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IS THE PAYROLL INDUSTRY AT RISK DUE TO ACH SYSTEM USED FOR DIRECT DEPOSIT? HEARING BEFORE THE SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS OF THE COMMITTEE ON SMALL BUSINESS HOUSE OF REPRESENTATIVES ONE HUNDRED SEVENTH CONGRESS SECOND SESSION WASHINGTON, DC, APRIL 9, 2002 Serial No. 107–52 Printed for the use of the Committee on Small Business ( U.S. GOVERNMENT PRINTING OFFICE WASHINGTON 79–639 : 2002 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001 VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 E:\HR\OC\A639.XXX pfrm12 PsN: A639 COMMITTEE ON SMALL BUSINESS DONALD MANZULLO, Illinois, Chairman LARRY COMBEST, Texas NYDIA M. VELAZQUEZ, New York JOEL HEFLEY, Colorado JUANITA MILLENDER-MCDONALD, California ROSCOE G. BARTLETT, Maryland DANNY K. DAVIS, Illinois FRANK A. LOBIONDO, New Jersey SUE W. KELLY, New York BILL PASCRELL, JR., New Jersey DONNA M. CHRISTENSEN, Virgin Islands STEVE CHABOT, Ohio ROBERT A. BRADY, Pennsylvania PATRICK J. TOOMEY, Pennsylvania TOM UDALL, New Mexico JIM DEMINT, South Carolina JOHN R. THUNE, South Dakota STEPHANIE TUBBS JONES, Ohio MICHAEL PENCE, Indiana CHARLES A. GONZALEZ, Texas MIKE FERGUSON, New Jersey DAVID D. PHELPS, Illinois DARRELL E. ISSA, California GRACE F. NAPOLITANO, California SAM GRAVES, Missouri BRIAN BAIRD, Washington EDWARD L. SCHROCK, Virginia MARK UDALL, Colorado FELIX J. GRUCCI, JR., New York JAMES R. LANGEVIN, Rhode Island TODD W. AKIN, Missouri MIKE ROSS, Arkansas SHELLEY MOORE CAPITO, West Virginia BRAD CARSON, Oklahoma BILL SHUSTER, Pennsylvania ANIBAL ACEVEDO-VILA, Puerto Rico DOUG THOMAS, Staff Director PHIL ESKELAND, Deputy Staff Director MICHAEL DAY, Minority Staff Director SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS PAT TOOMEY, Pennsylvania, Chairman STEVEN J. CHABOT, Ohio JAMES LANGEVIN, Rhode Island DARRELL ISSA, California GRACE F. NAPOLITANO, California EDWARD SCHROCK, Virginia ANIBAL ACEVEDO-VILA, Puerto Rico TODD AKIN, Missouri DANNY K. DAVIS, Illinois FRANK LOBIONDO, New Jersey ROBERT A. BRADY, Pennsylvania JIM DEMINT, South Carolina MIKE ROSS, Arkansas JOHN THUNE, South Dakota SEAN M. MCGRAW, Staff Director (II) VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00002 Fmt 5904 Sfmt 5904 E:\HR\OC\A639.XXX pfrm12 PsN: A639 CONTENTS Page Hearing held on April 9, 2002 ................................................................................ 1 WITNESSES Dawson, Chip, Co-Founder & Chairman, Payroll 1, Royal Oak, Michigan ........ Antich, Nick, AD Computer, President, Center Valley, Pennsyvlania ................ Brunskill, Dena, President, IPPA, Palm Desert, California ................................ Krause, Gene, ACH Direct, Director of Business Development, Cathedral City, California ..................................................................................................... Zeidner, Rita, Manager, Government Relations, American Payroll Association, Washington, DC ................................................................................................... 3 5 7 9 11 APPENDIX Opening statements: Toomey, Hon. Patrick ....................................................................................... Prepared statements: Dawson, Chip .................................................................................................... Antich, Nick ...................................................................................................... Brunskill, Dena ................................................................................................. Krause, Gene .................................................................................................... Zeidner, Rita ..................................................................................................... Additional Information: Written Testimony of Elliott McEntee, President & CEO, NACHA—The Electronic Payments Association ................................................................. 19 25 31 37 45 67 73 (III) VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 E:\HR\OC\A639.XXX pfrm12 PsN: A639 VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 E:\HR\OC\A639.XXX pfrm12 PsN: A639 IS THE PAYROLL INDUSTRY AT RISK DUE TO ACH SYSTEM USED FOR DIRECT DEPOSIT? TUESDAY, APRIL 9, 2002 HOUSE OF REPRESENTATIVES, COMMITTEE ON SMALL BUSINESS, SUBCOMMITTEE ON TAX, FINANCE AND EXPORTS, Washington, DC. The committee met, pursuant to call, at 2:04 p.m. in room 2360, Rayburn House Office Building, Hon. Pat Toomey (chairman of the committee) presiding. Chairman TOOMEY. At this time I would like to call the hearing to order and ask the witnesses to take their seats at the witness table, please, if they would. [Pause.] Thank you. This afternoon the Small Business Committee on Tax, Finance and Exports convenes to hear from some of our nation’s small payroll processing providers and third-party vendors about the problems they are encountering with the automated clearinghouse system that is used for direct deposits. The purpose of this hearing is to learn about the concerns of small payroll processing companies as they endure often significant financial liabilities as a result, in part, of the existing ACH system. The ACH system, and that stands for the automated clearinghouses, began operating about 30 years ago in response to the increased complications associated with a large volume of paper checks. In an effort to reduce both the number and cost of paper checks, banks in California began experimenting with ACHs. After much success, banks in different regions across the country began similar programs, and in 1974, the regional ACHs coordinated nationally under the National Automated Clearinghouse Association, which goes by the acronym NACHA. NACHA is now the private regulatory organization that oversees ACHs and the direct deposit payroll system. It should be noted that NACHA was offered an opportunity to testify today, but due to previous commitments they are not able to participate. They have, however, submitted testimony for the record. A quick description of the ACH system I think is in order here. ACH is basically a batch processing system. A payroll processing company will calculate and develop a file with all the relevant payroll information each pay period for each employee that they process. These files are forwarded to the company’s bank, which will initially sort of any internal accounts to identify employees that use (1) VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 E:\HR\OC\A639.XXX pfrm12 PsN: A639 2 the same bank as the company. The remaining files are then forwarded to the ACH, sorted by destination, and then forwarded to the appropriate bank. As a result of federal banking regulations, should there be an occasion of nonsufficient funds in an employer’s account on payday the payroll company, which is often held liable for these situations, is not allowed to do a reversal transaction to collect the funds back from the employee’s account, and herein lies a major part of the problem. If a client of a payroll processing company, namely, an employer, has insufficient funds to cover a payroll, the payroll processing company can be made to cover the shortfall. The subcommittee will hear several small payroll providers and third-party vendors who are experiencing problems with the existing system, and I trust any corrections if my account of how the systems works is in any way in error. But I want to specifically thank a number of folks, starting with Mr. Nick Antich from AD Computer; Ms. Dena Brunskill, the president of Independent Payroll Processors Association; Mr. Chip Dawson from Payroll 1; Mr. Gene Krause with ACH Direct; and Ms. Rita Zeidner with the American Payroll Association for their participation in this hearing. I look forward to the testimony of the witnesses before us today, and I want to particularly thank my constituent and a member of the panel, Mr. Nick Antich, for bringing this concern about this issue to my attention. At this time I will be happy to yield to my good friend, the subcommittee’s ranking member, Mr. Bill Pascrell, for his opening comments. Mr. PASCRELL. Thank you, Chairman Toomey, and good afternoon. Today, no one can doubt the wide saturation of computers and information technology in business. Small businesses led the way during the 1990 economic boom. The numbers speak for themselves. Contributed new technology, software and services that capitalized on emerging information super highway we call the internet. Even outside the technology sector computers are pervasive. Our one recent survey said 80 percent of small firms use computers for business purposes. Offices today have moved away from paper toward completely electronic business communications and transactions from e-mail to e-commerce, and we persuaded them, we have encouraged that. All the subcommittees of small business have encouraged that movement away from massive paperwork that we still are swimming in. One survey reported that 27 percent of small firms use the internet for sales, and 44 percent of small firms used the internet for purchasing. Employees too are becoming more computer savvy. More than half of all employees regularly use a PC, and they are frequently taking advantage of electronic services such as internet banking, online bill payments, and shopping on the web. Clearly, we are living through a revolution in the basics of how we do business. VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 E:\HR\OC\A639.XXX pfrm12 PsN: A639 3 One of the paperless transaction systems that evolved steadily during the last 15 years is direct deposit. It has evolved during the eighties as a novelty, and then flourished during the nineties when the mantra of better, faster and cheaper pushed information technology to new limits and capabilities. Capitalizing on the new revolution in electronic commerce direct deposit systems now offer substantial savings and money and time by cutting bank processing fees, paper costs, check replacement charges and delays in a time that employees once wasted in line just to deposit their own checks. However, as useful as direct deposit is to thousands of corporations and millions of their employees, there are significant barriers to these time and cost saving systems. Small businesses often simply do not have the resources to take full advantage of direct deposit, and as a consequence they waste more time and waste more money with older methods of paying their employees. One of the barriers they face is the prefunding requirement that many direct deposit automated clearinghouse services require. This is a demand that small businesses keep their payroll account flush with cash prior to payday. Unfortunately, many small business simply cannot spare that kind of seat saver money. So they don’t take advantage of the service. Another problem is the fees for direct deposit services. Many of those fees are outlandish. Many banks charge more for their service than small businesses can afford, and if the small businesses cannot fulfill the prefunding requirement the fees charged by the clearinghouses to cover the risk usually push the cost even higher out of range, so that is why we are having this hearing. When transaction systems are automated and paperless, small businesses can concentrate on what they do best. This constant push for new ways of doing things is one of the reasons American workers are the most productive in the world. I look forward to hearing from our witnesses today, Mr. Chairman, and I thank you for bringing this problem to our attention. Chairman TOOMEY. I thank the gentleman from New Jersey. At this time let me just explain very briefly the way the process will work from here. I will recognize each of the five panelists. If you could please keep your remarks to five minutes. There will be a light system which will be green at the beginning, it will go to yellow when there is one minute left, and go to red when your time has expired. And after each of the panelists have had a chance to make their presentation, then I will ask a series of questions, followed by ranking member Pascrell, and then any other members of the committee who join us will get their chance at that point. So at this time I would like to welcome and invite to share with us his testimony, Mr. Chip Dawson. STATEMENT OF CHIP DAWSON, CO-FOUNDER AND CHAIRMAN, PAYROLL 1, INC. Mr. DAWSON. Good afternoon, Chairman Toomey and Mr. Pascrell. VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00007 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 4 Chairman TOOMEY. If you could take the microphone and bring it right up to your mouth, please, that will enable us all to hear you. Mr. DAWSON. How is that? Chairman TOOMEY. I think that is going to work. Mr. DAWSON. Okay. Good afternoon. My name is Chip Dawson. I am co-founder and chairman of Payroll 1. I would like to do three things today: Provide a brief background, frame the problem, and conclude by offering two solutions, one short term and one long term. Our firm is headquartered in Michigan. We provide payroll processing for 10,000 businesses across the country. We operate from eight states. A few among them are Pennsylvania, Illinois, Missouri, and California. Payroll 1 serves small businesses from one to several hundred employees, and our average size payroll is 15 to 20 people. Among our services is direct deposit, and we do that utilizing NACHA. We are testifying today on behalf of our clients and the hundreds of thousands of clients of other payroll processors across the country for whom this system of moving money presents potential hardship. Direct deposit is a smart way to get paid. It is safe, it is confidential, it is convenient, and we continually look for the most cost-effective and efficient way to provide that service to our clients. NACHA statistics indicate that more than 80 percent of large companies offer direct deposit, but 100 plus employee companies represent a mere fraction, less than two percent in fact, of American businesses. Among smaller businesses direct deposit has not grown significantly until recently despite being available for many years. That is changing as demand for direct deposit picks up momentum in our ever-expanding electronic age. But the fees many banks charge for originating direct deposit transactions have increased over the years, to the point that they are just too high for small businesses to bear. These high bank fees have compelled payroll companies to search out alternatives for direct deposit processing. Now, one method we found is to consolidate direct deposits for multiple employers through a single ACH originator, such as one bank. That way a payroll company is able to create enough volume to attract third-party vendors to provide services at substantially lower fees than banks will offer. However, the single source is not the employer’s bank, and therefore will not bear the risk of insufficient payroll funds, so it is up to the payroll company to make that choice. The ACH system of today is a batch processing system that relies on overnight transmissions, and consequently the payroll company, the way we operate, is the initial receiver of the funds and cannot be certain in some cases that sufficient funds were transmitted until after employees have already been paid and receive their monies. As a result of this uncertainty, small businesses are frequently disadvantaged in obtaining direct deposit services because they VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00008 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 5 must choose from a series of unattractive options. A small business has three basic choices: It can have its payroll company send direct deposit files directly to the employer’s bank. As I have said, that results often in high bank fees and likely diminished use of direct deposit by small businesses. It can have its payroll company use a third-party vendor to send direct deposit files. This alternative is unacceptable to a responsible payroll company because it puts them at risk of NSFs. Now, this risk can be mitigated by the employer either by prefunding the account well in advance of payday or executing a letter of credit in favor of the payroll company, but arguably neither is the most efficient use of capital in a small business. It can choose one of the largest payroll processors who may accept the NSF risk, but then the employer is losing the individualized attention and personal service that is often the fundamental reason for choosing the smaller payroll company in the first place. I would conclude by offering two possible solutions. For the short term, change the NACHA rules to permit payroll companies to reverse entries from employee bank accounts in the event that the employer does not fund the payroll. And for the long term, to utilize a different system. Take advantage of newer technology as the funding source for direct deposit in the ACH network. For example, automated teller machine or point of sale network operates in real time, and thus could enable an ACH originator to verify funds at the time a transaction is initiated rather than finding out later that the funds are insufficient. I thank you for the opportunity to testify here today on this important issue, and I will be glad to try and answer any questions you might have. [Mr. Dawson’s statement may be found in appendix.] Chairman TOOMEY. Thank you very much, Mr. Dawson. At this time I would like to welcome and recognize Mr. Nick Antich, AD Computer in Center Valley, Pennsylvania. Welcome. STATEMENT OF C. NICHOLAS ANTICH, PRESIDENT, AD COMPUTER CORPORATION Mr. ANTICH. Good afternoon, Chairman Toomey, and members of the subcommittee. My name is Nick Antich. I am president of AD Computer Corporation in the Lehigh Valley, Pennsylvania. We are a payroll processing company. I am here today to alert you to the fact that when the automatic clearinghouse is used for payroll direct deposits, the small independent payroll computer company is put in peril and at great risk when there is a nonsufficient funds situation. With the advent of automated electronic bill payments, ATM machines, the internet, and debit cards, the public has become accustomed to electronic funds transfer. This has resulted in a great increased demand for payroll direct deposit over the last few years. There has been a switch from just the largest companies offering direct deposit to their employees to the very smallest companies. We are talking about companies with two to three to five to ten employees. VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00009 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 6 Small companies want to have the same efficiencies as the larger businesses. In addition, they have to offer similar options to their employees to retain them. In the U.S., there are three major public national payroll companies, and there are several behind them, and then there are approximately 3300 small independent payroll computer processors. The problem I am bringing to light is really a problem for the small, independent payroll computer processors. As was already stated, when direct deposit is offered, the small payroll processor must offer direct deposit to be competitive with the large payroll companies, a file is created of which there are multiple transactions. There is one debit from the employer’s account and a credit to each of the employee’s account. This file is then sent to an originator that originates or sends it through the ACH system. In the past that has always been the bank that the employer dealt with, that he had his accounts with. And if there were multiple companies dealing with the same bank, the payroll company would put all of the companies on one file, send that to the bank once a day, and then those transactions would be processed. The bank had determined particular limits that the direct deposit file could have for each customer based on their risk assessment and their relationship with the customer. Therefore, there was very, very minimal risk of an NSF. Should that direct deposit exceed their limit, they would not originate the funds until they contacted their customer to make sure there would be funds or made other arrangements. Third-party ACH vendors were established. This has eliminated the sending of the files to the banks, and therefore have put the small payroll companies on a level playing field with the large national public payroll companies. The big problem is that banks are more dependent on fee income today than they ever have been for their earnings, and they are charging sometimes five and ten times what they charge for the exact very same service that we had in the eighties and early nineties, and some of the consolidation in the banking industry is responsible for this. That is the bottom line of the problem. The fees are too high. The small companies cannot afford to go that route. Therefore, we had to use the third-party ACH vendors in order to offer an affordable direct deposit system for small companies which eliminate bank fees. The problem is we do not have any financial relationship with that customer, neither does the third-party vendor. Therefore, if there is a nonsufficient funds, it is the payroll company who by default is looked to to make good for the funds. In summary, the ACH system has not been updated to utilize today’s technology. It was developed in the seventies when Richard Nixon was president, before PCs, before companies had fax machines, when typewriters were used instead of word processing. Can you imagine doing today’s business with the tools of the seventies? There is a solution, and that can be automatic electronic authorization prior to originating the file, and those tools can be devel- VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00010 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 7 oped with the software companies who develop the ACH and the electronic authorization today, for example, with debit cards. Thank you very much for the opportunity to testify here today, and I will be very happy to answer any questions you may have for me regarding this important issue affecting all small business. [Mr. Antich’s statement may be found in appendix.] Chairman TOOMEY. Thank you very much, Mr. Antich. Next, I would like to welcome and invite Ms. Dena Brunskill, the president of IPPA from Palm Desert, California. STATEMENT OF DENA L. BRUNSKILL, PRESIDENT, INDEPENDENT PAYROLL PROVIDERS ASSOCIATION; CEO, COMPUTER PAYROLL COMPANY Ms. BRUNSKILL. Thank you. Good afternoon, Chairman Toomey, and to your committee. My name is Dena Brunskill, and I am president of the Independent Payroll Providers Association. Chairman TOOMEY. Excuse me, Ms. Brunskill. Could you bring the microphone closer? Ms. BRUNSKILL. It will not go. Chairman TOOMEY. That is all it will go. Okay. Well, then we will just listen carefully. Ms. BRUNSKILL. Sorry. [Pause.] Ms. BRUNSKILL. How is that? Thank you. Would you like me to start over? Chairman TOOMEY. If you could, please. Ms. BRUNSKILL. Okay. Good afternoon, Chairman Toomey, and to your committee. My name is Dena Brunskill. Chairman TOOMEY. A little closer still. Sorry. We are going to get this just exactly right. Ms. BRUNSKILL. My name is Dena Brunskill, and I am president of the Independent Payroll Providers Association, IPPA. Our organization represents 107 independent payroll service bureaus across the United States. Our members service approximately 50,000 small, medium and large employers, with an estimate of two million employees nationwide. IPPA’s primary focus is to provide forms and resources to assist our members in advancing their respective organizations by facilitating the exchange of best practices and top business resources. IPPA’s board of directors come from Kansas, Virginia, California, and Minnesota. Our executive offices are located in Kansas City, Kansas. My comments today will focus on how our members provide direct deposit service to their clients and the liability to which they are exposed to. For some members that exposure occurs 200 times plus a day. We are here before you to seek your guidance and support in creating a solution to this crisis, both short term and long term. Many of our members have been directly impacted by this exposure and all feel as if this is a land mine waiting to be stepped on. There are several different software packages our members use to send their direct deposit files for input into the fed line. The soft- VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00011 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 8 ware is dictated by the automated clearinghouse, ACH originator they have chose to do business with. Banks are the more prevalent choice for an ACH provider. However, third-party vendors are becoming a viable consideration when our members reevaluate their current vendors. Regardless of the software they use, the ACH originator converts and/or transmits the files into a format required by the National Automated Clearinghouse Association, NACHA, for ACH to the fed line. It appears every region and every ACH originator have differing windows of time in which the payroll provider has to transmit its data. Fees for these services are just as regional. Our members have implemented in-house procedures and processing steps along with checks and balances to ensure the accuracy of these transactions. Believe me, in our business it really does pay to do it right the first time. Because this is a repetitive set of steps, it is fairly easy to perfect the procedure as long as the audits are performed within the prescribed time frame. Audits need to be performed by the ACH provider, the payroll provider and the employer. It is the ethical obligation of each to inform the other parties of any problem that would hinder the successful completion of this task. The most crucial element of the whole equation is timing. Each party has a different timing requirement. The employer has to know how much and when to make certain the funds are in his account to cover his payroll obligations. He also needs to notify his payroll provider within 24 hours if there is a problem with his service. The payroll provider has to create schedules based on the client’s check dates and the ACH originator’s windows to ensure that all the necessary calculations are done by all parties in time to fund the employee’s account. The providers are totally dependent upon the employer for the accuracy of the input dates they agreed to during the start-up process. They are also responsible for correctly inputting the employer’s information into their software, calculating the data, and completing all segments of the payroll process. The ACH originator must follow its mandated procedures to ensure all of its checks and balances for its outside auditors and to fulfill the features of its service contract with the payroll provider. They have total control of the NSF information. The timing of furnishing this information to the provider varies. It can be anywhere from 24 hours to seven days. I have been told by my ACH originator a dispute can be submitted up to 30 days after settlement date. In reality, anything longer than four hours is too late. Payroll providers and ACH originators need to know if the employer has enough money to fund the employees’ pay checks electronically before the credit is sent to the employee, bottom line. The real significance of the situation is who really has control of this process. The employer dictates which employees to pay, how much to pay, when to pay, and what to do with the pay. The ACH originator dictates when the transactions go into the system and when the payroll provider is notified of a problem. The only responsibilities of the payroll provider are the accuracy of the data and to complete the steps of the process. VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00012 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 9 We believe the technology is available today in some already proven format for a real time solution. My time is over so I will go ahead and sum up. Chairman TOOMEY. Finish your thought if you would like, sure. Ms. BRUNSKILL. As my colleagues have stated, payroll providers need to offer direct deposits to their clients in order to compete with the big guys—end of the story. We have lost hundreds of thousands of dollars paying someone else’s employees, not to mention the time and effort expended to collect those losses. I would like to thank you for this opportunity to present the views of our membership and we look forward to working together to solve this most urgent problem. Thank you. [Ms. Brunskill’s statement may be found in appendix.] Chairman TOOMEY. Thank you very much. At this time I would like to welcome and introduce Mr. Gene Krause from ACH Direct. Mr. Krause. STATEMENT OF GENE P. KRAUSE, DIRECTOR OF BUSINESS DEVELOPMENT, ACH DIRECT, INCORPORATED Mr. KRAUSE. Mr. Chairman, Congressman Pascrell, good afternoon, and thank you for granting the opportunity to appear before this subcommittee, hearing recommendations pertaining to the ACH network as it relates to credit transactions, specifically the impact on companies performing payroll processing and those that process the direct deposit payroll transactions. My name is Gene Krause, and I am the director of business development for ACH Direct, Incorporated, a California-based company. My profession and the company I work for evolves centrally around the Federal Reserve’s ACH system. We are a company that is commonly referred to as a third-party ACH processor, a company that develops value-added technologies and services for the users of the ACH network, as well as performing ACH transaction processing. Approximately one month ago, I received correspondence from a company who performs payroll processing, in turn, providing direct deposit via the AHC network for their clients’ employees. This correspondence came at an interesting point in time as this topic has been central to our company focus in recent time. Relayed in the correspondence were frustrations and limitations pertaining to the ACH system as well as thought of alternative solutions to the issues they were faced with. We have known for some time that many share those same frustrations as they are voiced regularly to our staff. As many end-user companies view it, the electronic distribution or deposit of their company’s payroll should not be a difficult task. On the surface, most anyone would draw the same conclusion. These personal theories are borne from the basic principal of thought that because funds must first be debited from the client company’s account before being credited to the employees’ accounts, there should be no risk or problem in doing so. VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00013 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 10 Unfortunately, for this industry the ACH network does not provide for real time settlement finality. This operating limitation of a 72-hour risk of return window is then made significant because it requires various levels of collateral or risk alleviation measures to be utilized. Additionally, the industry or the payroll processing service providers have time constraints brought about by their clients, most of which cannot provide data four days in advance of the deposit credits to employees or for one reason or another do not want their company’s operating account debited four days before deposit credits are issued. The ACH network operates effectively and efficiently under most operating environments. Unfortunately, in the case of credit transactions for the purpose of direct deposit payroll it does not provide the ultimate solution. The central limiting factor, being the lack of real time settlement finality for the debit or funding transaction from where the credit dispersements come from. This limitation creates a severely unbalanced risk-to-reward scenario for any company performing ACH transactions assuming a 72-hour hold of funds has not been imposed. Without a 72-hour hold of funds, our company would be exposed to a potential loss that is 14,000 times greater than the profit received. While the ACH network does have operating limitations, the alteration of any rules governing its use would most probably not alleviate the issue of settlement finality. Any alteration to or adaptation for the ACH network that might provide for real time settlement would, in essence, be the creation of a new transaction network. It is most probable that a solution be found from one of the following areas: One, adaptation of a merging technology that can provide for funding settlement finality; or two, integrated use of additional transaction methodologies for funding settlement with the ACH network being used for credit dispersement transactions. Either one refers to the use of ATM networks and recent advancements made to them. Over the past year our company has dedicated a good percentage of resources towards the integration to ATM networks which would provide for company growth in the area of debit transactions. To utilize these systems for direct deposit purposes, a few things are still needed: One, rules adaptation for business account debits; two, increased participation from financial institutions which currently is growing. Item two refers to the supplemental use of other existing transaction methods such as wire transfers which could eliminate the processor’s risk for funding, ideally reverse wires would be used with the origination notification provided by the transaction processor, leading to a more automated solution. This potential solution also has limitations, including the availability. Not all financial institutions are capable of handling reverse wires, (b) increased costs. Wire transfers are much more expensive than ACH transactions. Risk exposure, with reverse wire risk exposure is not eliminated, but rather is transferred to the funding party. In summary, the current system makes for an unfavorable riskto-reward scenario which, in turn, makes it difficult for payroll VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00014 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 11 service providers, particularly small companies, to acquire a transaction processing that is flexible enough to meet their needs, and in turn, their clients’ needs. There is no doubt that the larger of the payroll processing companies have less difficulty in acquiring and providing for this service, but no matter who is the company or how large they are the risk of exposure is a constant. Only the management thereof can be an effective variable. And in an effort to be efficient with time, I have limited my oral testimony. I welcome your questions pertaining to it or to my more detailed written testimony. I thank this subcommittee for allowing our voice to be heard. Thank you. [Mr. Krause’s statement may be found in appendix.] Chairman TOOMEY. Thank you, Mr. Krause. At this time I would like to welcome and introduce Ms. Rita Zeidner from the American Payroll Association here in Washington. STATEMENT OF RITA ZEIDNER, MANAGER, GOVERNMENT RELATIONS, AMERICAN PAYROLL ASSOCIATION Ms. ZEIDNER. Thank you so much for having me, and I apologize for coming up here and squirming. I injured my knee in a ski accident about a month ago, and I am anxiously awaiting surgery which will speed up the recovery. So if you see me a little squirmy up here, I apologize. On behalf of the American Payroll Association, I am pleased to address the issues related to the automated clearinghouse system. The APA is a nonprofit professional association representing nearly 21,000 companies and payroll professionals in all 50 states and Canada. Our membership includes all employees as well as large firms and spans virtually ever sector of the economy, including financial services, retail manufacturing, restaurants, educational institutions, and state and local government. We represent payroll software developers and several hundred third-party payers, including all of the large firms, and hundreds of small and independently owned payroll service providers. As an organization, we represent our members’ interests in a broad range of areas, including the administration of federal and state wage and hour laws, employment tax withholding, remittance reporting and garnishment administration, and needless to say the efficient and cost effective running of the electronic banking system is an integral part of our members’ success. The overwhelming—the majority of our members favor direct deposit as a method of paying workers. In general, they find the system eliminates many of the administrative problems associated with traditional paychecks. While the savings that can be directly attributed to direct deposit vary from company to company, and are often difficult to quantify, respondents to a 1999 APA direct deposit survey reported that they could save as much as $5 per payment. Because most states don’t allow employers to require their workers to be paid by direct deposit, many of our members conduct elaborate direct deposit campaigns during the workday offering prizes and other incentives to induce their workers to abandon their allegiance to paper checks. VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00015 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 12 When all other direct deposit marketing efforts fail, some employers adopt policies that make it cumbersome for workers to receive a paper check. For instance, they might insist that paper checks be mailed to the workers’ homes with the accompanying risk of late or lost payment, or they may charge an employee for a replacement check, or they may refuse to issue advance payments to workers who will be away on business or on vacation on payday. Some employers have even looked into the legality of making direct deposit a condition of employment for new hires. Employers in 16 states have succeeded in convincing their state lawmakers to allow mandatory direct deposit. In all of these 16 states the employer can require workers to receive their pay via direct deposit so long as the worker is permitted to choose the financial institution. And I give you that introduction just to give you an idea of how popular direct deposit is among our members. My detailed testimony gives some explanation about how employers work with the ACH system, and I think most of the witnesses have already given that presentation, so I will skip over that. But I wanted to talk a little bit about the relationship of employers with payroll processors. Information circulated by this subcommittee suggests that there are more than 3,000 independent payroll processors handling payroll for U.S. employers. Many of these processors, along with the larger public companies, are members of the American Payroll Association. Both the independents and the large processors vie aggressively for business among APA’s 21,000 employer members. These payroll processors market to our members by buying advertising in our magazines, exhibiting in our conferences, and sponsoring payroll-related events, such as National Payroll Week. In fact, several hundred of these vendors will be leasing space in our exhibit hall during our annual meeting next month in San Antonio. The active marketing presence of so many payroll processors suggests that competition is stiff, and the fact that about half of our members use a payroll processor to assist in all or part of the payroll administration suggests that business in this industry is thriving. An informal survey we conducted of our membership in preparation for this hearing supported that premise. As part of this informal survey, we sent an e-mail to several hundred American payroll association members, asking about the fees they pay to originated direct deposit. And I see I am running a little bit long to. Should I summarize our may I continue? Chairman TOOMEY. Finish the thought you are on. You have a little time left. Ms. ZEIDNER. Okay. I received a broad array of answers, and in some instances the banker service bureau processing the payroll charge to flat fee. In other arrangements the employer was charged a flat fee per transmission, plus a fee per direct deposit transaction. Responses to our informal survey suggested that fees generally range from about three cents to 10 cents per transaction. Some VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00016 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 13 companies paid only per transaction, and in these instances the fee seemed slightly higher, around 15 cents per transaction. I asked our members whether loss of float figured into their decision to offer direct deposit or not. Information circulated by this subcommittee suggests that at least one smaller payroll processor believes—he or she believes she is at a disadvantage because he or she must ask employer clients to prefund their payroll to ensure that the employer has the funds on hand on payday. The vendor suggested that the larger service bureaus generally do not have the prefunding requirement. The majority of respondents, including APA’s own payroll director, said that prefunding was not an issue for them. Rather, they understood it to be part of the cost of doing business. Companies that were concerned with lose of float took that into consideration when negotiating other fees with their service provider and/or their bank. And what I would like to do is quickly summarize. I was asked to respond to three proposals, and I would like to quickly go over those. May I have the time? Chairman TOOMEY. Okay, if we could do that briefly. Ms. ZEIDNER. Okay. You asked us how we felt about regulating the fees that banks can charge for direct deposit or via the fed wire system. We do strongly oppose this proposal. Regulation is generally seen as a way to correct market imbalances or stop abuses, and our members don’t feel that that’s taking place. If they felt that they were being abused, then I think we wouldn’t see direct deposit as popular as we see it today. You also asked us to comment about proposal to allow payroll companies to do reversals from employee accounts when an employer doesn’t fund its accounts. I think it’s important to note that NACHA has very specific rules spelling out when an electronic payment can be reversed, and an employer’s failure to fund the payroll doesn’t seem to fit in with this rule. Reversals for ACH items can be only carried out within five days of the originating settlement date for the item, and they are allowed for only two reason: duplicate payments or erroneous payments. Some of the service bureau members we interviewed suggested that reversals wouldn’t even help them solve the problems they face by underfunded employers. These respondents noted that by the time the service bureau would attempt to recoup the misappropriated funds it’s likely that the payee would already have withdrawn the money and therefore the funds would no longer be available to debit. Because of the problems inherent in initiating a proposal, including the questionable legality under the NACHA rules, and the fact that the money wouldn’t be available anyway, several of the service bureaus that responded stressed that risk management was a far more effective means of limiting exposure. And lastly, regarding the ATM debit network, we don’t necessarily have any position on this proposal, but we do support innovative ways of administering payroll, and have been positively impressed by the rollout of payment card systems such as the Visa Payroll Card, and I think Mr. Dawson spoke a little bit about the VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00017 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 14 expansion and use of ATM debit systems as a means of paying folks, so I won’t go over that. I would like to thank you so much for the opportunity to testify here and for your interest in this interesting issue. [Ms. Zeidner’s statement may be found in appendix.] Chairman TOOMEY. Thank you very much, and I will begin with some questions. I have a number of questions. I would like to first make sure I understand the nature of the problem a little bit better. First of all, it strikes me that a business model that is all about providing the service of computing the payroll and administering and preparing the payroll need not necessarily also have with it the credit risk component of whether or not an employer has sufficient funds on hand. I do not see why those two features need to go together. And I guess I want to make sure I understand exactly why they do, so correct me if I am wrong here. But prior to the advent of ACHs, this really was not a problem; is that correct? Mr. ANTICH. [Nodding.] Mr. DAWSON. [Nodding.] Chairman TOOMEY. But since the advent of the ACH system the problem occurs. Now, perhaps Mr. Antich could address this. Others feel free to as well. Does the problem occur because the payments actually are run through your accounts of your company, and you have an obligation, you have made a credit, and you are waiting for a credit on the other side? Can you help us with mechanically how is it that you are out of cash when there is nonsufficient funds? Mr. ANTICH. Well, first of all, we have been doing direct deposits since 1980, and in many cases, and we still do also send files to the bank where the customer has their accounts. There is not a problem in that scenario because the bank has a financial interest with their customer. The bank has the credit limit that they have ascertained because of their risk management and so forth, and they electronically check that file. They know what the funds are for the company that has their account with that bank, so that is not where the issue is. The issue is really when, because of the extremely higher fees, and as I mentioned, five to ten times as much now as they were in the eighties for the exact same service, when you have a small company with two to five employees they can be charged $100 a month to $125 in order for them to just electronically send this file through the system. That is as much or more than our entire service. The problem is that there is no real time authorization. The file is now sent to a third party ACH vendor. Neither one of us has any knowledge whatsoever of what the employer has, whether he has funds or not. There is a date for the credits to hit the employees accounts. This is sent through. Now, sometimes you might debit the account a day or two ahead of time, but still you may not find out for three days after that that there were nonsufficient funds. VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00018 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 15 So since it is not real time, it is just done, the credits are just sent out. You then find out there is a nonsufficient funds, and if it is after the fact, even if it is the same day as the credits, they are already there, and that is where the transaction has to be made whole. Somebody has got to make good for those credits that went into those accounts. Chairman TOOMEY. So who is the enforcer on this? Is it one of the banks? Is it a bank employee or is it the bank for the employer, and when they come to you, and they call you up and say this is how much we were short, write us a check? Is that what happens? Mr. ANTICH. Well, it is going to be in this case the third-party ACH vendor, and Gene might be able to add on to this, they are going to be looking to the company who sent that file, which is the payroll company. The payroll company is certainly going to try to get the money from the employer, but they may be belly-up. They might be out of business. And if the payroll company goes out of business, then it seems to me it’s the third-party ACH vendor who is going to have to make good. Chairman TOOMEY. So Mr. Krause, in this scenario the first, in the information that there is insufficient funds comes to your firm, and then you, in turn, turn to the payroll processing company; is that what your company does? Mr. KRAUSE. Correct. In our model of business, ultimately the risk lies with us. However, I mean, if we cannot get the money from Nick’s company, we are assuming the risk, and so whatever payroll has not been funded that comes out of our pocket. Really the whole issues lies around one central point, and that is the lack of settlement finality from the funding of the client company’s payroll. The RDFIs have by law 72 hours to respond. Chairman TOOMEY. Excuse me. What is an RDFI? Mr. KRAUSE. Receiving financial institution. Chairman TOOMEY. Okay. Mr. KRAUSE. In this case the client company’s bank is an RDFI because the funding for the payroll is actually a debit from their account. Then we in turn send out credits to the employees. Chairman TOOMEY. Right. Mr. KRAUSE. So theoretically, and I will refer you to page 4 of my written testimony, theoretically a company could deposit a paper check on Friday, which is when they send off a file for the ACH transactions to us. They fund their bank account with a paper check. It shows up on the ledger as there being money in there. We go on Monday and debit that account, send the funds out. We are able to do that because the ledger says there is money there. A day later they come back to us and say, hey, there is no money there. Well, that company all of a sudden is out of business or for whatever reason we cannot get the money. That is where the risk lies and that is why these companies are having a hard time. Chairman TOOMEY. And given the technology that we have and we talked briefly about other kinds of electronic transfers, ATM, debit cards, mechanism that are in widespread use, seem to work very well as far as I can see, what is preventing a more modern way of solving this problem so that you can look in real time and VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00019 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 16 know that there is money there or there is not, and you have that finality you are talking about? What is the obstacle here? Mr. KRAUSE. We need a few more good programmers and a little bit more money. Chairman TOOMEY. I do not understand. Mr. KRAUSE. We are working on a solution. Chairman TOOMEY. I mean, the technology exists, right? Mr. KRAUSE. Yes, it does. Chairman TOOMEY. Has it not been adopted by this network? Is that the problem? Mr. KRAUSE. Exactly. We are the first company in the country that is integrated with the Star ATM network which may be a solution to this problem. There are a couple of limiting factors in that the rules are yet to be clarified as to what you can do with this network. At this moment we are able to look into a DDA or a bank account and find out if there is money there. We are able to do that right now. By the end of this year we will be able to debit in real time, or actually capture or freeze funds, and then the account will be funded the next day. So that is real close to being accomplished. We have got a couple of issues. Number one, how many participating financial institutions are there to make this worthwhile for this particular industry; and number two—I lost my train of thought here. Oh, the rules pertaining to the business debits. The network essentially was set up for business to consumer, yes, business to consumer transactions. Chairman TOOMEY. Well, I am going to yield to my colleague, Mr. Pascrell, but then I am going to go back and ask some more questions, and I am going to try to follow up with a question about whether there is existing legislation that in any way impedes the development of this network that would be more efficient or whether there is a need for new legislation to facilitate it, but at this time I will yield to the gentleman from New Jersey. Mr. PASCRELL. I just have a quick question, Mr. Chairman. I have to run to the other end of the campus for another meeting. My question to Mr. Dawson is, I mean, we’re talking about a lot of money here. Last year, I am looking at the, there was eight billion ACH payments worth over $22 trillion. That is pretty mindboggling, so we are not talking about nickel and dime stuff here. We are talking about something very critical. And assessing risk is not an easy task. You know, I understand that. What exactly—I mean, we know that processing a check actually cost the originating bank more than processing any ACH transaction. Just very briefly, how do we assess risk in terms of trying to answer what the Chairman just concluded with? In order to answer his questions, we are going to have to decide how to assess this risk. How do you assess it? Mr. DAWSON. Someone might have a better answer than this, but we assess it as we do not want it at all. Mr. PASCRELL. That is the bottom line, is it not? Mr. DAWSON. We are not a banker. Mr. PASCRELL. Right. VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00020 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 17 Mr. DAWSON. We are not a lender. We are not a credit provider. We are a transaction processor. We get a small fee, six-seven dollars—— Mr. PASCRELL. Right. Mr. DAWSON [continuing]. For initiating a file, and I think someone made the mention that the risk associated with that, if we choose to accept it, is 14,000 times or something the rewards, that six or seven dollars. In our case at our company we choose not to accept that risk. We require prefunding, which is an obstacle to ask a small company four or five days ahead of its payroll to fund its entire payroll. Mr. PASCRELL. So then how would you react, what is your response, what is the answer in your mind? Mr. DAWSON. The answer to which question? I am sorry. Mr. PASCRELL. The one you just very—you clarified, you crystallized. I mean, what is our response? Is it legislation? Is it something we need that is already on the books to enforce? What are you suggesting? Less regulation? More regulation? Mr. DAWSON. You know, actually, I am not certain with the technology being where it is today, that is, it looks like it could provide the solution, I am not really sure what the obstacle is, but it appears to be somewhere embedded in either NACHA or the banking system, or there is a lot of resistance to this occurring, and I really do not know where it is. Mr. PASCRELL. Yes, sir. Mr. DAWSON. Nick does. Mr. PASCRELL. Mr. Antich? Mr. ANTICH. No, I do not. Again, just a possible solution, and I know Gene mentioned they are working on something. But number one, we have gotten feedback that banks are not interested whatsoever in making any change because they do not see the risk, and that is number one. So this is really like a problem of moving mountains here. But I do believe that the technology is available with the software vendors today to come up with a solution. There are various payment types in the ACH NACHA format, and there could be, and this is just an idea, a new payment type, that if that payment type is used, it would automatically interface into a yet undesigned, electronic authorization system designed for commercial accounts. If the account has the funds, the company still has the use of those funds for earnings credit until settlement date, which might be two-three days later, the electronic authorization system would put a memo hold or a reserve on those funds with the date of settlement, knowing that this electronic debit is coming through on that date. To me, that is certainly a potential solution, but we would have to get the banking industry to embrace this. I know we could get the software vendors to do it, and there would have to be some changes in the NACHA rules as well, and formats and payments. Chairman TOOMEY. Thank you. I have a bill that is on the House floor momentarily, and I am going to have to run down and manage the floor debate on my bill. But I wanted to wrap up with a couple of maybe questions and thoughts. The changes that we have discussed, the potential solution that Mr. Antich just referred to, and the idea of an alternative, which VerDate May 23 2002 04:01 Jun 15, 2002 Jkt 079639 PO 00000 Frm 00021 Fmt 6633 Sfmt 6602 E:\HR\OC\A639.XXX pfrm12 PsN: A639 18 is real time ability to evaluate whether the money is here or not, is anyone of the opinion that that requires actual legislation to make that happen, or is there a legislative obstacle? Mr. KRAUSE. Depends on the rules that will come about. This is new, this is new technology. Chairman TOOMEY. Okay. At the moment is it fair to say that the existing system and methodology and the rules for participating in this network are designed by NACHA and they are within the authority of NACHA, which is, I assume, a voluntary association of members? Is that correct? Is it really? Mr. KRAUSE. For the AMT networks, I am not sure that all the rules reside within NACHA’s operating. Chairman TOOMEY. I am not referring for the ATMs. I am talking about for payroll processing and settlements, current system. Mr. KRAUSE. For the current system, yes, correct. Chairman TOOMEY. Yes. Okay. And there is nothing that—there is no legislation that anyone is aware of that governs or regulates NACHA? I mean it is not—even the reversibility of credits, for instance. Mr. KRAUSE. There are some FCC rules that—— Chairman TOOMEY. Okay. Mr. KRAUSE [continuing]. Taken into account, yes. Chairman TOOMEY. Okay. Is there legislation that precludes reversing out a credit to an account in the event that there is insufficient funds, or is that just a rule of NACHA? Mr. KRAUSE. I believe that is just a rule of NACHA. Chairman TOOMEY. Okay. Okay. All right, did anybody have any closing thoughts, if they could be brief, that are important that we have not touched on yet? Okay, I would like to actually continue for some time with questions, but I have to—unfortunately, leave and get down to the House floor. But I want to thank you all very much for your testimony. This has been very informative, and you have raised some very interesting issues. And if you have any further thoughts on this, please submit them to the committee. We will take them under consideration. Thank you very much. The hearing is adjourned. Mr. KRAUSE. Thank you. 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@FedFRASER