On March 21, 2014, a panel of the United States Court of Appeals for the District of Columbia Circuit issued its decision in the highly anticipated case relating to debit card interchange and exclusivity, NACS v. Board of Governors of the Federal Reserve System (the “FRB”). The Court overturned the district court’s opinion almost in its entirety.
As part of the Dodd-Frank Act, Congress enacted the so-called “Durbin Amendment,” so named after its sponsor Senator Richard Durbin (D-IL) which amended the Electronic Fund Transfer Act (the “EFTA”) to restrict the amount of interchange fees and required network exclusivity for debit card transactions. Section 920(a) directed the FRB to issue regulations to ensure that interchange fees were “reasonable and proportional” to the costs incurred by the issuers in the authorization, clearance and settlement (“ACS”) of debit card transactions. Section 920(a) also permitted the FRB to adjust the interchange fee to compensate for costs incurred by the issuer to prevent fraud. Section 920(b), which prohibited network exclusivity, directed the FRB to adopt regulations to 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 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 issuing a proposed rule, the FRB met with debit card issuers, payment card networks, merchant acquirers, consumer groups and circulated surveys to financial organizations, network, and merchant acquirers. Under the FRB’s final rule, which became effective in October 2011, an issuer could receive up to $0.21 per transaction plus an ad valorem amount of five basis points of the transaction’s value (0.05%). The FRB reasoned that the Durbin Amendment allowed it to consider additional costs not explicitly excluded from consideration by the statute.
Almost immediately after the final rule became effective, several merchant groups, including the NACS, filed suit challenging the final rule as “arbitrary” and “an abuse of discretion” and sought a declaratory ruling. In particular, the merchants alleged the Durbin Amendment limited the FRB’s consideration of allowable costs to the incremental cost of ACS and that by including other costs in the fee standard, the FRB acted unreasonably. With regard to network exclusivity, the merchants alleged 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 of any type (either pin or signature-based); rather than requiring that all debit card transactions be capable of being routed to two unaffiliated networks of each type. The merchants moved for summary judgment.
Lower Court Ruling
In a sharply-worded opinion, Judge Richard Leon of the United States District Court for the District of Columbia, ruled that the FRB’s final rule did not deserve Chevron deference because it countermanded the Durbin Amendment. In particular, Judge Leon held that the FRB’s rule “completely misunderstood the Durbin Amendment’s statutory directive and interpreted the law in ways that were clearly foreclosed by Congress.” Ultimately, there were two rulings by the district court: (1) the FRB’s interchange fee limits in rule were invalid under the Administrative Procedure Act and failed the first prong of Chevron deference—the statute and legislative history were clear, and therefore, it was unreasonable for the FRB to interpret the statute more broadly—because the Durbin Amendment was 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; and (2) the FRB’s rule countermanded Congressional intent by allowing a choice among unaffiliated networks for each card instead of each method of authentication. The FRB appealed to the District of Columbia Circuit Court Appeals.
Appellate Court Decision
The three-judge panel of the District of Columbia Circuit Court of Appeals resoundingly rejected the lower court’s decision.
Interchange fee. First, the Court concluded that the FRB “reasonably interpreted the Durbin Amendment” to allow issuers to recover certain costs that are incremental to the ACS costs. The Court reasoned that (1) the term “incremental costs” has several possible definitions, (2) Congress left “unmentioned” incremental costs other than incremental ACS costs, and (3) if Congress wanted to limit issuers to recovering only incremental ACS costs, it could have done so directly by, for example, specifically instructing the FRB to adopt regulations that did so. Finding that the FRB’s interpretation was reasonable, the Court then analyzed whether the FRB reasonably concluded that issuers could recover the four specific costs challenged by the merchants: fixed ACS costs, network processing fees, fraud losses and transaction monitoring costs. The Court acknowledged that such a task was not “an exact science” and involved policy determinations in which the FRB had “expertise” as to which the FRB was entitled to “special deference.” The Court did remand one issue relating to recovery of fraud-monitoring costs back to the FRB, asking it to articulate a reasonable justification for determining that transaction monitoring costs fell outside of the costs associated with fraud prevention.
Network exclusivity. The Court also rejected the merchants’ argument that the Durbin Amendment “unambiguously” required that there be multiple unaffiliated network routing options for each debit card transaction. The Court noted that the FRB’s rule “seems to comply perfectly with Congress’s command,” and ruled that the FRB’s final rule does exactly what Congress contemplated—under the rule, issuers and networks are prohibited from restricting the number of payment card networks on which an electronic debit transaction may be processed to only affiliated networks.