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November 08, 2010 • Issue 10:11:01

Challenges to Dodd-Frank, Durbin heat up

By Mark Brady and Ross Federgreen
CSRSI, The Payment Advisors

With the Federal Reserve mandate from Congress to establish debit interchange rates by second quarter 2011, two challenges to the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act and the Durbin Amendment have recently been filed.

First, American Express Co. is contesting the U.S. Department of Justice (DOJ) lawsuit that would require AmEx to cease prohibiting merchants from providing discounts to customers using other card brands or some other payment forms. Second, TCF Financial Corp. filed a lawsuit challenging the constitutionality of the Durbin Amendment.

The Durbin Amendment orders the Federal Reserve Board to enact regulations that strictly limit the amount of interchange fees banks can charge retailers on debit card transactions. The amendment directs the Federal Reserve to measure the processing costs of authorizing, clearing and settling debit card transactions and then to adopt regulations setting debit card interchange rates based on those costs alone.

On Sept. 13, 2010, the Federal Reserve sent a survey to issuers, processors and acquirers of debit transactions to gather this cost information. The survey was due to be completed and returned to the Fed by Oct. 12.

The Durbin Amendment also addresses other noncompetitive aspects of card issuance and acceptance rules.

Following is a discussion of these challenges to Dodd-Frank/Durbin.

The AmEx challenge

As stated, AmEx is fighting the DOJ lawsuit that requires MasterCard Worldwide, Visa Inc. and AmEx to cease prohibiting merchant discounts to customers using other card brands.

The DOJ recently reached a settlement with Visa and MasterCard regarding the companies' allegedly anti-competitive practices. The lawsuit against AmEx is ongoing, and the issue involves MasterCard, Visa and AmEx rules requiring that merchants must agree not to provide discounts to customers using other card brands. The government argues this strategy by the networks is bad for competition.

The Durbin Amendment already forbade some of these practices by stopping credit card networks from blocking discounts for other forms of payment like cash or debit. The DOJ goes further in allowing discounts for competing brands like Visa, MasterCard or PIN debit. So while the Dodd-Frank/Durbin bill already provides vendors the option of offering a cash discount, they can also now offer a discount to persuade the cardholder to use any other card brand.

AmEx Chairman and Chief Executive Officer Kenneth I. Chenault wrote in an Oct. 8 Washington Post op-ed that the DOJ's civil antitrust case does nothing for consumers and will eventually lead to less competition.

Mr. Chenault's contention is the government's remedy would allow merchants who sign AmEx contracts and post AmEx signage to ignore the AmEx contract's ban on discrimination by pressuring shoppers to use a different card when they pay. AmEx cardholders might be offered a small discount for paying with MasterCard or Visa, but this will not lead to lower prices overall for consumers, according to Mr. Chenault.

"Merchant associations won't commit to lower prices," he stated. "Nothing in the government's lawsuit requires them to do so. As it is, merchants are already allowed to offer a discount or incentive to customers who pay by cash, checks or debit cards. Very few do."

Chenault also said AmEx is the smallest card brand in terms of merchant acceptance, but it is "a network of choice" in that merchants are under no obligation to do business with AmEx. "Those that do, appreciate our overall service and value, including more business from higher-spending customers who carry our cards," he wrote. "In return, we require that they not discriminate against our card."

According to Chenault, almost all AmEx customers carry another card in their wallet, but most consumers carrying cards branded by Visa or MasterCard do not carry AmEx cards.

Thus, it is "possible to pressure our customers toward one of the backup products they carry deeper in their wallet," he wrote. "If the government is allowed to do away with the protections we build into our merchant contracts, the net result would be more business for the two dominant networks," which, he added, control 70 percent of the market.

He feels that if Visa and MasterCard gain an even greater market share, negotiating "freely or fairly" with them would be impossible, which would result in "higher costs for merchants and less value for consumers."

We can see how AmEx is concerned about the DOJ lawsuit. It might not be unusual, for example, to see a restaurant offer half-price desserts if you pay with your Visa card, or that free hammer at your local hardware store for every purchase over $100 paid with your MasterCard.

Most likely to gain from this fight are Discover Financial Services, because it is not named in the suit, and merchants. Retailers will probably provide incentives for people to use payment options with lower MasterCard and Visa interchange fees that may result from Dodd-Frank/Durbin. A half-price dessert will cost a restaurant less than the merchant discount difference between MasterCard and Visa and AmEx, especially if a few extra espressos are ordered.

AmEx executives are likely hoping the company's smaller market share will bolster its argument to the DOJ that its policies aren't anti-competitive. AmEx also is probably pulling for pro-business Republicans to gain in Congress in the mid-term elections (which, as of this writing, have not yet occurred).

The TFC challenge

The TCF National Bank (a subsidiary of TCF Financial Corp.) lawsuit filed Oct. 12 against the Federal Reserve challenges the constitutionality of the Durbin Amendment.

TCF Financial Corp. is a Wayzata, Minnesota-based bank holding company with $18 billion in total assets. The company has 441 banking offices located primarily in the Midwest. TCF hosted a teleconference on Oct. 12 to elaborate on the reasons it chose to file this suit and to further explain the legal basis for the complaint.

Following are some of the issues addressed on the call by William Cooper, TCF Financial Chairman and CEO:

  • Cooper argued that processing costs for "debit" transactions are only a fraction of the total costs required to manage the debit card system and deliver the product. The Durbin Amendment mandates that the Federal Reserve ignore other costs incurred by banks associated with debit card processing. Those costs include creation and administration of their system for establishment of customer checking accounts, including the costly physical bank branch system.

  • The Durbin Amendment applies only to banks like TCF with $10 billion or more in assets which, according to Cooper, constitutes a small percentage of banks in the country and exempts all others. The thousands of exempted banks will be free to continue to charge retailers the current debit card interchange rate and recover all their cost plus a profit. This will result in a competitive disadvantage for banks like TCF that are subject to the new regulations.

  • Cooper compared debit card services to selling hamburgers. To stay in business, the restaurateur has to sell burgers at prices that cover more than the cost of meat and buns; it also has to cover the cost of paying employees who make and serve hamburgers, the cost of the building leasing and maintenance, as well as the costs of advertising and product promotion.

    Under the Durbin Amendment, TCF only gets to recover the cost of the meat and bun. Cooper believes the Durbin Amendment confiscates TCF's assets by denying the bank an opportunity to earn a fair rate of return on its assets.

  • Congress has never enacted, without hearings, any regulatory statute like the Durbin Amendment before, which requires an administrative agency to order sellers of a product or service to cut their rates below their actual cost of delivering the product or service.

  • The amendment exempts a high percentage of sellers from the new interchange rate (about 7,000 banks, according to Cooper) and applies it to only about 90 banks.

  • The Durbin Amendment was a last-minute addition to the Dodd-Frank Act's comprehensive overhaul of the financial services industry. Neither the Senate nor the House held any hearings on the provision, which would have allowed for public analysis of its most questionable provisions. According to Cooper, the $10 billion floor for banks was an unfair, politically based threshold. Congressional opposition decreased as the exclusionary amount increased.

  • TCF's position is that political control in Congress may shift after the upcoming congressional elections, and Dodd-Frank may be readdressed. November mid-term election forecasts are that at least the House will likely return to GOP control. It appears TCF feels the suit will fare better in Republican hands. Its lobbyists are very likely at work as we speak.

  • Cooper stated that TCF discussed the suit with other banks, and these banks may file an "amicus brief" with the court. This type of brief is filed by a party (but not a party to a case) that volunteers to offer information to assist a court in deciding a matter before it.

Sen. Richard Durbin issued the following statement in response to the TCF lawsuit:

"TCF's complaint not only fundamentally misunderstands the law regarding interchange fees, but it also ignores the facts. The law in no way addresses the fees TCF, or any other bank, can charge and it does not set interchange rates. Our language simply ensures that debit interchange fees charged to retailers by the card networks - not the banks - are 'reasonable and proportional' to the cost of processing transactions and provides competition in an area of the market where there's none. Congress approved this language by a wide bipartisan margin in reaction to the frustrations of millions of merchants and consumers who were getting nickel and dimed by the anti-competitive interchange system set up by big banks and credit card companies - including TCF. I look forward to this provision's day in court and am confident that our language will be found to be fair and constitutional."

The legislation's path forward

Upon receipt of the surveys, the Federal Reserve must consider a number of factors, including the similarities between debit and checking account costs, and distinguish between incremental costs incurred by issuers, such as the cost of authorization, settlement, clearance, fraud and data security. To prescribe standards for assessing whether debit interchange fees are "reasonable and proportional" the Fed must go through several steps.

First, the agency has to gather and analyze the information necessary to determine the cost frameworks. Then it must publish and distribute a draft regulation that is recorded in the Federal Register.

Then, according to the Administrative Procedure Act, the Fed must afford reasonable notice and opportunity for the public to comment. Given the short nine-month time frame for final legislation, this will probably be a 30- to 90-day comment period.

We can assume there are going to be many comments, some highly detailed and contentious. Assuming issuers believe the Fed will set rates too low, issuers are likely to introduce detailed economic analyses of the Fed data to support that contention. The Fed will then likely have much work to do in the few remaining months before it issues the final regulation. end of article

Mark Brady is a Team Member at CSRSI, The Payment Advisors, a leading electronic payment consultancy specifically focused on the merchant. You can reach him by email at mbrady@csrsi.com or by phone at 866- 462-7774, ext. 5.

Ross Federgreen is founder of CSRSI, The Payment Advisors. He can be reached at 866-462-7774, ext. 1, or rfedergreen@csrsi.com.

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