United States: Financial Services Alert

Over the last 18 months there has been an increasing recognition by members of Congress that there is a need for federal legislation to establish a uniform standard for engaging in electronic commerce nationwide. Last week this federal legislation moved substantially closer to becoming a reality with the passage of S. 761, the Electronic Signatures in Global and National Commerce Act (the "Act" or "S. 761"), in the House of Representatives by a vote of 426 to 4, and in the Senate on a vote of 87 to 0. The President is expected to sign the legislation in the next 2 weeks.

Companies trying to establish an online presence have moved from merely displaying or posting service and product information on their websites to developing more sophisticated and interactive services. Many websites now offer consumers checking and savings accounts, credit cards, multiple loan products, the ability to transfer funds, the ability to view account activity from home or the office, the ability to receive and pay bills, the ability to trade securities or the ability to shop for and purchase insurance products. Although most financial transactions may be initiated online, much of the fulfillment process historically has occurred offline because many laws require documents to be manually or physically signed. In addition, many of the relevant consumer protection laws require that disclosures and other product and service information be provided to consumers "in writing."

The benefits of S. 761 thus are far-reaching, offering consenting parties the ability to substantially eliminate the offline, written transaction process described above. Financial services providers now will be able to deliver a wide range of products and services (e.g., mortgages, insurance, securities) to consumers electronically. For example, in the mortgage context, a consumer could apply for a mortgage to buy a new home with an online lender and elect to conduct the transaction electronically, including receiving federal and state disclosures online. After receiving approval through an automated underwriting system, the borrower and the lender could conduct an electronic closing with the note and mortgage created as an electronic record under the procedures set forth in S. 761. The ability to perform a totally electronic transaction should produce enormous cost savings and increased efficiencies in the delivery of financial services for consumers and businesses alike.

This Article summarizes the principal elements of S. 761. Generally, the legislation is an overlay statute (that is, one that is superimposed on existing federal and state laws) that gives legal force and effect to "electronic signatures" (defined as an electronic sound, symbol or process, attached to or logically associated with a contract or other record and executed or adopted by a person with the intent to sign the record) and

"electronic records" (which include notices and disclosures or any writing communicated by electronic means). As summarized below, the legislation sets forth a general rule of validity for electronic signatures and electronic records. Further, before a provider can use electronic delivery methods for the provision of government mandated disclosures, the consumer must affirmatively consent to the electronic delivery option (the details of the consent process are set forth below). In addition, S. 761 provides for federal preemption with respect to the use of electronic signatures and records (subject to the ability of a state to supersede the federal law in limited instances), and contemplates that (subject to the limitations described below) state and federal regulators will be able to adopt regulations which interpret the legislation. More specifically, the principal elements of S. 761 are as follows:

(1) The general rule of validity is that a signature, contract, or other record related to any "transaction" in or affecting interstate or foreign commerce may not be denied legal effect, validity, or enforceability solely because it is in electronic form.

(2) S. 761 only affects laws imposing writing or signing requirements.

(3) The legislation does not affect -

• substantive protections of consumer protection laws;

• the content or timing of disclosures required by law; or
• any requirement by a federal regulatory agency, self-regulatory organization, or state regulatory agency that records be filed in a specified standard (e.g., on paper).

In addition, the Act does not affect -

• laws governing the creation and execution of wills, codicils, or testamentary trusts;
• laws governing adoption, divorce, or other matters of family law;
• the Uniform Commercial Code, as in effect in any State, other than sections 1-107 and 1-206 and Articles 2 and 2A;
• court orders or notices, or official court documents (including briefs, pleadings, and other writings) required to be executed in connection with court proceedings;
• any notice regarding the cancellation or termination of utility services (including water, heat, and power);
• any notice regarding default, acceleration, repossession, foreclosure, or eviction, or the right to cure, under a credit agreement secured by, or a rental agreement for, the primary residence of an individual;
• any notice regarding the cancellation or termination of health insurance benefits or life insurance benefits (excluding annuities); or
• any notice regarding the recall of a product, or material failure of a product, that risks endangering health or safety.

It is important to note that S. 761 does not specify exactly what an electronic signature should look like, but rather allows financial institutions to determine for themselves the technology that is most effective for their company. The choices could range from a single string of numeric code that is encrypted to electronic scanners that read thumbprints or eye patterns.

Consumers (i.e., individuals for personal, family, and household purposes) receive special protection under the Act. Electronic records may be used to satisfy any law that requires that records be provided to consumers "in writing" only if the consumer has affirmatively consented to the use of the electronic records, and has not withdrawn such consent.

Prior to obtaining consent, the electronic record provider must deliver a clear and conspicuous statement informing the consumer of:

(1) any right or option of the consumer to have the record provided or made available in paper form;

(2) the right of the consumer to withdraw consent and any conditions or consequences (which may include termination of the parties’ relationship) of such a withdrawal;

(3) whether the consent applies (i) only to the particular transactions which gave rise to the obligation to provide the record, or (ii) to all identified categories of records that may be provided during the course of the parties’ relationship;

(4) the procedures the consumer must use to withdraw consent and to update information needed to contact the consumer;

(5) whether the consumer may after consenting, upon request, obtain a paper copy of the electronic record and whether any fee will be charged for such a copy; and

(6) the hardware and software requirements for access to and retention of the electronic records.

Importantly, a consumer must consent electronically, or confirm his or her consent electronically, in a manner that "reasonably demonstrates" that the consumer can access information in the electronic form that will be used to provide the information that is the subject of the consent.

Additionally, after the consumer has consented, if there is a change in the hardware and software requirements needed to access or retain the electronic records that creates a material risk that the consumer will not be able to access or retain subsequent electronic records, the consumer must be provided with a statement of the revised hardware and software requirements that also repeats the right to withdraw consent. Moreover, the provider of the electronic records must again comply with the access verification provisions.

An extremely significant aspect of S. 761 is the preemption of state laws. Because the Internet is a borderless medium, it cannot efficiently accommodate a patchwork of state rules regarding the electronic delivery of disclosures and signatures. S. 761 applies to transactions in or affecting interstate commerce and generally may be used to satisfy both federal and state law disclosure and/or signature requirements. The legislation does provide, however, that states may modify, limit or supersede the federal law if such state action constitutes an adoption of the Uniform Electronic Transactions Act ("UETA") as approved by the National Conference of Commissioners on Uniform State Laws in 1999. UETA functions similarly to S. 761 in that it is an overlay statute that provides legal validity to electronic signatures and records.

Notably, however, although UETA does differ from the Act, the Act overrides many provisions of UETA that otherwise would undermine the uniform application of S. 761. For example, section 3(b)(4) of UETA permits states to exclude by exemption specified state statutes from the benefits of UETA. A good example of a state using this discretionary authority is California, which exempted approximately 65 statutes, many of which were consumer protection statutes. Significantly, S. 761 overrides this by stating that "any exception to the scope of [UETA] enacted by a State under section 3(b)(4) of [UETA] shall be preempted to the extent such exception is inconsistent with this title." In addition, section 8(b)(2) of UETA allows states to specify the method of delivery for documents, disclosures and similar items, such as the U.S. mail. The Act overrides this by not permitting a state to circumvent the general rule of validity for electronic records through the imposition of non-electronic delivery methods under section 8(b)(2) of UETA. Accordingly, the Act appears to allow electronic signatures in many areas that may not otherwise be permissible by UETA.

Alternatively, under a second component to the preemption provisions, a state may modify, limit, or supersede S. 761 if it specifies alternative procedures or requirements for the use and/or acceptance of electronic records or electronic signatures. The alternative provisions, however, would need to be consistent with the Act’s general rule of validity for electronic signatures or records and, if enacted after the date of enactment of S. 761, the state law would need to reference specifically S. 761, an enacted.

The legislation does not affect any requirement by a state or federal regulatory agency that records be filed with such agency in accordance with specified standards. This provision therefore would allow state or federal regulators to still require paper filings with such bodies until such time as they could accept electronic filings.

S. 761 also provides that state and federal regulatory agencies may interpret the legislation pursuant to their rulemaking authority under another statute. There are many hurdles, however, that a regulator would need to overcome before issuing regulations interpreting the legislation. The regulatory action would only be permissible if:

• the action does not impose or reimpose any requirement that a record be in tangible or printed (i.e., paper) form;
• the regulation is consistent with S. 761;
• the regulation does not add to the requirements of S. 761;
• there is substantial justification for the regulation;
• the method is substantially equivalent to the requirements imposed on records that are not electronic records;
• the method will not impose unreasonable costs on the acceptance and use of electronic records; and
• the method d oes not require the implementation or application of a specific technology.

Importantly, a federal regulatory agency may, by regulation or order, exempt a specified category or type of record from the standard additional requirements relating to consumer consent (described above) if such exemption is necessary to eliminate a substantial burden on electronic commerce and will not increase materially the risk of harm to consumers.

The legislation generally becomes effective on October 1, 2000, with the record retention provision becoming effective on March 1, 2001 (documents that are required to be retained by state and federal law will not have the benefit of the legislation until the later effective date). If on or before March 1, 2001, however, a state or federal regulator has initiated a rulemaking proceeding concerning record retention performance standards, the Act’s record retention provisions will become effective June 1, 2001. With respect to certain transactions guaranteed or insured by the U.S. Government, the effective date of the Act is one year after the date of enactment.