Business Law Chapter 27 Homework Internet based Systems Subject The New Law May

(6) the term “electronic fund transfer” means any transfer of funds, other than a transaction originated by check, draft,

or similar paper instrument which is initiated through an electronic terminal, telephonic instrument, or computer or

magnetic tape so as to order, instruct, or authorize a financial institution to debit or credit an account. Such term

1. Disclosure Requirements

• If a debit card is lost or stolen, and misused, a customer is liable for (1) $50—if he or she notifies the

bank within two business days of learning of the loss; (2) $500—if he or she does not tell the bank until

after the second day; or (3) unlimited amounts—if notice is not within sixty days after transfer appears

2. Unauthorized Transfers

An unauthorized transfer is a transfer (1) initiated by a person who has no actual authority to initiate the

3. Violations and Damages

An institution’s failure to comply with the EFTA can result in liability for actual damages, court costs,

attorneys’ fees, and punitive damages.

ADDITIONAL BACKGROUND—

Unauthorized Electronic Fund Transfer

Under some circumstances, a customer can be liable for an unauthorized electronic fund transfer. In other

§ 1693a. Definitions

As used in this subchapter—

* * * *

(11) the term “unauthorized electronic fund transfer” means an electronic fund transfer from a consumer’s

account initiated by a person other than the consumer without actual authority to initiate such transfer and from

which the consumer receives no benefit, but the term does not include any electronic fund transfer (A) initiated by a

person other than the consumer who was furnished with the card, code, or other means of access to such consumer’s

account by such consumer, unless the consumer has notified the financial institution involved that transfers by such

654 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION

C. COMMERCIAL FUND TRANSFERS

UCC Article 4A, which most states have adopted, covers transactions not subject to the EFTA or other federal or

state law. Typically, these are transfers between commercial parties, often of large sums.

VI. E-Money and Online Banking

Electronic payments have been with us for some time. What is new and different is the potential to replace physical

cash with virtual cash (e-money) in the form of electronic impulses, or digital cash. The use of e-money promises to

change the nature of money and the world of banking.

A. STORED-VALUE CARDS

These are plastic cards embossed with magnetic stripes containing magnetically encoded data. Using a stored–

value card, a person buys specific goods and services offered by the issuer. Details are discussed in the text.

B. SMART CARDS

Smart cards are plastic cards containing microchips that can hold more information than a magnetic stripe. For

this reason, these cards are more versatile that stored-value cards. These cards are less prone to error, and carry

and process security programming (such as a digital signature). Debits and credits are automatic and can be

immediate, or stored for later use.

ENHANCING YOUR LECTURE—

  SMART CARDS

 

SECURITY PROGRAMMING

CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 655

DEPOSIT INSURANCE FOR SMART-CARD BALANCES

Normally, all depository institutions—including commercial banks and savings and loan associations—offer

$100,000 of federally backed insurance for deposits. The Federal Deposit Insurance Corporation (FDIC) offers this

insurance.

means that he or she would be entitled to reimbursement only after nearly everyone else who is owed money is paid

(except for other general creditors). At that point, there may not be any funds left.

LEGAL PROTECTION FOR SMART CARDS

Some laws that extend to e-money and e-money transactions. The Federal Trade Commission Act of 1914i

prohibits unfair or deceptive practices in, or affecting, commerce. Under this law, e-money issuers who misrepresent

the value of their products or make other misrepresentations on which e-money consumers rely to their detriment

may be liable for engaging in deceptive practices.

General common law principles, discussed in Chapter 1, also apply. For example, the rights and liabilities of e–

money issuers and consumers are subject to the common law of contracts. This means that the parties’ relationships

are affected by the terms of the contracts to which they agree. On the whole, however, it is unclear how existing laws

will apply to e-money.

proof of a transaction. Digital signatures could eliminate the problems associated with forged and bounced checks.

Digital signatures can also increase the enforceability of contracts entered into online.

IMPLICATIONS FOR THE BUSINESSPERSON

1. For businesspersons involved in global transactions, e-money may provide a number of benefits. This is because

2. Businesspersons must realize that there are some disadvantages to using e-money. For example, counterfeiting

and theft are potential problems with digital cash, just as they are with physical currency. There is also the potential

656 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION

for monetary breakdowns caused by power outages or hardware malfunctions, as well as security problems, such as

the threat of infection by computer viruses.

FOR CRITICAL ANALYSIS

C. ONLINE BANKING SERVICES

The text discusses three types of online banking services.

D. PRIVACY PROTECTION

1. E-Money Payment Information

2. E-Money Issuers’ Financial Records

An issuer of e-money may be subject to the Right to Financial Privacy Act of 1978 if the issuer is deemed to

3. Consumer Financial Data

The Financial Services Modernization Act (Gramm-Leach-Bliley Act) of 1999 proscribes the disclosure of

financial institutions’ customer data without notice and an opt-out opportunity.

ADDITIONAL BACKGROUND—

Financial Services Modernization Act (Gramm-Leach-Bliley Act) of 1999

CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 657

§ 6801. Protection of nonpublic personal information

(a) Privacy obligation policy

It is the policy of the Congress that each financial institution has an affirmative and continuing obligation to respect the

information.

(b) Financial institutions safeguards

In furtherance of the policy in subsection (a), each agency or authority described in section 6805(a) of this title shall

establish appropriate standards for the financial institutions subject to their jurisdiction relating to administrative,

technical, and physical safeguards—

(1) to insure the security and confidentiality of customer records and information;

(2) to protect against any anticipated threats or hazards to the security or integrity of such records; and

(3) to protect against unauthorized access to or use of such records or information which could result in substantial

harm or inconvenience to any customer.

CREDIT(S)

2000 Electronic Update

(Pub.L. 106-102, Title V, § 501, Nov. 12, 1999, 113 Stat. 1436.)

HISTORICAL AND STATUTORY NOTES

Revision Notes and Legislative Reports

1999 Acts. House Conference Report No. 106-434, see 1999 U.S. Code Cong. and Adm. News, p. 245.

Effective and Applicability Provisions

1999 Acts. Pub.L. 106-102, Title V, 510, Nov. 12, 1999, 113 Stat. 1445, provided that: “This subtitle [enacting this

required to be prescribed under section 504(a)(3) [15 U.S.C.A. § 6804(a)(3)], except—

“(2) that sections 504 [15 U.S.C.A. § 6804] and 506 [15 U.S.C.A. §§ 1681s(a)(4), (d), (e), and 6806] shall be effective

upon enactment.”

[Final regulations were promulgated at 65 F.R. 33646, May 24, 2000, which extended the date for financial institutions

to be in full compliance with the regulation and this subchapter to July 1, 2001.]

Copr. © West 2001 No Claim to Orig. U.S. Govt. Works

ADDITIONAL BACKGROUND—

12 C.F.R. Section 40.6

Under the Financial Services Modernization Act (FSMA), or Gramm-Leach-Bliley Act, of 1999, the Federal Trade

Commission issued rules that explain how to comply with the FSMA. The rules can be found in their entirety at 12 C.F.R.

Part 40. The following is, as it appears on Westlaw, the text of 12 C.F.R. Section 40.6, which states the information

that must be included in privacy notices under the FSMA.

CODE OF FEDERAL REGULATIONS

TITLE 12—BANKS AND BANKING

CHAPTER I—COMPTROLLER OF THE CURRENCY, DEPARTMENT OF THE TREASURY

PART 40—PRIVACY OF CONSUMER FINANCIAL INFORMATION

SUBPART A—PRIVACY AND OPT OUT NOTICES

§ 40.6 Information to be included in privacy notices.

(1) The categories of nonpublic personal information that the bank collects;

(2) The categories of nonpublic personal information that the bank discloses;

(3) The categories of affiliates and nonaffiliated third parties to whom the bank discloses nonpublic personal

information, other than those parties to whom the bank discloses information under §§ 40.14 and 40.15;

(4) The categories of nonpublic personal information about the bank’s former customers that the bank discloses and

and 40.15;

(5) If a bank discloses nonpublic personal information to a nonaffiliated third party under § 40.13 (and no other

(6) An explanation of the consumer’s right under § 40.10(a) to opt out of the disclosure of nonpublic personal

(7) Any disclosures that the bank makes under section 603(d)(2)(A)(iii) of the Fair Credit Reporting Act (15 U.S.C.

parties in each category:

(i) Financial service providers;

(ii) Non-financial companies; and

(iii) Others.

(8) The bank’s policies and practices with respect to protecting the confidentiality and security of nonpublic personal

information; and

(9) Any disclosure that the bank makes under paragraph (b) of this section.

(b) Description of nonaffiliated third parties subject to exceptions. If a bank discloses nonpublic personal information

the bank is required to state only that it makes disclosures to other nonaffiliated third parties as permitted by law.

(c) Examples.

(1) Categories of nonpublic personal information that the bank collects. A bank satisfies the requirement to

categorize the nonpublic personal information that it collects if it lists the following categories, as applicable:

(i) Information from the consumer;

(ii) Information about the consumer’s transactions with the bank or its affiliates;

(iv) Information from a consumer reporting agency.

(2) Categories of nonpublic personal information the bank discloses.

(i) A bank satisfies the requirement to categorize the nonpublic personal information that it discloses if the bank lists

(ii) If a bank reserves the right to disclose all of the nonpublic personal information about consumers that it collects,

(3) Categories of affiliates and nonaffiliated third parties to whom the bank discloses. A bank satisfies the

requirement to categorize the affiliates and nonaffiliated third parties to whom it discloses nonpublic personal

1681a(d)(2)(A)(iii) (that is, notices regarding the ability to opt out of disclosures of information among affiliates);

(4) Disclosures under exception for service providers and joint marketers. If a bank discloses nonpublic personal

information under the exception in § 40.13 to a nonaffiliated third party to market products or services that it offers

alone or jointly with another financial institution, the bank satisfies the disclosure requirement of paragraph (a)(5) of

this section if it:

(i) Lists the categories of nonpublic personal information it discloses, using the same categories and examples the

bank used to meet the requirements of paragraph (a)(2) of this section, as applicable; and

(ii) States whether the third party is:

(B) A financial institution with whom the bank has a joint marketing agreement.

(5) Simplified notices. If a bank does not disclose, and does not wish to reserve the right to disclose, nonpublic

authorized under §§ 40.14 and 40.15, the bank may simply state that fact, in addition to the information it must

provide under paragraphs (a)(1), (a)(8), (a)(9), and (b) of this section.

(6) Confidentiality and security. A bank describes its policies and practices with respect to protecting the

confidentiality and security of nonpublic personal information if it does both of the following:

(i) Describes in general terms who is authorized to have access to the information; and

(d) Short-form initial notice with opt out notice for non-customers.

(1) A bank may satisfy the initial notice requirements in §§ 40.4(a)(2), 40.7(b), and 40.7(c) for a consumer who is not

(2) A short-form initial notice must:

(i) Be clear and conspicuous;

(iii) Explain a reasonable means by which the consumer may obtain that notice.

(3) The bank must deliver its short-form initial notice according to § 40.9. The bank is not required to deliver its

privacy notice with its short-form initial notice. The bank instead may simply provide the consumer a reasonable

(4) Examples of obtaining privacy notice. The bank provides a reasonable means by which a consumer may obtain a

copy of its privacy notice if the bank:

(i) Provides a toll-free telephone number that the consumer may call to request the notice; or

(1) Categories of nonpublic personal information that the bank reserves the right to disclose in the future, but do not

(2) Categories of affiliates or nonaffiliated third parties to whom the bank reserves the right in the future to disclose,

but to whom the bank does not currently disclose, nonpublic personal information.

(f) Sample clauses. Sample clauses illustrating some of the notice content required by this section are included in

Appendix A of this part.

<<PART 40—PRIVACY OF CONSUMER FINANCIAL INFORMATION>>

Copr. © West 2001 No Claim to Orig. U.S. Govt. Works

ENHANCING YOUR LECTURE—

  THE UNIFORM MONEY SERVICES ACT (UMSA)

 

Money service businesses do not accept deposits, unlike banks, but do issue money orders, traveler’s checks, and

stored-value cards; exchange foreign currency; and cash checks. The UMSA applies to traditional money services the

same regulations that apply to other, traditional financial service businesses.

Internet-based systems subject to the new law may include:

662 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION

• Stored-value products (smart cards, prepaid cards, value-added cards) [UMSA 1–102(c)(21)].

The UMSA requires persons engaged in money transmission, check cashing, or currency exchange to obtain a

license from a state, to be examined by state officials, to report on its activities to the state, and to comply with certain

record keeping requirements [UMSA 1–104].

204].

TEACHING SUGGESTIONS

1. Commercial banks want to protect themselves against fraud and encourage the free flow of commerce. Ask

students to discuss whether they believe that the commercial banking system should be more concerned with

facilitating commercial transactions or preventing fraud. Do the cases reflect a judicial preference for one principle

over another? Ask the students if there is some way in which these competing values can be satisfactorily balanced.

2. Ask students to discuss the ramifications of widespread electronic fund transfers. Are we moving from a

“checkless” as well as a “cashless society” to one dominated by electronic transactions? How will this change affect the

ways in which commercial transactions are ordinarily conducted? Will the financial system itself become more

vulnerable to fraud and disruption? What sort of safeguards might be adopted to reduce the potential for

unauthorized electronic transfers of funds?

about and to indicate how these problems were resolved. Did the EFTA apply?

transactions, both consumer and commercial, and relevant Federal Reserve documents.

Cyberlaw Link

Is private electronic “cash” legal? To what extent should private authorities be liable when a fraud is perpetrated

in the context of an electronic transfer of funds via the Internet? Is the current law sufficient in this regard? If not,

what changes need to be made?

DISCUSSION QUESTIONS

1. What is a check? A check is a special type of draft drawn on a bank, ordering the bank to pay a sum of money on demand.

2. What is an overdraft? When a commercial bank provides checking services, it agrees to honor the checks written by its

3. When does a check become stale under the UCC? A check outstanding for longer than six months is a stale check. The

4. Who has the right to order that payment on a check be stopped? Only a customer—or, if a customer is deceased, any

5. Who is liable when a customer’s bank pays an altered check? Because the customer’s instruction to the bank is to pay the

6. What role does the Federal Reserve System play in clearing checks? The Federal Reserve System serves as the central

7. How might Check 21 affect the potential for banking fraud? Fraud may be more difficult to accomplish, in part because the

“float,” which contributes to the effective commission of a “check–kiting” scheme, is eliminated. Fraud may be no more difficult

to commit, however, because much “bank fraud” consists of forgeries that occur before items are presented to banks for

payment. Are there circumstances in which y a copy of an original canceled paper check could be demanded? No. After the

8. What types of financial institutions are covered by the EFTA? The EFTA governs financial institutions that offer electronic

9. Are there legal safeguards for the privacy of a user of e-money against the issuer? An issuer of e-money may be subject to

10. Should only banks and regulated financial institutions be allowed to issue ATM cards? Yes, because limiting the issuers

of ATM cards to regulated financial institutions reduces the number of methods by which terrorists and other criminals can

anonymously transfer money or launder illegally obtained funds. No, the financial-reporting provisions should be extended to

ACTIVITY AND RESEARCH ASSIGNMENTS

1. Although the bank-customer relationship is contractual in nature and arises from the contract executed by both parties,

this relationship is also governed in large part by the UCC. Ask the students to obtain form agreements for opening checking

2. Obtain copies of electronic fund transfer agreements from local banks and ask the class to compare the similarities and

differences of the agreements with each other. Ask the students to identify the provisions that appear to be purely contractual

in nature and the provisions that are modeled on the EFTA. Do any of the agreements contain provisions that appear to be

unreasonable? How might these provisions be redrafted to make them more reasonable while still protecting the interests of

the bank?

CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 665

EXPLANATION OF A SELECTED FOOTNOTE IN THE TEXT

Footnote 6: Espresso Roma Corp. and other businesses employed Joseph Montanez, whose duties included

bookkeeping. In October 1997, Montanez began to steal, and print on his home computer, blank company checks, which he

forged in amounts totaling more that $330,000. David Boyd, president of Espresso and the others, discovered the forgeries and

reported them to Bank of America (the drawee) in May 1999. Boyd and the businesses filed a suit in a California state court

against the bank, alleging, among other things, unauthorized payment of the checks. The bank filed a motion for summary

judgment in part on the ground that UCC 4–406(d) precluded the claims. The court granted the motion, and the plaintiffs

appealed. In Espresso Roma Corp. v. Bank of America, N.A., a state intermediate appellate court affirmed. Because the bank’s

customers did not report the first forged check to the bank within the thirty-day period of UCC 4–406(d), the bank’s liability for

payment of the checks was discharged. “[T]he forged checks were presented for payment between October 1997, and May

1999, but appellants [Boyd and the businesses] did not discover, or report them until on, or about, May 15, 1999,” although

they had received statements on a monthly basis, and the statements included canceled checks.

The plaintiffs also tried to establish that the bank “failed to exercise ordinary care in paying the [checks] and that the

failure contributed to the loss” under UCC 4–406(e). The court held that ordinary care, as used in UCC 4–406, is a “professional

negligence standard of care which looks at the procedures utilized in the banking industry . . . . Reasonable commercial

standards do not require the bank to examine the instrument if the failure to examine does not violate the bank’s prescribed

procedures and the bank’s procedures do not vary unreasonably from general banking usage.” Did the bank’s practices

constitute “ordinary care”? Yes, according to the court, and the plaintiffs were unable to create a triable issue to the contrary.

The bank “established that the reasonable industry standard prevailing in the area for similarly sized banks was to bulk process

checks through an automated system that employs fraud filters, but does not include sight review of individual checks for

signature verification. The Bank’s procedures conformed to this standard, which also was consistent with general bank usage as

reflected by the practices of other bulk file bookkeeping banks in California, and it followed those procedures in this case.”

What steps can a small business take to protect itself against embezzlement by a key employee? A small business might

1. What are the circumstances in which a customer might be unable to recover from a bank that pays on a forged check

drawn on the customer’s account? A forged signature on a check has no legal effect because the signature of a drawer and the

2. What are the principal features of the Electronic Fund Transfer Act (EFTA) of 1978? The Electronic Fund Transfer Act

(EFTA) was the first significant federal legislation (enacted in 1978, effective in 1980) to regulate electronic fund transfers. The

EFTA covers automated teller machines, point-of-sale systems, direct deposits and withdrawals, and pay–by-telephone systems.

The EFTA applies only to “consumer” transfers (that is, transfers by natural persons—not corporations or other business

entities) from accounts “established primarily for personal, family or household purposes.” As a result, the EFTA does not

REVIEWING—

 CHECKS AND BANKING IN THE DIGITAL AGE 

RPM Pizza, Inc., issued a $96,000 check to Systems Marketing. A few days later, RPM decided not to go through

with the deal and placed a written stop-payment order on the check. RPM and Systems had no further contact for

many months. Three weeks after the stop-payment order expired, however, Toby Rierson, an employee at Systems,

cashed the check. Bank One Cambridge, RPM’s bank, paid the check with funds from RPM’s account. Because the check

was more than six months old, it was stale, and thus, according to standard banking procedures as well as Bank One’s

1. How long is a written stop-payment order effective? What else could RPM have done to prevent this check from

being cashed? A written stop payment order (or an oral order confirmed in writing) is effective for six months, when it

2. What would happen if it turned out that RPM did not have a legitimate reason for stopping payment on the check?

A customer-drawer must have a valid legal ground for issuing a stop payment order on a check or a holder can sue the

3. What are a bank’s obligations with respect to stale checks? Should Bank One have contacted RPM before paying

the check? Why or why not? Under UCC 4–404, a bank is not obligated to pay a stale check, although the bank has that

4. Assume that Rierson’s signature on the check was a forgery. Would a court be likely to hold the bank liable for the

amount of the checks because it failed to verify the signature on the check? Why or why not? The failure to verify the

signature will result in Bank One’s loss of the amount of the check. A bank that pays a customer’s check bearing a

forged indorsement must recredit the customer’s account or be liable to the customer-drawer for breach of contract,

 DEBATE THIS: 

To reduce fraud, checks that utilize mechanical or electronic signature systems should not be honored. If

businesses were forced to always have physical person sign each check, then fraud would be reduced. Banks and

businesses would be involved in fewer lawsuits over who is responsible for such fraud.

The use of mechanical or electronic signatures systems for checks allows businesses to more cheaply carry out

their operations. Any attempt at eliminating such systems would cause businesses to use more employees. Costs and

therefore prices would rise as a result.



questions, using the information presented in the chapter.

668 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION

ANSWERS TO QUESTIONS—

 SPECIAL CASE ANALYSIS 

Case No. 27.3

Schultz v. Bank of America, N.A.

Court of Appeals of Maryland, 2010.

413 Md. 15,

990 A.2d 1078

(a) Issue: This case was about determining whether a bank was negligent in the handling of a certain transaction for

its customer. What was this transaction, and what was the specific issue before the court? The transaction was the

addition of a name to the account of one of the bank’s customers. The specific issue before the court was whether

expert testimony was required in order to show negligence on the part of the bank in this transaction.

(b) Rule of Law: What rule of law was applicable to this case’s circumstances? The applicable rule of law was the

Uniform Commercial Code’s requirement that banks exercise ordinary care in transactions involving its customers’

accounts. UCC 3–103(a)(7) defines ordinary care as the observance of reasonable commercial standards prevailing in

the relevant geographic area.

(c) Applying the Rule of Law: How did the rule of law apply to the specific circumstances in this case? The court

held that in the circumstances of this case, expert testimony was required to determine whether the bank had

exercised ordinary care—that is, whether the bank had observed reasonable commercial standards prevailing in the

relevant geographic area when it added a name to its customer’s account.

in favor of the bank.

