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Regulation CC Updates: A Regulation, Modernized

3/29/2018 - By Sarah Oliver, CRCM

After more than three years of deliberation, the Board of Governors of the Federal Reserve System (FRB) has published in the Federal Register a final rule amending the regulation that instructs financial institutions in complying with the Expedited Funds Availability Act (EFA Act) and the Check Clearing for the 21st Century Act (Check 21 Act).  On June 15, 2017 the FRB finalized its February 4, 2014 proposed rule amending Regulation CC: Availability of Funds and Collection of Checks. 

The original news release version of the final rule was 232 pages, but the Federal Register version is more environmentally friendly at only 50 pages, though your eyes may go crossed reading it.  Nonetheless, you should choose a version and keep as a desk reference in your Compliance and Deposit Operations areas.  Let’s get to the point; who, why, what, and when.

Who

The FRB is basically responsible for the nation’s check processing system, including the forwarding of checks for collection and returns. The banking industry (this includes credit unions) is charged with following the mandates set forth by the FRB, including in large part, Regulation CC. If you are bothering to read this, I assume you are part of the financial industry.  

Why

When implementing new or amended regulations, eventually you’ll tell someone that what they are doing today may not, or won’t work tomorrow.  As a consultant, I always suggest starting with the why.  In short, the banking industry has transitioned over the years from a paper-based check collection process to one that is conducted over 99% electronically. And so, the final rule establishes additional benefits that can apply to electronically created items.  Although the FRB stops short of making the industry stop using paper all together, the final rule states “The objective of the final rule is to is to encourage all banks to collect and return checks electronically.”  There you have it folks, take that to your Board. You’ve been encouraged.  

What

In a nutshell the FRB has: opted to keep the same day settlement rule for paper checks; definitively applied existing Regulation CC check warranties to electronic check related images; added definitions for electronic checks, electronic returned checks, and electronically created items; and applied existing, and adopted new warranties and indemnities related to the collection and return of electronically created items. 

Return Requirements:  

Currently, when an institution determines not to pay a check, it is required to return that check expeditiously. It is also required to provide a notice of nonpayment to the depository bank by 4 p.m. on the second business day following the business day the check was presented for payment if the item being returned is $2,500 or more. 

The final rule eliminates the current optional “forward collection test” and implements a modified version of the current “two-day test” which will apply to both paper and electronic checks, so that the check should be received by the depository bank no later than 2 p.m. on the second business day from the business day on which the check was presented to the paying bank. The FRB has added a new condition for expeditious-return liability; specifically, that a paying bank and returning bank may be liable to a depositary bank for failing to return a check in an expeditious manner only if the depositary bank has arrangements in place such that the paying bank or returning bank could return a returned check electronically, directly or indirectly, by commercially reasonable means. 

The depositary bank has the burden of proof for demonstrating that its arrangements for accepting returned checks electronically are commercially reasonable.  The FRB states “The ‘commercially reasonable means’ requirement is intended to prevent a depositary bank from establishing electronic return arrangements that are very limited in scope or that provide unreasonable barriers to presentment such that, in practice, the depositary bank would accept only a small number of its returns electronically.”

The final rule also increased the single check dollar threshold to provide a notice of nonpayment to the depository bank to $5,000 (up from $2,500) and shortened the cutoff hour to receive the notice to 2 p.m. instead of 4 p.m. on the second business day following the banking day the check was presented for payment. The commentary clarifies that the check itself, whether in paper or electronic form can serve as that notice, and removes certain information currently required on the notice such as the account number of the depositing customer, branch name or number of the depositary bank, and the name of the paying bank. In addition, the FRB has adopted an exception to providing a large dollar return notice if the paying bank cannot identify the depository bank. 

Same Day Settlement:

As proposed, the FRB retained the current same day settlement rule regarding paper checks, and further explained that items presented electronically are already effectively governed by agreements between banks, such that a same day settlement rule for electronic items “would be unnecessary or even burdensome.” 

Framework for Electronic Check Collection and Return:

Currently Subpart C of Regulation CC, titled Collection of Checks only applies to paper checks. 

The final rule clarifies that electronic checks and electronic returned checks will be covered under existing Subpart C as if they were checks and defines ‘‘electronically-created item’’ to mean an electronic image that has all the attributes of an electronic check or electronic returned check but was created electronically and not from a paper check.  Thus, the FRB has adopted the same warranties and indemnities for electronically created items, and new indemnities for losses caused by the fact that (1) the electronically-created item was not authorized by the account holder and (2) a subsequent bank pays an item that has already been paid.  These indemnities shall provide basic protections for banks handling electronically-created items that are unauthorized or presented more than once. 

The final rule also extends warranties specifically to electronic checks or electronic returned checks in that transferring banks warrant the images accurately represent the information from the original check at the time of truncation.  For example, pertaining to electronic checks sent for forward collection, warranties flow from the transferee bank, the subsequent collecting bank, the paying bank, and the drawer of the check. Lastly, the FRB adopted a new indemnity for remote deposit capture that would indemnify a depositary bank that received a deposit of an original paper check that was returned unpaid because the check was previously deposited using a remote deposit capture service and paid. There is an exception to the indemnity that would prevent an indemnified bank from making an indemnity claim if it accepted an original check containing a restrictive indorsement that is inconsistent with the means of deposit, such as ‘‘for mobile deposit only.’’ 

Miscellaneous:

Several definitions in Subpart A and throughout the regulation have been tweaked to incorporate new terms “electronic check,” “electronic returned check,” and “electronically created item.”  Additionally, the FRB has added two new examples for when “refer to maker” is appropriate, in the commentary to Regulation CC.  Lastly, the final rule states that the FRB will eliminate Appendix D in favor of incorporating into the regulation and accompanying commentary that industry indorsement standards for paper, substitute, and electronic checks are to be governed by the American National Standard (ANS) Specifications for Physical Check Indorsements, specifically ANSI X9. 100-140.

When

The amendments, including the new warranties and indemnities under the final rule are effective on July 1, 2018, a Sunday -- so no mad-rush, mid-week changes to your processing systems!  What also should not be a mad rush is figuring out what the final rule changes mean to your institution, including; the elimination of the “forward collection test” and modification to the ‘two day test’ as they pertain to expeditious standards, the increase in dollar threshold on large dollar return notices, the new indemnifications offered on remote deposit items with proper endorsements, as well as how your current paper based system stands up against the new “commercially reasonable” standard developed by the FRB. 

Remember this standard is to “encourage the broadest possible implementation of electronic check return for those institutions still using paper.” Start talking to your appropriate management and Board committees now.  And don’t hesitate to reach out to a member of our Financial Institutions Advisory Group if you have any questions. That’s what we are here for.

*The opinion expressed in this article is for informational purposes only and readers are encouraged to review any current state or federal law and regulation that applies in all jurisdictions where a company operates, and to seek legal counsel as necessary.

About the Author | Sarah Oliver, CRCM
Sarah is a consultant in the Financial Institutions Advisory Group of Saltmarsh, Cleaveland & Gund.  Her primary areas of expertise include providing compliance reviews, assisting with special research matters and consulting on deposit and lending related regulations as well as social media approaches for financial institutions. 

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