The Federal District Court for the District of Columbia (the “Court”) recently struck down portions of the FRB’s rule on interchange fees. The Court’s decision revolves around an amendment proposed by Senator Richard Durbin (D-IL) to the Electronic Funds Transfer Act, codified in Section 1075 of the Dodd-Frank Act (the “Durbin Amendment”) in response to rising interchange fees. Interchange fees are any fees established, charged or received by a payment card network for the purpose of compensating an issuer for its involvement in an electronic debit transaction.
Prior to the Durbin Amendment, the average interchange fee was approximately $0.44 per transaction. The Durbin Amendment capped the fee at $0.21 plus 0.05% and an additional discretionary $0.01 for institutions using fraud prevention initiatives. The Durbin Amendment also required that interchange fees for electronic debit transactions be “reasonable” and “proportional” to the cost incurred by the issuer and directed the FRB to issue rules interpreting such standards. The Durbin Amendment also required the FRB to adopt rules that would: (1) prohibit issuers and networks from restricting the number of payment card networks on which electronic debit transactions may be processed to one network or multiple affiliated networks; and (2) prohibit issuers and networks from inhibiting the ability of merchants to direct the routing of the electronic debit transaction for processing over any payment card network that may process the transactions.
In 2010, after meeting with debit card issuers, payment card networks, consumer groups and other interested groups, and circulating surveys to financial organizations and merchant acquirers, the FRB issued a proposed rule. First, the FRB proposed that the interchange fee be limited to the costs associated with authorization, clearing and settlement (“ACS”) of an electronic debit transaction. The FRB also proposed two standards to govern “reasonable” and “proportional” interchange fees: under Alternative 1 each issuer was allowed to recover its actual incremental ACS costs up to a safe harbor of $0.07; and under Alternative 2, the FRB placed a flat cap of $0.12 per transaction. Second, to implement the network exclusivity prohibition in the Durbin Amendment, the FRB proposed two alternative methods for implementation: Alternative A required at least two unaffiliated payment card networks active on each debit card, even if one network processed only signature transactions and one handled only PIN transactions; and Alternative B required at least two active unaffiliated payment card networks for each type of authorization method (i.e., at least two networks to process PIN transactions and two networks to process signature transactions). The proposed rule would prohibit issuers and networks from preventing a merchant from directing the routing of an electronic debit transaction over any available network.
In July 2011, the FRB finalized its rules implementing the Durbin Amendment. In a controversial move, the FRB adopted Alternative 2 as the standard for a “reasonable” and “proportional” interchange fee, but modified it from the alternative in the proposed rule. In particular, under the final rule, an issuer could receive up to $0.21 per transaction plus an ad valorem amount of 5 basis points (0.05%) of the transaction’s value. The FRB reasoned that the statute allowed it to consider additional costs not explicitly excluded from consideration by the statute. With regard to the network exclusivity prohibitions, the FRB adopted Alternative A interpreting the Durbin Amendment to restrict network exclusivity for each debit card and not for each method of authentication; thus a card complied with the FRB’s final rule if it were enabled with only one PIN network and one signature network.
The final rule became effective in October 2011. In November 2011, plaintiffs filed suit challenging the final rule. Plaintiffs claimed that the FRB’s final rule was “arbitrary” and “an abuse of discretion” and sought declaratory relief. More specifically, plaintiffs alleged that the Durbin Amendment limited the FRB’s consideration of allowable costs to the incremental cost of ACS and alleged that by including other costs in the fee standard, the FRB acted unreasonably. With regard to the network non-exclusivity provisions, plaintiffs claimed that the FRB disregarded the plain meaning of the Durbin Amendment and misconstrued the statute by requiring all debit cards be interoperable with at least two unaffiliated payment networks, rather than requiring that all debit transactions be interoperable over at least two unaffiliated networks. Plaintiffs moved for summary judgment in March 2012.
In granting plaintiffs’ summary judgment motion, the Court held that the FRB “completely misunderstood the Durbin Amendment’s statutory directive and interpreted the law in ways that were clearly foreclosed by Congress.” The Court held that the Durbin Amendment is unambiguous in “bifurcating” the universe of debit transaction fees—those incremental ACS costs that must be considered—and other costs not specific to the transaction, which must be excluded. The Court also noted that the Durbin Amendment required the FRB to issue rules “inhibiting the ability of any person to prohibit a merchant to direct the routing of the debit transaction” and Congress intended for each transaction to be routed over at least two competing methods for each authorization method. However, according to the Court, the FRB “countermanded” Congressional intent by adopting a rule that required a choice among unaffiliated networks for each card, but not for each method of authentication (i.e., signature and PIN transactions).
Because the FRB’s rules were “fundamentally” and “seriously” deficient, the Court remanded the case with instructions to the FRB to vacate both the interchange fee and network exclusivity rules. However, noting the importance of interchange and network fees to the debit card system and that many had made “extensive commitments in reliance” on the rules, the Court stayed the effect of its decision to allow the FRB to replace the rules and requested briefs on two issues: the appropriate length of the stay and whether current standard should remain in place until replaced by valid regulations or the FRB develops interim standards sufficient to allow the Court to lift the stay.