A U.S. District Court judge gutted the Federal Reserve’s debit card regulatory regime July 31, ruling the Fed rule disobeyed the law and ordering the regulator to rewrite it.
Judge Richard Leon’s comprehensive and often sarcastic 58-page opinion overturned the Fed’s 21-cent cap on debit card interchange for issuers of more than $10 billion in assets and scrapped the Fed’s requirement that all debit card issuers participate in at least two unaffiliated payments networks.
Both the cap and the unaffiliated network regulations flowed from the Durbin amendment, a piece of legislation that credit unions strongly opposed which was attached at the last moment to the 2010 Dodd-Frank regulatory reform law.
Leon’s decision came in the first direct legal challenge the regulation has faced.
He ruled the clear meaning of the Durbin amendment was for the debit interchange cap to be calculated based on a much narrower range of issuing costs and for merchants to have at least two network routing options per transaction and not per card. This could mean credit union debit cards will have to participate in at least four unaffiliated payment networks.
The only part of the Fed’s debit rules Leon, who sits on the District Court for the District of Columbia, left standing was the regulation mandating two debit interchange schedules, one for debit card issuers of over $10 billion in assets whose debit interchange must be capped, and one for smaller issuers whose debit interchange is left uncapped.
“The biggest immediate casualty for credit unions is certainty,” said Mansel Guerry, CEO of CU 24, a nationwide credit union owned payments network based in Florida. “Credit unions had thought that these questions were settled and had begun to move on to make debit decisions and adopt debit strategies, now all that is up in the air again,” he said. “Whatever happens, we will keep on helping credit unions make the decisions that best serve their members.”
And Guerry and other sources agreed that the uncertainty could last a long time.
Leon did not throw out the existing regulations immediately, choosing instead to stay his order pending the Federal Reserve rewrite. Both sides have until an Aug. 14 hearing to make cases for whether and for how long the stay should be continued. Leon’s only requirement was that the process of writing a new rule should take “months, not years.”
He concluded that Congress did not intend for the Federal Reserve to include the costs of debit card issuing in the cap calculation, saying only incremental authorizing, clearing and settling of individual transactions may be considered.
Leon also said the Fed’s two network per card requirement, which in practice has usually included a major card brand’s network and one other, does not fulfill the Durbin amendment.
“Indeed, by the board’s own admission, several common transaction types still cannot be authenticated using the PIN method, leaving signature debit the only available option,” he said. “This result cannot be reconciled with Congress’s goal of providing all merchants with a choice between multiple unaffiliated networks for every transaction.”
CO-OP Financial Services CEO Stan Holland called the idea complicated and expressed frustration with Leon’s reasoning about the factors that should be considered when calculating the costs of a debit transaction.
“Not allowing the costs of the card to be included in the price of a debit transaction is like not allowing the price of a train ticket to include the costs of the track,” he exclaimed. “If you don’t have the track, you don’t have the train to begin with and if you don’t have the card you don’t have the transaction.”
Retailers, predictably, didn’t see it that way.
“From the very beginning, retailers and restaurants knew the Federal Reserve Board of Governors had grossly misapplied the swipe fee law, also known as the Durbin amendment,” said Mallory Duncan, general counsel to the National Retail Federation, one of the associations that had brought the case. “They failed to heed Congress’ call to set fee standards that were reasonable and proportional to the actual cost of a transaction. Instead, the board manufactured a standard that was two to three times higher than the Fed staff recommended.”
“Congress clearly told the Fed to introduce competition and transparency into the debit card marketplace by making multiple networks available, so as to reduce swipe fees for merchants and their customers. The Fed failed to do so, and the court rightly ruled against them as a result. Today’s decision is the first step in setting these initial wrongs right and will ensure that swipe fee reform is done correctly,” he concluded.
CUNA and NAFCU expressed disappointment in the decision and left the door open for possible further legal action.
“This decision will have a potentially devastating impact on the ability of small debit card issuers, particularly credit unions, to continue offering this vital payments service to their members and customers,” said CUNA General Counsel Eric Richard after taking a preliminary read of the opinion. “The decision will, no doubt, challenge credit unions to continue their debit card programs without incurring drastic cuts in revenue, or imposing additional fees on their members–the last thing that credit unions want to do. Right now, the current debit interchange system remains the same. However, the court has signaled it is going to consider the current system further in the weeks to come. We are investigating our legal options on behalf of credit unions going forward.”
NAFCU General Counsel Carrie Hunt also lamented the ruling.
“NAFCU has maintained, and continues to maintain, that the Fed’s rules on debit interchange fee standards and network exclusivity are reasonable and in keeping with its own authority under the law. As it stands, the Court’s ruling will have an irreparable, detrimental impact on credit unions’ ability to ensure their members receive the services they need. We are reviewing it to determine our next steps.”
Both CUNA and NAFCU are members of the Electronic Payments Association, an industry coalition of issuers and networks, banks and credit unions, that formed to defend card interchange and which has generally handled litigation. CUNA has also filed an amicus brief in this particular case.
“This is an extraordinary decision that will have major repercussions for customers of both small and large financial institutions,” said spokesman Chris Matthews, who represents a coalition of association members involved in the litigation. “The Fed’s rule was already causing consumer harm and now it looks like it will only get worse. If the past is any indication, the merchants will add even more to their $6 billion windfall, and consumers will still see none of the promised benefits.”
Sarah Jane Hughes, university scholar and fellow in commercial law at the Maurer School of Law at Indiana University and an expert on administrative and payment law, said that while the Fed can be very persuasive, it’s not clear whether it will succeed in getting the Justice Department to appeal Leon’s decision.
“They might decide they don’t want to be seen as doing the bidding of the big banks or any number of things,” she said.
If the Department of Justice and Fed do not appeal, Hughes said the Fed has a number of ways to approach a new rule.
“It’s possible the Fed could use an interim final rule, which would let the key aspects of a new rule be put into place in the meantime, and then come back and make changes,” she said.
But whatever the Federal Reserve does, Hughes said she was skeptical its action would end the matter. It was possible, she pointed out, for retailers to dislike what the Fed did and sue again, or for the issuers, whether credit unions or banks, to sue if they don’t like the Fed’s new rule.
“It’s very possible this could run for some time,” she said.