What is the Red Flags Rule?

Are you complying with the Red Flags Rule? What is it and who does it apply to? The Red Flags Rule sets out how certain businesses and organizations must develop, implement, and administer their Identity Theft Prevention Programs. Your Program must include four basic  elements, which together create a framework to address the threat of identity theft.

First, your Program must include reasonable policies and procedures to identify the “red flags” of identity theft you may run across in the day-to-day operation of your business. Red flags are suspicious patterns or practices, or specifi c activities, that indicate the possibility of identity theft. For example, if a customer has to provide some form of identification to open an account with your company, an ID that looks like it might be fake would be a “red flag” for your business.

Second, your Program must be designed to detect the red flags you’ve identified. For example, if you’ve identified fake IDs as a red flag, you must have procedures in place to detect possible fake, forged, or altered identification.

Third, your Program must spell out appropriate actions you’ll take when you detect red flags.

Fourth, because identity theft is an ever-changing threat, you must address how you will re-evaluate your Program periodically to reflect new risks from this crime. Just getting something down on paper won’t reduce the risk of identity theft. That’s why the Red Flags Rule sets out requirements on how to incorporate your Program into the daily operations of
your business. Your board of directors (or a committee of the board) has to approve your first written Program. If you don’t have a board, approval is up to an appropriate senior-level employee. Your Program must state who’s responsible for implementing and
administering it eff ectively. Because your employees have a role to play in preventing and detecting identity theft, your Program also must include appropriate staff  training. If you outsource or subcontract parts of your operations that would be covered by the Rule, your Program also must address how you’ll monitor your contractors’ compliance.

The Red Flags Rule gives you the flexibility to design a Program appropriate for your company – its size and potential risks of identity theft. While some businesses and organizations may need a comprehensive Program that addresses a high risk of identity theft in a complex organization, others with a low risk of identity theft could
have a more streamlined Program.

Related Article: Red Flags Rule Video.

Who must comply with the Red Flags Rule?

The Red Flags Rule applies to “financial institutions” and  “creditors.” The Rule requires you to conduct a periodic risk assessment to determine if you have “covered accounts.” You need
to implement a written program only if you have covered accounts.  It’s important to look closely at how the Rule defines “financial institution” and “creditor” because the terms apply to groups that might not typically use those words to describe themselves. For example, many non-profit groups and government agencies are “creditors” under the Rule. The determination of whether your business or organization is covered by the Red Flags Rule isn’t based on your industry or sector, but rather on whether your activities fall  within the relevant definitions.

Financial Institution

The Red Flags Rule defines a “financial institution” as a state or national bank, a state or federal savings and loan association, a mutual savings bank, a state or federal credit union, or any other person that, directly or indirectly, holds a transaction account belonging to a consumer. Banks, federally chartered credit unions, and savings and loan associations come under the jurisdiction of the federal bank regulatory agencies and/or the National Credit Union Administration. Check with those agencies for guidance tailored to those businesses. The remaining financial institutions come under the jurisdiction of the FTC. Examples of financial institutions under the FTC’s jurisdiction are state-chartered credit unions, mutual funds that offer accounts with check-writing privileges, or other institutions that offer accounts where the consumer can make payments or transfers to third parties.

Creditor The definition of “creditor” is broad and includes businesses or organizations that regularly defer payment for goods or services or provide goods or services and bill customers later.

Utility companies, health care providers, and telecommunications companies are among the entities that may fall within this definition depending on how and when they collect payment for
their services.. The determination of whether your business or organization is covered by the Red Flags Rule isn’t based on your industry or sector, but rather on whether your activities fall within the relevant definitions.

The Rule also defines a “creditor” as one who regularly grants loans, arranges for loans or the extension of credit, or makes credit decisions. Examples include finance companies, mortgage
brokers, real estate agents, automobile dealers, and retailers that offer financing or help consumers get financing from others, say, by processing credit applications. In addition, the definition includes anyone who regularly participates in the decision to extend, renew, or
continue credit, including setting the terms of credit – for example, a third-party debt collector who regularly renegotiates the terms of a debt. If you regularly extend credit to other businesses, you also are covered under this definition.
Covered Accounts

Once you’ve concluded that your business or organization is a financial institution or creditor, you must determine if you have any “covered accounts,” as the Red Flags Rule defines that term. To make that determination, you’ll need to look at both existing accounts and new ones. Two categories of accounts are covered.

The first kind is a consumer account you offer your customers that’s primarily for personal, family, or household purposes that involves or is designed to permit multiple payments or transactions. Examples are credit card accounts, mortgage loans, automobile loans, margin
accounts, cell phone accounts, utility accounts, checking accounts, and savings accounts.

The second kind of “covered account” is “any other account that a financial institution or creditor offers or maintains for which there is a reasonably foreseeable risk to customers or to the safety and soundness of the financial institution or creditor from identity theft, including financial, operational, compliance, reputation, or litigation risks. Examples include small business accounts, sole proprietorship accounts, or single transaction consumer accounts that may be vulnerable to identity theft. Unlike consumer accounts designed to permit multiple payments or transactions – they always are “covered accounts” under the Rule – other types of accounts are “covered accounts” only if the risk of identity theft is reasonably foreseeable.

In determining if accounts are covered under the second category, consider how they’re opened and accessed. For example, there may be a reasonably foreseeable risk of identity theft in connection with business accounts that can be accessed remotely – such as through the Internet or by telephone. Your risk analysis must consider any actual incidents of identity theft involving accounts like these.

This is an excellent video to learn all about the Red Flags Rule.

3D Merchant Services solutions help businesses comply with both FACTA, Red Flags Rule and PCI Compliance.