic exchange agreements. 
Regardless of how checks are collected, banks will have the 
ability to provide their customers with accounts that return 
cancelled checks with bank statements. Assuming there is demand 
for accounts that return cancelled checks to customers, 
competition in the banking industry should drive banks to offer 
such accounts. Further, some States have laws that require 
banks to offer accounts that return cancelled checks to 
customers.

Q.6. It is my understanding that banks are required by law to 
maintain a copy of all checks for 7 years. As I have been 
informed, the majority of these copies are kept using 
nonelectronic means (generally microfiche), while some smaller 
percentage is stored electronically. If check truncation were 
implemented under this proposal would you expect this to change 
such that the vast majority of checks would be stored 
electronically?

A.6. Microfiche or microfilm technology is a relatively old 
technology. As the cost of digital imaging technology declines, 
banks are increasingly using this technology to maintain copies 
of checks that they handle. The proposed CTA would likely 
accelerate this trend because there would be more business 
applications for the technology, thereby making investments in 
the technology more 
attractive.

7. One general advantage of electronic documents is that they 
are easily transmitted and that large numbers of documents can 
be sorted according to a wide variety of information. Thus, it 
is possible, perhaps likely, that this legislation could lead 
to the creation of a large, electronic database containing the 
information of many consumers' check writing habits.

Q.7.a. Is it your opinion that the CTA would create new and 
expanded opportunities for banks to mine personal consumer 
information for commercial purposes?

A.7.a. A check is typically imaged several times in today's 
environment. The check is imaged by the bank at which it is 
deposited, it may be imaged by any intermediary handling the 
check, and it is imaged by the paying bank. Therefore, there 
are already significant databases containing check images. 
Check images, however, are simply pictures of checks. To mine 
information, extra steps are required to extract information 
from check images and to enter that information into a 
database. Given the 40 billion checks that are written each 
year, mining information from check images would likely be 
relatively expensive and labor intensive.

Q.7.b. Is there any provision in the proposed Act that would 
limit a bank's ability to search its database of electronic 
check information and use it to create and to share a detailed 
profile of the customer's buying and spending habits?

A.7.b. There are no provisions in the proposed CTA that address 
the privacy of financial information. The Congress has already 
addressed the protection, disclosure, and use of consumer 
financial information in Title 5 of the Gramm-Leach-Bliley Act. 
There are many ways by which banks obtain financial information 
about their customers other than through checks that they handle. If 
Congress wishes to expand the privacy provisions of the Gramm-
Leach-Bliley Act, it would be more effective to consider such 
expansions in separate, broadly applicable, legislation rather 
than in a narrowly targeted bill such as the CTA.

Q.8. The Board's section-by-section analysis of the CTA, 
accompanying Chairman Greenspan's transmittal letter to the 
Committee on December 17, 2001, includes the following 
sentences:

          ``The Federal Reserve Board believes that a next day 
        recredit limit of $2,500 is a reasonable compromise 
        between banks and consumer interests'' and ``the 
        expedited recredit procedure is intended to mitigate 
        the effects on consumers of any potential problems 
        associated with the receipt of substitute checks.''

    You failed to endorse this provision in your April 3 
testimony. Instead, your written testimony notes that, ``Upon 
further reflection, the Board has now concluded that the 
significant compliance burdens imposed by these provisions on 
banks that receive substitute checks outweigh the small 
incremental benefits that the provisions would provide 
consumers.'' There may be some practical problems with the 
expedited recredit provision contained in the Board's CTA 
proposal, but I am most interested in understanding what has 
changed since December 17, 2001? What are some of the new 
compliance burdens? Was the Board staff unaware of the Uniform 
Commercial Code's protections when the proposal was sent to 
Congress? If so, why was the provision included?

A.8. The Board submitted a draft of the CTA to the Congress in 
December 2001, with the understanding that it would serve as a 
starting point for discussions among the Congress, banks, 
consumer groups, and other interested parties. The Board 
expected that further revisions could and would likely take 
place as the interested parties, including the Board itself, 
continued to consider the pros and cons of various provisions 
of the legislation. In particular, the Board expected further 
debate on the expedited recredit provisions, which had been the 
subject of spirited discussions between banks and consumer 
groups well before December 2001.
    Two of the Board's guiding principles in developing the CTA 
were that: (1) the burdens associated with the proposed law did 
not outweigh the associated benefits for either banks in the 
aggregate or their customers in the aggregate; and (2) banks 
that choose to convert a check to, or receive a check in, 
electronic form should internalize, to the extent practicable, 
the costs and risks related to the creation of the substitute 
check, because they receive most of the associated benefits. 
The Board believed at that time (and continues to believe) that 
the risks of any serious consumer problems under the proposed 
CTA would be low and was well aware in December 2001, that the 
UCC provided strong check-related protections to consumers. 
Nevertheless, our discussions with the banking industry and 
consumer groups on this issue focused largely on how to craft 
expedited recredit provisions rather than on the need for such 
provisions.
    Since that time, however, the Board has had further 
opportunity to carefully consider the arguments on both sides 
of this debate. The Board has also had the opportunity to 
consider the results of ongoing experiments in the marketplace 
involving substitute checks, which have raised virtually no 
consumer problems. In addition, as the draft CTA has evolved, 
additional burdens in the form of notice requirements have been 
placed on banks that are passive recipients of substitute 
checks. After further reflection, the Board now believes that 
the compliance burdens imposed by the expedited recredit 
provisions on banks that receive substitute checks would 
outweigh the small incremental benefits that the provisions 
would provide to consumers. Therefore, the Board does not 
believe that the expedited recredit provisions are necessary to 
successfully implement the CTA. Nevertheless, if Congress 
concludes that expedited recredit provisions for consumers 
should be included in the legislation, we believe that any 
expedited recredit provisions should be consistent with the 
proposed legislation's basic purposes and should not go beyond 
the provisions proposed by the Board.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED  FROM ROGER W. 
                         FERGUSON, JR.

Q.1. Under the Fed proposal, if a hacker interferes with a 
check's electronic transmission (for example, the creation of 
electronic counterfeit checks), who would ostensibly bear the 
sole liability for lost assets? Does the indemnity provision of 
this proposal cover incidences of electronic fraud?

A.1. Under existing law, a bank can only charge a customer's 
account for transactions authorized by the customer. In the 
example you cite, the bank's customer has not authorized the 
fraudulent transaction and is not responsible for the loss. The 
customer, of course, has a duty to examine his or her bank 
statement and must notify the bank of any unauthorized charges. 
Where the ultimate liability falls depends on the facts of the 
particular case. Generally, banks that have agreed to exchange 
checks electronically would include in their agreement 
provisions governing the responsibility for data integrity at 
various points in the check collection process.
    The proposed CTA's indemnity provision only covers 
situations in which the receipt of a substitute check results 
in a loss to a bank customer or other party to the check. As I 
noted, existing law protects bank customers from electronic 
fraud.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER FROM ROGER W. 
                         FERGUSON, JR.

Q.1.a. Please comment on the implications of this proposal on 
the security of checks. My understanding is that today checks, 
like the U.S. dollar, are actually quite sophisticated pieces 
of paper ``technology'' with various safeguards against fraud 
``wired'' into the check. Will the Fed proposal preserve that 
high degree of security?

A.1.a. Today, some checks incorporate a variety of physical 
security features including microprinting, chemical 
sensitivity, security fibers, watermarks, high-resolution 
border text, and latent images. Many of these security features 
are lost when checks are imaged. A number of vendors, however, 
have developed a variety of image-survivable security features 
to address check security issues in an image environment. These 
features include two-dimensional bar coding, seal encoding, and 
digital watermarking. Banks could use these new features to 
protect against fraud. Also, we expect that, as the use of 
substitute checks becomes more prevalent, other new security 
features will be developed to help prevent fraud.

Q.1.b. Who will be responsible for authenticating a check?

A.1.b. Ultimately, the bank paying a check is responsible for 
``authenticating'' a check that is written by its customer. The 
paying bank has knowledge of the drawer's signature and 
generally has knowledge of check stock type, check serial 
number range, and so forth. This knowledge is useful in 
identifying many fraudulent checks. We also expect that over 
time the security features in checks would evolve to 
accommodate the technological developments in check processing.

Q.1.c. And if the physical check does not end up back at the 
bank that is on the hook for the funds--and presumably most 
motivated to do a thorough security verification--how will you 
ensure a high level of attention to security?

A.1.c. Today, most security verification is done at the paying 
bank. This process will likely continue, albeit through the use 
of new security features. Banks at which checks are deposited will 
have access to the original checks and will be able to perform the 
same verification they do today.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM LINDSAY A. 
                           ALEXANDER

Q.1. What is the difference in cost for clearing a check 
electronically versus paper?

A.1. Based on the volume of checks cleared at NIHFCU (a total 
of 2.5 million checks are cleared annually), our costs for 
clearing checks electronically versus paper are $6,250 compared 
to $37,500. The following figures showing the cost of each 
service are from the Federal Reserve's website, at 
www.frbservices.org. ACH origination--.25 cents per item 
($0.0025). ACH receipt--.25 cents per item ($0.0025). Check 
Truncation @ Fed--1.5 cents per item ($0.0150). Even without 
our labor and fixed costs factored in, it costs one-sixth as 
much to move transactions electronically.

Q.2. Your testimony states NIHFCU will be undergoing a 
conversion to an entirely electronic system. What are the costs 
associated with such a conversion?

A.2. The exact figures to convert to an entirely electronic 
system are not available. However, we expect the costs to be 
minimal, since NIHFCU already truncates its checks and offers 
imaging and online services to its members. The fees associated 
with such a conversion would mostly stem from internal 
conversions needed as a credit union to use the new 
technologies, in addition to a one-time fee from the Federal 
Reserve.

 RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED  FROM LINDSAY A. 
                           ALEXANDER

Q.1. Under the Fed proposal, if a hacker interferes with a 
check's electronic transmission (for example, the creation of 
electronic counterfeit checks), who would ostensibly bear the 
sole liability for lost assets? Does the indemnity provision of 
this proposal cover incidences of electronic fraud?

A.1. Under the Federal Reserve proposal, the liability for the 
lost assets would not be covered by the proposal itself. 
According to the section-by-section analysis of the Check 
Truncation Act, the indemnity section provides an indemnity for 
a loss incurred by the recipient of a substitute, if the loss 
is due to the receipt of the substitute check, rather than the 
original check. Moreover, under this section, if the loss would 
have occurred even if the original check had been transferred 
or presented instead of the substitute check, the party 
incurring the loss would not have an indemnity claim, because 
that party is no worse off as a result of having received the 
substitute check. In this case, the loss is not caused by the 
receipt of the substitute check. In fact, in your case, there 
is no mention of the substitute check. The consumer would be 
able to recover under the Uniform Commercial Code Article 4.
    What financial institution bears sole liability for this 
loss under Article 4 of the Uniform Commercial Code would 
depend on how the electronic check was altered to commit the 
fraud. For instance, if the electronic counterfeit alters the 
check writer's signature to obtain the payment then the paying 
bank would cover the loss pursuant to Uniform Commercial Code 
4-208(3). On the other hand, if the payee's endorsement is 
altered, then the presenting financial institution would be in 
breach of its warranty and the presenting bank would bear 
liability for the claim under Uniform Commercial Code 4-
208(a)(1). Under different scenarios, different parties would 
be liable.
    The indemnity provision would not cover incidences of 
electronic fraud. As described above, the scope of this Act and 
the indemnities and warranties are limited to substitute 
checks. For instance, the indemnity only begins when a 
financial institution converts an electronic check into a 
substitute check. From that point forward, the indemnity runs 
with the substitute check or any subsequent electronic version 
of the check. However, the loss must be suffered because of 
receipt of the substitute check instead of the original check. 
In order for that requirement to be fulfilled there would have 
to be a loss caused by receiving the substitute check when it 
was not good enough (for example, for forgeries where the 
original was necessary to make a determination) or for having 
two substitute checks presented or other similar circumstances.

Q.2. If we move forward with this legislation, what assurances 
can you give consumers that they will see lower costs or better 
services in their banking experiences: I believe consumers will 
benefit from this change, but perhaps you can outline some 
specifics for us?

A.2. Consumers would see lower costs and better services 
because the technology allows us to provide both. NIHFCU 
already truncates its checks and also offers imaging and online 
services to its members. By combining truncation with imaging, 
NIHFCU offers members greater access to their checks online. 
Members have used these enhanced services to access their 
checks much more frequently than was possible before imaging. 
Also as stated in the answers above, at any point in the 
process check truncation is much cheaper to NIHFCU than full 
manual processing of checks. Thus, since NIHFCU as a credit 
union is a member-owned institution these savings will be 
passed along to its members.

Q.3. In a dispute over check fraud, how will your policies 
change--if they change at all--in investigating fraud and 
making the consumer whole in the event of fraud?

A.3. NIHFCU does not believe that there would be increased 
fraud from electronic transactions. As a result, NIHFCU does 
not plan to change its policies regarding check fraud if check 
truncation legislation passes because its current policies and 
procedures to handle fraudulent items are more than sufficient 
to handle the fraud that may arise. If a member alleges that 
they have been the victim of check fraud, NIHFCU investigates 
the allegation and within time frames prescribed by applicable 
laws, NIHFCU makes consumers whole in cases of fraud.

   RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED  FROM JANELL 
                          MAYO DUNCAN

Q.1. Under the Fed proposal, if a hacker interferes with a 
check's electronic transmission (for example, the creation of 
electronic counterfeit checks), who would ostensibly bear the 
sole liability for lost assets? Does the indemnity provision of 
this proposal cover incidences of electronic fraud?

A.1. The Federal Reserve proposal doesn't appear to assign 
liability for losses due to unauthorized access or fraudulent 
alteration of a check during electronic transmission. In 
addition, the proposal does not create any new protections for 
electronically transmitted checks. Under the Fed proposal, the 
check must be transformed into a substitute check to trigger 
any additional protections, such as indemnity.
    The indemnity provision of the Fed proposal does not 
clearly 
address the issue of a fraudulently created substitute check. 
The indemnity provision relates to damages resulting from the 
creation of a substitute check, instead of the original check. 
However, it is not clear that the indemnity provision would 
assign liability to a bank, thrift, or credit union 
(hereinafter collectively referred to as banks) where a 
substitute check is fraudulently created or altered by a 
hacker.
    Even if the indemnity section applies to fraudulently 
altered or created checks, it would require a lawsuit to 
enforce, which would be very time consuming and potentially 
expensive for a consumer to pursue. Additionally, the indemnity 
section of the Fed proposal contains a comparative negligence 
section that would not assign ``sole liability,'' and instead 
would require a fact intensive exploration of comparative fault 
between the bank and the consumer.
    Presumably, common law negligence principles also would 
apply to a bank that negligently failed to safeguard consumer 
check information, leading to a loss. However, if a court were 
to look to the Uniform Commercial Code (UCC) to define 
negligence, a bank may be able to avoid responsibility if it 
maintained a low standard of care, but acted in compliance with 
industry standards. Under UCC 3-103(a)(7), ``ordinary care'' is 
defined only as ``observance of reasonable commercial 
standards, prevailing in the area in which the person is 
located. . . .'' In addition, UCC 4-103(c) further provides 
that, ``Action or nonaction consistent with . . . a general 
banking usage not disapproved by this Article, is prima facie 
the exercise of ordinary care.'' See also UCC 4 -103, Comment 
4. This standard of ordinary care raises the concern that if no 
other banks have taken sufficient security measures, it will 
provide prima facie evidence that a bank that has had its 
electronic check processing system breached is not negligent. 
This concern is heightened by the fact that the Fed proposal 
fails to create any new obligations on banks electronically 
transmitting consumer check information to safeguard the 
information from security breaches.
    Finally, under existing law, Section 4 - 401(a) of the UCC, 
a bank may only charge against a customer's account, ``An item 
that is properly payable from the account even though the 
charge creates an overdraft.'' The Section continues, ``An item 
is properly payable if it is authorized by the customer and is 
in accordance with any agreement between the customer and the 
bank.'' Under this Section of the UCC a bank may be liable for 
improperly paying a fraudulently created, or improperly altered 
consumer check because it is not a ``properly payable'' item. 
However, seeking a remedy places a tremendous burden on the 
consumer because in order to recover losses under the UCC, he 
or she must litigate the claim.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES FROM DANNE L. 
                            BUCHANAN

1. As the representative of the American Bankers Association, 
the Financial Services Roundtable, America's Community Bankers, 
Independent Community Bankers of America, and the Consumer 
Bankers Association, please answer the following questions.

Q.1.a. Are banks, subsidiaries, or affiliates of banks or other 
entities that process bank checks, currently using information 
from checks, such as payee or amount, to identify consumer 
spending patterns? If so, do firms use this information 
themselves or do they share it with or sell it to other firms 
or financial institutions?

A.1.a. Banks have always had the ability to extract information 
from paper checks or check images to detect potential fraud and 
to analyze customer spending habits and there are some 
depository institutions which extract information on an ad hoc, 
sporadic basis for internal purposes or for sharing with 
affiliates. However, this practice of extracting information 
from checks is not prevalent. First, extracting information 
from images is relatively difficult, time-consuming, and labor 
intensive for both paper checks and check images. We are aware 
that products may emerge that may extract information more 
efficiently that rely on character recognition, but to our 
knowledge, such techniques are currently unreliable. Second, 
public sensitivities inhibit use and sharing of such 
information. Finally, the privacy provisions of the Gramm-
Leach-Bliley Act significantly restrict how such information 
can be shared outside of the bank.

Q.1.b. Would the industry support check truncation legislation 
if it contained a provision that check images, or any data 
contained on the check, could not be used for any purpose other 
than check processing, dispute resolution, or responding to 
customer requests?

A.1.b. Any privacy issues related to the use of check 
information should be addressed in the broader context of 
financial information privacy and should not be included as 
part of any check truncation legislation. The check truncation 
process as envisioned by the Federal Reserve Board's proposal 
will have no impact one way or the other on the type of check 
information collected by banks, how that check information is 
or is not used for purposes outside of check processing, 
dispute resolution, or responding to customer requests.

2. As you know, on March 26, the American Banker reported that 
Viewpointe Archive Services shut down the JP Morgan and Bank of 
America image exchange pilot at the end of February. 
Viewpointe's Chairman and CEO, John Lettko, noted that the 
pilot was discontinued because the banks had reached, ``A point 
of diminishing returns.'' According to Mr. Lettko, the banks 
concluded that, to get further economic value from the 
exchanges, they needed to install more image capability in 
their back-office processing shops. The article further noted 
that only a small number of banks can process images ``from the 
front end of the office to the back.''

Q.2.a. As we explore legislation facilitating widespread check 
imaging, what lessons can be learned from the Viewpointe 
experience with image exchange?

A.2.a. To respond to the Committee's question regarding 
Viewpointe and check image exchanges, I consulted with Grant 
Cole, Senior Vice President at Bank of America, who has more 
direct information on the Viewpointe project. The response 
below is based in part on information obtained from Bank of 
America.
    In November 2001, JP Morgan Chase and Bank of America 
embarked on a research and development project to test 
assumptions about check image exchange using a shared central 
archive. Both banks are owners of Viewpointe Archive Services. 
The banks set out to develop processes, rules, agreements, and 
logistics related to the exchange of check images in a shared 
archive to facilitate the collection and settlement of checks 
that traditionally had been exchanged between the banks in 
paper form. The Federal Reserve was invited to participate in 
the design of the process, but not to exchange checks in this 
phase of the project. The Electronic Check Clearing House 
Organization (ECCHO) was asked to join the project as well, in 
the capacity of rules rationalization.
    Through this exchange project, the banks developed the 
design for exchanging images of checks within a central 
archive, the indices required, privacy requirements, and access 
capabilities. This design was then tested by exchanging through 
the Viewpointe archive a small sample of check images from each 
bank. During this test, the paper checks were still exchanged 
by the banks. The banks still needed the paper checks because 
they have not completely extended image technology to all 
aspects of the banks' check operations and so were needed to 
perform exceptions processing such as return item processing. 
It is anticipated that prior to a full rollout image exchange 
between two or more banks, the participating banks would extend 
the necessary technology throughout the check processing 
systems at such banks.
    The project to test image exchange through Viewpointe was a 
complete success as the banks involved in the test were able to 
prove an operational design that fulfilled all the objectives.
    The article that was published in the American Banker 
regarding the check image exchange through Viewpointe is 
misleading, as the comments out of context left the wrong 
impression. The quote by Mr. Lettko of ``diminishing returns'' 
is accurate, but only because the objective of testing the 
image exchange process was met, and as long as the original 
paper checks have to follow the exchanged check images, there 
would not be much of an additive economic 
benefit. Also, the banks recognized during the test that there 
is a need for more automation to handle images efficiently in 
``the back office'' which will be accomplished prior to the 
full implementation of check image exchange.
    The comment in the American Banker article about a ``small 
number of banks being able to process images from the front end 
of the process to the back'' is also misleading. There are 
check image projects underway today in almost all large banks, 
and many smaller financial institutions are generally ahead of 
large banks in deploying image technology. The 2002 ICBA and 
InFinet Resources Community Bank survey results indicate that 
community banks' use of check imaging technology outpaces that 
of larger banks by a margin of 2 to 1, with 47 percent of the 
respondents currently using the technology and another 41 
percent planning to evaluate the technology within the next 
12 -18 months. This corresponds to 88 percent of the 
respondents currently using or planning to evaluate imaging 
technology. Many small institutions have responded that they 
are waiting for check truncation legislation 
before investing in imaging. While not all banks are today 
implementing front-to-back exchange of images, the image 
programs established by these banks are the first and necessary 
step toward the day when banks can exchange images with any 
other bank in the Nation.
    We believe the Boards proposed check truncation legislation 
will provide the impetus for the expansion of image exchange 
programs.
    Lessons to be learned from the Viewpointe experience are 
that the image exchange using a common shared archive can be 
accomplished efficiently and securely. It also illuminated that 
in order for the real benefits of image exchange to be realized 
for the Nation's payment system, check images must be exchanged 
without the need for the original paper checks to be 
transported. For the reasons discussed above, we believe that 
the substitute check process contemplated in the Board's 
proposal will provide the impetus 
required for the furtherance of the business case for check 
image 
exchange.

Q.2.b. As the President of NetDeposit, a company that provides 
processing and clearing technology that facilitates the 
electronic presentment of paper checks, what are some of the 
problems you have experienced with imaging?

A.2.b. We have experienced very few problems with the 
technology or customer complaints. One reason is that paying 
banks are not required to have image capability since they are 
provided substitute checks. Some banks and merchants have 
expressed concerns about the lack of clarity with regard to the 
legal validity of substitute checks. The Board's proposal would 
provide that clarity by stating substitute checks are the legal 
equivalent of the original.

Q.2.c. Do the check images (substitute checks) contain 
securities features? If not, what are some of the obstacles 
currently preventing banks from imaging security features onto 
substitute checks?

A.2.c. New image-survivable security features have been 
developed, and are under development, that should provide all 
check issuers with superior security features for checks that 
are imaged or converted to substitute checks. For example, we 
are aware of one technology company that offers a security 
feature for checks that are image-survivable, but also machine-
readable, allowing for automatic processing. These image-based 
security features/processes are superior to the paper-based 
security features currently in use because check issuers can 
verify the security procedures carried on each image on an 
automated basis, rather than upon physical inspection of the 
paper check.
    Industry standards groups are also working on standards and 
other operational issues for check image systems and substitute 
checks. The standard defines a structure to properly identify 
security features. The standard enables the incorporation of 
standardized and proprietary security features into the 
original check by providing a trigger and identification 
structure. The standards do not specify requirements for the 
type of security features.
    At the time the check is issued or printed a one- or two-
dimensional bar code is printed on the check with information 
about the check. For example, the dollar amount or check number 
could be encoded. One of the benefits of this encoding process 
is that the image of the check with the encoding can be 
authenticated anywhere in the check collection process. The 
validating encoded information is carried on both the paper 
check, the image of the paper check, and a subsequent printed 
copy of the check image (such as a substitute check).
    See example below with a one-dimensional bar code.

    
    

Q.3. In your written testimony, you note that, ``Reducing the 
dependency on the physical presentment of original items will 
result in faster check collection, which will allow consumers 
sooner access to their funds.'' Moreover, the Federal Reserve 
has noted that due to check imaging under the CTA banks could, 
``Provide their customers with later deposit cut-off hours.'' 
It is my understanding that while the adoption of CTA will 
likely allow banks to benefit from faster check clearing, the 
CTA does not make changes in the Expedited Funds Availability 
Act (EFAA) that would ensure that banks make customers' funds 
available to them more quickly. In the absence of a change in 
the EFAA, how can we be certain that consumers will be able to 
access their funds more quickly? Would the industry support a 
change in the EFAA requiring that funds become available to 
customers more quickly?

A.3. No change is necessary as the Expedited Funds Availability 
Act already anticipates a reduction in the funds availability 
schedules in the event checks are processed and returned more 
quickly. Specifically, under Section 603(d) of that Act, the 
Board must, by regulation, ``Reduce the time periods . . . to 
as short a time as possible and equal to the period of time 
achievable under the improved check clearing system for a 
receiving depository institution to reasonably expect to learn 
of the nonpayment of most items for each category of checks.''

Q.4. Is it my understanding that banks are required by law to 
maintain a copy of all checks for 7 years. I have been informed 
that the majority of these copies are kept using nonelectronic 
means (generally microfiche), while some smaller percentage is 
stored electronically. If check truncation were implemented 
under this proposal, would you expect this to change such that 
the vast majority of checks would be stored electronically?

A.4. Over time, we would expect that most checks would be 
stored electronically regardless of whether the proposal is 
enacted.

5. A general advantage of electronic documents is that they are 
easily transmitted and many documents can be sorted according 
to a wide variety of criteria. Thus, it is possible, perhaps 
likely, that this legislation could lead to the creation of a 
large, electronic database containing the information of many 
consumers' check writing habits. In your written testimony, you 
stated that you are CEO of NetDeposit, ``A subsidiary of Zions 
Bancorporation that provides processing and clearing technology 
which allows organizations to move to electronic presentment of 
paper checks.'' The American Banker has reported that, ``Zions 
is selling the system [NetDeposit] to other institutions and 
has one money-center bank testing it.'' As CEO of NetDeposit, 
please answer the following questions.

Q.5.a. Does NetDeposit currently, or plan in the future, to 
handle electronic check processing for multiple banks?

A.5.a. NetDeposit will handle electronic check processing for 
multiple banks.

Q.5.b. What information is, or could be, kept electronically 
from an imaged check as it goes through the NetDeposit system?

A.5.b. The only information held by the NetDeposit system will 
be images that are stored for several days to ensure that if 
items are not received or lost, we can recreate the cash 
letter. At the end of 5 days, these images are backed up to 
tape for record retention only and stored offsite for 7 years.

Q.5.c. What restrictions regarding privacy exist for imaged 
checks?

A.5.c. The Gramm-Leach-Bliley Act (GLB Act) imposes significant 
restrictions on the sharing and use of information from paper 
checks or check images. Banks also could only use or disclose 
customer information from checks in compliance with their 
privacy policies adopted pursuant to the GLB Act. In addition, 
the GLB Act requires the banking agencies to establish 
appropriate standards for financial institutions relating to 
administrative, technical, and physical safeguards to protect: 
(1) the security and confidentiality of customer information, 
(2) against unauthorized access, and (3) against anticipated 
threats or hazards.

Q.5.d. Does the legislation proposed by the Federal Reserve 
provide any additional privacy protections?

A.5.d. No. The Federal Reserve Board proposal does not include 
additional privacy provisions. For the reasons stated above, we 
believe additional privacy legal provisions are not needed for 
check truncation programs. As a practical matter, customer 
privacy will be enhanced by the proposal as access to checks 
and their information will be far more restricted when 
controlled in an electronic check collection process. For 
instance, the current paper check route offers opportunity to 
acquire information more easily than if the check image were 
transmitted electronically. Today, paper checks sit in 
airports, etc. awaiting transport and delivery. They must also 
be physically handled along the various stops where the 
information can be compromised. Electronic delivery eliminates 
these physical stops and the opportunity to acquire the checks 
and information.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED   FROM DANNE L. 
                            BUCHANAN

Q.1. Under the Fed proposal, if a hacker interferes with a 
check's electronic transmission (for example, the creation of 
electronic counterfeit checks), who would ostensibly bear the 
sole liability for lost assets? Does the indemnity provision of 
this proposal cover incidences of electronic fraud?

A.1. Both the Federal Reserve proposal and the Uniform 
Commercial Code protect consumers from liability for any check, 
electronic or not, that is charged against their account and is 
not properly payable. Thus, under no circumstances would the 
consumer be liable in this case. Depending on how and where the 
hacker intercepted the information and how the hacker used it, 
one of the banks in the check process would bear the loss, 
based on warranties of the Uniform Commercial Code, the Federal 
Reserve proposal, and interbank agreements. If a hacker used 
the account numbers in the electronic check image database to 
create an electronic funds transfer from the customer's 
account, the consumer would be protected from liability under 
the Electronic Fund Transfer Act and its implementing 
regulation, Regulation E. That law protects consumers from 
liability for unauthorized electronic fund transfers.
    In addition, hacking would seem unlikely in this case. As 
currently envisioned and configured, banks use only secure data 
lines to transmit the check image data to the database, and the 
databases themselves are protected with data encryption and 
other 
security techniques.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER FROM DANNE L. 
                            BUCHANAN

Q.1. A question for the bankers on the panel: If we move 
forward with this legislation, what assurances can you give 
consumers that they will see lower costs or better services in 
their banking experiences? I believe the consumers will benefit 
from this change, but perhaps you can outline some specifics 
for us.

A.1. Generally, the potential benefits of the proposal derive 
from the expected cost savings and quicker access to funds and 
account information associated with the elimination of the need 
for paper checks to physically travel from the bank of first 
deposit, through various check processing participants, to 
reach the paying bank. Consumers benefit from the potential 
cost savings in the form of lower costs and better services. In 
a market as competitive as the banking industry, competitive 
pressures will compel depository institutions to pass on to 
consumers savings from a more efficient check collection 
system. In addition to the potential costs savings, consumers 
will benefit from better service:

 Reducing the dependency on the physical presentment of 
    original items will result in faster check collection, 
    which will allow consumers sooner access to their funds.
 Consumers will also have faster, more convenient 
    access to information about check transactions.
 Improving the check clearing process may also allow 
    banks to 
    develop new and more flexible banking services. For 
    example, image-capable ATM's that can forward deposits 
    electronically will allow banks to deploy more ATM's in 
    remote locations as the cost and frequency of physically 
    retrieving deposits and servicing ATM's could be reduced. 
    Consumers may be able to use these ATM's to cash their 
    payroll checks at their place of employments, which may be 
    particularly attractive for those without bank 
    accounts.

    In addition to the direct impact on costs, the proposal 
would serve to promote check imaging technology by adding 
another positive weight to the business case for adopting check 
imaging generally. This broader adoption of check imaging will 
help provide benefits beyond those attributable to the 
electronic processing facilitated by the proposal. New 
applications, services, and benefits will emerge and existing 
ones expand if check imaging is boosted by the electronic 
processing envisioned under the proposal.
    For example, today many consumers receive compendious and 
convenient image statements of checks rather than disorganized, 
loose checks. In addition, a more recent application of check 
imaging allows customers to view check images online. This 
helps consumers to quickly and conveniently review 
transactions, identify potential errors, and detect fraudulent 
transactions sooner. In addition to the timely receipt of 
information, the customer might also be able to print a copy of 
the check or send a copy of the check to a party questioning 
payment.
    Customers who do not bank online also benefit from imaging 
because customer service representatives can quickly bring up 
for view images to verify transactions for the customer. This 
requires a fraction of the time typically required to research 
microfilm or physical archives and transmit copies. Identifying 
the errors and potential fraud as soon as possible helps banks 
minimize customer inconvenience and control potential losses, 
and gives law enforcement an advantage in tracking down 
perpetrators. Such current imaging applications will expand 
with the additional applications contemplated in the Board's 
proposal.

Q.2. A question for the bankers on the panel: In a dispute over 
check fraud, how will your policies change--if they change at 
all--in investigating fraud and making the consumer whole in 
the event of fraud?

A.2. Generally, bank policies will remain unchanged with regard 
to investigating fraud and making the consumer whole.
    Today, depository institutions investigate and resolve 
claims as soon as possible because of the potential liability 
under the Uniform Commercial Code (UCC) for consequential 
damages for failure to properly pay items. The proposal 
preserves these UCC rights.
    In addition, though the industry believes it unnecessary 
and dangerous from a fraud perspective, the proposal adds new 
``expedited recrediting'' provisions that basically guarantee 
consumers that funds for unauthorized substitute check 
transactions will be available on the second day after the 
depository institution is notified of a claim. We believe that 
this provision is unnecessary as existing check law provides 
appropriate and adequate protection to consumers with respect 
to substitute checks as envisioned under the proposal.
    The banking industry and consumers have an established 
history with truncated checks and image documents. Indeed, 
millions of consumers have been receiving either images or a 
notation in their statements for years, without complaint that 
disputes are not 
addressed satisfactorily. The current check law works in the 
truncated and image environment. There simply is no evidence to 
justify deviation from existing check law.
    In fact, Board staff has indicated that an informal review 
of the consumer complaints filed with all the banking 
regulatory agencies reveal no significant consumer issues 
relating to the existing check protections. Banks report the 
same dearth of complaints on these matters. Complicated new 
recredit procedures would only serve to confuse customers, 
create compliance headaches for banks, and expose banks to 
potential new sophisticated fraud schemes.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BENNETT FROM DANNE L. 
                            BUCHANAN

Q.1. What is the effect of the provisions of Sections 5 and 8 
in the Federal Reserve's proposed Check Truncation Act that 
provide a comparative negligence standard for indemnification 
and other claims under the Act? Would this comparative 
negligence standard alter the current customer protections 
under check law?

A.1. The comparative negligence provision of Sections 5 and 8 
of the Federal Reserve proposal provides that the potential 
liability of a bank to another person under the proposal's 
indemnity relating to a substitute check or for other failures 
to comply with the proposal is limited to the extent that the 
resulting losses are caused in part by the negligence of the 
person making the claim. As an initial matter, it should be 
pointed out that the person making the claim against a bank 
could be a consumer, a business customer, or even another bank. 
The comparative negligence provision would apply the same way 
in all cases.
    This comparative negligence provision was included in the 
proposal to provide a similar defense to full liability that is 
available under common law in most States, as well as under the 
Federal Reserve's Regulation CC and the State law Uniform 
Commercial Code (UCC) provisions that currently regulate check 
operations. This comparative negligence standard does not 
change check law liabilities as they work today, but rather makes 
the application of the new warranties provided under the proposal 
similar to the liability structure established under the UCC, and 
Regulation CC for checks today.
    Under the Federal Reserve Board Regulation CC, the damages 
a person is entitled to as a result of a failure to comply with 
that Regulation are diminished in proportion to the amount of 
the negligence or bad faith attributable to that person. (See 
Regulation CC, Section 229.38(c).)
    The UCC similarly includes the concept of comparative 
negligence. For example, Section 4 - 406 of the UCC requires 
that a customer must exercise reasonable promptness to examine 
a statement of checks to determine if any unauthorized checks 
have been paid. If the customer fails to comply with this duty, 
the customer may be precluded from recovering the amount of the 
unauthorized checks. Furthermore, if the customer can establish 
that the bank's negligence contributed to the customer's loss 
under this UCC section, the loss is allocated between the bank 
and the customer on the basis of the relative comparative 
negligence of the parties.
    This comparative negligence approach in the proposal (as 
well as the UCC and Regulation CC) reflects the policy of 
fundamental fairness--if both parties acted wrongly and each 
contributed to the loss, they should share the loss 
accordingly.
    The comparative negligence provision of Sections 5 and 8 of 
the proposal only applies in the event of a claim made under 
the Section 5 indemnity or for a failure to comply with the 
Act. The comparative negligence provisions of the proposal do 
not alter or preempt any other State or Federal law rights or 
claims the customer may already have under existing law 
relating to a check payments.
    Finally, as a related matter, whenever one is discussing 
claims between a bank and its customer, it should be 
highlighted that the vast majority of customer complaints or 
disputes regarding a check transaction are resolved by the bank 
to the customer's satisfaction through the normal customer 
service process. Very few disputes between customers and banks 
actually go to arbitration or litigation. Accordingly, while 
this comparative negligence standard is very 
important for a large dollar dispute that results in 
litigation, in the typical consumer allegation of error in a 
check transaction, this comparative negligence standard would 
likely not be relevant or applied.
