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Federal Judge Overturns Durbin Rules, Debit Interchange up For Grabs Again

Aug. 1, 2013

The Durbin Amendment, a law capping debit interchange rates that has been in effect for nearly two years, was overturned yesterday by a federal judge in Washington. U.S. District Court Judge Richard Leon—calling the interchange fee and network non-exclusivity regulations under the Fed rules “fundamentally deficient”—ruled in favor of a group of retailers and trade organizations that had brought suit against the Federal Reserve Board on the matter in 2011. Judge Leon concluded in his order that the Fed “clearly disregarded Congress's statutory intent by inappropriately inflating all debit-card transaction fees by billions of dollars and [failed] to provide merchants with multiple unaffiliated networks for each debit-card transaction.”

Merchants, which widely hailed the Durbin Amendment when it was added to the Dodd-Frank Wall Street reform bill passed in the wake of the 2008 financial crisis, became disenchanted with the law’s provisions after the final rule was implemented by the Fed. Many merchants—notably those that process a high volume of low-value transactions—actually saw the amount they pay in interchange rise when the card networks eliminated lower rates for small-ticket purchases.

The suit—filed more than a year ago by retailer groups including the National Retail Federation, the National Association of Convenience Stores and the National Restaurant Association—charged that the rules approved by the Fed Board of Governors exceed the authority granted to the Fed by Congress, and that the final rule is “arbitrary, capricious, an abuse of process and otherwise not in accordance with the law in violation of the Administrative Procedure Act.”

“From the very beginning, retailers and restaurants knew the Federal Reserve Board of Governors had grossly misapplied the Durbin Amendment,” said Mallory Duncan, senior vice president and general counsel of the National Retail Federation. “They failed to heed Congress’ call to set fee standards that were reasonable and proportional to the actual cost of a transaction. As a result, small-ticket transactions, such as those imposed on convenience stores and restaurants, skyrocketed under the misapplied law.”

Less than three months ago, the Federal Reserve Bank of Richmond’s own economists confirmed the small-ticket phenomenon in an article about the law’s unintended consequences, bolstering Judge Leon’s decision that the Fed’s final rule did not follow the intent of Congress, which was to lower interchange for all categories of merchant.

The Richmond team’s economic research found “market-determined interchange fees tend to be too high compared with the social optimum, so [continuing to regulate] down interchange fees could be welfare enhancing.” But putting a cap on the maximum interchange fee may not be working the way lawmakers had hoped. “Capping the weighted average interchange fee, instead of the maximum interchange fee, may avoid the unintended consequence on small-ticket merchants.”

In the original motion, plaintiffs argued that the Fed’s final rule “greatly expanded the costs allowed in the interchange fee standard,” which resulted in “shifting billions of dollars in additional costs from the issuing banks to merchants that accept debit cards.” The suit also says the final rule mishandled the network non-exclusivity portion of the Durbin Amendment, resulting in “entire categories of debit card transactions—such as Internet and telephone transactions, hotel stays and car rentals—not being afforded the competitive network choice required by statute.”

Leon has dumped the matter back into the hands of the Fed, which will need to go through the lengthy rulemaking process again. In the interim, the judge said the current rules would remain in force, but that a new Final Rule would need to be formulated in “months, not years.”


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