Financial Services Law

D.C. Circuit Court Upholds Fed’s Debit Card Fee Cap, Antiexclusivity Rules

Dealing a blow to merchants nationwide, the D.C. Circuit Court of Appeals reversed a lower court and upheld the rules promulgated by the Board of Governors of the Federal Reserve capping fees on debit interchange and establishing antiexclusivity requirements for payment card networks.

While the rules themselves will decrease the bottom line for issuers and banks, the merchants had sought to decrease the cap even lower, and the three-judge panel’s opinion at the very least eliminates the uncertainty surrounding the rules.

The Board of Governors issued regulations in October 2011 at the direction of the Dodd-Frank Wall Street Reform and Consumer Protection Act’s Durbin Amendment with two primary changes: the imposition of a cap on the per-transaction fees banks receive when consumers use a debit card and a requirement that at least two networks owned and operated by different companies be able to process transactions on each debit card.

Prior to issuing the regs, the Board polled the industry to determine the actual costs to a bank when routing debit card transactions. Under a proposed rule, the cap was set at 12 cents per transaction. When the final rule raised the proposed cap to 21 cents plus 0.5 percent of a transaction’s value, trade groups like the National Association of Convenience Stores and the National Retail Federation sued.

The plaintiffs argued that both of the Board’s rules flew in the face of the intent behind the Durbin Amendment. According to the merchants, issuers should have been forced to route each debit transaction on multiple unaffiliated networks and the fee cap should not have included the ability to recover for costs like fraud losses, transaction-monitoring costs, and “fixed” authorization, clearance, and settlement (ACS) costs.

A D.C. federal court agreed last July, finding that “the Board completely misunderstood the Durbin Amendment’s statutory directive and interpreted the law in ways that were clearly foreclosed by Congress,” and granted summary judgment to the merchants.

But a unanimous three-judge panel of the D.C. Circuit Court reversed last week in an opinion authored by Judge David Tatel.

The Board’s rule was reasonable, the court said.

Section 920(a)(4)(B)(i) of the Durbin Amendment requires the Board to include “incremental costs” in the fee cap, while Section 920(a)(4)(B)(ii) prohibits the inclusion of “other costs incurred by an issuer which are not specific to a particular electronic debit transaction.” The Board argued that the Durbin Amendment also created a third category of costs that are specific to a particular transaction and yet not incremental. The decision to allow issuers to recover this third category of costs was within its power, the Board said.

The court agreed, noting that if Congress had wanted to limit issuers’ recovery simply to incremental ACS costs, “it could have done so directly” but failed to do so. “Given the Durbin Amendment’s ambiguity as to the existence of a third category of costs, we must defer to the Board’s reasonable determination that the statute splits costs into three categories,” the panel wrote.

The court then reviewed the four specific types of costs encompassed within the third category and challenged by the merchants.

“Fixed” ACS costs passed the court’s scrutiny, as “the Board reasonably distinguished between costs issuers could recover and those they could not recover on the basis of whether those costs are ‘incurred in the course of effecting’ transactions,” the court said. Such costs as equipment, hardware, and software could be recovered, while the costs of producing and distributing debit cards cannot. “Given the Board’s expertise, we see no basis for upsetting its reasonable line-drawing,” the panel said.

Networking processing fees (“obviously specific to particular transactions,” the court noted) and costs for fraud losses also passed muster, but the court remanded the issue of costs for transaction monitoring for further consideration. The Board has yet to articulate a reasonable justification for including transaction-monitoring costs, the panel wrote, allowing the Board to provide a sufficient explanation for the treatment of such costs on remand.

The federal appellate panel then turned to the Board’s antiexclusivity rules. According to the merchants, the Durbin Amendment required that all merchants have multiple unaffiliated network routing options for each debit transaction. But the court found that the Board “perfectly” complied with Congress’s direction to accomplish a particular objective. “Under the rule, ‘issuer[s] and payment card network[s] cannot ‘restrict the number of payment card networks on which an electronic debit transaction may be processed’ to only affiliated networks – exactly what the statute requires,” Judge Tatel wrote.

An argument by the merchants that the rule failed to serve the purpose behind the Durbin Amendment similarly failed, in part due to evidence presented by the Board that network competition has already increased as a result of the rule change, with more than 100 million debit cards activated on new networks since it took effect.

“Given that the Board’s rule advances the Durbin Amendment’s purpose, we decline to second-guess its reasoned decision to reject an alternative option that might have further advanced that purpose,” the court concluded.

To read the opinion in NACS v. Board of Governors of the Federal Reserve System, click here.

Why it matters: The D.C. Circuit Court noted that Congress put the court “in a real bind” having to interpret the “confusing” language and “convoluted” structure of the Durbin Amendment. However, the panel concluded that the Board’s regulations were faithful to Congress’s intent and issuers know where they stand without the uncertainty of the lower court’s opinion. An attorney for NACS told Bloomberg News that the retail groups are still considering their appellate options, either before the en banc D.C. Circuit or the U.S. Supreme Court. In a statement, Sen. Dick Durban (D-Ill.), who sponsored the amendment dissected by the court, called the decision a “giveaway to the nation’s most powerful banks and blow to consumers and small businesses.”

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D.C. Court Rejects Zip Code Consumer Protection Suit, Creates Split

In a major win for retailers, a Washington, D.C., federal court judge dismissed a putative class action suit alleging that the requests of customers’ ZIP codes in connection with credit card purchases violated D.C. consumer protection statutes.

The decision allows businesses in the nation’s capital to breathe a sigh of relief. Courts in California (click here to read our previous newsletter) and Massachusetts (click here to read our previous newsletter) have reached the opposite conclusion, resulting in a wave of consumer class action suits against retailers in those states.

But in a thorough rejection of the plaintiffs’ theory, U.S. District Court Judge Beryl A. Howell held that retailers may legally request a customer’s ZIP code at the time a credit card purchase is made.

Plaintiffs Jamie White and Whitney Hancock alleged that Urban Outfitters’ and Anthropologie’s requests for their ZIP codes when they made purchases at the stores violated the D.C. Use of Consumer Identification Information (CII) Act as well as the D.C. Consumer Protection Procedures (CPP) Act.

The CII Act prohibits any person “as a condition of accepting a credit card as payment for a sale of goods or services, request[ing] or record[ing] the address or telephone number of a credit card holder on the credit card transaction form,” with the ability to recover actual damages or $500 per violation, whichever is greater, along with attorneys’ fees and court costs. The CPP Act prohibits misrepresentations and deceptive representations and omissions by businesses in the district.

Plaintiffs argued that a ZIP code is both an essential part of an address and, by itself, an address – contentions the court was quick to refute.

First, the court held that “a ZIP code is the only component of an address . . . that is not necessary,” contrary to the plaintiffs’ assertions. Second, Judge Howell held that “[a]lthough a ZIP code is, as the defendants admit, part of an address, it is not, in and of itself, an address. . . . By asking for a ZIP code, standing alone, a person is not asking for an ‘address.’ ” A ZIP code is not a “unique location identifier,” the court held, because, at best, it “indicates an area in which multiple addresses may be located.” Because the statute does not prohibit the request for an integral part of an address, or a component of an address, but “the address” of the customer, the plaintiffs failed to state an essential element of the claim.

Even construing the CII Act broadly as a consumer protection statute, the “plaintiffs attempt to stretch [the] definition too far,” the judge said.

But the court was not done. Plaintiffs failed to sufficiently plead the other two elements of a CII Act claim because they did “not even hint” that they were not allowed to use their credit cards unless they provided their ZIP codes, meaning it was not a “condition of accepting a credit card as payment for a sale of goods,” the court reasoned.

Further, plaintiffs specifically alleged that their ZIP codes were recorded in the retailers’ point-of-sale registers, not the credit card swipe machines. “By pleading that the defendants used a system entirely separate from the credit card transaction machine to record the plaintiffs’ ZIP codes, the plaintiffs have utterly failed to plead that the defendants recorded anything ‘on the credit card transaction form,’ ” Judge Howell held. “Indeed, it appears that the defendants took steps specially designed to adhere to the law by affirmatively separating the zip code information from the credit card information.”

Plaintiffs’ CPP Act claims, which were predicated upon their erroneous interpretation of the CII Act, failed for the same reasons, as well as the fact that the plaintiffs alleged they provided their ZIP codes voluntarily.

Judge Howell took pains to distinguish opposite holdings from state courts in California and Massachusetts based on differences in statutory language. In those cases, the “statutes in question prohibited the collection of a substantially broader set of consumer information,” the court held, as each statute prohibited the recording of private consumer information, “including, but not limited to,” the cardholder’s address and telephone number. In addition, the court held that “neither the California nor the Massachusetts statutes required that the collection of such information must be a ‘condition of accepting a credit card as payment’ to trigger a violation, as is the case in the CII Act.”

Concluding that a second bite at the apple would be futile, since the plaintiffs’ complaint was based on an erroneous interpretation of the law, the court dismissed the suit with prejudice.

To read the opinion in Hancock v. Urban Outfitters, click here.

Why it matters: More than 15 states have statutes limiting the type of information that retailers can collect from customers. And the decisions in California and Massachusetts undoubtedly encouraged plaintiffs, like those in Hancock, to file their ZIP code collection class actions outside of these states. The wave of litigation in California and Massachusetts over the collection of ZIP codes has resulted in significant settlements ranging from a $600,000 payout by OfficeMax to plaintiffs in California (click here to read our previous newsletter) to a recent $875,000 deal agreed to by craft store Michael’s in Massachusetts (click here to read our previous newsletter). Retailers in Washington, D.C., dodged a major bullet with the Hancock decision. Judge Howell’s total rejection of the plaintiffs’ theory – striking down every element of the cause of action – leaves D.C. businesses on solid footing. In addition, the decision may impact retailers outside of D.C. as it could help to deter plaintiffs in states other than California and Massachusetts from bringing similar ZIP code suits.

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IRS Rules Virtual Currency Property and Key Treasury Official Reviews the Current Legal Responsibilities Related to Virtual Currency and Need for Further Regulation

In the latest federal developments regarding virtual currency, the IRS has issued a ruling that virtual currencies will be treated as “property” – not currency – for federal tax purposes. This will cause transactions conducted in virtual currencies to be taxed as capital gains, triggering significant recordkeeping and other problems for those using virtual currencies to purchase goods and services in the same manner as they would use U.S. dollars or other fiat currencies.

On the first anniversary of the Financial Crimes Enforcement Network’s issuance of guidance on how virtual currencies would be treated under the federal Bank Secrecy Act, a senior official in the U.S. Department of the Treasury discussed his office’s views on further regulating virtual currency.

The issue of government oversight of crypto-currencies like Bitcoin has ramped up in recent weeks, following announcements from regulators in New York and Texas on plans to release proposed rules for licensing virtual currency exchangers and other players as well as the recent bankruptcy filing by a major Bitcoin exchange and the shuttering of other exchanges (click here to read our previous newsletter). Other countries – including China, Israel, and Russia – are similarly struggling with whether and how to regulate virtual currency. Consumer protection alerts have also been issued by a number of states and countries.

David S. Cohen, the Undersecretary for Terrorism and Financial Intelligence for the U.S. Treasury, focused on the need for transparency. “Financial transparency can help bring stability to the virtual currency market and security to its users and investors,” Cohen said in a speech given at Bloomberg News offices in New York. “That is what we are trying to do through sensible, flexible, and – to use a word from the tech world – scalable regulation.”

Cohen acknowledged the concerns of backers of crypto-currency that regulation will hamper development. However, he said that when forced to choose between transparency and innovation, lawmakers “will err on the side of transparency.”

To help guide regulators, Cohen announced that the Treasury Department’s Bank Secrecy Act Advisory Group will add a member of the virtual currency industry.

Part of Cohen’s role in the office for terrorism and financial intelligence involves preventing the use of the financial system for criminal activity such as money laundering. To that end, he said the agency has encouraged digital currency developers to focus on technological methods to prevent criminal uses – instead of working on the means to “further obscure financial trails.”

“We do not currently see widespread use of virtual currencies as a means of terrorist financing or sanctions evasion,” Cohen said in his speech. “But these are adaptable actors who are drawn to ungoverned spaces, and so may increasingly look to this technology as an attractive way to transfer value.”

He also noted that some digital currency companies have failed to register with FinCEN since it released its guidance last year and that they are not following the recordkeeping and reporting requirements.

“Those that do not comply with these rules should understand that their actions will have consequences,” Cohen warned. “Not only are they subject to FinCEN civil monetary penalties, but the knowing failure to register a money transmitting business with FinCEN – or fail to register with state authorities when required – can be a federally criminal offense.”

Given the current levels of use of virtual currency, Cohen said the existing FinCEN oversight “is sufficient to guard against money laundering and other illicit financial threats.”

However, that could change.

“[W]e know the virtual currency industry is quickly evolving. While we surely don’t know where it will ultimately go, or even if one or more virtual currencies will really catch on, I assure you that as the industry evolves we will continue to assess whether the regulatory steps we have taken to combat illicit finance are sufficient,” Cohen said. “And so, for instance, if virtual currencies achieve much greater adoption and it appears that daily financial life can be conducted for long stretches fully ‘within’ a virtual currency universe, we will need to consider whether to apply ‘cash-like’ reporting requirements to the virtual currency space.”

To read the full text of Cohen’s remarks, click here.

Why it matters: Cohen’s office plays a key role in determining the U.S. government’s policy with respect to the BSA and OFAC. He made it clear in his speech that virtual currency providers that comply with the law have nothing to fear. As long as the government is comfortable that it has sufficient financial transparency and is getting the information it needs to address money laundering and terrorist financing, it is likely to provide the virtual currency world the necessary freedom and flexibility to continue to innovate. “At its core, financial transparency requires financial institutions to implement certain basic controls: they must know who their customers are; they must understand their customers’ normal and expected transactions; and they must keep the records and make the reports necessary for regulators and law enforcement to take action to hold accountable those who abuse the financial system,” he said.

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Businesses Challenge State Laws Prohibiting Swipe Fees

Now that the major credit card companies have dropped prohibitions against imposing surcharges for swipe fees, retailers have turned their attention to state laws that regulate the language used to describe such fees.

Small businesses in California, Florida, and Texas filed nearly identical lawsuits last week challenging the constitutionality of so-called “no-surcharge” laws in those states. By prohibiting retailers from describing the swipe fee as a “surcharge” – yet allowing companies to offer a “discount” for alternative forms of payment like cash – the laws violate their First Amendment rights and are unconstitutionally vague, the plaintiffs allege.

At the heart of the dispute: Retailers want to be able to call swipe fees a “surcharge” to effectively communicate to customers the nature of the fee. Offering a customer a “discount” by using a different form of payment implies that the business has higher prices than it really does, the plaintiffs allege.

A credit surcharge and a cash discount are “identical in every way except one: the label that the merchant uses to communicate that price difference,” the California complaint alleges. “This state-imposed speech code prevents the plaintiffs from effectively conveying to their customers – who absorb the costs of credit through higher prices for goods and services – that credit cards are a more expensive means of payment.”

Citing various studies, the complaint alleges that such labels matter because consumers have stronger reactions to losses and penalties than to gains. “In one study, 74 percent of consumers had a negative or strongly negative reaction to credit surcharges, while fewer than half had a negative or strongly negative reaction to cash discounts,” according to the complaints.

In addition, “the law’s discount/surcharge distinction is so vague” that the retailers claim they fear using any system of dual pricing at all to avoid running afoul of the law. The Texas complaint, for example, details the experience of Beaumont Greenery, a grocery store that wants to put up a sign to explain the surcharge to its customers; meanwhile, sporting goods store Cook’s Sportland received a letter from the Florida Attorney General stating that it was violating the state’s no-surcharge law by telling consumers they would pay an additional charge if they paid with a credit card.

Prior to the recent swipe fee settlements (click here to read our previous newsletter), the state laws were irrelevant because credit card companies imposed “no surcharge” prohibitions in their contracts with merchants. But retailers in states like California, Florida, and Texas are still prohibited from using the word surcharge – even though dual pricing is legal – because of state law.

One of the less than a dozen states with a no-surcharge law on the books has already tackled the issue and sided with retailers. Last October, a federal court judge in New York struck down the state’s law and entered a preliminary injunction against its enforcement, ruling that it violated the First Amendment.

Arguing that the laws in their states are no different from the law in New York, the new lawsuits seek similar relief: a declaration that the no-surcharge law is unconstitutional and an injunction against its enforcement (as well as payment for costs and fees).

To read the California complaint in Italian Colors v. Harris, click here.

To read the Florida complaint in Dana’s Railroad Supply v. Bondi, click here.

To read the Texas complaint in Rowell v. Abbott, click here.

Why it matters: States with no-surcharge laws appear to be the next battleground in swipe fee lawsuits, with a New York case already resulting in a victory for retailers and suits now filed in major states like California, Florida, and Texas. Whether litigation follows in the remaining no-surcharge states – Colorado, Connecticut, Kansas, Maine, Massachusetts, and Oklahoma – remains to be seen. Victory for retailers in the California, Florida and Texas suits may cause the remaining no-surcharge states to repeal the statutes.

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CFPB Sues For-Profit Education Institution Alleging Predatory Lending

Analogizing to the “misaligned incentives” found in the mortgage market in the lead-up to the financial crisis, the Consumer Financial Protection Bureau sued for-profit college chain ITT Educational Services for allegedly engaging in predatory lending by pushing students into high-cost student loans the school knew were likely to end in default.

At its roughly 150 locations nationwide, ITT used “high-pressure sales techniques” and misleading information about future job prospects to ensnare students into “high-rate, high-fee” loans, according to the CFPB, resulting in violations of the Truth in Lending Act (TILA) as well as the agency’s prohibitions on unfair and abusive practices pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Beginning with first-year students, the school encouraged new attendees to enroll in a “Temporary Credit” zero-interest loan their first year to cover the cost differential between attendance and federal loans, despite an awareness that most students would not be able to pay it back in full as required. When students failed to repay the loan, the CFPB said ITT pushed the borrowers into private student loans but neglected to fully detail the loan obligations.

If students elected not to take out private loans and instead carried a balance from their first-year loan from the school, ITT offered a “graduation discount” for those that paid the balance in a lump sum rather than an installment plan, according to the agency. Those discounts constituted finance charges subject to TILA’s disclosure requirements, the CFPB claims in its suit, and ITT failed to comply with statutory requirements to clearly and conspicuously disclose the charges in writing to borrowers who elected to enter an installment plan instead of paying the lump sum.

The CFPB’s complaint seeks injunctive relief to halt the allegedly illegal practices as well as monetary relief in the form of restitution for borrowers, disgorgement, rescission, and civil money penalties.

ITT responded with a vehement denial of the charges and a challenge to the agency’s jurisdiction. In a statement, the educational institution characterized the Indiana federal court lawsuit as an “aggressive attempt by the Bureau…to extend its jurisdiction into matters well beyond consumer finance.”

To read the complaint in CFPB v. ITT Educational Services, click here.

Why it matters: Student lending has been a focus of the CFPB recently, and the ITT suit – the agency’s first action against a for-profit educational institution – may not be its last. In remarks about the lawsuit, Director Richard Cordray cautioned that the action “should serve as a warning to the for-profit college industry that we will be vigilant about protecting students against predatory lending tactics.” He also noted that state attorneys general in California, Colorado, Illinois, Massachusetts, and New York are engaging in similar litigation against various for-profit educational institutions.

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