Federal Reserve Board Amendments to Regulation CC

Effective July 1, 2006, The Federal Reserve Board approved amendments to its Regulation CC that define "remotely created checks" and create transfer and presentment warranties to shift liability for an unauthorized remotely created check to the institution where it is first deposited.

In place of a signature, a remotely created check generally bears a statement that the customer authorized the check or bears the customer's printed or typed name. Remotely created checks can be useful payment devices. For example, a debtor can authorize a credit card company to create a remotely created check by telephone. This may enable the debtor to pay the credit card bill in a timely manner and avoid late charges. However, remotely created checks are vulnerable to fraud because they do not bear a signature or other readily verifiable indication that payment has been authorized.

In order to help reduce the potential for fraud, the amendments to Regulation CC create transfer and presentment warranties under which any bank that transfers or presents a remotely created check would warrant that the check is authorized by the person on whose account the check is drawn. The warranties would apply only to banks and would ultimately shift liability for losses attributable to an unauthorized remotely created check to the depositary bank. These amendments would not affect the rights of checking account customers, as they are not liable for unauthorized checks drawn on their accounts.

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FEDERAL RESERVE SYSTEM
12 CFR Parts 210 and 229
Regulations J and CC; Docket No. R-1226
Collection of Checks and Other Items By Federal Reserve Banks and Funds
Transfers Through Fedwire and 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 adopting a final rule amending Regulation CC
to define "remotely created checks" and to create transfer and presentment warranties for
such checks. The purpose of the amendments is to shift liability for unauthorized
remotely created checks to the depositary bank, which is generally the bank for the
person that initially created and deposited the remotely created check. The Board is also
adopting conforming cross-references to the new warranties in Regulation J.

EFFECTIVE DATE: July 1, 2006.

FOR FURTHER INFORMATION CONTACT: Adrianne G. Threatt, Counsel
(202/452-3554), or Joshua H. Kaplan, Attorney, (202/452-2249), Legal Division; or Jack
K. Walton, II, Associate Director (202/452-2660), or Joseph P. Baressi, Senior Financial
Services Analyst (202/452-3959), Division of Reserve Bank Operations and Payment
Systems; for users of Telecommunication Devices for the Deaf (TDD) only, contact
202/263-4869.

SUPPLEMENTARY INFORMATION:
Background
Existing Law and the Board's Proposed Rule
"Remotely created checks" typically are created when the holder of a checking
account authorizes a payee to draw a check on that account but does not actually sign the
check.
1
In place of the signature of the account-holder, the remotely created check
generally bears a statement that the customer authorized the check or bears the
customer's printed or typed name. Remotely created checks can be useful payment
devices. For example, a debtor can authorize a credit card company to create a remotely
created check by telephone, which may enable the debtor to pay his credit card bill in a
timely manner and avoid late charges. Similarly, a person who does not have a credit
card or debit card can purchase an item from a telemarketer by authorizing the seller to
create a remotely created check.
On the other hand, remotely created checks are vulnerable to fraud because they
do not bear the drawer's signature or other readily verifiable indication of authorization.
Because remotely created checks are cleared in the same manner as other checks, it is
difficult to measure the use of remotely created checks relative to other types of checks.

1
There is no commonly accepted term for these items. The terms "remotely created check," "telecheck,"
"preauthorized drafts," and "paper draft" are among the terms that describe these items.

2
However, there have been significant consumer and bank complaints identifying cases of
alleged fraud using remotely created checks.

Existing Law on Remotely Created Checks
A remotely created check is subject to state law on negotiable instruments,
specifically Articles 3 and 4 of the Uniform Commercial Code (U.C.C.) as adopted in
each state. Under the U.C.C., a bank that pays a check drawn on the account of one of
its customers may charge a customer's account for a check only if the check is properly
payable. A bank generally must recredit its customer's account for the amount of any
unauthorized check it pays.
2
This obligation is subject to limited defenses.
3
In addition,
the paying bank may obtain evidence that the depositor did in fact authorize the check
and is seeking to reverse the authorization. Under such circumstances, the paying bank
would not be obligated to recredit its customer for the amount of the check.
4


A paying bank may, until midnight of the banking day after a check has been
presented to the bank, return the check to the bank at which the check was deposited if,
among other things, the paying bank believes the check is unauthorized. Once its
midnight deadline has passed, the paying bank generally cannot return an unauthorized
check to the depositary bank.
5

The provisions of the U.C.C. cited above implement the rule set forth in the
seminal case of Price v. Neal,
6
which held that drawees of checks and other drafts must
bear the economic loss when the instruments they pay are not properly payable because
the drawer did not authorize the item.
7
Under the Price v. Neal rule, the paying bank
must bear the economic loss of an unauthorized check with little recourse other than
bringing an action against the person that created the unauthorized item. This rule
currently applies to all checks, including remotely created checks, in a majority of states.

The policy rationale for the Price v. Neal rule is that the paying bank, rather than
the depositary bank, is in the best position to judge whether the signature on a check is
the authorized signature of its customer. Remotely created checks, however, do not bear
a handwritten signature of the drawer that can be verified against a signature card. In
most cases, the only means by which a paying bank could determine whether a remotely
created check is unauthorized and return it in a timely manner would be to contact the
customer before the midnight deadline passes. However, before a paying bank can verify
the authenticity of remotely created checks, it first must identify remotely created checks
drawn on its accounts. Because there is no code or feature on remotely created checks

2
U.C.C. 4-401.
3
For example, the paying bank may be able to assert that the customer failed to notify the bank of the
unauthorized item with "reasonable promptness" (U.C.C. 4-406(c) and (d)).

4
The FTC's Telemarketing Sales Rule prohibits a telemarketer from issuing a remotely created check on a
consumer's deposit account without the consumer's express verifiable authorization. The authorization is
deemed verifiable if it is in writing, tape recorded and made available to the consumer's bank upon request,
or confirmed by a writing sent to the consumer prior to submitting the check for payment. 6 CFR part 310.
5
See U.C.C. 4-301 and 4-302. In limited cases, the paying bank may be able to recover from the
presenting bank the amount of a check that it paid under the mistaken belief that the signature of the drawer
of the draft was authorized. This remedy, however, may not be asserted against a person that took the
check in good faith and for value or that in good faith changed position in reliance on the payment or
acceptance. U.C.C. 3-418(a) and (c).
6
97 Eng. Rep. 871 (K.B. 1762).
7
See also Interbank of New York v. Fleet Bank, 730 NYS 2d 208 (2001).

3
that would enable a paying bank to identify them reliably in an automated manner,
remotely created checks rarely come to the attention of paying banks until a customer
identifies the check as unauthorized, usually well after the midnight deadline.

Recent Legal Changes to Address Remotely Created Checks
Amendments to the U.C.C.
In recognition of the particular problems presented by remotely created checks,
the National Conference of Commissioners on Uniform State Laws and the American
Law Institute in 2002 approved revisions to Articles 3 and 4 of the U.C.C. that
specifically address remotely created checks. The U.C.C. revisions define a remotely
created check (using the term "remotely-created consumer item") as "an item drawn on a
consumer account, which is not created by the paying bank and does not bear a hand
written signature purporting to be the signature of the drawer."
8
The U.C.C. revisions
require a person that transfers a remotely-created consumer item to warrant that the
person on whose account the item is drawn authorized the issuance of the item in the
amount for which the item is drawn.
9
Accordingly, the U.C.C. alters the Price v. Neal
rule for remotely-created consumer items by shifting liability for those items to the
transferors.
10

These revisions rest on the premise that it is appropriate to shift the burden of
ensuring authorization of a remotely created check to the bank whose customer deposited
the remotely created check because this bank is in the best position to detect the fraud.
11

The U.C.C. warranty provides an economic incentive for the depositary bank to monitor
customers that deposit remotely created checks and, therefore, should have the effect of
limiting the quantity of unauthorized remotely created checks that are introduced into the
check collection system.
Amendments to State Laws
Fewer than half the states in the U.S. have amended their Articles 3 and 4 to
include provisions to address remotely created checks.
12
Among the states that have
made such amendments, the definitions and warranties are not uniform in their scope or
requirements. In addition to the state codes, some check clearinghouses have adopted
warranties that apply to remotely created checks that are collected through these
clearinghouses. The state-by-state approach to the adoption of remotely created check
warranties complicates the determination of liability for remotely created checks
collected across state lines, because the bank that presents a check may not be subject to
the same rules as the paying bank.

8
U.C.C. 3-103(16).
9
U.C.C. 3-416(a). A person that transfers

a remotely-created consumer item for consideration warrants to
the transferee and, if the transfer is by indorsement, to any subsequent transferee, that the person on whose
account the item is drawn authorized the issuance of the item in the amount for which the item is drawn.
See also U.C.C. 4-207(a)(6), 3-417(a)(4), 4-208(a)(4).
10
For items other than remotely-created consumer items, the transferor must warrant only that it has "no
knowledge" that the instrument is unauthorized. U.C.C. 3-417(a)(3).
11
U.C.C. 3-416, Official Comment, paragraph 8. The Official Comment notes that the provision
supplements the FTC's Telemarketing Sales Rule, which requires telemarketers to obtain the customer's
"express verifiable authorization."
12
Those states include Arkansas, California, Colorado, Hawaii, Idaho, Iowa, Maine, Missouri, Minnesota,
Nebraska, New Hampshire, North Dakota, Oregon, Tennessee, Texas, Utah, Vermont, West Virginia, and
Wisconsin.

4
Proposed Rule

On March 4, 2005, the Board published for comment a proposal to amend
Regulation CC to provide transfer and presentment warranties for remotely created
checks.
13
This proposal was issued pursuant to the Expedited Funds Availability Act (the
EFA Act), Pub. L. 100-86, 101 Stat. 635 (codified at 12 U.S.C. 4001 et seq.), which
authorizes the Board to establish rules allocating losses and liability among depository
institutions "in connection with any aspect of the payment system."
14
As noted above,
the check collection and return system operates nationally. As a result, in order for the
remotely created check warranties to be effective they must apply uniformly and
nationwide.
The Board proposed to define a "remotely created check" as a check that is drawn
on a customer account at a bank, is created by the payee, and does not bear a signature in
the format agreed to by the paying bank and the customer. Unlike the U.C.C.
amendments, the Board's proposed definition would apply to remotely created checks
drawn on both consumer and non-consumer accounts.
The Board proposed to create transfer and presentment warranties that would
apply to remotely created checks that are transferred or presented by banks to other
banks. Under the proposed warranties, any transferor bank, collecting bank, or
presenting bank would warrant that the remotely created check that it is transferring or
presenting is authorized according to all of its terms by the person on whose account the
check is drawn. The proposed warranties would apply only to banks and ultimately
would shift liability for the loss created by an unauthorized remotely created check to the
depositary bank. A paying bank would not be able to assert a warranty claim under the
Board's proposed rule directly against a nonbank payee that created or transferred an
unauthorized remotely created check.
General Comments
The Board received over 250 comments on the proposed rule from depository
institutions of various sizes, trade associations that represent depository institutions, state
attorneys general, individuals, academics, consumer representatives, the Permanent
Editorial Board of the U.C.C., and Reserve Banks. This section presents an overview of
the central points contained in the comments that the Board received. The section-by-
section analysis of the final rule, set forth below, discusses the comments in greater detail
and responds to specific concerns regarding the definition of remotely created check and
the scope of the warranties.
The commenters provided overwhelming support for the proposed rule, although
many suggested that the Board make specific revisions in the final rule. The Board
received many comments in favor of the proposal from small depository institutions,
many of which noted that they regularly suffer losses as the result of unwittingly paying
remotely created checks that customers later identify as unauthorized. Large depository

13
70 FR 10509.
14
The Board is authorized to impose on or allocate among depository institutions the risks of loss and
liability in connection with any aspect of the payment system, including the receipt, payment, collection, or
clearing of checks, and any related function of the payment system with respect to checks. Such liability
may not exceed the amount of the check giving rise to the loss or liability, and, where there is bad faith,
other damages, if any, suffered as a proximate consequence of any act or omission giving rise to the loss or
liability. 12 U.S.C. 4010(f).

5
institutions and their trade associations also strongly supported the proposal and
specifically addressed a number of important issues discussed below.
Only one depository institution opposed the proposal in its entirety, arguing that
there is no factual predicate for the proposed rule because paying banks do not verify the
authenticity of customer signatures on any checks. The Board believes that many banks
do examine signatures on some subset of checks. Nevertheless, given that remotely
created checks do not bear a verifiable mark of authentication, the depositary bank is in a
better position to prevent the introduction of unauthorized remotely created checks into
the check collection process by acquainting itself with the business practices of its
customers who routinely deposit such checks. The purpose of the Board's rule is to
create an economic incentive for depositary banks to perform the requisite due diligence
on their customers by shifting liability for unauthorized remotely created checks to the
depositary bank.
Some commenters, including Attorneys General representing 35 states,
recommended that the Board prohibit the use of remotely created checks altogether,
arguing principally that legitimate use of remotely created checks has significantly
declined, largely as a result of new automated clearing house (ACH) payment
applications that can be used in place of remotely created checks. Several commenters,
however, reported an increase in the use of the remotely created checks (albeit some
noting that this increase in use has been accompanied by a commensurate increase in
unauthorized remotely created checks). The Board believes that substantial additional
research would be required about the uses of remotely created checks and the commercial
impact of an outright ban before a prohibition by statute or regulation could be justified.
The Board believes its rule provides effective protections against unauthorized remotely
created checks while still allowing for the legitimate use of those checks.
Some commenters argued that remotely created checks also should be covered by
the Board's Regulation E (12 CFR Part 205), because payments by remotely created
check are in fact electronic fund transfers subject to the Electronic Funds Transfer Act
(EFTA), which, among other things, requires certain disclosures related to transfers
covered by the Act.
15
Under the EFTA, the term "electronic fund transfer" includes any
transfer of funds, other than a transaction originated by check, draft, or similar paper
instrument.
16
Therefore, as a general matter, the EFTA does not apply to funds
transferred from a consumer's account by means of a check. The commenters argued
that a remotely created check is initiated by an electronic communication between the
consumer and a third party and not by a check or similar paper instrument. Further
clarification of the applicability of the EFTA to check transactions that are authorized on-
line or by telephone must be made within the context of Regulation E. The Board will
continue to monitor developments to determine whether further action is appropriate.
Extension of the midnight deadline.
The Board invited comment on whether a different approach to address the risks
of remotely created checks would be appropriate. One alternative on which the Board
requested comment was whether the Board should extend the U.C.C. midnight deadline
for paying banks that return unauthorized remotely created checks to give the paying
bank more time to determine whether a particular check was authorized. Some

15
15 U.S.C. 1693 et seq.
16
15 U.S.C. 1693a(6).

6
commenters favored the approach because it would mirror the ACH rules set forth by the
National Automated Clearing House Association for unauthorized ACH debits, while
others opposed this approach arguing that it would delay finality of check payments. One
commenter argued that if the Board adopted this approach, then it also should exempt
remotely created checks from the funds availability schedule in Regulation CC because
the availability schedules are generally related to the collection and return times for a
check.
Other commenters viewed the possible midnight deadline extension not as an
alternative to creation of new warranties, but as a different enforcement mechanism for
the new warranties. These commenters thought that instead of having to make a warranty
claim outside of the check collection process when the paying bank seeks to recoup
losses following a breach of the remotely created check warranty, extension of the
midnight deadline would enable the paying bank to return the unauthorized remotely
created through the check collection process. Many of the commenters in this group
advocated handling the warranty claim on a "with entry" basis, which is a procedure that
has been adopted by certain clearinghouses and which allows a warranty claim to be
made through the procedures for returned checks.
17
A few commenters suggested an
additional nuance to this approach: unauthorized remotely created checks under $1000
should be handled on a "with entry" basis and unauthorized remotely created checks over
$1000 should be handled as a warranty claim outside of the check collection and return
process.
Because the Board believes that finality of payment and the discharge of the
underlying obligation are fundamental and valuable features of the check collection
process, the final rule does not make any adjustments to the midnight deadline. Until
otherwise established by agreement, banks must assert claims arising under transfer and
presentment warranties for remotely created checks outside of the check collection
process.
Action by State Governments
The Board also requested comment on whether it should refrain from addressing
remotely created checks in Regulation CC and await adoption of the U.C.C. warranties
for remotely created checks, or some variation thereof, by all of the states. Numerous
commenters expressed opposition to this approach. Generally, these commenters argued
that states have been too slow to act on this issue and have not and will not necessarily
act uniformly. However, one commenter urged the Board to refrain from usurping the
U.C.C. process, arguing that hesitancy by state legislatures to adopt a uniform law may
signal defects in the proposed amendment. In light of the comments favoring action by
the Board from the Permanent Editorial Board of the U.C.C., as well as thirty-five state
Attorneys General, the Board believes that there is broad support for amendments to
Regulation CC to address remotely created checks on a nationwide basis and that such
amendments are appropriate.


17
Under the Electronic Check Clearing House Organization's Uniform Paper Check Exchange Rules, the
paying bank "may make a warranty claim" by "delivering such check to the clearinghouse or the depositary
bank for settlement, in accordance with the clearinghouse's rules for returned checks." While the claim is
processed through the return settlement process, the delivery of the check to the clearinghouse, and
ultimately the depositary bank, is not a "return" of the check under the U.C.C. or Regulation CC.

7
Section-by-Section Analysis
Section 229.2(fff) Definition

The Board proposed the following definition: a remotely created check means a
check that is drawn on a customer account at a bank, is created by the payee, and does not
bear a signature in the format agreed to by the paying bank and the customer.
Commenters had numerous concerns regarding the scope of the proposed definition.

On the issue of whether the definition of remotely created checks should cover
items drawn on both consumer and non-consumer accounts, all but one of the
commenters addressing this issue supported covering remotely created checks drawn on
both consumer and non-consumer accounts. These commenters stated that there is no
reason to distinguish between fraud against consumers and fraud against businesses for
purposes of this rule.
18
Furthermore, one commenter noted that, as an operational matter,
it would be more efficient for banks to treat remotely created checks drawn on both
consumer and non-consumer accounts the same. For these reasons, the final rule applies
to remotely created checks drawn on both consumer and non-consumer accounts.
With respect to the other elements of the definition, numerous commenters,
particularly large depository institutions, preferred the following definition (or minor
variations thereon): a remotely created check is a check that (i) is drawn on a customer
account at a bank, (ii) is not created by the paying bank, and (iii) does not bear a
signature purporting to be the signature of the customer. In the alternative, several
commenters favored the definition of demand draft in the commercial code of California,
arguing that this definition has been adopted in a number of states and has been applied
successfully over the past nine years.
19

With respect to the proposal that a remotely created check must be created by the
payee, numerous commenters noted that depository institutions have no physical means
of distinguishing between a remotely created check created by a payee and a remotely
created check created by, for example, a bill payment service on behalf of the drawer.
The Board considered alternative ways of defining remotely created checks from
the perspective of how they were created. Under one formulation, the definition could
require that a check not be created by the paying bank in order to be a remotely created
check. The advantage of that formulation is that the paying bank should be able to
determine whether it created a check and whether the warranty applies. That
requirement, however, would not exclude a check created by the customer (such as a
check that a customer filled out but forgot to sign) or the customer's agent, such as a bill
payment service. However, the Board believes that these checks do not present the same

18
The one commenter that favored limiting the scope to consumer items argued that if the definition
covers commercial accounts, it would weaken the ability of the bank to contract with its commercial
customers for timely review of account activity. The Board does not believe this concern warrants a
limitation on the scope of the definition. The Board's final rule creates transfer and presentment warranties
among banks and is not intended to interfere with the contractual relationships between depository
institutions and their customers. The legal relationship between the paying bank and its customer with
respect to whether a check was authorized or whether a claim was made in a timely manner continues to be
governed by state law.
19
Under California U.C.C. § 3104(k) a demand draft means a writing not signed by a customer that is
created by a third party under the purported authority of the customer for the purpose of charging the
customer's account with a bank. A demand draft shall contain the customer's account number and may
contain any of the following: (1) The customer's printed or typewritten name. (2) A notation that the
customer authorized the draft. (3) The statement "No Signature Required" or words to that effect.

8
risk that the check was not actually authorized by the drawer as the typical telemarketer-
created check that is made payable to the entity that created it.
Under another formulation, the definition could exclude checks that are created by
the paying bank as well as checks that are created by the customer or the customer's
agent. This formulation, however, would exclude from the warranty checks created by
telemarketers or other payees to the extent they were acting as agent of the customer, as
well as checks created on behalf of the customer by a bill payment service. At a
minimum, this formulation would raise issues as to the scope of the creating entity's
agency and would seem to cause as many evidentiary difficulties as the Board's original
proposal.
After considering the benefits and drawbacks of each formulation, the definition
in the Board's final rule requires that a remotely created check must be created by a
person other than the paying bank. This definition will be operationally efficient for
paying banks because they easily can determine whether the warranty applies to a
particular check. In addition, this formulation is consistent with the analogous definition
in the U.C.C. Under this definition, the parties to the check will not have to distinguish
checks that are created by the payee from checks that are created by a customer's bill-
payment service in order to assert a warranty claim. As noted above, the definition will
cover certain checks created remotely by bill-payment services, as well as checks that the
drawer created but neglected to sign, where there is a less compelling reason for shifting
liability for unauthorized checks to the depositor's bank. Including these checks,
however, is unlikely to result in significantly greater liability for depositary banks. It
appears that such checks are generally less prone to fraud, and, therefore, less prone to
trigger a warranty claim than are payee-created checks.
Numerous commenters objected to the requirement that a remotely created check
not bear a signature "in the format" agreed to by the paying bank and the customer.
Many commenters argued that litigation will ensue over the meaning of the phrase "in the
format," and that the language will sweep traditional forged checks into the warranty
because a forged check may be deemed to not bear a signature in the format agreed to by
the paying bank and its customer. Most commenters favored focusing simply on whether
a signature was present or not. The language of the proposed definition was intended to
introduce greater specificity around the term "signature," which is very broadly defined
under the U.C.C., to ensure that the definition does not include traditional forged checks
in the warranties. However, in light of the persuasive criticism from numerous
commenters, the final rule requires that a remotely created check not bear a signature
"applied by, or purported to be applied by, the person on whose account the check is
drawn." The commentary to the final rule explains that the term "applied by" refers to
the physical act of placing the signature on the check. This formulation should more
clearly exclude traditional forged checks from the operation of the new warranties, but
include checks created by telemarketers and similar payees.
Several commenters noted that under the definition of customer account in
Regulation CC, checks drawn on accounts such as money market accounts and credit
accounts would be excluded from the definition of remotely created check, because the
proposed definition is limited to checks drawn on a customer account, which under
Regulation CC does not include all types of accounts on which checks can be drawn.
These commenters pointed out that the U.C.C. definition of remotely created checks,

9
which covers "accounts" as defined by the U.C.C., includes checks drawn on various
types of consumer checking accounts and the Board should also expand its definition of
customer account for purposes of the remotely created check warranties. The Board sees
no reason to exclude these types of checks from the operation of the new warranties and
the final rule expands the definition of account in the final rule, solely for the purposes of
the new warranties, to include any credit or other arrangement that allows a person to
draw checks on a bank.
Commenters also argued that the definition of remotely created check should
cover "payable through" or "payable at" checks. Many of these checks are drawn on a
nonbank, such as a mutual fund, but payable through or at a bank. Under Regulation CC
the term "check" means a negotiable demand draft drawn on or payable through or at an
office of a bank.
20
Therefore, the definition of remotely created check could include a
"payable through" or "payable at" check if the other requirements of the regulation are
met. With regard to the requirement that a remotely created check not bear the signature
of the account-holder, the signature of the person on whose account the check is drawn
would be the signature of the payor institution (e.g., a mutual fund) or the signatures of
the customers who are authorized to draw checks on that account, depending on the
arrangements between the "payable through" or "payable at" bank, the payor institution,
and the customers. The Board has added clarifying language to the commentary.
One commenter urged the Board to confirm that a substitute check created from a
remotely created check benefits from the warranties for remotely created checks. The
commentary to the final rule specifically states that the transfer and presentment
warranties for remotely created checks would apply to a substitute check that represents a
remotely created check.
Section 229.34 Warranties

The Board proposed the following transfer and presentment warranties with
respect to a remotely created check: A bank that transfers or presents a remotely created
check and receives a settlement or other consideration warrants to the transferee bank,
any subsequent collecting bank, and the paying bank that the person on whose account
the remotely created check is drawn authorized the issuance of the check according to the
terms stated on the check.

Numerous commenters urged the Board to limit the warranty to the terms stated
on the "face of the check." Others urged the Board to adopt the U.C.C. approach,
requiring only a warranty that "the person on whose account the check is drawn
authorized the issuance of the check in the amount for which it is drawn."
21
Commenters
argued that the proposed warranty could be construed to cover the indorsements on the
back of the check and the date. The Board did not intend to create warranties that would
cover the indorsements on a remotely created check because the U.C.C. already contains
indorsement warranties. In addition, other information on the front of the check, such as
the date, does not give rise to the risk of fraud as does the name of the payee and the
amount. Accordingly, the final rule states with specificity that the transfer and
presentment warranties apply only to the fact of authorization by the account holder, the
amount stated on the check, and issuance to the payee stated on the check.

20
12 CFR 229.2(k).
21
See e.g. U.C.C. 3-417(a)(4).

10
A few commenters suggested that the depositor of a remotely created check
should also be required to make the new warranties, as is the case with the U.C.C.
warranties relating to remotely created consumer items. One commenter suggested that
the customer of the paying bank should be able to assert a § 229.34(d) warranty claim
directly against a transferring or presenting bank. The authority under which the Board is
adopting this amendment is limited to establishing rules imposing or allocating losses and
liability among depository institutions in connection with any aspect of the payment
system.
22
However, although these warranties do not extend to losses and liability as
between depository institutions and their nonbank customers, banks may choose to
allocate liability to customers by agreement. The final rule also does not alter the rights
or liabilities of customers of depository institutions under state law.

Commenters also suggested that the commentary address the situation in which
the customer authorizes that the check be made payable to the payee's trade name, but the
check is instead made payable to the legal name of the payee. Under the new transfer and
presentment warranties, banks will warrant that the customer authorized the issuance of
the check to the payee stated on the check. Whether an alteration of the payee's name
from the trade name to the legal name would result in a breach of warranty will depend
on whether the change is within the scope of the customer's authorization. Because that
determination would have to be made on a case-by-case basis, the Board has not added
any general statement on such a situation to the commentary.

A number of commenters urged the Board to state explicitly that the warranties
would not cover the situation in which the initial authorization by the account-holder was
subsequently disclaimed as the result of "buyer's remorse" by the account-holder. As
noted in the proposed rule, the Board anticipates that the transfer and presentment
warranties will supplement the FTC's Telemarketing Sales Rule (16 CFR 310.3(a)(3)),
which requires telemarketers that submit instruments for payment to obtain the
customer's "express verifiable authorization." A depositary bank could tender the
authorization obtained by its telemarketer customer as a defense to a paying bank
warranty claim. Therefore, the paying bank would not prevail on a warranty claim if the
customer had, in fact, authorized the transaction but later suffered "buyer's remorse." If
the paying bank can show that the check was properly payable from the customer's
account, then it would be able to charge the account for the check in accordance with
U.C.C. 4-401.
Defenses to Warranty Claims
Several commenters argued that when a paying bank makes a claim under the
remotely created check warranties a depositary bank should be able to assert certain
defenses that the paying bank would have against its customer under the U.C.C.
Specifically, the commenters noted that U.C.C. 4-406 places a duty on a customer to
discover and report unauthorized checks with reasonable promptness and limits a paying
bank's liability if the customer fails to perform that duty. The commenters suggested that
a paying bank should be precluded from asserting a warranty claim against a depositary
bank where the paying bank's liability to the customer would have been limited by
U.C.C. 4-406 had the paying bank asserted its own defenses. The commenters noted that
the U.C.C. warranty provisions permit similar defenses by warranting banks.

22
See footnote 14, supra.

11
The U.C.C. provides that the warrantor may defend a warranty claim based on an
unauthorized indorsement or alteration by proving that the drawer is precluded from
asserting that claim because of his or her failure to discover the lack of authorization in a
timely manner.
23
The Official Comment explains the purpose of the provision: if the
drawer's conduct contributed to a loss from a forged indorsement or alteration, the
drawee should not be allowed to shift the loss from the drawer to the warrantor.
24
While
the drafters of the U.C.C. did not extend this defense to an unauthorized remotely-created
consumer item, commenters argued that the stated purpose of the U.C.C. 3-417(c)
defense should apply to a remotely created check warranty claim under Regulation CC.
The Board believes that such a defense would be appropriate. Therefore, the regulation
and the commentary to the final rule provide that the depositary bank may defend a
remotely created check warranty claim by proving that customer is precluded under
U.C.C. 4-406 from asserting a claim against the paying bank for the unauthorized
issuance of the check. This may be the case, for example, when the customer fails to
discover the unauthorized remotely created check in a timely manner.
One commenter stated that the proposed warranty for remotely created checks
should be limited in a way that is similar to the indemnification related to the creation and
collection of substitute checks. The commenter argued that the indemnity provision of
the Check Clearing for the 21
st
Century Act, as implemented by Regulation CC, shifts
liability to the reconverting banks for losses due to the absence of security features that
do not survive the imaging process, and, therefore, do not appear on substitute checks,
only in those instances in which the paying bank's processes actually would have relied
on the security features that were lost in the imaging process. These lost security
features, it is argued, are analogous to the lack of an authorized signature on the remotely
created check.
25
The commenter argued that by analogy the warranty that the Board
proposed with respect to remotely created checks should not apply under circumstances
in which the paying bank would not have verified the signatures anyway, for example
because the checks were under the dollar amount set by the paying bank for such
purposes.
The Board's rule on remotely created checks is intended to reduce the fraudulent
use of unauthorized remotely created checks by creating an incentive for depositary
banks to be more vigilant when accepting such checks for deposit. This incentive would
be seriously weakened if the regulation required the paying bank to make the showing
suggested by the commenter. Therefore, the final rule does not adopt this suggestion.
Effective Date
A number of commenters suggested that the final rule include an implementation
period of not less than six months. The final rule is effective July 1, 2006.

Additional Considerations
MICR Line Identifier
The Board requested comment on whether digits should be assigned in the
External Processing Code (EPC) Field (commonly referred to as Position 44) of the
magnetic ink character recognition (MICR) line to identify remotely created checks.

23
U.C.C. 3-417(c).
24
U.C.C. 3-417, Official Comment, 6.
25
12 U.S.C. 5005, as implemented at 12 CFR 229.53(a) and the accompanying commentary.

12
Most commenters opposed this aspect of the proposal, arguing that the unassigned digits
in the EPC Field could best serve other purposes and that enforcement of such a rule
would be cumbersome at best. Ten commenters specifically expressed support for
assigning digits in the EPC Field, arguing that it would facilitate the tracking of remotely
created checks. However, without broad support for such a rule, and in light of the
impracticalities of enforcement, the Board has determined not to pursue a MICR
identifier for remotely created checks.
Relation to State Law
Many commenters supported the proposed amendment to Regulation CC as a
means to establish uniformity with respect to liability for unauthorized remotely created
checks. Some of these commenters presumed that the amendment to Regulation CC
would preempt state laws that address unauthorized remotely created checks or their
equivalents. However, several commenters raised the issue of preemption explicitly by
stating that the warranties provided in Regulation CC should preempt state law warranties
and that the one-year statute of limits for actions under subpart C of Regulation CC
should preempt statute of limitations for breach of demand draft warranties under state
law (generally 3 years). One commenter recommended that the Board's amendments
explicitly preempt the field to eliminate confusion about the application of state laws that
govern remotely created checks. Section 608(b) of the Expedited Funds Availability Act
provides that Board rules prescribed under that Act shall supersede any provision of state
law, including the UCC as in effect in such state, that is inconsistent with the Board rules.
To the extent that the state law is inconsistent with the Board's rules on remotely created
checks, the Board's rules would supersede such state law. The Board will monitor the
interaction of state law and Regulation CC, and may take further action at a later time if
necessary.
Price v. Neal
One commenter suggested that the Board overrule the Price v. Neal doctrine for
all checks. The Price v. Neal doctrine dates back to the 1760s and is based on the
assumption that the paying bank should bear the loss for unauthorized checks because it
is in the best position to prevent fraud by comparing signatures on checks with signature
cards on file with the bank. The commenter argued that, at present, automated check
processing that relies on the MICR line means that signature verification of checks by
back-room personnel no longer plays a meaningful role in stopping check fraud.
However, other commenters argued that the depositary bank generally has no better
means to detect unauthorized checks than the paying bank and, therefore, the argument
would provide no logical basis for abandoning the Price v. Neal doctrine. Furthermore,
as one commenter noted, the advent of signature recognition software may soon enable
the paying bank to verify signatures on an automated basis. The final rule reverses the
Price v. Neal rule for remotely created checks only. However, the Board would welcome
a public dialogue on broader check law issues, such as the utility of and possible
alternatives to the Price v. Neal rule in the modern check processing environment.
Conforming amendments to Regulation J

The Board is also amending Regulation J to make clear that the new remotely
created check warranties apply to remotely created checks collected through the Federal
Reserve Banks.


13

Regulatory Analysis
Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3506;
5 CFR 1320 Appendix A.1) and under authority delegated by the Office of Management
and Budget, the Board has reviewed the final rule and determined that it contains no
collections of information.
Regulatory Flexibility Act
In accordance with the Regulatory Flexibility Act (RFA), an agency must publish
a final regulatory flexibility analysis with its final rule, unless the agency certifies that the
rule will not have a significant economic impact on a substantial number of small entities.
(5 U.S.C. 601-612.) The Board certifies that the rule will not have a significant economic
impact on a substantial number of small entities.

The RFA requires agencies to examine the objectives, costs and other economic
implications on the entities affected by the rule. (5 U.S.C. 603.) Under section 3 of the
Small Business Act, as implemented at 13 CFR part 121, subpart A, a bank is considered
a "small entity" or "small bank" if it has $150 million or less in assets. Based on June
2005 call report data, the Board estimates that there are approximately 13,400 depository
institutions with assets of $150 million or less.
The amendments to Regulation CC create a definition of a remotely created check
and warranties that apply when a remotely created check is transferred or presented. The
amendments require any bank that transfers or presents a remotely created check to
warrant that the person on whose account the remotely created check is drawn authorized
the issuance of the check in the amount stated on the check and to the payee stated on the
check. The purpose of the amendments is to place the liability for an unauthorized
remotely created check on the bank that is in the best position to prevent the loss. By
shifting the liability to the bank in the best position to prevent the loss caused by the
payment of an unauthorized remotely created check, the Board anticipates that the
amendments will reduce costs for all banks that handle remotely created checks. Banks
seeking to minimize the risk of liability for transferring remotely created checks will
likely screen with greater scrutiny customers seeking to deposit remotely created checks.
The Board believes that the controls that small institutions will develop and implement to
minimize the risk of accepting unauthorized remotely created checks for deposit likely
will pose a minimal negative economic impact on those entities. Furthermore, there was
unanimous support for transfer and presentment warranties for remotely created checks
from the small institutions that commented on the proposal. These institutions noted that
the warranties will enable them to reduce losses they currently suffer when they
inadvertently pay an unauthorized remotely created check.

The RFA requires agencies to identify all relevant Federal rules which may
duplicate, overlap or conflict with the proposed rule. As noted above, the Board's
Regulation J includes cross-references to the warranties set forth in Regulation CC and
the rule amends such cross-references to include the warranties. As also noted above, the
rule overlaps with at least 19 state codes that presently provide warranties for instruments
that are similar to remotely created checks.



14
List of Subjects in 12 CFR Parts 210 and 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 parts 210 and
229 of chapter II of title 12 of the Code of Federal Regulations as set forth below:

PART 210-COLLECTION OF CHECKS AND OTHER ITEMS BY FEDERAL
RESERVE BANKS AND FUNDS TRANSFERS THROUGH FEDWIRE
(REGULATION J)


1. The authority citation for part 210 continues to read as follows:

Authority: 12 USC 248(i) and (j), 12 USC 342, 12 USC 464, 12 USC 4001 et
seq., 12 USC 5001-5018.


2. In § 210.5, revise paragraph (a)(3) to read as follows:
§ 210.5 Sender's agreement; recovery by Reserve Bank
(a) * * *
* * * * *
(3) Warranties for all electronic items. The sender makes all the warranties set
forth in and subject to the terms of 4­207 of the U.C.C. for an electronic item as if it were
an item subject to the U.C.C. and makes the warranties set forth in and subject to the
terms of § 229.34(c) and (d) of this chapter for an electronic item as if it were a check
subject to that section.
* * * * *

3. In § 210.6, revise paragraph (b)(2) to read as follows:
§ 210.6 Status, warranties, and liability of Reserve Bank
* * * * *

(b) * * *
(2) Warranties for all electronic items. The Reserve Bank makes all the warranties
set forth in and subject to the terms of 4­207 of the U.C.C. for an electronic item as if it
were an item subject to the U.C.C. and makes the warranties set forth in and subject to
the terms of § 229.34(c) and (d) of this chapter for an electronic item as if it were a check
subject to that section.
* * * * *


4. In § 210.9, revise paragraph (b)(5) to read as follows:
§ 210.9 Settlement and payment
* * * * *

(b) * * *

(5) Manner of settlement. Settlement with a Reserve Bank under paragraphs
(b)(1) through (4) of this section shall be made by debit to an account on the Reserve
Bank's books, cash, or other form of settlement to which the Reserve Bank agrees, except
that the Reserve Bank may, in its discretion, obtain settlement by charging the paying

15
bank's account. A paying bank may not set off against the amount of a settlement under
this section the amount of a claim with respect to another cash item, cash letter, or other
claim under § 229.34(c) and (d) of this chapter (Regulation CC) or other law.
* * * * *

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


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

Authority: 12 U.S.C. 4001 et seq., 12 U.S.C. 5001-5018.

6.

In section 229.2, add a new paragraph (fff) to read as follows:
§ 229.2 Definitions
* * * * *

(fff) Remotely created check means a check that is not created by the paying bank
and that does not bear a signature applied, or purported to be applied, by the person on
whose account the check is drawn. For purposes of this definition, "account" means an
account as defined in paragraph (a) of this section as well as a credit or other arrangement
that allows a person to draw checks that are payable by, through, or at a bank.


7. In § 229.34, redesignate paragraphs (d), (e), and (f) as paragraphs (e), (f), and
(g), and add a new paragraph (d) to read as follows:
§ 229.34 Warranties
* * * * *

(d) Transfer and presentment warranties with respect to a remotely created check.

(1) A bank that transfers or presents a remotely created check and receives a
settlement or other consideration warrants to the transferee bank, any subsequent
collecting bank, and the paying bank that the person on whose account the remotely
created check is drawn authorized the issuance of the check in the amount stated on the
check and to the payee stated on the check. For purposes of this paragraph (d)(1),
"account" includes an account as defined in § 229.2(a) as well as a credit or other
arrangement that allows a person to draw checks that are payable by, through, or at a
bank.

(2) If a paying bank asserts a claim for breach of warranty under paragraph (d)(1)
of this section, the warranting bank may defend by proving that the customer of the
paying bank is precluded under U.C.C. 4-406, as applicable, from asserting against the
paying bank the unauthorized issuance of the check.
* * * * *


8. In § 229.43, revise paragraph (b)(3) to read as follows:
§ 229.43 Checks Payable in Guam, American Samoa, and the Northern Mariana
Islands
* * * * *
(b) Rules applicable to Pacific islands checks. * * *
* * * * *
(3) § 229.34(c)(2), (c)(3), (d), (e), and (f);

16
* * * * *

9. In Appendix E to part 229:

a. Under paragraph II., § 229.2, paragraph (OO) is revised and a new paragraph
(FFF) is added.
b. Under paragraph XX., § 229.34, redesignate paragraphs D., E., and F. as
paragraphs E., F., and G., and add a new paragraph D.

APPENDIX E TO PART 229 ­ COMMENTARY
* * * * *


II. Section 229.2 Definitions
* * * * *
OO. 229.2(oo) Interest Compensation

1. This calculation of interest compensation derives from U.C.C. 4A-506(b).
(See §§ 229.34(e) and 229.36(f).)
* * * * *
FFF. 229.2(fff) Remotely Created Check

1. A check authorized by a consumer over the telephone that is not created by the
paying bank and bears a legend on the signature line, such as "Authorized by Drawer," is
an example of a remotely created check. A check that bears the signature applied, or
purported to be applied, by the person on whose account the check is drawn is not a
remotely created check. A typical forged check, such as a stolen personal check
fraudulently signed by a person other than the drawer, is not covered by the definition of
a remotely created check.


2. The term signature as used in this definition has the meaning set forth at
U.C.C. 3-401. The term "applied by" refers to the physical act of placing the signature
on the check.

3. The definition of a "remotely created check" differs from the definition of a
"remotely created consumer item" under the U.C.C. A "remotely created check" may be
drawn on an account held by a consumer, corporation, unincorporated company,
partnership, government unit or instrumentality, trust, or any other entity or organization.
A "remotely created consumer item" under the U.C.C., however, must be drawn on a
consumer account.

4. Under Regulation CC (12 CFR part 229), the term "check" includes a
negotiable demand draft drawn on or payable through or at an office of a bank. In the
case of a "payable through" or "payable at" check, the signature of the person on whose
account the check is drawn would include the signature of the payor institution or the
signatures of the customers who are authorized to draw checks on that account,
depending on the arrangements between the "payable through" or "payable at" bank, the
payor institution, and the customers.

5. The definition of a remotely created check includes a remotely created check
that has been reconverted to a substitute check.
* * * * *

17




XX. Section 229.34 Warranties
* * * * *
D. 229.34(d) Transfer and presentment warranties

1. A bank that transfers or presents a remotely created check and receives a
settlement or other consideration warrants that the person on whose account the check is
drawn authorized the issuance of the check in the amount stated on the check and to the
payee stated on the check. The warranties are given only by banks and only to
subsequent banks in the collection chain. The warranties ultimately shift liability for the
loss created by an unauthorized remotely created check to the depositary bank. The
depositary bank cannot assert the transfer and presentment warranties against a depositor.
However, a depositary bank may, by agreement, allocate liability for such an item to the
depositor and also may have a claim under other laws against that person.

2. The transfer and presentment warranties for remotely created checks
supplement the Federal Trade Commission's Telemarketing Sales Rule, which requires
telemarketers that submit checks for payment to obtain the customer's "express verifiable
authorization" (the authorization may be either in writing or tape recorded and must be
made available upon request to the customer's bank). 16 CFR 310.3(a)(3). The transfer
and presentment warranties shift liability to the depositary bank only when the remotely
created check is unauthorized, and would not apply when the customer initially
authorizes a check but then experiences "buyer's remorse" and subsequently tries to
revoke the authorization by asserting a claim against the paying bank under U.C.C.
4-401. If the depositary bank suspects "buyer's remorse," it may obtain from its
customer the express verifiable authorization of the check by the paying bank's customer,
required under the Federal Trade Commission's Telemarketing Sales Rule, and use that
authorization as a defense to the warranty claim.

3. The scope of the transfer and presentment warranties for remotely created
checks differs from that of the corresponding U.C.C. warranty provisions in two respects.
The U.C.C. warranties differ from the § 229.34(d) warranties in that they are given by
any person, including a nonbank depositor, that transfers a remotely created check and
not just to a bank, as is the case under § 229.34(d). In addition, the U.C.C. warranties
state that the person on whose account the item is drawn authorized the issuance of the
item in the amount for which the item is drawn. The § 229.34(d) warranties specifically
cover the amount as well as the payee stated on the check. Neither the U.C.C. warranties,
nor the § 229.34(d) warranties apply to the date stated on the remotely created check.

4. A bank making the § 229.34(d) warranties may defend a claim asserting
violation of the warranties by proving that the customer of the paying bank is precluded
by U.C.C. 4-406 from making a claim against the paying bank. This may be the case, for
example, if the customer failed to discover the unauthorized remotely created check in a
timely manner.

18
5. The transfer and presentment warranties for a remotely created check apply to
a remotely created check that has been reconverted to a substitute check.
* * * * *

By order of the Board of Governors of the Federal Reserve System, November
21, 2005.


Jennifer J. Johnson (signed)
Jennifer J. Johnson
Secretary of the Board.