[Senate Report 108-79]
[From the U.S. Government Publishing Office]



                                                       Calendar No. 168
108th Congress                                                   Report
                                 SENATE
 1st Session                                                     108-79

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



 
                      CHECK TRUNCATION ACT OF 2003

                                _______
                                

                 June 25, 2003.--Ordered to be printed

                                _______
                                

Mr. Shelby, from the Committee on Banking, Housing, and Urban Affairs, 
                        submitted the following

                              R E P O R T

                         [To accompany S. 1334]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Banking, Housing, and Urban Affairs, 
reported an original bill (S. 1334) to facilitate check 
truncation by authorizing substitute checks, to foster 
innovation in the check collection system without mandating 
receipt of checks in electronic form, and to improve the 
overall efficiency of the Nation's payments system, and for 
other purposes, having considered the same, reports favorably 
thereon and recommends that the bill do pass.

                              INTRODUCTION

    On June 18, 2002, the Senate Committee on Banking, Housing, 
and Urban Affairs considered original legislation entitled 
``The Check Truncation Act of 2003'', a bill to facilitate the 
use of check truncation and the electronic collection and 
return of checks. The Committee voted unanimously to report the 
bill, as amended by a managers' amendment that was adopted by 
voice vote, to the Senate for consideration.

                       PURPOSE OF THE LEGISLATION

    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. The 
electronic process for transmitting information allows banks 
which have these voluntary agreements to stop, or truncate, the 
flow of paper checks. Some banks have such agreements and have 
been able to take advantage of electronic processing using 
advanced imaging technology. However, since there are over 
fifteen thousand banks, thrifts, and credit unions, it is 
extremely difficult to obtain electronic agreements on a large 
scale, which has hampered the industry's ability to achieve 
substantial further improvements in the check collection and 
return process. As a result, billions of checks continue to be 
either trucked or flown across the country to complete the 
clearing process. Given the availability of inexpensive 
electronic transmissions media, this enormous dependence on 
ground and air transportation systems makes very little sense. 
The terrorist attacks on September 11, 2001, underscored the 
importance of increasing flexibility in the payment system. 
Truncation could be used to make the process less expensive 
over the long term. While the bank must make an initial 
technology investment, the bank saves money on processing and 
transportation of paper checks.
    This bill is designed to facilitate check truncation 
without requiring banks to fully convert to an electronic 
process on either end of the clearing process. The primary 
change in current law is that banks could use electronics to 
streamline the check collection and return process even in 
cases in which they do not have electronic exchange agreements. 
For those banks which do not choose to use an electronic 
system, a new instrument or ``substitute check'' would be 
created from the electronic check image for delivery to that 
bank. The substitute check would be the legal equivalent of the 
original check and could be processed by receiving banks just 
as original paper checks are today. The substitute check, would 
be machine readable and would bear a magnetic-ink character 
(MICR) line. It would also include an image of the front and 
the back of the original check. The bill also imposes warranty 
and indemnity obligations, which are intended to compensate 
consumers, banks, and other processors for losses caused by the 
creation of the substitute check. Finally, the proposal also 
provides an expedited recredit provision for consumer accounts 
in cases where consumers make claims against their banks for 
improper charges to their accounts for substitute checks that 
are provided to the consumers.
    The bill would apply existing check law, including the 
Uniform Commercial Code (UCC) and the Federal Reserve Board's 
Regulation CC, to substitute checks which would be legally 
equivalent to the original checks.
    The Federal Reserve Board believes that the proposed 
legislation may result in substantial payments system benefits. 
Banks could use substitute checks to collect and return checks 
more quickly and to reduce the banking industry's reliance on 
the physical transportation of checks. Banks might also be able 
to reduce their infrastructure costs because their branch and 
ATM networks would no longer need to be tied geographically to 
their processing centers. Banks' customers may also benefit 
from these infrastructure changes if they enable banks to offer 
broader deposit options, later cutoff hours, more timely 
information, and faster check collection and return.
    Credit unions have been using a truncation process since 
the mid-1970s. Of the checks written, credit unions process 
roughly 10 percent. Of the credit unions that offer checking 
(share draft) accounts, 91 percent truncate checks, according 
to the Credit Union National Association (CUNA). For credit 
unions, generally the check proceeds through the clearing 
process to the point where it is truncated or held by either 
the credit union or its corporate credit union or other 
processor. At that point, the information on the draft is 
stored electronically and printed on the member's monthly 
statement. In some cases, electronic images of the draft are 
returned with the statement, but that is not required.

                                HEARINGS

    The Banking Committee's action followed a hearing on the 
check truncation proposal. On April 3, 2003, the Committee 
heard testimony regarding the Federal Reserve Board proposal on 
Check Truncation. The witnesses testifying were Vice Chairman 
Roger Ferguson, Board of Governors of the Federal Reserve 
System; 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 Buchanan, Executive Vice President from Zions 
Bancorporation, representing the American Bankers Association, 
the Financial Services Roundtable, America's Community Bankers, 
Independent Community Bankers of America and the Consumer 
Bankers Association.

             SECTION-BY-SECTION ANALYSIS OF THE LEGISLATION

Section 1. Short title; table of contents

    The proposed Act is known as the Check Truncation Act of 
2003.

Section 2. Findings and purposes

    The purposes of this Act are to facilitate check truncation 
by authorizing substitute checks; to foster innovation in the 
check collection system without mandating receipt of checks in 
electronic form; and to improve the overall efficiency of the 
Nation's payments system.

Section 3. Definitions

    This section defines the terms used in the Act including 
``indemnifying bank'', ``MICR line'', ``reconverting bank'', 
``truncate'' and ``substitute check''.

Section 4. General provisions governing substitute checks

    This section permits a person to send a substitute check 
without the agreement of the recipient and provides legal 
authority for fully negotiable substitute checks to the extent 
that a bank makes the substitute check warranties pursuant to 
the requirement as of Section 5. A substitute check that 
complies with the requirements of this section is the legal 
equivalent of the original check. Substitute checks will be 
subject to the Uniform Commercial Code, Reg. CC and other 
applicable Federal or State law.

Section 5. Substitute check warranties

    The section creates warranties pertaining to substitute 
checks. A bank that transfers, presents or returns a substitute 
check and receives payment, warrants that: the check complies 
with the requirements for legal equivalence under Section 4 of 
the Act, and; the person that makes payment based on receipt of 
the substitute check will not receive another version of that 
check for payment.

Section 6. Indemnity

    This section provides indemnities for banks or consumers 
who receive substitute checks. Any bank that creates a 
substitute check, and any bank that receives payment for 
transfer of either an electronic or paper version of that check 
indemnifies all subsequent persons who receive the substitute 
check and incur a loss due to the receipt of the substitute 
check instead of an original check. Damages are limited to the 
amount of the check (along with interest and attorney fees) 
unless the indemnifying bank breaches a warranty imposed under 
Section 5, at which point the claimant is entitled to receive 
the amount of the loss proximately caused by the breach. 
Comparative negligence can be counter-claimed to limit damages.
    This Act provides a comparative negligence standard for a 
person making an indemnity claim under this section or seeking 
damages under section 9. If the person's losses resulted in 
whole or in part from that person's own negligence or failure 
to act in good faith, then the damages due to that person are 
reduced in proportion to the amount of negligence or bad faith 
attributable to that person.
    These comparative negligence provisions are not intended to 
reduce the rights of a consumer or any other person under the 
UCC. Rather, these provisions are intended to clarify that the 
same principles that are currently incorporated in existing 
law, such as Regulation CC, the UCC, and common law, will 
continue to apply under the Act. The Congress anticipates that, 
in the absence of fraud, the comparative negligence provisions 
generally will not be applicable to consumer check users.

Section 7. Expedited recredit for consumers

    This section provides that a consumer may make a claim for 
a recredit if he or she asserts that the bank charged the 
consumer's account improperly or the consumer has a warranty 
claim with respect to the substitute check that was provided to 
the consumer. The consumer must show that he or she suffered a 
loss and that the production of the original or a better copy 
of the original is necessary to determine the validity of the 
claim.
    The consumer is required to make a claim for expedited 
recredit within 40 days after the financial institution 
transmits the periodic statement or receipt of the substitute 
check, whichever is later. Under extenuating circumstances, 
including extended travel or illness of the consumer, the 
financial institution shall extend the period for a reasonable 
amount of time.
    A bank must recredit a consumer's account within one day of 
determining that the consumer's claim is valid. If the bank has 
not determined the validity of the claim within 10 business 
days, the bank must recredit the lesser of the amount charged, 
or $2,500 plus accrued interest, and any remaining amount must 
be recredited within 45 calendar days.
    A bank may delay the availability of the recredit on claims 
made on new accounts, on accounts that have repeated 
overdrafts, when a bank has a reasonable cause to believe that 
the claim is fraudulent, or in emergency situations. A bank 
that delays the availability of or reverses a recredit must 
notify the customer promptly. Notices of invalid claims, 
recredit and reversal of recredit must be made to consumers no 
later than the day following the day on which the bank makes 
these determinations.

Section 8. Expedited recredit procedures for banks

    Section 8 authorizes a bank to make a claim against an 
indemnifying bank for an expedited recredit if the claimant 
bank's customer has made a claim for recredit; the claimant 
bank has suffered a loss; and production of the original check 
or a better copy of the original check is necessary to 
determine the validity of the charge. The claim must be made 
within 120 days of the transaction and the indemnifying bank 
has 10 business days to produce the original check or a better 
copy of the original check. The indemnifying bank must also 
recredit the amount to the claimant bank, or provide 
information as to why the indemnifying bank does not have to 
provide a recredit. A recredit does not abrogate other 
liabilities the indemnifying bank may incur.

Section 9. Delays in an emergency

    This section permits banks to delay the time limits 
prescribed in the Act, if the payment system or 
telecommunications networks are interrupted by an emergency 
beyond the control of the bank, if the bank uses such diligence 
as circumstances require.

Section 10. Measure of damages

    This section sets out that, except as provided in Section 
6, damages are limited to the lesser of the amount of the 
check, or amount of loss suffered due to violation of the Act, 
plus interest and expenses. Comparative negligence applies, and 
this subsection does not affect the rights of the consumer 
under the UCC or other applicable Federal or State law.

Section 11. Statute of limitations and notice of claim

    This section requires that an action must be brought within 
one year of when the claimant learned, or should have learned, 
of the facts and circumstances giving rise to the action. 
Notice of claim must be given to the bank within 30 days of 
when a person has reason to know of the claim. A recredit claim 
under Section 7 constitutes notice for the purposes of this 
Section.

Section 12. Consumer awareness

    The section requires that banks must provide customers that 
receive original checks or substitute checks with a brief 
informative notice for the first three years that the Act is in 
effect. This notice will make customers aware of the legal 
status of substitute checks and the framework for the recredit 
process. By three months prior to the effective date of this 
Act, the Fed will make available model forms of such notice 
that banks may use.

Section 13. Effect on other law

    This section preempts any provision of Federal or State law 
only to the extent of the inconsistency.

Section 14. Regulations

    This section authorizes the Federal Reserve Board to 
promulgate final regulations necessary for implementation of 
this Act. Although the CTA gives the Board authority to adopt 
implementing regulations, the Committee recognizes that the 
Secretary of the Treasury has broad and long-standing authority 
to establish and administer the rules that govern payments 
disbursed by Treasury, including Treasury checks. The CTA does 
not affect the Secretary's authority to regulate Treasury 
checks, to the extent those regulations are not inconsistent 
with this Act. The Treasury cannot adopt regulations, for 
example, that would condition the payment of a substitute 
Treasury check on the subsequent delivery of the original 
check.
    The Committee acknowledges the Department of Treasury's 
concern about the legislation's impact on its ability to 
continue complying with its ongoing responsibilities and court 
orders in the Cobell et al v. Norton et al case. Treasury is 
currently operating under a Court order that it retain, among 
other documents, original Treasury checks for the duration of 
the litigation unless, and until, relieved of that obligation 
by the Court. Noting that no judicial relief has yet been 
granted, Treasury views as problematic the Act's provisions 
permitting banks, at their discretion, to retain only digital 
images of checks while destroying original paper checks.

Section 15. Study and report on funds availability

    No later than 30 months following the effective date of 
this Act, the Federal Reserve will provide the Congress with an 
evaluation of the implementation and impact of this Act. The 
study will address issues that the Federal Reserve monitors as 
part of its regulatory responsibilities under the Expedited 
Funds Availability Act.

Section 16. Evaluation and report by the Comptroller General

    The Comptroller General will also report on the 
implementation and administration of this Act, no later than 
five years after enactment.

Section 17. Variation by agreement

    This section provides that only provisions of section 8 may 
be varied by the banks involved. That is, banks could 
contractually vary the interbank recredit provisions and only 
those provisions.

Section 18. Effective date

    This Act shall become effective one year after the date of 
enactment.

                        CHANGES IN EXISTING LAW

    On June 18, 2003, the Committee unanimously approved a 
motion by Senator Shelby to waive the Cordon rule. Thus, in the 
opinion of the Committee, it is necessary to dispense with the 
requirement of section 12 of rule XXVI of the Standing Rules of 
the Senate in order to expedite the business of the Senate.

                      REGULATORY IMPACT STATEMENT

    In accordance with paragraph 11(b), rule XXVI, of the 
Standing Rules of the Senate, the Committee makes the following 
statement concerning the regulatory impact of the bill.
    The Act establishes a framework which would enable banks to 
achieve many of the benefits of electronic check processing 
without mandating that any bank receive checks in electronic 
form. Banks would be able to truncate, or stop, the flow of 
checks, process them electronically, and create machine-
readable substitute checks, if necessary, that would be the 
legal equivalent of the original checks. Substitute checks 
could be processed by receiving banks just as original paper 
checks are today, thereby not significantly affecting the 
operations of banks that do not wish to participate in the 
electronic collection or return of checks. By permitting choice 
of processing method, the Act represents regulatory reform and 
should result in reduced costs to the financial services 
industry and consumers over the long term.
    Congress intends this Act to leave a bank and its customer 
in substantially the same legal and practical position 
regardless of whether or not a substitute check is used. The 
Act's warranty, indemnity, and expedited recredit provisions, 
which provide rights to recipients of substitute checks in the 
event that they incur a loss due to the receipt of a substitute 
check instead of the original check, accomplish this purpose.
    The Act will improve the efficiency of the payments system 
by enabling banks to expand the use of electronics in the 
collection and return of checks, reducing the industry's 
reliance on transportation to move checks across the nation. 
Had the provisions of this proposed Act been in effect when air 
traffic came to a standstill due to the terrorist attacks on 
September 11, 2001, banks would have been able to reduce the 
impact of the disruption in air transportation on the check 
collection system. Because the Act seeks to provide choice of 
clearing mechanism and update the clearing process, the 
Committee believes that this legislation will have a favorable 
regulatory impact.

                          COST OF LEGISLATION

    Section 11(b) of rule XXVI of the Standing Rules of the 
Senate, and Section 403 of the Congressional Budget Impoundment 
and Control Act, require that each committee report on a bill 
contain a statement estimating the cost of the proposed 
legislation. The Congressional Budget Office has provided the 
following cost estimate and estimate of costs of private-sector 
mandates.

                                     U.S. Congress,
                               Congressional Budget Office,
                                     Washington, DC, June 24, 2003.
Hon. Richard C. Shelby,
Chairman, Committee on Banking, Housing, and Urban Affairs,
U.S. Senate, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for the Check Truncation 
Act of 2003.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contacts are Mark Booth 
(for revenues), Matthew Pickford (for spending), and Victoria 
Heid Hall and Greg Waring (for the state and local government 
impact).
            Sincerely,
                                     Douglas Holtz-Eakin, Director.
    Enclosure.

Check Truncation Act of 2003

    The Check Truncation Act of 2003 would alter the process of 
clearing checks. It would allow a depository institution that 
has a check presented to it to choose on its own to provide to 
the paying depository institution a paper copy of the check, 
called a ``substitute check,'' rather than the original check 
itself. The substitute check would be the legal equivalent of 
the original check. Under current law, the depository 
institution presented with the check must transmit the original 
check to the paying institution for settlement, unless the two 
institutions have entered into an agreement for transmission of 
a paper copy of the check or the electronic information from 
the check. In addition, the bill would require the Board of 
Governors of the Federal Reserve System and the General 
Accounting Office (GAO) to conduct studies on aspects of the 
check-clearing process and the implementation of this 
legislation.
    CBO estimates that enacting the bill would have a 
negligible effect on federal revenues through its effects on 
the Federal Reserve's income and expenses from its check-
processing operations and its expenses in producing the 
mandated study. The Federal Reserve remits its net income to 
the Treasury, and those payments are classified as governmental 
receipts, or revenues, in the federal budget. Any additional 
income or costs to the Federal Reserve, therefore, can affect 
the federal budget. By reducing the transportation costs 
associated with clearing checks, the bill would reduce the 
costs that the Federal Reserve incurs in providing check-
processing services to depository institutions. It would change 
the Federal Reserve's costs of processing checks in other ways, 
as well. However, the Federal Reserve is required by law to 
charge the depository institutions for its check-processing 
services. Based on information provided by the Board of 
Governors of the Federal Reserve System, CBO estimates that any 
reductions to the Federal Reserve's costs of check clearing as 
a result of the bill would result in a nearly equal reduction 
in its income. Furthermore, CBO estimates that any additional 
expenses incurred by the Federal Reserve in order to produce 
the mandated report would be negligible. As a result, CBO 
estimates that the bill would have a negligible effect on the 
Federal Reserve's net income and, hence, on federal revenues.
    In addition to mandating that the Federal Reserve produce a 
study, the legislation would require GAO to report on the 
implementation of this bill, including gains in economic 
efficiency and benefits to consumers and financial institutions 
made possible from check truncation. Based on information from 
GAO, CBO expects that new reporting requirements would cost 
less than $500,000, assuming the availability of appropriated 
funds.
    The bill provides that a substitute check would be the 
legal equivalent of the original check under any provision of 
federal or state law. It would thereby preempt state laws, 
including the Uniform Commercial Code, to the extent that such 
laws require an original check. Such a preemption of state law 
is a mandate under the Unfunded Mandates Reform Act (UMRA). CBO 
estimates that enacting this mandate would impose no costs on 
state, local, or tribal governments and that its cost, 
therefore, would not exceed the threshold established in UMRA 
($59 million in 2003, adjusted for inflation). The bill 
contains no new private-sector mandates as defined in UMRA.
    On May 30, 2003, CBO transmitted a cost estimate for H.R. 
1474, the Check Clearing for the 21st Century Act, as reported 
by the House Committee on Financial Services. CBO estimated 
that, like the Check Truncation Act of 2003, H.R. 1474 also 
would have a negligible effect on the federal budget.
    The CBO staff contacts for this estimate are Mark Booth 
(for federal revenues), Matthew Pickford (for federal 
spending), and Victoria Heid Hall and Greg Waring (for the 
state and local government impact). This estimate was approved 
by G. Thomas Woodward, Assistant Director for Tax Analysis, and 
Peter H. Fontaine, Deputy Assistant Director for Budget 
Analysis.

                                
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