For good reason, financial institutions are starting feel that their way of doing business is under siege by the regulators. Competition for deposits is fierce because income from loans and fees has dropped considerably. New credit card rules are pending to make it harder to get a risk-based return on credit card balances. Now the Fed has amended Regulation E to make it more challenging for financial institutions to be reimbursed for covering customers' ATM and point-of-sale overdrafts. That practice used to be considered a service; the new regulations imply that it is a predatory activity that has to be strictly controlled.

On Nov. 12, the Federal Reserve Board released the final rule on overdraft programs for ATM and one-time debit card transactions. It amends Regulation E and its Commentary. The rule was published at 74 Federal Register 59033. Mandatory compliance with the rule is July 1, 2010.

New Opt-In for Overdraft Protection

The rule requires a financial institution to obtain every consumer's prior, written consent in order to assess a fee or charge for paying an overdraft incurred by an ATM or one-time debit card transaction. The rule is applicable to this narrow range of transactions because "...an opt-in rule that is limited to ATM and one-time debit card transactions may result in fewer adverse consequences for consumers than a rule applicable to a broader range of transactions." 74 FR 59038

The final rule does not affect recurring debit transactions. Those are payments that consumers arrange to be made regularly from their accounts to the same recipient and that are processed through the automated clearing house (ACH), a financial system payment network. An example of a recurring debit transaction would be the payment of a monthly gym membership fee. These transactions are not covered because the consumer knows in advance when they are going to be made and, therefore, has the opportunity to make sure that sufficient funds will be in the account on the scheduled payment date. If the account does not have sufficient funds at the time a scheduled recurring payment is to be made, the payment is likely to be rejected automatically by the ACH.

Before it can assess a charge for covering an overdraft from an ATM or one-time debit card transaction of a depositor, the institution must (1) provide a description of the overdraft service to the consumer; (2) provide the consumer with a reasonable opportunity to opt-in to the service; (3) obtain the consumer's affirmative consent; and (4) provide the consumer with a confirmation of the consent in writing or electronically, if the consumer agrees, including a statement of the consumer's right to revoke consent. 12 CFR 205.17(b)(1).

The Model Form A-9, which can be used to comply with the final rule, is discussed below.

For existing customers, the timing of giving the notice is at the financial institution's discretion, but it must be in enough time to allow the consumer a "reasonable" opportunity to opt-in or opt-out prior to August 10, 2010. This is the cut-off date after which financial institutions cannot charge a fee for paying ATM and one-time debit card transactions for existing customers if they have not opted in. 12 CFR 205.17(c)(1)

For new customers, the notice must be given before the financial institution assesses any fee or charge for paying an overdraft resulting from an ATM or one-time debit card transaction. 12 CFR 205.17(c)(2). For most financial institutions, the easiest time to obtain the opt-in from new customers would be at account opening.

It appears that those institutions that began a program of paying ATM and one-time debit card transactions for consumers without their consent, and that imposed a fee for the service, may no longer do so after the effective date of the rule.

Disclosure of Opt-In Procedures

There are specific disclosures that must be included in the request for the consumer to opt-in to the overdraft program. 12 CFR 205.17(d). The Federal Reserve Board has created a Model Form A-9 for use by financial institutions in complying with the final rule. The model form is designed to be modified by each institution to describe its overdraft programs for checks, ACH, and other transactions, in addition to the overdraft program for ATM and one-time debit card transactions, and to disclose its fees.

Consumer Credit, Securities Credit, Decoupled Debit Not Covered

The final rule does not apply to overdraft programs that include (1) a line of credit subject to Reg Z; (2) an internal transfer program between accounts held individually or jointly by the consumer at the same institution; or (3) lines of credit from securities or commodities accounts. 12 CFR 205.17(a).

The language of the final rule excludes decoupled debit card issuers by stating that "overdraft fees charged by the account-holding financial institution for a decoupled debit transaction processed via ACH are not generally subject to the opt-in requirement of the final rule." 74 FR 59040. The final rules apply to "a financial institution holding a consumer's account..." 12 CFR 205.17(b)(1).

Coverage Under the New Rule Depends on Your Policies

An additional exception from coverage is an "institution that has a policy and practice of declining to authorize and pay any ATM or one-time debit card transactions when the institution has a reasonable belief at the time of the authorization request that the consumer does not have sufficient funds available to cover the transaction. Financial institutions may apply this exception on an account-by-account basis." Emphasis supplied. 12 CFR 205.17(b)(4).

This indicates that if an institution has a policy of not paying overdrafts arising from an ATM or one-time debit card transaction, it does not need to comply with the new rule. If that policy of non-payment is applicable only to certain types of accounts, such as basic checking, then the financial institution does not have to give the owners of those accounts the right to opt-in or opt-out. If, however, the institution does pay overdrafts resulting from ATM or one-time debit card transactions on some of its accounts, e.g., premium checking, then it must comply with this rule for consumers having those categories of accounts. 12 CFR 205.17(b)(4).

How Do You Distinguish Between Debit Card Transactions?

A significant issue for institutions is not having the systems to distinguish between various types of overdrafts, e.g., a one-time debit card transaction from recurring debit card transactions. An institution could inadvertently violate the rule if it pays and assesses a fee for paying a one-time debit card transaction if the consumer has not opted into the overdraft program for ATM and one-time debit card transactions, if the financial institution thought that this was an ACH transaction subject to another type of overdraft program at the institution, e.g., one that covers checks and ACH.

In response to this concern, "the Board is adopting a safe harbor in new comment 17(b)-1.ii to explain that a financial institution complies with the rule if it adapts its systems to identify debit card transactions as either one-time or recurring. If it does so, the financial institution may rely on the transaction's coding by merchants, other institutions, and other third parties as a one-time or recurring debit card transaction." 74 CFR 5904.

Financial institutions that do not have systems in place to recognize such merchant codes may have to choose between finding a way to make the current system recognize merchant codes or invest in a systems upgrade.

Consumer Consent

Consumer consent may be provided in a number of ways: by mail, telephone, electronic means or in person. Commentary 12 CFR 205.17(b)(4).

The consumer's consent must be obtained "separately from other consents or acknowledgements obtained by the institution, including a consent to receive disclosures electronically." Commentary 12 CFR 205.17(b)(6).

This provision prohibits financial institutions from including the overdraft program as a clause in the basic account agreement that consumers must sign in order to open an account. "Otherwise institutions could include information about the overdraft service in preprinted language in an account-opening disclosure, and a consumer might inadvertently consent to the institution's overdraft service by signing a signature card or other account-opening document on the cover page acknowledging acceptance of the account terms." 74 FR 59041.

Financial institutions will need to look at their current account agreements and signature cards to determine whether they need to be modified to comply with this new consent requirement.

Payment of Overdrafts is Not Mandatory

The Commentary clarifies that a financial institution is not required to pay overdrafts even if a consumer has opted in to the overdraft payment program for ATM and one-time debit card transactions. 12 CFR 205.17(b)(3). This provision appears to permit financial institutions to continue to adopt policies on overdrafts, such as frequency of occurrence, that would permit them not to honor overdrafts for some consumers who have opted in to the program.

Free Choice – No Advantage for Those Opting In

The rule prohibits a bank from conditioning other account features and services on a consumer opting in to the overdraft service for ATM and one-time debit card transactions. Specifically, a financial institution may not condition the payment of or refuse the payment of checks, ACH transactions, and other types of transactions on a consumer opting in to this overdraft service. 12 CFR 205.17(b)(2)(i) and (ii).

In addition, a financial institution must offer the same account terms, conditions and features to consumers regardless of whether or not they opt-in to the overdraft program. 12 CFR 205.17(b)(3). For instance, a financial institution may not offer a no-minimum-balance checking account to consumers who opt-in to the overdraft program, and make it unavailable to those who do not opt-in to the program. Commentary, 12 CFR 205.17(b)(3)(1).

Any One Owner Can Bind a Joint Account

The final rule permits financial institutions to "treat the affirmative consent of any of the joint consumers as affirmative consent for the account. Similarly, the financial institution shall treat a revocation of affirmative consent by any of the joint consumers as revocation of consent for that account." 12 CFR 205.17(e).

This provision should make it easier for financial institutions to adhere to the requirements of the rule. It eliminates the need "to determine which account holder is responsible for a particular transaction and then make an authorization decision based on whether the consumer has affirmatively consented to the institution's overdraft service." 74 FR 59049.

Final Thoughts

This final rule amending Regulation E and its Commentary creates many new obligations for financial institutions. Reed Smith has unparalleled experience in helping design implementation strategies, as well as drafting customized disclosures that comply with applicable law. The amendments affect numerous functional areas within a financial institution; if you need assistance with orchestrating the responsibilities of various parts of your organization to meet the demands of the new rule, we would be happy to assist in that effort.

Time to Comment

This proposed rule contains many minefields that financial institutions will have to navigate if it is adopted as proposed. It is important for the industry's voice to be heard. We can help you craft a comment letter by the deadline, which will be 30 days after the proposed rule is published in the Federal Register. Our team of gift card marketing and regulatory authorities assists clients with a variety of legal issues that this proposal generates.