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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 1 of 43



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,





BOARD OF GOVERNORS OF THE FEDERAL
RESERVE SYSTEM,


___________________________________________


Defendant.

Plaintiffs,

v.


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No. 1:11-cv-02075-RJL



BRIEF AMICI CURIAE OF 7-ELEVEN, INC., AUNTIE ANNE’S, INC., BURGER KING

CORPORATION, CKE RESTAURANTS, INC., INTERNATIONAL DAIRY QUEEN,

INC., JACK IN THE BOX INC., STARBUCKS CORPORATION, AND THE

WENDY’S COMPANY IN SUPPORT OF PLAINTIFFS’ MOTION FOR

SUMMARY JUDGMENT AND IN OPPOSITION TO

DEFENDANT’S CROSS-MOTION



David D. Golden (DC Bar No. 985047)
[email protected]
CONSTANTINE CANNON LLP
1301 K Street, NW, Suite 1050 East
Washington, DC 20005
Tel: (202) 204-3500
Fax: (202) 204-3501

Jeffrey I. Shinder
Alee N. Scott
CONSTANTINE CANNON LLP
335 Madison Avenue, 9th Floor
New York, NY 10017
Tel: (212) 350-2700
Fax: (212) 350-2701

Counsel for Amici Curiae 7-Eleven, Inc., Auntie Anne’s,
Inc., Burger King Corporation, CKE Restaurants, Inc.,
International Dairy Queen, Inc., Jack in the Box Inc.,
Starbucks Corporation, and The Wendy’s Company










Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 2 of 43



TABLE OF AUTHORITIES .............................................................................................. ii

TABLE OF CONTENTS



INTEREST OF AMICI CURIAE....................................................................................... 1

INTRODUCTION .............................................................................................................. 2

BACKGROUND ................................................................................................................ 6

I. Market Failure in the Debit Card Market Enabled Interchange

Fees on Debit Transactions..................................................................................... 6


II. Merchants Have No Choice But To Pay These Supracompetitive

Fees………………………………………………………………………………..8


III. The Durbin Amendment ....................................................................................... 10

IV. The NPRM and Commentary Regarding the Potential Impact to

Small-Ticket Transactions .................................................................................... 11

The Final Rule....................................................................................................... 16


V.

VI. The Impact on Small-Ticket Merchants ............................................................... 19

ARGUMENT.................................................................................................................... 23

The Final Rule is Not Entitled to Judicial Deference ........................................... 25

The Board’s Analysis is Not Reasonable.............................................................. 27

The Inclusion of Fraud Losses in the Interchange Standard is
Unreasonable……………………………………………………………..28

I.

II.




A.

B.

The Inclusion of Network Fees in the Interchange Standard
is Unreasonable…………………………………………………………..30


III. The Final Rule on Network Routing Also Should Be Invalidated ....................... 31

CONCLUSION................................................................................................................. 33

APPENDIX (May 1, 2012 PaymentsSource Article)...................................................... A1



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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 3 of 43

TABLE OF AUTHORITIES

CASES


Anderson Bros. Ford v. Valencia,


Bell Atl. Tel. Cos. v. FCC,

452 U.S. 205 (1981).........................................................................................................6

131 F.3d 1044 (D.C. Cir. 1997).....................................................................................26


Burlington Truck Lines, Inc. v. United States,

371 U.S. 156 (1962).......................................................................................................27

467 U.S. 837 (1984).....................................................................................24, 25, 26, 27


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


Cnty. of Los Angeles v. Shalala,

192 F.3d 1005 (D.C. Cir. 1999)...............................................................................24, 28


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

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


Home Box Office, Inc. v. FCC,


In re Visa Check/MasterMoney Antitrust Litig.,


In re Visa Check/MasterMoney Antitrust Litig.,


Jefferson Parish Hosp. Dist. No. 2 v. Hyde,


Marsh v. Or. Natural Res. Council,

567 F.2d 9 (D.C. Cir. 1977)...........................................................................................27

297 F. Supp. 2d 503 (E.D.N.Y. 2003) .............................................................................7

No. 96-cv-5238(JG), 2003 WL 1712568 (E.D.N.Y. Apr. 1, 2003)...........................3, 10

466 U.S. 2 (1984).....................................................................................................10, 25

490 U.S. 360 (1989).......................................................................................................27


Motor Vehicle Mfrs. Ass’n v. State Farm Mut. Auto. Ins. Co.,

463 U.S. 29 (1983)...............................................................................................6, 24, 27


NCAA v. Bd. of Regents of the Univ. of Okla.,


Nat’l R.R. Passenger Corp. v. Boston & Me. Corp.,

468 U.S. 85 (1984).........................................................................................................25

503 U.S. 407 (1992).......................................................................................................25






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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 4 of 43

Nat’l Cable & Telecomms. Ass’n v. FCC,

567 F.3d 659 (D.C. Cir. 2009).......................................................................................26


NRDC v. EPA,

859 F.2d 156 (D.C. Cir. 1988).......................................................................................28


Pharm. Research and Mfrs. of Am. v. Thompson,

251 F.3d 219 (D.C. Cir. 2001).......................................................................................26

988 F.2d 186 (D.C. Cir. 1993).......................................................................................27

982 F.2d 1043 (7th Cir. 1992) .........................................................................................6


Pub. Citizen, Inc. v. FAA,


Schurz Commc’ns, Inc. v. FCC,


Sierra Club v. EPA,


S. Cal. Edison Co. v. FERC,




294 F.3d 155 (D.C. Cir. 2002).......................................................................................29

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


United Parcel Serv., Inc. v. U.S. Postal Serv.,


United States v. Visa U.S.A. Inc.,

184 F.3d 827 (D.C. Cir. 1999).................................................................................28, 29

163 F. Supp. 2d 322 (S.D.N.Y. 2001),
aff’d, 344 F.3d 229 (2d Cir. 2003).............................................................................3, 10

5 U.S.C. § 701......................................................................................................................6

STATUTES

5 U.S.C. § 706(2) ...............................................................................................................29

15 U.S.C. § 1693..................................................................................................................3

15 U.S.C. § 1693o-2 ............................................................................................................4

15 U.S.C. § 1693o-2(a)(2) .............................................................................................4, 11

15 U.S.C. § 1693o-2(a)(4)(A)............................................................................................11

15 U.S.C. § 1693o-2(a)(4)(B)(i ) and (ii)...........................................................................11

15 U.S.C. § 1693o-2(a)(5) .................................................................................................28




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15 U.S.C. § 1693o-2(b)(1)(A)............................................................................................31

Dodd-Frank Wall Street Reform and Consumer Protection Act,

Pub. L. No. 111-203, 124 Stat. 1376, 2068-74 (July 21, 2010).......................................3

REGULATIONS

12 C.F.R. § 235.3...........................................................................................................6, 33

12 C.F.R. § 235.7...........................................................................................................6, 33

Regulation II, Debit Card Interchange Fees and Routing,

75 Fed. Reg. 81,722 (proposed Dec. 28, 2010) ...................................5, 8, 12, 29, 30, 32


Regulation II, Debit Card Interchange Fees and Routing,

Final Rule, 76 Fed. Reg. 43,394 (July 20, 2011).........................2, 16, 17, 19, 29, 30, 32

LEGISLATIVE MATERIALS


156 Cong. Rec. S3,695–96 (daily ed. May 13, 2010)........................................................11

156 Cong. Rec. S5,802–03 (daily ed. July 14, 2010) ..........................................................4

156 Cong. Rec. S5,926 (daily ed. July 15, 2010) ..............................................................31



OTHER AUTHORITIES


7-Eleven Website, “About Us”..........................................................................................22

Anand Goel Comments (Jan. 3, 2011)...............................................................................14

“Applying the Durbin Maximum, Visa And MasterCard Could Squash

Small Tickets,” Digital Transactions News (Sept. 27, 2011)........................................19


Board of Governors of the Federal Reserve System, 2009 Interchange

Revenue, Covered Issuer Cost, and Covered Issuer and Merchant
Fraud Loss Related to Debit Card Transactions (June 2011).......................................29


Coinstar News Release, “Coinstar, Inc. Announces 2011 Third Quarter

Results,” PRNewswire (Oct. 27, 2011)..........................................................................23


Federal Reserve Board Press Release, Federal Reserve issues a final rule
establishing standards for debit card interchange fees and prohibiting
network exclusivity arrangements and routing restrictions (June 29, 2011).................17












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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 6 of 43

Fumiko Hayashi et al., “A Guide to the ATM and Debit Card Industry—

2006 Update,” Federal Reserve Bank of Kansas City .....................................................8


Interlink Interchange Reimbursement Fees (Oct. 16, 2010)................................................8

International Franchise Association/National Council of Chain Restaurants

(“IFA/NCCR”) Comments (Feb. 22, 2011).................................................12, 13, 14, 32


Kate Fitzgerald, “Despite Durbin, Debit Still Offers Issuers Many Benefits,

MasterCard Exec Says,” PaymentsSource (May 1, 2012)...............................................5


Kenneth J. Morrison, The Canadian Experience with PIN Debit, On Behalf

of the Merchants Payments Coalition, Submitted to the Board of Governors
of the Federal Reserve System Concerning Its Rulemaking Pursuant to
Section 920 of the Electronic Fund Transfer Act (Oct. 27, 2010)...................................8


MasterCard Fact Sheet, “Setting a Minimum or Maximum Transactions

Amount—Frequently Asked Questions” (Nov. 2010) ..................................................15


MasterCard Rules, MasterCard Worldwide (Apr. 11, 2012).............................................15

McDonald’s Comments (Feb. 22, 2011) ...........................................................................12

Merchants Payments Coalition Comments (Feb. 22, 2011) ............................16, 29, 30, 32

Merchants Payments Coalition Submission for Meeting between the Federal
Reserve Board and Staff, the Merchants Payments Coalition and Consumer
Group Representatives (Feb. 23, 2011) .........................................................................16


National Restaurant Association (“NRA”) Comments (Undated)...............................12, 14

Starbucks Corporation Form 10-K for Fiscal Year Ended October 2, 2011

(Nov. 18, 2011)..............................................................................................................22


Steven C. Salop, Economic Analysis of Debit Card Regulation Under

Section 920, On Behalf of the Merchants Payments Coalition,
Submitted to the Board of Governors of the Federal Reserve
System Concerning Its Rulemaking Pursuant To Section 920 of
the Electronic Fund Transfer Act (Oct. 27, 2010) ...................................2, 3, 7, 8, 20, 30


Stephen Craig Mott, Industry Facts Concerning Debit Card Regulation
Under Section 920, On Behalf of the Merchants Payments Coalition,
Submitted to the Board of Governors of the Federal Reserve System
Concerning its Rulemaking Pursuant to Section 920 of the Electronic
Fund Transfer Act (Oct. 29, 2010).........................................................3, 7, 8, 25, 29, 30






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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 7 of 43

Submission of the Merchants Payments Coalition to the Board of

Governors of the Federal Reserve System Regarding Section 920 of
the Electronic Fund Transfer Act (Oct. 27, 2011) .........................................................28


“Visa Hikes Prepaid Interchange But Chops Some Debit Rates,” Digital

Transactions News (Sept. 9, 2011) ................................................................................19


Visa Inc. Comments (Feb. 22, 2011) .............................................................................5, 16

Visa International Operating Regulations (Apr. 15, 2012)................................................15

Visa Website, “Ask Visa—Popular Topics—Minimum Purchase”..................................15

Wendy’s (formerly Wendy’s/Arby’s Group, Inc.) Comments

(Feb. 22, 2011).........................................................................................................12, 14


Yum! Brands Comments (Feb. 21, 2011)....................................................................12, 15




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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 8 of 43



INTEREST OF AMICI CURIAE

Amici are 7-Eleven, Inc., Auntie Anne’s, Inc., Burger King Corporation, CKE






Restaurants, Inc. (Carl’s Jr. and Hardee’s), International Dairy Queen, Inc., Jack in the Box Inc.

(Jack in the Box and Qdoba Mexican Grill (“Qdoba”)), Starbucks Corporation, and The Wendy’s

Company (“Amici”). Their operations include tens of thousands of small business franchises

and licensed stores that are convenience stores, quick service restaurants (“QSRs”) and/or

specialty coffee shops, which accept substantial volumes of debit transactions that are almost

exclusively small-ticket transactions—or transactions of $15 or less. Amici are in the fastest-

growing merchant segment for debit transactions, as customers increasingly convert small

transactions from cash to debit for convenience. Their debit volumes have tripled in less than a

decade.

Amici, and all like-situated small-ticket merchants (including such widely-used services

as transit authorities, vending operators, and newsstands) probably have more at stake in this

case than any other interested segment. Amici provide a powerful example of the

anticompetitive debit market that motivated Congress to regulate debit interchange, as well as the

failure of the Board of Governors of the Federal Reserve System (the “Board”) to follow

Congress’s clear directives and implement regulations that prevented further exercises of market

power by the dominant debit networks. In fact, rather than putting in place regulations that

restrained further exercises of market power by the networks and the banks, the Board

empowered them to implement price increases ranging from approximately 15 percent to more

than 200 percent on the vast majority of debit transactions accepted by small-ticket merchants

like Amici. Nothing could better demonstrate the unlawful nature of the Board’s rulemaking



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than the fact that, just a few months after the ink was dry on the Board’s Final Rule,1 the debit

networks used it to justify hitting small businesses in the fastest-growing debit segment—the

“holy grail” of debit growth (according to MasterCard)—with a massive price increase.



Moreover, the Board enabled this exercise in market power even though it received

comments from some Amici and their trade association representatives, advising the Board that

its initial proposal, which was far better than the Final Rule, could result in a substantial price

increase on many small-ticket transactions. Now, Amici submit this brief in support of the

plaintiffs’ motion for summary judgment to vacate the Board’s Final Rule and in opposition to

defendant’s cross-motion. No party’s counsel has authored this brief in whole or in part, and no

person or party has contributed money to writing the brief other than Amici, their members, and

their counsel.

INTRODUCTION

For decades there has been little or no competition for merchants in the debit card market.

Prior to 1990, debit cards experienced robust growth based on a competitive at-par pricing model

that mirrored the system that prevailed (and still prevails) for checks. Under that competitive

model, merchants typically paid no interchange (sometimes called “swipe fees”) for virtually all

debit transactions and, because debit cards replaced more expensive and inefficient check and

cash transactions, banks had strong incentives to issue debit cards to their customers. Debit

cards were thriving under this model, as they have around the world where debit cards have been

priced to merchants at par, without swipe fees.2


1 Regulation II, Debit Card Interchange Fees and Routing, Final Rule, 76 Fed. Reg. 43,394 (July 20, 2011) (“Final
Rule”), http://www.gpo.gov/fdsys/pkg/FR-2011-07-20/pdf/2011-16861.pdf.
2 As of 2010, seven of the eight countries with the highest debit usage utilize an at-par pricing model—Canada,
Denmark, Finland, Iceland, the Netherlands, New Zealand, and Norway. See Steven C. Salop, Economic Analysis of
Debit Card Regulation Under Section 920, On Behalf of the Merchants Payments Coalition, Submitted to the Board
of Governors of the Federal Reserve System Concerning Its Rulemaking Pursuant To Section 920 of the Electronic



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In the early 1990s, however, competition began to fail when Visa and MasterCard

leveraged their market power in credit cards to gain a dominant position in debit cards. In doing

so, they eliminated the at-par pricing model that was thriving in the United States and replaced it

with a system that was based on continually-escalating interchange fees. The dominant networks

were owned and controlled by competing debit card issuers, including the largest banks in the

country, and the networks collectively set interchange fees on the banks’ behalf and used those

fees to reward the banks that owned and controlled them. This strategy worked because

merchants were (and are) powerless to resist these fees, even as they increased dramatically over

the past decade, because merchants cannot stop accepting debit card transactions without

devastating their businesses. As a result of this failed marketplace, debit card swipe fees

increased 234 percent between 1998 and 2006 for PIN debit alone, and they have continued to

increase since then.3

When several wide-ranging antitrust cases failed to redress this market failure,4 Congress

chose to address it through regulation, by way of Section 1075 of the Dodd-Frank Wall Street

Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376, 2068-74 (July 21,

2010), which amended the Electronic Fund Transfer Act (15 U.S.C. § 1693 et seq.) (“EFTA”)


Fund Transfer Act (Oct. 27, 2010) (“Salop Report”) ¶ 68 (attached as Exhibit C to Memorandum in Support of
Plaintiffs’ Motion for Summary Judgment (Mar. 2, 2010) (“Plaintiffs’ Mem.”)) (The Salop Report is also available
at http://www.federalreserve.gov/newsevents/files/merchants_payment_coalition_meeting_20101102.pdf.).
3 See Stephen Craig Mott, Industry Facts Concerning Debit Card Regulation Under Section 920, On Behalf of the
Merchants Payments Coalition, Submitted to the Board of Governors of the Federal Reserve System Concerning its
Rulemaking Pursuant to Section 920 of the Electronic Fund Transfer Act (Oct. 29, 2010) (“Mott Report”) ¶ 24
(attached as Exhibit E to Plaintiffs’ Mem.) (The Mott Report is also available at
http://www.federalreserve.gov/newsevents/files/merchants_payment_coalition_meeting_20101102.pdf.); see also
Salop Report Exhibits 1a-1d.
4 While Visa and MasterCard lost several landmark antitrust cases in the last decade, none of them materially
impacted their dominance in the industry. See In re Visa Check/MasterMoney Antitrust Litig., No. 96-cv-5238(JG),
2003 WL 1712568, *3, *4 (E.D.N.Y. Apr. 1, 2003) (granting partial summary judgment to merchant class against
Visa, finding that it had market power and tied its debit cards to its dominant credit cards); United States v. Visa
U.S.A. Inc., 163 F. Supp. 2d 322, 329 (S.D.N.Y. 2001) (finding that Visa’s and MasterCard’s exclusionary rules
harmed competition, including by barring entry into the debit card market), aff’d, 344 F.3d 229 (2d Cir. 2003).




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with a new Section 920, codified at 15 U.S.C. § 1693o-2 (the “Durbin Amendment”).

Specifically, Congress sought to restrain the dominant networks from exercising market power

through the imposition of supracompetitive debit interchange fees by requiring that such fees be

“reasonable and proportional to the cost incurred by the issuer.” 15 U.S.C. § 1693o-2(a)(2)

(EFTA Section 920(a)(2)). That this provision was designed to fix the market power that has

crippled competition in this industry was made clear by its principal author, Senator Richard J.

Durbin, in numerous statements made on the floor of the Senate, including the following:

For years, Visa and MasterCard, and their big bank backers, have unilaterally
fixed prices on the fees small businesses pay every time they accept a debit card
from a customer. The two giant card networks control 80 percent of the debit
card market—that is Visa and MasterCard. And it is no surprise that debit
interchange fees have risen, even as the price of processing the transaction has
fallen. They can impose these prices and say to the local businessperson: Take it
or leave it. Small businesses in Illinois and throughout the country have pleaded
over and over again with these card network giants: Give us some way to reduce
these costs so that we can reach profitability, hire more people, and prosper as a
business and pass on savings to consumers.

The conference report that we have before us will require the Federal Reserve to
ensure that Visa, MasterCard, and their big bank allies can only charge debit
interchange fees that are reasonable and proportional to the cost of processing
each transaction. It also prevents Visa and MasterCard from engaging in certain
specific anticompetitive practices. … Finally, Visa, MasterCard, and the Wall
Street banks will face some check against their unbridled market power in the
credit and debit industries.

Finally, small businesses and merchants are going to have relief that will lead to
real savings, profitability, and reduced cost for consumers. The Dodd-Frank Wall
Street Reform and Consumer Protection Act is a landmark bill, including the most
sweeping reforms to Wall Street since the New Deal.


156 Cong. Rec. S5,802–03 (daily ed. July 14, 2010).5

Yet, notwithstanding Congress’s clear directive that the dominant networks’ ability to

impose “take it or leave it” pricing be restrained going forward, the Board’s Final Rule on debit


5 Senator Durbin’s July 14, 2010 floor statement is also available at http://www.gpo.gov/fdsys/pkg/CREC-
2010-07-14/pdf/CREC-2010-07-14-pt1-PgS5801.pdf.




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interchange did the opposite. Contrary to the letter and spirit of the Durbin Amendment, the

Final Rule empowered the networks to drastically raise debit card interchange fees for small-

ticket transactions, the “holy grail” of debit growth and fastest-growing segment of debit card

use.6 Moreover, the Board enabled this massive price increase in the face of comments from

Amici and others that the Board’s Notice of Proposed Rulemaking (Regulation II, Debit Card

Interchange Fees and Routing, 75 Fed. Reg. 81,722 (proposed Dec. 28, 2010)) (“NPRM”)7—

which proposed debit card interchange fees ranging from $0.07 to $0.12—likely would result in

increased debit interchange for some small-ticket transactions. And it did so in the face of

numerous comments that, given the market failures that have plagued this industry, competition

could not be counted upon to restrain debit interchange fees for the foreseeable future.

The Board disregarded these submissions and configured a Final Rule that increased the

permissible range for debit interchange by approximately 100-243 percent over that set forth in

the NPRM. This resulted in the imposition of the very “take it or leave it” pricing that the

Durbin Amendment was supposed to prevent, as each of the debit networks quickly implemented

the highest possible fees for regulated small-ticket transactions. As a result, hundreds of

thousands of small businesses are experiencing punitive increases in debit card interchange fees.

Amici, and the small businesses that operate as franchisees or licensees under their brands, are

paying substantially more in debit card swipe fees because of the Board’s failure to faithfully


6 According to MasterCard’s Group Executive for Global Debit, Carlos Menendez, “‘[t]he holy grail’ for increasing
debit card purchase volume is increasing small-ticket purchases across a broad array of everyday expenditures.”
Kate Fitzgerald, “Despite Durbin, Debit Still Offers Issuers Many Benefits, MasterCard Exec Says,”
PaymentsSource (May 1, 2012), available by subscription at http://www.paymentssource.com/news/Debit-Still-
Offers-Issuers-Many-Benefits-MasterCard-Exec-Says-3010533-1.html (attached as Appendix A to this brief). And
as Visa noted in its comments submitted to the Board, “[t]oday, more than 30% of Visa Check Card (or signature)
transactions are at relatively small ticket sizes.” Visa Inc. Comments (Feb. 22, 2011), at 7 n.16,
http://www.federalreserve.gov/SECRS/2011/March/20110304/R-1404/R-
1404_022211_67810_571316902268_1.pdf.
7 The NPRM is available at http://www.gpo.gov/fdsys/pkg/FR-2010-12-28/pdf/2010-32061.pdf.




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implement Congress’s clear directive. At the end of the day, a statute designed to constrain

market power was somehow interpreted by the Board to empower it.

Such a result cannot withstand scrutiny under the Administrative Procedure Act, 5 U.S.C.

§ 701 et seq. (“APA”). The Final Rule reflects an “obvious repugnance to the statute,”

“unprincipled compromises,” and a complete “fail[ure] to consider an important aspect of the

problem.”8 For these reasons and the reasons set forth below, Amici urge this Court to invalidate

the Final Rule’s interchange fee standard (12 C.F.R. § 235.3) and the rules concerning network

routing (12 C.F.R. § 235.7), and remand to the Board with a direction to adopt rules that comply

with the plain language of the Durbin Amendment.

BACKGROUND

Rather than restate the facts surrounding the evolution of the debit market that are




adequately described in other submissions, we instead focus on the facts that are most germane

to the market failures that motivated the passage of the Durbin Amendment. Virtually all of

these facts were drawn from the record that was before the Board when it crafted the Final Rule.

I.



Market Failure in the Debit Card Market Enabled Interchange Fees on Debit
Transactions

Interchange is not necessary to motivate banks to issue debit cards and, thus, the

proliferation of interchange fees for debit transactions in the United States is a function of market

failure. Banks have strong incentives to provide debit cards even without substantial income

from interchange. When banks first began to offer PIN debit cards, they did not charge

interchange fees. To the contrary, they sometimes paid merchants to provide debit services, a

practice known as “reverse,” “negative,” or “issuer-paid” interchange. Under that structure,


8 Anderson Bros. Ford v. Valencia, 452 U.S. 205, 219 (1981); Schurz Commc’ns, Inc. v. FCC, 982 F.2d 1043, 1050
(7th Cir. 1992); Motor Vehicle Mfrs. Ass’n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983).




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banks profitably provided debit services without interchange. This model prevailed until the

early 1990s, a period that saw widespread expansion of debit card services.9

In fact, this model prevailed until Visa and MasterCard and their bank owner/members

leveraged their power in the credit card market to dominate the debit market. Beginning in the

early 1990s, the dominant networks began to implement and enforce a strategy to require

merchants to pay higher debit interchange through their “Honor All Cards” rules. This policy

forced merchants to accept signature debit cards as a condition of accepting the networks’

dominant credit cards. The networks set the same or similar interchange rates for merchants’

debit card transactions as they did for credit card transactions, and merchants had to pay these

fees. The networks then used the lucrative interchange stream created by this practice to reward

their bank owners and thereby entrench their dominance in the debit market.10 As banks became

accustomed to receiving high interchange rates for signature debit transactions—rates which

bore no relationship to costs—a dynamic of merchants being required to pay ever-increasing

interchange rates to underwrite the networks’ need to reward their bank owners became the norm

for the industry.11

The experience in other G-20 countries reinforces the conclusion that the development of

debit in the United States, with a high credit card-style interchange fee, was simply a function of

the market failures in the debit industry in this country. Tellingly, seven of the eight countries

with the highest debit usage utilize an at-par pricing model. For example, the Canadian debit

system has always been based on an at-par pricing model, and Canada traditionally has had


9 See Salop Report ¶¶ 21, 45, 136; Mott Report ¶¶ 7, 8, 9, 11, 14, 23.
10 The practice of tying debit card acceptance to credit card acceptance was challenged in a landmark antitrust
lawsuit, which resulted in a settlement involving over $3 billion in past damages and an estimated $25–$87 billion in
injunctive relief. See In re Visa Check/MasterMoney Antitrust Litig., 297 F. Supp. 2d 503 (E.D.N.Y. 2003).
11 See Mott Report ¶¶ 12-14, 16; Salop Report ¶¶ 4, 11, 24, 33, 43-44, 55, 139, 145.




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higher per-capita debit usage than the United States, as well as higher debit penetration in

merchant categories that do not accept PIN debit in the United States.12

Visa also used its acquisition of the leading PIN debit network, Interlink, to push a high

credit card-style interchange structure into the PIN debit segment as well. In PIN debit alone, for

example, merchants faced market-wide effective interchange increases of an estimated 234

percent between 1998 and 2006.13 These increases were even more severe for small non-

supermarket merchants who had faced an estimated 467 percent increase in Interlink PIN debit

prices between 1998 and 2010.14

II. Merchants Have No Choice But To Pay These Supracompetitive Fees


This strategy worked because merchants had no choice but to accept the networks’ debit

cards—because rejecting those cards would severely harm merchants’ operations—and thus the

networks could raise (collusively-set) interchange prices to merchants with impunity.15 Against

this backdrop, banks had no incentive to compete for merchant acceptance, as acting collectively

through Visa and MasterCard (and thereby exercising collective market power over merchants)

was far more lucrative than competing for merchants.


12 See Kenneth J. Morrison, The Canadian Experience with PIN Debit, On Behalf of the Merchants Payments
Coalition, Submitted to the Board of Governors of the Federal Reserve System Concerning Its Rulemaking Pursuant
to Section 920 of the Electronic Fund Transfer Act (Oct. 27, 2010) ¶¶ 2, 13-14, 42-43,
http://www.federalreserve.gov/newsevents/files/merchants_payment_coalition_meeting_20101102.pdf.); Salop
Report ¶¶ 48, 64-68.
13 See Mott Report ¶ 24. Moreover, the interchange associated with PIN debit has continued to increase since 2006.
Id. ¶ 24; Salop Report Exhibits 1a-1d. Even if the $0.23-per-PIN-debit-transaction figure reported in the NPRM (75
Fed. Reg. at 81,725) is used to calculate the growth rate after 1998, that growth is still 166 percent, which likely
understates the escalation of PIN debit costs for merchants.
14 See Fumiko Hayashi et al., “A Guide to the ATM and Debit Card Industry—2006 Update,” Federal Reserve
Bank of Kansas City, at 13 (Figure 8), http://www.kc.frb.org/publicat/psr/BksJournArticles/ATMDebitupdate.pdf;
Interlink Interchange Reimbursement Fees (Oct. 16, 2010), at 2, http://usa.visa.com/download/merchants/october-
2010-interlink-interchange-rate-sheet.pdf (percentage increase based on calculation of interchange fees using default
non-supermarket rate on a $50 debit transaction).
15 See discussion of merchant-side network market power in Salop Report ¶¶ 35-39.




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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 16 of 43




The experience of the convenience store, QSR, and coffee shop industries highlights this

market failure. Because of their low margins and smaller tickets, the overwhelming majority of

these merchants did not accept payment cards until the early-to-mid 2000s, many years after

most other merchant segments began to accept them.16 At the outset, the networks extended

“incentive” interchange rates to make it cost effective for these merchants to start accepting debit

cards. Within a few years after introducing plastic to their customers, many small-ticket

merchants experienced massive growth in card-based transactions, with the vast majority of that

growth on debit cards.17 Moreover, once these merchants started to see significant volumes on

these cards, they began to experience the same market power that was exercised over the rest of

the merchant community. With such volumes, convenience stores, QSRs, and coffee shops (and

other small-ticket merchants) had no choice but to accept these transactions to remain

competitive. Put simply, what happened to these industries is exactly what has happened to

every other merchant segment that widely accepts debit cards. Once these cards have gained

widespread acceptance and use, merchants cannot stop taking them without causing significant

harm to their businesses. That gives the networks and the banks the power to raise interchange

fees to merchants, and they have wielded that power liberally over the past twenty years.


16 For instance, Hardee’s began accepting debit cards in approximately 2003 (see Declaration of Luis Farias of CKE
Restaurants, Inc. (“Farias Decl.”) ¶ 6); Jack in the Box restaurants in 2002 (see Declaration of Stephen M. Brigandi
of Jack in the Box Inc. (“Brigandi Decl.”) ¶ 4); Auntie Anne’s restaurants in 2003 (see Declaration of Joseph R.
Hainthaler of Auntie Anne’s, Inc. (“Hainthaler Decl.”) ¶ 4); Wendy’s restaurants in 2004 (see Declaration of Mark
Inzetta of The Wendy’s Company (“Inzetta Decl.”) ¶ 5); Burger King restaurants in 2005 (see Declaration of Craig
S. Prusher of Burger King Corporation (“Prusher Decl.”) ¶ 4); and Dairy Queen required its franchisees to accept
debit cards beginning on October 1, 2007 (see Declaration of Shelly O’Callaghan of International Dairy Queen, Inc.
(“O’Callaghan Decl.”) ¶ 4).
17 For example, Jack in the Box’s payment card transactions were approximately 14 percent of sales in 2004 and
they have steadily risen to approximately 35 percent in 2012 (and debit currently represents 90 percent of total card
transactions) (see Brigandi Decl. ¶¶ 6-7); Wendy’s payment card transactions currently represent 42 percent of total
transactions (and debit transactions represented 81 percent of overall card transactions in 2011) (see Inzetta Decl. ¶¶
7-8); Burger King’s percentage of transactions paid with payment cards is now 30 percent (and debit represents 80
percent of total card transactions) (see Prusher Decl. ¶ 6).




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Notably, courts have recognized this phenomenon and have repeatedly found that the leading

networks have market power over merchants.18

III. The Durbin Amendment


The Durbin Amendment was passed as a direct response to this persistent market failure.

In one of many speeches on the Senate floor describing the Durbin Amendment’s underlying

rationale, Senator Durbin stated that:

Credit and debit cards are now used in more than half the retail sales in the United
States of America. Yes, being able to pay with plastic is a great convenience, but
there is another reality. The shift from cash and checks to credit and debit means
that the way we do business in America is increasingly falling under the control of
these two giants of the credit and debit card industry—Visa and MasterCard.

These card networks dominate the credit and debit industries .… Unfortunately,
these two companies are looking for profits, and they are not always looking out
for the best interests of the merchants, the small businesses, the retail businesses
or the consumers. Interchange fees are a classic example. ...

In a normal market, you see banks competing with one another to do business
with the restaurants, shops, and the merchants. With that competition, things
would be a lot better. But, in fact, the real world of credit cards with the two
giants, Visa and MasterCard, is a world where there is little or no competition.

The credit and debit card markets are not normal. Visa and MasterCard
unilaterally set interchange fee rates that apply to all banks within their card
networks. There is no negotiation between the banks and merchants over
reducing interchange rates. Individual businesses in New Hampshire, Illinois,
New York, and all across America have no bargaining power with these giant
credit card companies. They set the rules, they fix the fees, take it or leave it. …



18 For example, in United States v. Visa U.S.A. Inc., 163 F. Supp. 2d at 340, the court found that “merchants …
cannot refuse to accept Visa and MasterCard even in the face of significant price increases because the cards are
such preferred payment methods that customers would choose not to shop at merchants who do not accept them.”
“Defendants’ ability to price discriminate also illustrates their market power. Both Visa and MasterCard charge
differing interchange fees based, in part, on the degree to which a given merchant category needs to accept general
purpose cards.” Id. “Because Visa and MasterCard have large shares in a highly concentrated market with
significant barriers to entry, both defendants have market power in the general purpose card network services
market, whether measured jointly or separately; furthermore plaintiff has demonstrated that both Visa and
MasterCard have raised prices and restricted output without losing merchant customers.” Id. at 342. See also In re
Visa Check, 2003 WL 1712568, *4 (recognizing that “Visa [alone] indisputably possesses sufficient market power
‘to force [merchants] to do something that [they] would not do in a competitive market’”) (quoting Jefferson Parish
Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 13-14, 26-29 (1984)).




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What can businesses do to stop these rising interchange fees? Almost nothing.
Some—very rarely—businesses say they do not accept credit or debit cards, but
the vast overwhelming number of businesses do. They have to. It is part of doing
business in America.

Visa and MasterCard have 80 percent of the credit and debit market. Merchants
have to use them. They tell the merchants: If you want to take our card, you live
with the fees we charge. That is not a competitive situation at all.


156 Cong. Rec. S3,695–96 (daily ed. May 13, 2010).19

To restrain the debit networks from exercising market power going forward, the Durbin

Amendment requires that “[t]he 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.” 15 U.S.C. §

1693o-2(a)(2) (EFTA Section 920(a)(2)). The Durbin Amendment further requires that in

prescribing regulations regarding debit interchange, the Board shall 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.” 15 U.S.C. § 1693o-2(a)(4)(A)

(EFTA Section 920(a)(4)(A)). Moreover, the statute requires the Board to consider “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,” but not “other costs incurred by an issuer

which are not specific to a particular electronic debit transaction.” 15 U.S.C. § 1693o-

2(a)(4)(B)(i) and (ii) (EFTA Section 920(a)(4)(B)(i) and (ii)).

IV.



The NPRM and Commentary Regarding the Potential Impact to Small-Ticket
Transactions

In December 2010, the Board released the NPRM. In it, the Board set forth two

proposals for comment regarding the base regulation of debit interchange. Proposed Alternative


19 Senator Durbin’s May 13, 2010 floor statement is also available at http://www.gpo.gov/fdsys/pkg/CREC-2010-
05-13/pdf/CREC-2010-05-13-pt1-PgS3684-2.pdf.




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1 called for a safe harbor of $0.07 per transaction for debit interchange fees, with an upward

adjustment up to a cap of $0.12 based upon an issuer’s allowable costs. In contrast, proposed

Alternative 2 called for what was effectively both a safe harbor and a cap of $0.12 per

transaction for debit interchange fees. See NPRM, 75 Fed. Reg. at 81,726; 81,736-39; 81,755-

56.

The NPRM motivated several trade associations representing small-ticket merchants to

express concerns about the rule potentially enabling price increases for certain small-ticket

transactions. For example, the Board received detailed comments from the International

Franchise Association (“IFA”) and the National Council of Chain Restaurants (“NCCR”) (a

division of the National Retail Federation, one of the plaintiffs in this litigation), as well as the

National Restaurant Association (“NRA”) (another plaintiff in this litigation).20 Additional

comments came from small-ticket merchants, such as amicus Wendy’s, as well as McDonald’s

and Yum! Brands, Inc. (owners of KFC, Pizza Hut, Taco Bell, A&W Restaurants and Long John

Silver’s), among others.21

These submissions advised the Board that small-ticket transactions represent the fastest-

growing segment of debit transactions. The IFA, for its part, noted that:


20 The IFA “represents more than 90 different industries, including more than 11,000 franchisee, 1,100 franchisor
and 500 supplier members nationwide,” and the NCCR “is the leading trade association exclusively representing
chain restaurant companies.” See IFA/NCCR Comments (Feb. 22, 2011),
http://www.federalreserve.gov/SECRS/2011/March/20110323/R-1404/R-
1404_022211_67493_559268623510_1.pdf (beginning at p. 3 of the document). The NRA “represents the
restaurant and foodservice industry, which contains over 970,000 locations,” and its “members account for over one-
third of the industry’s retail locations.” Plaintiffs’ Mem. at 20-21; see also NRA Comments (Undated),
http://www.federalreserve.gov/SECRS/2011/March/20110303/R-1404/R-
1404_022211_67254_584334237408_1.pdf).
21 See, e.g., Wendy’s (formerly Wendy’s/Arby’s Group, Inc.) Comments (Feb. 22, 2011),
http://www.federalreserve.gov/SECRS/2011/March/20110302/R-1404/R-
1404_022211_67972_575538896396_1.pdf; McDonald’s Comments (Feb. 22, 2011),
http://www.federalreserve.gov/SECRS/2011/March/20110323/R-1404/R-
1404_022211_67493_559268623510_1.pdf; Yum! Brands Comments (Feb. 21, 2011),
http://www.federalreserve.gov/generalinfo/foia/R1404formletters.pdf (beginning at p. 25 of the document).




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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 20 of 43




Electronic debit transactions that have an average per transaction amount less than
$15 (“Small-Ticket Transactions”) represent a growing and vibrant segment of the
retail industry. Small-Ticket Transactions are common to retailers of all sizes
across a broad range of industries. In particular, quick service restaurants, sellers
of inexpensive and/or consumable goods, transit authorities, self-service and
vending operators, convenience stores, taxi services and other consumer service-
oriented businesses accept a disproportionate number of Small-Ticket
Transactions.

Today, the majority of noncash payment tender types are electronic debit
transactions. The proportion of these electronic debit transactions that are Small-
Ticket Transactions is significantly higher than that of large-ticket electronic debit
transactions that have an average per transaction amount greater than $15. This
market reality exacerbates the relative burden on Small-Ticket Transactions of the
high flat interchange fees supported under the Proposed Regulations. According
to the 2010 Federal Reserve Payments Study on Noncash Payment Trends, 35%
of noncash payment transactions in 2009 were electronic debit transactions,
representing only 2% of the noncash payment dollar value. Although the mean
dollar value of electronic debit transactions in 2009 was $38, the median dollar
value would likely have fallen within the Small-Ticket Transaction dollar value of
below $15. This assumption is supported by a prior Cash Product Office payment
size study which estimated 30% of electronic debit transaction volume was under
$15 in 2006. Debit growth rates and the introduction of transit, vending and other
Small-Ticket Transaction industry segments suggest this share has increased since
that study. Given the increasing prevalence of electronic debit transactions and
the number of these transactions that are Small-Ticket Transactions, we submit
that it is imperative that the Board consider the impact of proposed Regulation II
on these transactions, including the consumers that initiate them and the retailers
that accept them.


IFA/NCCR Comments at 2 (citations omitted).

Moreover, these submissions emphasized that flat interchange fees can be harmful to

small-ticket transactions because as transaction sizes decrease, the cost per transaction increases.

As a result, the Board was urged to reduce the caps to ensure that its final rules avoid implicitly

endorsing a price increase. The IFA, in this regard, emphasized that:

[T]he Durbin Amendment did not authorize, and a plain reading of the statute
does not support, interchange transaction fees as high as 7 to 12 cents per
transaction. Further, such high interchange transaction fee levels would be
particularly burdensome on merchants in connection with Small-Ticket
Transactions. While we do not oppose, and in fact encourage, a flat fee approach
to the Interchange Fee Restrictions, we are concerned about the harm the high




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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 21 of 43

interchange transaction fee amounts contemplated in the Proposed Regulations
may cause to retailers accepting Small-Ticket Transactions. Of particular concern
is the negative financial impact of the high interchange transaction fees allowed
under the Proposed Regulations on electronic debit transactions under $5
(“Micro-Payments”). Under current published Visa and MasterCard Small-
Ticket Transaction debit interchange fee rates (both set at 1.55% + 4 cents), a
$5 transaction incurs 11.75 cents in interchange transaction fees, which is
below the proposed 12 cent cap contemplated in the Proposed Regulations.
Similarly, under the same Visa and MasterCard Small-Ticket Transaction debit
interchange fee rates, a $1 transaction incurs 5.6 cents in interchange
transaction fees, which is lower than the proposed 7 cent safe harbor and less
than half of the proposed 12 cent cap. Thus, Micro-Payments will likely incur
higher interchange transaction fees under the Proposed Regulations than
under the existing interchange transaction fee regime, contrary to the intended
results of the Durbin Amendment.


IFA/NCCR Comments at 6 (emphasis added; citations omitted). The NRA reiterated the

IFA/NCCR Comments. See NRA Comments at 2-3. Amicus Wendy’s also expressed its

support for the IFA/NCCR position in its comments, as did McDonald’s. See also Wendy’s

Comments (urging “the Board to thoroughly examine the proposed regulations and consider the

unique circumstances surrounding small-ticket transactions”). Put simply, these comments

advised the Board that the NPRM could result in a price increase on some of the fastest-growing

debit transactions.

Concerns similar to those articulated by the IFA/NCCR were highlighted in other

submissions that are in the record. For example, a payments industry expert asked the Board to

“[c]onsider lower interchange rate for industries with low average tickets,” stating that:22

Capping debit interchange fees at $0.12 will benefit all merchants whose average
ticket is greater than $5. Many industries where the average ticket is less than $5
will pay more in interchange fees if issuers set debit interchange fees at $0.12.
For instance, cities and private companies that run parking meters and parking
garages where the average ticket is typically $2-$4 will incur higher interchange
fees at $0.12.



22 See Anand Goel Comments (Jan. 3, 2011), http://www.federalreserve.gov/SECRS/2011/January/20110106/R-
1404/R-1404_010311_59549_558300671921_1.pdf.




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Case 1:11-cv-02075-RJL Document 30 Filed 05/22/12 Page 22 of 43




Likewise, Yum! Brands expressed the following:


Please consider the impact of the maximum interchange cap to Small Ticket
merchants, like our businesses. We have a significant number of transactions
under $5, where the fees could actually become more expensive under your
current proposed cap of $0.12 per item. For example, under the current Visa and
MasterCard Small Ticket Interchange Fee, a $3.00 transaction costs us $0.0865
(1.55% + $0.04) which is much less than the $0.12 cap. And, by the way, if we
accept debit cards, we must accept ALL debit cards, regardless of the type of
card, interchange charged, or size of transaction. We may now be allowed to put
a minimum dollar amount on a credit transaction, but not a debit transaction.

We believe the Board should consider that Small Ticket transactions, and
merchants like us who have a very high proportion of these transactions, will be
particularly burdened by th