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Regulation E, Check Conversions, the ACH and Stop Payments
by John Burnett
Guru Bios

True or False?
  1. Regulation E does not cover transactions that originate on paper (except debit card transactions).
  2. Under Regulation E, consumers can stop payment on preauthorized debits from their accounts, and on no other type of EFT.
  3. ACH rules apply to all ACH transactions; Regulation E applies only to other EFTs.
Answers are at the end of this article.

New ACH Entries
Within the last five years the National Automated Clearinghouse Association (NACHA), the rule-making body for the U.S. ACH network, created five new transaction types (Standard Entry Classes) -
  • RCK - Resubmitted (bounced) check
  • POP - Point of Purchase check conversion
  • ARC - Accounts Receivable Check (conversion)
  • TEL - Telephone single authorization payment
  • WEB - Web (Internet) single authorization payment
In the case of the RCK, POP and ARC entries, NACHA's intent was to speed up the collection process by substituting the speed of the ACH for the physical transportation and presentment of a check. The TEL and WEB entries were designed to provide convenient payment methods for telephone and Internet sales, to augment the use of credit (and debit) cards. In each case, the ACH transaction held the potential of being less expensive to process than the paper or plastic alternative.

NACHA rules include a consumer's right to stop payment on each of these standard entry classes, in addition to a consumer's general right to stop any ACH transaction.

It's clear that the RCK transaction would be subject to a stop order, since it attempts to collect a check that has at least once been returned for insufficient or uncollected funds. The consumer's original instruction to pay (on the check) remains the authority for the RCK transaction. If the original check is stopped, the RCK loses its authorization. Since the RCK was the first in this series of five ACH entries to be authorized by NACHA, it has served in some fashion as a template for the other four. In each case, it was clear that the consumer would retain a right to stop the payment.

NACHA undoubtedly included stop payment rights for the other four entry types in order to make them palatable to consumers. It's likely that acceptance of these transactions would have been doubtful if important rights inherent in the paper check world were forsaken with conversion. It's also true that customers whose checks are converted into ARC or POP entries might expect a stop payment right, since they had tendered checks for payment at the start of the transaction.

What are some of the implications of these stop payments to banks?

Need for systems integration
In NACHA's Next Generation ACH Task Force report, "Future Vision of the ACH Network," one of 12 major recommendations addresses the "silo infrastructure" of the financial institution payment system. The Task Force's Executive Summary described the challenge: Financial institutions maintain different systems for the various payment mechanisms that they operate. Check and ACH systems, for example, typically do not talk to each other. This poses a particular problem for the conversion of checks where cash management risk controls are bypassed when these items are converted to ACH payments. In addition, stop payment orders placed on converted checks cannot be acted upon if the financial institution's ACH and check stop payment systems are not integrated. Put simply, paper check processing and ACH electronic payments processing are two separate "front-end" systems for most banks' deposit systems. The paper-oriented system has an efficient stop-payment capability. The ACH front-end often doesn't. Absent some sort of jury-rigged system that flags or stops every ACH debit on an account (ACH entries did not historically have serial number fields), some banks found that converted checks made it "under the radar" and posted to customers' accounts.

Although NACHA permits Receiving Depository Financial Institutions (RDFIs) to return the entries within 60 days of their settlement dates, the inability to prevent these payments from posting causes at best an inconvenience for the bank and its customers. When customers fail to review their statements and the 60-day period has lapsed, problems are clearly compounded. The RDFI can be at risk of loss as well. Under Reg E, the customer has 60 days from the time the institution sends the periodic statement to notify the institution of an unauthorized EFT. Under the NACHA rules, those entries can be returned within 60 days of their settlement dates. There is a disconnect between those two timing rules. As a result, a customer can make a timely claim against his institution under Reg E days after the return right under the NACHA rules expires. The RDFI will be in a position of having to recredit its customer's account without being able to pass the loss back to the ODFI.

Financial institutions should be working with vendors to develop systems enhancements designed to use standard stop payment data to filter ACH transactions. Note, however, that neither the WEB nor the TEL entry is required to include a serial number against which a stop order can be checked. The only two data fields in these transactions capable of comparison with a stop file are the customer account number and the dollar amount.

Until systems integration is attainable, however, financial institutions need to develop and use those jury-rigged tricks that will allow them to flag ACH transactions when stop orders are received.

There are also training issues implied here. Besides knowing about these single-authorization ACH entries, your staff needs to understand that they may be returnable even if the bank missed a stop (provided, of course, that the stop was placed before the entry posted). Such is not the case with paper checks under the UCC.

Synchronization with Regulation E disclosures
Regulation E itself requires that a consumer be provided a right to stop payment on any of a series of pre-authorized (read: recurring) transfers from the consumer's account. This right applies until the third business day before the settlement date of the transfer.

Financial institutions are required to disclose this stop payment right in their "initial disclosures." But what about ARC, POP, TEL, and WEB entries? Regulation E says nothing about disclosing the right to these stop payments.

It's correct that a literal reading of the regulation does not require that a financial institution inform its consumer customers of the right to stop these single-authorization transfers. However, it's also true that disclosures are supposed to be clear and understandable, and not be misleading. One could argue that by limiting a disclosure of stop payment rights to the those specifically required by the regulation, a financial institution might mislead a consumer into believing there are no stop payment rights on ARC, POP, TEL and WEB entries, or that the stop order has to reach the bank at least three business days before the entry posts (which would be before it was first authorized in many cases). Both assumptions would be incorrect, of course, but reasonable based on use of the model form language:
(1) Right to stop payment and procedure for doing so. If you have told us in advance to make regular payments out of your account, you can stop any of these payments. Here's how:
Call us at [insert telephone number], or write us at [insert address], in time for us to receive your request 3 business days or more before the payment is scheduled to be made. If you call, we may also require you to put your request in writing and get it to us within 14 days after you call. (We will charge you [insert amount] for each stop-payment order you give.)

(2) Notice of varying amounts. If these regular payments may vary in amount, [we] [the person you are going to pay] will tell you, 10 days before each payment, when it will be made and how much it will be. (You may choose instead to get this notice only when the payment would differ by more than a certain amount from the previous payment, or when the amount would fall outside certain limits that you set.)

(3) Liability for failure to stop payment of preauthorized transfer. If you order us to stop one of these payments 3 business days or more before the transfer is scheduled, and we do not do so, we will be liable for your losses or damages. One suggestion is to add to your disclosures language similar to the following:
Stop payments on certain other transfers: If you have authorized a transfer from your account by telephone or via the Internet by providing information about your account number at this bank, or if you believe that a check you have issued on your account has been converted to an electronic funds transfer, you may stop payment on any of these transfers by contacting us at [insert telephone number] before the transfer is completed. We will require the exact dollar amount of the transfer, the name of the party to whom you gave the check or authorization, and the check number (if any).We will charge you [insert amount] for each stop payment order you give.

True or False?
Now, let's revisit our True/False statements at the top of this article.
  1. Regulation E does not cover transactions that originate on paper (except debit card transactions). False. As we've seen, check conversion transactions are subject to Regulation E.
  2. Under Regulation E, consumers can stop payment on preauthorized debits from their accounts, and on no other type of EFT. Again, False. Although Regulation E doesn't discuss any other stop payment rights, ARC, POP, TEL and WEB ACH entries, which are all subject to Regulation E, carry with them stop payment rights.
  3. ACH rules apply to all ACH transactions; Regulation E applies only to other EFTs. False - that's three for three! While it's true that ACH rules apply to all ACH transactions, Regulation E also applies to many of the ACH entries to consumer accounts.

NACHA Operating Rules, Article 7, Section 4.
Future Vision of the ACH Network, February 2002,, page 4.
See 12 CFR 205.7(b)(7) and 205.10(c).
Model form A-2(h) in Appendix A to 12 CFR Part 205.

The original version appeared in the August/September 2004 edition of the Oklahoma Bankers Association Compliance Informer.

First published on 01/24/05

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