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Regulation and compliance Digital payments


A SHOWDOWN IS COMING OVER WHO IS LIABLE FOR P2P PAYMENTS FRAUD

By  Kate Berry
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August 23, 2022, 2:59 p.m. EDT 6 Min Read
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The Consumer Financial Protection Bureau is expected to issue guidance soon on
banks' liabilities for fraud perpetrated on digital payments platforms like
Zelle, setting up a major regulatory fight that could play out for years.  

Financial institutions claim they cannot be held liable when a consumer
incorrectly sends an electronic payment to the wrong person or gets tricked by a
criminal and authorizes a payment that turns out to be a scam or fraud. 



Banks and credit unions are likely to sue the bureau if it tries to assign broad
liability for fraudulent payments authorized by consumers. Some expect the CFPB
will need to issue a rulemaking if it tries to mandate that consumers get repaid
for fraud.


The Consumer Financial Protection Bureau is expected to issue a guidance
detailing the extent to which banks and credit unions are liable for fraud on
digital payments platforms like Zelle.
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"Most consumers do not know that there is a difference between sending payments
from PayPal's wallet or their underlying bank account," said Aaron Klein, senior
fellow at the Center on Regulation and Markets at the Brookings Institution. 



The issue is complicated because the 1970s-era law governing electronic payments
— the Electronic Fund Transfer Act of 1978 — is woefully out of date. 

The law never envisioned that consumers would transfer money to criminals or
someone they do not know in response to an unexpected text or phone call, Klein
says, and from a public policy perspective, consumers have come to believe that
instant payments and digital wallets have the same consumer protections as
credit cards.

"It's important that the bureau modernizes Regulation E to deal with the
realities of digital wallets existing outside of traditional banks," Klein said.

The CFPB has clear authority to interpret the EFTA and could clarify that, in
certain circumstances, a payment is an "error" when a consumer is defrauded into
initiating an electronic transfer to a fraudster. The bureau also could add a
new category of error for fraudulently-induced payment and may also clarify that
EFTA applies to all electronic payments. 

The EFTA has a list of seven categories of error, including unauthorized
payments and incorrect transfers by a financial institution that require
consumers be reimbursed if they notify their institution promptly. But at the
time the act was passed, electronic transfers were almost exclusively executed
by banks or other financial institutions, and as a result "errors" have
traditionally been interpreted to have been made by financial institutions — not
the consumer. 

Why Zelle's owners revived an old brand to battle ID fraud

Early Warning Services brought back its Authentify moniker for a new digital ID
service. It's not being marketed as a way to stop P2P fraud, but it should
appeal to banks wanting to improve security for online transactions.

"I think there's an excellent legal argument that a customer mistake is an
incorrect transfer," said Gail Hillebrand, a payments expert and former CFPB
associate director for consumer education and engagement. "What's more incorrect
than sending your money to the wrong person?"

Hillebrand also said that a failure by financial institutions or payment
providers to act to prevent fraud can be considered an "unfair" practice that
the CFPB could enforce under its general prohibition against "unfair, deceptive
or abusive acts or practices," known as UDAAP. 

The CFPB has already taken some steps to apply UDAAP to payments.

In July, the CFPB fined Bank of America $100 million for botching the
disbursement of unemployment benefits on prepaid cards. And earlier this month
the CFPB said in a circular that a failure to prevent fraud and identity theft
can constitute an "unfair" practice. 

Several Democratic lawmakers have urged CFPB Director Rohit Chopra to take steps
to provide stronger protections for consumers after a spate of news stories and
lawsuits against banks and payment providers.

"Determining liability based on whether a consumer or a fraudster physically
initiates a transaction is antiquated," the lawmakers wrote in a letter led by
Sens. Jack Reed, D-R.I., and Bob Menendez, D-N.J. "Our nation's consumer
protection rules must evolve to keep pace with the growth of instant payment
services like Zelle."

Zelle has become a poster child for digital payments fraud, with thousands of
consumers complaining that its parent company Early Warning Services, based in
Scottsdale, Arizona, refuses to investigate fraud or resolve mistakes. Early
Warning is owned by Bank of America, Capital One Financial, JPMorgan Chase, PNC
Financial Services Group, Truist Financial, U.S. Bancorp and Wells Fargo.

Complaints to the CFPB about Early Warning Services jumped 80% from March 2022
to June 2022, said Marcia Tal, the CEO of Tal Solutions, a New York-based
artificial intelligence firm that analyzes complaint data. 


BANKS ON THE OFFENSIVE



Many of the largest banks have already gone on offense by issuing more frequent
warnings to customers and added layers of confirmation to use Zelle. Some banks
tell consumers outright that the money they send "may not be recoverable" and
that a bank will never ask a consumer to transfer money to themselves or to
anyone else. 

Some of the most pernicious fraud in electronic payments involves criminals
sending out mass emails and then posing as bank representatives to those that
respond, instructing them to send money to a bogus account. Some experts think
the CFPB could take a narrow approach by issuing guidance that banks reimburse
consumers in those instances.

Trace Fooshee, a strategic advisor at Aite-Novarica Group, said he is concerned
that the CFPB may change the standard used to test whether a payment order was
authorized by a consumer or not. 

"The standard that has been used has been whether the customer had authenticated
properly and issued the payment order. The banks prefer this standard because
it's a tangible, verifiable fact," Fooshee said. "If the CFPB changes the
standard to whether or not the customer intended to issue the payment order,
then the banks will have a nightmare of a time dealing with the new standard.
How can they be expected to prove intent?"

Banks will have to spend more money investigating mistakes and fraudulent
payments authorized by a consumer, he said. Some think banks and credit unions
will be forced to increase fees and shoulder more losses, or in a worst-case
scenario, they would have to withhold or curtail some peer-to-peer payments.

Credit unions  and small community banks also would suffer if they had any
exposure to fraud-related losses and if they are required to conduct
investigations into peer-to-peer payments. 

"Credit unions that are only tangentially connected to P2P transactions because
of a linked debit or credit card may share full responsibility for investigating
alleged errors despite being in an inferior position to research the cause of
the error and validate the consumer's claims," Dan Berger, president and CEO of
the National Association of Federally-Insured Credit Unions, said recently in a
letter to the CFPB. 

Others suggest that the Federal Reserve bears some responsibility for failing to
modernize the payments system that has largely been under-regulated, in part,
because it has been controlled by banks for so long. The Fed has made
substantial headway on its own real-time payments platform FedNow, which is
expected to launch in 2023.

"It's a national disgrace that the Fed's payment system moves at the same speed
as it did when we had flip phones and went to Blockbuster whereas the rest of
the world has iPhone13 and streams," said Klein. 

Others suggest the CFPB needs to act precisely because the massive losses due to
fraud are unsustainable. 

"The payment system is a national economic asset," said Hillebrand. "It should
be safe for everyone to use no matter which rail they use. People shouldn't have
to understand their plumbing in order to get safe water."

Kate Berry
, American Banker
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Regulation and compliance Digital payments
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