The Fed Loses in Court? – D.C. District Court Concludes Federal Reserve’s Interchange Fee Rules Are “Utterly Indefensible”

On July 31, 2013, a federal district court sitting in Washington D.C. invalidated several rules written by the Federal Reserve, and intended to implement the Durbin Amendment’s new requirements for interchange fees.

Congress enacted the Durbin Amendment in July 2010 to address rising credit and debit card fees. The Durbin Amendment requires that any interchange fee charged by a card issuer be “reasonable and proportional to the cost incurred by the issuer . . . .” The Federal Reserve is charged with drafting regulations that determine whether a debit card interchange fee is “reasonable and proportional to the cost incurred by the issuer . . . .” The Federal Reserve was also charged with creating regulations governing network exclusivity agreements.

The Federal Reserve engaged in an extensive rulemaking process that ultimately delivered rules that permitted interchange fees up to $.21 per transaction plus an ad valorem amount of five basis points of the transaction value. The Federal Reserve based its $.21 figure on its conclusion that the Durbin Amendment allowed the Federal Reserve to consider additional costs not expressly excluded from consideration by the statute. Thus, the Federal Reserve determined it could authorize a higher interchange fee based on: (1) fixed costs related to network connectivity and software, hardware, equipment, and labor; (2) transaction monitoring costs; (3) an allowance for fraud losses; and (4) network processing fees.

Several groups, including the National Retail Federation, challenged these rules. They argued that the Federal Reserve’s decision to allow for costs in the interchange fees that were not expressly provided for in the Durbin Amendment was “arbitrary, capricious, and an abuse of discretion” and not in accordance with the law.

The court conducted a close analysis of the text and history of the Durbin Amendment. The court concluded that the Durbin Amendment divides all costs associated with payment networks into two categories: costs that the Federal Reserve can consider and costs the Federal Reserve cannot consider when setting the interchange fee.

The court explained that the only costs the Federal Reserve could consider when setting the interchange fee is the incremental ACS costs of individual transactions incurred by issuers. According to the court, the Federal Reserve’s decision to consider other costs in setting the interchange fees was “utterly indefensible.”

Regarding the Federal Reserve’s network exclusivity regulations, the court also concluded that the Federal Reserve’s rules are inconsistent with the Durbin Amendment. The Durbin Amendment requires that the Federal Reserve ensure that “networks stop restricting merchants’ ability to route each transaction over different networks.”

The Federal Reserve’s rules provide that a debit card complies with the Durbin Amendment if it is enabled on one PIN network and one signature network. The court said this was inconsistent with the plain text of the statute. This rule had the effect of permitting issuers and networks to make only one network available for a given transaction, which is contrary to the Durbin Amendment’s plain intention to require two or more network options per transaction.

In summary, the court found that: “The [Federal Reserve] Board has clearly disregarded Congress’s statutory intent by inappropriately inflating all debit card transaction fees by billions of dollars and failing to provide merchants with multiple unaffiliated networks for each debit card transaction.”

Based on the court’s conclusion that the Federal Reserve’s rules were inconsistent with the Durbin Amendment, it vacated the rules. However, the court did agree to stay its order vacating the rules until the Federal Reserve has an opportunity to replace them. The court did not address the length of the stay, nor whether the invalid rules should remain in effect during the stay. The court invited the parties to submit supplemental briefing on these issues.

It is unclear what will happen in light of this ruling. The Federal Reserve may appeal to the Court of Appeals for the D.C. Circuit. Alternatively, the Federal Reserve may decide it is more efficient to simply rewrite the rules.

In addition, this ruling may have important implications for all Dodd-Frank rulemaking, particularly because the federal courts in D.C. are responsible for a great deal of judicial review of agency action. We will continue to monitor this litigation.