[Federal Register Volume 80, Number 157 (Friday, August 14, 2015)]
[Rules and Regulations]
[Pages 48684-48686]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-19979]


=======================================================================
-----------------------------------------------------------------------

FEDERAL RESERVE SYSTEM

12 CFR Part 235

[Regulation II; Docket No. R-1404]
RIN No. 7100-AD 63


Debit Card Interchange Fees and Routing

AGENCY: Board of Governors of the Federal Reserve System

ACTION: Clarification.

-----------------------------------------------------------------------

SUMMARY: The Board is publishing a clarification of Regulation II 
(Debit Card Interchange Fees and Routing). Regulation II implements, 
among other things, standards for assessing whether interchange 
transaction fees for electronic debit transactions are reasonable and 
proportional to the cost incurred by the issuer with respect to the 
transaction, as required by section 920 of the Electronic Fund Transfer 
Act. On March 21, 2014, the Court of Appeals for the District of 
Columbia Circuit upheld the Board's Final Rule. The Court also held 
that one aspect of the rule--the Board's treatment of transactions-
monitoring costs--required further explanation from the Board, and 
remanded the matter for further proceedings. The Board is explaining 
its treatment of transactions-monitoring costs in this Clarification.

DATES: Effective August 14, 2015.

FOR FURTHER INFORMATION CONTACT: Stephanie Martin, Associate General 
Counsel (202-452-3198), or Clinton Chen, Attorney (202-452-3952), Legal 
Division; for users of Telecommunications Device for the Deaf (TDD) 
only, contact (202-263-4869); Board of Governors of the Federal Reserve 
System, 20th and C Streets NW., Washington, DC 20551.

SUPPLEMENTARY INFORMATION

I. Background

    The Dodd-Frank Wall Street Reform and Consumer-Protection Act (the 
``Dodd-Frank Act'') was enacted on July 21, 2010.\1\ Section 1075 of 
the Dodd-Frank Act amends the Electronic Fund Transfer Act (``EFTA'') 
(15 U.S.C. 1693 et seq.) to add a new section 920 regarding interchange 
transaction fees and rules for payment card transactions.\2\ EFTA 
section 920(a)(2) provides that the amount of any interchange 
transaction fee that an issuer receives or charges with respect to an 
electronic debit transaction must be reasonable and proportional to the 
cost incurred by the issuer with respect to the transaction.\3\ Section 
920(a)(3) requires the Board to establish standards for assessing 
whether an interchange transaction fee is reasonable and proportional 
to the cost incurred by the issuer with respect to the transaction. 
Without limiting the full range of costs that the Board may consider, 
section 920(a)(4)(B) requires the Board to distinguish between two 
types of costs

[[Page 48685]]

when establishing standards under section 920(a)(3). In particular, 
section 920(a)(4)(B) requires the Board 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,'' 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.
---------------------------------------------------------------------------

    \1\ Public Law 111-203, 124 Stat. 1376 (2010).
    \2\ EFTA section 920 is codified as 15 U.S.C. 1693o-2. EFTA 
section 920(c)(8) defines ``an interchange transaction fee'' (or 
``interchange fee'') as any 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.
    \3\ Electronic debit transaction (or ``debit card transaction'') 
is defined in EFTA section 920(c)(5) as a transaction in which a 
person uses a debit card.
---------------------------------------------------------------------------

    Under EFTA section 920(a)(5), the Board may allow for an adjustment 
to the amount of an interchange transaction fee received or charged by 
an issuer if (1) such adjustment is reasonably necessary to make 
allowance for costs incurred by the issuer in preventing fraud in 
relation to electronic debit card transactions involving that issuer, 
and (2) the issuer complies with fraud-prevention standards established 
by the Board. Those standards must, among other things, 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.
    The Board promulgated its final rule implementing standards for 
assessing whether interchange transaction fees meet the requirements of 
section 920(a) in July 2011. (Regulation II, Debit Card Interchange 
Fees and Routing, ``Final Rule,'' codified at 12 CFR part 235).\4\ 
Among the provisions of the Final Rule was one relating to 
transactions-monitoring costs. Transactions-monitoring costs are costs 
incurred by the issuer during the authorization process to detect 
indications of fraud or other anomalies in order to assist in the 
issuer's decision to authorize or decline the transaction. The Board 
included transactions-monitoring costs as part of the interchange fee 
standard called for in section 920(a)(3)(A) (costs incurred by an 
issuer for the issuer's role in the authorization of a particular 
transaction) 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.
---------------------------------------------------------------------------

    \4\ Regulation II also implemented a separate provision of 
section 920 relating to network exclusivity and routing.
---------------------------------------------------------------------------

    The Board amended Regulation II on August 3, 2012 to implement the 
fraud-prevention cost adjustment permitted by EFTA section 
920(a)(5).\5\ Fraud-prevention costs included in that adjustment 
included costs associated with research and development of new fraud 
technologies, card reissuance due to fraudulent activity, data 
security, and card activation.\6\ These costs are not incurred during 
the transaction as part of the authorization process.
---------------------------------------------------------------------------

    \5\ See 77 FR 46,258 (Aug. 3, 2012).
    \6\ See 77 FR at 46,264.
---------------------------------------------------------------------------

    On March 21, 2014, the Court of Appeals for the District of 
Columbia Circuit upheld the Board's Final Rule relating to the 
interchange fee standard. NACS v. Board of Governors of the Federal 
Reserve System, 746 F.3d 474 (D.C. Cir. 2014).\7\ The Court of Appeals 
held, however, that one aspect of the rule--the Board's treatment of 
transactions-monitoring costs--required further explanation from the 
Board, and remanded the matter for further proceedings. The Court of 
Appeals agreed with the Board's position that ``transactions-monitoring 
costs can reasonably qualify both as costs `specific to a particular 
transaction' (section 920(a)(4)(B)) and as fraud-prevention costs 
(section 920(a)(5)).'' 746 F.3d at 492. 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.
---------------------------------------------------------------------------

    \7\ The U.S. Supreme Court denied the retailers' petition for a 
writ of certiorari on January 20, 2015. 135 S. Ct. 1170 (2015).
---------------------------------------------------------------------------

II. Rationale for Including Transactions-Monitoring Costs in the 
Interchange Fee Standard

    In the Final Rule, the Board identified the types of costs that 
could not be included in the interchange fee standard under section 
920(a)(4)(B)(ii) (other costs ``not specific to a particular 
transaction'') on the basis of whether those costs are ``incurred in 
the course of effecting'' transactions.\8\ Costs that were ``not 
incurred in the course of effecting any electronic debit transaction'' 
were determined to be outside of the allowable ambit 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.'' \9\ Thus, 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.'' \10\ In 
upholding the rule, the Court of Appeals found this to be ``reasonable 
line-drawing.'' \11\
---------------------------------------------------------------------------

    \8\ 76 FR 43,394, 43,426 (July 20, 2011).
    \9\ Id.
    \10\ 76 FR at 43,430.
    \11\ 746 F.3d at 490.
---------------------------------------------------------------------------

    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.\12\ 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, the Board 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.
---------------------------------------------------------------------------

    \12\ 76 FR at 43,430-31.
---------------------------------------------------------------------------

    By contrast, fraud-prevention costs that the Board used to 
calculate the separate fraud-prevention adjustment authorized under 
section 920(a)(5) 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. As the Board stated in the 
Final Rule, 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.\13\ For 
example, in setting the fraud-prevention adjustment, the Board 
considered costs associated with research and development of new

[[Page 48686]]

fraud prevention technologies, card reissuance due to fraudulent 
activity, data security, and card activation.\14\
---------------------------------------------------------------------------

    \13\ 76 FR at 43,431.
    \14\ 77 FR at 46,264.
---------------------------------------------------------------------------

    As noted above, section 920(a)(4)(B) specifically directs the Board 
to consider in establishing the interchange fee standard the costs 
``incurred by the issuer for the role of the issuer in the 
authorization, clearance or settlement of a particular transaction.'' 
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. In addition, 
the statutory language of section 920(a)(5), which differs in important 
respects from section 920(a)(4)(B), supports the Board's decision to 
include transactions-monitoring costs in the interchange fee standard 
rather than in the separate fraud prevention adjustment. The costs 
considered in section 920(a)(5)(A)(i) are those of preventing fraud 
``in relation to electronic debit transactions,'' rather than costs of 
``a particular electronic debit transaction'' referenced in section 
920(a)(4)(B). Congress's elimination of the word ``particular'' and its 
use of the more general phrase ``in relation to,'' along with its use 
of the plural ``transactions,'' indicates that the fraud-prevention 
adjustment may take into account an issuer's fraud prevention costs 
over a broad spectrum of transactions that are not linked to a 
particular transaction.
    Moreover, section 920(a)(5) permits the Board to adopt a separate 
adjustment ``to make allowance for costs incurred by the issuer in 
preventing fraud in relation to electronic debit transactions involving 
that issuer'' if certain standards are met, and directs that those 
standards include that the issuers take steps to ``reduce the 
occurrence of, and costs from, fraud in relation to electronic debit 
transactions,'' including ``development and implementation of cost-
effective fraud prevention technology.'' Section 920(a)(5)(A)(i), 
(A)(ii)(II) (emphasis supplied). The use of the general phrase ``fraud 
in relation to electronic debit transactions'' and the specific 
reference to developing fraud prevention technology suggest 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. The types of 
costs the Board included in the separate fraud prevention adjustment 
are programmatic costs, such as researching and developing new fraud 
prevention technologies and data security, and other costs that 
encourage enhanced fraud prevention that are not necessary to effect 
particular transactions.
    The Board is publishing this explanation in accordance with the 
opinion of the Court of Appeals.

    By order of the Board of Governors of the Federal Reserve 
System, August 10, 2015.
Robert deV. Frierson,
Secretary of the Board.
[FR Doc. 2015-19979 Filed 8-13-15; 8:45 am]
BILLING CODE P