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Federal Reserve Board Clarifies Debit-Card Rule

WASHINGTON — The Federal Reserve Board has clarified debit-card interchange fee and routing rules that set standards for assessing whether swipe fees for electronic debit transactions are “reasonable and proportional” to the cost incurred by the issuer, as required by the Electronic Fund Transfer Act (EFTA).

In January, the U.S. Supreme Court denied a petition by the National Association of Convenience Stores (NACS), the Food Marketing Institute (FMI), the National Retail Federation (NRF), Boscov’s Department Stores, the National Restaurant Association and Miller Oil Co. that challenged the Federal Reserve’s rule on debit-card interchange fees.

NACS and the other plaintiffs filed suit to challenge the amounts of those debit-card swipe fees and lack of merchant choices for network routing under the Fed’s rule, the association said. The lawsuit argued that the rule was not consistent with the language of the law passed by Congress as part of Dodd-Frank.

On March 21, 2014, the Court of Appeals for the District of Columbia Circuit upheld the board’s final rule in NACS v. Board of Governors of the Federal Reserve System). The court also held that one aspect of the rule—the board’s treatment of transactions-monitoring costs—required further explanation.

The Dodd-Frank Wall Street Reform & Consumer-Protection Act enacted on July 21, 2010, amends the EFTA section regarding interchange transaction fees and rules for payment card transactions.

The amended section also requires the board to establish standards for assessing whether the fee is reasonable and proportional.

Without limiting the full range of costs that the board may consider, the section requires the board to distinguish between two types of costs when establishing the standards—“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 the statute requires the board to consider, and “other costs incurred by an issuer which are not specific to a particular electronic debit transaction,” which the statute prohibits the board from considering.

The board may allow for an adjustment to the amount of a swipe fee received or charged by an issuer if the adjustment is reasonably necessary to make allowance for costs incurred by the issuer in preventing fraud in compliance with the board’s standards. Those standards must require issuers to take effective steps to reduce the occurrence of and costs from fraud in relation to electronic debit transactions, including through the development and implementation of cost-effective fraud-prevention technology.

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Among the provisions of the final rule was one relating to the issuer’s transactions-monitoring costs during the authorization process to detect indications of fraud or other anomalies to assist in the decision to authorize or decline the transaction. The board included transactions-monitoring costs as part of the interchange fee standard based on the board’s determination that these costs are incurred in the course of effecting a particular transaction and an integral part of the authorization of a specific electronic debit transaction.

Fraud-prevention costs associated with research and development of new fraud technologies, card reissuance due to fraudulent activity, data security and card activation are not incurred during the transaction as part of the authorization process.

The Court of Appeals agreed that “transactions-monitoring costs can reasonably qualify both as costs ‘specific to a particular transaction’ … and as fraud-prevention costs.”

The court held, however, that the board had not adequately articulated its reasons for including transactions-monitoring in the interchange fee standard rather than in the fraud-prevention adjustment.

In the final rule, the board identified the types of costs that could not be included in the interchange fee standard—other costs “not specific to a particular transaction”—on the basis of whether those costs are “incurred in the course of effecting” transactions.

Costs that were “not incurred in the course of effecting any electronic debit transaction” were determined to be outside of the allowable sphere of influence of the interchange fee standard, but the standard could include “any cost that is not prohibited; i.e., any cost that is incurred in effecting any electronic debit transaction.”

For example, the costs of equipment, hardware, software and labor associated with transactions processing were properly included in the interchange fee standard because no particular transaction can occur without incurring these costs, and thus these costs are “specific to a particular transaction.”In upholding the rule, the Court of Appeals found this to be “reasonable line-drawing.”

The same rationale supports including transactions-monitoring costs in the interchange fee standard. Transactions-monitoring systems, such as neural networks and fraud-risk scoring systems, 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. Like other authorization steps, such as confirming that a card is valid and authenticating the cardholder, transactions-monitoring is integral to an issuer’s decision to authorize a specific transaction.

In fact, most costs of the authorization process (which are costs Congress required to be considered in determining the interchange fee) assist in preventing some type of fraud. Steps in the authorization process may include ensuring that the transaction is not against an account that has been closed, checking to be sure the card has not been reported lost or stolen, checking that there is an adequate balance and authenticating the cardholder. Like transactions-monitoring, these authorization steps are all “specific to a particular transaction” in the sense that they occur in connection with each transaction that is authorized or declined.

Because the statute requires the board to consider incremental authorization costs in setting the interchange fee standard, it concluded that that it should consider the costs of all activities that are integral to authorization, even if those costs are also incurred for the dual purpose of helping to prevent fraud.

By contrast, fraud-prevention costs that the board used to calculate the separate fraud-prevention adjustment were not necessary to effect a particular 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.

The types of fraud-prevention activities considered in connection with the fraud-prevention adjustment were those activities designed to prevent debit-card fraud at times other than when the issuer is authorizing, settling or clearing a transaction, for example, costs associated with research and development of new fraud-prevention technologies, card reissuance due to fraudulent activity, data security and card activation.

Transactions monitoring is an integral part of the authorization process, so that the costs incurred in that process are part of the authorization costs that the board is required by the statute to consider when establishing the interchange fee standard.


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