[Federal Register Volume 64, Number 212 (Wednesday, November 3, 1999)]
[Rules and Regulations]
[Pages 59607-59613]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-28580]


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FEDERAL RESERVE SYSTEM

12 CFR Part 229

[Regulation CC; Docket No. R-1034]


Availability of Funds and Collection of Checks

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board is adopting amendments to Subpart C of Regulation 
CC, which contains rules governing the collection and return of checks. 
The amendments to the regulation and Commentary are intended to provide 
further clarification as to the extent to which depository institutions 
and others may vary the terms of the regulation by agreement for the 
purpose of instituting electronic return systems.

EFFECTIVE DATE: December 15, 1999.

FOR FURTHER INFORMATION CONTACT: Louise Roseman, Director, Division of 
Reserve Bank Operations and Payment Systems (202/452-2789); Oliver I. 
Ireland, Associate General Counsel (202/452-3625), Stephanie Martin, 
Managing Senior Counsel (202/452-3198), Legal Division. For the hearing 
impaired only, contact Diane Jenkins, Telecommunications Device for the 
Deaf (TDD) (202/452-3544), Board of Governors of the Federal Reserve 
System, 20th and C Streets, NW, Washington, D.C. 20551.

SUPPLEMENTARY INFORMATION:

Background

    In February 1999, the Board requested comment on options for 
amending provisions in Regulation CC governing when paying or returning 
banks may send notices instead of returning the original 
checks.1 The purpose of the proposal was to explore whether 
more flexibility is needed to enable check system participants to 
experiment with methods to return checks electronically.
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    \1\ 64 FR 9105, Feb. 24, 1999.
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    The collection and return of checks is governed by both Regulation 
CC and state law (Articles 3 and 4 of the Uniform Commercial Code 
(U.C.C.)). When a paying bank decides to return a check, the U.C.C. and 
Regulation CC require it to send the check or a notice within certain 
deadlines.2 The U.C.C. and Regulation CC differ on when a 
bank can return a notice rather than the check itself. If a check is 
``unavailable for return,'' U.C.C. 4-301(a) allows a paying bank to 
charge back the check by revoking its provisional settlement with the 
presenting bank based on a notice of dishonor or nonpayment. The 
Official Comment to U.C.C. 4-301 states that a check may be considered 
unavailable for return if, under a collecting bank check retention 
plan, presentment is made by a presentment notice and the check is 
retained by the collecting bank. Presumably, therefore, the U.C.C. 
would allow a paying bank to return a notice when a check has been 
truncated. (It is not clear whether a check would be deemed unavailable 
for return under the U.C.C. if the paying bank, rather than the 
collecting bank, retains it.)
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    \2\ The paying bank must initiate the return by midnight of the 
banking day following the day the check was presented (U.C.C. 4-
301). The paying bank must return the check so that it reaches the 
depositary bank expeditiously, in accordance with Sec. 229.30(a) of 
Regulation CC.
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    Regulation CC (Secs. 229.30(f) and 229.31(f)) establishes a 
``notice in lieu of return,'' which substitutes for the original check 
and carries value. The notice-in-lieu provisions of Regulation CC 
provide that the paying (or returning) bank must return the original 
check unless the check is unavailable, in which case the bank may 
return a notice that meets certain information requirements. The 
Regulation CC Commentary states that notice is permitted in lieu of 
return only when a bank does not have and cannot obtain possession of 
the check or must retain possession of the check for protest. The 
Commentary explains that a check is not unavailable for return if it is 
merely

[[Page 59608]]

difficult to retrieve from a filing system or from storage by a keeper 
of checks in a truncation system.
    The primary reason for the difference between the U.C.C.''s and 
Regulation CC's treatment of notices is that there is likely to be less 
risk for a depositary bank in accepting a notice (instead of the 
original check) from a bank it knows than from a bank it doesn't know. 
Under the U.C.C., the paying bank returns a check to the presenting 
bank, which in turn charges back the check against the prior collecting 
bank, and so on back up the forward collection chain until the check 
reaches the depositary bank. Therefore, under the U.C.C., the 
depositary bank receives returns from the bank to which it had sent the 
check for collection and with which it has a previously established 
relationship. One of the purposes of Regulation CC was to speed up the 
check return system that existed under the U.C.C. Regulation CC 
eliminated the requirement that returned checks follow the forward 
collection chain. Under Regulation CC, the paying bank may send the 
returned check directly to the depositary bank or to any returning 
bank, even if that bank did not handle the check for forward 
collection. Therefore, under Regulation CC, depositary banks may 
receive returned checks from banks with which they have no previous 
relationship.
    Some check system participants asked the Board to clarify the 
interrelationship between the U.C.C. and Regulation CC in order to 
provide additional legal certainty for institutions that wish to 
experiment with electronic return systems, under which they would 
return images or other notices rather than the checks. These 
participants were concerned about their ability to bind all relevant 
parties to an electronic return arrangement under the variation-by-
agreement provisions of Regulation CC. Regulation CC (Sec. 229.37) 
permits the parties to a check to vary the notice-in-lieu provisions; 
however, an agreement under Regulation CC cannot affect banks, 
customers, or others that are not party to the agreement or otherwise 
bound by it. The Regulation CC variation-by-agreement provision differs 
from the corresponding language in U.C.C. 4-103 in that the U.C.C. 
allows clearinghouse rules (as well as Federal Reserve regulations and 
operating circulars) to be effective as agreements whether or not 
specifically assented to by all interested parties.3 
Regulation CC does not incorporate the U.C.C.''s special treatment for 
clearinghouse rules (or for Federal Reserve rules and circulars) but 
does not affect the status of such under the U.C.C.
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    \3\ The Official Comment to U.C.C. 4-103 (note 3) indicates, 
however, that there are limitations on the scope of clearinghouse 
rules. The Comment notes that clearinghouses are not authorized to 
rewrite the basic law generally and that clearinghouse rules should 
be understood in the light of functions the clearinghouses have 
exercised in the past.
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    This difference in variation-by-agreement provisions exists because 
Regulation CC does not govern the relationship between banks, their 
customers, and remote parties to the extent that the U.C.C. does. While 
Board rules can bind depository institutions, the Board does not appear 
to have the authority under the Expedited Funds Availability Act to 
bind depositors or payees to an electronic check return system. Section 
611(f) of the Act, which authorizes the Board to establish rules 
allocating loss and liability in the payments system, applies to loss 
and liability among depository institutions only. The Act does not 
authorize such allocations to customers of depository institutions.
    Although banks would be able to obtain agreement to the terms of an 
electronic return arrangement from their customers through account 
agreements, under Regulation CC they would not be able to bind remote 
parties to the check, such as non-depositor payees. Some check system 
participants sought an amendment to Regulation CC that would eliminate 
the risk that these remote third parties would bring a claim under 
Regulation CC in the event they suffered losses due to the fact that a 
check was returned electronically rather than in physical form. A claim 
could potentially arise under the following circumstances:
    Drawer A writes and delivers a check payable to Payee B. Payee B 
negotiates the check to Depositor C, who deposits the check in his 
bank. Depositor C's bank presents the check to Drawer A's bank. Both 
banks are participating in an electronic return system, and Drawer A's 
bank returns an image of the check to Depositor C's bank, which, in 
turn, charges Depositor C's account. Depositor C would have to attempt 
to collect the funds from Payee B or Drawer A without the physical 
check. Assuming that Depositor C has agreed to the electronic return 
system through an account agreement, Depositor C would bear the risk 
that Payee B or Drawer A would not pay without the original check. 
(Payee B or Drawer A may be concerned about the risk of double payment 
if the original check is not returned.) If Payee B pays Depositor C in 
return for the check image or similar notice, Payee B may still be 
unable to collect from Drawer A without the check and could suffer 
losses (although Payee B may still have recourse against Drawer A under 
the U.C.C. even without the original check). Presumably, an electronic 
return arrangement would allow banks or customers to request the 
original check within a certain amount of time. If Drawer A becomes 
insolvent before the original check is retrieved, Payee B would suffer 
losses. If Payee B would have been able to collect from Drawer A had 
Payee B originally received the check rather than the notice, then 
Payee B's losses would likely be attributable to the electronic return 
system.
    Regulation CC imposes a duty on banks to exercise ordinary care and 
act in good faith in handling checks under Regulation CC. This duty 
runs to the depositary bank, the depositary bank's customer, the owner 
of a check, or another party to the check. If a bank violates these 
duties, resulting in harm to one of these parties, the party may have a 
claim against the bank for damages. Therefore, if a bank returned a 
notice-in-lieu when the physical check was deemed ``available'' under 
Regulation CC, and the return of the notice rather than the physical 
check caused a party to the check to incur a loss, the bank potentially 
could be liable for damages. The bank sending the notice could be 
liable even if it had agreed with the receiving bank to use notices in 
lieu of return. The injured party would have to show lack of good faith 
or failure to exercise ordinary care.
    The risk of a bank becoming liable to a remote third party under 
the circumstances described above appears to be low. Nevertheless, some 
check system participants stated that they were reluctant to begin 
experimenting with electronic check return systems without additional 
protection. To flesh out the pros and cons of making regulatory changes 
in this area, in February 1999 the Board sought commenters' input on 
two options.4
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    \4\ 64 FR 9105, Feb. 24, 1999.
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    The first option was to amend the Commentary to Regulation CC to 
state that banks could send a notice of dishonor or nonpayment in 
accordance with the provisions of U.C.C. 4-301 when they return the 
notice through the forward collection chain, as contemplated in the 
U.C.C. The U.C.C. notices would be subject to the Regulation CC 
expeditious return rules. This proposal would clarify that banks could 
avail themselves of the U.C.C. rules regarding return of notices to the 
same extent that they could before Regulation CC was adopted. The Board 
noted, however, that this proposal may

[[Page 59609]]

not provide relief for check truncation or image systems if returns do 
not follow the forward collection chain and that it could have 
consequences for the depositors or payees of the checks, who may have 
difficulty recovering from the drawers without the original checks.
    The second option was to delete the Regulation CC Commentary 
language that explains when a check is unavailable for return. Instead 
of this language, the Commentary would indicate that notices in lieu of 
return are permissible whenever they would be permissible under the 
U.C.C. The Board noted that this option would liberalize the 
circumstances under which banks could use notices in lieu of return and 
potentially make it easier for banks to establish electronic check 
return mechanisms that feature check truncation, but would force 
depositary banks to accept notices from banks with whom they may have 
no established relationships. This option could also have consequences 
for the depositors or payees of the checks as discussed above under 
option one.
    The Board also proposed to delete Sec. 229.36(c) of Regulation CC 
and its associated Commentary, which states that a bank may present a 
check electronically under an agreement with the paying bank and that 
the agreement may not extend return times or otherwise vary the 
provisions of Regulation CC with respect to persons not party to the 
agreement. This provision of the regulation is subsumed by the 
variation-by-agreement provisions in Sec. 229.37, and it may be 
unnecessary and potentially confusing to retain special provisions 
regarding a particular type of variation by agreement. The Board 
proposed to add an example to the Commentary to Sec. 229.37, listing an 
electronic check presentment agreement as a permissible variation by 
agreement under Regulation CC. The Board noted that eliminating 
Sec. 229.36(c) and its Commentary would result in no substantive change 
to the regulation regarding the validity of electronic presentment 
agreements.

Summary of Comments

    The Board received 72 comments on its proposed options, classified 
as follows:

Banks/Bank holding cos: 32
Thrifts/Thrift holding cos: 2
Credit unions/Corporate credit unions: 9
Trade associations representing--
    Banks: 5
    Credit unions: 5
    Clearing houses: 2
    Non-banks: 2
Clearing houses/organizations: 9
Federal Reserve Banks: 2
Non-bank service providers: 4

Problems Raised by Notices in Lieu of Returns

    Overall, the commenters were supportive of changes that would 
improve efficiency and reduce risk in the check collection and return 
system, but were reluctant to support changes that would impose costs 
on depositary banks, their customers, and other parties to the check 
without their consent. Thirty-five commenters specifically discussed 
the problems that would arise if depositors received notices of 
returned checks instead of the physical checks. Many of these 
commenters echoed the problems stated by the Board in its proposal, 
i.e. that customers generally expect checks to be returned to them when 
their accounts are charged back and that customers have ownership 
rights in the physical checks. Commenters were concerned about whether 
their customers would be able to collect from drawers without the 
original checks and some noted that the drawer's risk of double payment 
needs to be addressed. Some of these commenters stated that the U.C.C. 
limits a holder's rights to enforce a check without possession of the 
physical item. Several commenters raised concerns about whether a 
notice of a returned check would be sufficient evidence of the return 
in court, and others noted that law enforcement authorities often 
require the original check in order to lift fingerprints from the check 
or examine the handwriting. Four commenters, however, stated that even 
though the customer, as the legal owner, may have a right to the 
original check, there may be no practical consequence if an image or 
other electronic return has legal equivalence under the U.C.C. or the 
Uniform Electronic Transactions Act.5
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    \5\ The Uniform Electronic Transactions Act is a model law 
drafted and approved by the National Conference of Commissioners on 
Uniform State Laws and recently adopted in California. It does not 
provide that a check image or other electronic returned check is 
legally equivalent to the original check, except for limited record-
keeping purposes.
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    Twenty-one commenters raised concerns about whether the information 
provided on a notice-in-lieu-of-return would be sufficient to allow the 
depositary bank to charge back its customer's account. The commenters 
listed such necessary information as the indorsement (especially on 
third-party checks), the check date, the payee, the amount, the reason 
for return, the teller stamp, trace numbers, and the account number. 
Some commenters noted that missing information is already a problem for 
notices-in-lieu under the current regulation. Some of these comments 
were related to concerns about the quality of the photocopy or image 
that depositary banks would receive, and others were related to the 
sufficiency of information in an electronic notice that did not include 
an image of the check. One commenter suggested that if notices-in-lieu 
become more permissible, then all of the information requirements of 
Sec. 229.33(b) should be mandatory and no questions marks allowed.

Costs and Benefits of Electronic Returns

    Thirty-one commenters specifically mentioned the benefits of an 
electronic return system. These commenters generally believe that 
electronic returns will enable checks to be returned faster and will 
allow depositary banks and their customers to protect themselves better 
against check fraud. They stated that an electronic return system would 
lead to operational savings and make forward check truncation feasible.
    On the other hand, eight commenters believed that the costs of an 
electronic return system could likely outweigh the benefits. The 
commenters noted that costs could take the form of incomplete 
information to the depositary bank, potentially resulting in delays in 
charging back the customer's account, as well as the expense of 
hardware and software to operate an electronic return system.
    Six commenters discussed the potential competitive effects of 
establishing an electronic return system. These commenters were 
generally concerned that community banks and other small depository 
institutions may not be technologically prepared for electronic returns 
and should not be placed at a disadvantage by any regulatory change.

Option One

    Only one commenter expressed a preference for option one. Thirty-
two commenters pointed out specific problems that would arise if the 
Board were to adopt option one. Many stated that application of option 
one would be too limited in scope to provide sufficient incentive for 
experimentation in electronic returns. Several commenters believed that 
certain checks may be impossible to return through the forward 
collection chain within the expeditious return deadlines. Others 
commented that the U.C.C. standards are not clear as to what 
information must be included in a U.C.C. notice of nonpayment and were 
concerned that the depositary bank would not receive information 
sufficient to charge the check back to its customer's account.

[[Page 59610]]

Some commenters believed that adoption of option one would lead to 
confusion as to when the U.C.C. applied to a returned check rather than 
Regulation CC, and one commenter noted that state-to-state variation in 
the meaning of ``unavailable for return'' could lead to confusion with 
respect to interstate transactions. Commenters raised other questions 
as to the implementation of option one, such as (1) whether the 
presenting bank that receives a U.C.C. notice of nonpayment, but holds 
the truncated physical check, has the option to either send a notice or 
the check to depositary bank and (2) whether the physical check must be 
made available to the depositary bank or its customer upon request.

Option Two

    Eighteen commenters supported proposed option two, although nearly 
all of those commenters raised additional issues that they believed 
should be addressed. The Electronic Check Clearing House Organization 
(ECCHO) and seventeen other commenters supported option two so long as 
the regulation made clear that the depositary bank would have to agree 
to receive electronic notices in lieu of return. These commenters 
stated that experimentation with electronic notices should be conducted 
on a voluntary basis, governed by bilateral or multilateral agreements. 
The commenters stated that the depositary bank would need to know from 
whom it would be receiving electronic returns and would have to work 
out such issues as who would own the returns/images, acceptable quality 
standards, who to contact in case of problems, and what procedures to 
follow. One supporter of option two, however, did not expect that the 
receipt of unexpected electronic returns from unfamiliar banks would be 
widespread. This commenter stated that the issue of the quality of 
electronic returns from unfamiliar banks would be an operational matter 
that would likely be self-regulated between paying banks and depositary 
banks and should be left for the banks to police.
    Eleven commenters discussed specific problems regarding option two. 
Some of these commenters raised issues related to dealing with an 
unknown returning bank. They stated that accepting notices from banks 
with which the depositary bank has no relationship could pose 
significant financial or customer service risk exposure. They also said 
that handling returned items could become more complex and time-
consuming if images are received from multiple sources, and the amount 
of manual sorting could outweigh the advantages of new technology. 
Another concern raised by the commenters was that option two could 
increase the use of notices in lieu of returns, placing the burden on 
the depositary bank in providing the depositor with the information on 
the return item when a charge-back occurs without the physical check. 
The commenters also raised other matters that would need to be 
addressed under option two, such as (1) Whether the presenting bank 
that receives a notice but holds the physical check has the option to 
send either the notice or the check to the depositary bank and (2) 
whether the physical check must be made available to the depositary 
bank or its customer on request.

Other Comments on Options.

    Seventeen commenters opposed both options. Most of these commenters 
stated that the proposals would make the return process more 
complicated, particularly in connection with reconcilement, without a 
comprehensive all-electronic approach. They stated that the Board 
should address other issues related to electronic returns before 
adopting either option. One commenter favored either option, stating 
that either would accomplish the goal of reconciling Regulation CC with 
the U.C.C. as to when a check is available for return.
    Most of the commenters suggested additions or enhancements to the 
two options proposed by the Board:

Variation by Agreement.

    Nine commenters stated that the Board should permit clearing house 
rules to vary Regulation CC in same way as they vary the U.C.C. The 
commenters stated that this would avoid the need to change Regulation 
CC to accommodate innovations and would put private-sector banks on a 
more equal footing with non-banks and Federal Reserve Banks.
    The Federal Reserve Bank of Atlanta (FRB Atlanta) believed that the 
concern as to whether Sec. 229.37 of Regulation CC limits the ability 
of an agreement to bind remote parties is ameliorated by at least two 
factors: (1) FRB Atlanta stated that the only remote party right under 
Regulation CC is the right to receive a notice of return, which can be 
met by an image of sufficient quality to permit the depositary bank to 
identify its customer; other remote party rights arise under the U.C.C. 
and can be addressed in the context of agreements under the U.C.C.; and 
(2) At least one court decision 6 held that the depositary 
bank, as the collection agent for its customer, can enter into 
agreements on behalf of the customer without prior consent as long as 
agreement is reasonable. FRB Atlanta stated that accepting an image 
return (with the paper check to follow) seems to be reasonable. FRB 
Atlanta suggested, as an alternative to the proposed options, that the 
Board revise the Commentary to Sec. 229.37 to provide that depositary 
bank may agree with paying or returning banks to accept images or other 
notices of dishonored checks as notices in lieu of return and that 
those banks may be responsible under other applicable law to parties 
interested in the check for any losses caused by the handling of check 
returns under such agreements (except to the extent addressed in 
effective agreements with those other parties).
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    \6\ Graubert v. Bank Leumi, 399 N.E. 2d 930 (Ct. App. N.Y. 
1979).
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U.C.C. Availability Requirement.

    Three commenters stated that the proposal's reference to U.C.C. 4-
301 is not sufficient because it is not clear what types of check 
programs are encompassed by the U.C.C.'s Official Comment to 4-301 
regarding ``availability'' of checks for return. The commenters 
suggested that the Regulation CC Commentary should specifically permit 
notice in lieu of return when a check is difficult to retrieve from a 
filing system or from storage pursuant to a truncation, image or other 
check electronification program, provided the receiving bank has agreed 
to accept notices in lieu of return in such circumstances.
    Two commenters raised other questions concerning what sorts of 
truncation arrangements are contemplated by U.C.C. 4-301(a). These 
comments reflected the uncertainty as to whether it matters which bank 
in the collection or return chain is the truncating bank in determining 
if a check is unavailable for return under the U.C.C.
    Three commenters suggested that the Board allow a bank to provide a 
notice-in-lieu at will, rather than only when the original check is 
unavailable for return. These commenters noted that such returns may 
not be permissible under the U.C.C., but they anticipated that the 
U.C.C. or its state variations may become less restrictive in the 
future as technology changes.

Address Legal Status of Images.

    Five commenters requested that the Board address the legal status 
of images to provide comfort that an image or electronic notice legally 
replaces the original check. Some of these commenters suggested that 
the

[[Page 59611]]

Commentary should explicitly state that images are acceptable in the 
U.S. check collection and return system to bolster banks' ability to 
convince customers to accept images in lieu of the original check.

Establish Standards.

    Fifteen commenters asked the Board to establish standards for an 
electronic return system. The commenters expressed a need for standards 
in areas such as image quality, standardized return reason codes, data 
communication, procedures to verify system integrity and compatibility, 
and indorsements. Some of these commenters stated that the Board should 
set time limits for the returning bank to provide the depositary bank 
with the paper check and procedures for request and retrieval. One 
commenter stated that the Board should provide for migration to more 
image-friendly check stock. Another commenter stated that a new 
regulatory infrastructure is necessary to address detailed issues, even 
more specifically than the Board's same-day settlement provisions in 
Regulation CC.

Address Return Deadlines.

    Seven commenters stated that the Board should clarify how an 
electronic return system would affect return deadlines. For example, 
one commenter suggested that the Board should clarify when the return 
clock starts if checks are presented electronically and the physical 
item is necessary to create a return. Other commenters suggested that 
the Board amend Regulation CC to provide that, if a bank sends image 
returns under a truncation arrangement where the check was presented 
electronically, it would not be required to meet the U.C.C. return 
deadline. The commenters stated that this rule would nurture the 
development of electronic check presentment and would enable the paying 
bank to examine the physical check and create an image return without 
violating the U.C.C. midnight deadline.

Representment.

    Eleven commenters stated that the Board should address how a 
depositary bank could represent a check that had been returned 
electronically. They said that representment of checks returned 
electronically would pose technical and operational challenges, 
including the form of the represented check and what would replace the 
indorsement audit trail. One commenter suggested that the Board 
establish redeposit rules allowing for prompt representment of 
electronic returns to protect consumers from the potential loss from 
dishonored checks.

Depositary Bank Protections.

    Thirteen commenters requested that the Board take steps to protect 
depositary banks under electronic return systems. Several commenters 
suggested that the depositary bank should be able to send back an 
electronic return and require return of the physical check instead. 
Other commenters suggested providing warranty protection for the 
depositary bank by requiring the bank that sends an electronic return 
to indemnify a depositary bank that charges back its customer based on 
the electronic return. One commenter also stated that the depositary 
bank and its customers should receive guarantees that the original 
check will not be returned.

Allow Images Only.

    Ten commenters suggested that the Board limit electronic return to 
images only. One of these commenters stated that the regulation should 
reflect a preference in favor of check imaging rather than the 
transmission of a detailed accounting of the check. Another commenter 
stated that the regulation should discourage the proliferation of 
written notices, which are often incomplete and expose the depositary 
bank to undue risk.

Address Coordination Issues.

    Two commenters suggested that the Board should address various 
issues related to the interaction of an electronic return system with 
other electronic payment initiatives. One commenter asked for 
clarification as to how a paying bank could return an image if it is 
receiving check presentment electronically. This commenter also asked 
how a depositary bank could create ACH returned-check entries (RCKs) 
without the physical checks. Another commenter suggested that the Board 
should provide a statement authorizing use of a notice in lieu of 
return when the check has been processed electronically and returned to 
its owner at the point of sale. The commenter stated that this would 
encourage increased experimentation with electronic check truncation at 
the point of sale.

Comprehensive Approach.

    Seven commenters believed that the Board should take the lead in 
working with the industry on a comprehensive approach to structuring an 
all-electronic return process. One commenter stated that electronic 
returns need to be part of a new regulatory approach for overall check 
electronification. Another commenter stated that the Board should 
express its willingness to consider and act on appropriate regulatory 
changes on an ongoing basis during the transition to electronics in 
check processing. Another commenter suggested that the Board fund a 
nationwide education and marketing campaign to ensure consumer and 
corporate acceptance of images in lieu of checks. Finally, one 
commenter stated that the current return rules hold the check system 
hostage to the needs of a few payees, and the Board should endorse the 
notice-in-lieu process more enthusiastically rather than merely 
condoning it.

Implementation Date.

    Seven commenters made statements regarding the implementation date 
of any rule change. Most of these commenters favored implementation as 
quickly as possible, but one commenter asked for at least one year lead 
time to allow for updating of internal systems.

Amendments to Secs. 229.36 and 229.37.

    Seven commenters explicitly supported the proposed amendments to 
Secs. 229.36 and 229.37 regarding electronic presentment agreements. 
One commenter suggested that the restriction on the expansion of check 
return deadlines should be retained explicitly.
    Board staff invited all of the public commenters to participate in 
a meeting on July 26 to discuss issues related to the proposed 
amendments. Twenty-eight commenters attended the meeting.

Discussion

    As indicated in the comment summary, overall, most commenters were 
open to the idea of an electronic return system but were very concerned 
about the effects of such a system on depositary banks and their 
customers. Many commenters were reluctant to support regulatory changes 
without knowing the details of how an electronic return system would 
work and how they and their customers would be protected. This concern 
prompted many commenters to suggest that the Board, in cooperation with 
banks, establish more detailed rules and standards that would govern 
such a system. The Board continues to believe that practices and 
standards would be developed most efficiently through commercial 
practice and market experimentation rather than by regulation. The 
Board believes that its appropriate role is to facilitate 
experimentation by determining whether its rules create barriers to 
experimentation and if so, whether

[[Page 59612]]

those rules can be changed without creating undue adverse affects.
    As noted above, under Regulation CC, the inability to bind remote 
parties to an interbank agreement could lead to liability on the part 
of banks for relying on electronic returns. Some participants in the 
July 26 meeting reiterated that it is this potential liability they 
would like to avoid. ECCHO and various others suggested in their 
comment letters that the Board adopt option two but permit an 
electronic return only if the depositary bank agrees to accept it. 
ECCHO restated its proposal at the July 26 meeting, laying out a 3-part 
plan for revising option two: (1) All of the banks involved, including 
the depositary bank, would have to agree to participate in any 
electronic check return program, (2) a notice in lieu of return, 
whether specifically permitted under Regulation CC or permitted as part 
of an interbank agreement on electronic check returns, would satisfy 
the requirements of Regulation CC to the same extent as the return of 
the original paper check for all bank and non-bank parties to the 
check, and (3) banks that are parties to an electronic return agreement 
may be liable under other law to non-bank parties unless that liability 
is covered by other agreements.
    Most of the discussion at the July 26 meeting focused on the cut-
off of rights under ECCHO's point (2), which would shield participating 
banks against claims by remote parties under Regulation CC but would 
not operate as a shield against claims under other law. (Presumably, 
ECCHO and others would rely on their ability to bind remote parties by 
clearinghouse rules under the U.C.C. to address these potential 
claims.) The Board's proposed option two would have cut off Regulation 
CC rights, but those rights would have been cut off for both banks and 
non-banks. The ECCHO proposal would allow banks to opt out of the 
electronic return arrangement but would not allow their customers or 
other parties to the check to do so. Supporters of the ECCHO proposal 
reasoned that this distinction was justified because depositary banks 
would have to make operational changes to be able to accept electronic 
returns, but depositors and others would not necessarily need to make 
such changes.
    Meeting participants were unable to quantify the risk presented by 
the possibility that non-assenting parties may assert Regulation CC 
rights if an electronic return program caused them to incur losses. In 
general, participants agreed that, because banks can generally obtain 
assent from their customers through deposit agreements, the most 
serious risks would be from potential claims by remote third parties, 
such as non-depositor payees, unless those rights are cut off. ECCHO 
and some of the bank representatives stated that the uncertainty as to 
the size of this risk was preventing banks from investing in pilot 
electronic return programs. Without quantifying this risk, some banks 
stated that they are unable to judge whether the benefits of an 
electronic return system outweigh the risks, although some bank 
representatives said that they had not made a focused attempt to 
determine the magnitude of the risk. At the close of the meeting 
representatives from ECCHO and certain banks stated that they would 
take a closer look at the risks of claims from non-assenting parties 
under Regulation CC to determine whether those risks are actually 
outweighed by the perceived benefits to banks of electronic returns.
    In a subsequent letter to the Board, ECCHO reiterated its support 
for a Regulation CC amendment that would incorporate its proposal as 
outlined at the meeting.7 In its letter, ECCHO argued that 
its proposal would result in increased efficiency in the check return 
system that would benefit banks as well as depositors in terms of 
protection against check fraud. ECCHO believes that customer service 
incentives will lead banks to make the original paper checks available 
to customers within a reasonable window of time and that banks that are 
not comfortable with the arrangement can opt out.
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    \7\ The Board received five other follow-up letters from 
organizations that attended the July 26 meeting. The letters 
supported the ECCHO proposal in general, but some stated that the 
Board should seek additional comment before adopting the ECCHO 
proposal.
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    ECCHO's proposal would eliminate the risks of potential Regulation 
CC claims against banks that participate in electronic check return 
systems. The risk would, in effect, be shifted from depositary banks to 
their customers and remote third parties. Those who favor this proposal 
have not demonstrated the magnitude of this risk. They state that the 
risk is significant enough to prevent banks from experimenting with 
electronic returns. On the other hand, they state that shifting the 
risk to non-bank parties is justified by the efficiencies and cost-
savings that an electronic return system would bring. The Board's 
proposed option 2 would also, in effect, shift this risk to non-bank 
parties to the check, as well as to depositary banks. The Board 
believes that the risk of Regulation CC claims by remote third parties 
is quite low and finds it difficult to justify shifting that risk to 
the remote third parties to benefit banks that have agreed among 
themselves to return checks electronically. The barrier that the 
current regulation presents to electronic check return does not appear 
to be significant enough to warrant shifting risks to non-assenting 
parties. Further, the commenters indicated that proposed option one 
would not be useful in many situations where checks are not returned 
back through the forward collection chain.
    Instead, the Board has taken a different approach, similar to that 
suggested by FRB Atlanta. The Board has revised the Commentary to 
Sec. 229.37 to clarify that depositary banks may agree with paying or 
returning banks to accept images or other notices in lieu of returned 
checks even when the checks are available for return under Regulation 
CC. Except to the extent that other parties interested in the checks 
assent to or are bound by the banks' agreements, banks entering into 
such agreements may be liable under Regulation CC or other applicable 
law to other interested parties for any losses caused by the handling 
of returned checks under such agreements. This revision leaves the 
rights of depositary banks, depositors, and remote parties intact under 
both Regulation CC and the U.C.C., avoiding the potential consumer 
issues of the proposed options and the ECCHO proposal.
    Given the Board's action, the final analysis of any electronic 
return system will be driven by a cost decision on the part of the 
banks involved. If the cost savings of an electronic return system will 
be as great as some check system participants expect, then the risk of 
Regulation CC claims by non-assenting remote third parties may be 
outweighed by those savings and could be absorbed by participating 
banks. The Board notes that banks have taken on these risks in other 
contexts. For example, the banks that are participating in the Federal 
Reserve electronic return pilot in Montana have agreed to assume the 
risk of claims by non-assenting parties.8
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    \8\ In other electronic payment experimental programs, banks 
have been willing to assume risks that appear to be more significant 
than the risk presented in this instance. For example, under 
recently adopted National Automated Clearing House Association rules 
that allow check payees to collect the funds from the checks through 
the automated clearing house (ACH) under certain circumstances, the 
bank that originates the ACH transaction warrants that all 
signatures on the check are genuine and that the underlying paper 
check will not be presented, even though the bank itself may not 
have possession of or control over the check.
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    The Board believes that the best long-term solution to this 
particular electronic return issue, as well as other

[[Page 59613]]

issues related to the electronic collection and return of checks, would 
best be addressed in a coordinated effort to bring subpart C of 
Regulation CC and the U.C.C. into conformance. The Board is pursuing 
this solution with the National Conference of Commissioners on Uniform 
State Laws.
    In addition, as proposed, the Board has removed the electronic 
presentment agreement provisions from Sec. 229.36(c) and its related 
Commentary and added a corresponding example to the Commentary to 
Sec. 229.37. These amendments will not have any substantive effect.

Regulatory Flexibility Act Certification

    In accordance with section 605 of the Regulatory Flexibility Act, 
(12 U.S.C. 605), the Board certifies that the amendments to Regulation 
CC and its Commentary will not have a significant economic impact on a 
substantial number of small entities. The amendments will clarify the 
extent to which banks may agree to vary the terms of Regulation CC by 
agreement to experiment with electronic return systems, but will not 
affect any entities who have not agreed.

List of Subjects in 12 CFR Part 229

    Banks, banking, Federal Reserve System, Reporting and recordkeeping 
requirements.

    For the reasons set forth in the preamble, 12 CFR Part 229 is 
amended as set forth below:

PART 229--AVAILABILITY OF FUNDS AND COLLECTION OF CHECKS 
(REGULATION CC)

    1. The authority citation for part 229 continues to read as 
follows:

    Authority: 12 U.S.C. 4001 et seq.

Sec. 229.36  [Amended]

    2. In Sec. 229.36, paragraph (c) is removed and reserved.
    3. In Appendix E, under section XXII, paragraph C. is removed and 
reserved.
    4. In Appendix E, under section XXIII, new paragraphs C.9. and 
C.10. are added to read as follows:

Appendix E to Part 229--Commentary

* * * * *

XXIII. Section 229.37  Variations by Agreement

* * * * *
    C. * * *
    9. A presenting bank and a paying bank may agree that 
presentment takes place when the paying bank receives an electronic 
transmission of information describing the check rather than upon 
delivery of the physical check. (See Sec. 229.36(b).)
    10. A depositary bank may agree with a paying or returning bank 
to accept an image or other notice in lieu of a returned check even 
when the check is available for return under this part. Except to 
the extent that other parties interested in the check assent to or 
are bound by the variation of the notice-in-lieu provisions of this 
part, banks entering into such an agreement may be responsible under 
this part or other applicable law to other interested parties for 
any losses caused by the handling of a returned check under the 
agreement. (See Secs. 229.30(f), 229.31(f), 229.38(a).)
* * * * *
    By order of the Board of Governors of the Federal Reserve 
System, October 27, 1999.
Robert deV. Frierson,
Associate Secretary of the Board.
[FR Doc. 99-28580 Filed 11-2-99; 8:15 am]
BILLING CODE 6210-01-P