egulatory imbalance doesn't get much traction in the retail payments business. So it shouldn't come as much of a surprise that the Federal Reserve wants to close a regulatory loophole that lets merchants and other businesses that convert checks to electronic payments skirt consumer electronic funds transfer (EFT) rules.

Proposed changes to Regulation E and its interpretive commentary the Fed is now circulating would also clarify that payroll cards are covered by the protections and disclosure requirements of Reg E.

The regulatory changes, if adopted, would also make it clear that the Federal Trade Commission (FTC) is authorized to oversee non-banks that convert consumer checks to EFT transactions but don't follow the rules.

Reg E implements the federal EFT Act, which was passed in 1978 to ensure that consumers using budding retail EFT activities were covered in line with consumer credit protection laws (such as the Truth-in-lending and Equal Credit Opportunity acts).

Congress appointed the Fed to write the regulation as well as maintain an ongoing official commentary to interpret it. Regulators of other financial institutions (such as credit unions) oversee Reg E compliance among their constituent institutions.

The FTC has regulatory oversight for non-banks, including merchants that provide EFT payment options.

The Fed has requested public comments on proposed changes to the regulation and its commentary through Nov. 19, 2004. And while the proposal to include payroll cards under the scope of Reg E has met little resistance, the idea of bringing merchants under the rule has some girding for a fight.

In fact, murmurs can already be heard in the marketplace that the proposed new notification requirements will dampen merchant enthusiasm about converting checks to EFTs.

When the Check's in the ACH

In electronic check conversion, a merchant or other business electronically captures MICR-line and other information from a consumer's check to initiate a one-time EFT from that consumer's account. The transaction is then cleared and settled using the automated clearing house (ACH) system.

There are actually five different types of transactions that can be created to electronically clear checks through the ACH system, including those specifically designed for point-of-sale and remittance checks.

During the second quarter of 2004, nearly half a billion checks were converted to EFTs using ACH check conversion, according to NACHA - The Electronic Payments Association, the private sector ACH rules group.

The EFT Act does not cover payments originated by check or similar paper instruments. But in 2001, as POS check conversion was taking hold in the market, the Fed updated its official commentary on Reg E.

The Fed clarified that these new transactions were, indeed, covered by the rules and that businesses converting checks to ACH items must notify consumers upfront when a check payment will be processed as an EFT.

As check conversion transactions have swelled, however, concerns have been raised about the uniformity and adequacy of some of the notices provided consumers.

The Fed's Reg E proposals address this issue of uniformity, as well as the timing and substance of consumer disclosures.

Specifically, merchants would need to provide a "clear and conspicuous" sign or handout at the checkout explaining that they will convert customer checks to electronic payments and, as a result, funds might be debited from the customer's checking account more quickly than in the past.

Additionally, the sign/statement/handout would need to inform consumers that their financial institutions would not return checks converted to EFTs. The Fed has proposed model language that merchants can use in crafting POS disclosures, as well as provisions for bank disclosures regarding electronic check conversion.

The intent of the proposed amendments, Fed staffers explained, is to protect merchants and other payees from civil and criminal liability in the event something goes awry with a converted check transaction.

For their part, retailers have been heard to grumble that the new disclosures will slow their checkout lines.

Consumer advocacy groups have been pushing for more and better information for consumers whose checks get converted to ACH payments.

Spokespeople for Consumers Union, for example, have complained that initiatives such as check conversion make consumers more prone to bouncing checks. They want banks to be required to disclose this fact to customers.

Although the Fed hasn't taken such a bold step, by working with other financial institution regulatory agencies, it has developed an initiative to help educate consumers about new check clearing initiatives and the likelihood of account overdrafts.

You can find a new and informative handout, titled "Protecting Yourself From Overdraft and Bounced Check Fees" on the Web at www.federalreserve.gov/pubs/bounce./gs_archive.php?emagazineIssueNumber=041002.

Corralling Payroll Cards Under Reg E

Payroll and other types of stored value cards are also a point of contention for groups such as Consumers Union, which argue there aren't enough safeguards for people who use the cards.

The Fed's response is to clarify that Reg E applies to payroll cards. But that's as far as it wants to go for right now. Other types of stored value cards (such as gift cards) are currently not being pulled under the Reg E umbrella, according to the Fed, although this might change

Payroll cards that are tied to individual employee accounts or "pooled" accounts managed by employers, banks and third-party processors all would be covered by Reg E under this proposal.

A growing number of firms (particularly in the QSR market) use payroll cards to compensate "unbanked" employees (people without access to traditional bank accounts). In 2003, nearly 2.4% of consumers received paychecks by way of payroll cards, according to research firm Dove Consulting.

A payroll card account holds a consumer's wages and other compensation. In other words, his or her liquid assets.

Typically, an employer, in conjunction with a bank, will provide an employee a card that looks and acts like a debit card that is tied to a bank account, either in the employee's or the company's name.

The employer credits the account each payday (usually by way of the ACH) instead of cutting checks. Employees then use the cards (many of which carry MasterCard/Visa logos) as POS debit cards or to withdraw cash at ATMs.

The Fed has been itching to regulate payroll cards for some time. Eight years ago it drafted a proposal to include payroll cards under Reg E, but that proposal was scrapped at the urging of Congress.

The argument in 1996 was that the overall costs of implementing payroll card regulations were too high and might stymie market penetration. But that argument no longer holds true, the Fed said in explaining the proposed rule change.

"The Board believes that it is appropriate to apply the Regulation E provisions, such as initial disclosures, periodic statements, error resolution procedures and other consumer protections, to consumers who receive their salaries through payroll card accounts, which in many cases, will constitute the bulk of the consumer's income," the Fed wrote.

As the Fed sees it, there's no uniformity in the disclosures banks and employers provide cardholders, because there's no clear-cut definition of these types of cards under Reg E. The proposal it's now floating would define payroll cards as debit cards with all the protections and legal requirements accorded under Reg E.

You can view a copy of the Fed's proposed Reg E amendments on its Web site at: www.federalreserve.gov/boarddocs/press/bcreg/2004/20040913//gs_archive.php?emagazineIssueNumber=041002 .