On August 10, 2015, the Federal Reserve Board issued a clarification on its reasoning for including “transaction monitoring costs” in the debit card interchange fee standard rather than the separate fraud prevention adjustment. This clarification was issued at the direction of the US Court of Appeals for the District of Columbia which included the requirement in its March 2014 opinion upholding the entire debit card interchange regulation. A debit card transaction results in the amount of the transaction being debited from the customer’s account at the bank that issued the card, as opposed to a credit card transaction, where essentially a customer is advanced funds to pay for goods and services and required to pay the credit card issuer later.
A debit card interchange fee is a fee established, charged, or received by a payment card network for the purpose of compensating an issuer for its involvement in an electronic debit transaction. Generally, issuers of debit cards are banks. Concerned about the high costs of debit card interchange fees, Congress in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) included what is known as the Durbin Amendment, which, among other mandates, required that any interchange fee must be reasonable and proportional to the cost incurred by the issuer with respect to the transaction.
The Federal Reserve Board was tasked with promulgating regulations establishing standards (“interchange fee standard”) in assessing whether such fee was indeed reasonable and proportional to the cost incurred by an issuer with respect to a debit card transaction. In establishing the interchange fee standard, the Federal Reserve Board was required, among other things, to distinguish between “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,” (“ACS costs”), which was required to be considered by the Federal Reserve Board in setting the standard, and “other costs incurred by an issuer which are not specific to a particular electronic debit transaction,” which the Federal Reserve Board was prohibited from considering in setting the standard.
Another mandate in the Durbin Amendment allowed the establishment of an adjustment to the interchange fee costs associated with an issuer’s fraud prevention costs. The Federal Reserve Board was required to promulgate regulations establishing standards for allowing issuers to charge this adjustment (“fraud prevention adjustment”).
After notice and comment with respect to both fees, the Federal Reserve Board issued final regulations in 2011 setting the interchange fee standard for a debit card transaction at 21 cents plus 5 basis points multiplied by the dollar value of the transaction, and in 2012 setting the fraud prevention adjustment at no more than one cent per transaction provided that the issuer meet certain standards including adoption and compliance with policies and procedures covering fraud prevention.
Merchants sued the Federal Reserve Board asserting that the interchange fee standard included costs that should not have been considered in setting that standard. When the Federal Reserve Board first proposed an interchange fee standard for comment by the public, it took a more restrictive view of what could be included and capped the fee at 12 cents per transaction, taking into account only the ACS costs. After consideration of the comments, when the final regulations were issued, the Federal Reserve Board not only had raised the cap to 21 cents per transaction plus the 5 basis points multiplied by the dollar value of the transaction, it had changed the basis for the interchange fee standard, noting that there were costs associated with a debit card transaction that could be something other than a permitted ACS cost, or a prohibited cost not associated with a particular debit card transaction. As a result, the final interchange fee standard allowed issuers to recover all costs other than those specifically prohibited. Issuers thus could recover the fixed ACS costs (mentioned in the statute); costs incurred as a result of transactions-monitoring to prevent fraud; fraud loss costs incurred as a result of settling fraudulent transactions; and card network (such as Master Card or VISA) processing fees.
In its decision, the Court upheld the rule, finding that the Federal Reserve Board had made a reasonable interpretation of the statute as permitting three categories of costs, two permissible and one not. However, it directed the Federal Reserve Board to explain its justification for including transaction monitoring costs in the interchange fee standard as opposed to the fraud prevention adjustment.
As required by the Court, the clarification set forth the Federal Reserve Board’s rationale for including transaction monitoring costs in the interchange fee standard. Prohibited costs were those not related to the processing of a particular debit card transaction, such as corporate overhead and debit card production and delivery costs. On the other hand, the interchange fee standard could include any cost that is incurred in effecting a debit card transaction, such as all costs associated with monitoring transactions “that assist in the authorization process by providing information needed by the issuer in deciding whether the issuer should authorize the transaction before the issuer decides to approve or decline the transaction,” even if some of those costs also could have the dual purpose of helping to prevent fraud in the first place.
In determining the fraud prevention adjustment, the Federal Reserve Board used costs “not necessary to effect a specific transaction and were not part of the authorization, clearing, or settlement process, and thus a particular electronic debit transaction could occur without the issuer incurring these costs,” such as research and development of new fraud prevention technologies. The general statutory language of the fraud prevention adjustment referred to costs preventing fraud “in relation to electronic debit transactions involving that issuer,” as opposed to the interchange fee standard’s costs being related to a particular debit card transaction. The Federal Reserve Board notes in the clarification that use of the more generic language in the fraud prevention adjustment suggests “a Congressional intent to use the fraud prevention adjustment to encourage issuers to develop and adopt programmatic improvements to address fraud outside of the context of particular transactions that incur costs for authorization, clearance, or settlement,” and that it was those programmatic costs that it relied upon in determining the fraud prevention adjustment.