Retail Groups Challenge Federal Reserve’s New Debit Card Rules

On November 22, 2011, the NACS (formerly the National Association of Convenience Stores), the National Retail Federation, the Food Marketing Institute, and individual retailers filed a declaratory judgment action in the U.S. District Court for the District of Columbia challenging the Federal Reserve Board’s new debit card rules.

The Durbin Amendment to the Dodd-Frank Act required the Federal Reserve Board to establish regulations that would ensure that debit card interchange transaction fees were “reasonable and proportional to the cost incurred by the issuer.” 15 U.S.C. § 1693o-2(a)(2). Effective October 1, 2011, the Board implemented 12 CFR 235 (the “Durbin Rules”), capping interchange fees at 21¢, plus 5 basis points multiplied by the value of the transaction, and a 1¢ fraud prevention fee if the issuer implements prescribed fraud prevention measures. The Durbin Rules also prohibit debit card network exclusivity, requiring at least two networks to be available on debit cards.

The retailers challenge both the 21¢ cap, and the network exclusivity rules. The 21¢ cap departs from the 12¢ cap originally proposed by the Board on December 28, 2010, and the retail groups argue that the Board exceeded the scope of the Durbin Amendment when determining that 21¢ is a reasonable cap. The retailers further argue that the Board’s exclusivity rules are not effective because a debit card can still have a single network for PIN transactions and a single network for signature transactions.

The retailers argue that the 21¢ cap exceeds the Board’s authority under the Durbin Amendment for the following reasons:

• The Durbin Amendment requires consideration of incremental costs of authorization, clearance, and settlement of a particular electronic debit transaction, but “other costs incurred by an issuer which are not specific to a particular electronic debit transaction . . . shall not be considered.” The Board noted in its opening statements that its originally proposed interpretation of “authorization, clearance, and settlement” arbitrarily excluded costs related to account set-up and dispute settlement because these costs are incurred before and after a transaction occurred. Thus, for the final rule the Board excluded only costs that are not incurred in the course of effecting any electronic debit transaction, and considered all costs incurred in the course of effecting an electronic debit transaction (without having to link a cost to any one specific transaction). The retailers argue that the Board’s new interpretation of included and excluded costs exceeds the scope of the Durbin Amendment.
• The Durbin Rule allows recovery of 5 basis points multiplied by the value of the transaction for fraud losses incurred by issuing banks. According to the retailers, that element of the fee cap is excessive because the Durbin Amendment addresses fraud prevention, not fraud loss.
• The Board included network switch fees when establishing the 21¢ cap. The retailers argue that the Durbin Amendment creates a separate structure for regulating network switch fees, so they should not be included in the interchange fee cap.

The retailers further argue that the Board’s exclusivity rules do not effectively prohibit network exclusivity. Under the Durbin Rules it is still “sufficient for an issuer to issue a debit card that operates on one signature-based card network and on one PIN-based card network, as long as the two card networks are not affiliated.” Comment 7(a)-1. Because retailers often have no choice whether a transaction will be a PIN transaction or signature transaction, they argue that the networks are still exclusive and anti-competitive.

The retailers’ action faces the substantial hurdle of proving that the Durbin Rules are arbitrary or capricious. Importantly, the Board received thousands of comments from the public while crafting the rule, and the Board provided a lengthy analysis of its basis for establishing the 21¢ cap and exclusivity rules. The average debit card interchange transaction fee was reportedly approximately 44¢ before implementation of the Final Rule, so a 21¢ cap is a substantial reduction, so long as the 5 basis points multiplied by the value of the transaction does not raise the fee significantly.

With respect to the retailers’ fraud loss fee claim, the Board likely will argue that an incremental fee for fraud loss is part of the proportionate cost of settling a particular electronic debit transaction, particularly under the Board’s broad interpretation of included costs.

The case is NACS v. Bd. of Governors of the Fed. Reserve Sys., No. 1:11-cv-02075-RJL (D.D.C. 2011).