Court Strikes Down Debit Pricing And Routing Rules, Orders Fed ‘Back to Drawing Board’

In one of the most dramatic developments of the year in the electronic-payments business, a federal judge on Wednesday struck down the Federal Reserve Board’s pricing and routing rules for debit card transactions, arguing the banking regulator misinterpreted federal law.

The rules, which implemented the Durbin Amendment to the 2010 Dodd-Frank Act, have been in effect for more than a year and rose out of one of the most contentious lobbying efforts ever seen in the payments industry. Now the once-settled issues of interchange caps and transaction-routing choice for merchants have been thrown into a cocked hat.

“Whether people like or don’t like Durbin, everyone has adjusted to the current status quo,” says Tony Hayes, a debit expert and partner at Oliver Wyman, a Boston-based consultancy. “To have this thrown wide open again is going to create upheaval.  It’s a massive change.”

In a stinging 58-page opinion, Judge Richard J. Leon of the U.S. District Court for the District of Columbia said the Fed misread the Durbin Amendment’s clear language in crafting its debit-interchange limit of 21 cents plus 0.05%, plus a penny allowed for fraud losses. That rule took effect in October 2011. The Fed’s routing rule, which requires at least two unaffiliated networks for each card, also violates the intent of the law, Leon said, arguing that the statute requires that each transaction offer at least two networks for each authentication method, PIN or signature. The Fed’s routing regulation took effect in April of last year.

In vacating the existing debit-interchange ceiling and routing rule, Leon issued a stay of his order to give the Fed time to rewrite its regulations. He also invited briefs on how long the stay should be and whether the current rules should remain in effect until the Fed devises new ones. A status conference on these matters is set for Aug. 14.

A Fed spokesperson did not immediately return a call seeking comment on the decision.

Groups representing merchant interests were jubilant. “Today\’s decision is a victory for small businesses and consumers across the country,” said the Merchants Payments Coalition, a merchant group formed to lobby on interchange issues, in a statement. “The court has told the Federal Reserve to go back to the drawing board on debit card swipe fees to make sure the fees are reasonable and proportional to what it costs banks to process debit transactions.”

Mallory Duncan, senior vice president and general counsel for The National Retail Federation, one of six merchants and merchant groups whose November 2011 lawsuit against the Fed led to Wednesday’s decision, said the Fed had failed to carry out the will of Congress. “The court rightly ruled against them as a result,” he said in a statement. “Today’s decision is the first step in setting these initial wrongs right and will ensure that swipe-fee reform is done correctly.”

Besides the NRF, the other five plaintiffs in the case are: NACS (a trade group for convenience stores); the Food Marketing Institute; Miller Oil Co.; Boscov’s Department Store LLC; and the National Restaurant Association.

A coalition of financial-institution trade groups, meanwhile, blasted Leon’s opinion, arguing it will benefit retailers at the expense of consumers. “This is an extraordinary decision that will have major repercussions for customers of both small and large financial institutions,” said coalition spokesman Chris Matthews, in a statement. “The Fed’s rule was already causing consumer harm and now it looks like it will only get worse.”

The coalition includes Credit Union National Association; Independent Community Bankers of America; National Association of Federal Credit Unions; National Bankers Association; Midsize Bank Coalition of America; Consumer Bankers Association; The Clearing House Association; American Bankers Association; and The Financial Services Roundtable.

While Judge Leon’s verdict came as a surprise to observers accustomed to courts granting wide latitude to regulators in how they read the law, attorneys representing merchant interests say in this case the Fed had strayed too far from the intent of the Durbin Amendment. “Although agencies have discretion to interpret the law, they can’t depart from the law,” Doug Cantor, counsel for the MPC, tells Digital Transactions News.

Indeed, Leon’s opinion offers one blunt assessment after another of how the judge saw the Fed veering away from the intent of the law. On the matter of interchange caps, for example, he charges the Fed with allowing too many extraneous costs in setting its cap: “Accordingly, I find that the text and structure of the Durbin Amendment…are clear with regard to what costs the Board may consider in setting the interchange fee standard: Incremental [authorization, clearing, and settlement] costs of individual transactions incurred by issuers may be considered. That’s it!”

On the routing question, the opinion issues a sharp rebuke: “The Board\’s Final Rule not only fails to carry out Congress’s intention; it effectively countermands it!”