Decision Favoring Merchants Could Potentially Cost Banks Billions

A U.S. District Court judge recently granted summary judgment against the Board of Governors of the Federal Reserve System (the “Federal Reserve” or “Board”), ruling that the Federal Reserve disregarded Congress’s statutory intent by “inappropriately inflating all debit card transaction fees” and considering data it was not permitted to use in setting a 21-cent cap on debit-card transaction fees under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). In NACS v. Board of Governors of the Federal Reserve System, 11-cv-02075, U.S. District Court, District of Columbia (Washington), Judge Richard J. Leon also ruled in favor of the retailers’ challenge to the network non-exclusivity and routing provisions, stating that the Board’s rule is inconsistent with the “clear, defined language in the network non-exclusivity and routing provisions” and does not support competition or choice in the marketplace.


Pursuant to the so-called “Durbin Amendment” (which implemented Section 920 of the Electronic Fund Transfer Act, as enacted by Section 1075 of the Dodd-Frank Act), the Federal Reserve was directed to establish standards to determine whether debit card interchange fees are “reasonable and proportional to the cost incurred by the issuer” with respect to a transaction. Congress provided specific guidelines to establish interchange transaction fee standards, and called upon the Federal Reserve also to prescribe rules related to network non-exclusivity for routing debit transactions.

The Federal Reserve’s final interchange rule (Regulation II, “Debit Card Interchange Fees and Routing”) set forth the maximum permissible interchange fee that an issuer may receive for an electronic debit transactions and became effective on October 1, 2011. Under the final rule, issuers are permitted to charge a base fee of 21 cents (representing 80% of an issuer’s average transaction cost), plus 5 basis points on the full value of the transaction to cover fraud losses. (“fee cap”). The Federal Reserve also approved rules governing routing and exclusivity, requiring issuers to offer two unaffiliated networks on each debit card for routing debit transactions.

Shortly after the rule went effective, NACS (formerly, the National Association of Convenience Stores), National Retail Federation, Food Marketing Institute, Miller Oil Co., Inc., Boscov’s Department Store, LLC and National Restaurant Association (collectively, “plaintiffs”) brought an action against the Federal Reserve to overturn the Board’s final rule. The plaintiffs believe that the fee cap was set too high due to the fact that the Board factored in certain issuer costs that should not have been taken into account under the law. On March 2, 2012, the plaintiffs moved for summary judgment, arguing that the final rule be declared invalid under the Administrative Procedure Act (“APA”). The Board cross-moved for summary judgment, contending that plaintiffs’ claims lacked merit and that the Board is entitled to judgment as a matter of law.

District Court Ruling

The plaintiffs contended that the final rule constituted an unreasonable interpretation of the Durbin Amendment because it ignores Congress’s directives set forth in the statute (i.e., that only the incremental costs for authorization, clearing and settlement (“ACS”) of a transaction be considered). The plaintiffs argued that the Federal Reserve exceeded its authority under the APA, and accordingly, asked the court to invalidate the rule.

More specifically, the plaintiffs claimed that the provision setting forth guidelines to establish reasonable interchange fees (15 U.S.C. § 1693o-2(a)(4)(B)) bifurcated interchange costs into two categories:

(i) costs that the Federal Reserve was required to consider (“the incremental cost incurred by an issuer for the role of the issuer in the authorization, clearance, or settlement of a particular electronic debit transaction”) and

(ii) costs that the Federal Reserve was prohibited from considering (“other costs incurred by an issuer which are not specific to a particular electronic debit transaction”).

The Federal Reserve disagreed with the plaintiffs’ interpretation of the guidelines, arguing that there is a third category of costs as to which the law was silent: other costs which ARE specific to a particular transaction, and which could be considered. The Federal Reserve argued that the law did not preclude taking into account such other costs that are “specific to a particular electronic debit transaction,” but are not incurred by an issuer for authorization, clearance or settlement. Thus, the Federal Reserve position was that they could consider other costs that were in fact specific to a particular transaction.

The court strongly disagreed with the Federal Reserve, claiming that Congress had a clear intent to bifurcate the entire universe of costs associated with interchange fees. The court, citing comments made by Sen. Durbin on the floor of the Senate prior to passage as confirmation of such congressional intent, held that only incremental costs of individual transactions incurred by issuers for purposes of ACS could be considered by the Board in determining the fee cap. All other costs, whether specific to a particular electronic debit transaction or not, were precluded from consideration.

The court also ruled against the Federal Reserve’s rule regarding network exclusivity, concluding that the statute requires merchants to be provided with a choice between multiple, unaffiliated networks for each transaction, not just a choice over two or more unaffiliated networks on each debit card. According to the court, “Congress intended for each transaction to be routed over at least two competing networks for each authorization method.” Again, citing statements from Sen. Durbin from the Senate floor, and also from his amicus brief, the court stated that the non-exclusivity and routing provisions were meant to “inhibit the continued consolidation of the dominant debit networks’ market power and to ensure competition and choice in the debit network market.” Thus, “any reading [of the statute] that denies merchants the ability to choose between multiple networks for each transaction cannot be squared with a statute that plainly requires at least two networks per transaction.”

Accordingly, since the court found the Federal Reserve’s final rule in violation with Congress’s clear intent and inconsistent with the statute, it set aside the rule under the APA.

Next Steps

While held invalid, the Federal Reserve’s interchange rule will stay in place in order to minimize any disruptive consequences from the court’s decision, at least until the ruling is appealed or a new interchange rule is finalized. A hearing is scheduled for August 14, 2013 to determine how long the current rules will stay in place and whether the Board should develop interim rules rather than waiting for a new set of valid regulations to be established. The ruling marks a significant victory for merchants, and if ultimately upheld, poses significant consequences for issuers, program managers and other payments stakeholders.

Conclusion – What does this mean?

Interchange provisions:

If the decision stands (and many expect it to be appealed to the DC Circuit) it would result in a significant reduction in debit card interchange, from the 21 cent cap, likely to a cap of 7-12 cents. Please note however, that other aspects of the interchange regulations would not be impacted:

  • The exemption for banks with less than $10 billion in assets remains.
  • The exemption for certain general purpose reloadable prepaid cards remains.
  • The exemption for “3-party” card systems, such as cards on the American Express and Discover networks issued by those entities, remains.

Some believe that even with the exemptions, given the significant reduction in interchange both prepaid card issuers and small banks can expect downward pressure on interchange overall.

Routing and Exclusivity provisions:

If this portion of the decision stands, it would mean that every debit card (including prepaid cards and cards issued by banks with less than $10 billion in assets, but excluding 3-party system cards) would need to have at least four routing options – two signature networks and two PIN networks.


This will certainly be a matter for continued litigation and monitoring. It is worth noting that the overall tone of the District Court’s opinion was surprisingly belligerent toward the Federal Reserve, with inserted comments such as “Please!” and “Not quite!”

Nevertheless, the highly technical discussion about the meaning of the word “which” as used in the phrase “other costs incurred by an issuer which are not specific to a particular electronic debit transaction” would seem to indicate that was indeed a difficult matter to interpret and not nearly as “clear” as the Court indicates. (Note that the term “clear” or “clearly” was used to describe Congress’s intentions and the statutory language more than 20 times in the 58 page opinion.) While the Court’s reasoning may have some validity, the suggestion that this is truly so clear and obvious seems to be a stretch.

One thing is clear: if this decision stands, it will force sweeping and disruptive changes on a payment system that has worked relatively well for the last 50 years. It will also undoubtedly raise costs for consumers and increase revenues for merchants.

A copy of the court’s ruling may be found here.

A copy of the Federal Reserve’s final rule may be found here.

If you have any questions or would like more information about the implications of the court’s determination, please contact Margo Strahlberg or Judie Rinearson.