Availability of Funds and Collection of Checks

Federal RegisterAug 4, 2004

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FEDERAL RESERVE SYSTEM

12 CFR Part 229

[Regulation CC; Docket No. R-1176]

Availability of Funds and Collection of Checks

AGENCY:

Board of Governors of the Federal Reserve System.

ACTION:

Final rule.

SUMMARY:

The Board of Governors is publishing final amendments to Regulation CC that add a new subpart D, with commentary, to implement the Check Clearing for the 21st Century Act. These amendments set forth the requirements of the Act that apply to banks, a model consumer awareness disclosure and other model notices, and indorsement and identification requirements for substitute checks. The final amendments also clarify some existing provisions of the rule and commentary.

DATES:

This rule is effective on October 28, 2004, except for model form C-5A in appendix C, which is effective August 4, 2004, and paragraph (4) of appendix D, which is effective on January 1, 2006.

FOR FURTHER INFORMATION CONTACT:

Jack K. Walton, II, Assistant Director ((202) 452-2660), or Joseph P. Baressi, Senior Financial Services Analyst ((202) 452-3959), Division of Reserve Bank Operations and Payment Systems; or Stephanie Martin, Associate General Counsel ((202) 452-3198), or Adrianne G. Threatt, Counsel ((202) 452-3554), Legal Division; for users of Telecommunication Devices for the Deaf (TDD) only, contact (202) 263-4869.

SUPPLEMENTARY INFORMATION:

Background

I. The Need for and General Provisions of the Check 21 Act

Under current law, a bank must present the original paper check for payment unless the paying bank has agreed to accept presentment in some other form.

Sections 3-501(b)(2) and 4-110 of the Uniform Commercial Code (U.C.C.) specifically authorize banks and other persons to agree to alternative means of presentment, such as electronic presentment. However, to engage in broad-based electronic presentment, a presenting bank would need electronic presentment agreements with each bank to which it presents checks. This has proven impracticable because of both the large number of paying banks and the unwillingness of some paying banks to receive electronic presentment.

The requirement that banks present the original check absent agreement to the contrary and the difficulty of obtaining alternate presentment agreements with all paying banks impedes the ability of banks that want to process checks electronically to take full advantage of that technology. As a result, the payment system as a whole has not achieved the efficiencies and potential cost savings associated with handling checks electronically.

See, e.g.

, section 3-501(b) of the Uniform Commercial Code.

Some paying banks and bank customers prefer to receive checks in paper form for operational or other reasons.

By authorizing the use of a new negotiable instrument called a substitute check, the Check Clearing for the 21st Century Act (the Check 21 Act or the Act) facilitates the broader use of electronic check processing without mandating that any bank change its current check collection practices.

A substitute check is a paper reproduction of an original check that contains an image of the front and back of the original check, is suitable for automated processing in the same manner as the original check, and meets other technical requirements. A bank that for consideration transfers, presents, or returns a substitute check (or a paper or electronic representation of a substitute check) warrants that (1) the substitute check contains an accurate image of the front and back of the original check and a legend stating that it is the legal equivalent of the original check, and (2) no depositary bank, drawee, drawer, or indorser will be asked to pay a check that it already has paid. A substitute check that meets the Check 21 Act's requirements regarding accuracy, bears the legend, and for which a bank has made the substitute check warranties is the legal equivalent of the original check for all purposes and all persons.

Pub. L. 108-100, 117 Stat. 1177 (codified at 12 U.S.C. 5001-5018). The Check 21 Act was enacted on October 28, 2003, and takes effect on October 28, 2004.

The use of legally equivalent substitute checks should facilitate collection and return of checks in electronic form. For example, a depositary bank in California that receives a check drawn on a bank in New York now must send the original paper check for collection unless it, or an intermediary collecting bank that presents checks sent by it, has an electronic presentment agreement with the paying bank. Under the Check 21 Act, by contrast, the California bank could transfer check information electronically to a collecting bank in New York with which it had an agreement to do so. The New York collecting bank then could create a substitute check to present to the New York paying bank. The New York paying bank would be required to take presentment of a substitute check that met all the legal equivalence requirements. Thus, instead of processing and transporting the original check across the country, the California bank could collect the substitute check using only local New York transportation.

II. How the Check 21 Act Affects Banks

A. In General

Although the Check 21 Act is designed to enable more efficient use of electronic check processing by allowing use of one piece of paper in place of another, the law does not require any bank to use electronic check processing, receive electronic presentment, or create a substitute check. The Check 21 Act also does not make electronic check images or electronic check information the legal equivalent of an original check. Moreover, the Check 21 Act does not alter existing arrangements under which banks agree to return paid paper checks to account holders with periodic account statements. However, after the effective date of the Check 21 Act, account holders that receive paid checks with their statements may receive a mix of original checks and substitute checks.

The characteristics of a substitute check are such that a bank receiving a substitute check would be able to process that substitute check to the same extent that it could process the original check. As a result, banks would not be required to change their check processing equipment because of the Check 21 Act, and, except as described in the next section, there would be no need for a bank to treat original checks and substitute checks differently during the check collection and return process. Because a legally equivalent substitute check contains an accurate representation of the information on the original check and all indorsement information associated with the check, drawers and other persons should be able to rely on a substitute check just as they would an original check for other purposes, such as proof of payment.

B. Provisions Affecting All Banks

Certain provisions of the Check 21 Act will affect all banks, even those that do not choose to create substitute checks. For example, any bank that transfers, presents, or returns a substitute check (or a paper or electronic representation of a substitute check) for consideration would make

the substitute check warranties and would be responsible for indemnifying any person that suffered a loss due to the receipt of a substitute check instead of the original check. A bank that transferred a substitute check to a consumer who incurred a loss associated with the substitute check also might be required to provide an expedited recredit to that consumer. A bank that provides paid checks to consumer customers with periodic account statements or that otherwise provides a substitute check to a consumer customer must provide a disclosure that describes substitute checks and substitute check rights.

Although the Check 21 Act does not require banks to make processing changes to receive substitute checks, a bank will be required to qualify a substitute check for return differently than it does an original check. A bank must place a “2” in position 44 of the MICR line of a qualified returned original check. A bank that qualifies a substitute check for return instead must encode position 44 of the substitute check's qualified return MICR line with a “5.”

C. Provisions Affecting Banks That Create Substitute Checks

Although the foregoing provisions of the Check 21 Act would apply to all banks, the law is designed so that losses associated with a substitute check ultimately would be borne by the party that first transferred, presented, or returned the substitute check (the reconverting bank).

A bank that paid a warranty claim or provided an indemnity or expedited recredit for a substitute check that it received from another bank could, in turn, bring a warranty, indemnity, or interbank expedited recredit claim against the bank that transferred the substitute check to it and thereby pass the associated loss back to the reconverting bank.

Thus, if there is a duplicative check payment involving a substitute check, a substitute check indemnity claim, or a breach of the legal equivalence warranty, the Check 21 Act places ultimate responsibility on the reconverting bank.

The Check 21 Act also requires the reconverting bank to identify itself as such and to preserve the indorsements of parties that previously handled the check in any form.

A reconverting bank is (1) the bank that creates a substitute check or (2) the first bank that receives a substitute check created by a person that is not a bank and transfers either that substitute check or in lieu thereof the first paper or electronic representation of that substitute check.

Banks may further allocate liability amongst themselves as part of their agreements to handle checks electronically. A reconverting bank that received a check in electronic form therefore could, by agreement, pass back to the sender of that item some or all of the losses the reconverting bank incurred if it used the electronic item to create a substitute check that gave rise to a Check 21 Act warranty, indemnity, or expedited recredit claim.

But see

footnote 5.

III. Overview of the Board's Proposed Rule

The Board in January 2004 proposed to implement the Check 21 Act by adding to Regulation CC a new subpart D that would incorporate the requirements of the Act applicable to banks that create, receive, or provide substitute checks or paper or electronic representations of substitute checks.

The Board proposed that subpart D would contain provisions concerning requirements a substitute check must meet to be the legal equivalent of an original check, reconverting bank duties, the warranties and indemnity associated with substitute checks, expedited recredit procedures for consumers and banks, liability for violations of subpart D, and the interaction between subpart D and existing federal and state laws. The Board proposed new model notices in appendix C for the consumer awareness disclosure and other consumer notices regarding substitute checks.

69 FR 1470 (Jan. 8, 2004).

The Board also proposed amendments to implement the Check 21 Act that would affect some existing provisions of Regulation CC and its commentary. For example, the Board proposed to supplement some existing defined terms in § 229.2 for which the Check 21 Act had slightly different definitions and to define several new terms used in subpart D. The Board also proposed to amend the magnetic ink character recognition (MICR) line requirements for qualified returned checks to allow for differences to facilitate the processing of substitute checks and to amend § 229.35 and appendix D to include indorsement and identification standards for substitute checks.

The Board also proposed revisions to several other provisions of Regulation CC and its commentary that were unrelated to the Check 21 Act. For example, the Board proposed amending the commentary to clarify that a returned check notice need not be written, clarify the application of the Electronic Signatures in Global and National Commerce Act (the E-Sign Act) to consumer disclosures that Regulation CC requires to be in writing, and clarify the time by which a paying bank may extend the return or notice of nonpayment deadline. The Board also sought general comment on several issues, including whether it should include in Regulation CC a new U.C.C. warranty regarding the drawer's authorization of remotely-created demand drafts.

Overview of Comments on the Proposed Rule

The Board received comments on the proposed rule from 168 commenters, including 107 depository institutions and organizations representing depository institutions, 35 consumers and consumer groups, 14 nonbank service providers, and 12 other organizations and persons (including one United States Senator). The vast majority of these commenters generally approved of the Check 21 Act and the Board's proposed rule but expressed views about how the Board could change specific provisions of the rule. Specific substantive comments are discussed in more detail in the portions of the Section-by-Section Analysis that analyze the commented-upon provisions.

I. Comments Expressing General Concerns

Several commenters expressed general disapproval of the Check 21 Act and the Board's proposed rule. These commenters expressed concern that the use of substitute checks would increase fraud, benefit banks at the expense of consumers, and confuse consumers and bank employees.

Some commenters argued that banks would be unable to make an informed decision about whether to process checks physically or switch to electronic processing because of uncertainty about the relative costs of each option. There are a variety of factors in determining the relative costs of check processing options, some of which are institution-specific. The Board expects that most banks should be able to analyze their own cost structures and make informed processing decisions.

The commenters concerned about consumer harm argued that the Check 21 Act would shorten the time needed to collect checks and would not reduce fees for consumers.

The Board expects that the Check 21 Act ultimately will decrease the time needed to collect checks, which is an outcome that the Board deems desirable, and will result in other benefits to banks and their

customers.

For example, processing changes that a bank makes in reliance on the Check 21 Act could enable the bank to offer its depositors later cutoff times for certain deposits or to make check images available to consumers online. These changes would allow consumers faster access to deposited funds and to records relating to their check payments, respectively.

Some commenters also expressed concern that existing hold periods for deposited checks were either too long or too short. The existing hold periods in subpart B of Regulation CC are those set forth in the Expedited Funds Availability Act, and the Board is required to shorten (but may not lengthen) those hold periods as the time periods for clearing local and nonlocal checks improve on a widespread basis. The Board will adjust the hold periods in subpart B if and when the check clearing timeframes for checks improve substantially enough to warrant such adjustments.

The more time needed to collect a check, the greater the risk that the depositary bank will make funds deposited by check available for withdrawal before it knows whether the paying bank will pay or return the check. The Board's policies therefore seek to reduce, rather than preserve, the time for collecting checks.

See, e.g.

, the Board's Policy Statement on Delayed Disbursement, Fed. Res. Reg. Service ¶ 9-750, p. 9-247.

Several commenters noted that people already are confused because some checks are used to obtain information to initiate an automated clearing house (ACH) debit rather than to effect the payment transaction by check. These commenters expressed concern that adding substitute checks to the payment system would exacerbate confusion about the rights associated with checks. The Board agrees with commenters that substitute checks could increase confusion about the ways in which checks can be used to process payments and the legal rights associated with each processing choice. The Board plans to prepare guidance on these topics.

II. Comments Urging Action Inconsistent With the Check 21 Act

Several commenters suggested that the Board take actions that would be inconsistent with the language or intent of the Check 21 Act.

Three commenters suggested that the Board delay the effective date of the rule beyond the effective date of the statute. However, to implement the Check 21 Act effectively, the rule generally must take effect no later than the effective date of the statute.

Model disclosure C-5A in appendix C takes effect immediately so that banks need not delay their use of that model in preparing the consumer awareness disclosure required by § 229.57. The requirement in appendix D that all indorsements be printed in black ink does not take effect until January 1, 2006, to give banks a transition period to make necessary processing changes.

One commenter suggested that the Board establish standards for the exchange of electronic check images. This would go beyond the scope of the provisions of the Check 21 Act, which only relate to substitute checks. Electronic presentment will continue to be governed, as it is today, by agreements between the paying bank and the presenting bank.

One commenter suggested that the Federal Reserve Banks publish a list of banks that have agreed to send or receive checks in electronic form. Reserve Banks and other collecting banks may publish lists of banks that accept electronic presentment from them. However, any such lists will reflect only the agreements of the listed banks to receive presentment electronically from that particular collecting bank and would not indicate a general agreement of the receiving bank to receive presentment electronically.

Another commenter opined that the costs of using substitute checks should be borne by paying banks and bank customers that demand paper checks. This would be at odds with the Act's intent to allow banks that choose to process checks electronically to do so and create substitute checks in a manner that is transparent to banks and other persons that require paper checks.

Several commenters expressed particular concern that the use of substitute checks would make the original check more difficult to obtain, which in turn would impede law enforcement's ability to obtain physical evidence, such as fingerprints, pen pressure analysis, and other forensic evidence from paper checks.

These commenters requested that the Board impose original check retention requirements in subpart D. Original checks are truncated in today's environment, and the U.C.C. requires the person that truncates the check to give the original check to the drawer, keep the original check, or destroy the original check but maintain the ability to provide a legible copy for a specified period of time (usually seven years). The Board expects that, after the Check 21 Act takes effect, more checks potentially will be truncated and destroyed. The Check 21 Act does not impose any additional requirements on original check retention, and the Board is not imposing any such requirements by regulation. Rather, the choice of whether, and after what period of time, to destroy a check will remain a business decision for the bank or other person that removes the check from the collection or return process. Banks and other persons that destroy checks may take fraud risks into account when deciding whether to destroy a truncated check. For example, some banks may choose to keep original checks above a certain dollar amount due to the potentially greater risks associated with those items.

The commenters did not quantify how often or how many checks are used for forensic purposes by law enforcement; however, the Board understands from staff of the Financial Management Service of the Department of Treasury that cases in which examination of an original Treasury check is necessary to determine a fraud or forgery are relatively rare.

III. Comments That Misunderstood the Check 21 Act or the Board's Proposed Rule

The Board received numerous comments that indicated confusion about the scope, requirements, or effects of the Check 21 Act or the proposed rule.

Fourteen individuals expressed concern that the Act would preclude them from receiving paper checks with their periodic account statements, and four individuals stated that consumers should be able to stop banks from converting their checks to substitute checks. The Check 21 Act does not preclude arrangements whereby customers receive paid checks, although it does make a substitute check acceptable for that purpose.

Two other commenters argued that the Act and the proposed rule would make it more difficult to comply with requirements to produce original checks and suggested that the Board confirm that the Internal Revenue Service (IRS) would accept substitute checks or full-sized photocopies for tax purposes. Substitute checks that meet the legal equivalence requirements of the Check 21 Act can, by the terms of the Act, be used wherever an original check is required. The Board also notes that the IRS currently allows documents other than original checks to be used for tax purposes.

See, e.g.,

IRS Publication 552—Recordkeeping for Individuals, which discusses the permissibility of account statements to prove payments made by check, credit card, or electronic fund transfers.

Three commenters asked the Board to ensure that banks' implementation of electronic check processing services as contemplated by the Check 21 Act would not impede nonbanks' ability to arrange for checks deposited at disparate locations to be returned to a single location. A check is returned to the bank whose routing number appears in the depositary bank indorsement on the back of the check. To facilitate banks' ability to receive returned checks at a centralized location, § 229.35(d) of Regulation CC permits banks to agree that the depositary bank indorsement applied to the back of the check can be the indorsement of a bank other than the bank into which the check was deposited. The Check 21 Act and the Board's final rule do not affect § 229.35(d), and the Board accordingly expects centralized returned check arrangements to function with respect to substitute checks just as they do with respect to original checks today. The Board also notes that industry standards include fields within electronic check records that are specifically designed to

facilitate centralized check return programs.

Another commenter was concerned that the Act and subpart D would impede banks' ability to use “positive pay” and “positive payee” programs to detect fraud. Under a positive pay program, a bank compares the check number and amount of a presented check against a list of check numbers and amount information provided by the drawer. The use of a substitute check should not affect this program. In a positive payee program, the drawer identifies the payee of a check, and the bank scans the payee field of a presented check to verify that the payee information is correct. The payee information on a substitute check will appear in a different location than on an original check, because the image of the original check is reduced and shifted when it is placed on a substitute check. However, position 44 of the MICR line of a substitute check is required to bear a “4” for forward collection or a “5” for qualified return. This information should allow the paying bank's check-processing equipment to identify the document being scanned as a substitute check and to adjust the location at which it scans the payee field accordingly.

Overview of the Board's Final Rule

The Board's final rule is substantially similar to the rule that the Board proposed for comment. However, the Board has made a number of clarifying changes in response to comments received and its own further analysis. These changes include adjustments to certain definitions, particularly regarding how MICR-line variations affect a document's status as a substitute check. The commentary to the final rule provides further clarification about the flow of responsibility for the warranties and indemnity. In addition, the final rule clarifies the scope of, and timeframes that apply to, expedited recredit claims and the general consumer awareness notice requirement. The Board also has provided additional commentary in response to comments that indicated confusion about the interaction between particular provisions of the Check 21 Act and particular provisions of the U.C.C.

Section-by-Section Analysis

This section-by-section analysis focuses on the provisions of the rule that the Board changed or considered changing in light of comments or the Board's further consideration. This analysis does not discuss provisions of the final rule that are substantially similar to the corresponding provision of the proposed rule and on which the Board received no substantive comment. Regarding the Board's reasoning for those provisions, the section-by-section analysis of the Board's proposed rule is incorporated by reference.

I. Amendments To Implement the Check 21 Act

A. Definitions and Word Usage

In General.

Three commenters suggested that the final rule should use terms that are defined in Articles 3 and 4 of the U.C.C. in a manner consistent with the U.C.C.’s usage of those terms. The commenters argued that to do otherwise would produce uncertainty and increase the likelihood of litigation. In particular, these commenters stated that the commentary of the proposed rule used the terms accept and party in ways not contemplated by the U.C.C. The Board agrees that subpart D's word usage should be consistent with the U.C.C. The final rule and commentary therefore replace the word accept with more appropriate verbs, such as take or receive, and replace the word party with person where subpart D contemplates a meaning of the term party that is different from the meaning in the U.C.C.

Section 229.2(a) Account; Section 229.2(n) Consumer Account.

Four commenters expressed concern about aspects of the Board's proposed definitions of account and consumer account.

One commenter suggested that the Board's expansion of the definition of account to include any deposit account at a bank for purposes of subpart D was inappropriately broad. The broad account definition for purposes of the Check 21 Act and subpart D is statutory, and the final rule retains it. Although the Board has not substantively modified the account definition, it has revised the language of the rule and commentary to distinguish more clearly accounts for purposes of subpart D from accounts for purposes of the other subparts of Regulation CC.

One commenter expressed confusion about when interbank deposits would be excluded from the account definition. Existing Regulation CC excludes interbank accounts for purposes of all subparts of Regulation CC. However, the context in which subpart C uses the term account clearly indicates that interbank accounts are meant to be included within that term. The final rule retains the proposed rule's exclusion of interbank accounts for purposes of only subpart B and, in connection therewith, subpart A. The commentary to the final rule explicitly notes that interbank deposits are included in the account definition for purposes of subparts C and D.

To determine when a consumer awareness notice would be necessary, one commenter asked whether the term consumer account included an omnibus clearing account held by a brokerage firm at a bank for purposes of allowing the brokerage firm to pay checks drawn by consumers. The commentary to the final rule clarifies that this type of account is not a consumer account. The commentary to the consumer account definition also clarifies that a credit card account or home equity line of credit that a consumer can access by check is not a consumer account for purposes of Regulation CC because in those cases the consumer's relationship with the bank is a loan rather than a deposit relationship.

Section 229.2(m) Check Processing Region.

One commenter stated that the commentary to § 229.2(m) erroneously states that there are 46 check processing regions. A check processing region is defined as the area served by a Reserve Bank's main office, branch, or other office for check processing purposes. Because the number of Reserve Bank locations that process checks is not static, the final rule omits any numerical reference.

Section 229.2(z) Paying Bank.

One commenter expressed concern that the proposed rule's definition of paying bank stated that the Treasury of the United States or the U.S. Postal Service was a paying bank for a check payable by that entity and sent to that entity for collection, whereas the statutory definition states that these entities are paying banks to the extent that they act as payors. The commenter expressed concern that the proposed rule's definition could be read to exclude Treasury checks and postal service money orders that are sent to Federal Reserve Banks for collection rather than sent directly to the Treasury or the U.S. Postal Service.

The proposed amendment to the paying bank definition was intended to parallel the construction of the existing definition and not to alter the meaning of the Check 21 Act's definition. The final rule retains the proposed definition. The Board has amended the commentary to the definition to clarify that, because the Federal Reserve Banks act as fiscal agents for the Treasury and U.S. Postal Service, Treasury checks and U.S. Postal Service money orders that are sent to the Reserve Banks for collection are deemed to be sent to the Treasury or the U.S. Postal Service, respectively.

Section 229.2(ww) Original Check.

One commenter expressed confusion about the proposed definition of original check and stated that the definition could be read to mean that only one substitute check could be created with respect to any original check. As indicated in the proposed rule and commentary, the Board defined the term original check to distinguish the first paper item authorized by the drawer from any later electronic file or substitute check that represents that item. The Board has left the definition unchanged but has provided commentary to clarify that multiple substitute checks could be created at various points in the collection and return process to represent the same original check.

Section 229.2(vv) MICR Line.

The final rule identifies the applicable industry standards for MICR-line printing and adds a sentence to the commentary to highlight that those standards can vary the technical aspects of printing the MICR line. This would include, for example, the circumstances under which magnetic ink is not required. This revision responds to comments suggesting that a bank not be required to use magnetic ink when printing a paid substitute check solely for the purpose of providing it to the account holder.

Section 229.2(xx) Paper or Electronic Representation of a Substitute Check.

The phrase “paper or electronic representation of a substitute check” was used at many points of the proposed rule and commentary, particularly with respect to the flow of the warranties and indemnity. Several commenters expressed confusion about the need for this phrase or asked that the Board provide more detail about what types of documents or files were included within its scope.

The statute intends that the chain of banks that make the warranties and indemnity will flow uninterrupted from the first reconverting bank to the claimant regardless of how many times the form of the item changed after creation of the first substitute check. The phrase “paper or electronic representation of a substitute check” ensures that responsibility for the warranties and indemnity will flow from the reconverting bank to the last bank that for consideration transfers, presents, or returns the substitute check or representation thereof. The phrase also ensures, as contemplated by the statute, that drawers will have the ability to make a warranty claim under the Check 21 Act even if they received a paper or electronic representation of a substitute check instead of a substitute check. The final rule therefore defines the phrase, and the commentary to the new definition provides examples to illustrate its scope.

Section 229.2(zz) Reconverting Bank (corresponding to Section 229.2(yy) of the proposed rule).

Several commenters expressed concern about the proposed definition of reconverting bank and the accompanying commentary.

Most of these comments focused on the portion of the definition describing the identity of the reconverting bank when a nonbank created the substitute check.

One commenter was confused that the rule used the term reconverting, rather than converting, bank. Reconverting bank is the statutory term and reflects the fact that the original check is converted to electronic form and then later reconverted back to a paper substitute check.

A few commenters opined that the rule should prohibit a person other than a bank from creating a substitute check. However, the statutory text defining a reconverting bank explicitly contemplates nonbank creation of a substitute check, because it states that a bank can be a reconverting bank if it is the first bank to transfer or present a substitute check created by a person other than a bank. The legislative history also explicitly states that Congress intended to allow nonbanks to create substitute checks.

The Board therefore has retained the portion of the definition pertaining to nonbank creation of substitute checks.

When discussing circumstances under which the substitute check warranties are made, the House Report on the Check 21 Act states as follows:

The Committee intends that this language allow depositing customers of a bank to create substitute checks with the same legal protections for recipients under this legislation as if they had been converted by a financial institution at the point of first deposit. If a bank allows its depositing customer to create substitute checks, the bank is warrantor for the substitute checks created by its depositing customer. For example, if a grocery store creates a substitute check, the bill makes the grocery store's bank, and not the grocery store, responsible for the section 4 warranties. A bank may choose to pass along, by agreement with the depositor that creates the substitute check, any liability it may incur due to the depositor in this regard. The Committee believes that requiring a bank's credit to stand behind a substitute check will provide strong protections when paper checks are removed from the system at the point of sale or purchase before they are deposited at, or presented to a financial institution. H.R. Rep. No. 108-132, at 17 (2003).

One commenter was confused by the provision in the proposed rule that a bank receiving a substitute check for deposit from a nonbank would be the reconverting bank if, in lieu of the substitute check, that bank transferred the first paper or electronic representation of the substitute check. This provision ensures that ultimate responsibility under the Act for the substitute check warranties and indemnity will flow back to the bank that received the substitute check from the nonbank. Without this provision, if a bank received a substitute check but instead transferred an electronic representation of that substitute check and a subsequent bank created a second substitute check, that second bank would not be able to pass back losses under the Act to the initial depositary bank. The final rule therefore retains the proposed provision.

Several commenters expressed concern about the potential for a bank to become a reconverting bank without its knowledge and consent. For example, commenters were concerned that a nonbank customer could create and deposit a substitute check without first consulting the bank about its willingness to accept substitute checks in lieu of original checks. The first bank that transfers, presents, or returns a substitute check created by a nonbank (or in lieu therefore the first paper or electronic representation of that substitute check) is the reconverting bank regardless of whether it explicitly agreed to do so. However, generally only large corporate depositors would be equipped to create and deposit substitute checks. Banks therefore should be able to address this issue through their deposit agreements.

One commenter requested that the commentary to the reconverting bank definition provide an example about the identity of the reconverting bank if a bank used a nonbank service provider to create a substitute check on its behalf. The proposed rule already had such an example and the final rule retains it with minor revisions. The Board also has revised the proposed commentary to describe more clearly how to identify the reconverting bank for a check created by a nonbank and to provide additional examples about when a bank would or would not be a reconverting bank.

9. Section 229.2(aaa) Substitute Check (corresponding to Section 229.2(zz) of the proposed rule).

General Comments

. One commenter stated that the industry standard for substitute checks supported substitute checks as well as other types of “image replacement documents,” such as photocopies in lieu of the original check. The commenter requested clarification about whether the other types of documents contemplated by the standard would be substitute checks.

At the time of the proposed rule, the draft standard developed by the Accredited Standards Committee X9 and approved for trial use by the American National Standards Institute

was labeled ANS X9.90 and contemplated three different types of documents, one of which was the substitute check that the Check 21 Act authorizes. Going forward, this standard will be known as ANS X9.100-140 and apply only to substitute checks. However, any document that met all the requirements of 229.2(aaa) would be a substitute check.

Nine commenters expressed concerns about the image standards and other quality standards that apply to substitute checks. Three commenters suggested that the Board identify or give examples of industry standards for substitute checks, and one commenter suggested that the industry standards for substitute checks that the Board identified should not disrupt existing industry standards for checks. The proposed commentary to the substitute check definition identified ANS X9.90 as the industry standard for substitute checks. Because that standard was renamed, the final rule identifies the industry standard for substitute checks as ANS X9.100-140 (unless the Board by rule or order determines that a different standard applies), notes that that standard is exclusive standard, and further notes that ANS X9.100-140 incorporates by reference other existing generally applicable industry standards for checks. The Board has included the “unless the Board by rule or order determines that a different standard applies” language to indicate specifically that the Board ultimately determines what standard applies to substitute checks. The Board does not expect to change the identified standard. In the unlikely event that the Board does identify a different standard, it almost certainly would do so by amending Regulation CC. The Board in no case would change the standard without providing notice of such change.

Three commenters requested that the Board establish standards regarding image quality for substitute checks. In particular, these commenters suggested that substitute checks should be required to use gray-scale, as opposed to black-and-white, images. The Board believes that this level of detail is more appropriately left to industry standards. Although ANS X9.100-140 does not prescribe image standards, that standard may evolve as the industry gains more experience with substitute checks.

A few commenters had particular questions about how the image of the original check would be applied to a substitute check. Two of these commenters erroneously believed that a second substitute check would contain an image of the full front and back of the previous substitute check. Persons wishing to obtain detailed information regarding the layout of a substitute check should consult ANS X9.100-140. This standard generally provides that the images of the front and back of the original check will be reduced so that they can be placed on the first substitute check. A subsequent substitute check would not contain an image of the entire first substitute check. Rather, a subsequent substitute check would contain the image of the original check as that image appeared at the time the previous substitute check was converted to electronic form, and the remainder of the front of the second substitute check would contain identification, MICR-line, and legend information applied by the second reconverting bank. By contrast, the back of a subsequent substitute check would contain an image of the full length of the back of the previous substitute check in order to preserve previous indorsements. The commentary to the substitute check definition and the commentary to § 229.35 regarding indorsement requirements explain image and indorsement requirements for later-generation substitute checks in detail.

Substitute Checks and ACH Debits

. Several commenters requested clarification about how, if at all, checks that are used as source documents to create ACH debits are covered under the Check 21 Act, particularly whether such checks can be used to create substitute checks.

A substitute check must be a representation of an original check. Therefore, something that is not an original check cannot be reconverted to a substitute check. The final rule defines an original check as the first paper check issued with respect to a particular payment transaction. Under U.C.C. 3-105, a check is issued when it is delivered by a drawer with the purpose of giving rights on the check to any person.

The drawer's authorization regarding the use of a check it provides to initiate an ACH debit will determine whether the drawer has issued the check within the meaning of Regulation CC and thus whether the check may be used to create a substitute check. If the drawer authorizes the check only to be used as a source document for an ACH debit and does not authorize the check to be collected as a check, then the check has not been issued because it has not been delivered in a manner that gives any person rights on the check. Therefore, a check authorized for use solely as an ACH debit source document is not an original check within the meaning of Regulation CC, and a bank cannot create a substitute check from that document.

MICR-line Requirement

. The Board's proposed rule adopted the statutory definition of substitute check without substantive change, although the commentary provided extensive discussion of how the MICR line of a substitute check could vary from the MICR line of the original check. Specifically, the proposed commentary clarified that (1) position 44 of the MICR line must contain a “4” or a “5,” (2) a bank could correct an encoding error that appeared on the original check when applying a MICR line to the substitute check, (3) a bank could encode an amount on the substitute check if the original check's MICR line did not contain that information, and (4) no other variation from the original check's MICR line would be permitted. The proposed commentary highlighted that an impermissible error could be caused, for example, if a check reader-sorter misread or failed to read the MICR line of the original check, causing the MICR line applied to the substitute check to contain an error that did not appear on the original check. The proposed rule further provided that a document that failed to meet the substitute check definition only because of a MICR-line error (

i.e.

, a document that “purported” to be a substitute check) would be treated as if it were a substitute check for purposes of the liability and consumer-related provisions of subpart D but would not be the legal equivalent of the original check.

The Board received comments on its proposed treatment of the MICR-line component of the substitute definition from numerous commenters, most of which were depository institutions or organizations representing depository institutions. Some of these commenters generally approved of the MICR-line clarifications and the related purported substitute check provision proposed by the Board. However, the vast majority of commenters on these issues disagreed with the proposed approach.

Commenters that disagreed with the proposed rule expressed concern that the proposed commentary would create confusion because it would allow substitute check MICR lines to contain some variations from the original check but not others. These commenters also expressed concern that paying banks could not charge a customer's account for a document that was not a substitute check because of a MICR-line error and therefore not the legal equivalent of the original check. These commenters advocated that a document with any MICR-line error should be a substitute

check that could be the legal equivalent of the original check. Commenters also stated that the proposed rule provided insufficient guidance about (1) the requirement for encoding position 44 of the MICR line on a qualified return substitute check, (2) whether a bank that failed to encode a substitute check properly would be liable under the Check 21 Act or existing encoding warranties, and (3) which bank ultimately would bear liability for substitute check encoding errors. Many of these commenters suggested that encoding of substitute checks should be covered by existing encoding warranties. Commenters opposing the Board's proposed treatment of the MICR-line requirement also expressed concern that the proposed rule inadequately addressed the extent to which banks could repair a MICR-line error. These commenters generally indicated that the rules for repairing the MICR line of a substitute check should parallel as closely as possible the rules for repairing the MICR line of an original check.

The MICR-line component of the substitute check definition in the Check 21 Act provides that a substitute check is a paper representation of an original check that “bears a MICR line containing all the information appearing on the MICR line of the original check, except as provided under generally applicable industry standards for substitute checks to facilitate the processing of substitute checks.”

In response to the many concerns expressed about the Board's proposed treatment of the MICR-line replication requirement, the Board's staff invited commenters that addressed MICR-line issues to a meeting to explore these issues further. The meeting took place on May 3, 2004, at the Board, and representatives of 53 commenters attended in person or by conference call. A summary of this meeting, including a list of participants, is available at

www.federalreserve.gov/SECRS/2004/May/20040625/R-1176/R-1176_150_1.pdf.

ANS X9.100-140 requires a substitute check used for forward collection to bear a “4” in position 44 and a qualified returned substitute check to bear a “5” in that position. Proper encoding of position 44 ensures that downstream banks will be on notice that the document they have received is a substitute check and can, if converting such an item to electronic form or qualifying it for return, handle it appropriately. The final commentary to the substitute check definition therefore clarifies that a reconverting bank or a bank qualifying a substitute check for return must encode position 44 with a “4” or a “5,” as appropriate.

The final rule clarifies that a substitute check MICR line must have information in each field of the MICR line that was encoded on the original check at any time before an image of the original check was captured. This would include all of the information preprinted on the original check, plus any additional information, such as the amount, that was encoded prior to the time the image of the original check was captured.

In light of the highly technical nature of the MICR line and its important operational role in check processing, the Board's final rule leaves the details regarding permissible MICR-line variations up to ANS X9.100-140 instead of identifying them in the rule and commentary. The Board believes that allowing the MICR line of a substitute check to vary from the original check's MICR line as specified in ANS X9.100-140 is appropriate because the full range of issues relating to MICR-line errors and the most practical solutions to those issues will be revealed through operational experience with substitute checks.

The Board expects that the variations from the original check's MICR line permitted by ANS X9.100-140 would be kept to the minimum necessary to facilitate substitute check processing in the same manner as the original checks. Such variations could include, for example, allowing reconverting banks to correct errors appearing on the MICR-line of the original check. The commentary to the final rule clarifies, however, that industry standards cannot allow a substitute check MICR line to omit a field that, at any time prior to truncation, was encoded on the original check's MICR line. The Board further expects that, in determining what variations from the original check's MICR line should be permitted, the standards committee will incorporate the overriding goal of the Check 21 Act that substitute checks should function as much as possible like original checks so that paying banks and other persons that demand paper checks will not bear costs associated with receiving a substitute check instead of an original check. If the Board concludes that the variations permitted by ANS X9.100-140 are inconsistent with this or other purposes of the Check 21 Act, the Board will consider identifying permissible MICR-line variations by rule or order instead of relying on ANS X9.100-140.

Through revisions to § 229.34(c)(3) and its commentary, the final rule provides that application of MICR-line information to a substitute check is subject to Regulation CC's encoding warranties. The commentary to the substitute check definition also notes that, once a document that meets the substitute check definition has been created, banks may apply MICR-encoded strips to that document as necessary to complete the collection and return process.

10.

Section 229.2(bbb) Sufficient Copy and Copy (corresponding to § 229.2(aaa) of the proposed rule)

. The final rule's definition of sufficient copy more closely tracks the statutory language in the indemnity section of section 6(d)(1) of the Check 21 Act than did the proposed rule. The Board also has reorganized and revised the commentary to illustrate more clearly the definitions of copy and sufficient copy.

Several commenters were confused about the relationship between copy and sufficient copy, which are defined as paper documents, and § 229.58, which allows banks to provide information electronically if the recipient agrees. Although the terms copy and sufficient copy, as well as the term original check, refer only to particular pieces of paper, a bank that is required to provide a paper check or copy may satisfy that requirement by instead providing an electronic image of the check or copy in accordance with § 229.58.

11.

Section 229.2(ccc) Transfer and consideration (corresponding to Section 229.2(bbb) of the proposed rule)

. In response to a comment, the Board has revised the definition of consideration to clarify that a bank receives consideration for the substitute check (or paper or electronic representation thereof) that it transfers to a nonbank if the bank has received value for the check in that or any other form.

The proposed rule contained an exception from the consideration definition stating that a bank would not receive consideration for a substitute check solely in response to a warranty, indemnity, expedited recredit, or other claim with respect to the substitute check. The Board proposed this exception so that a bank could respond to an indemnity or expedited recredit claim by providing a substitute check without a legal equivalence legend as a sufficient copy without automatically breaching the legal equivalence warranty. Several commenters were confused about the operation of this exception. The Board has deleted the exception from the final rule. Because industry standards require application of the legal equivalence legend to a substitute check, the problem that the exception was designed to address is not likely to arise in practice. Moreover, on further consideration, the Board believes that it would be appropriate for a substitute check provided in response

to a claim to carry full warranty, indemnity, and recredit rights.

12.

Section 229.2(ddd) Truncate; Section 229.2(eee) Truncating Bank (corresponding to sections 229.2(ccc) and 229.2(ddd) of the proposed rule, respectively)

. Several commenters expressed concern about the definitions of and commentary to truncate and truncating bank. For example, one commenter expressed concern that the definition of truncate would preclude banks from truncating items that are not handled on a cash basis. Another commenter suggested that the Board clarify that a truncating bank does not make the substitute check warranties and indemnity under §§ 229.52 and 229.53, but that a bank receiving a check electronically could by agreement pass back to the truncating bank losses that the recipient bank incurred under those sections.

The proposed rule used the statutory definition of truncate, and the final rule retains that definition. However, the Board has amended the commentary to truncating bank to clarify that a bank receiving a check electronically from the truncating bank may pass back losses by agreement.

B. Section 229.30(d) Identification of Returned Checks

Section 229.30(d) requires a paying bank to identify its reason for returning a check unpaid on the front of the returned check but does not require a specific location for that information. The Board has revised this section and the accompanying commentary to clarify that a paying bank that returns a substitute check must place the reason for return within the image of the original check. This requirement ensures that the reason for return would be retained on any subsequent substitute check.

C. Issues Relating to Indorsement and Identification Standards—Sections 229.35 and 229.38 and Appendix D

The Board proposed to require all indorsements to be in black ink and to make depositary bank name/location information optional as opposed to mandatory. The Board requested comment about whether returning banks should retain the option to indorse a check on the front. The Board proposed applying to existing substitute checks the indorsement standards in § 229.35 and appendix D, with proposed amendments, that would apply to original checks. The Board proposed separate indorsement and identification requirements that would apply to reconverting banks at the time they create substitute checks.

The Board received a number of comments relating to its proposed treatment of indorsements. Several of these commenters generally questioned whether the proposed changes would improve the legibility of indorsements, particularly because some indorsements on substitute checks would be preserved through images of a previous item. The Board believes that it is too early to determine how the use of substitute checks ultimately will affect the legibility of indorsements. It is likely, as commenters stated, that more indorsements will be preserved through images of previous items. It also is likely that, as the efficiency of the collection process improves through wider use of electronic processing and substitute checks, fewer banks will handle and thus be required to indorse a check. A reduction in the number of indorsements on an item should contribute to greater legibility of the indorsements that are applied.

A few commenters stated that, in some cases, check-handling equipment would first capture an image of a check and then spray a physical indorsement on the check. These commenters requested that the Board clarify that in such cases the indorsement applied after the check image was captured would be conveyed as an electronic indorsement rather than an image of the physical indorsement. The Board agrees with these commenters' analysis of how such an indorsement would be carried forward and has revised the commentary to the substitute check definition and § 229.35 accordingly.

The Board has made additional clarifying changes to these portions of the commentary to address questions posed by commenters regarding the application and preservation of indorsements.

One commenter requested clarification about how a second depositary bank should indorse a substitute check that was returned and redeposited. Substitute checks in such a case would be indorsed just as a redeposited original check is indorsed today.

Commenters generally agreed with the Board's proposal to require indorsements to be in black ink, although several indicated that requiring banks to switch from purple to black ink immediately would be burdensome and requested a grace period.

The final rule retains the black ink requirement but delays the mandatory compliance date until January 1, 2006.

One commenter suggested that the Board should delay the effective date for all the new reconverting bank indorsement and identification requirements. The requirement that a substitute check contain a reconverting bank identification is statutory and takes effect on the effective date of the Check 21 Act.

Three commenters stated that name and location information in the indorsement should be optional, while three others stated that many banks relied on that information and recommended that it remain mandatory. Three other commenters indicated that electronic indorsement standards did not provide for name/location information and suggested that the Board make name/location information mandatory for physically-applied indorsements but optional for electronically-applied indorsements. The final rule adopts this suggested approach.

A few commenters opined that indorsement on the front of the check would be useful under some circumstances, although they differed on what those circumstances would be. By contrast, the majority of commenters that addressed this issue stated that any indorsement on the front of the check would clutter the front of the check and potentially obscure other necessary information. To reduce the risk of obscuring information on the front of the check, the final rule provides that all indorsements must appear on the back of the check.

A few commenters stated that the new indorsement and identification standards with which a reconverting bank must comply when creating a substitute check were too detailed. The Board notes that, in general, the level of detail for indorsement location information for substitute checks at the time of creation parallels that for existing paper checks. The Board therefore has retained specific indorsement location information for newly-created substitute checks. However, the Board has removed specific location information for the reconverting and truncating bank identifications that appear on the front of the check and simply provided that such identifications must be outside the image of the original check. For purposes of the Check 21 Act, reconverting banks should be required to place this information on the front of the check in a manner that does not obscure necessary MICR-line and payment information. The Board believes that the precise location of that information is best left to industry standards.

A few commenters expressed concern that the reconverting bank and truncating bank identifications applied to the front of substitute checks would be considered acceptances or indorsements of such checks under the U.C.C. The Board therefore has clarified

in the commentary that identifications applied to the front of the check are not acceptances or indorsements. A reconverting bank that is a paying bank must place its routing number on the back of the check to ensure that its identification as a reconverting bank is not lost if there is a subsequent substitute check.

The Board also has clarified in the commentary to §§ 229.35(a) and 229.51(b) that this use of the paying/reconverting bank's routing number is for identification only and is not an indorsement.

One commenter questioned why a reconverting bank must apply its routing number twice to a substitute check. The routing number on the front of the substitute check identifies the bank as the reconverting bank for that particular check. The front of a subsequent substitute check thus would bear the routing number of the reconverting bank for that substitute check but not the routing number of the reconverting bank for the previous substitute check. A reconverting bank's routing number on the back of the check therefore serves both as its indorsement (except when the reconverting bank also is the paying bank) and also, because it is set off by asterisks, preserves its identity as a reconverting bank on subsequent substitute checks.

The proposed rule contained amendments to the text of and commentary to § 229.38(d) to clarify a reconverting bank's liability for indorsements that, although applied in accordance with § 229.35 and appendix D, were illegible because of the reduction in size of the original check image that appeared on the first substitute check and the corresponding shifting in the placement of indorsements preserved within the image of the original check. Several commenters requested clarification about how this provision would work in practice. The final rule clarifies that the reconverting bank is liable if the reduction in size and placement of the original check image on the substitute check caused an indorsement previously applied to the original check in accordance with § 229.35 and appendix D to be rendered illegible by a subsequent indorsement that also was applied to the substitute check in accordance with those standards. The final rule also clarifies that the reconverting bank is liable if the shift in placement on a substitute check of an indorsement that was applied to the original check in accordance with § 229.35 and appendix D precluded the subsequent bank from legibly applying its indorsement to the substitute check in accordance with those standards.

Subsequent substitute checks will contain an image of the entire back of the previous substitute check and therefore should not perpetuate the shifting indorsement problem.

D. Section 229.51 General Provisions Governing Substitute Checks

Legal Equivalence.

Section 229.51 combined the legal equivalence and warranty concepts in sections 4(a) and 4(b) of the Check 21 Act by stating that a substitute check would be the legal equivalent of the original check for all purposes and all persons if (1) a bank had made the substitute check warranties in § 229.52 and (2) the substitute check accurately represented all the information on the front and back of the original check as of the time of truncation and bore the required legal equivalence legend.

General Comments about Legal Equivalence.

The Board received several general comments about legal equivalence. One commenter agreed with the concept that a substitute check should not be legally equivalent to an original check unless the substitute check were subject to bank warranties. Two commenters opined that a substitute check created by a nonbank should not be a legal equivalent unless the first bank to transfer that substitute check explicitly agreed to do so. However, the definition of reconverting bank indicates that a bank that transfers a substitute check created by a nonbank thereby becomes the reconverting bank, even if that bank did not explicitly agree to accept the item. If such a substitute check met the accuracy and legend requirements for legal equivalence, it would become a legally equivalent substitute check as of the time the bank transferred it for consideration and thereby made the substitute check warranties. As discussed in the analysis of the reconverting bank definition, banks should be able to work with customers that wish to create and deposit substitute checks so that the banks do not become reconverting banks unwittingly.

Accuracy of Information and Image Quality.

Commenters generally supported the concept that a substitute check must contain an accurate representation of all the information on the original check as a condition of legal equivalence. One commenter requested clarification that a substitute check need not be more legible than an original check to meet the legal equivalence requirements. The Board agrees that a substitute check is not held to a higher standard of accuracy in order to satisfy the legal equivalence requirements. The Board has clarified in the commentary that an accurate image of an illegible original check would, if all other requirements for legal equivalence were satisfied, be a legally equivalent substitute check. This commenter further suggested that, if the back of the original check contained no indorsement information, only an image of the front of that item should be required for a substitute check associated with that item. The Check 21 Act defines a substitute check as a representation of an original checks that bears “an image of the front and back of the original check.” A bank that creates a document without an image of the back of the original check and sends that document as if it were a substitute check therefore bears the associated risk of doing so.

Several commenters raised specific concerns about the proposed commentary to the accuracy requirement. The commentary to that requirement generally stated that “all the information” on the original check that must be retained includes the information preprinted on the original check, payment information added to the check, and other required information added to the check. Requiring features that do not survive the image capturing process to appear on a substitute check as a condition of legal equivalence would preclude the use of substitute checks, thus undermining the primary purpose of the Check 21 Act. The proposed commentary therefore noted that watermarks, micro printing, and other security features that cannot survive the imaging process need not be represented on a substitute check as a condition of legal equivalence.

Some commenters expressed concern about the loss of security features during the creation of a legally equivalent substitute check. Although the loss of some paper-based security features will be inevitable, the Board expects that the industry will develop additional security features that can survive the image capturing process.

Other commenters expressed concern about whether the accuracy requirement for legal equivalence would be met if the drawer or a bank applied payment

information to the check using an ink color or ink type that would not survive the image capturing process. The commentary to the final rule clarifies that payment information always must be accurately represented on a substitute check because that information is an essential element of a negotiable instrument. If a substitute check failed the legal equivalence requirement because of ink choice or some other feature, such as check color or a decorative image, the reconverting bank would be responsible for associated liabilities. However, a reconverting bank could attempt to address this issue through agreements with its depositors and the banks that send checks to it.

One commenter expressed concern because the proposed commentary indicated that a latent security feature that became clearer after an image was captured (such as a void watermark that is faint on an original check but is revealed clearly on a photocopy or other image) would not cause a substitute check to fail the accuracy requirement, provided that it did not render any of the required information illegible. The presence of the void language on the substitute check is problematic to the extent that the recipient of the substitute check is unable to determine if the substitute check reproduced a fraudulent original item that contained clear void language before it was truncated or a legitimate original check on which the void language was latent. A person that suffered a loss because of this uncertainty would have an indemnity claim under § 229.53 and possibly an expedited recredit claim under § 229.54.

Several commenters expressed concern about the lack of uniform standards that apply to the image requirements for substitute checks. The Board understands that some banks intend to capture black and white images of items converted to electronic form, while other banks intend to capture gray scale images that contain a wider range of tones. Any substitute check that is subject to bank warranties, contains an accurate representation of the front and back of the original check, and bears the legal equivalence legend is the legal equivalent of the original check regardless of whether the image is black and white or gray scale. If issues relating to capturing images of checks prove problematic in the creation of substitute checks, the Board expects that industry standards would evolve to address those issues.

Section 229.51(c) Applicable Law.

One commenter requested clarification about whether a substitute check that represented a fraudulent original check would have legal equivalence. The commentary to the final rule clarifies that such a substitute check, if it met the legal equivalence requirements, would be legally equivalent to the underlying check but as such would be treated in the same manner as the original fraudulent item for purposes of other law. For example, a bank could not properly charge a customer's account for a substitute check that represented a fraudulent original check.

This commenter also enquired about the legal status of a substitute check that did not meet the legal equivalence requirements. An item that meets the substitute check definition is a check even if it does not meet the additional requirements for legal equivalence. The proposed commentary to the check definition acknowledged that such substitute checks would be subject to the U.C.C. and Regulation CC. The final rule retains this sentence and, in addition, amends the check definition to state specifically that the term check includes an original check and a substitute check.

Purported Substitute Checks.

In the proposed rule, the Board recognized that some banks attempting to create a substitute check would instead create a document that failed to satisfy the MICR-line replication requirement to be a substitute check. The proposed rule referred to these documents as purported substitute checks. In many cases, a purported substitute check would be processed just like a check but because of the MICR-line error would cause a loss. For example, a document with a MICR-line error only in the amount field or the account number field likely would go through the entire collection process but may be charged for the wrong amount or to the wrong account, respectively. Because purported substitute checks would not be subject to the Check 21 Act, a person suffering such a loss would not have the Act's rights and protections regarding substitute checks. To fill this gap and protect persons who collect, pay, or otherwise receive a purported substitute check, § 229.51(d) of the proposed rule provided that a purported substitute check would be subject to the warranty, indemnity, and consumer-related provisions of the Check 21 Act and subpart D.

Several commenters generally supported the concept of the purported substitute check, although some of these commenters suggested specific revisions to this provision or clarifications about its application. A few commenters that supported the provision requested that it be expanded to apply to a document that failed any of the four substitute check requirements. One commenter neither supported nor opposed the purported substitute check concept but requested clarification about how a document would purport to be a substitute check.

The majority of commenters, however, suggested that the Board delete the purported substitute check provision. These commenters suggested that a document should be a substitute check and a legal equivalent if it contained any MICR-line error, thus obviating the purported substitute check provision.

The final rule leaves the scope of permissible MICR-line variations to ANS X9.100-140. The Board expects this standard to identify the circumstances under which a substitute check's MICR line may vary from the original check in order to facilitate processing of substitute checks. An item that satisfies all the requirements of ANS X9.100-140 is a substitute check that is legally equivalent to the original check (provided all the other requirements for substitute checks and legal equivalency are met).

Regardless of how ANS X9.100-140 addresses permissible MICR-line variations and other substitute check requirements, there inevitably will be instances where a document intended to be a substitute check will fail one or more components of the substitute check definition and thus will not be a substitute check.

The Board notes that there are cases in the current check-processing environment where documents that are not checks or the legal equivalent thereof (for example, photocopies and image replacement documents) nonetheless go through the collection and return process and ultimately are paid, resulting in a charge to a customer's account. It is uncertain how often a bank attempting to create a substitute check instead will create a document with a MICR line that does not satisfy the substitute check definition. The Board therefore has removed the purported substitute check provision from the final rule. If the purported substitute check problem appears broad in scope, creates uncertainty for paying banks regarding whether to make payments, or is detrimental to drawers, the Board will consider addressing those problems by rule or order.

E. Section 229.52 Substitute Check Warranties

The Check 21 Act provides that any bank that transfers, presents, or returns a substitute check for consideration warrants that the substitute check meets the requirements for legal equivalence and that no depositary bank, drawee, drawer, or indorser will be asked to make a duplicative payment.

Section 229.52 of the proposed rule reorganized the statutory language and clarified that the responsibility for the warranties flows with the substitute check and with a paper or electronic representation of that substitute check. The proposed commentary also clarified that warranties associated with the first substitute check continue to flow if a second substitute check is created. These clarifications were intended to ensure that the warranty chain would continue from the first reconverting bank all the way through to the final recipient of a substitute check or representation thereof. The proposed commentary also clarified that a bank's responsibility for the warranties would run only to subsequent parties that received a substitute check or a paper or

electronic representation thereof, not to parties that handled only the original check or that handled the substitute check or representation prior to the warranting bank.

The final rule adopts the text of proposed § 229.52 without revision. However, the Board has revised the commentary to clarify further the issues identified in the previous paragraph and additional issues identified by commenters.

Legal Equivalence Warranty.

Several commenters expressed concern about a reconverting bank being held liable for breaching the legal equivalence warranty because of something that was beyond its control, for example if the drawer wrote payment information on the original check in a type of ink that did not survive the image capturing process well. One commenter suggested that the paying bank should bear the loss for breach of the legal equivalence warranty in such cases because it can control for ink type and the use of security features by agreements with its depositors. This commenter also suggested that the drawer in such cases should not be permitted to make an indemnity claim or expedited recredit claim if the legal equivalence defect was attributable to the drawer's action. Another commenter requested clarification about whether a bank would have an obligation not to convert a check that would not legibly survive the image capturing process.

The Check 21 Act contemplates that a bank can create a substitute check to represent any check as defined in § 229.2(k) and use that substitute check instead of the original check. However, the statute also attempts to place as little burden as possible on those that receive substitute checks, such as a drawer that receives paid checks or a paying bank that demands presentment of a paper check. Because the reconverting bank chose to use a substitute check instead of the original check, the Check 21 Act allocates liability to the reconverting bank for a substitute check that, at the time of its creation, did not meet the legal equivalence requirements. However, a reconverting bank may by agreement pass this liability back to the party that sent the electronic check image to it.

Duplicative Payment Warranty.

One commenter stated that the duplicative payment warranty should apply regardless of the order in which duplicative payment requests occur. The commentary to the final rule makes this point explicitly.

Several commenters acknowledged that the commentary to the proposed rule stated that a reconverting bank would be liable for breach of the duplicative payment warranty even if a duplicative payment was caused by a fraud of which the bank was unaware. However, some of these commenters suggested that the reconverting bank should not be liable for a warranty breach under these circumstances. Responsibility under the Check 21 Act for the duplicative payment warranty does not depend upon the warranting bank's knowledge or fault, although a bank can further allocate such liability by agreement or under provisions of otherwise applicable check law. The final rule therefore contains a fraudulent duplicative payment example.

The Board's proposed rule did not directly address whether a payment made through an ACH debit, as opposed to a check payment made by electronic presentment, would be subject to the duplicative payment warranty. The Board noted that the language of the warranty, which states that a person will not be asked to pay a check it already has paid, could be read to exclude a payment made by ACH debit. The Board specifically requested comment on this issue.

Several commenters stated that an ACH debit should be covered under the duplicative payment warranty because recipients of such debits were not adequately protected by Regulation E and the NACHA rules. Approximately 60 commenters stated that the duplicative payment warranty should not apply to ACH debits because such debits are already adequately covered by existing laws and rules.

The statutory language indicates that the duplicative payment warranty applies to charges initiated by check, and ACH debits are not checks. The Board therefore believes that the best reading of the Check 21 Act is to exclude ACH debits from coverage under the Act's duplicative payment warranty. The Board notes that the U.C.C. applies to unauthorized check payments and the NACHA rules apply to unauthorized ACH debits. In addition, Regulation E applies to unauthorized ACH debits to consumer accounts.

F. Section 229.53 Substitute Check Indemnity

The Check 21 Act indemnity protects against losses that any recipient of a substitute check suffers due to receipt of a substitute check instead of an original check. The Board's proposed rule and commentary clarified that, like the Check 21 warranties, all banks that transfer a substitute check or a paper or electronic representation of a substitute check make the indemnity. This is to ensure that, if an indemnity recipient makes a claim for a loss caused by receipt of a substitute check, that loss would be passed back to the first reconverting bank regardless of the number of times the item changed forms. The proposed rule and commentary also attempted to clarify that, unlike a warranty claim, which can be triggered by receipt of a substitute check or a representation of a substitute check, an indemnity claim is triggered in the first instance only by a loss that is due to receipt of a substitute check instead of the original check. The proposed commentary further clarified the scope of losses recoverable under the indemnity. The Board has adopted the regulatory text of the proposed indemnity section and the accompanying commentary with changes, discussed in the following paragraphs, designed to further clarify operation of that provision.

One commenter indicated that the Board should more clearly distinguish between the flow of responsibility for making the indemnity and the flow of an indemnity claim back up the chain of indemnifying banks. In particular, the commenter requested that the Board better articulate that an indemnity claim must be based on a loss due to any person's receipt of a substitute check. The proposed commentary noted that an indemnity claim must be “ultimately traceable” to the receipt of a substitute check, but another commenter objected to that language and preferred that the Board return to the statutory “due to” language. The commentary to the final rule addresses these concerns.

Several commenters requested clarification about the interaction between the substitute check indemnity and other law. Two commenters suggested clarification about the measure of damages under the indemnity section and the general liability provision (§ 229.56). The proposed commentary contained examples of the indemnity amount with and without a warranty breach, and the final rule further clarifies this distinction. The Board also has added a paragraph describing how production of the original check or a sufficient copy by the indemnifying bank will limit that bank's damages under § 229.53. Production of that item, however, would not absolve the indemnifying bank from warranty claims under any other law. In response to a comment, the Board has clarified that Regulation CC and the U.C.C. are sources of such other warranties.

Three commenters suggested that the Board establish a time limit for bringing an indemnity claim. The liability

provisions of the Check 21 Act, as implemented at § 229.56 of Regulation CC, already establish a one-year statute of limitations for claims under the Check 21 Act.

Several commenters indicated that the examples the Board provided in the commentary to § 229.53 to illustrate the application of the indemnity provision were useful, although some commenters requested that the Board include additional examples. Although the Board has clarified the existing examples, the final rule does not provide additional examples. If experience indicates that there are particular aspects of the indemnity that call for greater clarification, the Board may add examples.

G. Section 229.54 Expedited Recredit for Consumers

The Board's proposed rule reorganized the structure of the consumer expedited recredit provision and clarified how to calculate the time periods that applied for consumer and bank action. The proposed commentary provided a number of examples about how the expedited recredit provision would work in practice.

General Comments.

Numerous commenters, including consumers and consumer groups, stated that the expedited recredit provision should apply even if the consumer was not provided a substitute check. These commenters argued that the Check 21 Act produces this result because the information a consumer must provide to make a claim does not include a statement that the consumer received a substitute check. These commenters also suggested that the legislative history indicated a congressional intent that the expedited recredit apply any time a substitute check was used to process a check. Several of these commenters further suggested that, if the Board retained the requirement that a consumer must receive a substitute check as a condition of the expedited recredit right, then provision of a substitute check or a paper or electronic representation of a substitute check should meet that requirement.

Another commenter understood the rule to mean that the expedited recredit procedure would apply if a consumer received a substitute check that was returned unpaid to the consumer's account but was concerned that the introductory paragraph to the model consumer awareness disclosure (which focused on checks written by consumers) might obscure that point. The Board has amended the model notice to address this concern.

The requirement that a consumer must receive a substitute check to have an expedited recredit claim comes directly from section 7(a) of the Check 21 Act, which states that a consumer may make an expedited recredit claim if he or she can assert in good faith that, among other things, “the bank charged the consumer's account for a

substitute check that was provided to the consumer

” (emphasis added).

When the Check 21 Act gives rights to a person that received a paper or electronic representation of a substitute check, it explicitly so indicates. For example, section 5 states that the warranties are given to the listed persons “regardless of whether the warrantee receives the substitute check or another paper or electronic form of the substitute check or original check.” The consumer expedited recredit provision contains no language to indicate that receipt of something other than a substitute check is meant to trigger the right. In addition, only those consumers who receive substitute checks are entitled to the consumer awareness disclosure that explains expedited recredit rights, which further demonstrates that the right applies only to recipients of substitute checks.

Section 7(h) further provides that “a consumer

who was provided a substitute check

may make a claim for an expedited recredit under this section with regard to a transaction involving the substitute check whether or not the consumer is in possession of the substitute check” (emphasis added).

The expedited recredit procedure is intended to place consumers who receive substitute checks in the same position to the extent practicable as if they had received the original check. The right is not intended to apply to consumers who already have agreed not to receive paper checks. Giving consumers an expedited recredit right in the additional situations suggested by the commenters thus would exceed both the text and the underlying intent of the statute. The Board therefore has not expanded the scope of § 229.54.

Several commenters requested clarification about whether the expedited recredit right would apply to checks that are not drawn on a consumer account, such as travelers' checks, credit card checks, and checks used to access a home equity line of credit. The statute specifically states that a substitute check is subject to the expedited recredit right if the bank holding the consumer's account charged the account for that substitute check. The Act specifically defines the term account to be a deposit account. Therefore, a consumer generally would not have an expedited recredit right associated with a check that was not drawn on his or her deposit account. However, the consumer could have an expedited recredit right for such a check deposited into his or her account if the check was returned to the consumer unpaid in the form of a substitute check for which the bank debited the consumer's account. A consumer who did not have an expedited recredit right for a substitute check that he or she wrote but that was not charged to his or her account nonetheless might have a substitute check warranty or indemnity claim or a U.C.C. claim with respect to that item. The Board has clarified these points in the commentary to § 229.54(a).

Several commenters objected to the portion of the proposed commentary to § 229.54 stating that any warranty claim, not just a claim for a substitute check warranty provided in § 229.52, could trigger an expedited recredit right. The Board notes that the returned check warranties in § 229.34(b) of Regulation CC would run to the drawer of the check. In addition, the Check 21 Act states that a consumer may use the expedited recredit procedure to recover for “a warranty claim” and does not limit such claims to the substitute check warranties. The final commentary therefore retains the concept that losses associated with any warranty breach are recoverable under § 229.54, although the Board has provided more detail about the additional warranties contemplated.

Several commenters suggested that, if a consumer requests an original check, then the bank should be required to provide either the original check or a legally equivalent substitute check. Such a requirement is beyond the scope of the Check 21 Act, which does not establish requirements for when an original check or substitute check must be given but rather establishes the circumstances under which a substitute check may be used as the legal equivalent of the original check. Such a requirement also would go beyond the scope of U.C.C. 4-406, which, as adopted in most states, does not require a bank to provide original checks to consumers or to retain original checks.

The Board therefore has not adopted the commenters' suggestion.

However, State law in New York and Massachusetts requires banks to give their customers the option of receiving paid paper checks with periodic account statements.

The Board also has clarified in the commentary that the amount a consumer may claim as a loss under the consumer expedited recredit section includes the amount of the improper charge as well as any resulting fees that the consumer believes were improper, up to the amount of the substitute check. The commentary provides examples about the amount a consumer could claim.

Time Period for Consumer Action.

The Check 21 Act states that the consumer must make a claim within 40 days of the later of two dates: either the date on which the relevant account statement was mailed (or delivered by other means to which the consumer agreed) or the date on which the problematic substitute check was made available to the consumer. The proposed rule combined these concepts by stating that the claim was due within 40 days of the date that the relevant account statement or substitute check was mailed or delivered. The accompanying commentary clarified that the term delivery includes making the account statement or substitute check available through various means agreed to by the consumer, including in-person delivery.

The Board received numerous comments expressing concerns about the events that should trigger the 40-day time period within which a consumer must make an expedited recredit claim and what a consumer must do to constitute timely action within that period. A few commenters suggested that the final rule's construction should parallel that of the statute.

The Board has retained the “mailed or delivered” language in the rule text because the Board believes this construction clarifies rather than changes the statute's meaning. The Board has amended the final commentary to clarify that delivery includes making the statement or check available at the bank for the customer's retrieval pursuant to the customer's request.

Several commenters suggested that the Board adjust the 40-day time period for consumer action to parallel Regulation E (which gives consumers a 60-day period to make a claim for a disputed electronic fund transfer) or the U.C.C. (which gives consumers a reasonable period to examine a bank statement for errors). These commenters were concerned that having three different yet somewhat related timing requirements for consumer action would be confusing. Some commenters also were concerned that a consumer might receive a substitute check that triggered the time period for making a claim well after the underlying transaction, which could compromise the bank's ability to make a timely interbank expedited recredit claim under § 229.55.

The 40-day period in the proposed rule comes directly from the statute, and the Board has retained it in the final rule. A bank concerned about differences between Regulation E and § 229.54 could choose to give a consumer a longer period than required by § 229.54 to bring a substitute check claim.

Several commenters asked for further clarification about what constituted extenuating circumstances that would require a bank to extend the consumer's 40-day period for making a claim. The proposed rule paralleled the approach in Regulation E by stating the existence of the extenuating circumstances extension in the rule text but moving to the commentary the statutory examples of what might justify an extension. The Board is unaware of any problems in applying the Regulation E extension provision and does not expect problems applying the corresponding provision in § 229.54. The Board therefore is not further clarifying the extenuating circumstances provision at this time.

Several commenters requested further clarification about what action by the consumer would satisfy the requirement to “submit” a claim within the specified period. These commenters noted that some portions of the rule and commentary referred to a consumer's making the claim, while others appeared to focus on the bank's receipt of the claim. Other commenters requested further clarification about the interaction between the consumer's ability to make an oral claim and the bank's right to require a consumer to submit a claim in writing.

The Board has clarified in the final rule that a consumer must submit his or her claim such that the bank receives it within the 40-day time period (extended if necessary) described in the regulation. The final rule also clarifies that, if a consumer submits a claim orally and the bank requires a written claim, the bank must inform the consumer of the written claim requirement at that time and may require the consumer to submit that written claim such that the bank receives it within 10 business days of the oral claim. This time period parallels the corresponding period in Regulation E for written confirmation of oral claims. In such a case, the consumer's claim would be timely if the bank received the oral claim within the 40-day period and the written claim within the 10-day period. In addition, the final rule and commentary provide that if a consumer attempts to submit a claim in any form and does not provide all the information required to constitute a claim, the bank must inform the consumer that the claim is incomplete and identify what information is missing.

One commenter requested that the Board clarify that a consumer who fails to bring a timely expedited recredit claim under § 229.54 nonetheless might have claims under other law, such as a warranty or indemnity claim under § 229.52 or § 229.53, respectively, or a claim under the U.C.C. The Board has made this clarification in the commentary.

Form of Claim and Time Period for Bank Action on Consumer Claims.

The statute provides that a bank must act on a consumer expedited recredit claim within 10 business days after the business day on which the consumer submits the claim. The proposed rule changed the latter occurrence of business day to banking day to parallel other provisions of Regulation CC. The Board received numerous comments on this clarification, all but four of which supported the adjustment. The final rule retains the proposed rule's use of the term banking day. The final rule also clarifies that the 10-day period within which the bank must act on the consumer's claim does not begin until the bank receives the claim. The Board believes that it is appropriate to focus on the bank's receipt, rather than the date of the consumer's mailing or delivery to provide certainty to the bank about the time period within which it must take action.

The final rule retains, with some revisions, the proposed rule's provision stating that the time period for bank action is measured from the bank's receipt of the written claim if the bank requires a consumer to submit an initial oral claim in writing. The final rule and commentary also clarify, in response to a comment, that a bank that requires a claim to be in writing must state that requirement in the consumer awareness disclosure it provides under § 229.57 and always must inform a consumer who makes a claim orally of the requirement at the time of the oral claim.

Bank Action on Consumer Claims.

Bank Action Generally

. The proposed rule reorganized and clarified the provisions of the Check 21 Act related to the bank's options for responding to consumer claims and the notices associated with each of those options. Commenters that addressed the Board's reorganization strongly supported it. The final rule therefore retains the proposed organization of the bank action and notice provisions, but with some specific revisions suggested by commenters.

A Bank's Choices for Responding to a Consumer Claim

. Under the Act and final rule, a bank may grant or deny a consumer's claim or provisionally recredit a consumer's account pending further investigation. The bank may reverse a recredit if it later determines the claim was invalid. A bank must provide a specific notice for each of

these actions. In addition, a bank that denies a claim must demonstrate to the consumer why the claim is not valid and provide the original check or a sufficient copy. One commenter asked whether a bank must retain a copy of expedited recredit claims that it receives. The Check 21 Act does not contain a retention requirement, although other record retention laws and regulations to which the bank is subject might apply.

Regarding provisional recredits, one commenter requested that the Board clarify that the interest due on a provisional recredit would be interest only on the amount of the recredit, rather than on the entire amount claimed by the consumer if that amount is greater than the recredit. The Board agrees that this is the correct result under the rule and therefore has not revised the final rule or commentary to address this point.

A few commenters expressed concern that the Board had diminished the requirement that the bank “demonstrate to the consumer that the claim is not valid” because the proposed rule instead stated that the bank must explain to the consumer the basis for its denial. The Board did not intend to deviate from the statutory requirement but rather to describe more specifically how a bank would satisfy it. These commenters also suggested that the consumer, rather than the bank, is the person that should determine whether a copy provided with a denied claim was sufficient to determine that the claim was not valid. In response to these comments, the text of the final rule uses the statutory language, and the commentary provides more detail about how a bank would demonstrate to the consumer that a claim is not valid.

In describing the bank's ability to reverse a recredit on a later determination that a claim was not valid, the proposed rule clarified that the bank could reverse the basic amount of the recredit plus interest on that amount. All commenters that addressed this point supported allowing a bank to reverse associated interest, although some suggested that the Board further clarify that the interest to be reversed included both the interest component of the initial recredit and the interest that accrued on the entire recredited amount. The final rule and commentary make this clarification.

Several commenters expressed concern about the provision of the proposed rule allowing the bank to reverse a recredit, particularly the statement that the bank may reverse a recredit “at any time.”

The Board has removed the quoted language from the text of the final rule and clarified in the commentary that the time period for the bank's reversal is subject to the applicable statute of limitations.

One commenter suggested that the Board clarify that a bank cannot use the recredit reversal provision as a blanket right of set off to recover amounts from the consumer that are unrelated to the recredit claim. The recredit reversal provision of the rule only allows a bank to reverse a previously-provided recredit and does not apply to other amounts that the consumer might owe the bank.

Delayed Availability

. In response to comments, the commentary to the final rule clarifies that the rule allows a bank to delay the availability of both the base amount of the recredit and any interest on that amount. The Board in response to comments also has clarified in the commentary that the new account and repeated overdraft exceptions in subpart D apply as described in the commentary to the corresponding exceptions in subpart B.

Notice Requirements

. Several commenters suggested that a bank should not be required to notify a consumer of a recredit if the bank affirmatively determines that the consumer's claim is valid. Section 7(f)(2) requires a notice for all recredits, not just those that are made provisionally pending further investigation. The Board therefore has retained the requirement in § 229.54 that a bank always notify the consumer of a recredit.

Notices regarding expedited recredit claims are deemed to be given on the business day that they are mailed or otherwise delivered in a manner agreed to by the consumer. One commenter suggested that electronic delivery of the consumer expedited recredit notices should be subject to the E-Sign Act. The E-Sign Act applies to notices that other law requires to be in writing (rather than in electronic form) and requires a consumer to affirmatively consent to electronic delivery of a written notice after the bank provides a detailed notice concerning electronic delivery. The Check 21 Act specifically states that a bank may provide the expedited recredit notices through any means to which the consumer has agreed. The Board believes that because the Check 21 Act specifically addresses alternative means of providing written information required by that Act, the E-Sign Act does not apply. A bank therefore need not comply with E-Sign when providing materials electronically under the Check 21 Act, although a bank voluntarily may choose to do so.

Other Claims Not Affected

. One commenter questioned the need for § 229.54(f) of the proposed rule, which stated that providing a consumer expedited recredit under § 229.54 does not absolve a bank from liability under other law. This provision of the Board's proposed rule came directly from the statute. A consumer may recover only up to the amount of the substitute check under § 229.54, although the consumer's losses associated with the substitute check may exceed that amount. Paragraph (f) is intended to clarify that a consumer may be able to recover those additional losses under other provisions that allow for proximately-caused damages exceeding the amount of the check, such as the substitute check indemnity or U.C.C. 4-402. The Board has added a reference to the U.C.C. in the rule text and a paragraph in the commentary that explains the intent and application of § 229.54(f).

Sufficiency of Commentary and Examples

. The Board specifically requested comment on whether additional commentary to § 229.54 was needed. Commenters' reactions to this request were mixed. Thirteen commenters requested more commentary. Some of these were general requests, while other commenters offered specific examples that they wanted the Board to include. By contrast, ten commenters argued that no additional examples were needed, and some of these commenters even suggested that the Board omit certain of the proposed examples.

The Board has retained the examples from the commentary to the proposed rule with some clarifying changes. The Board has not, however, added examples or commentary except as noted in the preceding paragraphs. The Board expects that use of the consumer expedited recredit provision will be relatively rare and that the commentary addresses the most likely questions that banks might have regarding practical application of that provision. The Board will consider adding or deleting commentary and examples if experience indicates that the level of detail in the commentary is inappropriate.

H. Section 229.55 Expedited Recredit Procedures for Banks

Several banks expressed concern that the interbank recredit right would not work well in practice and identified various reasons for that concern. For example, some commenters stated that a bank that received an interbank expedited recredit claim might not know within the 10-day period for acting on that claim whether it could produce an original check or sufficient

copy. Such a bank might seek to obtain the original check or sufficient copy by submitting its own interbank recredit claim, which also would be subject to a 10-day response time. One commenter requested that the Board identify which transaction gave rise to a bank's claim and thus started the clock for making an interbank expedited recredit claim. A commenter also requested that the Board specify a particular method for calculating interest on a claim.

Other commenters requested additional clarification about who would enforce the interbank recredit process. Still another commenter asked how a consumer's receipt of an extension to make a consumer expedited recredit claim would affect the timing requirements for the interbank recredit process.

Another commenter questioned why banks had 120 days to make a claim when the corresponding provision of § 229.54 gives consumers only 40 days. As the commentary to the proposed rule explained, the 120-day period for a bank to make a claim allows time for the statement to be delivered to the consumer and for the consumer to make a timely claim, plus it allows for multiple interbank claims with respect to the same substitute check. The Board thinks this explanation is more appropriate in the preamble, which discusses the basis for the rule's provisions, than in the commentary, which clarifies the application of those provisions. The Board accordingly has omitted this text from the commentary to the final rule.

The Board has amended the time periods in § 229.55(b)-(c) for making and responding to an interbank claim to parallel the Board's amendments to the corresponding provisions of the consumer expedited recredit section. In response to a comment, the final commentary also clarifies which transaction triggers the claimant bank's 120-day period for making a claim. Aside from those changes, the Board has adopted § 229.55 and the accompanying commentary as proposed. The interbank recredit section may be varied by agreement. If banks determine that particular provisions of § 229.55 are problematic, they may agree to modify those provisions by agreement as they deem appropriate.

I. Section 229.56 Liability

The Board has adopted the provisions of proposed § 229.56 with some minor changes suggested by commenters.

In response to a comment, § 229.56(a)(1)(i) now contains language that parallels § 229.53(b)(1)(ii) when describing that losses recoverable under subpart D are, in the absence of a warranty and indemnity claim, limited to the amount of the substitute check plus interest and expenses.

Several commenters expressed concern that the Board's proposed rule included the identity of the party to be sued as an element of accrual of a cause of action under § 229.56. The Board included this clarification in the proposed rule to make the standard for accrual parallel to the standard for making a timely claim. The final rule therefore retains the proposed accrual language regarding the identity of the party to be sued.

Two commenters expressed concern or confusion about the interaction of § 229.54, which requires a consumer to bring an expedited recredit claim within 40 days of the delivery of the relevant account statement or substitute check, with the timing requirements of § 229.56. One commenter noted that § 229.56 generally states that a claim must be made within 30 days of accrual to be timely, whereas § 229.54 provides that a consumer has 40 days from delivery of the relevant account statement or substitute check to make a timely expedited recredit claim. This commenter suggested that a consumer be allowed this same 40-day period to make a timely claim for purposes of § 229.56. The Board notes that the statute and rule produce this result by providing that a timely consumer recredit claim under § 229.54 satisfies the timing requirement of § 229.56.

J. Section 229.57 and Appendix C Consumer Awareness and the Board's Model Language

Consumer Awareness Disclosure in General

. The Board has amended the text of § 229.57 of the rule to parallel the statutory text more closely by providing that the consumer awareness disclosure required by subpart D must be brief.

The proposed rule required banks to provide the disclosure to consumers who received paid checks and consumers who received substitute checks on an occasional basis. Several commenters suggested that banks should be required to provide the disclosure to all consumers, not just those who receive substitute checks. Requiring notice for consumers who do not receive substitute checks would go beyond the requirements of the statute and could confuse consumers who receive a notice describing rights that they do not have. The Board therefore has not altered the basic scope of the consumer disclosure requirement. However, the final rule and commentary clarify that the reference to paid checks means paid original checks and paid substitute checks and does not refer to a statement that contains multiple check images per page.

The proposed rule stated that a bank responding to a request for a check by providing a substitute check must provide the disclosure in connection with that substitute check “unless [the] bank already has provided the disclosure” to a consumer who receives paid checks. Some commenters understood the proposed rule to mean that a bank that already had provided the notice to a consumer who received paid checks with account statements would not be required to provide an additional notice when responding to a consumer's request for a check. Other commenters believed that notice upon provision of a substitute check always would be required.

The final rule provides that a bank always is required to provide the disclosure when responding to a request for a check by providing a substitute check. This approach more closely parallels the statutory language, which does not provide an exception to the requirement to provide a disclosure when providing a substitute check on an occasional basis. Moreover, the time that a consumer receives a substitute check in response to a particular request is likely when the disclosure will be most useful.

One commenter suggested that a bank should not be required to provide the substitute check disclosure in a separate mailing but rather should be allowed to provide the disclosure along with other account information. The rule would permit a bank to combine the substitute check disclosure with other information.

One commenter suggested that the consumer awareness disclosure should be required based on the consumer relationship rather than the account relationship, such that a bank need not provide an additional disclosure if an existing consumer customer opened a new account. The text of the final rule incorporates this interpretation. Another commenter suggested that the Board explain how the consumer awareness disclosure would apply in the context of joint account relationships. This commenter stated that notice to one account holder on a joint account should suffice as notice to each consumer on the account. The final rule includes language similar to that in § 229.15(c) regarding notice to joint account holders.

Timing for a Disclosure Provided in Response to a Consumer's Request for a Check.

The statute requires a bank that provides a substitute check in response to a consumer's request for a check to provide the consumer awareness disclosure to the consumer “at the time of the request.” There are some cases in which a bank would be able to provide the notice at the time of the consumer's request in a manner that is useful to the consumer, while other requests may

present practical difficulties for banks. For example, a bank may not know at the time of the request what it will provide in response. Ultimately, the bank might provide something other than a substitute check to the consumer. If that bank had given the substitute check disclosure to the consumer at the time of the request, the consumer might be confused by receipt of a disclosure explaining rights that did not apply to the document (s)he received. Moreover, the consumer may make his or her request in such a manner (such as by telephone) that the bank is unable to provide the disclosure at the time of the request.

In light of the foregoing difficulties, the Board proposed two alternatives for when a bank must provide the disclosure to a consumer who requests a substitute check and requested comment on which alternative was preferable. The first alternative used the statutory language, while the second would have allowed the bank in all cases to provide the disclosure at the time it provided a substitute check in response to the consumer's request. Commenters overwhelmingly preferred the second alternative.

The final rule takes an approach that combines elements from the first and second alternatives. The final rule states that a bank must provide the disclosure to a consumer who requests a check or check copy at the time of the request if feasible and otherwise must provide the disclosure no later than the time at which the bank provides a substitute check in response to the request. The commentary provides examples of when it would not be feasible to provide the disclosure at the time of the request.

Model Language for the Disclosure Required by § 229.57.

The Check 21 Act requires the Board to publish model language that banks could use to satisfy the consumer awareness disclosure requirement and that, when used appropriately, would be deemed to comply with that requirement. The Board requested comment on the model language that it proposed to include in existing appendix C.

The Board received numerous comments on the proposed model disclosure. Several commenters generally opined that the proposed language was adequate, although some of these commenters suggested that the model disclosure could be more concise. Numerous commenters expressed concern that the proposed language was so detailed that it would discourage consumers from reading the disclosure. These commenters suggested a specific, alternative model disclosure that was much shorter than the Board's proposed disclosure. By contrast, five commenters suggested that the model disclosure should provide consumers with more detail about expedited recredit rights.

Many commenters made specific wording suggestions for the Board's consideration.

These commenters also suggested that the Board should require banks to respond accurately to consumer enquiries about how a particular check was processed. The Check 21 Act does not contain such a requirement. However, banks have a business incentive to respond appropriately to consumer enquiries on this and other topics.

The final model disclosure, published as model 5A in appendix C, is shorter than the proposed model. In crafting this model disclosure, the Board has attempted to balance the requirement that the disclosure be brief and the need for the disclosure to contain enough information to enable a consumer to understand and, if necessary, exercise the expedited recredit right in § 229.54. The Board's revisions also reflect its consideration of the specific wording concerns expressed by commenters.

Additional Model Language for Consumer Expedited Recredit Notices.

Although not required to do so by statute, the Board published for comment model notices that banks could use to respond to consumer expedited recredit claims under § 229.54(e). The Check 21 Act does not provide a safe harbor for appropriate use of these model notices, and the Board requested comment on whether having model language would be useful for banks in the absence of a safe harbor. Commenters strongly supported inclusion of the model notices, although many requested that the Board either give the language safe harbor status or specifically state that appropriate use of the models in the Board's view would constitute compliance with the Check 21 Act.

The Board has retained the model consumer expedited recredit notices in appendix C but has revised them. The proposed models focused on responding to claims for an improper charge to a consumer account, but the final models instead focus on whether the consumer's claim is or is not valid. These revisions will allow banks to use the model notices to respond to a consumer's claim regarding an improper charge to his or her account or regarding a warranty breach. Because the statute does not provide safe harbor status to these model notices, the Board has not indicated that appropriate use of the notice constitutes compliance with the rule. However, the Board has revised the language discussing the status of the model notices to indicate that the Board has provided these models to help banks to comply with the rule.

K. Section 229.58 Mode of Delivery of Information Required by This Subpart

One commenter suggested that the Board should delete § 229.58, which contains the rule for electronic delivery of documents that applies to all of subpart D, and instead discuss electronic delivery of documents in each place in the rule where that concept is relevant. The Board has retained the proposed organization because it believes that discussing the issue of electronic delivery in one section and cross-referencing that section when appropriate is straightforward and efficient.

L. Section 229.60 Variation by Agreement

The Check 21 Act and final rule provide that the only provision that may be varied by agreement is the interbank recredit provision at section 8 of the Act and § 229.55 of the rule. The final rule provides commentary clarifying that this provision does not prevent a bank from taking action that is more favorable to the consumer than required by the Check 21 Act or the final rule.

II. Changes Unrelated to the Check 21 Act

In addition to the changes necessary to implement the Check 21 Act, the Board also proposed changes to a number of existing provisions in Regulation CC based on a general review of the rule. Commenters generally supported these proposed changes, although some expressed particular concerns as noted in the following paragraphs. With the exception of the changes discussed in the following paragraphs, the Board is adopting the proposed revisions to existing provisions in substantially the same form as in the Board's proposed rule.

A. Section 229.15 General Disclosure Requirements

The Board proposed to amend the commentary to § 229.15 to require that disclosures under subpart B be clear and conspicuous. The Board proposed this change in Regulation CC to parallel proposed changes to its consumer regulations.

However, the Board received numerous comments opposing the proposed changes to the consumer rules, and several commenters opposed inclusion of clear and conspicuous

language in the Regulation CC commentary.

See

68 FR 68786, 68788, 68791, 68793, 68799 (all dated Dec. 10, 2003).

In response to concerns expressed regarding the proposed consumer regulations, the Board recently withdrew all the proposed amendments to the consumer rules.

In connection with that action, the Board determined that the goal of ensuring that consumers receive noticeable and understandable information should be achieved by developing proposals that focus on improving individual disclosures rather than the adoption of general definitions and standards applicable across all regulations.

See

69 FR 35541 (June 25, 2004).

The existing notice requirements in subparts B and C of Regulation CC have been in effect since 1988, and the Board is not aware that recipients of those notices have expressed concerns regarding the manner in which banks provide them. The Board therefore has determined that adding a clear and conspicuous requirement is unnecessary at this time and has not amended the commentary as proposed. The Board will reevaluate this issue in connection with its future periodic reviews of Regulation CC.

B. Section 229.30(c)(1) Paying Bank's Responsibility for Return of Checks

Section 229.30(c)(1) currently provides that a paying bank's midnight deadline for returning a check is extended if it uses a means of delivery that ordinarily would result in receipt by the receiving bank's next banking day. In response to a case holding that Reserve Banks have a 24-hour banking day for processing checks (see

Oak Brook

Northern Trust,

256 F.3d 638 (7th Cir., 2001)), the Board proposed to amend § 229.30(c)(1) to provide that the deadline would be extended if a paying bank used a means of delivery that ordinarily would result in the receiving bank's receipt of the check before the cutoff hour for its next processing cycle if sent to a returning bank or before its next banking day if sent to a depositary bank.

The Board received several comments on this proposed change, most of which indicated that using the cutoff hour for the next processing cycle would be confusing and difficult to apply. These commenters noted that some banks have more than one such cutoff hour and that paying banks might not know the relevant times for each of the banks to which they return checks.

In response to these comments, the final rule provides that a paying bank must return a check “on or before the receiving bank's next banking day following the otherwise applicable deadline by the earlier of the close of that banking day or a cutoff hour of 2 p.m. or later set by the receiving bank under U.C.C. 4-108.” This approach should provide the certainty of identifying a specific cutoff hour but also allow the receiving bank to set a cutoff hour of 2 p.m. or later or to close before 2 p.m.

C. Other Comments Concerning Non-Check 21-Related Changes

Manner of Providing Subpart B notices.

Commenters generally supported the proposed changes to the commentary to §§ 229.13 and 229.15 that clarified the application of the E-Sign Act to notices and disclosures that subpart B requires to be in writing. However, one commenter expressed concern about existing language in the commentary stating that a notice is in a form that the consumer can keep if it can be “downloaded or printed.” This commenter suggested that the standard be changed to “downloaded and printed.” The Board is not aware of consumer problems associated with this requirement and notes that downloading information on a computer allows the recipient to access and use the information later. The Board also believes that it would be unusual for a bank to send an electronic notice such that it could not be printed. The Board therefore has retained the existing language.

Another commenter expressed concern about the requirement that notices and disclosures required by §§ 229.13(g), 229.16(c)(2), and 229.33(a)-(b) must include an account number, which the commenter interpreted to mean the entire account number. The commenter suggested that a bank should be permitted to redact all but the last four digits for information security purposes. The Board has amended §§ 229.13(g) and 229.16(c)(2) to allow for the proposed redaction. The Board has not amended § 229.33(a)-(b) because the notice required by that section is an interbank notice, and the receiving bank likely would need full account information for the notice to serve its intended purpose.

Section 229.33 Notice of Nonpayment.

The Board received eleven comments concerning its request for comment on whether the time period for giving the notice of nonpayment should be reduced. Only two commenters opined that an adjustment was necessary. The Board therefore has left the time period unchanged. One commenter suggested that the Board amend this section to state that the bank must “provide or give” the notice, as opposed to the “send or give” language proposed by the Board. This commenter was concerned that the Board's proposed language might be read to exclude providing notice by e-mail. The Board believes that the send or give language is sufficiently broad to allow notice in any form, and the proposed commentary explicitly stated that electronic notice would suffice if sent to the address specified by the recipient for that purpose. The Board therefore has adopted the language as proposed.

Another commenter suggested that the Board amend § 229.33 to provide that a bank could provide notice in the form of a substitute check or another paper or electronic representation of a check. The Board believes that the text of § 229.33(a), when combined with the revised commentary addressing the form of the nonpayment notice, already produces this result.

III. Responses to Specific Requests for Comment

In addition to proposing Check 21-related and non-Check 21-related changes, the Board also requested comment on several specific issues.

A. Remotely-Created Demand Drafts

The Board requested comment on whether Regulation CC should incorporate a U.C.C. warranty that would shift liability for an unauthorized remotely-created demand draft from the paying bank to the depositary bank, although the Board did not propose specific regulatory language. Approximately 76 commenters addressed this issue, all but two of which strongly supported the general idea of covering liability for remotely-created demand drafts in Regulation CC. However, many commenters advocated changes from the uniform version of the warranty. For example, some commenters stated that the warranty should apply to all remotely-created demand drafts instead of only those drafts drawn on consumer accounts, and others suggested that the warranty should extend to all the draft's terms instead of the amount only. Many commenters encouraged the Board to propose specific language for comment in a separate rulemaking. The Board intends to issue a separate proposal regarding remotely-created demand drafts later this year.

B. Treatment of Industry Standards

The Board also received comments regarding whether it should identify specific industry standards in the rule text or the commentary. The vast majority of commenters on this issue preferred the Board's proposed

approach of placing a general reference to industry standards in the text of the rule and identifying specific standards in the commentary. However, particularly with respect to substitute checks, many commenters preferred that the Board should indicate that a particular standard is exclusive.

In cases where the Board intends that an exclusive industry standard apply, such as the standards relating to MICR-line printing and substitute checks, the Board has identified a specific standard in the text of the final rule. The Board believes that this approach is more transparent for the reader and will better facilitate compliance with the rule.

C. Plain Language

The Board received four comments about whether the proposed rule and commentary were in plain language. Two of these commenters opined that the rule and commentary were in plain language, especially in light of the complexity of some provisions of the law. Another commenter suggested that the rule could be shortened if some elements were moved to an appendix but did not identify specific changes it would make. Another commenter requested that the rule better clarify the application or non-application of the Check 21 Act to non-consumer accounts. The Board has addressed this concern through its revisions to the account and consumer account definitions and through revisions to certain parts of the commentary.

Paperwork Reduction Act

In accordance with the Paperwork Reduction Act of 1995 (PRA) (44 U.S.C. 3506; 5 CFR 1320 Appendix A.1), the Board reviewed the final rule under the authority delegated to the Board by the Office of Management and Budget (OMB). The final rule contains requirements subject to the PRA. The collection of information that is required by this final rule is found in 12 CFR 229.54, 229.55, and 229.57. This information is required to obtain a benefit for consumers and mandatory for depository institutions.

All depository institutions, of which there are approximately 19,280, potentially are affected by this collection of information, and thus are respondents for purposes of the PRA, because all depository institutions may respond to and make expedited recredit claims under §§ 229.54 and 229.55, respectively. In addition, all depository institutions that provide paid checks to consumer customers with periodic account statements or that otherwise provide substitute checks to consumer customers must provide the consumer awareness notice in § 229.57. However, the extent to which this collection of information affects a particular depository institution will depend on whether and under what circumstances that depository institution provides substitute checks to consumers. For example, institutions that do not provide paid checks with account statements or provide substitute checks in response to consumers' occasional requests for paid checks will have significantly fewer consumer awareness disclosures and expedited recredit notices than will depository institutions that routinely provide paid checks to consumers.

The collection of information in this regulation is a new requirement for which the Federal Reserve has no direct method for estimating burden. The following average burden estimates for respondents regulated by the Federal Reserve therefore are based on the Federal Reserve's experience under similar, existing regulations with respect to the 1,244 state member banks and uninsured U.S. branches and agencies of foreign banks for which the Federal Reserve has administrative enforcement authority (collecting referred to in the following paragraphs as respondents regulated by the Federal Reserve) and for consumers who submit claims to those depository institutions. The following average burden estimates for respondents regulated by the Federal Reserve also represent an average across all such respondents and reflect variations between institutions based on their size, complexity, and practices. The Federal Reserve also has estimated the total annual burden associated with each notice both for respondents regulated by the Federal Reserve and for all affected depository institutions. The Federal Reserve estimates that half of all depository institutions affected by this rule do not provide paid checks with account statements or provide substitute checks and thus would have little or no burden for these requirements. The Federal Reserve has taken this fact into account by estimating total burden for all affected depository institutions on a weighted basis. The other banking agencies are responsible for estimating and reporting to OMB the total paperwork burden for the depository institutions for which they have administrative enforcement authority. They may, but are not required to, use the Federal Reserve's burden estimates.

Except as noted in the following paragraphs, the burden estimates for the final rule are the same as those the Federal Reserve identified for the proposed rule. One commenter expressed concern that the Federal Reserve's proposed paperwork burden estimates in its proposed rule were too low. However, that commenter did not suggest specific revisions to those estimates.

The first notice, described in § 229.54(b)(2), is the information a consumer would provide when making an expedited recredit claim in writing. The Federal Reserve estimates that each respondent regulated by the Federal Reserve will receive, on average, 25 of these claims per year. The Federal Reserve estimates that it will take consumers, on average, 15 minutes to complete and send this claim. The Federal Reserve estimates that the total annual burden for consumers submitting claims to respondents regulated by the Federal Reserve is 7,775 hours. Using the Federal Reserve's methodology, the total annual burden for consumers submitting claims to all depository institutions would be approximately 67,300 hours.

The second notice, described in § 229.54(e), is required when a depository institution validates the consumer's claim, denies a consumer's recredit claim, or reverses a consumer's recredit claim. The Federal Reserve estimates that each respondent regulated by the Federal Reserve will send, on average, 35 of these notices per year. The Federal Reserve estimates that it will take each such respondent, on average, 15 minutes to prepare and distribute these notices (the Board has provided a model disclosure that depository institutions may use for this purpose). The estimated total annual burden for the respondents regulated by the Federal Reserve to respond to consumer claims is 10,885 hours. Using the Federal Reserve's, the total annual burden for all depository institutions would be approximately 94,200 hours.

The third notice, described in § 229.55 (b)(2), is required for each depository institution that is required to make a written claim against an indemnifying depository institution for a substitute check. The Federal Reserve estimates that each respondent regulated by the Federal Reserve will submit, on average, 15 of these claims per year. The Federal Reserve estimates that it will take each such respondent, on average, 15 minutes to complete and send each claim. The estimated total annual burden for respondents regulated by the Federal Reserve to submit interbank recredit claims is 4,665 hours. Using the Federal Reserve's methodology, the total annual burden for all depository institutions would be approximately 40,400 hours.

Finally, § 229.57 describes the requirements for depository institutions

to provide consumer awareness disclosures to consumers who receive paid checks with their periodic statements, who receive a substitute check in response to a request for a check, and who receive a returned check in the form of a substitute check. A model disclosure that depository institutions may use is provided in appendix C-5A.

The proposed rule contained an exception to the disclosure requirement for a depository institution that provided a substitute check on an occasional basis to a consumer who already had received the disclosure. The final rule, by contrast, requires that a depository institution always provide the disclosure when providing a substitute check on an occasional basis. The Federal Reserve believes that provision of a substitute check on an occasional basis in response to a consumer's request will be rare and thus does not expect that elimination of the proposed rule's exception will appreciably increase the number of disclosures. The final rule's paperwork burden estimate for notices provided on an occasional basis therefore is only slightly higher than that in the proposed rule.

The Federal Reserve estimates that each respondent regulated by the Federal Reserve will, on average, provide 510 disclosures per year (as compared with 500 disclosures per year in the proposed rule) and that, on average, it will take one minute to prepare and distribute the disclosure to each consumer. The one-minute estimate is a change from the proposed rule due to further analysis. The consumer awareness disclosures are standardized and machine-generated and do not substantively change from one individual account to another; thus, the average time for providing the disclosure to all consumers who are entitled to receive it should be small. The Federal Reserve estimated that the estimated total annual burden for respondents regulated by the Federal Reserve to provide the consumer awareness disclosure is 10,574 hours. Using the Federal Reserve's methodology, the total annual burden for all depository institutions would be approximately 91,500 hours.

The final rule would increase the total burden under Regulation CC for respondents regulated by the Federal Reserve and consumers submitting claims to those respondents by 33,899 hours, from 327,052 to 360,951. Using the methodology explained above, the final rule would increase total burden under Regulation CC for all depository institutions by approximately 293,400 hours.

The Federal Reserve may not conduct or sponsor, and an organization is not required to respond to, this information collection unless it displays a currently valid OMB control number. The OMB control number is 7100-0235.

Regulatory Flexibility Act

The Board has prepared a final regulatory flexibility analysis as required by the Regulatory Flexibility Act (

see

12 U.S.C. 604).

I. Need for and Objective of Rule

The Board is adopting this rule to implement the Check 21 Act. The Act requires the Board to publish a model disclosure that depository institutions may use to satisfy their consumer awareness disclosure requirements. The Act also authorizes the Board to adopt rules necessary to implement, prevent circumvention or evasion of, or facilitate compliance with the Act. The final rule adopts the text of the Check 21 Act with clarifying changes and commentary designed to aid depository institutions' understanding of and compliance with the Act. The final rule is incorporated into existing Regulation CC so that all the Board's generally applicable check collection requirements will be contained within one rule.

II. Summary of Issues Raised by Comments in Response to the Initial Regulatory Flexibility Analysis

The Board received two comments on its initial regulatory flexibility analysis. One commenter opined that the impact of the rule on small depository institutions should be proportional to that on larger depository institutions and should not be adverse to either. The other commenter expressed concern that the use of substitute checks could increase fraud and that small depository institutions would not have sufficient resources to develop fraud prevention techniques to respond to such increased risks. This commenter acknowledged that additional fraud risks associated with substitute checks could not yet be quantified but expressed concern that these risks would be burdensome. These comments did not provide specific information about the impact of the proposed rule on affected small depository institutions. The Board has not made regulatory changes based on the comments.

III. Description of Affected Small Entities

Under section 3 of the Small Business Act, as implemented at 13 CFR part 121, a bank is considered a “small entity” or “small bank” if it has $150 million or less in assets. Based on March 2004 call report data, the Board estimates that there are approximately 14,251 depository institutions with assets of $150 million or less.

The Check 21 Act does not require any depository institution to create substitute checks or change its general check collection procedures, although after the Act's effective date any depository institution may receive a substitute check instead of an original check. The provisions of the Check 21 Act and the final rule potentially apply to all depository institutions regardless of their size. However, the extent to which any depository institution will be economically affected by the final rule depends on several variables, including how many substitute checks a depository institution handles and whether it creates those substitute checks. Even though all depository institutions that handle a substitute check for value make the substitute check warranties and indemnity and potentially are responsible for providing expedited recredit for a substitute check to a consumer or another depository institution, the final rule allocates most associated losses to the reconverting depository institution that first transferred, presented, or returned the substitute check for value. Thus, a depository institution's costs associated with substitute check-related problems primarily will depend on whether it chooses to create substitute checks. In addition, whether a depository institution must provide the consumer awareness disclosure contained in the final rule will depend on the depository institution's specific practices regarding providing checks to consumers.

Due to current uncertainty about each of the foregoing variables, aside from the burden estimates in the Paperwork Reduction Act section, the Board cannot at this time determine the number of small depository institutions that will be directly affected by the final rule or the rule's overall economic impact on small depository institutions.

IV. Recordkeeping, Reporting, and Compliance Requirements

The final rule does not contain recordkeeping or reporting requirements. However, a depository institution that provides paid checks to consumer customers with account statements or otherwise provides a substitute check to a consumer must provide consumer awareness disclosures. In addition, a depository institution that receives an expedited recredit claim from a consumer or other depository institution must comply with

the requirements of the relevant expedited recredit provision, including the requirements regarding timing for and notification of the depository institution's determination regarding the claim. The final rule allows depository institutions to vary by agreement the terms of the interbank recredit provision, but not the consumer expedited recredit provision.

V. Steps Taken To Minimize the Economic Impact on Small Entities

The requirements of the Check 21 Act that potentially affect small depository institutions are statutory. The Board has minimal flexibility to vary those requirements by regulation, but when possible it has indicated steps depository institutions may take to minimize risks under the Act. The substitute check warranties and indemnity are made as a matter of law when a depository institution transfers, presents, or returns a substitute check, but the final rule and commentary clarify in various places that depository institutions may further allocate liability amongst themselves by agreement. The maximum periods for acting on claims and the notices and other documentation that depository institutions must provide in connection with providing an expedited recredit to a consumer are specifically prescribed by the statute, but § 229.60 of the Board's final rule and the associated commentary clarify that a depository institution may choose to act in a manner more favorable to the consumer than the Act requires. Although the final rule also uses the statute's requirements regarding interbank expedited recredits, § 229.60 specifically notes that depository institutions themselves may vary any of those requirements by agreement. Finally, the statute specifically sets forth the events that trigger provision of and the timing requirements that apply to the consumer awareness disclosure, but § 229.57(b)(2)(i) gives depository institutions flexibility to provide disclosures for a substitute check given in response to specific request for a check at a later date when necessary.

Administrative Procedure Act

In accordance with 12 U.S.C. 553(d)(3), the Board for good cause finds that model disclosure C-5A in appendix C is effective immediately. The Check 21 Act requires the Board to publish model disclosure C-5A three months before the Act's effective date. A bank's appropriate use of model C-5A would constitute compliance with the consumer awareness disclosure requirements in section 12 of the Act and § 229.57 of the final rule. The Board believes that delaying the effective date of model disclosure C-5A would undermine the Act's intent that banks be able to rely on the model language as soon as the Board publishes it.

12 CFR Chapter II

List of Subjects in 12 CFR Part 229

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

Authority and Issuance

For the reasons set forth in the preamble, the Board is amending 12 CFR part 229 to read as follows:

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

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

Authority:

12 U.S.C. 4001-4010, 12 U.S.C. 5001-5018.

§ 229.1

[Amended]

2. In § 229.1, revise paragraph (a) and add a new paragraph (b)(4) to read as follows:

(a)

Authority and purpose.

This part is issued by the Board of Governors of the Federal Reserve System (Board) to implement the Expedited Funds Availability Act (12 U.S.C. 4001-4010 ) (the EFA Act) and the Check Clearing for the 21st Century Act (12 U.S.C. 5001-5018) (the Check 21 Act).

(b)

Organization.

* * *

(4) Subpart D of this part contains rules relating to substitute checks. These rules address the creation and legal status of substitute checks; the substitute check warranties and indemnity; expedited recredit procedures for resolving improper charges and warranty claims associated with substitute checks provided to consumers; and the disclosure and notices that banks must provide.

§ 229.2

[Amended]

3. In § 229.2, revise the introductory sentence to read as follows:

As used in this part, and unless the context requires otherwise, the following terms have the meanings set forth in this section, and the terms not defined in this section have the meanings set forth in the Uniform Commercial Code:

4. In § 229.2(a):

A. Redesignate existing paragraphs (1), (2), (3), (4), and (5) as paragraphs (a)(1)(i), (a)(1)(ii), (a)(1)(iii), (a)(1)(iv), and (a)(1)(v), respectively;

B. Designate paragraph (a) as paragraph (a)(1) and revise the first sentence of that paragraph;

C. Designate the undesignated paragraph as paragraph (2) and revise that paragraph; and

D. Add a new paragraph (3).

The revisions and addition read as follows:

(a)

Account.

(1) Except as provided in paragraphs (a)(2) and (a)(3) of this section,

account

means a deposit as defined in 12 CFR 204.2(a)(1)(i) that is a transaction account as described in 12 CFR 204.2(e). * * *

(2) For purposes of subpart B of this part and, in connection therewith, this subpart A,

account

does not include an account where the account holder is a bank, where the account holder is an office of an institution described in paragraphs (e)(1) through (e)(6) of this section or an office of a “foreign bank” as defined in section 1(b) of the International Banking Act (12 U.S.C. 3101) that is located outside the United States, or where the direct or indirect account holder is the Treasury of the United States.

(3) For purposes of subpart D of this part and, in connection therewith, this subpart A,

account

means any deposit, as defined in 12 CFR 204.2(a)(1)(i), at a bank, including a demand deposit or other transaction account and a savings deposit or other time deposit, as those terms are defined in 12 CFR 204.2.

5. In § 229.2(e), remove the phrase “subpart C” from the last, undesignated paragraph and add the phrase “subparts C and D” in its place, and after the undesignated paragraph add a new paragraph to read as follows:

(e) * * *

Note:

For purposes of subpart D of this part and, in connection therewith, this subpart A,

bank

also includes the Treasury of the United States or the United States Postal Service to the extent that the Treasury or the Postal Service acts as a paying bank.

6. In § 229.2(k):

A. After paragraph (6), add a new paragraph (7) to read as follows:

(k) * * *

(7) The term check includes an original check and a substitute check.

B. Designate the undesignated paragraph with the word “Note” followed by a colon and remove the phrase “subpart C” from the last sentence of that paragraph and add the phrase “subparts C and D” in its place.

7. In § 229.2(q), add the phrase “to a collecting bank for settlement or” between the words “basis” and “to.”

8. In § 229.2(z), remove the phrase “subpart C” from the undesignated paragraph and add the phrase “subparts C and D” in its place, and after the undesignated paragraph add a new paragraph to read as follows:

Note:

For purposes of subpart D of this part and, in connection therewith, this subpart A,

paying bank

also includes the Treasury of the United States or the United States Postal Service for a check that is payable by that entity and that is sent to that entity for payment or collection.

9. In § 229.2(ff), add a new sentence after the first sentence to read as follows:

(ff) * * * For purposes of subpart D of this part and, in connection therewith, this subpart A,

state

also means Guam, American Samoa, the Trust Territory of the Pacific Islands, the Northern Mariana Islands, and any other territory of the United States.

10. In § 229.2, revise paragraph (qq) to read as follows:

(qq)

Claimant bank

means a bank that submits a claim for a recredit for a substitute check to an indemnifying bank under § 229.55.

11. In § 229.2, after paragraph (qq) add the following new paragraphs (rr) through (eee), to read as follows:

(rr)

Collecting bank

means any bank handling a check for forward collection, except the paying bank.

(ss)

Consumer

means a natural person who—

(1) With respect to a check handled for forward collection, draws the check on a consumer account; or

(2) With respect to a check handled for return, deposits the check into or cashes the check against a consumer account.

(tt)

Customer

means a person having an account with a bank.

(uu)

Indemnifying bank

means a bank that provides an indemnity under § 229.53 with respect to a substitute check.

(vv)

Magnetic ink character recognition line

and

MICR line

mean the numbers, which may include the routing number, account number, check number, check amount, and other information, that are printed near the bottom of a check in magnetic ink in accordance with American National Standard Specifications for Placement and Location of MICR Printing, X9.13 (hereinafter ANS X9.13) for an original check and American National Standard Specifications for an Image Replacement Document—IRD, X9.100-140 (hereinafter ANS X9.100-140) for a substitute check (unless the Board by rule or order determines that different standards apply).

(ww)

Original check

means the first paper check issued with respect to a particular payment transaction.

(xx)

Paper or electronic representation of a substitute check

means any copy of or information related to a substitute check that a bank handles for forward collection or return, charges to a customer's account, or provides to a person as a record of a check payment made by the person.

(yy)

Person

means a natural person, corporation, unincorporated company, partnership, government unit or instrumentality, trust, or any other entity or organization.

(zz)

Reconverting bank

means—

(1) The bank that creates a substitute check; or

(2) With respect to a substitute check that was created by a person that is not a bank, the first bank that transfers, presents, or returns that substitute check or, in lieu thereof, the first paper or electronic representation of that substitute check.

(aaa)

Substitute check

means a paper reproduction of an original check that—

(1) Contains an image of the front and back of the original check;

(2) Bears a MICR line that, except as provided under ANS X9.100-140 (unless the Board by rule or order determines that a different standard applies), contains all the information appearing on the MICR line of the original check at the time that the original check was issued and any additional information that was encoded on the original check's MICR line before an image of the original check was captured;

(3) Conforms in paper stock, dimension, and otherwise with ANS X9.100-140 (unless the Board by rule or order determines that a different standard applies); and

(4) Is suitable for automated processing in the same manner as the original check.

(bbb)

Sufficient copy and copy.

(1) A

sufficient copy

is a copy of an original check that accurately represents all of the information on the front and back of the original check as of the time the original check was truncated or is otherwise sufficient to determine whether or not a claim is valid.

(2) A

copy

of an original check means any paper reproduction of an original check, including a paper printout of an electronic image of the original check, a photocopy of the original check, or a substitute check.

(ccc)

Transfer and consideration.

The terms

transfer

and

consideration

have the meanings set forth in the Uniform Commercial Code and in addition, for purposes of subpart D—

(1) The term

transfer

with respect to a substitute check or a paper or electronic representation of a substitute check means delivery of the substitute check or other representation of the substitute check by a bank to a person other than a bank; and

(2) A bank that transfers a substitute check or a paper or electronic representation of a substitute check directly to a person other than a bank has received

consideration

for the substitute check or other paper or electronic representation of the substitute check if it has charged, or has the right to charge, the person's account or otherwise has received value for the original check, a substitute check, or a representation of the original check or substitute check.

(ddd)

Truncate

means to remove an original check from the forward collection or return process and send to a recipient, in lieu of such original check, a substitute check or, by agreement, information relating to the original check (including data taken from the MICR line of the original check or an electronic image of the original check), whether with or without the subsequent delivery of the original check.

(eee)

Truncating bank

means—

(1) The bank that truncates the original check; or

(2) If a person other than a bank truncates the original check, the first bank that transfers, presents, or returns, in lieu of such original check, a substitute check or, by agreement with the recipient, information relating to the original check (including data taken from the MICR line of the original check or an electronic image of the original check), whether with or without the subsequent delivery of the original check.

§ 229.3

[Amended]

12. In § 229.3, remove the phrase “the Act” from paragraphs (b)(1) and (c)(2)(ii) and add the phrase “the EFA Act” in its place.

§ 229.13

[Amended]

13. Revise § 229.13(g)(1)(i)(A) to read as follows:

(g) * * *

(1) * * *

(i) * * *

(A) A number or code, which need not exceed four digits, that identifies the customer's account;

§ 229.16

[Amended]

14. Revise § 229.16(c)(2)(i)(A) to read as follows:

(2) * * *

(i) * * *

(A) A number or code, which need not exceed four digits, that identifies the customer's account.

§ 229.20

[Amended]

15. In § 229.20, remove the phrase “the Act” wherever it appears and add the phrase “the EFA Act” in its place.

§ 229.21

[Amended]

16. In § 229.21(g)(2), remove the phrase “the Act” and add the phrase “the EFA Act” in its place.

§ 229.30

[Amended]

17. In § 229.30:

A. In the undesignated paragraph after paragraph (a)(2)(iii), remove the next-to-last sentence and add two new sentences in its place; and

B. Revise paragraphs (c)(1) and (d).

The revisions and addition read as follows.

(a) * * *

(2) * * *

(iii) * * *

* * * A qualified returned check shall be encoded in magnetic ink with the routing number of the depositary bank, the amount of the returned check, and a “2” in the case of an original check (or a “5” in the case of a substitute check) in position 44 of the qualified return MICR line as a return identifier. A qualified returned original check shall be encoded in accordance with ANS X9.13, and a qualified returned substitute check shall be encoded in accordance with ANS X9.100-140. * * *

(1) On or before the receiving bank's next banking day following the otherwise applicable deadline by the earlier of the close of that banking day or a cutoff hour of 2 p.m. or later set by the receiving bank under U.C.C. 4-108, for all deadlines other than those described in paragraph (c)(2) of this section; this deadline is extended further if a paying bank uses a highly expeditious means of transportation, even if this means of transportation would ordinarily result in delivery after the receiving bank's next cutoff hour or banking day referred to above; or

(d)

Identification of returned check.

A paying bank returning a check shall clearly indicate on the front of the check that it is a returned check and the reason for return. If the check is a substitute check, the paying bank shall place this information within the image of the original check that appears on the front of the substitute check.

§ 229.31

[Amended]

18. In the undesi

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