Breaking News: Merchants Get Big Win on Interchange/Routing; Court Calls for Fed to Revise Rule (July 31, 2013)

July 31, 2013

Merchants, which have continued to oppose the Durbin interchange fee caps set by the Fed, won a huge victory in court today. U.S. District Judge Richard Leon in Washington, D.C., ruled that the Federal Reserve Board of Governors overreached in its interchange and network routing rulemaking. The decision, which, if upheld, will have huge consequences for issuers, program managers and other payments stakeholders, calls for the Fed to revise its rule without taking into account any fixed costs associated with processing transactions, such as fraud losses,  and asserts that network routing rules must require at least two unaffiliated networks for each authentication method—signature and PIN. Under the current rule, issuers can meet the routing requirements by having at least one signature and one unaffiliated PIN-debit network.

“I find that the text and structure of the Durbin Amendment, as reinforced by its legislative history, are clear with regard to what costs the Board may consider in setting the interchange fee standard: Incremental ACS [authorization, clearance and settlement] costs of individual transactions incurred by issuers may be considered. That’s it!” the judge wrote in his decision.

The Federal Reserve final rule caps debit card interchange fees at 21 cents per transaction plus 0.05 percent of the transaction amount to pay for fraud losses and a separate fraud-prevention adjustment of 1 cent to pay for “effective” fraud prevention policies and procedures. The 21-cent cap was half of the 44-cent average issuers were receiving for debit transactions in mid-2011.

The judge denied the merchants’ request for a stay of the current rule, which remains in effect, but he noted that the Fed had months—not years—to finalize new rules.

“First, I assume the Board of Governors will appeal the decision, so it may be a year before we know the final outcome,” says Terry Maher, partner at Baird Holm LLP. “If the ruling is upheld, I expect that the interchange fee cap will look more like what was proposed in the interim final rule—somewhere between 7 and 12 cents,” he tells Paybefore.

While any reduction in fee caps will hurt issuers’ bottom lines, Maher says the network routing issue could be even more problematic. Issuers may be more likely to opt for two signature networks on a card—something that is unheard of today—rather than two PIN networks, given the lack of PIN pads at certain merchants. “The industry will have an interesting challenge of figuring out how two signature networks coexist on the same card,” he says. “Ultimately, if the decision is upheld, there will be a significant increase in costs to issuers and program managers that may find their way to the consumer.” Lower fee caps also could affect the appetite of large issuers (over $10 billion) for non-reloadable prepaid cards, such as gift cards or corporate promotions, which are not exempt from the caps. “It’s a dramatic decision, and if it is upheld, it’s going to have a real impact—more on debit cards but also on prepaid cards.”

Merchants applauded the court’s decision. The National Retail Federation, which was one of the plaintiffs in the case, issued the following statement from Senior Vice President and General Counsel Mallory Duncan: “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. 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. As a result, small ticket transactions, such as those imposed on convenience stores and restaurants, skyrocketed under the misapplied law.”