Check 21 FFIEC Payment Systems Risk Conference Arlington

Check 21 FFIEC Payment Systems Risk Conference Arlington, Virginia November 2, 2004 David Walker dwalker@eccho. org 1

Topical Agenda · Check 21 the Act · Check 21 the Regulations · Minimum Requirements · Potential Minimum Requirements 2

Status of Check 21 · Passed by U. S. House and Senate – No opposition in House – Unanimous consent in Senate · President signed – October 28, 2003 · Effective date – October 28, 2004 3

Check 21 Challenge · Encourage check truncation by allowing unilateral decisions to truncate paper checks – Unlike current environment with requirement to obtain agreements from all the parties (tens of millions) · BUT WITHOUT MANDATING THE RECEIPT OF ELECTRONIC TRANSACTIONS 4

Check 21 Solution · Create a new federal law to replace the original paper check 1) For those customers that have not agreed to check truncation and want to receive their paid checks 2) For those banks that have not agreed to receive electronic check files · “Substitute Check” becomes the legal equivalent of the original check 5

Original Check VOID – IRD TEST SAMPLE 6

Front Substitute Check/IRD “ 4” IN POSITION 44 7

Back Front SI DS X 9 TU. 90 AN Substitute Check/IRD 8

Example - Collections Traditional Paper Collection Check Intermediary Check BOFD Paying Bank Substitute Check Collection Check BOFD Intermediary Sub Ck Paying Bank 9

Return Processing Traditional Paper Return Check CUSTOMER PAYING BANK BOFD RETREIVE CHECKS Substitute Check Returns IMAGE CUSTOMER Return Sub Check Return Sub BOFD Check PAYING BANK PRINT Sub Ck 10

Collections – W/Image Traditional Paper Collection Check Intermediary Check BOFD Paying Bank Substitute Check Collection Check Image BOFD Intermediary Sub Ck Paying Bank 11

Remote Depositing Traditional Paper Collection ATM Check BOFD Transit Items Branch Substitute Check Collection with Branch Capture ATM Sub Ck Check Image Branch BOFD Transit Items 12

Image Exchange Pre Check 21 Image Check OR Check BOFD IMAGE PAYING BANK Image with Substitute Checks IMAGE Check PRINT Sub Ck Image BOFD PAYING BANK Sub Ck 13

Lockbox – Check 21 Process Biller’s Processor S K EC AL All check payments Captures Check Images, Stores Checks & Sends Images to Bank Covered by Check 21 CH L STORE CHECKS IMAGES Biller’s Depository Bank Clears the Images IMAGES Statement Sub Ck Customer Paying Bank Posts Statements Substitute Check to Customer’s Account Intermediary Print (Reconverts) Substitute Check 14

Substitute Check / IRD · Designed to be processed exactly as if it were the original paper check · Substitute check is legal equivalent of original check for all purposes if: – Contains image of front & back of check – Conforms to industry standards · · – – – MICR Physical characteristics of checks Suitable for automated processing Must accurately represent all information on original check Bears legend Includes all indorsements Includes identification of party creating it 15

Eligible Checks? · ALL CHECKS are eligible for replacement with substitute checks, for example: – – – – Retail checks Non retail checks Government warrants Treasury checks Money orders Controlled disbursement Payable through drafts Etc. 16

Checks Covered? · Only checks replaced with substitute checks are covered by the Act · Not all truncated or safekept checks are covered by the Act – For example, original checks truncated or safekept under agreement are not covered by the Act · Act is designed to encourage truncation and it is not needed if customer already agreed to not receive their checks back 17

Myth & Reality · Myth – Check 21 validates the exchange of check images · Reality – Check 21 does not address exchanges under agreement such as ECP or image exchanges · Confusion – Check 21 is dependent on the use of image technology for substitute checks but – Does not cover image exchanges between banks or their customers 18

Source of Confusion · Fact - Check 21 uses check imaging – Check 21 uses image technology to create a replacement paper document – substitute check – Check 21 is all about creating an alternate paper exchange process – Check 21 is not about image exchange 19

Opting Out? · Can banks opt-out of Check 21? No! · Can bank customers opt-out? No! · Can governmental organizations opt-out? – No! All check eligible for replacement by substitute check · Do banks have to accept substitute checks presented to them? – Yes, they are the legal equivalents of the original checks · Preserving the status quo is not an option – All checks are in and all banks have impact 20

Check 21 Warranties · Bank that creates the substitute check warrants 1) Substitute check meets all requirements for legal equivalency 2) No double debit 21

Check 21 Indemnification · Indemnification – Bank that creates substitute check and each subsequent bank indemnifies all parties for loss, if loss is due to receipt of substitute check instead of original 22

Expedited Recredit · New Protection For Consumers – May make claim under Act for Substitute Check that was not properly charged to their account or for a warranty claim, and – The consumer suffered loss, and – The original check or copy of original check is necessary to determine validity 23

Expedited Recredit Consumer Statement 40 DAYS 120 DAYS CLAIM $$$ 10 DAYS SUBSTITUTE CHECK Check, Copy PAYING BANK or $$$ RECONVERTING BANK 1) Paying bank must provide consumer with original check, copy of original check or recredit within 10 days of claim up to $2, 500 per check 2) Amounts > $2, 500 must be recredited to consumer within 45 days 3) Paying bank must make claim to reconverting bank within 120 days of of transaction that gave rise to claim 4) Reconverting bank must provide recredit, original check or copy within 10 days of paying bank claim 24

Expedited Recredit · Additional provisions – Bank may withhold availability in Reg CC like exception situations · New accounts, excessive ODs, or cause to believe fraud · Bank may withhold availability for 45 days – Bank must notify Consumer of delay in availability · Bank cannot charge OD fees for five days 25

Check 21 Regulation · Federal Reserve may prescribe regulations to implement, prevent circumvention or evasion of, or facilitate compliance with the provisions of this Act · Fed proposing new subpart D in Regulation CC 26

Final Regulation · Selected Provisions – Clarified - Treasury Checks & U. S. Postal Money orders sent to the Fed for collection are deemed to be sent to the Treasury and Postal Service – Provided - Banks should address the potential for a bank to become a reconverting bank without its knowledge and consent through its deposit agreement 27

Final Regulation · Selected Provisions – Substitute check is a check for purposes of Reg CC & UCC even if it does not meet the requirement for legal equivalence – Recognized X 9. 100 -140 as standard for substitute checks – Substitute check must be a piece of paper – Eliminated purported substitute checks 28

Final Regulation · Selected Provisions – Elimination of use of purple ink in indorsement as of January 1, 2006 – Substitute check must have an image of the back of the original even if it is blank 29

Required Disclosures · Check 21 & Regulation CC Subpart D provide for many disclosures & notices – Substitute Check Policy Disclosure – Substitute Checks and Your Rights (Consumer Awareness Notification) – Expedited Recredit Claim, Valid Claim Refund Notice – Expedited Recredit Claim, Provisional Refund Notice – Expedited Recredit Claim, Denial Notice – Expedited Recredit Claim, Reversal Notice – See Reg CC Subpart D for full details 30

Minimum Requirements · Consumer Awareness Notification a) One-time notices and b) Every-time notices · Follow standards for substitute checks a) Modify repair process to include a “ 4” in position 44 and b) Modify return process to include in “ 5” in 31

Required Disclosures · Implications of Every-time Notices – Check 21 tenets · Institutions that make decisions to truncate should bear the cost of that decision & · Other institutions not involved in that decision should experience minimal impact – New requirement violates these tenets · Adds a new daily operational requirement for every institution · Adds a new daily compliance risk for every institution 32

Required Disclosures · Brief Notice – Check 21 Act provides for a “brief” notice – December 2003 proposal included a 2+ page notice – Final version was only one and one half pages · Safe Harbor – Check 21 Act provides that the Fed may provide a standard awareness notice – Banks not required to use the Fed’s version but if they do · Deemed to be in compliance with Act 33

Substitute Check Standard 34

Standards · ANS X 9. 100 -140 -2004 – Specifications for Image Replacement Document – Formerly known as DSTU X 9. 90 – IRD is term used by standard – Substitute check is statutory term – Regulation CC Subpart D provides that X 9. 100140 is the standard for substitue checks – Any document meeting X 9. 100 -140 requirements is a substitute check 35

Sub. Check Creation · MICR line of original check – Must include all of the MICR line from the original check plus the encoded amount – Including special character in position 44 36

Sub. Check Creation · Without a “ 4” in 44 Original Check 37

Sub. Check Creation · Without a “ 4” in 44 Substitute Check 38

Sub. Check Creation · Without a “ 4” in 44 2 nd Generation 39

Sub. Check Creation · Without a “ 4” in 44 4 th Generation 40

Endorsement Chain · Presentation on Image and document flow overview – Can be printed from ECCHO website by following these steps · Check 21 · Implementation Aids · Standards · Endorsements · Click here – Presentation to large to e-mail 41

Mixing Check 21 & Image Exchange Things to consider 42

Check 21 Risks · Indemnification creates risks – Warranty Breach - Consequential damages rests with bank that creates substitute check – No Warranty Breach - Bank that creates substitute check can limit liability, if it produces original check or copy of original check on request 43

Potential Risk to Bank · Image risk & Check 21 - collections X 9. 37 and/or Sub Ck Image COLLECTING BANK (BOFD) RECONVERTING BANK PAYING BANK CUSTOMER Warranties & Indemnifications 1) Check 21 covers these relationships 2) Reconverting bank makes warranties & indemnifications to other parties 44

Potential Risk to Bank · Image risk & Check 21 - collections X 9. 37 and/or Image COLLECTING BANK (BOFD) At sk Ri Sub Ck RECONVERTING BANK Sub Ck PAYING BANK CUSTOMER Warranties & Indemnifications Reconverting bank makes warranties & indemnifications not carried back to original imager of the item 45

Potential Risk to Bank · Risk avoidance – Clearinghouse Rules X 9. 37 and/or Sub Ck Image COLLECTING BANK (BOFD) RECONVERTING BANK PAYING BANK CUSTOMER Warranties & Indemnifications 1) CH rules needed to cover these relationships 2) Reconverting bank’s warranties & indemnifications ARE carried back to original 46 imager of the item

Potential Risk to Bank · Need both Check 21 & CH Rules X 9. 37 and/or Sub Ck Image COLLECTING BANK (BOFD) RECONVERTING BANK PAYING BANK CUSTOMER 1) CH rules to cover these relationships 2) Check 21 to cover these relationships Need a common, national set of image exchange rules 47

Potential Risk to Bank · IRD risk & Check 21 - collections Sub Ck NON BANK At sk Ri RECONVERTING BANK Sub Ck PAYING BANK CUSTOMER Warranties & Indemnifications Reconverting bank makes warranties & indemnifications not carried back to the non bank creator of substitute check 48

Additional Considerations · Customer agreements – Protect bank from unknown customer deposit of substitute check through deposit agreements · Under Act only banks can make warranties · Without customer agreement, bank assumes risk – Banks may want to ID deposited substitute checks for special handling · Need agreement with customer – Reg acknowledges need for agreement · Does not specify what constitutes an agreement 49

ECCHO Rules · ECCHO is a national clearinghouse and it has adopted rules – Image exchange rules – Image return rules – IRD rules · Pre-Check 21 - Provides necessary IRD exchange agreements – ECP with image replacement document (IRD) – Warranties to parallel the Check 21 IRD warranties · Post-Check 21 - Supplements Check 21 with other necessary agreements – Image exchanges prior to reconverting bank – Moves warranties and indemnifications to imaging bank 50

Industry Recognitions · Best solution for rules is one set of clearing house rules · Following organizations recognize & support ECCHO as the national provider of ECP and image exchange rules 51

45 Supporters Alogent America Banker Association America’s Community Bankers AQUBANC, LLC Automated Financial Systems Aurum Technology Inc. Banc. Tec BAI Bearing. Point, Inc. BITS Carreker Corporation Check Payments Systems Association Computer Services, Inc. CONIX Systems Data Support Services EDS Information Services Empire Corporate FCU EPSON Fiserv FSTC Global Concepts IBM Independent Community Bankers of America IPSO Meta Software Mobius Management Systems, Inc. Net. Deposit, Inc. NCR Payments Resource One Puerto Rico Clearing House Association RDM Corporation RWC Small Value Payments Company Software Earnings Southern Financial Exchange Symcor, Inc. TAWPI Great Lakes Chapter The Clearing House Thillens Tronitech Tri. Syn Group Unisys VECTORsgi Viewpointe Archive Services Wespay 52

Check 21 Minimum Requirements 53

Not Required · Banks do not have to – Change any current relationships – Capture images – Have their day two and/or back office applications image enabled – Image enable their ATMs and branches – Participate in image exchange with any organization – Purchase expensive image hardware – Purchase expensive image software – Purchase any hardware or software – Hire consultants to develop a Check 21 plan · Banks may choose to do any or all of these things, but they are NOT Required for implementing Check 21 54

Minimum Requirements · Banks must 1) Accept substitute checks 2) Provide consumer awareness notifications 3) Implement expedited credit procedures 4) Follow standards for substitute checks 55

Minimum Requirements · Consumer Awareness a) One-time notices and b) Every-time notices · Follow standards for substitute checks a) Modify repair process to include a “ 4” in position 44 and b) Modify return process to include in “ 5” in 56

A – Forward Collections Traditional Paper Stateme nt Check BOFD Paying Bank Substitute Check Paper Statement Minimum Stateme nt Check Sub Ck BOFD Paying Bank Paper Statement 57

A – Forward Collections Minimum Stateme nt Check Sub Ck BOFD Paying Bank Paper Statement Minimum Requirements Additional Considerations • Accept substitute checks • Provide consumer awareness notice • Develop & implement expedited recredit procedures • • • Capture and retain “ 4” from 44 Customer service training Implement duplicate checking Mixed statement processing Potential impact on products: e. g. payables through, ARP, controlled disbursements, etc. 58

Consumer Awareness · Act Requires that notice be provided to – Existing customers who receive original checks or substitute checks with statement – New account holders – Consumers who request copies and receive substitute checks · Notice may be provided by U. S. mail or other means as agreed to by consumer 59

Check 21 Expedited Recredit Consumer Statement 40 DAYS 120 DAYS CLAIM $$$ 10 DAYS Sub. Check, Copy Paying Bank or $$$ Reconverting Bank 1) Paying bank must provide consumer with original check, copy of original check or recredit within 10 days of claim up to $2, 500 per check 2) Amounts > $2, 500 must be recredited to consumer within 45 days 3) Paying bank must make claim to reconverting bank within 120 days of of transaction that gave rise to claim 4) Reconverting bank must provide recredit, original check or copy within 10 days of paying bank claim 60

Check 21 Expedited Recredit CLAIM OR PAYING BANK INTERMEDIARY RECONVERTING BANK CLAIM · Between institutions – Claim must be made by end of 120 days of transaction – Check 21 allows inter-bank claims to: · Travel back up the collection stream through bank that did not create substitute check, or · Go directly to the reconverting bank who created substitute check 61

Additional Considerations · Capturing and retaining “ 4” from 44 – Ensure that capture system will not reject checks with character in EPC – Paying bank may want to know that it has received a substitute check – Expedited recredit provisions only apply to substitute checks – Check 21 warranties only apply to substitute checks · Other uses for 44 – Some institutions may already use 44 for other uses 62

Additional Considerations · Customer service training – Customer receiving substitute checks may call the bank to inquire · About what they are · If they are legal · If they can get their original checks back · To file a claim · To explain they are moving their business down the street to avoid the fake checks · Etc. 63

Additional Considerations · Identifying duplicate checks – Check 21 warranty · Customers will not be double debited · Greater likelihood of multiple substitute checks for same original being presented – Other reasons to enhance duplicate checking · Cross application logic to determine double debits for checks converted to ACH · Double debits from ECP and/or image files and original paper 64

Additional Considerations · Mixed statements – For customers receiving paper checks in their statements · Will receive both original checks and substitute checks – Consumers will receive checks of two different sizes in their statements · Normal retail checks · Substitute check – Cost of mailing increases with larger checks – Potential impact on bank process 65

Additional Considerations · Corporate customers – Impact on disbursement products · Code line matching requirements will be impacted by position 44 – ARP – Positive Pay · Font size and location requirements 66

A 1 – Repair Minimum Stateme nt Sub Ck Paying Bank Reject & Repair Post & Return + Minimum Requirements + Additional Considerations • Allows for traditional reject repair • Train repair staff to encode substitute checks 67

Check 21 Ops Minimum · Repair – Final Reg CC Subpart D allows for traditional MICR line repair – Rejected substitute checks may be repaired with a full MICR line · Must also include a “ 4” in 44 – Rejected substitute checks may be repaired with a partial MICR line e. g. amount and R/T number · May but not required to have a “ 4” in 44 68

A 2 – Statement Rendering Minimum Statement Check Sub Ck BOFD Paying Bank Image Statement + Minimum Requirements + Additional Considerations • None under Check 21 • Customer agreement to truncate paper • Consider format of retail image statements with mixed image sizes • IRD larger than retail check • Legibility of reduced image • Cost of additional statement pages 69

Additional Considerations · Image statements – Does Check 21 allow institutions to provide image statements to their customers without agreements? · No – Mixture of images of original checks substitute checks · For consumers, difference in size of checks and substitute checks · Normalize image sizes? – Can images of substitute checks be reduced as much as original checks and remain eligible? · Clipping image from substitute check to put on statement 70

Check 21 Minimum Requirements Returns 71

B - Returns Traditional Paper Check Consumer Depositor Check Return Decision BOFD Substitute Check Sub Check Consumer Depositor Paying Bank Minimum Sub Check BOFD Return Decision Paying Bank 72

B - Returns Sub Check Consumer Depositor Minimum Sub Check Depositary Bank Return Decision Paying Bank DB Minimum Requirements PB Minimum Requirements • Accept substitute check • Consumer awareness notification • Develop & implement expedited recredit procedures for depositor • Train customer service staff • Re-strip - qualified return - “ 5” in 44 • Train return staff about sub check • Placement of indorsement Additional Considerations Note: DB = depositary bank PB = paying bank • Capture and retain “ 5” from 44 • Consider returned check envelop size & postage 73

B – Returns Ops Minimum · Paying bank – Qualified returns of substitute checks · “ 5” in 44 for a qualified substitute return – Avoids additional shrinkage – Must continue to have a “ 4” in 44 · “ 4” on substitute check MICR line and · A “ 5” on the strip to ID qualified return 74

Check 21 Minimum Requirements Representments 75

C - Representments Traditional Paper Stateme nt Check BOFD Paying Bank Substitute Check Paper Statement Minimum Stateme nt Sub Ck BOFD Paying Bank Paper Statement 76

C - Representments Minimum Stateme nt Sub Ck Depositary Bank Paying Bank Paper Statement + DB Requirements + PB Requirements • Accept deposited substitute checks • Same as forward collection Additional Considerations • Train tellers about sub. checks • Modify software to ID deposited substitute checks Additional Considerations • None beyond forward collection 77

Additional Considerations · Train tellers – Train to recognize & accept substitute checks · Avoid non-acceptance of valid items · Avoid acceptance of invalid items – Train them in new consumer rights · Expedited recredit and claim process 78

Need More Information · Accurate and updated Check 21 Information on ECCHO Website – www. eccho. org – Implementation Aids · · · FAQ – Available Description and Overview -Available Minimum Compliance Requirements - Available Processing and Quality Standards - Available Other Implementation Considerations - Shortly Endorsement Chain - Available 79

Check 21 FFIEC Payment Systems Risk Conference Arlington, Virginia November 2, 2004 David Walker dwalker@eccho. org 80