Overdraft Programs: What You Need to Know About the FDIC Guidance and Posting Order Litigation

January 4, 2011 at 3:35 pm Leave a comment

On November 24, 2010, the FDIC issued final supervisory guidance relating to the implementation and ongoing oversight of automated overdraft payment programs. The final guidance was virtually unchanged from the proposed guidance on which we reported last August. The final guidance was targeted at automated overdraft programs. In addition, although the guidance only applies to FDIC regulated institutions, other institutions should consider the FDIC’s expectations as the guidance will likely have an effect on other regulators’ views of overdraft programs.

The guidance requires banks to make significant changes to the operation of their automated overdraft programs by July 1, 2011. The most significant of these changes are as follows:

  • Monitor Overdraft Program for “Excessive Use.” Banks must monitor their overdraft programs for excessive use (defined as seven overdrafts in a rolling 12 month period) and undertake meaningful and effective follow-up action,” including (i) contacting the customer to discuss alternatives to automatic overdraft protection, or (ii) giving the customer an opportunity to opt out or choose another alternative. This could require a bank to contact frequent users of overdraft programs several times a year.
  • Impose Daily Limits. The FDIC also expects its banks to institute daily limits on overdraft charges, although it does not provide any guidance as to what a reasonable limit might be. This limit could be in the form of a limit on the number of transactions that would be subject to a fee or a dollar limit on total fees that may be imposed in a day.
  • Ensure that Posting Order Does Not Maximize Overdrafts. The guidance requires banks to review check-clearing procedures to ensure that they “operate in a manner that avoids maximizing customer overdrafts and related fees through the clearing order.” Examples of appropriate procedures include “clearing items in the order received or by check number.” Oddly, although the FDIC Guidance explicitly mentions checks, it does not address electronic transactions, such as ATM and debit card transactions, although it is unclear whether this omission was intentional. In addition, although the FDIC Guidance does not specifically mention high-to-low posting (with respect to checks or any other items), the FDIC will likely criticize banks with automated overdraft programs for posting checks or any other items in high to low order.

Posting Order and Other Overdraft Litigation
Following the $203 million ruling against Wells Fargo Bank over “high-to-low” (HTL) posting that was issued on August 10, 2010, we are seeing a proliferation of class-action lawsuits challenging financial institutions’ overdraft practices.

Gutierrez v. Wells Fargo Bank. In a 90-page opinion, a federal district court judge in California found that Wells Fargo manipulated its processing of debit card transactions to maximize overdraft fees in violation of California law. In 2001, Wells Fargo changed its debit processing order from low-to-high to HTL posting. The switch to HTL posting was followed by two other practices that the court determined were intended to amplify the overdraft multiplying effect of HTL posting: Wells Fargo (1) switched to commingling of debit-card purchases with checks and ACH transactions and (2) deployed a secret “shadow line” to authorize transactions into overdraft. The opinion explained that posting debit-card transactions in HTL order confers no benefit upon Wells Fargo customers because they are “must pay” items, unlike checks or ACH transactions, which the bank can return unpaid.

The court found that Wells Fargo’s account agreement was inadequate. The account agreement described the bank’s posting order as follows:

We may pay Items presented against your account in any order we choose, unless a particular order is either legally required or prohibited. In particular, we may choose to pay Items in the order of highest dollar amount to lowest dollar amount (unless such a practice is specifically prohibited by an applicable state or federal law, rule or regulation). We may change the order of posting Items to your account anytime without notice to you.

According to the court, by informing the customer that the bank “may” use HTL posting, the bank was not reserving complete discretion to do so. The California court concludes that the term “may” suggests that HTL would only be used occasionally. The court found that Wells Fargo’s overdraft maximizing practices as described above were “unfair” and “fraudulent” under California law. The case is currently being appealed.

More Litigation Is Expected. There are currently dozens of pending federal cases, for which the pretrial proceedings have been consolidated in the multidistrict litigation in Florida. In addition, there are numerous lawsuits in state courts throughout the country. Fifth Third Bank recently agreed to pay $9.5 million in a proposed settlement involving its HTL posting practices.

Another theory under which financial institutions are being sued is that the overdraft fee imposed by a financial institution for paying an electronic transaction into overdraft is usurious under state law. We have seen a recent increase in the number of HTL and state usury lawsuits, and expect that trend to continue. We are representing a number of financial institutions involved in class action litigation over their overdraft programs, both on HTL posting and state usury issues.

What does the Wells Fargo case mean to you? If your institution currently engages in any of the activities criticized in the Wells Fargo case, it could be the target of a class action lawsuit. Your institution should consult with legal counsel and review the institution’s account disclosures and practices in light of the recent litigation. Bankers should also be familiar with the ever-expanding types of practices, products and services that may constitute “unfair and deceptive acts or practices” to avoid any potential liability under those laws.

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