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Risks of Automated Clearing House Payments
The National Automated Clearing House Association (NACHA) is a nonprofit membership organization with about 40 regional member ACH associations that represent more than 12,000 financial institutions, which, in turn, provide ACH services to more than 3,500,000 companies and to more than 100 million consumers. NACHA sponsors the the Bankers Electronic Data Interchange (EDI) Council, the Electronic Check Council, the Bill Payment Council, the Cross-Border Council, the Electronic Benefits Transfer Council, the Internet Council and other councils, which oversee the rules and suggest changes and new rules for consideration by NACHA.
NACHA’s stated purpose is “to develop and promote the national exchange of electronic entries among participating financial institutions.”1 For such an exchange to function effectively, a high degree of mutual understanding and cooperation among the individual participants is necessary, and the Operating Rules are designed to promote such a culture.2 The ACH Operating Rules are issued annually by NACHA.
There are two types of ACH transfers: a “credit” transfer and a “debit” transfer. In a credit transfer, the original instructions to make the transfer are given by the payor, the entity paying the funds. In a debit transfer, the instructions are given by the payee, the entity receiving the funds.
More precisely, in ACH terminology: In a “credit” transfer,
funds are paid by the payor (the Originator) to the receiving payee (the Receiver). In a credit transaction, it is often said that funds are “pushed” from the account of the Originator into the account of the Receiver. The transfer is originated by the Originator instructing its bank, the Originating Depository Financial Institution (the ODFI), to make the transfer. The ODFI then instructs the ACH Operator to make the transfer. The instructions to the ACH Operator are routed through the processing facility of the Federal Reserve System in East Rutherford, New Jersey.
The ACH Operator is typically a Federal Reserve Bank, but if there is a private sector Operator in the region, the ODFI may choose to send the instructions to the private sector Operator instead of to the Federal Reserve Bank in the region. The ACH Operator advises the Receiving Depository Financial Institution (RDFI) of the transaction, and the RDFI notifies the Receiver and makes the funds available to the Receiver.
ACH credit transfers are governed by U.C.C. Article 4A except when any part of the transfer affects the account of a consumer. Consumer transfers are governed by the Electronic Fund Transfer Act (EFTA) and Regulation E, issued under EFTA by the Federal Reserve Board. The ACH Rules are designed to harmonize with the rules of Article 4A and Regulation E. ACH debit transfers are not governed by U.C.C. Article 4A, but under the ACH Rules, a debit entry is deemed an “item” under U.C.C. Article 4, the uniform law on checks and other negotiable instruments, and Article 4 applies to debit transfers except where its application is inconsistent with the ACH Rules.
Every Federal Reserve District is an ACH region. The ACH regional associations have typically employed the Federal Reserve Banks in their regions as the ACH Operators for transactions originating in the regions. There are, however, three private sector ACH Operators: (1) the Electronic Payments Network (EPN), an affiliate of the New York Automated Clearinghouse, (2) the American Clearinghouse Association in Phoenix, Arizona, and (3) VisaNet, which is owned by Visa, U.S.A. and operates for the most part in the Twelfth Federal Reserve District. Although private sector Operators have participated in a relatively small number of ACH transfers historically, EPN (which is owned by major money-center banks) has in recent years acted as the ACH Operator in a significant number of transfers.
Exhibit 6.1 provides a credit transfer illustration.
In a debit transfer, the flow of funds is the reverse of the flow in a credit transfer. It is often said that funds are “pulled” from the account of the Receiver into the account of the Originator. For
Risks of Automated Clearing House Payments Exhibit 6.1 ACH Credit Transfer
Receiver Financial Institution
example, an insurance company may pull funds from the account of a policyholder to pay premiums on the policy. As in a credit transfer, the Originator instructs the ODFI, the ODFI instructs the ACH Operator, and the ACH Operator instructs the RDFI. However, instead of making funds available to the Receiver, the RDFI debits the account of the Receiver. Thus, in a debit transfer, the funds flow from the Receiver’s account into the Originator’s account.
A debit transfer is illustrated in Exhibit 6.2.