Warranty Claims on Remotely Created Checks

Through the ACH Network

Executive Summary
December 16, 2008

REQUEST FOR INFORMATION – RESPONSES DUE FEBRUARY 6, 2009

NACHA requests information from ACH Network participants and other payment system
stakeholders on a concept that would allow paying banks to make warranty claims on
unauthorized Remotely Created Checks1 (“RCC”) through the ACH Network (“warranty claim
entry”). NACHA is proposing the warranty claim entry as a concept; specific amendments to the
NACHA Operating Rules are not being proposed at this time. Responses are due February 6,
2009.

NACHA STAFF CONTACTS

Return comments to: Maribel Bondoc, Manager, ACH Network Rules
Fax (703) 787-0996
E-mail: mbondoc@nacha.org

Questions: Michael Herd, Managing Director, ACH Network Rules

Phone (703) 561-3924
E-mail: mherd@nacha.org

Ian Macoy, AAP, Managing Director, Network Development

Phone (703) 561-3929
E-mail: imacoy@nacha.org

NACHA is researching a concept that would enable:

• Paying banks to make warranty claims on unauthorized RCCs through the ACH Network;
• NACHA to begin generating data on the number of RCCs that are not authorized by paying
banks’ accountholders; and
• NACHA to provide information on sources of disproportionately high numbers of
unauthorized RCCs to the appropriate clearinghouses/Federal Reserve banks.

1
In this Request for Information, the term Remotely Created Check is the same as the term defined by the Federal
Reserve Board in Regulation CC – “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.” Note that this definition
covers both consumer and non-consumer accounts.
 NACHA Request for Information – Warranty Claims on RCCs
Executive Summary, 12/16/08, Page 2

CURRENT SITUATION

NACHA and its members continue to hear from law enforcement and consumer protection
agencies about the fraudulent use of RCCs (aka demand drafts). As the electronic payments
networks have implemented risk management and anti-fraud programs, it appears that some
fraudulent activity has migrated to this form of payment.

For example, NACHA began its current risk management program in late 2002. By late 2003,
after NACHA had contacted the ODFIs, schemes such as Pharmacycards.com and YMA had
switched much of their activities from ACH debits to RCCs to debit consumers’ accounts. At a
risk conference hosted by the Federal Reserve Retail Payments Office in January 2008, law
enforcement and consumer protection agencies continue to describe this phenomenon.

Since 2002, NACHA’s risk management program has implemented processes to collect, monitor,
and analyze ACH payments returned as unauthorized. The program has had success in
identifying sources responsible for originating a disproportionate number of ACH payments that
are returned as unauthorized.

Similar capabilities and data do not exist regarding RCCs, and it seems reasonable that this is a
contributing factor in the use of RCCs to commit fraud. Significant challenges in tackling the
problem of fraudulent RCCs are 1) the lack of data on the frequency of unauthorized RCCs, and
2) the lack of a method to identify the sources of disproportionately high numbers of
unauthorized RCCs.

POTENTIAL SOLUTION

This concept would allow paying banks to make and to obtain payment through the ACH
Network for claims based on the warranty in the Federal Reserve Board’s Regulation CC (“Reg
CC”).2 A warranty claim entry would be structured and formatted as a forward ACH debit entry
governed by the NACHA Operating Rules. The transaction would not be the return of a check or
an ACH return entry. The transaction would also not be either a check conversion entry or a
check truncation entry.

When a bank’s customer reports that an RCC was not authorized, the bank could send a warranty
claim entry to the bank of first deposit (“BOFD”). The paying bank could use the same forms
and documentation it currently requires from the customer for reporting unauthorized
checks/RCCs. The customer would not need to complete a Written Statement Under Penalty of
Perjury (“WSUPP”), as they would for an unauthorized ACH debit. The reason is to make the
warranty claim process consistent with those already used to process checks.

To create the warranty claim entry, the paying bank would need the ability to originate ACH
payments manually. The paying bank would also need to know the routing number of the BOFD
and the amount of the RCC. Both pieces of information are available on the RCC itself, so the
paying bank would need access to the original RCC or a legible copy of the front and back.

2
Reg CC now provides for a warranty by a bank that transfers or presents an RCC that the check is authorized (this
warranty became effective July 1, 2006).

2
 NACHA Request for Information – Warranty Claims on RCCs
Executive Summary, 12/16/08, Page 3

In order to process the warranty claim entry to the correct depositor’s account, the BOFD (the
RDFI of the ACH debit) would need to receive along with the warranty claim entry either the
depositor’s account number or a check research/sequence number. The paying bank would need
to include the depositor’s account number, if it is included on the RCC, and/or the check
research/sequence number from the RCC, in the warranty claim entry.

From reports provided by the ACH Operators, NACHA would be able to count the number of
these transactions, providing the industry’s first data on the frequency of unauthorized RCCs.
NACHA would further be able to identify disproportionate senders of these RCCs based on the
routing numbers of the BOFDs contained in the ACH payments, and perhaps through descriptive
information provided in the ACH payment which could be used to identify the original depositor.
NACHA could provide this information to the appropriate check clearinghouses and Federal
Reserve banks, which could then alert the banks of first deposit to the problem.

ANTICIPATED BENEFITS

NACHA anticipates three primary benefits would result from warranty claim entries:

1. Paying banks would have a more efficient and cost-effective method to make warranty claims
on unauthorized RCCs;
2. Data could be gathered on the number of unauthorized RCCs and their sources; and
3. Banks of first deposit could receive alerts from their check clearinghouses or Federal Reserve
banks about unauthorized RCCs.

Benefits for Paying Banks

Paying banks’ existing ability to recover funds from unauthorized RCCs may be limited, as well
as labor- and cost-intensive. A warranty claim entry may be a more cost effective method to
recover funds. This may be especially true for low-dollar RCCs, for which paying banks may be
more likely to write-off losses. In addition, the time period for originating a warranty claim
entry need not be limited to the same 90-day time period as for the Federal Reserve’s check
adjustment process.3 A longer time period would allow paying banks a method for making
warranty claims after the expiration of the window for using the check adjustment process. This
would provide paying banks with a method to recover funds that does not exist today. For
purposes of requesting information, NACHA is asking industry respondents to consider a time
period of one year for originating a warranty claim entry (i.e., a warranty claim entry could be
originated for up to one year from the date of presentment of the original RCC).

3
Because the Federal Reserve did not extend the midnight return deadline for RCCs, it requires that “banks must
assert claims arising under the transfer and presentment warranties for remotely created checks outside the check
collection process.” The Federal Reserve therefore handles a claim of an unauthorized RCC by a paying bank under
its check adjustment process, rather than as a return of the RCC. The adjustment process, however, may be labor
intensive and expensive for the paying bank, and may only be used for 90 days after the RCC was presented. Other
check clearinghouses may have rules and/or similar adjustment processed for handling claims of unauthorized
RCCs.

3
 NACHA Request for Information – Warranty Claims on RCCs
Executive Summary, 12/16/08, Page 4

Gathering Data on Unauthorized RCCs

By uniquely identifying warranty claim entries, NACHA could monitor the number transiting the
ACH Network. The ACH Operators would be asked to develop capabilities to identify these
transactions, and report to NACHA on the volume and the routing numbers of the banks of first
deposit. NACHA could then begin to generate data on the scope of this problem, and can help
identify sources of disproportionately high numbers of unauthorized RCCs.

This approach would be similar to how NACHA monitors and tracks returns of ACH payments.
Data generated from NACHA’s existing process has been useful in identifying the sources of
disproportionately high numbers of unauthorized ACH payments. As warranty claim entries
would be voluntary on the part of paying banks, the thoroughness and usefulness of this
information depends on the extent that paying banks elect to use it.

Alerts for Banks of First Deposit

Check clearinghouses and Federal Reserve banks would be able to provide alerts to banks of first
deposit that disproportionate numbers of unauthorized RCCs were being generated from their
institutions. In the ACH world, ODFIs that receive similar alerts about Originators have been
able to act more quickly to address problems. Receiving alerts about unauthorized RCCs may
enable banks of first deposit to similarly address problems more quickly.

CONCLUSION
NACHA requests information from ACH Network participants and other payment system
stakeholders on the warranty claim entry concept. Information is requested on:

• The general concept;

• Operational considerations; and
• The anticipated benefits.