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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 1 of 75

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLUMBIA




NACS, NATIONAL RETAIL FEDERATION,
FOOD MARKETING INSTITUTE, MILLER
OIL CO., INC., BOSCOV’S
DEPARTMENT STORE, LLC, and
NATIONAL RESTAURANT ASSOCIATION,

Plaintiffs,




v.





BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM,

Defendant.






Case No. 1:11-cv-02075-RJL











PLAINTIFFS’ MOTION FOR SUMMARY JUDGMENT



Pursuant to Federal Rule of Civil Procedure 56, Plaintiffs NACS, National Retail

Federation, Food Marketing Institute, Miller Oil Co., Inc., Boscov’s Department Store, LLC, and

National Restaurant Association (collectively, “Plaintiffs”), by and through the undersigned

counsel, respectfully move for summary judgment declaring invalid recently enacted regulations

issued by the Defendant Board of Governors of the Federal Reserve System (the “Board”). See

Final Rule, Debit Card and Interchange Fees and Routing, 76 Fed. Reg. 43,394 (July 20, 2011).

In particular, the Board’s “interchange transaction fee” regulation (12 C.F.R. § 235.3) and

“network non-exclusivity” regulation (12 C.F.R. § 235.7) exceed the authority granted to it by

Congress in 15 U.S.C. § 1693o-2. Plaintiffs respectfully move that the Court declare the Final

Rule to be arbitrary, capricious, an abuse of process and otherwise not in accordance with the

law in violation of Administrative Procedure Act. See 5 U.S.C. § 701 et seq.



Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 2 of 75

The grounds for this motion are set forth in the accompanying memorandum of law.

Pursuant to Local Rule 7(f), Plaintiffs request oral argument on this motion.

Dated: March 2, 2012







Email: [email protected]



Respectfully Submitted,

/s Shannen W. Coffin
Shannen W. Coffin (D.C. Bar # 449197)

Douglas S. Kantor (D.C. Bar # 455895)
Linda C. Bailey (D.C. Bar # 985081)
STEPTOE & JOHNSON LLP
1330 Connecticut Ave., N.W.
Washington, D.C. 20036
Tel: (202) 429-3000
Fax: (202) 429-3902

Counsel for Plaintiffs NACS, National Retail
Federation, Food Marketing Institute, Miller
Oil Co., Inc., Boscov’s Department Store,
LLC, and National Restaurant Association



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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 3 of 75

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLUMBIA




NACS, NATIONAL RETAIL FEDERATION,
FOOD MARKETING INSTITUTE, MILLER
OIL CO., INC., BOSCOV’S
DEPARTMENT STORE, LLC, and
NATIONAL RESTAURANT ASSOCIATION,

Plaintiffs,

BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM,

Defendant.




v.


















Case No. 1:11-cv-02075-RJL









MEMORANDUM IN SUPPORT OF PLAINTIFFS’

MOTION FOR SUMMARY JUDGMENT





Email: [email protected]

Shannen W. Coffin (D.C. Bar # 449197)

Douglas S. Kantor (D.C. Bar # 455895)
Linda C. Bailey (D.C. Bar # 985081)
STEPTOE & JOHNSON LLP
1330 Connecticut Ave., N.W.
Washington, D.C. 20036
Tel: (202) 429-3000
Fax: (202) 429-3902

Counsel for Plaintiffs NACS, National Retail
Federation, Food Marketing Institute, Miller
Oil Co., Inc., Boscov’s Department Store,
LLC, and National Restaurant Association

Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 4 of 75

TABLE OF CONTENTS



TABLE OF AUTHORITIES .......................................................................................................... ii
INTRODUCTION .......................................................................................................................... 1
BACKGROUND ............................................................................................................................ 6
ARGUMENT ................................................................................................................................ 22
STANDARD OF REVIEW .................................................................................. 22
THE FINAL RULE’S INTERCHANGE FEE STANDARD VIOLATES
THE APA .............................................................................................................. 23
A.

I.
II.

III.

2.

3.

The Board’s Interpretation of Its Interchange Fee Authority Cannot
Survive Scrutiny Under Chevron Step One .............................................. 24
1.

The Durbin Amendment Limits Allowable Costs to Those
Costs Specifically Delineated in 15 U.S.C. § 1693o-
2(a)(4)(B)(i) .................................................................................. 25
The Board Improperly Expanded the Costs Allowable
Within Its Interchange Fee Standard ............................................. 31
The Particular Items of Costs Considered by the Board Are
Foreclosed from Consideration by the Durbin Amendment ......... 37
The Board’s Interpretation Is Unreasonable ............................................. 43

B.
THE FINAL RULE’S IMPLEMENTATION OF THE DURBIN
AMENDMENT’S NETWORK NON-EXCLUSIVITY PROVISION
VIOLATES THE APA ......................................................................................... 46
A.

The Board’s Non-Exclusivity Regulation Fails Chevron’s First
Step ........................................................................................................... 48
1.

The Plain Language of the Statute Requires that Merchants
Be Given a Choice Between Multiple Unaffiliated
Networks for Each Transaction .................................................... 48
The Durbin Amendment’s Legislative History Proves that
the Statute Was Intended to Increase Competition by
Mandating that Merchants Be Given a Choice of Network
for Each Transaction ..................................................................... 52

2.

B.

The Board’s Interpretation Is Unreasonable and Fails Chevron’s
Second Step ............................................................................................... 53
CONCLUSION ............................................................................................................................. 56
ADDENDUM .............................................................................................................................. A1


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CASES

TABLE OF AUTHORITIES

Page(s)

*ABA v. FTC,

430 F.3d 457 (D.C. Cir. 2005) ...........................................................................................35, 46

American Scholastic TV Programming Found. v. FCC,

46 F.3d 1173 (D.C. Cir. 1995) .................................................................................................30

Associated General Contractors, Inc. v. California State Council of Carpenters,

459 U.S. 519 (1983) .................................................................................................................49

Atl. City Elec. Co. v. FERC,

295 F.3d 1 (D.C. Cir. 2002) .....................................................................................................35

Begier v. IRS,

496 U.S. 53 (1990) ...................................................................................................................31

Beverly Health & Rehab. Servs. v. NLRB,

317 F.3d 316 (D.C. Cir. 2003) .................................................................................................27

Blair-Bey v. Quick,

151 F.3d 1036 (D.C. Cir. 1998) ...............................................................................................31

Brown v. Gardner,

513 U.S. 115 (1994) .................................................................................................................34

California State Bd. of Optometry v. FTC,

910 F.2d 976 (D.C. Cir. 1990) .................................................................................................27

Cascade Health Solutions v. Peacehealth,

515 F.3d 883 (9th Cir. 2008) ...................................................................................................38

*Chevron U.S.A. Inc. v. NRDC,

467 U.S. 837 (1984) ......................................................................................................... passim

City of Cleveland v. U.S. Nuclear Regulatory Comm’n,

68 F.3d 1361 (D.C. Cir. 1995) .................................................................................................43

Davis v. Michigan Dep’t of Treasury,

489 U.S. 803 (1989) .................................................................................................................30

DXS, Inc. v. Siemens Med. Sys., Inc.,

100 F.3d 462 (6th Cir. 1996) ...................................................................................................38

*Ethyl Corp. v. EPA,

51 F.3d 1053 (D.C. Cir. 1995) .................................................................................................35

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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 6 of 75

FDA v. Brown & Williamson Tobacco Corp.,

529 U.S. 120 (2000) .................................................................................................................22

First Nat’l Bank & Trust Co. v. Nat’l Credit Union,

90 F.3d 525 (D.C. Cir. 1996) ...................................................................................................25

GTE Serv. Corp. v. FCC,

205 F.3d 416 (D.C. Cir. 2000) ...........................................................................................43, 53

Hammontree v. NLRB,

894 F.2d 438 (D.C. Cir. 1990) .................................................................................................25

In re Visa Check/MasterMoney Antitrust Litigation,

192 F.R.D. 68 (E.D.N.Y. 2000) ...............................................................................................11

Independent Ins. Agents of Am., Inc. v. Hawke,

211 F.3d 638 (D.C. Cir. 2000) .................................................................................................29

Maine Public Serv. Co. v. FERC,

964 F.2d 5 (D.C. Cir. 1992) .....................................................................................................38

Massachusetts v. Dep’t of Transp.,

93 F.3d 890 (D.C. Cir. 1996) .............................................................................................43, 46

Meredith v. Federal Mine Safety & Health Review Comn’n,

177 F.3d 1042 (D.C. Cir. 1999) ...............................................................................................29

Michigan v. EPA,

268 F.3d 1075 (D.C. Cir. 2001) ...............................................................................................35

Morgan v. Ponder,

892 F.2d 1355 (8th Cir. 1989) .................................................................................................38

National R.R. Passenger Corp. v. Boston & Me. Corp.,

503 U.S. 407 (1992) .................................................................................................................24

Natural Resources Defense Council, Inc. v. Browner,

57 F.3d 1122 (D.C. Cir. 1995) ...........................................................................................25, 30

*Natural Resources Defense Council, Inc. v. Daley,

209 F.3d 747 (D.C. Cir. 2000) ...............................................................................25, 34, 43, 55

National Resources Defense Council, Inc. v. Reilly,

983 F.2d 259 (D.C. Cir. 1993) .................................................................................................35

Nuclear Energy Inst., Inc. v. EPA,

373 F.3d 1251 (D.C. Cir. 2004) ...............................................................................................34

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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 7 of 75

Public Citizen v. FTC,

869 F.2d 1541 (D.C. Cir. 1989) ...............................................................................................30

Qi-Zhuo v. Meissner,

70 F.3d 136 (D.C. Cir. 1995) ...................................................................................................38

*Qwest Corp. v. FCC,

258 F.3d 1191 (10th Cir. 2001) ...................................................................................28, 38, 44

Sea-Land Serv., Inc. v. Dep’t of Transp.,

137 F.3d 640 (D.C. Cir. 1998) .................................................................................................36

Sec’y of Labor v. Fed. Mine Safety & Health Review Comm’n,

111 F.3d 913 (D.C. Cir. 1997) .................................................................................................23

Shook v. Dist. of Columbia Fin. Responsibility & Management Assistance Auth.,

132 F.3d 775 (D.C. Cir. 1998) .................................................................................................29

Southern California Edison Co. v. FERC,

116 F.3d 507 (D.C. Cir. 1997) .................................................................................................25

Southern California Edison Co. v. FERC,

195 F.3d 17 (D.C. Cir. 1999) .............................................................................................24, 25

Texas v. United States,

497 F.3d 491 (5th Cir. 2007) ...................................................................................................35

Theodore Roosevelt Conservation Partnership v. Salazar,

616 F.3d 497 (D.C. Cir. 2010) .................................................................................................22

Thompson Ramo Wooldridge Inc. v. United States,

361 F.2d 222 (Ct. Cl. 1966) .....................................................................................................33

Transohio Sav. Bank v. Dir., Office of Thrift Supervision,

967 F.2d 598 (D.C. Cir. 1992) .................................................................................................23

United States v. Indoor Cultivation Equip.,

55 F.3d 1311 (7th Cir. 1995) ...................................................................................................27

Whitman v. Am. Trucking Assns., Inc.,

531 U.S. 457 (2001) .................................................................................................................36

ACTS

Dodd-Frank Wall Street Reform and Consumer Protection Act, § 1075, Pub. L. No. 111-

203, 124 Stat. 1376, 2068-2074 (2010) .....................................................................................1

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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 8 of 75

STATUTES

5 U.S.C. § 706 (2006) ..........................................................................................................2, 22, 23

15 U.S.C. § 1693o-2 (Supp. IV 2010) ................................................................................... passim

5 U.S.C.A. §§ 701 et seq. (2006 & Supp. IV 2010) ........................................................................5

LEGISLATIVE MATERIALS

156 Cong. Rec. S3,703-05 (daily ed. May 13, 2010) ....................................................................53

156 Cong. Rec. S4,978 (daily ed. June 16, 2010) ..........................................................................20

156 Cong. Rec. S5,802 (daily ed. July 14, 2010) ...........................................................................10

156 Cong. Rec. S5,925 (daily ed. July 15, 2010) .................................................................. passim

H.R. 4,173, 111th Cong. (2009).....................................................................................................52

H.R. 4,173, 111th Cong. (2010).....................................................................................................53

H.R. Conf. Rep. No. 111-517 (2010) .............................................................................................53

RULES

Fed. R. Civ. P. 56(c) ......................................................................................................................22

CODE OF FEDERAL REGULATIONS

12 C.F.R. § 235.3 .................................................................................................................5, 17, 56

12 C.F.R. § 235.7 .................................................................................................................5, 19, 56

BOOKS AND ARTICLES

Black’s Law Dictionary at 1119 (6th ed. 1990) .......................................................................33, 38

Webster’s New College Dictionary 417 (2007) ................................................................. 26-27, 33

William Strunk Jr. & E.B. White, The Elements of Style 59 (3d ed. 1979) ...................................27

OTHER AUTHORITIES

Final Rule, Debit Card and Interchange Fees and Routing, 76 Fed. Reg. 43,394 (July 20,

2011) ................................................................................................................................ passim

Interim Final Rule, Debit Card Interchange Fees and Routing, 76 Fed. Reg. 43,478 (July

20, 2011) ..................................................................................................................................13

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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 9 of 75

Notice of Proposed Rulemaking, Debit Card Interchange Fees and Routing, 75 Fed. Reg.

81,722 (Dec. 28, 2010) .................................................................................................... passim





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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 10 of 75

As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress

INTRODUCTION



sought to contain the rapidly escalating costs that merchants incur for accepting debit cards as a

method of payment. As debit cards have become a dominant method of payment by American

consumers, anticompetitive practices by and among the major debit card networks—Visa and

MasterCard—and banks that issue those cards have led to significantly higher transaction fees

for merchants that accept debit cards. For many merchants, especially small businesses,

payment card costs have become one of their largest operating costs—exceeding all other major

operating costs except labor. Because of a lack of competition among networks and issuing

banks, the two major components of debit card fees paid by merchants—(a) “interchange fees”

or “swipe fees,” i.e., the fees set by networks to compensate issuing banks for their role in a debit

card transaction; and (b) “network fees,” i.e., the fees charged by networks for their role in

processing the transaction—have risen steadily as debit card use has become more ubiquitous.

In an amendment sponsored by (and named for) Senator Richard Durbin, Congress

adopted measures designed to curb these rising debit card fees. The “Durbin Amendment”

directed the Board of Governors of the Federal Reserve System (“Board”) to adopt rules

regulating, among other things, the transaction fees charged by debit card issuing banks and debit

card networks.1

Plaintiffs, a group of retail merchants that accept debit cards as payment for retail

transactions and trade associations comprised of such merchants, contest here the Board’s




1 Codified at Section 920 of the Electronic Fund Transfer Act (“EFTA”), 15 U.S.C.

§ 1693o-2 (Supp. IV 2010) (set forth in Addendum). See Dodd-Frank Wall Street Reform and
Consumer Protection Act, § 1075, Pub. L. No. 111-203, 124 Stat. 1376, 2068-2074 (2010)
(“Dodd-Frank Act”).

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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 11 of 75

implementation of the two particular aspects of the Durbin Amendment’s debit card cost control

measures. First, plaintiffs challenge recently adopted regulations establishing a debit card

interchange fee standard to limit the amount of interchange fees that networks and issuing banks

may charge merchants to process debit card transactions. Second, plaintiffs challenge the

Board’s implementation of the statute’s network routing requirements, which were designed to

prohibit exclusivity arrangements limiting merchant choice among debit card networks. In each

case, the Board’s regulation impermissibly implements the Durbin Amendment’s statutory

command and thus exceeds the authority delegated to the Board. Because they run afoul of the

Administrative Procedure Act, 5 U.S.C. § 706(2), these regulations must be invalidated.

First, the statute directs the Board to adopt regulations limiting “interchange transaction

fees”—i.e., the fees paid by the merchants that accept debit cards to the banks that issue those

cards. See 15 U.S.C. § 1693o-2(a). In the years prior to the enactment of the Durbin

Amendment, debit card interchange fees had skyrocketed as a result of anticompetitive practices

among the dominant debit card networks, Visa and MasterCard, and banks that issue debit

cards—costing merchants more than $16 billion in 2009 alone. The average interchange fee for

the most common type of debit transaction amounted to about 1.5% of every transaction. See

Notice of Proposed Rulemaking, Debit Card Interchange Fees and Routing, 75 Fed. Reg. 81,722,

81,725 (Dec. 28, 2010) (“NPRM”) (attached as Ex. A).

The Durbin Amendment sought to curb these rising costs by requiring that debit card

interchange fees be reasonable and proportional to the cost incurred by the issuing bank (the

“issuer”) with respect to the debit card transaction. In order to accomplish this objective, the

statute directs the Board to set an interchange fee standard that takes into account certain

statutory considerations. Chief among them, the Board must distinguish between two categories

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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 12 of 75

of costs associated with debit card transactions: (a) the incremental cost incurred by an issuer for

its role in the authorization, clearance or settlement of a particular electronic debit transaction,

which must be included in the Board’s interchange fee standard; and (b) other costs incurred by

an issuer which are not specific to a particular electronic debit transaction, which must be

excluded from consideration. 15 U.S.C. § 1693o-2(a)(4)(B).

In a Notice of Proposed Rulemaking published in December 2010, the Board proposed to

follow the letter of Congress’s command. It thus proposed an interchange fee standard that

allowed issuing banks to recover only those costs that are specifically mentioned for

consideration in the statute (i.e., the variable cost incurred by an issuer in authorizing, clearing

and settling a debit card transaction) and excluded from consideration all other costs. 75 Fed.

Reg. at 81,734-35. Based on its review of data regarding the components of allowable costs, the

Board proposed two alternative interchange fee standards, allowing issuers to recover

interchange fees in amounts ranging from 7 cents to 12 cents per debit card transaction. Id. at

81,736.

After significant pushback from the banking community in the comment process, the

Board reversed course and adopted a Final Rule that greatly expanded the costs allowed in the

interchange fee standard. See Final Rule, Debit Card and Interchange Fees and Routing, 76 Fed.

Reg. 43,394 (July 20, 2011) (“Final Rule”) (attached as Ex. B). Where it had once proposed to

properly distinguish between costs required to be included and costs required to be excluded

from its interchange fee standard, the Board now invented a third category of costs over which it

claimed unbridled discretion to consider in its standard. As a result of this novel interpretation—

at odds with the statute’s plain text, purpose and legislative history—the Board adopted a Final

Rule that doubled or even tripled the interchange fees allowable (as compared to the alternatives

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proposed in the NPRM), shifting billions of dollars in additional costs from the issuing banks to

merchants that accept debit cards.

The Board seeks refuge for its stunning reversal in the deferential judicial review

required under Chevron U.S.A. Inc. v. NRDC, 467 U.S. 837 (1984). But the Board asks too

much of Chevron. In finding statutory ambiguity where it once saw clarity, the Board disregards

the letter of the Durbin Amendment, which established a clear dichotomy between transactional

costs that must be considered in the Board’s interchange fee standard and all other costs, which

must be excluded. The Final Rule further includes within its interchange fee standard a number

of individual cost items—such as fraud losses and fixed processing costs—specifically excluded

by the statute’s plain terms. The Board’s final rule is thus beyond the authority delegated by

Congress, unreasonably implements the statute’s terms, and should be invalidated.

Second, Congress also recognized the problem of rising network fees—the fees charged

by Visa, MasterCard and other debit card networks for their role in processing debit card

transactions. In a legislative compromise, however, Congress declined to regulate the level of

those fees directly, as it had with interchange fees. Rather, it sought to control network fees

through increased network competition, by removing prevailing restrictions on merchant routing

of debit card transactions at the point of sale. To enhance that competition, the Board is required

to adopt regulations prohibiting debit card networks and issuing banks from “restrict[ing] the

number of payment card networks on which an electronic debit transaction may be processed” to

fewer than two unaffiliated networks. 15 U.S.C. § 1693o-2(b)(1). As the Board acknowledged,

this provision would “give merchants the flexibility to route transactions over the network that

will result in the lowest cost to the merchant. . . .” 76 Fed. Reg. at 43,446.

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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 14 of 75

The Final Rule improperly implements this network non-exclusivity provision by

requiring issuers to maintain two unaffiliated networks on each debit card issued to customers.

By focusing on the debit card, the Board loses sight of the statute’s requirement of network

choice as to each electronic debit transaction. The Board concluded that an issuer can comply

with the network choice requirement by maintaining a single network for each method of debit

card authentication—signature and personal identification number (“PIN”) authentication. But

because of technological limitations and prevailing practices in the market, the majority of

merchants are not enabled to accept both signature and PIN transactions. Thus, as a result of the

Board’s interpretation, entire categories of debit card transactions—such as internet and

telephone transactions, hotel stays, and car rentals—are not afforded the competitive network

choice required by the statute. The Board’s interpretation deprives the nearly 75% of merchants

that accept debit cards but that are not enabled for PIN transactions of any competitive network

choice. For these and other reasons explained below, the network non-exclusivity rule

contravenes both the letter and purpose of the Durbin Amendment and cannot survive judicial

review.

This case presents issues of statutory interpretation that are appropriate for summary

judgment on the basis of an undisputed administrative record. Because the Final Rule’s

“interchange transaction fee” provision (12 C.F.R. § 235.3) and “network exclusivity” provision

(12 C.F.R. § 235.7) exceed the Board’s statutory authority and arbitrarily and capriciously

implement Congress’s statutory command, they should be invalidated under the Administrative

Procedure Act. See 5 U.S.C.A. §§ 701 et seq. (2006 & Supp. IV 2010) (“APA”).





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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 15 of 75

I.

DEBIT CARDS AND DEBIT CARD NETWORKS

BACKGROUND



Debit cards, introduced in the late 1960s and early 1970s, provided an additional

means—other than checks and in-person withdrawals—by which consumers could access funds

in their bank deposit accounts. See 76 Fed. Reg. at 43,395. Debit cards essentially operate like

an electronic check, accessing funds in a consumer’s deposit account when presented for

payment to the merchant at the point of sale. Originally used through banks’ regional ATM

networks, debit cards rapidly evolved from facilitating banking activities to a direct payment

method for consumer purchases of goods or services. Id. They are generally issued by

depository institutions to their deposit account holders and have “eclipsed checks as the most

frequently used noncash payment method,” estimated by the Board to account for about 50

billion transactions in 2011 alone. Id. at 43,395 & n.8.

A typical debit card transaction involves four parties in addition to the network that

processes the transaction: (1) the consumer, who presents a debit card for payment for goods or

services; (2) the issuing bank, the depository institution that holds the consumer’s account and

issues the debit card to the consumer (see 15 U.S.C. § 1693o-2(c)(9) (defining “Issuer”)); (3) the

merchant, which accepts payment by debit card; and (4) the merchant’s bank (also known as an

acquiring bank), which facilitates the authorization, clearance and settlement of a debit

transaction on behalf of its the merchant. See 76 Fed. Reg. at 43,395 (describing “the so-called

four-party system”). The network provides the infrastructure and software for routing data for

debit card authorization, clearance, and settlement. See 15 U.S.C. § 1693o-2(c)(11) (defining

“Payment Card Network”). It receives transaction information and data from the merchant and

the merchant’s bank, routes the information to the issuer bank, and determines each side’s daily

settlement position for interbank monetary transfers. 76 Fed. Reg. at 43,395.

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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 16 of 75

Debit card transactions are segregated into two categories based on how the transaction is

initiated and authenticated by the consumer: PIN and “signature” transactions. See generally

76 Fed. Reg. at 43,395. Currently, PIN and signature transactions are processed over separate

networks. PIN debit networks evolved from ATM networks, id., and include Interlink and Plus

(Visa-affiliated PIN networks), Maestro (a MasterCard-affiliated PIN networks), Pulse (a

Discover-affiliated PIN network), and independent PIN networks such as NYCE, STAR, and

Shazam. In a PIN debit transaction, the consumer typically enters a personal identification

number (“PIN”) to authorize the transaction. Id.

Signature debit networks sprung from Visa and MasterCard’s credit card network

infrastructure, id., and those networks are thus the dominant signature card networks, accounting

for virtually all signature interchange fees.2 In a signature transaction, the consumer usually

authenticates the transaction by signing a receipt. Increasingly, however, signature debit

transactions are authenticated without a customer signature (for instance, in transactions under

$25). 76 Fed. Reg. at 43,395 & n.10.

Most debit cards issued by banks covered by the Durbin Amendment (88%, excluding

prepaid cards) are configured to support both PIN and signature transactions. 76 Fed. Reg.

at 43,395. But not all transactions can be paid for through either method of authentication.

Certain transactions, such as hotel stays and car rentals, cannot generally be accommodated in




2 Visa and MasterCard collectively have over 80% market share of all debit transactions.

Visa alone has 65%—almost two-thirds—of all debit transactions, Visa’s signature debit
network accounts for 50% of all debit transactions and 74% of all signature debit transactions,
and its Interlink PIN debit network accounts for 15% of all debit transactions. MasterCard's
combined signature and PIN debit networks account for about 17% of all debit transactions.
Discover Card is a recent entrant into the signature card market, but accounts for a negligible
portion of the current market. See generally Steven C. Salop et al., Economic Analysis of Debit
Card Regulation Under Section 920 ¶¶ 3, 26 & Ex. 2 (Oct. 27, 2010) (attached as Ex. C).

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Case 1:11-cv-02075-RJL Document 20 Filed 03/02/12 Page 17 of 75

PIN-transactions because the exact amount of the transaction cannot be known at the time of

authorization (when clearance information is also sent in a PIN transaction). Id. Similarly, PIN-

based debit payments cannot generally be accepted for Internet, mail order or phone purchases.

Id. In adopting the Final Rule, the Board estimated that only “one-quarter of the merchant

locations in the United States that accept debit cards have the capability to accept PIN-based

debit transactions.” Id.

II.

THE RISE IN DEBIT CARD FEES

There are various fees associated with debit card transactions, the largest of which is the

interchange fee. The interchange fee is set by the networks to compensate issuing banks for their

involvement in electronic debit transactions. See 76 Fed. Reg. at 43,396; see also 15 U.S.C.

§ 1693o-2(c)(8). This fee is borne by the merchants. See 75 Fed. Reg. at 81,723. The networks

also charge fees for their own services, known as “network fees” or “switch fees,” which are

“charged by the network to [merchants’] acquirers and issuers to compensate the network for its

role in processing the transaction.” 76 Fed. Reg. at 43,396; see 15 U.S.C. § 1693o-2(c)(10)

(defining “network fee”).

In the early days of debit card transactions, issuing banks did not generally charge

interchange fees to merchants for accepting those cards as a form of payment. To the contrary,

banks were so eager to realize the savings from debit transactions—as compared to the cost of

processing paper checks and operating brick-and-mortar teller operations—that many networks

paid merchants to install the equipment and accept debit transactions. Many banks also

profitably provided debit services without charging any interchange (described as “at-par”

clearance). This model prevailed until the early 1990s, a period that saw widespread expansion

of debit card services. See Comments of the Merchants Payments Coalition (“MPC”) in Docket

No. R-14 04 / RIN No. 7100AD63 (Debit Card Interchange Fees and Routing) (Feb. 22, 2011)

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(“MPC Comments”) (attached as Ex. D) (citing Salop, supra, ¶¶ 21, 45, 136; Stephen Craig

Mott, Industry Facts Concerning Debit Card Regulation Under Section 920 ¶¶ 7, 8, 9, 11, 14, 23

(Oct. 29, 2010) (attached as Ex. E));3 see also 76 Fed Reg. at 43,396. As debit card use became

more ubiquitous, the networks began to add interchange fees requiring merchants to compensate

issuing banks on the transactions. 76 Fed. Reg. at 43,396.

Since the early 2000s, interchange fees have skyrocketed. As explained by the MPC in

comments filed with the Board, “merchants faced market-wide effective interchange increases of

an estimated 234% between 1998 and 2006.” MPC Comments at 2 (citing Mott, supra, at 14).

These increases followed the entry of Visa and MasterCard into the debit card market. Those

networks “leverage[d their existing] credit card network infrastructure” to build a dominant

market position in the debit card market. See 76 Fed. Reg. at 43,395. In his comments to the

Board, Senator Durbin explained that “every time a sale is made with a Visa or MasterCard debit

or credit card the person who makes the sale only receives 97 or 98 cents on the dollar because

the card networks take an unregulated cut out of the transaction amount and share it with their

issuing banks.” See Letter from Senator Durbin to Jennifer J. Johnson, Secretary Board of

Governors of the Federal Reserve System, at 2 (Feb. 22, 2011) (“Durbin Letter”) (attached as

Exhibit F).

For most retailers, interchange fees have become a significant operational expense. As

explained by plaintiff NACS, an international trade association of convenience store operators, in

its comments to the Board, payment card costs, “with interchange as the largest component,

represents the single largest operating expense in our industry behind payroll expense, and is




3 The Salop and Mott reports are also available at http://www.federalreserve.gov/

newsevents/files/merchants_ payment_coalition_meeting_20101102.pdf.

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forecast to have cost the industry $8.9 billion in 2010.” Comments of the National Association

of Convenience Stores (“NACS”) in Docket No. R-14 04 / RIN No. 7100AD63 (Debit Card

Interchange Fees and Routing), at 1 (Feb. 22, 2011) (“NACS Comments”) (attached as Ex. G).

Debit card interchange grew by 8.1% annually for NACS members between 2007 and 2010. Id.

This sharp and steady rise in interchange fees has been due, in large measure, to the

absence of competition. Issuing banks all receive the same schedule of fees for Visa and

MasterCard debit transactions because the fee schedules are set by the networks. See 76 Fed.

Reg. at 43,396. Because networks set the interchange fees, “there is no competition between

issuing banks over the fees they receive, and each bank that issues the network’s cards receives

exactly the same network-established fee no matter how efficiently or inefficiently that bank

processes transactions or prevents fraud.” See Durbin Letter at 5. The system, by its nature,

favors issuing banks and networks: networks establish high fees for the issuing banks to collect,

and issuing banks issue more of the networks’ cards in order to continue to collect these tens of

billions of dollars in fees. Id.; see generally Salop, supra, ¶ 5.

The lack of competition between banks resulted in upward pressure on interchange fees

as more banks participated in the networks. Networks attracted more banks to issue cards by

increasing interchange fees, and issuers incentivized consumers to use the cards (especially for

signature transactions, which carried a higher interchange fee) by employing rewards programs

and other incentives. Because accepting payment cards for point-of-sale transactions has

become an operational necessity, merchants have little leverage to negotiate with the networks

and issuers with respect to interchange fees. See 156 Cong. Rec. S5,802 (daily ed. July 14, 2010)

(statement of Sen. Richard J. Durbin) (attached as Ex. H). Visa and MasterCard, in turn, used

their market power in the credit card market to grab a dominant market share in the debit card

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market, forcing merchants to accept their debit cards as a condition of accepting their prominent

credit cards. These practices, among others, were the subject of antitrust tying claims, since

settled by a consent decree, against Visa and MasterCard. See In re Visa Check/MasterMoney

Antitrust Litigation, 192 F.R.D. 68 (E.D.N.Y. 2000), aff’d, 280 F.3d 124 (2d Cir. 2001); see also

Salop, supra, ¶¶ 23-25.

At the same time that they increased interchange fees for the benefit of issuing banks, the

major networks were also rapidly escalating their own network fees. Visa and MasterCard

operating rules have long prohibited any other network from handling signature transactions on

their cards, permitting limited network competition only for PIN transactions. The networks

sought to squelch even this limited competition through exclusivity agreements that provide

revenue to issuers if they include only one PIN network (either Visa’s Interlink or MasterCard’s

Maestro) on their debit cards. With these exclusive deals in place, Visa and MasterCard were

able to dramatically increase their network fees charged to merchants without fear of losing

transaction volume because merchants had no other options for routing the transactions. See

generally Salop, supra, ¶¶ 32-48.

III. THE DURBIN AMENDMENT

In 2010, Congress adopted legislation to address the rapid escalation of debit card fees.

The Durbin Amendment was enacted as part of the Consumer Financial Protection Act of 2010,

which in turn is part of the Dodd-Frank Act, enacted on July 21, 2010. The legislation addressed

the problems of rapidly rising debit interchange transaction fees and network fees in different

manners. For interchange fees, the statute directs the Board to establish specific standards

governing those fees, effectively regulating for the first time on a national level the amount of

those fees. For network fees, the statute does not directly establish a similar fee standard, but

requires instead increased competition and merchant choice among debit networks.

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A.

The Interchange Fee Standard

The Durbin Amendment requires that a debit-card interchange fee be “reasonable and

proportional” to the issuer’s costs relating to a particular debit transaction. The statute places

this requirement in a new § 920(a)(2) of the pre-existing EFTA, 15 U.S.C. § 1693o-2(a)(2):

(2) Reasonable Interchange Transaction Fees. The amount of any
interchange transaction fee that an issuer may receive or charge
with respect to an electronic debit transaction shall be reasonable
and proportional to the cost incurred by the issuer with respect to
the transaction.

Congress directs the Board to promulgate regulations establishing “standards for

assessing whether the amount of any interchange transaction fee” meets the requirement set forth

in Section 1693o-2(a)(2) that the fee be “reasonable and proportional to the cost incurred by the

issuer with respect to the transaction.” 15 U.S.C. § 1693o-2(a)(3)(A).

In developing these standards, Congress directs the Board to take into account certain

statutory “Considerations.” Id. § 1693o-2(a)(4). Specifically, the Board is required, first, to

“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,” i.e., at face

value with no transactions fees. Id. § 1693o-2(a)(4)(A).

Next, to create a closer equivalency between the debit card system and the checking

system in which transactions are regulated and clear at par, Congress directed the Board to

“distinguish between” two categories of cost items:

(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
paragraph (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 paragraph (2). . . .

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Id. § 1693o-2(a)(4)(B).

Once the Board determines the interchange transaction fee standard, Congress permits the

Board to allow a separate “fraud-related adjustment” to that fee. See 15 U.S.C. § 1693o-2(a)(5).

Congress specifically limited this adjustment, however, to an “allowance for costs incurred by

the issuer in preventing fraud,” id. § 1693o-2(a)(5)(i) (emphasis added). The Board is directed to

require issuers to take effective steps to reduce the occurrence of and cost from debit card fraud.

Id. § 1693o-2(a)(5)(A)(ii)(II). No other provision grants the Board authority to account for other

fraud-related costs.4

B.

Network Regulation

The Durbin Amendment explicitly withholds from the Board similar authority over

network fees. Instead, the statute limits the Board’s authority to prescribe regulations regarding

network fees to those regulations necessary to ensure that:

a network fee is not used to directly or indirectly
to an electronic debit

issuer with respect

(i)
compensate an
transaction; and

(ii)
a network fee is not used to circumvent or evade the
restrictions of this subsection and regulations prescribed under
such subsection.

15 U.S.C. § 1693o-2(a)(8)(B)(i)-(ii).




4 This fraud prevention cost adjustment is currently the subject of a separate, but related,
rulemaking proceeding before the Board. In an interim final rule adopted on July 20, 2011, the
Board allowed for an upward adjustment of no more than 1 cent to an issuer’s debit card
interchange fee if the issuer develops and implements policies and procedures reasonably
designed to achieve the fraud-prevention standards set out in the interim final rule. See Interim
Final Rule, Debit Card Interchange Fees and Routing, 76 Fed. Reg. 43,478 (July 20, 2011)
(attached as Ex. I). The Board is still considering comments on that interim final rule.

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While withholding from the Board the authority to establish a network fee standard, the

Durbin Amendment addressed the problem of network fees through a market-oriented approach.

The statute adopts a pair of restrictions designed to expand the range of networks through which

merchants may route transactions. See 15 U.S.C. § 1693o-2(b). First, the statute requires the

Board to promulgate regulations prohibiting exclusivity arrangements between issuers and

networks. The Durbin Amendment directs the Board to adopt regulations providing that issuers

or payment card networks shall not “restrict the number of payment card networks on which an

electronic debit transaction may be processed” to—

(i)

1 such network; or

2 or more such networks which are owned, controlled, or

(ii)
otherwise operated by—

(I) affiliated persons; or

(II) networks affiliated with such issuer.

Id. § 1693o-2(b)(1)(A) (emphasis added).

In a companion provision, the statute directs the Board to prescribe regulations that

prevent networks and issuers from imposing network routing restrictions on merchants. It

prohibits networks and issuers from “inhibit[ing] the ability of any person who accepts debit

cards for payments to direct the routing of electronic debit transactions for processing over any

payment card network that may process such transactions.” Id. § 1693o-2(b)(1)(B) (emphasis

added).

IV.

THE BOARD’S PROPOSED RULE

In formulating its proposed rule, the Board collected and compiled cost and fee

information from issuers, networks and merchant banks. The Board calculated that the median

per-transaction variable processing cost for a debit transaction was 6.7 cents for signature

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transactions and 4.5 cents for PIN debit—or 7.1 cents for all debit card transactions (including

prepaid cards). See 75 Fed. Reg. at 81,722, 81,725 & n.26. The median total processing cost,

including fixed and variable costs, was 13.7 cents for signature transactions and 7.9 cents for PIN

debit transactions. Id. at 81,725 & n.25. Total interchange fees (including prepaid cards)

amounted to $16.2 billion in 2009, with the average fee for all debit transactions equaling

44 cents per transaction—56 cents for signature transactions and 23 cents for PIN debit

transactions. Id. at 81,725.

The Board published its Notice of Proposed Rulemaking on December 28, 2010. 75 Fed.

Reg. at 81,722. The Board’s proposed interchange fee standard was based on its determination

to include “only those costs that are specifically mentioned for consideration in the statute.” Id.

at 81,734-35. It thus proposed to limit recovery to only those costs “associated with

authorization, clearing, and settlement of a transaction.” Id. at 81,734.

Based in part on “the statute’s mandate to consider the functional similarities between

debit transactions and check transactions,” the Board explicitly rejected including other costs

associated with a particular transaction. Id. at 81,735. Thus, the Board explicitly proposed to

exclude recovery of any network fees as part of the interchange standard, “because the Board

recognize[d] that if network processing fees were included in allowable costs, acquirers (and, by

extension, merchants) might be in the position of effectively paying all network fees associated

with debit card transactions.” See id. The Board also specifically excluded fraud losses from

allowable costs. Id. at 81,760.

Drawing on its proposed interpretation of the statute and its survey of cost data relating to

allowable costs, the Board proposed to adopt an allowable interchange fee set in cents-per-

transaction and left for public comment which of two alternative standards should be adopted.

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Alternative 1 was an issuer-specific standard with both a safe harbor and a cap. This alternative

would allow each issuer the opportunity to recover its actual incremental costs of authorization,

clearance and settlement, up to a cap of 12 cents per transaction. Under Alternative 1, if an

issuer chose not to determine its individual allowable costs, the issuer could collect a safe harbor

interchange fee not to exceed 7 cents. See id. at 81,736-38. Alternative 2 set a safe harbor and

cap at a flat 12 cents per transaction. See id. at 81,738.

The Board also offered two alternative approaches for implementing the restrictions on

debit card network exclusivity. Id. at 81,749. Alternative A required that at least two

unaffiliated payment card networks be made active on each debit card. Id. An issuer could

comply with this requirement by having one payment card network available for signature debit

transactions and a second, unaffiliated payment card network available for PIN debit

transactions. Id. Alternative B required that a debit card have at least two unaffiliated payment

card networks available for processing each electronic debit transaction. That meant that two

options would be necessary for each method of authorization available to the cardholder. Id.

at 81,750. Thus, if a debit card could be used for both signature and PIN debit transactions, the

issuer would need to offer at least two unaffiliated networks available to process signature

transactions and at least two unaffiliated networks available to process PIN transactions. Id.

The Board requested comment by February 22, 2011. See id. at 81,722. Several of the

named plaintiffs, including NACS, NRF, and FMI submitted extensive comments supporting the

proposed rule. See NACS Comments; Comments of the National Retail Federation in Docket

No. R-14 04 / RIN No. 7100AD63 (Debit Card Interchange Fees and Routing) (Feb. 22, 2011)

(“NRF Comments”); Comments of the Food Marketing Institute (“FMI”) in Docket No. R-14 04

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/ RIN No. 7100AD63 (Debit Card Interchange Fees and Routing) (Feb. 21, 2011) (“FMI

Comments”) (attached as Ex. G, J, and K respectively).

V.

THE FINAL RULE

On July 20, 2011, the Board released the Final Rule. See 76 Fed. Reg. 43,394 (July 20,

2011). The Final Rule became effective on October 1, 2011.

The Interchange Fee Standard. With respect to the interchange fee standard, the Board

rejected both of its own proposed alternatives. Based on a new interpretation of the statute, it

instead adopted “a modified version of the approach in proposed Alternative 2.” See 76 Fed.

Reg. at 43,422. Under this modified approach, the allowable interchange fee increased

markedly, from the proposed cap of 12 cents per transaction to a statutory cap of 21-cents plus an

ad valorem amount of 5 basis points of the transaction’s value (0.05%). 12 C.F.R. § 235.3. For

the average transaction, then, the Final Rule nearly doubled the amount of fees recoverable as

compared to maximum amount recoverable under the NPRM.5

The Board reached this drastically different outcome only by rejecting its prior

interpretation of the statute. Where it had proposed including only those costs of authorization,

clearance and settlement that Congress directed it to consider and excluding all other costs, the

Board now invented a third category of costs—“those that are specific to a particular electronic

debit transaction but that are not incremental costs related to the issuer’s role in authorization,

clearance, and settlement.” See 76 Fed. Reg. at 43,426. The Board then stretched its authority




5 The Board determined that the average transaction had a value of $35.58 in 2009.

75 Fed. Reg. at 81,725. The NPRM proposed a maximum allowable interchange fee of 12 cents
for such a transaction. Under the Final Rule, the interchange fee for the same transaction would
be 21 cents plus an ad valorem allowance of 1.78 cents, for a total of 22.78 cents—or a 90%
increase.

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even further by defining “specific to a particular electronic debit transaction” to mean “specific

to effecting debit transactions as a whole.” Id. (emphasis added) It thus interpreted “costs that

‘are not specific to a particular electronic debit transaction,’ and therefore cannot be considered

by the Board, to mean those costs that are not incurred in the course of effecting any electronic

debit transaction.” Id. (emphasis added).

Under the Board’s new interpretation, the Board claimed discretion to decide which of

such costs in this third category it would include in allowable cost. It reasoned “all costs related

to a particular transaction may be considered, and some—the incremental costs incurred by the

issuer for its role in authorization, clearance, and settlement—must be considered.&rd