Merchants File Suit Accusing the Fed of Departing from the Law with Its Durbin Regs

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Three retail trade groups and two merchants filed a lawsuit on Tuesday against the Federal Reserve Board, accusing the Fed of failing to follow the law when it set its debit card interchange price controls and related regulations that implement the Durbin Amendment in 2010’s Dodd-Frank Act.

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The suit, filed in U.S. District Court in Washington, D.C., asks the court for a declaratory judgment that would force the Fed to reconsider its rulemaking. The parts of Fed’s final rule in question are “arbitrary, capricious, an abuse of discretion and otherwise not in accordance with law,” the suit says.

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The Fed responded with a one-sentence statement from a spokesperson: “We are aware of this lawsuit and we will be reviewing it.”

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Retailers had hinted last summer that a trip to court might be in the offing. The plaintiffs are the National Retail Federation, the Food Marketing Institute representing 40,000 grocery and drug stores, NACS, formerly the National Association of Convenience Stores, department store chain Boscov’s Department Store LLC, and Miller Oil Co., a convenience store/gas-station chain based in Norfolk, Va. Merchants, who said for years that the market wasn’t responding to their complaints about rising interchange, pay the expense to card issuers based on rates set by payment card networks such as Visa Inc. and MasterCard Inc.

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The controversial Durbin Amendment ordered the Fed to set “reasonable and proportional” debit card interchange price controls for issuers with more than $10 billion in assets. The Fed last December proposed caps of 7 to 12 cents per transaction, caps that would have cut big issuers’ interchange by more than 70% over their 44-cent per-transaction average and caused an uproar in the banking industry. After receiving more than 11,000 comments, the Fed on June 29 issued final regulations setting a price cap of 21 cents with a 0.05% of the sale ad valorem and another 1 cent pending for fraud control. That represented a cut of 47% on the average debit sale.

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The law called for the Fed to consider only what the plaintiffs call a “bucket” of incremental costs for authorization, clearing, and settlement, and forbade it from factoring in another bucket of other costs not specific to a transaction, according to Mallory Duncan, senior vice president and general counsel for the Washington-based NRF. The Fed had determined that the actual cost for authorization, clearing, and settlement was 4 cents per transaction.

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Instead, according to the plaintiffs, the Fed essentially created at bankers’ behest a third bucket of costs not covered by the statute, including network switch fees; fraud losses represented by the 0.05% ad valorem versus the permitted fraud-control expenses, and some fixed hardware and software costs. “They created a subset of the non-allowed costs and said, ‘we probably should be allowed to use these,’” Duncan says. He adds that the first proposal “was high” but “came close” to following the law. But with the final rule, “the Fed came back and increased it, and the way they increased it was in basically ignoring the law.”

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The retailers also say the Fed’s rule fails to implement the amendment’s ban on network exclusivity in which merchants’ transaction-routing choices are limited only to affiliated networks. (The biggest example is Visa for signature debit and the Visa-owned Interlink network for point-of-sale PIN debit.) The Fed said an issuer could satisfy the requirement by offering  a card with one unaffiliated signature and one unaffiliated PIN-debit network. But that plan, according to the retailers, actually circumvents the exclusivity ban because, with neither Visa nor MasterCard allowing the other’s brand for signature debit, the law’s requirement that merchants have an unaffiliated choice for each transaction may not be realized.

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Retailers during rule-making process came out in support of a Fed proposal that if a card offered both signature and PIN debit, it must offer at least two unaffiliated networks for each authentication method. The suit says that Boscov’s, a Reading, Pa.-based regional chain with 40 stores, does not accept PIN-debit cards and thus its routing choices for each debit transaction are limited to only one network. Boscov’s paid about $2.9 million in interchange last year on $200 million in debit charges, according to data in the lawsuit.

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Eric Grover, a Nevada consultant and former Visa International executive who defends the pre-Durbin interchange system, says that while he strongly dislikes the Durbin Amendment, it is clear to him that the Fed indeed went well beyond the statutory language. That, he says, undercuts the rule of law and also undercuts chances of repealing the amendment. (A bi-partisan repeal bill in the House still awaits its first hearing, according to Grover.)

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“I find myself in the funny position of wishing the retailers well in this suit despite the fact that I think the law is a horrendous law,’ he says.

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A spokesperson for the Electronic Payments Coalition, a lobbying group of banks and payment networks, said by e-mail that, “Apparently, retailers aren’t happy with their $8 billion windfall, even though they’re pocketing all of it, with no evidence of passing any of it back to their customers.” She added that retailers “won’t truly be happy until they pay zero to accept cards.”

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A spokesperson for the Durbin Amendment’s chief sponsor, U.S. Sen. Richard Durbin, D-Ill., said the senator would not comment on pending litigation.