CHAPTER 28: BANKING IN THE DIGITAL AGE 13
2. Check Collection between Customers of the Same Bank
An item payable by the depositary (payor) bank that receives it—an “on–us item”—that is not
dishonored by the opening of the second banking day following its receipt is considered paid [UCC
4–215(c)(2)].
3. Check Collection between Customers of Different Banks
4. How the Federal Reserve System Clears Checks
The text explains that the Federal Reserve System simplifies the check-collection process.
5. Electronic Check Presentment
Most checks are processed electronically. The text discusses encoding and its warranty.
D. CHECK CLEARING AND THE CHECK 21 ACT
The Check Clearing in the 21st Century Act facilitates the use of electronic check processing.
1. Substitute Checks
2. Faster Access to Funds
V. Electronic Fund Transfers (EFTs)
A. TYPES OF EFT SYSTEMS
There are four principal types of EFT systems—
• Automated teller machines.
B. CONSUMER FUND TRANSFERS
The Electronic Fund Transfer Act (EFTA) of 1978 governs consumer electronic fund transfers. The
1. Disclosure Requirements
• Financial institutions must provide monthly statements that show the amounts and dates of
14 UNIT FIVE: NEGOTIABLE INSTRUMENTS
• 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
2. Unauthorized Transfers
An unauthorized transfer is—
3. Violations and Damages
Unauthorized access to an EFT system is a crime subject to a fine of up to $10,000 and
ENHANCING YOUR LECTURE—
DIGITAL FUNDS PROVIDE
NEW OPPORTUNITIES FOR MONEY LAUNDERING
Money laundering occurs when profits obtained from illegal activities, such as drug trafficking, are
processed through various financial transactions in an effort to conceal their illegal source. This is how
criminals make illegitimate funds appear legitimate. Money laundering has been going on for many years, but
REPORTING REQUIREMENTS FOR CASH TRANSFERS
Federal law requires reporting of any financial transactions or funds transfers that involve more than
$10,000.a According to estimates of the White House Office of National Drug Control Policy, the sales of illicit
drugs in the United States produce more than $65 billion a year in revenue.b Internationally, the amount of
proceeds from drug trafficking that are laundered globally are somewhere between 2 and 5 percent of the
CHAPTER 28: BANKING IN THE DIGITAL AGE 15
ADVANTAGES OF PREPAID ATM CARDS
As discussed in the text, ATM cards normally are issued by banks and connected online to a customer’s
account. Because the government strictly regulates banks, however, this type of ATM card leaves a paper
trail that can be investigated if the customer is suspected of criminal or terrorist activity. Also, as just
mentioned, banks and other regulated financial institutions are required to the report financial transactions
involving amounts above the $10,000 threshold.
MONEY LAUNDERING THROUGH VIRTUAL GAMING CURRENCY
The dramatic increase in virtual gaming also opens the door up for cyberlaundering. Online gaming has
become extremely popular in the United States and elsewhere. For years, gamers who participated in these
virtual worlds (using digital personas, or “Avatars”) have been selling their digital monies, goods, or
properties, for real-world compensation. A number of Avatars have managed to create wealth for the persons
controlling them by selling (or taxing) assets in the virtual world.
to add monies to their online accounts.) Soon, Web sites developed at which gamers could exchange virtual
currency. Then, in 2006, the makers of Entropia Universe—a giant in the virtual gaming industry that
to report it to the government. In addition, these assets can be purchased, transferred, and accessed from
any place in the world and are completely unregulated and unreported. Once the funds are withdrawn from a
terrorist ask for? The anonymous virtual world holds great appeal for those who want to hide their assets
from governmental view and transfer funds internationally without risking detection.
In the beginning, players were only able to convert their virtual dollars or credits to real-world cash by
selling them on online auction sites. (Gamers could always do the reverse and use real cash or credit cards
16 UNIT FIVE: NEGOTIABLE INSTRUMENTS
CHAPTER 28: BANKING IN THE DIGITAL AGE 17
FOR CRITICAL ANALYSIS
Should only banks and regulated financial institutions be allowed to issue ATM cards? Why or
why not? How else might the government regulate digital funds to reduce the potential for
cyberlaundering?
c. This statistic was taken from the Web site of the United States Department of Justice, www.usdoj.gov/dea/programs/money.htm.
ADDITIONAL BACKGROUND—
Electronic Fund Transfers
The Electronic Fund Transfer Act (EFTA) of 1978 was passed “to provide a basic framework establishing
the rights, liabilities, and responsibilities of participants in electronic fund transfers.” The EFTA provides the
following definition for electronic fund transfer at 15 U.S.C. Section 1693a(6).
TITLE 15. COMMERCE AND TRADE
CHAPTER 41—CONSUMER CREDIT PROTECTION
SUBCHAPTER VI—ELECTRONIC FUND TRANSFERS
§ 1693a. Definitions
As used in this subchapter—
* * * *
(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 instru–
ADDITIONAL BACKGROUND—
Unauthorized Electronic Fund Transfers
Under some circumstances, a customer can be liable for an unauthorized electronic fund transfer. In
other circumstances, a financial institution may be liable. The Electronic Fund Transfer Act of1978 provides
the following definition for unauthorized electronic fund transfer at 15 U.S.C. Section 1693a(11).
18 UNIT FIVE: NEGOTIABLE INSTRUMENTS
§ 1693a. Definitions
As used in this subchapter—
* * * *
(Pub.L. 90-321, Title IX, § 903, as added Pub.L. 95-630, Title XX, § 2001, Nov. 10, 1978, 92 Stat. 3728.)
(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)
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. Online Banking and E-Money
A. ONLINE BANKING SERVICES
Online banking services include bill consolidation and payment, transferring funds among accounts, and
applying for loans.
B. STORED-VALUE CARDS AND SMART CARDS
• Stored-value cards are plastic cards embossed with magnetic stripes containing magnetically
ENHANCING YOUR LECTURE—
SMART CARDS
CHAPTER 28: BANKING IN THE DIGITAL AGE 19
with a financial institution.
SECURITY PROGRAMMING
to confirm the authenticity of a smart card by examining a unique digital signature stored on its microchip.
Because of microchip technology, a smart card can do much more than maintain a running cash balance
in its memory or authorize the transfer of funds. A smart card carries and processes security programming.
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.
LEGAL PROTECTION FOR SMART CARDS
Some laws that extend to e-money and e-money transactions. The Federal Trade Commission Act of
19141 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.
115 U.S.C. Sections 41–58.
20 UNIT FIVE: NEGOTIABLE INSTRUMENTS
IMPLICATIONS FOR THE BUSINESSPERSON
1. For businesspersons involved in global transactions, e-money may provide a number of benefits. This is
security problems, such as the threat of infection by computer viruses.
2. Businesspersons must realize that there are some disadvantages to using e-money. For example,
FOR CRITICAL ANALYSIS
1. The federal government imposes bank-reporting requirements designed to limit money laundering. Do
2. In what ways might bank fraud be easier to perpetrate using smart cards and online banking
methods instead of traditional banking practices?
TEACHING SUGGESTIONS
satisfactorily balanced.
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
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
3. Ask students to discuss any electronic fund transfer problems they have either personally encountered or
heard about and to indicate how these problems were resolved. Did the EFTA apply?
Cyberlaw Link
Is private electronic “cash” legal? To what extent should private authorities be liable when a
CHAPTER 28: BANKING IN THE DIGITAL AGE 21
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
2. What is an overdraft? When a commercial bank provides checking services, it agrees to honor the checks
written by its customers with the usual stipulation that there be sufficient funds in the account to pay each check. A
3. When does a check become stale under the UCC? A check outstanding for longer than six months is a stale
normally has the right to charge the customer’s account for the amount of the check.
4. Who has the right to order that payment on a check be stopped? Only a customer—or, if a customer is de-
5. Who is liable when a customer’s bank pays an altered check? Because the customer’s instruction to the
6. What role does the Federal Reserve System play in clearing checks? The Federal Reserve System serves
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
22 UNIT FIVE: NEGOTIABLE INSTRUMENTS
8. What types of financial institutions are covered by the EFTA? The EFTA governs financial institutions that
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 the Right to Financial Privacy Act of 1978. Although it is yet unclear if this act applies to e-money
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
government regulate digital funds to reduce the potential for cyberlaundering? Laws could be passed to cover
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
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 28: BANKING IN THE DIGITAL AGE 23
EXPLANATIONS OF SELECTED FOOTNOTES IN THE TEXT
Footnote 7: Wulf worked for Auto-Owners Insurance Co. He opened a checking account at Bank One in
the name “Auto–Owners, Kenneth B. Wulf.” Over an eight-year period, he deposited $546,000 in Auto-Owners’ checks
that he stole and endorsed with a stamp that said “Auto-Owners Insurance Deposit Only.” When the scam was
discovered, Auto-Owners filed a suit in an Indiana state court against Bank One, contending that the defendant failed
to exercise ordinary care in opening Wulf’s account because it did not ask for documentation to show that he was
authorized to open an account in the name of Auto-Owners. The courts ruled in the defendant’s favor. Auto-Owners
appealed.
In Auto-Owners Insurance Co. v. Bank One, the Indiana Supreme Court affirmed, finding that Bank One’s
conduct did not “substantially contribute” to bringing about Auto–Owners’ loss. The major reason for Auto–Owners’
loss was its weak monitoring of its own files and the lack of controls in the handling of checks. The bank breached no
duty by opening Wulf’s checking account.
In circumstances such as those in the Auto-Owners case, should a customer have the burden of
proving a lack of ordinary care on the part of its bank, or should the bank have to show that it exercised
Why should a customer have to report a forged or unauthorized signature on a paid check within a
certain time to recover the amount of the payment? The consequence of a customer’s failure to report a forged or
Would the situation have been different if Wulf had handled his account electronically rather than
manually? Electronic banking would have made no difference in the outcome in this instance. The liability rules are
What reasonable steps could Auto-Owners have taken to prevent such internal fraud? Spot audits of
Would the outcome in this case have been changed if Auto-Owners had never given Wulf (and other
staff members) the authority to deposit checks to its bank account? It would not likely have changed the court’s
holding in this case because the UCC section involved in this case, UCC 3–405(b), does not mention a bank’s
Footnote 8: The Michigan Basic Property Insurance Association (MBP) issued a check for $69,559.06 on
its account with Fifth Third Bank to Joyce Washington, Countrywide Home Loans, and T&C Federal Credit Union as
co–payees. Washington indorsed the check by signing all the payees’ names but did not share the proceeds. Fifth
Third notified MBP of the payment through daily and monthly account statements. MBP did not object until it was
24 UNIT FIVE: NEGOTIABLE INSTRUMENTS
forced to issue a second check to Countrywide. MBP then sued Fifth Third for the amount. The court held Fifth Third
liable.
In Michigan Basic Property Insurance Association v. Washington, a Michigan state intermediate
appellate court reversed. The check was not properly payable because it had two forged indorsements. When a bank
pays a check bearing a forged indorsement, the UCC ordinarily requires the bank to recredit the customer’s account.
Why should a customer have to report a forged or unauthorized signature on a paid check within a
certain time to recover the amount of the payment? The consequence of a customer’s failure to report a forged or
Would the situation have been different if MBP had handled its account electronically rather than
As a practical matter, does it make sense for the customer to bear primary responsibility for
discovering instances of fraud? Which party is in a better position to detect any irregularities? Explain. It
probably does make sense for customers to bear primary responsibility for discovering fraud. Banking has become
What reasonable steps could MBP have taken to have prevented its loss? MBP might have negotiated
different terms in its account agreement with Fifth Third. These terms might have included a different assessment of