arlier this month, during the Northeast Acquirers' Association (NEAA) meeting in Vermont, I took part in a panel discussion of the Check 21 Act. Some of the questions posed by the audience gave me the sense that Check 21 isn't something people in the acquiring business have spent much time pondering.

With implementation of Check 21 set for this fall, it's a good idea to start considering the implications of this new law, and in particular what it will mean for check acceptance at the merchant checkout.

The Check 21 Act-shorthand for the Check Clearing in the 21st Century Act-will usher in the most significant changes to payments businesses since the introduction of ATMs. To be sure, these changes will not occur overnight-heck, it took more than a decade for ATMs to become pervasive.

But with time, the changes brought about by Check 21 will transform the check system into a truly electronic payments system. And best of all, this transformation will have little or no discernable impact on American check writers.

Okay, maybe that's a slight exaggeration. People who like to play the float won't be able to continue that questionable practice in this new check clearing environment, since the lag time between the writing and posting of checks is substantially reduced.

The really big changes brought on by Check 21, though, are going to take place at banks: investments in big iron machinery that sorts and routes paper checks; the fleets of trucks and airplanes that move paper checks within and between banking organizations; special agreements between banks, and between customers and banks that make check truncation and electronic check clearing possible today-all these things go away.

The payoff for banks? Billions of dollars a year in potential savings, industry-wide, from the elimination of transportation, float and back-office costs; plus, they'll benefit from revenue boosts from new product opportunities.

One obvious new product we can expect to see as a result of Check 21 is check truncation at the point of sale, eventually (if not initially) backed by new-age authorization services. (The ATM infrastructure is situated to play a critical role in this line of services.)

What is Check 21?

Let's be clear about one thing: Check 21 does not mandate check truncation; instead, it creates a new legal environment in which truncation can evolve.

It does this by sanctioning a legal replacement for checks, called the "substitute check," which can be generated from a check image file when the paying bank and/or the check writer insist on receiving paper rather than electronic check images as proof that a payment occurred and was settled.

Technically, substitute checks will need to be created by banks, according to regulations proposed by the Federal Reserve that implement the new law.

But banks can enter into agreements with merchants (similar to the way things are handled in the ACH check conversion arena today) that allow merchants to capture check images at the point of sale and begin the truncation/electronic clearing process before those checks enter the inter-bank collection stream.

It Bests ACH Check Conversion

POS truncation will prove to be a lot more popular than POS check conversion, for a variety of reasons. For example, a check imaged and truncated at the point of sale continues to be covered by check law even though it clears electronically.

In POS (ACH) check conversion, checks cease to be governed by check law because the payments, in reality, have been converted to electronic payments.

Federal and state EFT laws are more consumer friendly than check laws. Under ACH law, consumers have 60 days from the date they learn of a questionable transaction (presumably when they receive their monthly bank statement) to file a complaint with their bank. Check law allows consumers just 40 days to dispute transactions.

More checks are eligible for POS truncation in a post-Check 21 environment. Business checks, courtesy checks, cashiers' checks-any and all checks can be truncated. ACH check conversion is limited to traditional consumer checks.

Perhaps the most obvious advantage of POS truncation for merchants, though, is that truncated checks will clear and post more expeditiously than checks converted to ACH transactions. That means better availability and a better jump start on identifying fraudulent payments-a problem that is believed to be costing the merchant community $10 billion, or more, a year.

The ACH is a batch processing system. That means checks converted to ACH payments must be sent en masse by a certain cut-off each day (usually in the afternoon) to the bank that processes the items through the ACH. With truncation, a merchant conceivably could image and transmit a check payment to its bank at the moment of acceptance.

A merchant may choose (or have to because of technology constraints) to send truncated check images all at once. But with truncation, a bank's cut-offs for check deposits can be much later than is the case today, because there's no transportation component to the deadlines. That means a larger share (possibly all) of a merchant's check deposits become one-day items.

In other words, when checks are truncated and electronically deposited, funds are posted to the merchant's account the very next day, even if the electronic files arrive at the bank after 9:00 pm. Most ACH payments post to merchant accounts two days after a check is converted at the point of sale.

The benefits of POS check truncation are too significant to ignore. That's why acquirers, ISOs and merchant level salespeople need to be thinking now about how they can help merchants get ready for this new era of check acceptance.

To assist in that process, I have developed this short Q&A on Check 21. You may wish to refer to these as you discuss Check 21 and the emergence of POS check truncation with employees and your merchant customers.

What's all the fuss over Check 21?

Check 21 represents a new era for check payments. Instead of moving paper checks between merchants and banks, it is now possible to clear checks using advanced electronic technologies, such as check imaging and electronic image exchange. (No more paper shuffle.)

This significantly reduces check clearing times, and eliminates the impact of unforeseen problems (like inclement weather) on the check collection process.

When does the Check 21 Act take effect?

The law is effective beginning October 28, 2004.

Does Check 21 preempt existing law?

Check 21 supersedes any state or federal law that is inconsistent with this new law, including provisions of the Uniform Commercial Code.

What, exactly, is check truncation?

Check truncation refers to any of several techniques that stop the movement of paper checks through the clearing and settlement systems.

Under Check 21, check truncation occurs when a bank or business payee captures an electronic image of a paper check and the subsequent forward and return collection processes occur through the exchange of electronic check files.

What is a substitute check?

A substitute check is a legally sanctioned document about the size of a "business" check that can be provided to a paying bank or consumer in lieu of an original check that has been truncated along the collection stream. A substitute check is considered the legal equivalent of its original check for all purposes and reasons, including proof of payment.

A substitute check (which can be generated by a bank or its check services provider) must contain images of the front and back of the original check (complete with necessary signatures and endorsements), a statement identifying it as a substitute check and legal copy of the original and MICR encoding (which allows for the document to be handled using traditional check processing equipment).

What types of checks will be eligible for truncation as a result of Check 21?

Any and all types of checks can be truncated and re-converted, as needed, into substitute checks.

What is an IRD?

IRD is an acronym for Image Replacement Document. IRD is sometimes used interchangeably with substitute check.

What happens to the originals of truncated checks?

In many cases, original checks are destroyed once the electronic (digitized) versions are created. However some may be stored in a secure location at the discretion of the bank/merchant that digitized the checks, to be destroyed at a later date once the payments have cleared and have been posted to check writers' accounts.

What does truncation mean for bank deposit cut offs?

Merchants are often constrained by narrow windows for depositing paper checks into the collection stream. Substitute checks and check image exchange push open those windows.

With modest investments on their part, business customers will be able to capture check images upon acceptance, transmitting those electronic check files to their banks 24/7. Good riddance to late-night deposit drops.

How will Check 21 and truncation affect check fraud?

Check fraud is a serious and growing problem for merchants. Annual losses to check fraud are believed to exceed $10 billion in the retailing community. Having access to check images as soon as the items enter the collection stream means banks (and merchant customers) can identify potential frauds early and take immediate steps to prevent losses.

Patti Murphy is Contributing Editor of The Green Sheet and President of The Takoma Group. She can be reached at patti@greensheet.com