Robert E. Feldman
Executive Secretary
Federal Deposit Insurance Corporation
550 17th Street, N.W.
Washington, D.C. 20429
ATTN: Comments/Legal ESS
Re: Notice of Proposed Rulemaking -- Definition of Deposit;
Stored Value Cards (“Stored Value Card NPR” or “Proposed Rule”)
RIN 3064-AC80
Dear Mr. Feldman:
We are writing in response to your request for comments regarding the Stored
Value Card NPR published by the FDIC on April 16, 2004. We appreciate the
opportunity to provide comments on the Proposed Rule, particularly in light
of the pioneer
role taken by several of our clients in the development of stored value card
programs. Our clients issue payroll cards, a variety of reloadable cards,
gift cards, and promotional cards, and we are pleased to note that one of
them ranks
among the largest issuers of gift cards bearing the Visa® brand. We have
been involved in a myriad of legal issues associated with stored value cards
over the last several years, including FDIC insurance issues associated with
General Counsel’s Opinion No. 8 (“GC8”). In that regard,
we requested and received an opinion from your legal division dated September
11, 2003, regarding FDIC insurance on payroll card accounts underlying payroll
cards issued by a client.1
In general, we believe that the sweep of the Proposed Rule is excessive and
will result in funds underlying too many stored value cards being characterized
as deposits. This conclusion results from the fact that technology today
permits data processors to reflect available balance information on stored
value cards
in real time. In addition, technology permits electronic batching of names
and addresses of cardholders so efficiently that virtually all data processors
record and maintain cardholder information as to stored value cards. Under
the Proposed Rule, the existence of these “subaccounts,” even
by a data processor, would result in the funds meeting the definition of
deposit.
Most programs would be impacted, and the unintended consequences in terms
of the applicability of other federal laws and regulations could be harsh.
Moreover, stored value card issuers use the same technology platform for all
of their cards. As a result, payroll cards, reloadable cards, gift cards, and
promotional cards of an issuer will all activate in the same manner; will all
have available balance information that is attainable on the internet or by
telephone; and will all use the same customer support service center. It would
be cost prohibitive for issuers to build different platforms for different
card programs in order to differentiate what is a deposit from what is not.
Notwithstanding, we believe that there should be definitive rules as to what
funds underlying stored value cards are deposits, and we applaud the FDIC for
addressing this important issue. We believe that the tests used for this purpose
should be designed to recognize the fundamental differences in card programs
and distinguish between (i) funds on cards that are the functional equivalent
of a deposit in terms of longevity, purpose, usability, and ownership and (ii)
funds on cards that are the functional equivalent of a payment mechanism more
akin to cash.
Fundamental Differences in Card Programs
As is recognized by the FDIC in the Stored Value Card NPR, depository institutions
offer a number of distinct stored value card programs. We view these programs
as a spectrum from payroll cards to promotional cards, each with a fundamentally
different function that should be recognized in the definition of deposit
in Section 3(l) of the Federal Deposit Insurance Act (“FDI Act”):
•
Payroll Cards – payroll cards are loaded with the wages of employees.
They are the functional equivalent of a transaction account in that they may
be used to: receive automatic deposits of wages at regularly scheduled intervals
like a checking account; pay bills like a debit card; purchase goods and services
like a debit card; and access cash like an ATM card. In fact, they work like
a checkless, electronic-access-only demand deposit account. They have permanency,
as demonstrated by the long periods before expiration, and any unclaimed funds
would typically escheat to the state of residence of the cardholder under unclaimed
property laws –like a deposit account.
•
Gift Cards – gift cards may be instant issue or personalized. In the
latter event, the issuer will have records on the name and address of the
recipient. They are intended to replace cash as a gift and typically are
disposable and
have very short lives, consistent with their function as a cash substitute.
They would generally not be useable at ATM machines for cash. State laws
differ on escheatment of unused funds.
•
Promotional Cards –these cards are loaded with funds from a corporate
sponsor and are given to individuals for incentive or reward purposes. They
are disposable and quite short in duration, with expiration dates averaging
six-months. They typically may not be used at ATM machines to obtain cash.
The funds belong to the corporate sponsor if they are not used and do not
escheat. They are more akin in function to a coupon and do not serve a deposit
function.
•
Reloadable Cards – these cards are issued for a variety of purposes.
We use the term “reloadable” generically to include cards issued
to cardholders for purposes other than those delineated above.
These programs
may involve: licensed lenders who load cards with installment loan proceeds;
health insurers who load cards with healthcare benefits; cards sold by merchants
to customers; or funds transferred from one card to another. To the extent
any funds are not spent, they would generally be subject to unclaimed property
laws. They are not one-use disposable obligations and tend to have more permanency
and longer periods until expiration. Many programs, excepting benefit programs,
would permit ATM usage.
These card programs typically have subaccounting in common. Yet they are fundamentally
different in function and, we submit, in cardholder expectation. We believe
that their definition vis-a-vis deposits must turn on those attributes that
distinguish them. To that end, we request that the FDIC consider the following
tests to facilitate defining what constitutes a deposit-like product and what
does not without sweeping all the funds underlying bank card programs into
deposits:2
•
Predicate the determination of whether funds underlying cards are a deposit
on the duration of the card as shown by the expiration date or disposability
feature (a disposable card would not be reloadable by its terms). A very
short duration of six-months to a year, with no ability to reload the card, would
indicate that the card is really a cash substitute with no deposit feature.
A longer duration before the expiration date or a reloadability feature would
indicate that the funds underlying the card are more akin to a deposit; and/or
•
Predicate the determination on whether the cardholder may access cash
with the card.3 The
ability to receive cash makes the card more akin to an account or a deposit;
whereas, the inability to obtain cash would be inconsistent
with
the fundamental premises of a transaction account and would indicate that
the funds are not deposits.4
Use of either or both of these tests would draw a bright line between deposits
and non-deposits that would be consistent with cardholder expectation as
to his/her funds and would be adaptable by the industry without hardship
or excessive
cost.
Legal Discussion
Under the Proposed Rule, “funds received by an insured depository institution
from cardholders, or funds received from others on behalf of cardholders
or for payment to cardholders,” in exchange for such cards, would constitute
deposits, unless the institution records its liabilities for such funds in
an account representing multiple cardholders and the institution does not
maintain “supplemental
records or subaccounts reflecting the amount owed to each cardholder.” 5 There
is no distinction for the type of stored value card program or the function
of the card. What “matters to the FDIC is whether the stored value
card provides access (directly or indirectly) to money received and held
by an insured
depository institution.” 6 As
a result, the Proposed Rule would apply to any stored value card, whether
it is a gift card, a payroll card or a
promotional
card, where the funds underlying the card pass through a clearing process
and where the card’s value is dependent on “whether a bank holds
sufficient funds to back-up the card.” 7
More specifically, under the Proposed Rule for stored value cards issued
by a depository institution, “funds received by an insured depository
institution from cardholders, or funds received from others on behalf of
cardholders or
for payment to cardholders,” in exchange for such cards, would constitute
deposits, unless two conditions applied, namely, the institution “records
its liabilities for such funds in an account representing multiple cardholders” and
the institution does not maintain “supplemental records or subaccounts
reflecting the amount owed to each cardholder.” 8
As a result, the Proposed Rule does not focus on the functional equivalency
of stored value cards, such as payroll cards and gift cards. Instead, it
asks only whether funds are received by an insured depository institution
in exchange
for stored value cards and whether that institution uses a subaccount accounting
methodology to track the value remaining with respect to each cardholder.
If so, such funds would constitute deposits. Accordingly, the only stored
value
cards issued by a depository institution and supported by a general liability
account that do not lead to the creation of an insured deposit may be stored
value cards where the only record of the amount due the cardholder is on
the card itself.
As shown above, most gift cards fundamentally differ from bank deposits,
even though the proceeds of both are held by banks. Gift cards serve as a
more flexible
substitute for store gift certificates by providing broader transaction capabilities.
At the same time, these transaction capabilities generally are more limited
than deposit accounts in terms of the parties to whom payment can be made — payments
generally cannot be made to individuals and cash withdrawals may not be available.
Further, the recipients of gift cards do not choose the financial institution
issuing the card, nor is the gift card produced on the assumption that it
is backed by the deposit insurance system. Similarly, gift cards are not
viewed
by either the producers or recipients as an investment or savings vehicle.
Policy Implications
Furthermore, the Proposed Rule ignores the policy implications of deposit
insurance coverage. The purpose of deposit insurance is to protect the banking
system
by reducing the incentives for retail product bank runs and to protect depositors’ savings
and liquid funds. Implicit in both of these policies is that the depositor
is relying on the security of the banking system, including the Federal Deposit
Insurance system, to protect his or her funds. While some stored value products,
such as payroll cards and in some instances reloadable cards, have these
characteristics, others, such as gift cards and promotional cards, are purely
payment vehicles
that serve as substitutes for cash. While it may be appropriate to characterize
certain stored value cards as insured deposits, such as certain payroll cards,
for deposit insurance assessment purposes, we believe that the FDIC should
take into account the policy rationale for characterizing the underlying
funds contained in certain stored value products as deposits.
Effect on Other Regulations
The Proposed Rule appears to distinguish what is and is not a “deposit” based
on the underlying records and refers to “subaccounts” in this regard –a
subaccount being a record kept by the bank or its processing agent. This construction
is problematic because it seems to equate a “commercial, checking, savings,
time or thrift account” under paragraph 3(l)(1) of the FDI Act with these “subaccounts”.
We respectfully submit that a general ledger liability entry on the books
of a depository institution should not morph into a fund with underlying
insured
deposit accounts merely because the data processor has the technical ability
to maintain records matching account numbers to available balance information.
As discussed below, this construction has significant unintended consequences
to the extent these subaccounts constitute accounts under Regulation E, the
USA Patriot Act, Regulation D, Truth in Savings, and the like. We submit
that it is critical that the distinction between what is and what is not
an account
be maintained.
While the Proposed Rule is concerned with whether funds backing stored value
cards constitute deposits, with all the rights and responsibilities that
would follow, the FDIC acknowledges in a footnote that this result could
raise “a
number of other issues,” including reserve requirements, money laundering
and application of the electronic fund transfer rules.9 Indeed,
the application of many laws to stored value products is not clear, and will
likely differ
significantly, depending upon the type of product. For that reason, we submit
that the legal issues outlined below would be cured by the FDIC’s application
of the tests we delineated above. If card funds are deposits, they should
be accounts for the purposes of these laws. By the same token, card funds
that
would not be deposits, should not constitute accounts.
Regulation D Requirements
Regulation D establishes requirements for depository
institutions to hold reserves in the form of either vault cash or non-interest
earning
balances held at a Federal Reserve Bank against transaction accounts
that are held by banks on behalf of their customers. If the Federal
Reserve Board (“FRB”) were to address the status of prepaid
cards as transaction accounts based on the subaccount theory espoused
by the
FDIC, there is some likelihood that it would find that stored value
cards issued by a bank to raise funds would be considered transaction
accounts.
The reserve requirement is 10% of the amount of net transaction accounts
over $45.4 million, 3% for net transaction accounts over $6.6 million
up to $45.4 million and 0% for net transaction accounts below $6.6 million.
To the extent that stored value cards give rise to insured deposits,
they also may be viewed as giving rise to transaction accounts. The marginal
reserve that would apply to the amounts on the cards would depend on
the current level of transaction accounts held by the bank, but in most
cases would be 10%. This reserve requirement would affect the cost of
providing cards that likely would be reflected in the fees charged for
cards such as gift cards. Moreover, the opportunities to reduce reserve
requirements that are available for conventional bank deposits, such
as sweep arrangements, would not be available for cards.
Regulation E Requirements
The FRB’s Regulation E sets forth the requirements for electronic
fund transfers to or from a consumer asset account, such as a deposit
account, at a financial institution. The applicability of many Regulation
E provisions, including periodic statements, limited liability for unauthorized
transactions and error resolution procedures, to certain stored value
products is not clear. Section 205.2(b)(1) of Regulation E defines the
term “account” as a “demand deposit (checking), savings,
or other consumer asset account . . . held directly or indirectly by
a financial institution and established primarily for personal, family,
or household purposes.” The FRB has refrained from adopting final
amendments to Regulation E to specifically cover stored value products
out of concern that too much regulation could inhibit the development
of these emerging products. If the Proposed Rule is adopted, however,
the FDIC’s characterization of certain stored value products
as deposits could influence an FRB determination that such deposits
are
consumer asset accounts under Regulation E.
USA PATRIOT Act Customer Identification Rules
Financial institutions are required to gather specified
information about customers and to verify the identity of customers.
In addition,
financial institutions must establish risk-based procedures for verifying
the identity of each customer to the extent reasonable and practicable.
Also, a Customer Identification Program (“CIP”) must have
procedures in place for opening an account that specify the identifying
information that will be obtained from each customer. Further, at a minimum,
a financial institution must obtain the customer’s name, date
of birth, address and identification number. It is simply not feasible
for
financial institutions to comply with CIP requirements for the recipients
of gift cards and promotional cards because they may have no business
relationship with the recipients.
CALL Reports and Related Issues
Also not addressed by the FDIC in the Proposed Rule is the effect on
bank CALL Reports if stored value card funds are constituted deposits.
Must the bank report those as insured deposits in its CALL Report? Will
assessments have to be paid against them (assuming assessments are paid
in the future)? Will examiners criticize these deposits as volatile or
require them to be considered as non-core deposits for ratio purposes?
Disclosures
We believe that there should be required disclosures as to stored value
cards and agree that the examples in the preamble adequately address
consumer protection issues.
Conclusion
We believe that the FDIC should promulgate a rule to clarify the meaning
of deposit in this context and should replace GC8. But it should not
be in the form of the Proposed Rule. We respectfully submit that the
FDIC must recognize the functionality of stored value card programs and
apply tests that differentiate funds that meet traditional deposit expectations
and those that do not.
• In this regard, we believe that payroll cards are deposits because
of their duration and by the fact that they feature cash accessibility.
• On the other hand, we believe that gift cards should not generally
constitute deposits. We suggest that this conclusion either be tied
to the disposability and duration until expiration of the cards or
to cash accessibility.
•
Furthermore, we assert that promotional cards should never be deposits.
They are corporate funds that belong to the corporate sponsor until
spent by the recipient. Again, this result may be accomplished by
excepting from the definition of deposit those cards that are disposable with
short duration until expiration or by using a definition of this
kind
of card or by recognizing that they do no feature cash accessibility.
•
As to reloadable cards, we believe that their definition will turn
on the expiration date or on cash accessibility based on the program
under which they are issued.
We hope that our comments are helpful in connection with this important
initiative. Thank you for the opportunity to provide these comments.
Should you have any questions, please contact Karol K. Sparks at 312-984-3186.
Very truly yours,
Barack Ferrazzano Kirschbaum Perlman &
Nagelberg LLP
_____________________________
1 Letter
from Christopher L. Hencke, Counsel, to Karol K. Sparks (Sept. 11, 2003).
2
We
note that the following, although they are variants among the programs, would
not be effective tests to differentiate deposits from non-deposits:
--Whether the card is personalized as to the cardholder or not. While this will
be critical in determining any pass-through FDIC insurance coverage, using this
criterion to determine what constitutes a deposit could have the perverse impact
of motivating issuers not to collect information on cardholders.
--Whether the funds escheat to the state or are returned to the sponsoring company.
The state unclaimed property laws are evolving on items such as gift certificates
and gift cards because of the potential for unjust enrichment that exists when
a merchant sells a gift certificate or gift card and maintains the proceeds if
it is never used. One way in which states including Connecticut, California,
and Illinois have addressed this is to require escheatment if there is an expiration
date. Thus, escheatment would be inconsistent from state to state, and the bank
would have to look to state unclaimed property laws to determine whether the
funds constitute deposits.
3 The
Proposed Rule, published at 69 Fed. Reg. 20,558 (April 16,2004), defines the
term “stored value card” at 20,566 only with reference to the
transfer of funds to merchants at point of sale terminals and does not differentiate
cards based on cash accessibility.
4 This
is a distinction being recognized by several states, including Massachusetts,
New Jersey, and New York, as to whether or not the funds on gift certificates
and cards escheat –if they may only be used to purchase merchandise, the
unclaimed funds do not escheat.
5 69
Fed. Reg. 20,558 (April 16,2004) at 20,565.
6 Id.
7 Id.
at 20,558 n.1.
8 Id.
at 20,565. Although the term “supplemental record” is not defined,
it appears to be meant to apply broadly so that any record maintained by, or
on behalf of, a depository institution that enables a depository institution
to determine the amount due a particular cardholder would constitute a supplemental
record. The Proposed Rule also states that it does not suggest that insured depository
institutions can “ignore” a law or regulation that would require
such institutions to maintain records on amounts owed to cardholders.
9 Id.
at 20,559 n.2.
