JP MORGAN
July 14, 2004 Robert E. Feldman
Executive Secretary
Attention: Comments/Legal ESS
Federal Deposit Insurance Corporation
550 17th Street NW
Washington DC 20429 Re: Comments Regarding Federal Deposit Insurance Corporation (FDIC) Proposed Definition of “Deposit”; Stored Value Cards—Federal Register, Vol. 69, No. 74 (April 16, 2004), pages 20558-66 Dear Mr. Feldman:
On April 16, 2004, FDIC issued a proposed rule to clarify under what circumstances the accounts relating to stored value cards qualify as deposits (Proposed Rule). For funds held by a depository institution for stored value cards issued by that institution, the Proposed Rule provides:
[T]he funds are “deposits” unless:
(1) The depository institution records its liabilities for such funds in an account representing multiple cardholders; and
(2) The depository institution (directly or through an agent) maintains no supplemental records or subaccounts reflecting the amount owed to each cardholder. Proposed Rule § 303.16(b), 69 Fed. Reg. at 20565.
JPMorgan Electronic Financial Services (JPMorgan EFS) agrees with the definition of “deposits” in the Proposed Rule insofar as it is applied to procurements of governmental agencies seeking debit card services for child support and unemployment compensation payment recipients, and other similarly situated individuals. The practice underlying the Proposed Rule is consistent with the manner in which JPMorgan EFS has treated such government-procured accounts for over a decade, based on a standing opinion from the FDIC.
We obtained this opinion in connection with debit card-accessed accounts we had established under a pilot program in the early 1990s for recipients of Social Security annuities. The business practices that we formed in connection with those accounts have extended to our provision of debit card services under contracts with various state governmental agencies, as explained in greater detail below. Obtaining a consistent application of federal regulations in the context of these state-procured banking services is the focus of this comment.
JPMorgan EFS is uniquely qualified to comment on this issue. We are known as a leader in the field of Electronic Benefits Transfer (EBT). EBT is the use of debit cards and cost-effective Electronic Funds Transfer (EFT) technology to replace paper methods under which various public assistance benefits were once delivered, including those issued under the Food Stamp Program and Temporary Assistance to Needy Families (TANF). There is a federal statutory requirement for EBT to replace the use of paper Food Stamp Program coupons. See 7 U.S.C. § 2016(i)(1)(A). This process is now complete.
Prior to our significant expansion of EBT services in the mid-1990s, JPMorgan EFS also launched variations on EBT that would today be regarded as “stored value” debit card products, and therefore subjects of the proposed FDIC rule. First, in 1992, we contracted with the U.S. Department of the Treasury, Financial Management Service (FMS) to launch a pilot program in Houston, Texas through which account holders voluntarily enrolled in a debit card program to replace their checks, issued under the Social Security, Veterans Administration, Railroad Retirement, Black Lung and Civil Service payments and annuities programs. Our agreement with FMS provided for compliance with the Federal Reserve Board’s Regulation E, 12 C.F.R. Part 205 (Reg. E).
The sole exception in our Reg. E compliance was under a waiver from FMS making the mailing of periodic statements optional to the consumer at an additional monthly cost of $1.00, but this waiver was not a change in the regulation and its scope was limited to customers enrolled under this contract. Our Houston project also included reaching agreement with FDIC on how to define these new accounts so that they would satisfy the conditions necessary for FDIC insurance eligibility for each individual subaccount.
That pilot service was so successful, FMS called upon us to expand the Houston pilot statewide and later, again on a pilot basis, to add debit card accessed accounts for expatriated Social Security recipients in Argentina. At the time, these individuals were receiving U.S. dollar checks mailed to the American Embassy then forwarded to their homes. Those two ventures later helped lead to an expanded arrangement between FMS and our organization to offer federal payment accounts accessed by debit cards in eight additional Southeastern states. FMS extended its waiver of the monthly statement requirement to consumers in these states as well, but, again, this waiver was limited to consumers enrolled under this particular contract and it was not a regulatory change.
Each of our FMS contracts has since expired. We still, however, have in excess of 50,000 federal payment account holders in nine states, many of whom chose to remain our customers from the original FMS contracts, and, as they transitioned from services under the FMS contracts, began to receive monthly statements as part of their basic service package. Also, at this time, approximately 4,000 expatriated Social Security recipients in several Latin American countries are accessing their funds by debit card, a number that will increase as the program expands to other countries and depositors. As is our standard practice, these accounts are all offered in full compliance with Reg. E, including its monthly statement requirement, and are structured to satisfy the conditions necessary to qualify for up to $100,000 in federal deposit insurance coverage for each subaccount.
We also have been historically active in the payroll card business, dating back to the mid-1990s. Payroll cards have recently been recognized as “a success story” among the products that banks have used to reach out to the unbanked. See, e.g., “Regulators Eye Payroll Cards,” American Banker (May 24, 2004); “Payroll Cards: An Innovative Product for Reaching the Unbanked and Underbanked,” Office of the Comptroller of the Currency Community Development Analysis, http://www.occ.treas.gov/cdd/payrollcards.pdf (October 2003).
It is the growth in the use of payroll cards that appears to be the basis for much of the current attention on these federal regulatory issues, including the Proposed Rule. Another important industry development is rapidly taking place, however. State agencies faced with budget deficits are seeking new ways to use EFT to reduce the number of paper checks that they are required to produce and handle. One area of significant state procurement activity at this time is child support.
State human services agencies are actively pursuing the use of debit cards and stored value accounts to replace paper checks formerly used by the state to transmit court-ordered child support to custodial parents who do not have bank accounts and thus are not candidates for direct deposit. This EFT approach is also being extended to unemployment compensation and is available for use in other government-managed payment processes, including government payroll distribution.
JPMorgan EFS is very concerned that a lack of clear understanding among state agencies that are procuring consumer account services on behalf of unbanked custodial parents, recipients of unemployment compensation, and other consumers could lead to a proliferation of debit card accounts that may not comply with FDIC insurance eligibility requirements or the requirements of Reg. E.
The state agencies procuring these services generally require that the competing providers agree to comply with applicable state and federal regulations. The state agencies procuring these services on behalf of consumers, however, are not always in the best position to evaluate whether other bidders comply with these requirements to the same extent as does JPMorgan EFS and as we believe the law requires. Significantly, as the commentary accompanying the Proposed Rule notes, a person making false representations about FDIC insurance could be subject to criminal penalties. Proposed Rule, 69 Fed. Reg. at 20564.
We are therefore taking the opportunity presented by the invitation for comment to address the FDIC insurance question as well as certain other regulatory compliance issues in this governmental procurement context.
FDIC Insurance Requirement
Bank deposits are protected by federal deposit insurance if they meet certain requirements. To determine whether a particular account is protected by deposit insurance, the threshold inquiry is whether the account satisfies the FDIC’s definition of “deposit.” In other words, if it is not a “deposit,” it is not covered by deposit insurance.
The JPMorgan EFS stored value debit card programs offered through state and federal agencies utilize a structure under which all funds on all stored value cards issued under the programs are held in an omnibus “reserve” account at a depository institution, while JPMorgan EFS provides all transaction processing and customer services. JPMorgan EFS addressed the question of insurance eligibility in 1993. The company, then known as “Citicorp Services Inc.” and an affiliate of Citibank, sought the advice of the FDIC through a letter sent by Citibank describing the company’s account structure and deposit insurance practices in connection with our projects for FMS.
FDIC Advisory Opinion 93-35 (June 28, 1993), issued in response to the Citibank inquiry, confirmed for our company that consumer funds in pooled reserve account systems and deposits in subaccounts essentially identical to those described in the Proposed Rule are covered by pass-through federal deposit insurance, implicitly concluding that the consumers’ Social Security funds held by Citibank for our programs were deposits.
We found additional confirmation of our position in the characteristics required of an “Electronic Transfer Account” or ETA® as mandated by FMS in 1999. The ETA was designed by FMS to enable financial institutions to offer a low-cost direct deposit alternative to Social Security checks and other forms of recurring federal checks. See 31 CFR 208.5; Federal Register, Vol. 64, No. 136 (July 16, 1999), pages 38509-25. The ETA® regulations issued as final at that time reflect the FDIC insurance and Reg. E compliance approach that JPMorgan EFS had already been offering for several years.
The FDIC has made a similar determination on another occasion. FDIC Advisory Opinion No. 02-03 (August 16, 2002) set forth the following requirements for the separate insurability of funds held on each card in stored value card programs: (i) the cardholder, not the issuer or the bank, must have title to the funds, and neither the issuer nor the bank may have any reversionary interest in the funds, (ii) the style of the account on the bank’s books and records must indicate that the account “is held in an agency capacity,” and (iii) each cardholder’s ownership interest “must be indicated either in the depository institution’s deposit account records, the agent’s records (maintained in good faith and in the ordinary course of business) or a third party’s records (again, maintained in good faith and in the ordinary course of business).”
Opinion No. 02-03 addressed this matter with straightforward language. A 1996 FDIC General Counsel’s opinion, however, had relied on a statutory requirement found in 12 U.S.C. § 1813(l)(1) that, to be a “deposit,” funds must be in a “commercial, checking, savings, time or thrift account,” FDIC, General Counsel’s Opinion No. 8; Stored Value Cards, 61 Fed. Reg. 40490, 40492 (August 2, 1996) (“GC8”), in determining that when the cardholders’ funds are aggregated in a single, omnibus, “reserve” bank account, this does not meet the definition of “deposit.” This advice carried over into the question of whether the funds had to be covered by pass-through deposit insurance.
We are aware that some banks issuing stored value cards that use omnibus reserve accounts (perhaps relying on GC8) have stated in their disclosure materials that the funds held on the cards are not FDIC insured. If these banks did not intend for the funds stored on the cards to be insured, they may have also not complied with the insurability requirement that the agency capacity be noted in the style of the account on the books of the depository institution. In a state procurement where the state agency clearly expects FDIC insurability of the subaccounts, however, bidders defeat the state’s intention if they are in fact relying on FDIC insurability of the omnibus account only.
Also, we note that banks are required to reserve against transaction accounts under statutory and regulatory reserve requirements. See, e.g., 12 U.S.C. § 461(b)(2); 12 C.F.R. Part 204. Some banks may have concluded that, if an omnibus reserve account for a stored value card system is not a “deposit” under FDIC rules, it is not a “transaction account” for reserve purposes, either. JPMorgan EFS finds the possibility of states inadvertently awarding contracts dealing with child support payments or unemployment compensation that might allow such practices to be very problematic. We therefore support the operational principles underlying the FDIC’s decision to offer a rule that is consistent with Opinion 93-35, Opinion No. 02-03, ETA® standards and JPMorgan EFS historical practices for the potential to bring uniformity to state procurements for account services in these specialized markets.
JPMorgan EFS and the depository institution serving the JPMorgan EFS stored value card system have historically followed all the rules and procedures required to treat the funds held in a cardholder’s subaccount within the omnibus reserve account as a “deposit” and to assure the eligibility of each cardholder’s subaccount for deposit insurance up to $100,000. These practices include (i) maintaining a title for the account on the depository institution’s records that indicates that the account is held in an agency capacity for the cardholders, and (ii) providing the required FDIC insurance disclosures to cardholders.
JPMorgan EFS is concerned that states now in the process of procuring account services on behalf of custodial parents for direct deposit of child support have not uniformly applied or enforced their own requirements that individual subaccounts be FDIC insured up to $100,000. Public statements made by some state officials indicate that these officials are proceeding under the assumption that state involvement as a “pass through” entity in the payment process converts these payments to “entitlements,” i.e., “benefits” that are not within the scope of FDIC coverage for “deposits.”
JPMorgan EFS disagrees with this characterization. This “entitlements theory” is essentially an extension of the treatment of 100% government-funded benefits delivered through EBT services under the Food Stamp Program, TANF, and other forms of assistance to limited-means households and individuals. But in these true “benefits” programs, there are no “deposits” held by the EBT contractor as an agent for the EBT cardholder. An EBT transaction is generally settled in arrears. During a defined settlement cycle, the state’s EBT services contractor accesses government-owned funds in program funding accounts to reimburse retailers, ATM owners and financial networks that have previously provided value as a result of an EBT transaction authorized and recorded on the contractor’s processing system. Benefit program rules make these essentially “use or lose” benefits; if the benefits are not accessed within prescribed time limits, they eventually become inaccessible under program rules. Also, wherever these programs’ benefits are distributed by EBT, the responsible government agencies hold title to the funds, which pass from the government instantaneously through the EBT contractor’s settlement processes to be deposited in the merchants’ commercial bank accounts. Even in the absence of the Proposed Rule’s definition, there is no “deposit” as the EBT cardholder never has title to these funds so there is no basis to claim that an insurable account exists or that an account relationship exists between the financial institution and the cardholder. This claimed status of the “payment as an entitlement” clearly does not apply to child support. In state child support enforcement programs the role of the state is to accept funds from an absent parent pursuant to a court order and, assuming the custodial parent is not able to obtain or not interested in a traditional bank account for direct deposit, instead of issuing a check, the state transmits the funds to a service provider that the state has selected to make a debit card-accessed account available to the payee. Whether the state electronically deposits funds into a traditional financial institution or into a limited-purpose account for the benefit of the custodial parent, it is the parent who has title to the funds once they are deposited. They are not “use or lose” benefits that belong to the government until they are accessed as in the case of the Food Stamp Program or the TANF program. After an electronic deposit takes place, recipients of child support in state-brokered stored value systems have an ownership interest in identifiable funds on deposit. The Proposed Rule confirms that these funds will be insured up to $100,000 for each recipient if the card system operator and its depository institution correctly follow the requirements to make the funds eligible for deposit insurance. JPMorgan EFS believes that the Proposed Rule reflects the actual intent of the states procuring debit card account services on behalf of custodial parents, the unemployed or other similarly situated individuals. Regulation E
By extension, we believe that the Proposed Rule’s definition of “deposit” will help to resolve any confusion within state agencies over the applicability of Reg. E to various non-EBT stored value card services that they are attempting to procure. Reg. E requires certain disclosures and establishes liability standards for electronic transfers of money involving consumers. In the early years of EBT, federal authorities concluded that the access to benefits provided via EBT was effectively an “account” for Reg. E purposes, thus the regulation’s protections for consumer accounts was originally extended to EBT cardholders. It required a change in federal law to reverse that position. See Federal Register, Vol. 62, No. 157 (Aug. 14, 1997), pages 43467-69.
When Congress mandated EBT to replace Food Stamp Program coupons, it also recognized that state compliance with Reg. E would make EBT cost-prohibitive. This was substantiated in part by research performed by Citicorp Services Inc. for FMS and described in the report entitled “Implications of Regulation E in Electronic Benefit Transfer Programs” (August 31, 1993). As a result, in enacting the EBT mandate, Congress also provided in 7 U.S.C. § 2016(i)(10) that:
Disclosures, protections, responsibilities, and remedies established by the Federal Reserve Board under section 1693b of Title 15 [i.e., Reg. E] shall not apply to benefits under this chapter delivered through any electronic benefit transfer system.
Any attempt to leverage this statutory exemption into other, non “needs-tested” payments (as distinguished from government benefits) in the area of stored value cards contradicts settled law. Among its other requirements, Reg. E requires in section 205.9 that a bank issue periodic written statements for every month in which a transfer has occurred (and at least quarterly if no transaction has occurred) on any account permitting electronic transfers of money. JPMorgan EFS complies with Reg. E’s periodic statement requirement by printing and mailing monthly (or quarterly, as applicable) statements to cardholders.
At least one JPMorgan EFS competitor, however, apparently does not intend to print or mail periodic statements for its child support stored value accounts at all. Instead, it relies on the exemption for “government benefits” in Reg. E section 205.15 and provides the periodic statement information by telephone, online, or upon request. This company admits that its decision to rely on the government benefits exception in its Georgia program was motivated primarily by financial concerns: “It is important to note that regular account statements can be extremely costly to produce, print, and mail to each cardholder and counter many of the advantages afforded by an electronic disbursement system.” ACS State & Local Solutions proposal response to section 3.7.7.2 item 9, page 36.
In accepting the ACS State & Local Solutions Proposal for services under these terms, Georgia essentially waived the consumers’ rights under Reg. E. A state agency may not unilaterally waive federal disclosure requirements designed to protect consumers. See Reg. E § 205.12(b)(2)(iv) (federal preemption of state laws or requirements for “initial disclosures, periodic statements, or receipts that are different in content from those required by the federal law except to the extent that the disclosures relate to consumer rights granted by the state law and not by the federal law”).
We are unaware of any legal authority to support the position that Reg. E does not require monthly or quarterly statements for child support payments while there is substantial legal authority that it does. As the Proposed Rule’s focus is on the definition of “deposit” we have omitted a full analysis and citations of this issue from this comment.
Thus, in their laudable mission to cut the cost of government by reducing the number of paper checks produced and handled, states may be indirectly relying on an erroneous legal assumption and negating the federal consumer protections provided by Reg. E and FDIC deposit insurance. Ironically, the costs of these stored value accounts are entirely passed on to the consumers by the account services provider. Therefore, these actions are not only unwise and contradict federal banking laws; they do not result in any savings to the state. Other Issues Presented
JPMorgan EFS is aware of a number of other debit card products in the stored value category that do not meet the criteria for “deposits” set forth in the Proposed Rule, or for an “account” as defined by Reg. E. They include employee relocation assistance cards, gift cards, consumer rebate and incentive cards, insurance reimbursement cards, and airline industry cards for lost passenger luggage reimbursement.
The concerns that JPMorgan EFS has expressed in this comment do not include these types of products. These stored value card products are essentially EFT replacements for incidental paper payment instruments such as checks and vouchers. It is both sound law and policy that the funds represented by these types of stored value card products are not treated as consumer deposits or as consumer accounts.
It is not reasonable to expect federal consumer protections applicable to bank accounts to be extended to the use of cash, checks or vouchers, nor should these protections be extended to electronic variants of these payment methods simply because they mimic electronic access to other types of accounts and deposits that merit such protection.
Despite our advocacy for full eligibility for FDIC insurance and compliance with Reg. E in state-procured accounts for child support and unemployment compensation, we are concerned that “over-regulating” in certain areas will be highly detrimental to the business case that makes these and other specialized account products potentially available to many under-served consumers. There are several common characteristics among the debit card accounts and services that JPMorgan EFS and our competitors are offering to state agencies that provide a basis for a more tailored application of certain federal regulatory frameworks, such as the USA PATRIOT Act, anti-money laundering laws, know your customer (KYC) policies and others:
• Intermediary funding entity. In each of the JPMorgan EFS stored value card products, the business case requires a “wholesale” rather than a “retail” distribution strategy to maintain a low cost to the consumer. Whether the intermediary is a corporation, a state agency, or other type of recognized organization, institutional involvement in the process of funding accounts and identifying the potential customer base minimizes the risks targeted by the USA PATRIOT Act, anti-money laundering laws, KYC policies, funds availability and other compliance mechanisms.
• Small-dollar values. It is generally acknowledged that the primary users of the specialized governmental account products JPMorgan EFS offers are typically Low to Moderate Income (LMI) consumers. The dollar values in the accounts are relatively small and experience shows that amounts tend to be drawn down very early in the funds availability cycle. While this makes it unfeasible for these accounts to be interest bearing, these characteristics tend to make stored value cards a less attractive avenue for illegal funds transfers than other means.
• Controlled funds flow. Deposits are from known sources of funds, are generally predictable in frequency and amount (child support is an exception due to the collection process) and are accessible by debit card only. These characteristics also tend to make such accounts less than optimum vehicles for illicit activity.
• Banking the Unbanked. As mentioned, our stored value cards that access deposits held in accounts are generally designed for the LMI consumer. They present the most attractive business case JPMorgan EFS has identified to date for extending banking services to consumers who are cash-based or under-served by traditional financial institutions. The business case, however, can quickly be diminished or destroyed by imposing regulatory burdens that are not justified by the risk. It can be enhanced, however, by recognizing the value of these services, for example, through Community Reinvestment Act credits.
• Risk-Based Compliance. Even though the actual risks in our government-procured account services are minimal, JPMorgan EFS employs automated tools that our staff has developed for monitoring customer and depositor activity (i.e., Office of Foreign Asset Control and Suspicious Activity reporting) to identify, escalate and report relevant information to government officials. These monitoring tools are designed to keep officials informed whenever appropriate without imposing such a financial and technical burden on these stored value account services that they are priced out of the range of the LMI consumers for whom they are intended and defeat the government’s cost reduction objectives.
Conclusion
JPMorgan EFS appreciates the opportunity to address these issues. Our position on FDIC insurance and Reg. E protection in the delivery of government-procured payment services to custodial parents and the unemployed is one of full compliance, based on our early FDIC guidance. When state agencies clearly require the protections afforded by full FDIC insurance and Reg. E, we are not aware of any persuasive legal authority to provide less than this.
A combination of viable consumer protection and judicious application of other types of federal banking laws and regulations will help the financial community to work with government agencies to offer stored value card services to consumers considered to be under-served by traditional financial institutions. With only modest compromise, this process can save taxpayer funds while preserving consumer protections and meeting regulators’ other needs.
Sincerely,
Brian Kibble-Smith
Vice President
JPMorgan Electronic Financial Services
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