District Court Ruling on Durbin Amendment: The Future for Interchange and Broader Regulatory Environment

In a widely reported and reacted to ruling July 31st, Judge Richard Leon of the U.S. District Court found that the Fed ran “completely afoul of the text, design and purpose of the Durbin Amendment” in its final ruling on interchange fees and network exclusivity that went into effect October 1, 2011.  For Issuers (Banks), it got worse: “The board’s final rule permits banks to recover significantly more costs than permitted” and “deprives plaintiffs of the benefits of the statute’s anti-exclusivity provisions.”

In ruling for the National Association of Convenient Stores (NACS), Judge Leon cites and explicitly rebukes the Fed’s reasoning with respect to the costs included in forming its base for interchange caps and in deeming two payment networks per card sufficient.  The Fed appealed in August, and the legal process will extend the timeline at least through 2013, very likely considerably beyond.  With supplemental briefs submitted earlier in October and reply briefs set for December, scheduling the appeals hearing in Q1 2014 is realistic.  Subsequent appeals would extend it indefinitely, particularly if escalated to the Supreme Court, which has a February deadline to submit briefs requesting a hearing in 2014.

The specific language of the District Court ruling is significant, as it is specific to the reasoning and interpretation of the Durbin Amendment the Fed employed in issuing its final ruling.  In order for interchange fees to be “reasonable,” the Fed was tasked with linking interchange fees with costs incurred and to mitigate the effective monopoly bargaining power being exercised by the major networks through network exclusivity requirements.  The Fed examined cost data and received comments from all concerned parties to arrive at its initial proposal, which included only incremental Authorization, Clearing and Settlement (ACS) costs; a proposal welcomed by merchants.  Pursuant to the comments received, the Fed ultimately expanded its final ruling to include a number of costs in arriving at ‘reasonable’ cap on interchange.  As to network exclusivity, the Fed considered requiring acceptance of at least two payment networks active per card, or at least two for each transaction type (PIN and Signature), deciding to settle on the former in its ruling.  Considering the above, while the Durbin Amendment in general was a blow to interchange, the Fed’s softening of its initial interpretation was a minor victory for issuers and networks.

Enter Judge Leon.  Given the rationale documented by the Fed, should Leon’s ruling be upheld it is possible the required revision would resemble the alternate options initially considered; that is, the basis for fee caps limited to consideration of variable ACS costs, further lowering the cap on fees, and expansion of the multiple payment network requirement for each transaction type, increasing competition amongst payment networks.

Banks would also do well to consider the potential precedent being set; that the objective manifestation (interchange fee caps) of a subjective term (“reasonable”) remains forever open to scrutiny.  Should the Fed lose in appeal, it is not difficult to conceive another lawsuit being brought in 1, 3, or 5 years challenging that the new fee restrictions are no longer “reasonable.”  Perhaps by citing future cost efficiencies gained from technological innovation or the need to further expand minimum payment networks in the name of competition, a future legal challenge almost writes itself.  Banks, already seeing per transaction revenue in decline, now face another period of uncertainty and further deterioration of  a significant Non-interest income stream.

In many ways, the instability and subjectivity of the headline grabbing Durbin Amendment is a fitting representation for Dodd Frank, a bill that includes as one of its opening stated goals “other purposes” amongst the equally indefinite “financial stability” and improvement of “transparency and accountability.”  A push for complete implementation of Dodd Frank is currently being revived in political circles, and if the Durbin Amendment is an apt forebear, the broader regulatory grounds show no signs of stabilizing.

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