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Nacs v. Board of Governors of Federal Reserve System

United States District Court, District Circuit

July 31, 2013



RICHARD J. LEON, District Judge.

Plaintiffs NACS (formerly, the National Association of Convenience Stores), National Retail Federation ("NRF"), Food Marketing Institute ("FMI"), Miller Oil Co., Inc. ("Miller"), Boscov's Department Store, LLC ("Boscov's) and National Restaurant Association ("NRA") (collectively, "plaintiffs") bring this action against the Board of Governors of the Federal Reserve System ("defendant" or "the Board") to overturn the Board's Final Rule setting standards for debit card interchange transaction fees ("interchange fees") and network exclusivity prohibitions. Before the Court are the parties' cross-motions for summary judgment [Dkts. ##20, 23]. Upon consideration of the pleadings, oral argument, and the entire record therein, the Court concludes that 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. Accordingly, the plaintiffs' motion is GRANTED and defendant's motion is DENIED.


Four of the six plaintiffs in this case are major trade associations in the retail industry. NACS is an international trade association comprised of more than 2, 100 retail members and 1, 600 supplier members in the convenience store industry, most located in the United States. Am. Compl. ¶ 15 [Dkt. #18]. NRF is "the world's largest retail trade association, " representing department, specialty, discount, catalog, Internet, and independent stores, as well as chain restaurants, drug stores, and grocery stores in over 45 countries. Id. ¶ 17. FMI advocates for 1, 500 food retailers and wholesalers, including large multi-store chains, regional firms, and independent supermarkets. Id., ¶ 19. NRA is the "leading national association representing th[ e] [restaurant and food-service] industry, and its members account for over one-third of the industry's retail locations." Id. ¶ 23. According to plaintiffs, these trade associations and their members accept debit card payments and therefore are directly affected by the Board's interchange fee and network non-exclusivity regulations. Id. ¶¶ 16, 18, 20, 23-25.

The remaining plaintiffs are individual retail operations. Miller is a convenience store and gasoline retailer that also sells heating oil, heating and air-conditioning service, and commercial and wholesale fuels in the United States. Id. ¶ 21. Boscov's is an in-store and online retailer with a chain of forty full-service department stores located in five states in the mid-Atlantic region. Id. , 22. Both accept debit cards. See id. ¶¶ 21-22.

The Board is a federal government agency responsible for the operation of the Federal Reserve System and promulgation of our nation's banking regulations. Id. ¶ 26.

I. Debit Cards and Networks

Although now ubiquitous, debit cards were first introduced as a form of payment in the United States in only the late-1960s and early-1970s. See Final Rule, Debit Card and Interchange Fees and Routing, 76 Fed. Reg. 43, 394, 43, 395 (July 20, 2011) (codified at 12 C.F.R. §§ 235.1-235.10) ("Final Rule"). Unlike other payment options, debit cards allow consumers to pay for goods and services at the point of sale using cash drawn directly from their bank accounts, and to withdraw and receive cash back as part of the transaction. Id. Prior to debit cards, consumers had to use paper checks or make in-person withdrawals from human bank tellers in order to access their accounts. Id.

After decades of slow growth, the volume of debit card transactions increased rapidly in the mid-1990s, as did transactions involving other forms of electronic payment such as credit cards. Id. at 43, 395 & n.5. This upsurge in debit card usage continued into the 2000s, reaching approximately 37.9 billion transactions in 2009. Id. at 43, 395. By 2011, debit cards were "used in 35 percent of noncash payment transactions, and have eclipsed checks as the most frequently used noncash payment method." Id.

Most debit card transactions involve four parties, in addition to the network that processes the transaction. Id. at 43, 395 & n. 14. These parties are: (1) the cardholder (or consumer), who provides the debit card as a method of payment to a merchant; (2) the issuer (or issuing bank), which holds the consumer's account and issues the debit card to the consumer; (3) the merchant, who accepts the consumer's debit card as a method of payment; and (4) the acquirer (or acquiring bank), which receives the debit card transaction information from the merchant and facilitates the authorization, clearance, and settlement of the transaction on behalf of the merchant. Id. at 43, 395-96. The network provides the software and infrastructure needed to route debit transactions; it transmits consumer account information and electronic authorization requests from the acquirer to the issuer; and it returns a message to the acquirer either authorizing or declining the transaction. See 15 U.S.C. § 1693o-2(c)(11) (defining "payment card network"); 76 Fed. Reg. at 43, 396. In addition, "[b]ased on all clearing messages received in one day, the network calculates and communicates to each issuer and acquirer its net debit... position for settlement." 76 Fed. Reg. at 43, 396.

There are two types of debit card transactions-PIN (or "personal identification number") and signature-each of which requires its own infrastructure. In a PIN transaction, the consumer enters a number to authorize the transaction, and the data is carried in a single message over a system evolved from automated teller machine ("ATM") networks. Id. at 43, 395. In a signature transaction, the consumer authenticates the transaction by signing something (like a receipt), and the data is routed over a dual-message system utilizing credit card networks. Id. [1] "Increasingly, however, cardholders authorize signature' debit transactions without a signature and, sometimes, may authorize a PIN' debit transaction without a PIN." 76 Fed. Reg. at 43, 395 & n. 10.

The vast majority of debit cards (excluding prepaid cards) support authentication by both PIN and signature, but which one is used in a given transaction depends in large part on the nature of the transaction and the merchant's acceptance policy. Id. at 43, 395. For instance, hotel stays and car rentals are not easily processed on PIN-based systems because the transaction amount is unknown at the time of authorization. Id. Internet, telephone, and mail-based merchants also generally do not accept PIN transactions. Id. Of the eight million merchants in the United States that accept debit cards, the Board estimates that only one-quarter have the ability to accept PIN transactions. Id.

II. Debit Card Fees

There are several fees associated with debit card transactions. The largest is the interchange fee, which is set by the network and paid by the acquirer to the issuer to compensate the latter for its role in the transaction. Id. at 43, 396; see also § 1693o-2(c)(8) (defining "interchange transaction fee"). The network also charges acquirers and issuers a switch fee to cover its own transaction-processing costs. 76 Fed. Reg. at 43, 396; see also § 1693o-2(c)(10) (defining "network fee"). Once these fees are assessed, the acquirer credits the merchant's account for the value of its transactions, less a "merchant discount, " which includes the interchange fee, network switch fees charged to the acquirer, other acquirer costs, and a markup. 76 Fed. Reg. at 43, 396.

When PIN debit cards were first introduced, most regional networks set their interchange rates at "par, " offering no cost subsidization to either merchants or issuers.[2] Some networks, however, implemented "reverse" interchange fees, which issuers paid to acquirers to offset the cost to merchants of installing terminals and other infrastructure needed to accept PIN at the point of sale. 76 Fed. Reg. at 43, 396; Salop, supra note 1, ¶ 21; Mott, supra note 2, ¶ 7. Because this model eliminated the costs associated with paper checks and human bank tellers, issuers could provide debit services at a profit, even without collecting interchange fees.[3] Furthermore, issuers touted the convenience of PIN-debit to their customers, and customers in tum maintained higher account balances, which issuers could loan out at a profit. Mott, supra note 2, ¶ 3.

As debit cards became more popular, interchange fee rates and the direction in which the fees flowed began to shift. See 76 Fed. Reg. at 43, 396. By the early-2000s, acquirers were paying issuers ever-increasing interchange fees for PIN transactions. See id. Interchange fees for signature transactions, meanwhile, were modeled on credit card fees and were even higher than for PIN. Id.; Salop, supra note 1, ¶ 23.

In recent years, interchange fees have climbed sharply with PIN outpacing signature debit fees. From 1998 to 2006, merchants faced a 234 percent increase in interchange fees for PIN transactions, Mott, supra note 2, ¶ 24, and by 2009, interchange fee revenue for debit cards totaled $16.2 billion, 76 Fed. Reg. at 43, 396. For most retailers, debit card fees represent the single largest operating expense behind payroll.[4]

Because debit card transaction fees, including interchange fees, are set by the relevant network and paid by the acquirer (on behalf of merchants) to the issuer, perhaps the best way to understand why such fees have skyrocketed over the past two decades is to recognize the market dynamics among the networks, issuers, and merchants. Although there are many debit card networks in the United States, networks under Visa's and MasterCard's ownership account for roughly 83 percent of all debit transactions and nearly 100 percent of signature transactions.[5] Visa also owns Interlink, the largest PIN network.[6] Due to their hefty market share, Visa and MasterCard exercise considerable market power over merchants with respect to debit card acceptance. See Salop, supra note 1, ¶ 35. Hundreds of millions of consumers use cards that operate on Visa's and MasterCard's debit networks. Id. ¶ 36. Merchants know that if they do not accept those cards and networks, they risk losing sales, and "losing the sale would be costlier to the merchant than accepting debit and paying the high interchange fee." Id.

At the same time, Visa, MasterCard, and other debit networks vie for issuers to issue cards that run on their respective networks. Id. ¶ ¶ 33, 43. They can entice issuers by emphasizing their relative market power and ability to set interchange and other fees. Id .; see also 76 Fed. Reg. at 43, 396. Networks thus have an incentive to continuously raise merchants' interchange fees-which, again, flow from merchants to issuers-as a way to attract issuers to the network.[7] Visa, for instance, more than tripled the Interlink interchange fee since the early-1990s, forcing small competitor PIN networks to increase their fees as well. Mott, supra note 2, ¶ ¶ 23-24; Salop, supra note 1, ¶ ¶ 40, 46. Within each network, issuers all receive the same interchange fee, regardless of their efficiency in processing transactions or their efforts to prevent fraud. See Durbin Comments, supra note 5, at 5, 9.

In addition, Visa's and MasterCard's "Honor All Cards" rules force merchants that accept their networks' ubiquitous credit cards also to accept their signature debit cards with their corresponding high signature transactions fees.[8] As a practical matter, then, merchants cannot put downward pressure on interchange fees by rejecting network-affiliated debit cards. Durbin Comments, supra note 5, at 2, 5. And issuers have implemented reward programs, special promotions, and penalty fees to encourage debit (especially signature-debit) usage. Mott, supra note 2, ¶¶ 16-18; Salop, supra note 1, ¶ 47. Merchants have responded by raising the price of goods and services to offset the fees. See Durbin Comments, supra note 5, at 5, 9; NRF Comments, supra note 8, at 5.

The major card networks, not surprisingly, have also increased their own network fees, facilitated in part by exclusivity deals between the leading networks and debit issuers. Mott, supra note 2, ¶¶ 26-27; Salop, supra note 1, ¶¶ 30-31. Although there has been some network competition for PIN transactions, Visa and MasterCard have long-standing operating rules that disallow any other network from handling signature transactions on their cards. 76 Fed. Reg. at 43, 396; Mott, supra note 2, ¶¶ 26-27; Salop, supra note 1, ¶¶ 30-31. Within the PIN market, too, Visa has agreements with particular issuers that create exclusivity via "volume commitments that are pegged to incentives such as reduced fees" or require that Interlink be their sole PIN debit network. Salop, supra note 1, ¶ 30. Thus, the dominant networks have been able to raise their network fees on merchants without concern for lost transaction volume because merchants have no other alternatives for routing transactions. Id. ¶ 31. According to information collected by the Board, total network fees exceeded $4.1 billion in 2009, with networks charging issuers and acquirers more than $2.3 billion and $1.8 billion, respectively. 76 Fed. Reg. at 43, 397.

III. The Durbin Amendment

On July 21, 2010, Congress passed legislation to address the rise of debit card fees. Coined the "Durbin Amendment" after its sponsor, Illinois Senator Richard J. Durbin, the legislation seeks to implement Section 920 of the Electronic Fund Transfer Act ("EFTA"), 15 U.S.C. § 1693o-2, as enacted by Section 1075 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"), Pub. L. No. 111-203, 124 Stat. 1376, 2068-2074 (2010). The Durbin Amendment imposes various standards and rules governing debit fees and transactions. See id.; 76 Fed. Reg. at 43, 394. The regulations apply only to issuers with assets exceeding $10 billion. § 1693o-2(a)(6)(A).

A. Interchange Fees

The Durbin Amendment first addresses interchange transaction fees, which are defined as "any fee established, charged or received by a payment card network for the purpose of compensating an issuer for its involvement in an electronic debit transaction." § 1693o-2(c)(8). It provides that the fee charged by the issuer "with respect to an electronic debit transaction shall be reasonable and proportional to the cost incurred by the issuer with respect to the transaction." Id. § 1693o-2(a)(2) (emphasis added). It then directs the Board to establish standards to determine whether the amount of a debit card interchange fee is "reasonable and proportional to the cost incurred by the issuer" with respect to the transaction. Id. § 1693o-2(a)(3)(A). To promulgate these standards, Congress instructs the Board that it:

(A) consider the functional similarity between-
(i) electronic debit transactions; and
(ii) checking transactions that are required within the Federal Reserve bank system to clear at par; [and]
(B) distinguish between-
(i) the incremental cost incurred by an issuer for the role of the issuer in the authorization, clearance, or settlement of a particular electronic debit transaction, which cost shall be considered under[§ 1693o-2(a)(2)]; and
(ii) other costs incurred by an issuer which are not specific to a particular electronic debit transaction, which costs shall not be considered under[§ 1693o-2(a)(2)]

Id. § 1693o-2(a)(4)(A)-(B).

Once the Board establishes this interchange transaction fee standard, Congress authorizes the Board to adjust the fee to allow for fraud-prevention costs, provided the issuer complies with standards established by the Board relating to fraud prevention:

(5) Adjustment to interchange transaction fees for fraud prevention costs
(A) Adjustments. The Board may allow for an adjustment to the fee amount received or charged by an issuer under[§ 1693o-2(a)(2)], if-
(i) such adjustment is reasonably necessary to make allowance for costs incurred by the issuer in preventing fraud in relation to electronic debit transactions involving that issuer; and
(ii) the issuer complies with the fraud-related standards established by the Board under[§ 1693o-2(a)(5)(B)], which standards shall-
(I) be designed to ensure that any fraud-related adjustment of the issuer is limited to the amount described in clause (i) and takes into account any fraud-related reimbursements (including amounts from charge-backs) received from consumers, merchants, or payment card networks in relation to electronic debit transactions involving the issuer; and
(II) require issuers to take effective steps to reduce the occurrence of, and costs from, fraud in relation to electronic debit transactions, including through the development and implementation of cost-effective fraud prevention technology.

Id. § 1693o-2(a)(5)(A).[9]

B. Network ...

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