Beware of banks bearing 'gift' cards

Gift cards are hot items this holiday season -- both at stores and in the courts.

Sales of the cards are projected to hit $55 billion this year, up 22 percent over a year ago, according to research firm Tower Group. One consumer survey from financial consulting firm Deloitte & Touche indicated the cards are likely to be the top gift purchase item this year, edging out apparel for the first time.

But just as sales are soaring, a relatively new breed of card is bringing court challenges. The card, issued by banks instead of retailers or restaurants, can be used nearly anywhere the bank card brand is accepted but comes with a slew of fees that can whittle away at the card's value over time.

Chris Kochem of Belmont said she is refusing to buy the new bank-issued cards on principle. "You're giving them your money, and they want you to pay more on top of that just to use the money," she said. "It's outrageous."

The battle over these cards shifted to the courts this month when the attorneys general in Massachusetts, New Hampshire, and Connecticut and the seller of a leading bank-issued card sued one another. The states contend the Simon Gift Card, cobranded with Bank of America, violates state gift certificate statutes. But Simon Property Group Inc., which operates 14 malls in Massachusetts, says its card is federally regulated and exempt from state laws.

The legal tussle, particularly in Massachusetts, may have huge implications because state law defines gift certificates broadly. The law, which was amended last year to require that gift certificates be redeemable at full face value for seven years, includes among its definitions of a gift certificate "an electronic card with a banked dollar value."

What that means will probably have to be decided by the courts, but it could be argued the Legislature intended the definition to be interpreted broadly. After the gift certificate bill was signed into law on New Year's Day last year, questions arose over whether it applied to prepaid calling cards. Lawmakers amended the law to exempt those cards, but no others.

Could that mean the law applies to bank-issued cards as well as other prepaid cards that don't have "gift card" in their name? For example, many banks sell Visa Buxx cards, prepaid cards that parents purchase for their teenage children. BankFirst of Sioux Falls, S.D., sells prepaid cards that feature R&B singer Usher and Hello Kitty on the cover. All of these cards come with hefty fees that would violate the state law.

Massachusetts Attorney General Thomas F. Reilly isn't saying right now how far he thinks the state law reaches, but he clearly believes it stretches far enough to include bank-issued prepaid gift cards. At a news conference last week, he recommended that consumers buy retailer gift cards and be wary of those bearing the Visa or MasterCard logos. (The American Express card complies with Massachusetts law.)

Reilly said state law requires gift cards to be redeemable at full face value for seven years, but he noted monthly fees would drive down the value of an unused $25 Simon card to $12.50 after 11 months and to zero when the card expires after a year.

Nancy Wilsker, an attorney representing Simon Malls, said state laws don't apply to the Simon card because it is issued by Bank of America, which is regulated by the US Office of the Comptroller of the Currency.

The comptroller office, normally very turf-conscious when it comes to state intrusions on its authority, isn't asserting its jurisdiction in this case. A spokesman said the agency has no plans to take the position that the Simon Malls gift card is a bank product.

Wilsker isn't deterred. She said the comptroller just wants to stay out of the court fight. As for the Massachusetts law, she said, "I don't think the whole thing was thought through."

Part of the problem for lawmakers and litigators is that the gift card market is moving so fast. Videostore chain Blockbuster is credited with introducing the first gift card in 1996, a mere eight years ago. Sales have exploded since, hitting $45 billion last year and forecast to grow to $89 billion in 2007, according to Tower Group, a Needham research firm owned by MasterCard.

The vast majority of cards being sold are issued by retailers, but bank-issued cards are rapidly gaining in popularity because they can be used so many places. (Exceptions include online and phone airline ticket purchases and reservations for hotels and rental cars.) Bank-issued cards are expected to account for 13 percent of gift card sales this year, rising to 35 percent in 2007, according to Tower Group.

John Gould, director of consumer lending and bank cards at Tower Group, said bank and retailer gift cards are fundamentally different, and most people don't grasp the distinction.

Gould said retailers make money on gift cards three ways -- from future sales, from the interest earned on gift card proceeds, and from any unspent funds. Because of the different revenue streams, retailers typically don't charge an upfront fee for their cards, and many don't charge dormancy fees.

Retailers with cards that charge dormancy fees or have expiration dates routinely waive those rules in states where they are prohibited. Amazon.com, for example, says on its website that its gift certificates expire after two years except in Massachusetts, California, Connecticut, New Hampshire, Maine, and Washington, states that have passed gift card laws.

In sharp contrast with retailers, Gould says banks make money on their gift cards only through fees. There are upfront purchase fees, account maintenance fees, fees for checking a balance, and fees to issue a replacement card. Unlike retail cards, bank-issued cards come with zero liability if they are lost or stolen and charge-back rights if there's a dispute about a purchase.

"When you buy a bank-issued card, you're buying a payment instrument," Gould said. "When a retailer provides you with a gift card, it's all about loyalty."

Gould says existing state laws and proposed federal laws (a bill filed by Senator Charles E. Schumer of New York would restrict gift card fees) that don't take into account the distinctions between retail and bank-issued gift cards threaten to undermine the bank-card concept.

"The financial model doesn't hold water if you don't have those fees on the card," he said.

Bruce Mohl can be reached at mohl@globe.com.