On July 31 2013 the US District Court for the District of Columbia granted summary judgment in NACS v Board of Governors of the Federal Reserve System,(1) ruling in favour of a group of retailers and retailer trade associations in a lawsuit in which those parties sought to overturn the final rule of the board of governors of the Federal Reserve System that set standards for debit card interchange transaction fees and network exclusivity prohibitions. In an opinion highly critical of the board's legal analysis, the district court held that both challenged components of the final rule were invalid as a matter of law because, according to the court, the board's implementation of both was contrary to the plain language of the Durbin amendment, which was enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. As a result, the district court ordered that the challenged components of the final rule must be vacated, but temporarily stayed its order to provide the board with an opportunity to amend the final rule to a form that conforms to the district court's reading of the Durbin amendment. If the district court's order is not overturned on appeal, the board will be required to draft new regulations implementing these provisions of the Durbin amendment.
The Durbin amendment consists of several provisions affecting "electronic debit transactions". The retailers' lawsuit challenged the final rule's implementation of two of these provisions:
- The Durbin amendment requires that any interchange fee that an issuer receives or charges with respect to an electronic debit transaction must be "reasonable and proportional to the cost incurred by the issuer with respect to the transaction".(2)
- It requires that an issuer or payment card network may not "restrict the number of payment card networks on which an electronic debit transaction may be processed" to either one network or two affiliated networks.(3)
The Durbin amendment directs the board to prescribe regulations to carry out these two requirements.
The board issued the final rule in June 2011, in which it set a cap on debit card interchange fees with three components:
- a base component of $0.21 (which accounted for network connectivity costs, costs of hardware, software and labour used to effect electronic debit transactions, network processing fees and transaction monitoring costs);
- five basis points of the transaction to reflect a portion of fraud losses; and
- an additional $0.01 per transaction if the issuer adopted effective fraud prevention policies and procedures.
With respect to network non-exclusivity, the board determined that an issuer must enable two unaffiliated networks on each debit card.(4)
The plaintiffs filed their lawsuit in November 2011, seeking declaratory judgment that the final rule's interchange fee and network non-exclusivity provisions were arbitrary, capricious, an abuse of discretion and otherwise not in accordance with the law, and that the board was therefore not entitled to any deference under the Administrative Procedures Act and Chevron USA, Inc v Natural Resources Defense Council, Inc.(5) The plaintiffs moved for summary judgment on March 2 2012 and the board cross-moved for summary judgment on April 13 2012. The district court heard oral arguments on the summary judgment motions on October 2 2012. As described in more detail below, the district court accepted substantially all the plaintiffs' arguments and granted the plaintiffs' motion for summary judgment.
With respect to the interchange fee regulation, the plaintiffs alleged that the Durbin amendment:
"limits the Board's consideration of allowable costs to the 'incremental cost' of 'authorization, clearance and settlement [(ACS)] of a particular electronic debit transaction', and that, by including other costs in the fee standard, the Board 'acted unreasonably and in excess of its statutory authority'."(6)
The board, on the other hand, argued that the statute was silent, and thus ambiguous, as to certain costs that were included in its determination of the interchange fee cap in the final rule.
The district court began with the language of the Durbin amendment requiring the board 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 not to consider "other costs incurred by an issuer which are not specific to a particular electronic debit transaction".(7) The district court accepted the plaintiffs' argument that this language "evidences an intent by Congress to bifurcate the entire universe of costs associated with interchange fees".(8) It described the board's argument – that the statute is silent as to costs that are specific to a particular electronic debit transaction but are not "incremental" ACS costs – as "wholly unpersuasive".(9)
The district court next concluded that the Durbin amendment excluded from the allowable interchange fee all costs other than the incremental ACS costs incurred by the issuer for a particular debit transaction. Under the district court's reading:
"[t]he plain text of the Durbin Amendment thus precludes the Board from considering in the interchange fee standard any costs, other than variable ACS costs incurred by the issuer in processing each debit transaction."(10)
The district court relied in part on the Durbin amendment's requirement that the board:
"consider the functional similarity between (i) electronic debit transactions; and (ii) checking transactions that are required within the Federal Reserve bank system to clear at par."(11)
Since the statute states only that the board was required to consider similarity, the district court reasoned that the board was not authorised to consider differences as well.(12) The district court also held that the Durbin amendment's allowance of a fraud-related adjustment must be on an issuer-specific basis, and as a separate adjustment to the interchange fee.
Finally, the district court determined that the board's interpretation of the Durbin amendment allowing it to account for costs that are incurred to effect "debit card transactions as a whole" in the interchange transaction fee was "utterly indefensible".(13) Moving through the four costs considered by the board – fixed ACS costs, transaction monitoring costs, fraud allowance and network processing fees – the district court held that the board was specifically prohibited from factoring such costs into the interchange fee standard. While it analysed each fee separately, the district court's conclusion as to each was essentially the same: because Congress forbade the board from considering fees that were not incremental fees incurred by the issuer for a particular transaction, the board's inclusion of such fees is policymaking in contravention of Congress's specifically stated intentions.(14)
The parties' disagreement with respect to network non-exclusivity hinged on their interpretations of the Durbin amendment's prohibition on debit card issuers and payment card networks from "restrict[ing] the number of payment card networks on which an electronic debit transaction may be processed" to fewer than two unaffiliated payment networks.(15) In the final rule the board concluded that this requirement could be met by requiring all debit cards to operate on at least two unaffiliated networks – usually, a signature network and a personal identification number (PIN) network.
The district court, again relying on its reading of the statutory language and legislative history, concluded that the Durbin amendment instead required merchants to be given a choice between multiple unaffiliated networks for each transaction – in other words, that debit cards must be able to operate on multiple signature networks and multiple PIN networks.(16) The district court also relied on statements made by the board during the rule-making process that certain types of transaction are incompatible with PIN authentication, "leaving signature-debit as the only available option".(17)
The decision also rejected additional arguments made by the board in support of the final rule. First, the district court did not find persuasive the argument that, in many cases, the customer (rather than the issuer or network) determines the authentication method at the point of sale. The district court instead concluded that any reading of the statute "that denies merchants the ability to choose between multiple networks for each transaction" could not be squared with the statutory text.(18) Second, the district court rejected the board's argument that the final rule minimises the compliance burden on institutions and presents less logistical burden on the payment system by requiring little re-programming of routing logic; instead, it held that "the law does not impose those burdens" and endorsed proposals by commenters during the rule-making process that other technological solutions were available.(19)
The district court held that the proper remedy was to remand to the board with instructions to vacate both the interchange transaction fee and debit card non-exclusivity aspects of the final rule. While acknowledging that vacatur is not required, the district court found that the final rule was "fundamentally deficient" and that the board interpreted the law in ways that were "clearly foreclosed by Congress".(20) Based on its finding, the district court concluded that the board was unlikely to draft a new regulation on its own that would satisfy the requirements of the Durbin amendment.
However, the district court did acknowledge the importance of interchange and network fees to the debit card system, and noted that participants in the debit card system had made "extensive commitments" in reliance on the final rule. It accordingly determined that it would stay the vacatur order, pending briefing on two issues that had not been addressed by the parties:
- the appropriate length of the stay; and
- whether existing standards should remain in place until replaced by "valid regulations" or the board should develop interim standards acceptable to the district court to lift the stay.
A status conference was set for August 14 2013, at which the parties were expected to discuss the briefing of these issues. However, it is unclear how much longer the final rule will remain in effect.
The district court's opinion represents a significant victory for merchants and a thorough rejection of the board's implementation of the Durbin amendment. If the opinion is not appealed,(21) or not overturned on appeal, the board will be required to overhaul extensively its interchange transaction fee and network non-exclusivity regulations. Based on the district court's commentary, a regulation that satisfied the district court's requirements would, at a minimum:
- cap debit card interchange fees at the incremental cost incurred by an issuer for the role of the issuer in the authorisation, clearance or settlement of a particular electronic debit transaction; and
- require debit cards to be enabled to function on multiple PIN-authorisation networks, as well as multiple signature-authorisation networks.
For further information on this topic please contact David E Teitelbaum, Joel D Feinberg or Thomas L Devlin at Sidley Austin LLP by telephone (+1 202 736 8000), fax (+1 202 736 8711) or email (email@example.com, firstname.lastname@example.org or email@example.com).
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