Fed's Debit-Card Swipe-Fee Rules Rejected by U.S. Judge

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The Federal Reserve disregarded the Congress's intent in deciding how much banks can charge merchants for debit-card transactions, a judge ruled, handing a victory to retailers who challenged the fees as being too high.

U.S. District Judge Richard Leon in Washington ruled today that the Fed considered data it wasn't allowed to use in setting a 21-cent cap on debit-card transaction fees under the Dodd- Frank law. Leon said the rule, in effect since October 2011, would remain in place until the Fed drafts new regulations or interim standards.

"The 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," Leon said in his ruling.

The decision, unless overturned on appeal, will force regulators to revisit rules that bankers said would cost them 45 percent of their swipe-fee revenue. Lenders collected about $16 billion annually from those fees before the Fed's regulation and responded by cutting back on perks such as rewards programs and free checking to soften the blow to their profits.

"This is clearly saying 21 cents may be too much," said Nancy Bush, an analyst at SNL Financial LC, a bank research firm in Charlottesville, Va. "You'll have to go back to the drawing board and figure out how much a debit-card transaction actually costs and is there going to be some kind of premium paid to that."

More than 38 billion debit-card transactions took place in 2009 at retailers that include grocery and electronics stores, gas stations and large chains such as Wal-Mart Stores Inc. and Target Corp., all of whom lobbied for limits on the power of banks and payment networks to impose fees.

Swipe, or interchange, fees are set by Visa Inc. and MasterCard Inc., the biggest electronic-payment networks, which collect the money and remit it to card-issuing member banks.

Visa, the biggest bank-card network, fell less than 1 percent in New York trading to $189.88 at 10:48 a.m. MasterCard, the No. 2 network, rose 2.7 percent to $617.47 after reporting today that second-quarter profit beat analysts' estimates.

James Issokson, a spokesman for Purchase, N.Y.-based MasterCard, had no immediate comment on the ruling. Barbara Hagenbaugh, a spokeswoman for the Fed, didn't immediately respond to a phone message seeking comment.

The retailer groups, in a lawsuit filed in November 2011, said merchants would be "substantially harmed" by the fees the Fed set under an amendment to Dodd-Frank pushed by Senator Dick Durbin, the Illinois Democrat.

"The board's final rule permits banks to recover significantly more costs than permitted by the plain language of the Durbin Amendment and deprives plaintiffs of the benefits of the statute's anti-exclusivity provisions," the retailers argued in their complaint.

The case was filed by the National Retail Federation, the Food Marketing Institute and NACS, formerly the National Association of Convenience Stores. Oil Miller Co., a residential heating and air company based in Norfolk, Va., and Boscov's Department Store LLC, based in Reading, Pa., also joined the complaint.

Dodd-Frank, the regulatory overhaul enacted in July 2010, required the Fed to ensure that fees charged for debit-card purchases were "reasonable and proportional" to the cost of processing transactions.

The 21-cent cap approved by the central bank was a pullback from a 12-cent limit it earlier proposed.

While retail and merchant groups lobbied successfully to defend the cut in swipe fees, a competing banking-industry campaign to delay the rules failed.

Durbin filed a brief supporting the retailers' suit that asked Leon to order the rule revised.

In their complaint, the retailers alleged the Fed didn't determine the incremental costs associated with a debit transaction and instead "invented" a category of costs not mentioned in the statute, giving the central bank unfettered discretion in setting the cap.

Leon said he had "no difficulty" concluding Congress intended "to bifurcate the entire universe of costs associated with interchange fees."

The law makes clear that the incremental cost associated with authorization, clearing, and settlement of an electronic debit transaction is the only cost the board was authorized to consider in its interchange transaction fee standard, Leon said. He said he was inclined to give the Fed "months, not years" to rewrite the rule in light of his decision.

Leon also sided with the retailers' challenge to the Fed's regulation of exclusivity agreements between banks and payment networks, saying it doesn't create "competition choice" among networks.

Under the rule, a debit card may allow only one network choice for signature transactions and one network choice for PIN transactions, the groups claim.

The regulation doesn't apply to debit-card issuers with consolidated assets of less than $10 billion, certain government-administered debit cards and certain prepaid cards, according to the Fed.

The case is NACS v. Board of Governors of the Federal Reserve System, 11-cv-02075, U.S. District Court, District of Columbia (Washington).

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