Do Gift Cards Make You a Bank?

Studies estimate that nearly three out of four shoppers bought at least one gift card last year. Many analysts believe that the late surge in retail spending at the end of 2003 was due to the increased popularity of gift card giving during the holiday season. Retail stores, restaurants, service industries and entire malls are discovering the benefits of issuing gift cards.

In addition, many businesses are discovering the benefits of another type of prepaid card: the stored value card. For customers, stored value cards are a convenient alternative to cash. For businesses, stored value cards are a way to increase consumer loyalty and impulse purchasing. A cup of coffee, a loaf of bread or a ride at an amusement park can all be purchased using a stored value card.

In the midst of this explosive growth of gift cards and stored value cards (or "convenience cards," as we will call them for purposes of this article), many businesses appear to have jumped on the bandwagon without considering and addressing important business and legal concerns. This article will look at some of the questions raised by convenience cards at both the state and federal level, in a legal environment in which electronic commerce is increasingly regulated and the definition of a "financial institution" is no longer limited to traditional banks.

Do States Regulate Convenience Cards?

Yes, and in a surprising number of ways. One ostensible reason for such regulation is that convenience cards resemble bank accounts. In each case, funds are paid to and held for subsequent use by someone other than the beneficial owner. Accordingly, public policy makers have concluded that issuers of convenience cards need to be subject to some level of governmental oversight in an effort to assure that "deposited" funds are available when the cardholders try to use their cards.

Licensing

In a number of states, convenience card issuers may be subject to regulation as either money transmitters or check sellers. While such laws may not seem designed to regulate convenience cards, it's important to look at statutory definitions. For example, a representative state statute regulating the "business of selling checks" covers any business receiving money by any means from a purchaser for the purpose of subsequently transferring the money. The business of selling checks is defined as:

[T]he activity of receiving money by any means from a purchaser for the purpose of subsequently transferring the money in the form of a check payable by the seller to a person designated by the purchaser, for direct or indirect compensation, including earnings from money received from the purchaser or the purchaser's agent and held pending disbursement on a check sold to the purchaser, whether or not the activity is conducted on a regular basis or as an organized business concern.

On its face, it appears the statute would not regulate convenience cards. A closer look suggests such a conclusion may be wrong. Several states define the term "check" to include an electronic equivalent to a draft, traveler's check, or money order. Accordingly, in some cases, issuers will have to analyze whether a convenience card is the electronic equivalent of a draft, traveler's check or money order.

The fact that state statutes appear to regulate convenience cards should not be the end of any analysis. For example, some statutes specifically exclude devices that are redeemed by the issuer. Such statutes raise several issues in mall management or where franchisers are issuers of cards that are redeemed at franchisees. In other cases, separate corporate entities controlled by the same parent may be involved as issuer and redeemer. In such cases, it may be reasonable to assert that if one wholly-owned or controlled affiliate issues the stored value product and another redeems it, the transaction is substantially the same as a transaction where the same entity issues and redeems the product – and as such, should be exempt.

What's the Cost of Obtaining and Maintaining a License?

The cost of obtaining and maintaining a state license varies widely from state to state. For example, initial application fees can be several thousands of dollars and the application approval process can take several months. In addition, there may be annual fees, periodic audits and other ongoing requirements.

What's the Risk of Failing to Obtain a License?

The risk also varies from state to state. Potential risks range from simply negative publicity to cease and desist orders and even civil or criminal penalties. In addition, federal law (12 USC 1960) creates a criminal sanction that is applicable in some cases.

Gift Certificate Laws

In some states, gift certificate laws also apply to issuers of convenience cards, regulating such things as expiration dates, dormancy fees, and even required disclosures to be printed on the convenience card (including detailed requirements for placement and size). Some of these state laws only apply if the issuing entity of the convenience card is different than the redeeming entity. However, because of their complexity and scope, close analysis of each state's law is required in every case.

Abandoned Property

Issuers of convenience cards may also be subject to escheat laws, which provide that certain types of abandoned property left in the hands of third parties must be reported and sent to the state. Property may be presumed abandoned under state law if there is no activity with respect to the property for a specified time period. The defined "abandonment period" varies from state to state, and some states do exclude gift certificates (and perhaps gift cards) from their escheat laws.

OK, There's State Law, But Federal Law Doesn't Apply, Does It?

It may. It can be argued that issuers of convenience cards are financial institutions and thus subject to certain federal laws. Given the widespread use of convenience cards, there is surprisingly little clarity on the issue.

Financial Privacy

Title V of the Gramm-Leach-Bliley Act of 1999 ("GLBA") requires covered organizations to provide privacy disclosures and limits the instances in which a covered organizations may disclose nonpublic personal information about a consumer.

GLBA applies to information about individuals who obtain a financial product or service from a financial institution to be used for personal, family, or household purposes. The law only applies to financial institutions, which include any entity substantially engaged in financial activities. There is no definitive list of the entities that are subject to GLBA, but it clearly covers parties beyond traditional credit, insurance, or securities businesses.

Financial activities include "lending, exchanging, transferring, investing for others, or safeguarding money or securities. There is again no definitive guidance addressing whether issuance of stored-value products is considered the equivalent of "exchanging, transferring…or safeguarding money," and we are unaware of any instance so far in which a federal agency has asserted that issuers of convenience cards are subject to GLBA because they are exchanging, transferring or safeguarding money.

However, other activities that have some similarities to convenience cards are defined by GLBA as financial activities. They include: the issuance and sale at retail of money orders and similar consumer-type payment instruments; the issuance and sale of travelers checks; and transmitting money or providing any device or other instrumentality for transferring money or other financial assets.

The Electronic Funds Transfer Act

The Act establishes the basic rights, liabilities, and responsibilities of consumers who use electronic fund transfer services and of financial institutions that offer such services. Its primary objective is the protection of individual consumers engaging in electronic fund transfers. It "applies to any electronic fund transfer that authorizes a financial institution to debit or credit a consumer's account." To determine whether the Act applies to a particular convenience card product, one must analyze the definitions of "electronic fund transfer," "financial institution" and "account."

Is An Issuer A "Financial Institution"?

The definition is deliberately broad to cover a wide range or persons who offer electronic fund transfer services. The definition of "financial institution" includes not only traditional financial institutions such as banks, savings institutions and credit unions, but also any other person "that directly or indirectly holds an account belonging to a consumer or that issues an access device and agrees with a consumer to provide electronic fund transfer services." Accordingly, an entity can be a financial institution if it holds an "account" or issues an access device that accesses an "account."

Does Purchase of a Convenience Card Create an "Account"?

The definition of "account" includes any checking account, savings, or other consumer asset account. While it seems reasonable to assert that the term account is limited to banking accounts, nothing in the definition indicates that the definition is limited to traditional bank accounts and no guidance specifically excludes stored-value type arrangements that involve non-financial institution issuers.

Would Use of a Convenience Card Involve an "Electronic Fund Transfer"?

An "electronic fund transfer" is "any transfer of funds that is initiated through an electronic terminal, telephone, computer, or magnetic tape for the purpose of ordering, instructing, or authorizing a financial institution to debit or credit an account." It is difficult to conceive of a situation whereby customers using convenience cards to make purchases could conduct the transaction without initiating the transaction through an electronic terminal. In addition, transactions will involve an instruction that results in a reduction of available value, in other words, a debit. Assuming that an issuer is a "financial institution" and that the use of a convenience card involves an "account," it is reasonable to conclude that an electronic funds transfer is involved.

Bank Secrecy Act

The federal Bank Secrecy Act, as amended by the USA Patriot Act, has several provisions that may apply to convenience cards issuers, depending on features of such products. The Act applies to "financial institutions." The definition of financial institution includes a variety of "money services businesses," including issuers, sellers and redeemers of stored value. The definition excludes those issuing stored value of $1000 or less to any person on any single day. The Act contains a variety of requirements, including filing reports of suspicious transactions that exceed specified thresholds. In addition, covered entities have to establish anti-money laundering programs.

Conclusion

You may not think of yourself as a financial institution. Nevertheless, a variety of state and federal laws regulating financial activities cast a wide net covering a variety of businesses and activities. As technology creates new and convenient alternatives to traditional payment systems, the purchase of a latte at your area coffee house may no longer be so different than a swipe of a card to get cash at an ATM.

Not surprisingly, many businesses have concluded that convenience cards are a great way to increase customer loyalty and impulse purchases. However, our experience with convenience cards suggests that many businesses are not considering the full range of applicable issues before rolling out the product.