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Banks Score Come From Behind Victory on Interchange Fees

In the bankers’ version of March Madness drama, on March 21, 2011, a three judge panel of the U.S. Court of Appeals for the D.C. Circuit handed down a decision that is broadly perceived as a significant victory for banks at the expense of merchants.  (The decision is captioned NACS f/k/a National Association of Convenience Stores, et al. v. Board of Governors of the Federal Reserve System.)

The issue was the legality of the Federal Reserve’s rules implementing the “Durbin Amendment” portion of Dodd-Frank.  That portion of the legislation is generally viewed as having required regulatory caps on the interchange fees that can be charged to merchants.  Merchants criticized the Federal Reserve’s rules for allowing interchange fees at a level much higher than allowed by Dodd-Frank and for allowing interchange competition rules less strict (and thus more favorable to banks) than permitted under Dodd-Frank.  The merchants essentially won this argument at the lower court, the U.S. District Court for the District of Columbia.  The Court of Appeals reversed the district court on all key issues.  The merchants can still appeal the decision to the entire D.C. Circuit appeals court, or to the U.S. Supreme Court.  However, based on our review of this decision, such an appeal appears to have a limited chance of success.  And it seems highly unlikely that either party in Congress is willing to legislate any further on interchange fee issues.

To understand the scope and effect of the decision, a brief review is in order.  The Dodd-Frank Financial Reform Act passed in 2010 included a provision now widely known as the Durbin Amendment, due to its authorship by Illinois Sen. Richard Durbin.  It is widely believed that Senator Durbin authored the provision at the request of the merchant Walgreens, one of his important constituents.  One portion of the Durbin Amendment applies to banks and credit unions with over $10 billion in assets.  For those institutions, the Federal Reserve was required to promulgate regulations to cap interchange or “swipe” fees on debit-card transactions at a level “reasonable and proportional” to the cost the financial institution actually incurs.  Another part of the Durbin Amendment required the Federal Reserve to promulgate regulations to ensure that merchants had at least two unaffiliated networks through which debit card transactions could be routed.

In response to the Durbin Amendment, the Federal Reserve initially proposed capping interchange fees at about $0.12 per transaction.  Then, after considerable study, analysis and uproar from the banking industry that argued with some force that a $0.12 rate would force them to operate at a loss, the Fed’s final regulation capped interchange fees at approximately $0.24 per debit transaction.  The Fed also provided in its final regulations that debit cards may use one PIN debit network and one signature debit network, as long as the two networks were not affiliated.

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District Court Judge Strikes Down Federal Reserve Board’s Interchange Rule

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.

Background

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.

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The Durbin Amendment: What Does the Final Ruling Mean for Prepaid?

Final interchange regulations under the Durbin Amendment of the Dodd-Frank Act will go into effect October 1, changing the rules for interchange transaction fees.  Judith Rinearson, Linda Odom and Courtney Stolz of the Bryan Cave Payments team presented a webinar on August 2, 2011 explaining what the new interchange and routing rules mean for the prepaid industry and how to comply.   A copy of the slides is available online.

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Durbin Amendment Webinar

Final interchange regulations under the Durbin Amendment of the Dodd Frank Act will go into effect October 1, changing the rules for interchange transaction fees.  The Bryan Cave Payments team will present a live webinar and Q&A session on Tuesday, August 2, 2011 from 2:00 to 3:00 pm EDT explaining what the new interchange and routing rules mean for the prepaid industry and how to comply.

The Durbin Amendment:

What Does the Final Ruling Mean for Prepaid?

You can register for free online. Attendees are encouraged to submit in advance and without attribution, any questions they would like addressed during the webinar.  Please enter your questions when you register.

The Webinar will be presented by Judie Rinearson (Bryan Cave – New York), Linda Odom (Bryan Cave – Washington, D.C.) and Courtney Stolz (Bryan Cave – Washington, D.C.).

CLE credit for this webinar will be available for attendees in California, Georgia, Illinois, New York and Virginia.

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New "Durbin" Interchange and Routing Final Regulations Issued

On June 29, 2011, the Federal Reserve Board approved its final interchange rules, entitled Regulation II, “Debit Card Interchange Fees and Routing,” setting the maximum permissible interchange fee that an issuer may receive for an electronic debit transactions made with debit cards and general use prepaid cards, codes, and other account access devices.

Under the final rules, issuers are permitted to charge a base fee of 21 cents plus 5 basis points (.05%) multiplied by the full value of the transaction, to cover fraud losses.  In addition, a 1 cent per transaction fraud prevention adjustment was also proposed, for those issuers who meet eligibility requirements (such as having fraud prevention and data security policies and procedures in place, which must be updated and certified on an annual basis.)  The fraud prevention adjustment rules are new, and are open for comment through September 30, 2011.

Under the new rules, a covered $50 debit or prepaid transaction would have a total possible interchange fee of  = 23.5¢ [21¢ + 2.5¢ ($50 x .05  /100) + 1¢], and a $500 transaction would have a total possible interchange fee of  = 47¢  [21 ¢ + 25¢ ($500 x.05 /100) + 1¢].   While this is a significant improvement over the original suggested cap of 12¢, it still represents a substantial decrease in interchange revenues for both prepaid and debit card issuers.

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Final Interchange Rules Approved

Prepaid Industry Gets Some Relief but General Purpose Reloadable Cards Face Unanticipated Restrictions

At a publicly held board meeting on June 29, 2011, the Federal Reserve Board approved its final interchange rule, entitled Regulation II, “Debit Card Interchange Fees and Routing,” setting the maximum permissible swipe fee an issuer may receive for an electronic debit transactions, adopting routing requirements and applying unanticipated new restrictions to General Purpose Reloadable (GPR) cards to take advantage of the interchange cap exemption. In addition—to the relief of the banking industry—the Fed announced that the rules on pricing requirements will go into effect on Oct. 1, 2011, as opposed to July 21 as dictated by the Durbin Amendment.

Under the final rule, issuers are permitted to charge a base fee of 21 cents (representing 80 percent of an issuer’s average transaction cost), plus five basis points on the full value of the transaction to cover fraud losses (representing the average per-transaction fraud loss of the median issuer). The fraud loss recoupment (referred to by the Fed as an “ad valorem” or “according to value” charge) came as a surprise to most and is viewed as a big win for the banking industry. The Fed also issued an interim final rule that would allow issuers to charge an additional fraud prevention adjustment of one cent if the bank meets, and certifies compliance of, certain security standards. The Fed requested comments on whether the one-cent cap should be adjusted.

In addition, the Fed approved rules governing routing and exclusivity, requiring issuers to offer two unaffiliated networks for routing debit transactions.

Perhaps the biggest surprise in the final rule is that GPR cards will not benefit from the interchange cap exclusion if they allow funds to be accessed through means other than the card.

Open Board Meeting

At the board meeting, Chairman Ben Bernanke stated that the interchange rule has been one of its most challenging rulemakings under the Dodd-Frank Act to date. The Fed had to consider myriad players impacted by debit interchange, as demonstrated by the more than 11,000 comment letters the Fed received.

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Financial Services Update – June 10, 2011

Goldman Settles Massachusetts Trading Investigation

On Thursday, the Massachusetts Securities Division announced that Goldman Sachs agreed to a consent order to pay $10 million and to ban so-called “trading huddles.”  The Massachusetts Securities Division had been investigating Goldman for the past two years to determine whether the trading ideas that analysts had shared with traders during these huddles “favored the interests of certain priority clients.”  Goldman settled the matter without admitting or denying the state regulator’s allegations and agreed to disclose to future research clients that they would not all be treated equally.  In its consent order, the Massachusetts regulator said it found no instances of fraud.

Senate Defeats Bill to Delay Interchange Fee Caps

On Wednesday, after a long and divisive lobbying fight, retailers defeated the banking industry in the Senate on a vote to delay new caps on debit-card swipe fees.  The legislation was offered by Sens. Jon Tester (D-Mont.) and Bob Corker (R-Tenn.) and failed on a 54-45 vote, falling just six votes shy of the 60 needed for passage and clearing the way for a provision in last year’s Dodd-Frank Wall Street reform law to take effect July 21.  The provision, often referred to as the “Durbin Interchange Amendment,” required the Federal Reserve to establish fair and reasonable interchange fees for many debit and prepaid card transactions.  Last fall, the Federal Reserve proposed new rules which (among other things) would limit to 12 cents per transaction the fee that large banks (with more than $10 billion in assets) can charge merchants every time a consumer uses a debit card or a prepaid gift card.  These proposed rules garnered significant criticism and final rules, which are now overdue from the Federal Reserve, are expected shortly.  Senators Tester and Corker initially proposed legislation to delay the Durbin amendment from taking effect for 24 months. The final version of the Tester-Corker bill cut the delay in half to 12 months and called for a six-month study of the costs associated with debit transactions and their impact on consumers and community banks.

Bernanke Signals End to Fed’s Monetary Stimulus

On Tuesday, in a speech at the International Monetary Conference in Atlanta, Fed Chairman Ben Bernanke signaled that the central bank plans to end its “quantitative easing” program on schedule this month.  Bernanke’s announcement comes seven months after the central bank began a historic round of monetary stimulus.  In his speech, Bernanke acknowledged the recovery has fallen short of the central bank’s expectations because of the high unemployment rate and falling home prices.

Goolsbee Leaving Council of Economic Advisors

On Monday, Austan Goolsbee, chairman of the White House Council of Economic Advisers, announced that he plans to leave the White House and return to teaching economics at the University of Chicago this fall.  Goolsbee has been on leave for four years from the University’s Booth School of Business where he was a professor for 14 years before joining the Administration.

Diamond Withdraws Fed Nomination

On Sunday, MIT professor Peter A. Diamond announced he was withdrawing his nomination to the Federal Reserve Board from consideration before the Senate.  Diamond’s nomination had been blocked by Senate Republicans for over a year because of Senate Banking Committee Ranking Member Richard Shelby’s (R-AL) contention that Diamond lacked the proper qualifications.  President Obama first nominated Diamond in April 2010.

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Senate Defeats Bill to Delay Interchange Fee Caps

After a long and divisive lobbying fight, retailers defeated the banking industry Wednesday as the Senate narrowly defeated legislation to delay new caps on debit-card swipe fees.

The legislation was offered by Sens. Jon Tester (D-Mont.) and Bob Corker (R-Tenn.) and failed on a 54-45 vote, falling just six votes shy of the 60 needed for passage and clearing the way for a provision in last year’s Dodd-Frank Wall Street reform law to take effect July 21.

The provision, often referred to as the “Durbin Interchange Amendment” required the Federal Reserve to establish fair and reasonable interchange fees for many debt and prepaid card transactions.  Last Fall, the Federal Reserve proposed new rules which (among other things) would limit to 12 cents per transaction the fee that large banks (with more than $10 billion in assets) can charge merchants every time a consumer uses a debit card or a prepaid gift card.  These proposed rules garnered significant critcism and final rules, which are now overdue from the Federal Reserve, are expected shortly.

Senators Tester and Corker initially proposed delaying the Durbin amendment from taking effect for 24 months. The final version of the Tester-Corker plan was to cut the delay in half to 12 months and called for a six-month study of the costs associated with debit transactions and their impact on consumers and small, community banks.

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Financial Services Update – April 1, 2011

Government Shutdown Looms

With the current temporary funding resolution set to expire April 8, House and Senate Appropriations committees worked toward crafting a six-month compromise bill, setting annual spending at $1.055 trillion, $28 billion more than the House-passed level but still a $33 billion cut from the original spending measure. However, House Republicans remain splintered over whether a shutdown would be good politically, or whether they should compromise with Democrats in order to move on to larger future battles such as next year’s budget and the debt ceiling increase. Meanwhile, Democrats also remain divided over whether to allow a shutdown to happen or acquiesce to Republican cuts. Whether a compromise can be reached to avoid a shutdown will be known next week.

Unemployment Rate Drops to 8.8%

On Friday, the Department of Labor announced that the unemployment rate dipped to 8.8% in March from 8.9% in February. Nonfarm payrolls gained 216,000, with private-sector employment rising by 230,000. Payroll employment stood at 130.7 million in March. There were gains of 199,000 jobs in services and 17,000 jobs in manufacturing in March. Government employment fell by 14,000 and 9,000 jobs were lost in education. Nearly half of the unemployed have been out of work for 27 weeks or more. Private-sector wages fell 2 cents an hour to $19.30.

Ally Financial Files for IPO

On Thursday, Ally Financial, the former finance arm of General Motors, filed for an initial public offering that would allow the federal government to begin selling off its 73.8 percent stake.  Ally said in its registration statement with the Securities and Exchange Commission (SEC) that it was seeking to raise $100 million.  Citigroup, Goldman Sachs, JPMorgan Chase and Morgan Stanley are the lead underwriters.  The company did not give an estimated date or share price for the offering.  The Treasury Department, which invested more than $17 billion in Ally, did not say how much of its stake it intended to sell.  In addition to common shares, the Treasury Department owns $5.9 billion in convertible preferred stock.  Earlier this month, the Treasury Department began unwinding its holdings in Ally, selling $2.7 billion in trust preferred securities.

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Financial Services Update – March 18, 2011

G7 Rescues the Yen

On Friday, the central banks of the United States, the United Kingdom, Canada, and the European Central Bank joined with Japan to intervene and strengthen the Yen in foreign exchange markets. The Yen’s unexpected surge on Wednesday was driven by speculation that Japanese firms would repatriate some of their huge foreign assets to help meet insurance claims and pay for reconstruction.

Temporary Government Funding Bill Passed and Signed into Law

The House and Senate passed, and President Obama signed into law, a stopgap spending measure to keep the government operating through April 8. The 87-13 Senate vote averts any threat of a shutdown Friday and delivers another $6 billion in cuts to current fiscal year spending. The temporary funding bill is the sixth such continuing resolution, or CR, for the 2011 fiscal year which began October 1. To an unprecedented degree, the entire government, including war funding, has been without permanent appropriations for almost six months.

Senate and House Bills Introduced to Delay Durbin Rule

On Wednesday, lawmakers in the House and Senate introduced bills to delay a Federal Reserve proposal that would cap debit-card “swipe” fees. The main sponsors of the bipartisan legislation were Senator Jon Tester, a Montana Democrat, and Representative Shelley Moore Capito, a West Virginia Republican. The Senate bill would put off implementation of the rule for two years while the House version would delay it for one year. Tester’s bill, which has nine co-sponsors, would require a joint study of the rule’s impact to be conducted within the first year by the Fed’s board, the chairman of the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the chairman of the National Credit Union Administration. The bill by Capito, the Chairman of the House Financial Services subcommittee on Financial Institutions and Consumer Credit, has twenty-seven cosponsors and would require the same agencies to conduct an impact study.

FDIC Proposes New rules for Liquidation

On Tuesday, the FDIC unanimously approved a proposed rule that regulates the repayment of creditors if the federal government seizes and breaks up a large, faltering financial firm. The proposed rule establishes criteria the FDIC would use to determine if a firm’s senior executives or directors are “substantially responsible” for the failure of the firm, and thus could be forced to repay past compensation. Under the new rules, as has been the case with banks for decades, the FDIC can take over flailing firms, pay off some creditors, fire the management and temporarily operate the entities until it closes or sells them. The draft rule also lays out the order in which unsecured creditors would get paid and how creditors would file claims. After the proposal is published in the Federal Register, it is opened to public comment for 60 days. It would then be subject to another vote before it would take effect.

More Information

If you have any questions regarding any of these issues, please contact:

Matt Jessee, Policy Advisor
matt.jessee@bryancave.com
1 314 259 2463

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