A three-judge appeals panel may wind up preserving the Federal Reserve’s debit interchange regulation that the lower court invalidated.
The panel from the U.S. Court of Appeals for the D.C. Circuit – Judges David Tatel, Harry Edwards and Stephen Williams – heard from lawyers representing financial institution debit card issuers, the Federal Reserve and merchants on the morning of Jan. 17.
The rules capped debit card interchange earned by cards issued by financial institutions of more than $10 billion in assets and dictated how many networks have to be available on each card for debit transaction processing.
At several points the judges, particularly Edwards, interrupted Shannen Coffin, the lead attorney for the merchants in the case, to urge him not to continue to argue that the Federal Reserve ignored Congress’ intent when it issued its debit rule.
“I can tell you, none of us is buying that,” Edwards said at one point while, at another point, Tatel agreed.
“You have a steep hill to climb if you continue to advance that argument,” he said, “but you have the podium and I won’t tell you how to spend your time.”
Tatel also contended at another point that Congress intended to give the central bank room to consider costs other than those explicitly set out in the Dodd-Frank law, differing sharply from the retailers’ position that Congress had never intended to give the Federal Reserve such discretion.
“We think there are non-incremental costs that are transaction-specific that can be included,” Tatel said.
The judges’ comments appeared to support the Federal Reserve’s effort to show it was correct in allowing expenses such as computers, software and labor to be considered in setting a fee cap. Their comments also suggested that the case might boil down to whether the judges consider the costs the Federal Reserve chose to include in its calculations were, in fact, reasonable under the statute.
Many of the panel’s questions centered on which costs the Federal Reserve chose to include in its calculations to arrive at the debit fee cap, with the judges asking critical questions about the notion that the agency had erred in including fixed costs as what should be considered incremental costs.
“Doesn’t the definition of what is or is not an incremental cost have a lot to do with the time line you use,” Williams asked Coffin at one point, pointing out that over time, incremental costs turn into fixed costs.
Katherine Wheatley, associate general counsel for the Federal Reserve, also had to field some difficult questions, but many of those had less to do with what the Fed had done in developing its regulation and more to do with why it chose one course over another.
“We were surprised at several points what was not considered,” Williams said to Wheatley, asking at another point whether or not the Federal Reserve should have included the costs of issuing a card as part of the costs used to set the cap.
But Wheatley explained that because of the Durbin Amendment’s analogy of debit cards and checks the Fed had not considered the costs of issuing a card as one of the costs covered in the cap.
Wheatley explained that just as financial institutions are not reimbursed for the costs of producing checks, the Fed had not thought it appropriate to reimburse financial institutions under the cap for the production of debit cards.
CUNA and NAFCU lawyers said they thought the hearing had gone better than they had expected, but cautioned that it is impossible to predict how a ruling will go based on the oral argument discussion.
They also would not predict when the court might render a ruling on the case, but several said they would be surprised if it did not come before the end of the court’s term in August.
The National Retail Federation did not comment on the hearing.
The panel only tangentially touched upon the costs of fraud and fraud prevention as part of the costs of debit transactions – in large part because the costs of fraud prevention are part of a separate rule under the Durbin Amendment that the retailers did not challenge.
If the appeals panel instructs the lower court to oversee a partial rewrite of the debit interchange regulation – for example, leaving the cap intact but including or removing different things from its calculation – it appears that fraud costs might become a significant line item cost that regulators will not address in a new regulation.
In an interview with Credit Union Times prior to the hearing, Douglas Kantor, like Coffin a partner at Steptoe & Johnson and a counsel to the NRF in the case, pointed out the Durbin Amendment precludes the Federal Reserve from including the costs of fraud in calculating the debit interchange cap. Instead, the amendment created an additional rule and calculation which was supposed to address the costs of fraud prevention.
Kantor suggested that retailers, who already shoulder a large portion of the costs of fraud through chargebacks and fines from the card brands when breaches occur, would not favor having to pay for an even greater portion of the costs of fraud through debit interchange.
Given the breaches in the past two months, Kantor wondered what issuers were spending on fraud prevention and whether those efforts should be counted in fraud prevention charge.
He maintained that retail members of the NRF had long supported the switching the payment system over to one based on debit and credit cards with embedded chips in them, but added that the NRF was much less interested in supporting chip-embedded cards whose transactions were still validated with a cardholder signature, a position he said the major card brands have pressed.
“We really don’t even see how using a chip card without a PIN necessarily limits the fraud risk,” Kantor said. “Certainly not as much as when the cardholder uses a PIN.”
Kantor said regardless of what happens on debit interchange, merchants wanted to have more of a partnership role in developing the fraud protection standards the entire payments industry uses.