TCF Challenges the Durbin Amendment’s Constitutionality

TCF National Bank, a top 10 debit card issuer, on Tuesday filed a federal lawsuit challenging the constitutionality of the so-called Durbin Amendment, which, as part of the Dodd-Frank financial reform bill Congress passed in July, will regulate debit card interchange beginning next year. TCF alleges the debit card provisions are unconstitutional because they affect only 1% of financial institutions and, by limiting what costs approximately 90 big debit card issuers can recover through interchange, will result in smaller issuers having an unfair competitive advantage.

“It is unprecedented for Congress, or any regulatory agency, to mandate a fee charged in the free market that not only denies a reasonable rate of return on investment, but actually requires the rate to be lower than the incremental cost of providing the service,” William A. Cooper, chairman and chief executive of the bank’s parent company, Wayzata, Minn.-based TCF Financial Corp., said in a statement.

TCF filed its suit in U.S. District Court in Sioux Falls, S.D. To mount its constitutional challenge, the suit names the Federal Reserve Board and its individual governors, including Chairman Ben Bernanke, as defendants. Congress charged the Fed with devising regulations by late next April to implement “reasonable and proportional” debit card interchange. The Fed had no immediate comment on the suit.

The amendment’s author, U.S. Sen. Richard J. Durbin, however, said in a statement that he expects his provisions will survive. “TCF’s complaint not only fundamentally misunderstands the law regarding interchange fees, but it also ignores the facts,” the Illinois Democrat and Senate majority whip said. “The law in no way addresses the fees TCF, or any other bank, can charge and it does not set interchange rates. Our language simply ensures that debit interchange fees charged to retailers by the card networks—not the banks—are ‘reasonable and proportional’ to the cost of processing transactions and provides competition in an area of the market where there’s none.”

In a briefing with analysts Tuesday morning, Cooper said he expects the Fed will stick closely to what Congress is allowing and not allowing it to consider in setting debit card interchange. Banks and credit unions with less than $10 billion in assets will be exempted. The Fed late this summer sent surveys to financial institutions asking them about their various debit card-related expenses. Those survey responses are due Oct. 12.

TCF hired as lawyers for the case a prominent constitutional scholar, Richard A. Epstein of the University of Chicago, along with Timothy D. Kelly of Kelly & Berens P.A., Minneapolis. “The Durbin Amendment blatantly confiscates TCF’s assets by denying the bank an opportunity to earn a fair rate of return on its assets,” Epstein said in a statement. “The amendment also engages in invidious discrimination against the bank by making it impossible for it to compete on even ground with the thousands of banks that are exempted from the amendment. Well-established Supreme Court case law prohibits Congressional rate regulation that does not allow the bank to attract and retain the capital necessary to run its debit card business.”

Cooper said debit cards aren’t a separate product, but an integral part of checking accounts. Still, debit cards are an important revenue generator for TCF, which has 822,493 active Visa check users, according its second-quarter report. The bank doesn’t have a credit card program. In its complaint, TCF says its debit card yield is 1.35% of the transaction ticket, and that after regulation, the yield will drop by 80%. That would take annual debit revenues down from $102 million to about $20 million, the filing says.

Payments attorney Anita Boomstein, a partner at Hughes Hubbard & Reed LLP in New York, believes TCF faces some high hurdles in convincing a court that Congress didn’t have the authority to impose debit card regulations. She notes that the bank doesn’t charge its cardholders anything for their debit cards. “I don’t see any provision of the Constitution which allows this bank to shift to the merchants the burden of all of the expenses of their checking-account program,” she says. “I don’t really see a viable constitutional argument here.”

At the conference call, the plainspoken Cooper traced the origin of the conflict to retailers, who ultimately pay interchange, getting the upper hand over banks in a political dispute as the Durbin Amendment and Dodd-Frank bill worked their way through Congress earlier this year. “This is a bonanza for big retailers on the backs of retail customers,” he said.