John Muller is Of Counsel with the law firm of Brobeck, Phleger & Harrison LLP in San Francisco. His practice focuses on bank mergers and acquisitions, new bank powers, electronic commerce, corporate governance and general regulatory advice.
For more information on Brobeck, Phleger & Harrison LLP, please see http://www.brobeck.com .
(Emerging Methods for Making Electronic Payments)
A. Can Non-banks Issue Electronic Money?The concerns most commonly raised by those who question whether non-banks should be permitted to issue electronic money are:
(2) non-banks may have an unfair competitive advantage over banks because they are not subject to the costs of extensive government regulation and supervision; and
(3) because non-banks do not report to the central bank, non-bank issuance of e-money creates a greater threat that the central bank will be unable to track the money supply and will lose the ability to set monetary policy.
The Fed doesn't expect e-money, whether issued by banks or nonbanks, to have a substantial impact on the Fed's ability to track the level of the money supply or to conduct monetary policy: if every person in the United States held $150 of electronic money, which is not likely any time soon, the total amount of electronic money would be less than 10% of U.S. currency currently in circulation. If non-banks become significant issuers of e-money, the Fed will seek to establish a voluntary reporting system, similar to the system in place today under which non-bank issuers of travelers' checks report on the amount of travelers' checks in circulation (which is a component of the M1 monetary aggregate). The Fed will monitor developments closely to ensure that non-bank involvement in e-money issuance does not create unanticipated problems. See:
The Bankers Roundtable has formed a Banking Industry Technology Secretariat (BITS) to address cyberbanking issues. BITS has recently issued a Request for Information with respect to the potential design, development and implementation of real-time payment systems for electronic transactions. See:
B. Does the Receipt of Funds from a Consumer by an Electronic Money Issuer Create a "Deposit?"
Many states have comparable laws. California law: "no person which has not received a certificate ... authorizing it to engage in the banking business shall solicit or receive deposits, issue certificates of deposit with or without provision for interest, make payments on check, or transact business in the way or manner of a commercial bank or trust company." Cal. Financial Code §3390.
A conclusion that the funds a non-bank e-money issuer takes in from its customers in exchange for electronic value are "deposits" would also subject the non-bank to Federal Trade Commission ("FTC") jurisdiction. If the FTC determines that a non-bank is engaged in the business of receiving deposits and could reasonably be mistaken for a depository institution by the entity's customers, the non-bank may not use the mails or other forms of interstate commerce to receive or facilitate receiving deposits unless the non-bank's state supervisor has determined that the institution would be eligible for FDIC insurance if it were a bank. 12 U.S.C.A. §1831t(e).
In addition, if non-banks both accept "deposits" that can be withdrawn by check or similar means for payment to third parties and make commercial loans, they will be treated as banks for purposes of the Bank Holding Company Act, subjecting their parent companies to signficant activities restrictions and Fed supervision. 12 U.S.C.A. §1841(c)(1).
The existence of these laws restricting non-bank acceptance of "deposits" has not kept non-banks from taking in consumer funds in return for transmitting money or issuing travelers' checks or money orders; federal and state regulators have viewed these activities as not involving any deposit. These activities, however, are regulated by the states (see Part E below). Similar state level regulation may be the price for non-banks that wish to issue electronic money.
The FDIC General Counsel's opinion divides stored value cards into four separate categories: Bank Primary-Customer Account Systems (funds remain in the customer's bank account until the electronic value is transferred to a merchant or other payee), Bank Primary-Reserve Systems (when value is downloaded onto the customer's card, funds are transferred from the customer's account to a reserve or general liability account held at the institution to pay merchants and other payees); Bank Secondary-Advance Systems (the issuer of the card is a third party, which provides electronic value to banks to make available to their customers; the customers then pay the third party for the stored value out of their bank accounts); and Bank Secondary-Pre-Acquisition Systems (the issuer of the card is a third party; banks pay the third party for the electronic value and subsequently resell that value to bank customers).
The opinion concludes that:
The opinion also states that the FDIC expects that institutions will clearly disclose to their customers the insured or non-insured status of their stored value products.
The FDIC also has regulatory authority to treat bank obligations relating to stored value cards and other electronic payment systems as deposits even if such obligations do not fall within the statutory definition of "deposit." The FDIC held public hearings on September 12 and 13, 1996 to take comments on deposit insurance issues related to electronic payment systems. See:
If such an institution does come into being, it must receive written acknowledgement from its depositors that they understand the institution is not federally insured and, if it fails, the government will not guarantee the return of the depositors' money. The institution must also include the same disclosure in all of its advertisements and on every instrument evidencing a deposit. 12 U.S.C.A. §1831t(b).
C. For Banks, is Participation in the Issuance of Electronic Money a Permissible Banking Activity?
According to the OCC approval, Mondex USA will operate through two limited liability companies ("LLCs"), which will be respectively the issuer of electronic value and the servicer of the Mondex USA system. The LLCs will be owned by a group of four national banks and three non-banks. See:
The OCC's approval is subject to several conditions, including:
(b) the LLCs must stipulate that they are "institution affiliated parties" with respect to their national bank investors, giving the OCC enforcement jurisdiction; and
(c) the LLCs must obtain OCC approval of any material changes to the LLC Operating Agreements.
The OCC Bulletin analyzes safety and soundness issues by identifying the various functions that banks may perform with respect to a stored value card system: investment in a company operating a stored value system, issuance of stored value, distribution of stored value cards for third party issuers, transaction authorization for systems that involve authorization prior to merchant acceptance, redemption of stored value held by merchants and consumers, clearing and settling, and transaction archiving. Banks must understand the different risks associated with each of these roles, as well as the need to ensure consumer understanding of the product.The OCC suggests several specific items which banks should disclose to their stored value card customers: the identity of the issuer/obligor of the stored value, how to use the card, how and where the customer can load value on the card, whether the stored value earns interest or any kind of return, where it can be redeemed, any fees imposed on the customer, protection for lost or stolen cards, the availability of FDIC insurance, whether and under what circumstances information on transactions may be available to third parties, who is liable for transactions that are not completed properly, what happens to stored value that is not used for lengthy periods, and what dispute resolution mechanisms are available.
The FDIC examination procedures identify six specific areas of concern: planning and deployment (has senior management been involved in making decisions, and have cost and strategic implications been thoroughly considered), operating policies and procedures, auditability, legal risk (e.g., risk of unenforceability of electronic contracts, uncertainty regarding liability for errors, uncertainty regarding which jurisdictions may seek to regulate electronic transactions), administration and system operations (is the bank's security adequate? is the bank prepared to administer multiple standards and protocols?) and outsourcing (can the bank adequately monitor and control vendor performance?).
D. For Banks, Are Accounts that Hold Funds out of Which Electronic Money is Redeemed Subject to Reserve Requirements?
Numerous banks have also instituted arrangements which regularly sweep funds from a transaction account into a money market account that qualifies as a savings deposit. The Fed is "monitoring closely" the effect of such arrangements in lowering system-wide reserves and thereby influencing the implementation of monetary policy. 61 Fed. Reg. 69023 (Dec. 31, 1996).
The Fed, or at least some Fed staffers, are also beginning to consider a future in which monetary policy is conducted through means other than the manipulation of bank reserves maintained at the Fed. See
E. For Non-bank Issuers, will States Attempt to Regulate Using Money Transmitter or Travelers' Check Statutes?
F. ConsumerProtection Issues
Under the Fed's proposal, in all three systems, a transaction in which a stored-value card is "loaded" with value by accessing a consumer's deposit account will be subject to Regulation E and its transaction receipt and dispute resolution requirements. As to transactions in which the value on a card is used to make a payment, however, off-line unaccountable systems would be exempted completely from Regulation E, and off-line accountable and on-line systems would be exempted completely if the maximum value that can be stored is $100 or less. If the maximum value is not limited to $100, off-line accountable systems would be subject only to the Regulation E requirements on initial disclosures, while on-line systems would be subject to all requirements of Regulation E other than periodic statements (as long as an account balance and account history is available on request) and the requirement of advance notice of changes in terms.
The Fed proposal recognizes that banks and others are developing systems for computer network payment products that operate in a manner similar to stored value cards, i.e., a customer transfers value from the customer's bank account to the network payment product, and then uses that product to purchase goods or services. The Fed has not made any specific proposal, but requested comment on the extent to which the Board should address the applicability of Regulation E to network payment products. 61 Fed. Reg. 19696 (May 2, 1996).
Privacy of information is shaping up as perhaps the major item for the widespread consumer acceptance of new electronic money systems. Principal areas to watch:
(b) the battle between privacy/commerce advocates and law enforcement over the widespread availability of strong cryptography and the ability to conduct transactions anonymously or pseudonymously. For (a), see:
For (b), see:
With a number of competing e-money products available, likely the most important element in addressing consumer issues will be communicating clearly the features of the product, against the backdrop of consumers' knowledge of how existing payment systems work, and then ensuring that the product actually works as described. The key issues to be addressed, in addition to privacy, are (a) the identity of the obligor, (b) limits on consumer liability for unauthorized transactions (and on the corresponding payee side, the ability of merchants to obtain comfort that payments will not "bounce" and transactions cannot be repudiated), and (c) the effect of lost value (lost cards or unretrievable information on the consumer's hard drive). See:
|http://www.oecd.org/daf/ccp/cons/index.htm (OECD Committee on Consumer Policy)|
As a corollary to #4 above, e-money issuers must take care to avoid inflated claims for their product. Are stored value cards and Internet payment products today as good as cash, given limited acceptance by merchants and limited ability to conduct anonymous transactions? The FDIC and Fed have already informally indicated that e-money issuers should not refer to their products as cash.
G. Commercial Law Issues
The issuance of electronic money will raise numerous commercial law issues of the type that are already settled for checks, Automated Clearing House transactions and wire transfers by the Uniform Commercial Code, Federal Reserve circulars and clearing house rules. Among such issues are when payments become final, liability for authorized payments completed improperly and the ability to pledge electronic value as collateral for a debt. The American Bar Association Section of Business Law has convened a Task Force whose report, A Commercial Lawyer's Take on the Electronic Purse, will be published in the February 1997 Business Lawyer.
Another important element in establishing the commercial viability of electronic commerce and electronic money is the development of rules of contract law and evidence regarding the validity of electronic contracts. In turn, the desire to establish methods for ensuring that electronic signatures are valid and cannot be repudiated creates a need in commerce for "trusted third parties" to verify the link between a person and his or her electronic signature. Because banks are already in the business of marketing their trustworthiness, banks are natural candidates to act as trusted third parties, e.g., as certificate authorities to tie a user to his/her public key in systems that use public key cryptography. For information regarding ongoing efforts to establish the validity of electronic contracts, state digital signature laws and the role of trusted third parties, see:
|1. In this article, I will use the term "electronic money" to refer to both chip card-based and computer network-based stored value systems (systems which simply use the Internet to conduct credit card transactions do not raise the same legal issues). I will also use the term "bank" to include commercial banks, savings associations and any other FDIC-insured institutions.|
|2. Although funds held by non-banks are not insured by the FDIC, a non-bank e-money issuer can obtain deposit insurance for its customers by placing the funds on deposit at a bank. For example, the FDIC legal department, in an unpublished interpretation issued to Cybercash, has concluded that if a non- bank issuer were to accumulate the funds it receives from its customers and place those funds into a bank account, that account would be eligible for pass-through deposit insurance (up to $100,000 per customer).|