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Improving ACH Network Quality by Reducing Exceptions Request for Comment and Information

Executive Summary and Rules Description November 11, 2013

RESPONSES DUE BY MONDAY, JANUARY 13, 2014

NACHA requests comments on a proposal to amend the NACHA Operating Rules that is

intended to improve ACH Network quality by reducing the incidence of ACH exceptions.

Generally speaking, an exception is an ACH transaction: 1) that an RDFI cannot straight-through

process due to some incorrect data within the transaction; or 2) the validity of which is disputed

by a Receiver customer of an RDFI.1 These types of exceptions impose costs on RDFIs and

impact their Receiver customers. Exceptions can be caused by poor origination practices, as well

as through use of the ACH Network by high-risk Originators. A reduction in exceptions would

provide a cost-reduction benefit to RDFIs, improve their Receiver customers’ satisfaction with

ACH payments, and shift some of the cost of exceptions to the DFI in the best position to avoid

those costs.

The proposed rule is one component of NACHA’s overall risk management strategy, which also

includes industry education and information sharing, the development of tools and services, as

well as risk management-related Rules and enforcement. A related and complementary rule

proposal on ACH Network Risk and Enforcement is also open for comment concurrently (see

https://www.nacha.org/page/request-comment).

Comments are due by Monday, January 13, 2014 at 5:00 p.m. Eastern Time.

NACHA STAFF CONTACTS

Return comments to: Maribel Bondoc, Manager, ACH Network Rules

Fax: (703) 787-0996

E-mail: [email protected]

Questions: Michael Herd, Senior Managing Director, ACH Network Rules

E-mail: [email protected]

1 For the purpose of this proposal, an ACH debit which is not paid due to insufficient or uncollected funds (“NSF”)

is not included within the scope of ACH exceptions. Additional discussion on NSFs is included later in this

document.

https://www.nacha.org/page/request-comment

mailto:[email protected]

mailto:[email protected]

Request for Comment: Improving ACH Network Quality by Reducing Exceptions

Rule Proposal Description; November 11, 2013,

Part I: Proposal Summary

This proposed rule (“Rule”) is intended to improve ACH Network quality by reducing the

incidence of ACH exceptions. “Quality” in the context of the ACH Network is generally

considered to be an environment with reasonably low rates and incidences of returned

transactions. For RDFIs, “ACH quality” can also be considered to be an environment with

reasonably low rates and incidences of exceptions, which frequently involve customer service

contacts and a manual resolution, and which also may result in the RDFI transmitting a returned

entry or a Notification of Change (“NOC”) to the ODFI.

The Rule would improve ACH quality and reduce exceptions by establishing a system of

economic incentives for ODFIs to improve the quality of the ACH transactions they originate,

and for both RDFIs and ODFIs to use and comply with the existing NOC process within the

ACH Network.

The proposed economic incentives are as follows:

1. A fee for certain Return Entries for which an RDFI returns an ACH transaction to an ODFI

due to incorrect account data within the transaction (“Erroneous Data Fee”);

2. A fee for certain Notifications of Change (NOCs) for which an RDFI corrects information

within an ACH transaction and transmits an NOC to the ODFI of the transaction (“NOC

Fee”);2

3. A fee for certain Return Entries and Extended Return Entries for which an RDFI returns an

ACH transaction to an ODFI due to a problem with the Receiver’s authorization, such as a

Receiver’s dispute of the validity of the transaction (“Unauthorized Entry Fee”).

For each of these incentives, the fee would be paid by the ODFI and passed through to the RDFI

to partially offset the RDFI’s costs for exception processing and customer service.3 Under this

proposed Rule, NACHA is not the beneficiary of any of the proposed fees. No portion of any

fees proposed under this Rule would be passed to NACHA for NACHA’s benefit.

The primary objective of this set of incentives is to improve ACH Network quality by reducing

the incidence of returns and exceptions. By establishing fees for specific types of exceptions,

ODFIs would have a direct financial incentive to implement processes and tools with their

Originators to reduce the number of such returns and exceptions. ODFIs with the highest return

rates would have the greatest incentives to work with their Originators to reduce those rates.

Economic incentives applied to certain returns would provide additional impetus for ODFIs to

address ACH origination practices that result in returns, such as poor data capture or unclear,

confusing or deceptive authorizations. Economic incentives applied to certain NOCs provide

additional impetus for RDFIs to send NOCs, and for ODFIs to encourage their Originators to use

the corrected information.

2 The NOCs covered by this proposal are those that represent incorrect information sent by the ODFI, and not those

that represent changes to routing and account information due to RDFI mergers and acquisitions. 3 An NOC bears an SEC Code of “COR.” The RDFI of the original Entry retains its role as the RDFI, even though

it is initiating the COR Entry; i.e., it is not considered an ODFI by virtue of transmitting an NOC. See Section 3.9.



Regardless of the previous adoption of risk-management related rules, the ACH Network is still

used by some high-risk originators4, such as debt collectors, payday lenders, credit repair

services, sweepstakes, travel clubs, and online and telemarketers, occasionally resulting in

episodes of high rates of customer disputes, returned transactions, consumer and business harm,

and damaged reputations for both the ACH Network and RDFIs alike. More recently, such

episodes have resulted in attention by certain regulatory and law enforcement agencies, as well

as the news media, and improper assignment of responsibility to RDFIs for solving high-risk

practices that are better addressed by ODFIs. A system of Quality Fees would serve to provide

an additional incentive for ODFIs of such high-risk Originators to adequately monitor these

Originators’ ACH activity and returns, and to provide some economic relief to RDFIs if and

when any such episodes occur in the future.

If such a system is successful in improving ACH quality, a reduction in exceptions would

directly lead to cost savings by RDFIs. Additionally, economic incentive fees passed through to

RDFIs would provide some cost recovery for a portion of RDFIs’ costs for exception processing,

and would shift this cost to the ODFIs that are responsible for the transactions that caused the

exceptions. Those ODFIs that are responsible for generating the greatest volume of ACH

exceptions, such as those that process for high-risk originators, would incur the greatest impact

from the shift in these costs. To the extent that an ODFI does not reduce its unauthorized and

administrative return rates in response to these financial incentives, it would be appropriately and

fairly bearing some of the costs that these exceptions impose on RDFIs.

These quality incentives should not be seen as the complete solution for ACH quality issues.

They do not replace the NACHA System of Fines and enforcement actions already in place to

address Rules violations, nor do they replace other tools to improve quality. Rather, the

proposed ACH quality incentives should be seen as part of a process of continuous improvement

in the ACH Network. As a complementary approach to reduce exceptions in the ACH Network,

NACHA has concurrently issued a related proposed rule that would improve the ability to

identify and enforce the Rules against outlier Originators that are responsible for generating the

most disproportionate levels of exceptions (see https://www.nacha.org/page/request-comment).

Part II: Background

NACHA’s Previous Risk Management Strategy, and Unauthorized and Administrative Returns

NACHA’s previous risk management strategy covering the 2005-2012 time period focused

mainly on unauthorized ACH debits. Individual components of that strategy included: the

Network Enforcement Rule; the Company Name Rule; Direct Access Registration; the

Terminated Originator Database; and many other rules and industry educational efforts.

During that time period, the overall unauthorized debit rate on the ACH Network decreased from

0.06 percent (i.e., 6 out of 10,000 debits) in 2004 (the year before the strategy began) to 0.03

4 For purposes of this RFC, “high-risk originators” generally means those originators in certain lines of business that

result in exceptions or returned transactions substantially higher than the average across the ACH Network.

Additional discussion of high risk activities and examples or high-risk industries can be found in OCC Bulletin

2006-39 at http://www.occ.gov/news-issuances/bulletins/2006/bulletin-2006-39.html.


http://www.occ.gov/news-issuances/bulletins/2006/bulletin-2006-39.html



percent in 2012.5 Further, the number of unauthorized debits fell slightly from 3,062,114 in

2004 to 2,942,349 in 2012.

A closer look at unauthorized volume shows that a significant portion of the decrease occurred

during 2008-2010, which coincides with the period immediately following the effective date of

the Network Enforcement Rule and Company Name Rule. More recently, the decline in the

unauthorized debit rate has leveled off, with the rate of 0.03 percent in 2012, and projected for

2013, being identical to that of 2010. Further, the number of unauthorized debits is increasing

again in proportion with increases in ACH volume.

Regardless of the past success, unauthorized debits remain a significant pain point for RDFIs.

Inherent to any unauthorized debit is a Receiver customer whose account has been debited, and

for which the Receiver is disputing the validity of the debit, resulting in customer contact with

his/her financial institution, and attendant Regulation E dispute resolution procedures. All this

results in costs for the RDFI to handle the customer’s dispute, and frequently can result in

dissatisfied customers as well.

While focusing on unauthorized transactions, the risk management strategy of 2005-2012 did not

substantially address administrative returns and other exceptions such as NOCs. High

administrative return rates also can be associated with fraud, or indicative of poor-quality

origination that also imposes costs on RDFIs.

5 As measured by the number of debits returned bearing the R-codes R05, R07, R10 and R29.



In contrast to unauthorized debits, the number of administrative returns6 increased during the

time period of the risk management strategy, from 21,962,881 in 2005 to 29,953,930 in 2012,

although the rate of return has not increased. A closer look at the data shows that the

administrative return rate for ACH debits declined from 0.30 percent in 2005 to 0.23 percent in

2009, largely due to the rapid adoption of ARC transactions, which inherently had very low

return rates. There has been no further rate decline since 2009, which is consistent with the

plateau and subsequent decrease in ARC volume. For ACH credits, the administrative return

rate has increased slowly but consistently throughout the 2005-2012 period from 0.09 percent to

0.11 percent.

To further drive down both the rate and the number of administrative returns, the risk

management strategy updated in 2012 includes a focus on improving ACH quality, potentially

through the implementation of economic incentives.

Part III: RDFIs’ Costs to Handle Exceptions

To investigate RDFIs’ actual costs of handling exceptions, NACHA collected data from

receiving financial institutions of various types and sizes. NACHA asked these RDFIs to

provide cost information related to their ACH operations – labor, systems, and office space

allocated to full-time equivalents that handle exception processing. Thirteen financial

institutions provided data regarding account data exceptions, and fourteen provided data

regarding authorization-related exceptions. These costs were then divided by the volume of

exceptions to arrive at a cost per exception. Note that this data covers only the costs to RDFIs of

their ACH operations, and not additional costs related to customer contact and service via

branch, phone, Internet, etc., nor any compliance costs for Regulation E dispute resolution and

6 As measured by the number of debit and credit transactions returned bearing the R-codes R03 and R04.



NACHA rules for obtaining a customer’s written statement. Therefore, the cost calculations and

estimates below should be considered very conservative, understating “all-in” costs for these

exceptions.

Perhaps not surprisingly, reported costs varied widely, but also inversely correlate very strongly

with size (i.e., unit cost goes down as volume increases). Costs for handling administrative

errors and corrections ranged from a low of less than one cent per exception for a large RDFI

(that presumably has automated much of this work), to a high of $63.20 per exception for a small

RDFI (with a low volume of administrative exceptions over which to spread its fixed costs). The

average cost of per-exception handling among this group of RDFIs is $9.40. The “weighted

average” cost – which factors in each RDFI’s volume – is $0.26. This significant difference

between “average” and “weighted average” again shows the strong inverse correlation of unit

cost and volume.

As might be expected, the costs reported for unauthorized exceptions are significantly higher

than for administrative exceptions, but still correlate with size. Costs ranged from a low of $2.30

per unauthorized exception for a large RDFI, to a high of $509.09 per unauthorized exception for

a small RDFI. The average cost of per-unauthorized exception handling among this group of

RDFIs is $100.52. The “weighted average” cost – which factors in each RDFI’s volume – is

$4.99. As with administrative exceptions, this significant difference between “average” and

“weighted average” shows the strong inverse correlation of unit cost and volume.

Based on extrapolating the cost data reported by these 13 RDFIs, the cost of ACH operations to

all RDFIs of handling all 46,381,3717 account data-related returns in 2012 that would be covered

by the proposed Rule was $12.1 million on a weighted average basis.

Also based on extrapolating the cost data reported by these 13 RDFIs, the cost of ACH

operations to all RDFIs of handling all 11,527,812 8 NOCs in 2012 that would be covered by the

proposed Rule was $3.0 million on a weighted average basis.

Again, based on extrapolating the cost data reported by the 14 RDFIs, the cost of ACH

operations to all RDFIs of handling all 6,433,1629 authorization-related returns in 2012 that

would be covered by the proposed Rule was $32.1 million on a weighted average basis.

The total cost of ACH operations to RDFIs in 2012 for these three categories combined was

$47.2 million using a weighted average basis.

As noted above, these reported costs do not include other cost areas such as customer care. A

study in 2006 by Global Concepts (primarily of large and regional banks, using 2005 data)

estimated a median labor cost of $8.54 for an RDFI to obtain a customer’s written statement

7 This figure does not precisely match that of the research firm because they cover different time periods, though

both time periods reviewed cover 12 months. 8 This figure does not precisely match that of the research firm because they cover different time periods, though

both time periods reviewed cover 12 months. 9 This figure does not precisely match that of the research firm because they cover different time periods, though

both time periods reviewed cover 12 months.



contesting the validity of a transaction. If this cost figure is still valid, then RDFIs experienced

an additional $25.1 million in customer service costs in 2012 for these customer service contacts

related to ACH debits that consumers disputed as unauthorized. This raises RDFIs’ total costs

for exception handling in 2012 to approximately $72.3 million.

Via this RFC, NACHA solicits comments from other RDFIs on their costs to handle exceptions,

and welcomes the submission of cost data from additional RDFIs. A template for RDFIs to

report the cost to their ACH operations to handle exceptions will be provided on NACHA’s web

site accompanying this RFC.

Part IV: Fee Ranges for Evaluation

For the purpose of evaluating this proposed Rule, NACHA asks respondents to consider the

following ranges for each fee type. The proposed types and ranges of fees were developed and

recommended through a significant research effort conducted by an expert payments consulting

firm that included the RDFI cost data cited above. The firm’s methodology, analysis and

recommendations are appended to this rule proposal in the Appendix beginning at page 15.

For each type of fee and the suggested ranges, NACHA requests comment on whether a fee that

is within the suggested range, or some other specific fee amount, would have an appropriate

incentive effect to improve origination practices while not unduly impacting use of the ACH

Network (i.e., the fee should be viewed as fair to both the ODFI and RDFI).

1. Erroneous Data Fee – Evaluate a range of $0.10 - $0.40 per account data-related

return

For each return using the R-codes R02, R03, R04, R20, R24, R39, and R50, the ODFI would

be assessed a fee estimated to be in the range of $0.10 - $0.40, which would be passed

through to the RDFI. In 2012, there were a combined 46,381,371 returns using these R-

codes. An Erroneous Data Fee in this range would result in fees of $4.64 million to $18.55

million annually assessed to ODFIs and passed through to RDFIs.

Based on the industry average return rate for these combined R-codes in 2012 of 0.28

percent, the fee range would result in average cost per entry across all ODFIs of $0.00028 to

$0.0011.

ODFIs with returns rates significantly higher than the industry average would bear

proportionately higher per-entry costs. For example, an ODFI with an administrative return

rate of 1 percent would bear a cost of $0.001 to $0.004 per entry.

2. NOC Fee – Evaluate a range of $0.25 - $0.75 per NOC10

For each NOC using the change code reasons C01, C05, C06, C07, C08, C09, C13 and C14,

the ODFI of the underlying entry would be assessed a fee estimated to be in the range of

10

The change code reasons C02 and C03 relate to a change in routing information due to an RDFI’s merger or

consolidation, and so therefore are not proposed to be included within the scope of NOC Fees.



$0.25 - $0.75, which would be passed through to the RDFI of the underlying entry. In 2012,

there were a combined 11,527,812 NOCs using these C-codes.11

An NOC Fee in this range

would result in fees of $2.9 million to $8.6 million annually assessed to ODFIs and passed

through to RDFIs.

Based on the industry average rate for these combined C-codes in 2012 of 0.07 percent, the

fee range would result in average cost per entry across all ODFIs of $0.00017 to $0.00052

per entry.

ODFIs that receive NOCs at rates significantly higher than the industry average would bear

proportionately higher per entry costs. For example, an ODFI with an NOC rate of 1 percent

would bear a cost of $0.0025 to $0.0075 per entry.

3. Unauthorized Entry Fee – Evaluate a range of $1.50 - $2.50 per authorization-related

return

For each return using the R-codes R05, R07, R08, R10, R29, R37, R38, R51, R52 and R53,

the ODFI would be assessed a fee estimated to be in the range of $1.50 - $2.50, which would

be passed through to the RDFI. In 2012, there were a combined 6,433,162 returns using

these R-codes. An Unauthorized Entry Fee in this range would result in fees of $9.71 million

to $16.08 million annually assessed to ODFIs and passed through to RDFIs.

Based on the industry average return rate for these combined R-codes in 2012 of 0.066

percent, the fee range would result in average cost per entry across all ODFIs of $0.0010 to

$0.0017.

ODFIs with returns rates significantly higher than the industry average would bear

proportionately higher per entry costs. For example, an ODFI with an unauthorized return

rate of 1 percent would bear a cost of $0.015 to $0.025 per entry.

Total Cost Recovery of All Three Fee Categories

As described above, the total of all three categories of proposed quality fees ranges from a low of

$17.1 million annually to a high of $43.3 million annually. Compare this to the total estimated

annual costs to RDFIs of ACH operations described in the previous section of $47.2 million, not

including non-ACH operations costs, such as customer service. As recommended by the

research, the estimated fee levels do not represent full cost recovery for RDFIs, but do

acknowledge and attempt to ameliorate the significant cost of dealing with exceptions.

On a per-entry basis, the total of all three fees amounts to a range of $0.00147 to $0.00322. In

other words, an ODFI whose overall return/NOC rates are exactly at the industry average would

incur quality fees that amount to between $0.00144 and $0.00327 per entry. ODFIs with higher

rates would incur a greater amount of fees. An ODFI with a rate of 1 percent in each of the three

categories would incur fees on a per-entry basis of $0.0185 to $0.0385.

11

The change code C14 was added in March 2013; therefore there was no volume of C14 in 2012 included within

this total.



Part V: Other Topics

A. Insufficient Funds

High return rates for insufficient funds can often be a red flag for fraudulent or otherwise

problematic origination activity. Most ACH debit Originators, however, experience a much

lower, more routine level of NSFs over which they likely have very little control. Therefore,

returns of insufficient and uncollected funds are not proposed to be covered by the system of

incentive fees. NACHA requests comment on the appropriateness of excluding returns for NSF

from the proposed system of Quality Incentive Fees.

B. Check conversion

The existing NACHA rules for check conversion (ARC, BOC, and POP) require Originators to

use a reading device to capture the routing number and account number from the Receiver’s

check. With respect to the proposed Erroneous Data Fee, one view could be that ODFIs should

not be assessed a fee when the Originator has accurately obtained the routing and account

number from a check provided by the Receiver but subsequently receives a return with a code of

R03 or R04.

A different view could be that most R03 and R04 returns are due to misreads, and are not related

to transactions with accurate information. Additionally, under the NOC Fee proposal, RDFIs

would not receive fees due for NOCs that relate to merger and acquisition activity; therefore,

they would not be compensated for NOCs related to check conversion transactions originated

after the change in routing or account information.

On balance, NACHA believes the benefits to the ACH Network of assessing the Erroneous Data

Fee to discourage poor origination practices that are likely to result in R03 or R04 returns

outweigh the burden on Originators; and so check conversion transactions are proposed to be

included within the scope of the Erroneous Data Fee. NACHA specifically requests comment on

the applicability of the proposed Erroneous Data Fee to check conversion transactions.

C. Stopped Payment

As proposed, ODFIs would be charged an Unauthorized Entry Fee for each Return using the R08

(Payment Stopped) R-code. This is because high numbers of R08 Returns are often indicative

of a fundamental and pervasive problem with an ODFI’s origination practices such as deceptive

authorization processes or language, and inconvenient or unavailable cancellation mechanisms.

However, NACHA recognizes that in some cases, an R08 Return may result from the consumer

Receiver’s behavior without any fault of the ODFI or Originator. For example, an Entry may be

returned pursuant to the R08 R-code when a consumer stops the payment of an otherwise valid

Entry but fails to notify the Originator to prevent transmission of the Entry.

In determining whether to apply the Unauthorized Entry Fee to R08 Returns, NACHA must

balance the risk that ODFIs (and ultimately Originators) will be asked to pay some costs for

unavoidable Returns versus the significant burden that is imposed on the ACH Network and



other participants by Originators who trigger large volumes of R08 Returns as a result of poor

origination practices. On balance, NACHA believes the benefits to the ACH Network of

imposing a fee to discourage poor origination practices that are likely to result in R08 Returns

and compensate RDFIs outweigh the burden of a relatively small amount of R08 Returns that

any individual Originator might be asked to absorb as a result of occasional consumer error in

failing to notify the Originator. It is worth noting in this regard that the proposed fee would not

fully compensate RDFIs in any event. Nonetheless, NACHA specifically requests comment on

whether inclusion of the R08 Return strikes the right balance for enhancement of ACH Network

quality without unduly burdening ODFIs and Originators.

D. Collection and Disbursement of Fees

In order for a system of Quality Fees to function effectively, the fees must be assessed, collected

and disbursed accurately and timely. NACHA is currently exploring a number of options for

such a system, understanding that there may be specific features of any system that would make

the system either viable or unworkable for ACH Network participants.

Part VI: Examples

The following examples are provided to illustrate how Quality Fees might work in practice.

A. Payroll originator / ACH credit – An employer adds a newly hired employee to its payroll

Direct Deposit file. The first Direct Deposit intended for this employee has an incorrect

account number (perhaps key-entered incorrectly). The ACH credit in not postable at the

RDFI, and is automatically placed in an exceptions review queue. The RDFI’s ACH

Operations staff determines the correct account for posting the credit, and sends an NOC to

the ODFI of the ACH credit. The ODFI of the ACH credit would be assessed an NOC Fee,

which would be passed to the RDFI. Under this proposed Rule, the NOC Fee would be in

the range of $0.25 to $0.75.

Across all its 500 employees, the employer experiences just five Direct Deposit errors each

year (for example, an employee closed a bank account and didn’t inform the employer). The

total amount of the NOC Fees and Erroneous Data Fees assessed to its ODFI for the year is

likely to be no higher than about $2.50. Spread across 12,000 Direct Deposits annually, the

fees amount to $0.0002 per transaction.

B. Utility bill / ACH debit – A utility company customer goes to the company’s web site to pay

a bill. The customer enters his bank account number inaccurately. The resulting ACH debit

is returned by the RDFI as an R03 (No Account/Unable to Locate Account). The ODFI of

the ACH debit would be assessed an Erroneous Data Fee for this account data-related return,

which would be passed to the RDFI. Under this proposed Rule, the Erroneous Data Fee

would be in the range of $0.10 to $0.40.

Across all its customers, the utility company has an administrative return rate of 0.05 percent

(i.e., 1 in every 2,000). It originates 1 million ACH debits per year, resulting in 500

administrative returns. The total amount of the Erroneous Data Fees assessed to its ODFI for



the year would be between $50 - $200. Spread across its 1 million origination volume, the

fees amount to $0.00005 to $0.00020 per transaction.

C. High-risk Originator / ACH debits – An online payday lender collects customers’ routing and

account numbers while enrolling them for payday loans. During a calendar month, the lender

originates 10,000 ACH debits to collect loan payments, of which 15 percent are returned

collectively as R02, R03 and R04, and another 1 percent are returned as R10. Additionally,

the lender resubmits all NSFs, and 500 of those are returned R08 (stop payment).12

Collectively, within this calendar month, the lender has received 1,500 account data-related

returns and 1,000 authorization-related returns. The ODFI of the lender would be assessed

Erroneous Data Fees on the 1,500 administrative returns; and Unauthorized Entry Fees on the

600 authorization-related returns. Under this proposed Rule, the Erroneous Data Fee would

be in the range of $0.10 to $0.40, so the total to the ODFI would be between $100 and $400.

Under this proposed Rule, the Unauthorized Entry Fee would be in the range of $1.50 to

$2.50, so the total to the ODFI would be between $900 and $1,500.

If this level of return activity persisted across a full calendar year, the total amount of the

Erroneous Data Fees assessed to its ODFI would be between $1,200 and $4,800; and the total

amount of the Unauthorized Entry Fees assess to its ODFI would be between $10,800 and

$18,000. Spread across the lender’s annual volume of 120,000 debits, the total fees amount

to $0.10 to $0.19 per transaction.

D. Bill payment scam / ACH debits – A scam is perpetrated in which unsuspecting consumers

are informed that “President Obama will pay your bills” if they would just provide their

Social Security Numbers in exchange for the “correct” routing and account numbers to use.

These consumers use these routing and account numbers on several billers’ web sites to

“pay” their bills. Because the billers do not receive returned ACH debits for 2 days, the

consumers think their bills really have been paid successfully, and through social media

platforms encourage their families and friends to do the same thing. Before too long, 50,000

ACH debits from several dozen national and local billing companies have been originated

using a single RDFI’s otherwise valid routing number. The RDFI is able to return all 50,000

debits timely as R04s. The ODFIs of the debits are assessed Erroneous Data Fees on each of

the R04s, all of which would be passed to the single RDFI. Under this proposed Rule, the

Erroneous Data Fee would be in the range of $0.10 to $0.40, so the victimized RDFI in this

case would receive recompense of between $5,000 and $20,000.13

12

A concurrent and complementary proposed rule would establish return rate thresholds for certain categories of

returns, and for an overall return rate (see https://www.nacha.org/page/request-comment). The ODFI of an

Originator with return rate as shown in this example could also be subject to enforcement and sanctions or fines for

exceeding those return rate thresholds. 13

Billers could seek to avoid Erroneous Data Fees in such a circumstance by validating account information when a

customer uses new routing and/or account information, or by performing “velocity checks” to detect multiple or

repeated use of the same routing and account information across multiple billing accounts.




Part VII: Impact of the Proposal

Benefits of the Proposal

Arguably, all ACH Network participants will experience at least some indirect benefit through

higher quality, fewer exceptions, greater customer satisfaction, and lower reputational risk for

the Network. Any beneficial impact of the proposed Rule on ACH Network quality should be

visible through monitoring of the return and NOC activity covered by the proposed Rule.

While ODFIs will directly bear the costs of the Quality Fees, the system of fees might encourage

ODFIs to perform enhanced risk management and monitoring of Originators with high volumes

or rates of entries that result in exceptions. Conceivably, service providers will bring new tools

and services to market to enable ODFIs to avoid some Quality Fees. ODFIs might be able to

provide new tools and services to Originators. Ultimately, the goal is to incent different actions

to improve overall Network quality, recognizing that this is only one aspect of risk management

and quality focus of the ACH Network.

RDFIs will directly benefit from the Quality Fees that are passed to them, which will provide a

partial cost recovery for externally-imposed costs. Of perhaps greater benefit, any reduction in

the number of exceptions will also directly benefit RDFIs through the direct avoidance of costs

that would have been caused by those exceptions, and indirectly through fewer customer service

contacts and less dissatisfaction.

Receivers would directly benefit from fewer unauthorized entries or other entries that result in

exceptions.

While Originators would likely bear at least some of the costs initially borne by their ODFIs, it is

conceivable that as a result of this focus on exceptions their ODFIs and other service providers

would bring new tools and services to market to reduce the number of transactions that cause

exceptions and help discourage bad actors from using the ACH Network.

Costs to Comply with the Proposal

ODFIs would directly bear the costs of the Quality Fees. Further, ODFIs would have costs to the

extent that they work with their Originations to implement systems, processes and tools to lower

return rates. Success in lowering return rates, however, would lessen the cost burden of fees.

The proposed Rule does not require or envision that RDFIs would need to make changes to their

exception handling. Therefore RDFIs would not incur direct costs due to changes in exception

handling. RDFIs would likely have some costs to implement systems to account for the receipt

of Quality Fees.

Either the ACH Operators or NACHA, or both, likely would incur costs to implement a system

to assess, collect and disburse Quality Incentive Fees.

Receivers likely would not incur any costs as a result of this proposed Rule.



Originators would likely bear at least some of the costs initially borne by their ODFIs, such as

through transaction, returns, and other service fees. Alternatively, Originators might incur other

costs in an attempt to improve the quality of their origination, for instance, by implementing new

processes to detect “fat-fingering” of account information.

Part VIII: Effective Date

This Rule is proposed to become effective on March 19, 2015, which should provide sufficient

time for the industry to prepare and implement. NACHA and the ACH Operators will need time

to generate the data to determine the collection and disbursement of the fees. ODFIs and RDFIs

will need time to properly account for fees paid and received. ODFIs will need time to work

with their Originators, if desired, on implementing systems, tools and processes to reduce returns

and thereby minimizing fees they incur.

Part IX: Rules Framework

The proposed Rule would add a new Section in Article One (General Rules) to establish “Quality

Fees.” One subsection establishes the obligation of the ODFI to pay the fees to the respective

RDFIs. A second subsection establishes the authority of the NACHA staff, and the methodology

used, to determine the specific amounts of the Quality Fees. The Quality Fees would further be

defined in Article Eight (Definitions).



Request for Information

Part X: NACHA Requests Information on Additional Concept of a Prenote Validation Fee

In addition to the proposed Rule on Improving ACH Network Quality described above, NACHA

also requests information on a related but separate idea that would also improve ACH quality by

providing an incentive for ODFIs and RDFIs to make fuller use of the existing prenotification

transaction and process. The concept is as follows:

A fee paid by the ODFI to the RDFI for a new type of NOC in which an RDFI responds to a

prenote when the account information in the prenote is valid (“Prenote Validation Fee”).

The new NOC would be defined to mean that the RDFI has validated the account information in

the prenote and that it is correct. For such an NOC, a fee would be paid by the ODFI of the

prenote and passed through to the RDFI.14

This concept would support NACHA’s efforts to address Originators’ stated desire for the ACH

Network to support account validation. This desire for account validation has been documented

in several recent NACHA surveys. Originators today might be hesitant to use a prenotification

because, among other reasons, they do not receive a response when the account information in

the prenote is valid. The basic framework is structured as “no news is good news.” Some

Originators might use, or increase their use of, prenotes if they knew they would receive a

response regardless of whether the information was valid or invalid.

An initial step in a separate rulemaking will reduce an Originator’s “waiting period” for initiating

live entries after sending a prenote, from six to three Banking Days.15

Additional future steps

could include ways to further quicken the prenote process and/or provide validation of additional

account or balance information. These future steps could result in additional Rules proposals or

other projects. Each of these measures could provide progressively more information to more

robustly provide value associated with account validation.

While a Prenote Validation Fee itself is not directly an incentive for ODFIs to improve quality

based on a return or a correction to a specific transaction, functionally it is nearly identical to the

NOC Fee being proposed, and so therefore could be implemented utilizing the same NOC Fee

rules and implementation framework. Further, a Prenote Validation Fee could be an incentive

for Originators to make fuller use of prenotes if the value of receiving an explicit, positive

response from the RDFI justifies the amount of the fee.

Under such a concept, an Originator sending a prenote would be assured of receiving a response,

which would take one of three forms:

An NOC meaning “account number is valid”;

14

As with the “NOC Fee,” the Prenote Validation fee would be paid by the ODFI of the prenote, and passed to the

RDFI that initiates the NOC. 15

Effective September 19, 2014.



An NOC meaning “account number is not valid and corrected data is included;” or

A return.

For purposes of evaluating the concept of a Prenote Validation Fee, NACHA suggests the same

range as for the NOC Fee – i.e., $0.25 to $0.75 per NOC sent in response to a prenote meaning

that the account information is valid. Because the RDFI is sending a NOC to indicate either that

the account information is valid or invalid, presumably the same fee amount would be both

appropriate, and easier to implement that some different fee amount.



Appendix A

Part XI: Research Performed by Payments Industry Consultants

NACHA engaged a payments industry consulting firm to perform research into the benefits,

costs, impacts, and feasibility of a system of ACH quality fees. It is worth quoting directly from

the research paper at length:16

Executive Summary

The purpose of the proposed incentives is to reduce the incidence of ACH exceptions –

which is a goal of NACHA’s Risk Management Strategy – while providing some cost

recovery to RDFIs for the expense of handling returns and exceptions caused by

Originator practices. By ensuring the efficiency of operations and fairness for all

participants, ACH Quality Incentives should help the ACH Network remain relevant and

competitive in an increasingly demanding payments environment.

These concepts should not be seen as the complete solution for ACH quality issues. They

do not replace the NACHA system of fines and enforcement actions already in place to

address rules violations. The ACH Network should also continue to develop operational,

technical and commercial approaches to improve quality. Rather, the proposed

incentives should be seen as part of a process of continuous improvement.

Background

The ACH Network relies on ODFIs and their Originators to ensure the accuracy and

validity of ACH entries submitted for clearing. Originators are also responsible for

obtaining and maintaining authorization from Receivers for ACH debit entries, and for

obtaining routing data from Receivers for both debits and credits.

While the vast majority of Originators cause few problems, others create problems for

ODFIs, Receivers and especially RDFIs. In some instances, the problems result from

poor operational practices – such as not checking for accurate routing and account data,

or the failure to discontinue pre-authorized Direct Payments when requested by

Receivers. Other problems have less benign causes such as fraudulent debit origination

or payments related to scams. Some Originators have high return rates because they are

in high-risk businesses. Poor customer communications can result in high return rates for

some Originators if Receivers do not understand that they will be debited, or do not

recognize the name of the parties debiting their accounts. Regardless of the cause, poor

quality of origination can result in inconvenience for Receivers, return and regulatory risk

for ODFIs, and additional cost for RDFIs.

16

Most of the substantive portions of the research paper are quoted here, with some editing and paraphrasing for

length and clarity.



The ACH Network has made remarkable strides in reducing unauthorized entries.

Nonetheless, nearly 3 million ACH debits are returned unauthorized every year, and an

additional 3 million ACH debits are returned for other reasons that are related to

authorization. In addition, more than 45 million entries are returned every year because

of problems with account data.

ACH Quality Framework

When designing a program to incent different behavior or actions, it is essential to

balance several factors. The first is to define what the program is intended to accomplish,

i.e., its objectives. It is also important to understand and mitigate the potential for

unintended consequences. The program should not be overly complex, which can lead to

difficulty in implementation. And the program should be perceived as fundamentally fair

– which can be difficult to achieve when there are multiple points of view.

(We) employed the following framework for developing and evaluating quality incentive

options – including objectives, design considerations and potential incentive types.

Quality Incentive Objectives

Improved Quality: The primary objective is to reduce ACH exceptions, either by

increasing the cost of poor quality (disincentive), or potentially decreasing the cost of

higher quality (incentive).

Cost Recovery: The program should also help financial institutions recover some of

the cost of poor quality. In most cases, this means providing for at least some cost

recovery to the RDFI for the work they are obligated to perform to correct problems

caused by the Originator. Successfully reducing exceptions would also provide

RDFIs with a second benefit – reducing exception costs in proportion to that

reduction in the volume of exceptions.

Simplicity: The program should be easy for participants to understand, easy to

implement, and easy to maintain.

Maintain Ubiquity: The program should encourage continued RDFI participation in

the ACH Network, and should not in any way compromise the ubiquity of the ACH

Network by placing unreasonable restrictions on origination, creating excessive costs

for Originators or ODFIs, or imposing technical requirements that become a barrier

for participation.

Minimize IT and Operational Requirements: The program needs to be universal.

Any change or investment ODFIs or RDFIs need to make becomes an impediment to

adoption, and Operator IT modifications delay implementation.

Proactive Solutions: The program should encourage the development of network

and third-party solutions to quality problems, either directly by providing funds for

solution development, or indirectly by creating a business case for ODFIs to improve

quality. For example, ODFIs might pay for an account validation service if it allows

them to avoid paying fees for incorrect data.



Don’t discourage the use of ACH: Financial incentives or disincentives should not

significantly increase the cost of origination, either directly or indirectly, to the extent

that they undermine the attractiveness of ACH as a payment option.

While the program will provide an economic incentive for improving the quality of

forward work, penalizing bad practice is not the primary objective of the quality incentive

program. NACHA already has a system of fines and enforcement actions to deal with

rule violations and other harmful behaviors.

* * *

Potential Incentive Types

Return Fee: a surcharge on each returned entry (may apply to only some SECs or

return codes);

Exception Fee: a charge to the ODFI for certain types of RDFI exceptions caused by

poor origination data – regardless of whether the item is returned;

NOC Fee: a surcharge on each NOC (COR SEC Code) received by a financial

institution;

Threshold-Based Incentive: a fee that only applies to ODFIs that exceed a

designated return rate for a certain class of returns;

Tiered-Incentive: a fee that varies based on quality metrics, exception/return rates

or exception/return volumes, and that may include tiers that are wholly exempt from a

fee;

Discounts/Allowances: a deduction from the volume of returns subject to a fee, in

order to account for exceptions that are beyond the control of the ODFI or Originator;

Forward Item Cost Tiers: surcharging forward item fees based on Originator return

rate.

Return fees and NOC fees are preferable to exception fees because they are simpler to

administer. Returns and NOCs are already handled through the network. Exceptions that

do not result in returns or NOCs would need to be tracked, and would be subject to

dispute by ODFIs.

Thresholds and tiers make it possible to tailor fees to enhance their incentive effect,

address concerns about fairness and mitigate the cost of “normal” levels of returns.

However, thresholds and tiers are much more complicated to administer, and would

require additional technical implementation.

Analysis of ACH Returns

At the Network level, ACH exceptions generally result in returned entries. The reason

for an ACH return is denoted by a return reason code. There are 55 return reason codes,

some of which apply to all types of ACH entries, and others that are only used for

designated SEC codes.



Most returns can be grouped into three categories of return codes, according to the

underlying cause of the return:

1. Funding Issues – returns due to insufficient funds, uncollected funds or frozen

accounts

2. Account Data Issues – returns due to incorrect account data or a problem with the

account, including invalid account numbers, inability to locate the account, closed

accounts, deceased account holder or deceased beneficiary

3. Authorization Issues – returns due to a problem with authorization, including

unauthorized, revoked authorization, stopped payments or RDFI customer disputes.

This look at return rates points to a several key insights with respect to the three main

categories of returns:

Funding Issues (i.e., insufficient funds) are the majority of returns, in most cases

reflecting an inherent aspect of debit payments.

o Unlike other returns, RDFIs are usually compensated for insufficient funds

returns by the Receiver.

o Among ACH debits, however, some have much lower return rates – notably

ARC, CCD and POP.

o The low return rate for POP is likely because these transactions are typically

screened at the point of sale using check verification or guaranty services.

o More widespread use of verification, guaranty or online authorization may

reduce the NSF return rate for other types of ACH debit transactions.

Account Data Issues are the most widespread cause of quality exceptions (as opposed

to NSF) occurring at a rate of 0.28 percent of ACH entries originated. In addition,

another 0.11 percent of entries result in account-data corrections – NOCs and thereby

avoided a return. In most cases, both administrative returns and NOCs are the result

of Originator errors. As such, these are a prime focus of ACH quality incentive.

Authorization Issues are the other significant cause of quality-related returns. As a

point of comparison, the authorization-related return rate for ACH (0.05 percent) is

slightly lower than reported fraud rates for credit cards (0.07 percent) and signature

debit cards (0.06 percent). This is impressive when you consider that the ACH

Network has no online authorization process. However, unauthorized debits can

cause harm to RDFIs and Receivers, and are a significant source of costs to RDFIs.

These three categories accounted for 97 percent of all ACH returns in the 12 months

ending in the 2nd

quarter 2012 (the period we studied); we focus our attention on quality

incentives on the latter two categories.



ACH Quality Incentive Options

(We) evaluated three potential incentives that meet the operational imperatives of: (1)

addressing issues that have a significant impact on ACH participants, and (2) allowing for

Originator or ODFI actions to modify behavior and reduce their exceptions.

ODFI fees for Account Data returns

o Fees charged to ODFIs and passed through to RDFIs related to the cost of

handling exceptions caused by account data issues

o Assessed on returns with reason codes R02, R03, R04, and R20.

ODFI fees for Authorization debit returns

o Fees charged to ODFIs and passed through to RDFIs related to the cost of

handling disputed or revoked authorization – only for debit entries

o Assessed on returns with reason codes R05, R07, R08, R10, R29, R38, R39,

R50, R51, R52 and R53.

ODFI Fees for Correction Entries (NOCs)

o Fees charged to FIs that receive NOCs, passed through to the FI originating

the NOC, related to the cost of correcting account data and avoiding a return.

For each of the two return categories (Account Data and Authorization), (we) developed

five alternative types of fees to assess:

1. A fee charged for all returns in the return category;

2. A fee charged only for returns involving select SEC codes;

3. A fee minus a discount, to allow for returns outside the control of the Originator;

4. A tiered fee, with no charge for an ODFI’s returns below a target return rate, and a

fee for all returns in excess of that rate;

5. A threshold fee, with no charge if an ODFI’s returns are below a target return rate,

but if the ODFI’s return rate exceed the threshold, the fee applies to all of its returns

(not just those that exceed the threshold).

As a general principle, a quality incentive fee should be commensurate with the costs

incurred by RDFIs due to exceptions. More expensive types of exceptions should be

subject to higher return fees. The optimal fee will be different for each type of

exception. Account data exceptions occur about once in 400 entries (i.e., approximately

0.25 percent), and much of the handling is automated. Authorization exceptions occur

much less frequently, affecting about one in 2,000 entries (i.e., approximately 0.05

percent). They are also relatively costly for RDFIs to handle, because they usually

involve a disputed transaction with a customer service interaction, and frequently a

Written Statement of Unauthorized Debit. These factors call for a relatively higher fee

for authorization returns.

The incidence of NOCs falls in between these the two return categories, occurring once

in 900 entries (11 basis points). NOCs require the RDFI receiving an error-containing



ACH to correct account data and take the extra step of sending the NOC, but usually

without any customer interaction. NOCs also present a unique opportunity for incentives

to have a direct impact on quality. Although a Notification of Change (NOC) is the ACH

Network’s standard approach to correct information errors, current practice among

RDFIs and ODFIs is inconsistent. Preparing NOCs is an additional expense for RDFIs,

so some simply create routing tables to post entries with erroneous data without notifying

ODFIs. Conversely, ODFIs depend on Originators to make corrections in response to

NOCs, but compliance by Originators varies. Originators often fail to respond to NOCs,

continuing to generate entries with incorrect data. An incentive fee would encourage

RDFIs to originate NOCs, and would increase the cost to ODFIs of not responding to

NOCs.

Recommendations

Based on (our research) and the financial impact analysis on overall ACH and

participating FIs, we recommend the following incentives for consideration by NACHA:

1. NOCs (COR SEC code): a flat fee for every Notification of Change. The fee is paid

by the ODFI of the original entry to the RDFI of the original entry. Such a fee should

have a direct incentive effect, because it encourages both sides of the transaction to

respectively initiate or respond to NOCs – and therefore improve ACH quality. In the

interest of simplicity, there would be no attempt to identify repeat NOCs or failure to

respond to NOCs.

2. Account data returns: a flat fee for every return. A tiered-fee was rejected due to the

significantly higher complexity and cost of implementing and administering tiers, as

well as the unpredictability of RDFI cost recovery levels due to different average fees

paid by ODFIs.

3. Authorization debit returns: a flat fee for every return. Again, a tiered-fee was

rejected due to the significantly higher complexity and cost of implementing and

administering tiers, and the unpredictability of RDFI cost recovery.

Together, these fees would:

Provide cost recovery to RDFIs to offset the cost of handling exceptions, which costs

include receiving customer service calls, researching unpostable entries and initiating

the return entry itself

Create incentives to justify the cost of reducing account data and authorization

exceptions, which may be enough to encourage the development of account

validation and fraud reduction utilities

Keep the average cost per ACH transaction low enough for most ODFIs to avoid any

negative impact on usage or ubiquity.

As with almost all changes, these recommended concepts are not without shortcomings.

For one, a fee for unauthorized returns likely would be significantly lower than the actual



cost of handling customer disputes for most RDFIs. The offsetting argument, however, is

that higher fees would increase the average cost per ACH entry to a level that might

begin to discourage ACH usage. Further, by setting the fee for authorization returns at a

level well below the cost of these exceptions to RDFIs, the recommended level

essentially provides ongoing incentive to both to continue to address the causes of

exceptions.

For another shortcoming, flat fees do not address concerns about ODFIs being charged

for problems they do not cause, e.g., spurious authorization disputes. That said, tiered

fees – while potentially with greater incentive effects – would create uncertain and

varying (cost recovery), and would be expensive to implement and maintain.

Overall (we) believe the proposed fees should strike the right balance between incentive

effect, RDFI cost recovery, simplicity and fairness. They also should leave unrecovered

enough of RDFI exception cost to encourage RDFIs to support solutions to further reduce

exceptions.

(We) believe that the recommended fees should provide a reasonably compelling

incentive for ODFIs – especially those with high return rates – to take steps to reduce

exceptions. They would provide cost recovery to RDFIs for at least some of the costs

they incur. Developers of utilities to validate account data or prevent fraud should find a

ready market among ODFIs seeking to avoid return fees, and among RDFIs seeking to

reduce exception costs. To the extent that ODFIs take steps to reduce return rates, the

ACH Network will become even more efficient and reliable, reducing cost and risk for all

participants.

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