FTC Report

Excerpts from a
PREPARED STATEMENT OF
THE FEDERAL TRADE COMMISSION
PRESENTED BY JODIE BERNSTEIN
DIRECTOR OF THE BUREAU OF CONSUMER PROTECTION
“DEMAND DRAFT FRAUD”
BEFORE THE HOUSE BANKING COMMITTEE
WASHINGTON, D.C.

APRIL 15, 1996

Despite the potential for fraudulent misuse, demand drafts are a completely legitimate, though relatively unfamiliar, payment method. Consumers are generally aware that arrangements can be made for recurring payments, such as mortgage payments or car payments, to be withdrawn automatically from their checking accounts. The surprise for many consumers is that withdrawals from their checking accounts can happen on a one-time basis, with no prior written authorization. This one-time third party withdrawal was also a surprise to the Commission when it first observed unauthorized debiting in some of our telemarketing fraud cases. The Commission's initial conclusion was that demand drafts were just another tool in the fraud operator's toolbox. Accordingly, the Commission's initial proposal for a Telemarketing Sales Rule pursuant to the Telemarketing and Consumer Fraud and Abuse Prevention Act,(7) required sellers who use demand drafts to obtain express prior written authorization, which, in effect, would have eliminated demand drafts as an alternative payment method. In response to that initial proposal, the Commission received hundreds of comments from members of the automated payment industry and from legitimate merchants and businesses objecting to the elimination of demand drafts as a payment method.

These comments and oral presentations persuaded the Commission that there is nothing inherently unfair or deceptive about the use of demand drafts as a payment method; and, in fact, that demand drafts provide consumers the same convenience and opportunity to purchase goods or services that they could enjoy using credit cards. But like so many other innovative developments in the marketplace, demand drafts are susceptible to misuse by unscrupulous operators.

During the rulemaking, the Commission learned that millions of consumers use demand drafts in lieu of credit cards and that demand drafts are used by Fortune 500 companies, airlines, car rental companies, insurance companies, and mortgage companies. In fact, demand drafts are used by a variety of businesses that are characterized by quick turn-around transactions, and as a payment alternative for consumers who do not have, or would rather not use, credit cards. Demand drafts are a large and growing payment mechanism. One member of the automated payment industry, Telephone Check Payment Systems (“TCPS”), commented in the telemarketing rulemaking that nine of the current twenty demand draft service bureaus process approximately 38,000 demand drafts weekly, totaling over five million dollars for over 700 business clients throughout the country.(8) Accelerated Payment Systems (“APS”) stated at the Commission's rulemaking workshop in April 1995, that it processes half a billion dollars a year through demand drafts.(9) The vast majority of these transactions are not tainted by fraud. So the lesson the Commission staff learned during the telemarketing rulemaking proceeding, was that it was not the payment method itself that was the problem; rather, the problem was a lack of uniform industry standards, ineffective dispute resolution methods, and consumers’ lack of awareness that their bank accounts could be debited without their written authorization.

In demand draft transactions, consumers are largely unprotected, in marked contrast to credit card transactions, where consumers are protected nationwide against unauthorized or incorrect charges by the Fair Credit Billing Act (“FCBA”).(10) The FCBA creates a mechanism for consumers to dispute charges before they pay, and requires the creditor to investigate a consumer's dispute. Moreover, under the FCBA a consumer can only be liable for up to $50 for unauthorized charges. By contrast, in the case of demand drafts, there is no legally mandated dispute mechanism, and no limit on liability. Disputes are governed by state law, specifically, state laws that follow the Uniform Commercial Code (“UCC”). The UCC requires that checks or drafts be signed, but unbeknownst to many consumers, the signature need not take any particular form,(11) and the authority to sign can be granted orally.(12) The UCC’s liberal definition of what constitutes a signature creates a problem of proof for a consumer who is victimized by demand draft fraud. Under the UCC, a consumer can only recover money from his or her bank if the consumer can persuade the bank that he or she did not in fact authorize the demand draft in the first place.(13) When a consumer disputes an unauthorized demand draft to his or her checking account, banks often take the position that the mere fact that the consumer's bank account number is on the draft shows that the consumer gave authority for the draft.(14) Indeed, banks may hold consumers responsible for fraudulent demand drafts because of the consumers’ negligence in giving out their checking account numbers.(15) Although some banks may refund consumers’ money in some instances, it is largely consumers who must bear monetary losses related to demand draft fraud, losses that many consumers cannot afford. As noted by the Federal Reserve Bank of San Francisco in a comment submitted during the Telemarketing Sales Rulemaking proceeding, any protection under the UCC for consumers victimized by demand draft fraud is largely illusory.

It is with this background and knowledge that the Commission has taken various actions to limit demand draft fraud. In adopting certain provisions of the Telemarketing Sales Rule that require consumers’ express verifiable authorizations for demand drafts in telemarketing transactions, the Commission has addressed the problem of nonexistent demand draft industry standards by establishing such standards, at least in the telemarketing context. The Commission has taken and will continue to take a strong enforcement stance against demand draft fraud under the Telemarketing Sales Rule,(16) and, where appropriate, will bring actions under Section 5 of the FTC Act against fraudulent users of the automated payment system that are not covered by the Rule.(17) Additionally, the Commission has taken the lead in establishing a broad consumer education campaign to help consumers learn about and therefore protect themselves against demand draft fraud.