FED Issues Final Debit Card Rules

The Dodd-Frank financial reform legislation required the Federal Reserve Board to regulate debit card merchant fees. Over the past year, the FED has taken comments, issued proposals, delayed the announcement of a final recommendation, and unsuccessfully sought to change or delay this difficult task. This week, the Board adopted a staff recommendation that is in the truest sense a compromise that like most successful compromises is unlikely to please any of the players involved. The result is also an example of administrative law making at its most creative, interpreting the statutory language to most effectively achieve Congressional intent while minimizing the economic risks that the Act's proponents likely did not understand or anticipate.

Section 920(a)(2) of the Act required the FED to limit debit card interchange -- the portion of merchant card acceptance fees that are paid to the card issuer -- to an amount that "shall be reasonable and proportional to the cost incurred by the issuer with respect to the transaction."

A fee meeting this standard, the Act asserted, should include "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," but should not include "other costs incurred by any issuer which are not specific to a particular electronic debit transaction."

Early on the FED staff concluded that it should set the fee based on costs for a representative issuer and transaction. Basing fees on the actual costs of particular issuers would impose undue compliance burdens. The Board decided to set a fee cap based on the average per-transaction cost, excluding fraud losses, of the issuer at the 80th percentile based on a survey of the large banks covered by the statute. Each issuer would be permitted to receive interchange fees not exceeding the cap without demonstrating its actual per transaction costs.

Initially, the staff read the statute to permit the Board to take account only of variable per transaction costs. That led to the initially proposed fee cap of $.12 per transaction. Issuers objected that fees at that level would not come close to covering their actual costs of operating a debit card system. The staff responded to those concerns by creatively reinterpreting the statute to include a third type of cost that was neither an "incremental cost" of a debit transaction, nor a cost of the system that was "not specific to a particular transaction." This third type of cost, the staff reasoned, consisted of fixed costs of a debit program that are nonetheless specific to particular transactions. And since the statute did not explicitly require or prohibit including these costs in the regulated fee, the Board could exercise its discretion.

The staff concluded that prohibited costs of a debit system included corporate overhead (e.g., executive compensation, human resources, the issuer's branch network); establishing account relationships; general debit program costs (e.g., production and delivery); marketing; research and development; and network membership fees. Conversely, non-incremental costs that are specific to particular debit transactions -- and that could thus be included in the regulated fee at the Board's discretion -- included (1) network connectivity; (2) software and hardware for processing transactions; (3) operational labor; (4) network processing fees; (5) transaction monitoring costs; (6) reward programs; (7) handling cardholder inquires; and (8) non-sufficient funds handling.

Ultimately, the FED adopted a regulation including the first five of these costs, but not the last three, resulting in a cap of $.24 per transaction. In addition, the FED determined that transaction monitoring as a means of fraud protection also fell within the discretionary category of fixed costs attributable to specific transactions. Because losses vary with the size of the transaction, the regulation permits a fee of up to 5 basis points on top of the $.24 flat fee per transaction.

Finally with respect to fees, the legislation permitted an adjustment for investments in fraud prevention, and the Board included a 1 cent per transaction bonus for issuers that meet the FED's standards to help offset the costs of implementing activities that are effective at reducing fraud looses.

The legislation also required the FED to adopt regulations prohibiting network exclusivity so that merchants had choices with respect to the network on which to process a transaction. The FED required that each card provide access to at least two unaffiliated networks, but it did not require that each card link to multiple networks for both PIN and signature access.

The FED also excluded from the regulation three-party networks that did not have separate entities issuing cards and signing up merchants. American Express, for example, is not covered by the fee limit.

The fee regulation provisions are to go into effect on October 1, 2011, followed by the network exclusivity rules on April 1, 2012. You can read the Board's full report on the regulations here.

Are Larger Down Payment Requirements for Homes Needed?

This week's news reported another 4% drop in home prices in 20 U.S. cities from the prior year (See Bloomberg). With prices lower than we've seen in some time, shouldn't that necessarily translate into home purchases? Not necessarily so. Of course, even if homes are less expensive, one's ability to buy is not just tied to a credit score. It is tied to cash. Right now, cash buyers are the kings in the weak housing market (See USA Today). These cash buyers are primarily investors who account for about 30% of home purchases in the current market.

So, what is happening to the regular people? Well, credit is still tight. According to the Center of Responsible Lending, high down-payment requirements (20% generally) is enough to keep many who might be good bets on home mortgage repayment from buying a home. First time home buyers and minority home-buyers could be hardest hit At the root of some concern about down payment requirements are portions of D0dd-Frank that require lenders to retain a portion of mortgages they sell, but Qualified Residential Mortgages (QRM) are exempt from this rule. To the extent Congress sets the QRM at 20% down payment for residential mortgages, this rate would be expected to have an impact on how the market views risk on residential mortgages (See, Wall Street Journal). This could in turn affect what mortgages are available to home buyers and the cost of those mortgages.

Currently, the regulators have extended the comment period on QRMs until August 1, 2011 (See Federal Reserve). So, if you have an opinion . . .

- JSM

Richard Nash Delivers Plenary Address

"Books are social glue."

Today's CALI Conference day began with Richard Nash delivering the Plenary address to the conference participants. For those not familiar with him, Nash is a publisher, having sold the successful Softskull Press to Counterpoint and since then beginning Cursor which promises to help independent publishers. Nash's view of the future of publishing involves a look to the past and the history of the development of printing.

Nash is dedicated to bring printing and publishing to all writers so that they can, in turn, connect with readers. More writers more readers, more readers more writers. . . . Basically, there should be wide access to publishing resources. Nash believes that we've arrived at a time when supply of writing is available widely. The next hurdle will be tackling issues surrounding matching the writings with those who need them. Classic demand issues in the marketplace. Accordingly, the way in which we connect people through the web and otherwise leads to a developing preeminence of readers.

Nash's theory is dependent on recongition that more than content, culture matters. Now that individuals can self publish and distribute materials on the internet through unlimited means of sharing, the emphasis for publishers should be on the connections. The gatekeeping power of publishers controlling the content that arrives at the marketplace is diminished. Material will arrive at the market. The question is how will we find it?

Interesting thoughts on the future of publishing. Surely, it is equally applicable to legal education where, for instance, CALI has Legal Education Commons where faculty can post all types of various educational materials in differing presentations and new E-Langdell e-text project which aims to make a limited number of law textbooks available to students for free. Access is surely present. Nash commented that textbooks help students harness information in a tangible format between class sessions when they need to engage in independent learning. The big question is how that format will change now that alternative materials are available in a widespread manner. The most important facet is simply that they read, not the format.

Nash recommends for summer reading . . . Lynne Tilman's Someday This Will Be Funny. Enjoy.

- JSM

Connecticut Amends Its Affiliate Nexus Law To Mirror Illinois

We have written frequently in recent months about affiliate nexus legislation introduced this legislative session in a number of states, and enacted recently in Illinois, Arkansas, Connecticut and, on a deferred basis (to take effect only after 15 states have adopted similar legislation) Vermont. (A similar bill has been passed in California, but has not yet been signed by Governor Brown.) Nearly every such bill has closely paralleled the affiliate nexus law adopted in New York in 2008, which provides for a presumption of nexus that can be rebutted by a retailer if the retailer can establish that its in-state affiliates have not engaged in any active solicitation in the state, but have merely posted online advertisements on behalf of the retailer that link to the retailer’s website. Illinois was the only state to adopt a law without such a rebuttable presumption.

The Connecticut legislature has now amended the affiliate nexus statute it passed in May 2011, to eliminate the rebuttable presumption and, instead, to closely mirror the Illinois law. Connecticut HB 6652, signed by Governor Malloy on June 21, repeals the affiliate nexus statute adopted in May, and instead modifies the definition of “retailer” (as well as the definition of “engaged in business in the state”) to classify as a Connecticut retailer any company that has affiliate relationships with persons in Connecticut pursuant to which the affiliates refer customers to the retailer in return for commissions or other consideration based on sales, via an online link or otherwise. The retailer must realize cumulative gross receipts of at least $2,000 on sales to Connecticut customers as a result of such referrals in order to be “engaged in business in the state.” In addition, HB 6652 makes the change in the definitions of “retailer” and “engaged in business” retroactive to May 4, 2011 – prior to the date on which the previously enacted affiliate nexus law was even adopted.

It warrants mention that the Connecticut legislature amended its affiliate nexus statute after the Performance Marketing Association filed suit in federal court in Chicago challenging the constitutionality of the Illinois law. Brann & Isaacson represents the PMA in that action.

CALI Conference in Milwaukee

For the next couple of days I am at the CALI Conference in Milwaukee. The theme of the conference is "Unbound," focusing on e-books, social media and electronic resources. I will be presenting tomorrow on Cali's E-Langdell program that is starting to make available electronic casebooks to law students that are free and available in a number of formats.

The first session is a mini-session with a group of speakers highlighting for 5-10 minutes the presentation they will make later. While many of us use social media in both personal and professional capacities, a session I will attend later was Rich Cure's pitch for student's use of social media to enrich their own learning when the classroom component fails to deliver or needs supplementation.

More later for sure. Hopefully, our students are using Facebook, Twitter and Youtube to enrich their commercial law studies, but I wonder . . .

- JSM

New Twists on the Economic Loss Rule?

What most of us remember: Section 1-103(b) of the Uniform Commercial Code embraces liberal supplementation of the Code by directing that “[u]nless displaced by the particular provisions of this Act, the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, Bankruptcy, or other validating or invalidating cause shall supplement its provisions.” What sometimes gets tricky is reading this premise of liberal supplementation alongside Article 2’s remedy provisions and the common law’s economic loss rule which precludes a plaintiff from recovering in tort, for purely economic losses. Even Section 2-721’s directives regarding fraud in the sales of goods that provides that remedies for fraud or misrepresentation under Article 2 include remedies for sales of goods that do not involve fraud is read to constrain non-breaching parties to contract remedies under Article 2 in most cases.

An interesting issue that courts are taking a closer look at is whether plaintiffs can bring client claims for tort damages is whether a second product commonly attached to another to make a whole product constitutes one product in terms of damages for purposes of the economic loss rule. In a decision that appears to expand the economic loss rule, the court in OneBeacon Ins. Co. v. Deere & Co., 2011 U.S. Dist. LEXIS 25156 (E.D. Mo. Mar. 11, 2011) considered the case of a combine that suddenly caught fire and destroyed the combine and damaged an attached cornhead. While the two formed an integrated harvesting unit, the plaintiff purchased the Deere & Co. combine and cornhead on separate occasions secondhand from a reseller with no warranty furnished by Deere & Co. The court reasoned that if the part of the whole could be considered part of the product, then the economic loss doctrine would bar the tort action. If the part of the whole was a separate product, then damage to the part would be “additional damage” and the economic loss doctrine would not apply. The court, examined the relationship of the combine and cornhead under three prevailing tests that look to whether the product is “integrated;” whether a commercial purchaser could foresee the risk of harm at the time of purchase; and whether the object of the bargain was for separate products. Ultimately, with electing any of the three tests, the court determined that because the cornhead could only be used with the Deere & Co. combine, the cornhead was not separate property and the economic loss rule precluded the tort claims.

Moreover, the plaintiff, as a secondhand purchaser of used equipment from another seller, did not have a warranty claim against Deere &Co., the manufacturer in tort. In concluding that the economic loss doctrine applies to secondhand purchasers, the court explained, “[p]laintiff’s reasoning- that the economic loss doctrine should not apply to secondhand purchasers because they cannot negotiate with the manufacturer- would apparently give secondhand purchasers a better warranty and more remedies than the party who originally purchased the equipment new. That cannot be the law.” Id.

The scope of the economic loss rule has important implications for buyers and sellers of goods. The traditional scope of cases governed by the economic loss rule to preclude recovery of tort damages would be those which are (1) governed by UCC Article two, and (2) where the only property damage (if any) is to the product that was purchased itself. But see, Lott v. Swift Transportation Co. Inc., F.Supp.2d 923, 931 (W.D. Tenn. 2010)(court declined to extend the economic loss doctrine, to cases “not involving UCC remedies, especially those concerning the provision of services”). In cases such as Tennis, the court did not apply the rule to damage to the property stored in the nearby warehouse that the vehicle fire destroyed. Yet, other courts such as Deere & Co. have expanded the doctrine when property might be seen as one product. Importantly, the Deere & Co. court observed that some courts have opened the door to allow for possible expansion of the doctrine even to “other nearby property of commercial purchasers who could foresee such risks at the time of purchase.” Deere & Co., supra, at *10 (emphasis supplied). See also, Travelers Indem. Co. v. Dammann & Co., Inc., 594 F.3d 238, 243-44 (3rd Cir. 2010)(tort claims barred “where a plaintiff could have contractually allocated the risk”). This is a potentially significant expansion of the doctrine, because it allows the economic loss doctrine to bar tort recovery even where there is additional harm or damage to other property, other than the product at issue in the lawsuit. As a result, this potential expansion of the doctrines’ application has important implications in the future of the doctrine and the sale of goods as a whole.

- JSM

Consumer Financial Protection Bureau on the Move

The new Consumer Financial Protection Bureau (CFPB) has a website now that is running with the logo "Know Before You Owe" prominently displayed. Elizabeth Warren, Special Advisor to the Secretary of the Treasury for the Consumer Financial Protection Bureau, has a short video that doesn't speak directly to any particular changes the CFPB will make, but assures all that they are at work and listening to consumer responses.



Also on the website is Elizabeth Warren's testimony from May 24th before The Subcommittee on TARP, Financial Services, and Bailouts of Public and Private Programs Committee on Oversight and Government Reform in order to determine the accountability and oversight for the agency. You may remember the news about this hearing where Representative Patrick McHenry of North Carolina, accused Warren of lying during her March testimony, where Warren had previously appeared to answer questions concerning the CFPA and its function and power structure (See Decorum Breaks Down at House Hearing, New York Times).

Of course, both the CFPB and Warren herself have faced strong opposition from Republican lawmakers. It seems that this time around, the advances in consumer protections were not secured by simply passing the Consumer Financial Protection Act. Appropriations and confirming an official head of the CFPB remain open issues while the CFPB continues its organization. On the consumer front, I am pleased to note that the new website contains a number of consumer oriented videos and outreach to the banking community. Being a big fan of the power of information, it is a good sign that the CFPB has taken their first steps in reaching consumers in the electronic mediums. Oh, and you can even share the videos on Facebook or Twitter, for all you consumer rights junkies . . .

- JSM

Debt Collectors Go on the Offensive

The New York Times this weekend ran a piece that caught my eye, "Debt Collectors Ask to Be Paid a Little Respect." While the article first laments the rise in business that our struggling economy has brought them and the often rude response debt collectors get from consumers, the debt collectors seem to be on the offensive legally. Like the banking industry, the article notes the concern the debt collectors have about coming under the auspices of the Consumer Financial Protection Bureau (CFPB). After all, the Federal Trade Commission did not concern the debt collectors as the FTC did not have regulatory authority. The CFPB would, though, be able to write regulations to police the industry.

So, the debt collectors want some updating of their own to the Fair Debt Collection Practices Act. After all, why not? Who says consumer protection has to be just for consumers? The debt collectors are asking for access to consumers emails, cell phones and to use auto-dialers. After all, don't consumer's prefer this? My word, don't we all get enough robo-calls already on our cell phones? A robo-call system would seem to violate Section 806(5)'s prohibition on causing a telephone to ring repeatedly in any event. With the coming political season, though, perhaps the debt collectors are right that we all better get used to robo-messages on our cell phones anyways.

ACA International, the trade union for collection agencies, posted a Blueprint for Modernizing Debt Collection on its website. The Blueprint does advocate that debt collectors be permitted to call consumer cell phones (despite the additional charges imposed by some carriers), text and email consumers and even leave pre-recorded messages on cell phones. The Blueprint expressly advocates that debt collectors be permitted to communicate by any method of communication available. How about a consumer's facebook page? Linked-In? What about email accounts that are accessible by a consumer's employer? Of course, there is more there in the Blueprint that troubles me, but this area is full of difficulty for protecting consumers.

Surely, I am skeptical about allowing debt collectors unfettered access to the digital mediums available for use by consumers. The risk and cost to consumers would surely increase, with little exposure to debt collectors who violate the law (currently up to $1000 in most cases). While I am sure that the debt collectors that the New York Times spoke with are genuinely the nicest of people, I had the experience last year of having one of the not so nice debt collectors call me erroneously about a medical bill that had long been paid. Of course, the hospital apologized for the mistake, and wasn't sure how the information even was referred to debt collector. Of course, the lack of documentation that persists the industry at present becomes the first issue to tackle before erroneous robo calls and auto-mated emails flood our accounts. Can I opt-out?

- JSM

The Lone Star State Follows a Different Path Regarding Nexus

Bucking the trend of other states, Texas’ Governor recently vetoed proposed legislation to expand the scope of the Texas sales and use tax law regarding collection of sales and use tax. The proposed legislation—HB 2403—was approved by both houses of the Texas legislature, but vetoed by Governor Perry on May 31. This legislation was not as aggressive as that in other states that have recently adopted nexus legislation. (Illinois, Connecticut, Arkansas and Vermont are examples). It merely provided that a retailer has nexus with Texas if it has an affiliated company that operates a distribution center in Texas or if an affiliated company located in Texas performs services on behalf of the retailer or sells under the same brand name as the retailer. This was in part directed at the Amazon situation in which an affiliate of Amazon.com operated a distribution center in the state of Texas (that reportedly led to a $269 million assessment of sales tax by the Texas Comptroller of Public Accounts).

A piece of good news for sellers of digital goods does result from the legislature’s work on the bill. The legislation, as introduced, also provided that use by a remote seller of a website on a server in Texas from which digital goods are sold or delivered creates nexus. However, the House Committee that first reviewed the bill removed the language before submitting the bill to the full House for a vote. This may signify that such activity does not create nexus in Texas. But, before embarking on any such activity in Texas, a seller of digital products should examine carefully the Texas law and applicable constitutional cases in light of the proposed sales activity.

It is also noteworthy that Texas is not yet done. The legislature has before it in committee a Bill—HB 1317—that would be similar to the recently-enacted Arkansas and Connecticut laws that provide for a presumption of nexus for any retailer that pays a commission or other consideration to a company located in Texas which provides a link to the retailer’s website. While the legislature adjourned on May 31, it was back in session last week and this week to consider various budget-related issues, and may reconvene yet again. It may be that this click-through legislation would be deemed legislation that the legislature will be permitted to consider under its authorization for reconvening.

Stay tuned to developments in Texas.

UPDATE: SB1, currently under review by the legislature, has been amended to include the nexus legislation vetoed by the Governor on May 31, as discussed above.  We will track the progress of the Bill and keep you posted concerning any further developments.

Call for Papers: Fringe Economy

Call for Papers

Regulation in the Fringe Economy

The symposium Regulation in the Fringe Economy represents the most significant attempt to date by legal scholars to address the vexing legal and social issues created by lenders on the fringes of the economy who offer payday, auto title, for-profit college, and refund anticipation loans. A complete list of confirmed participants and their paper topics is available at the conference website: http://law.wlu.edu/fringe.

The Frances Lewis Law Center and the Washington and Lee Law Review are delighted to sponsor this conference which will take place on November 11, 2011 at the Washington and Lee University School of Law in Lexington, Virginia. The Washington and Lee Law Review will publish a symposium issue featuring the conference papers in 2012.

The sponsors’ goal is to encourage and recognize excellent legal scholarship in this area. To advance their goal, the sponsors invite lawyers, judges, and scholars to submit papers on regulation in the fringe economy. Papers on related high-risk consumer financial products are also encouraged. An author should submit his or her manuscript in an exclusive submission on or before August 15, 2011. A submission should be no longer than 50 pages or 15,000 words. A limited number of submissions will be accepted. Authors will be notified of the acceptance of their paper and participation in the symposium no later than August 20, 2011.

Selected authors will present their papers at the November 11 conference. All participants are asked to provide their own travel expenses. Papers specifying the conference may be mailed to the Washington and Lee Law Review or sent electronically to lawreview@wlu.edu. The Law Review Articles Editors and Washington and Lee University School of Law Professor Margaret Howard will review the papers.

Even if you are not able to submit a paper, the sponsors invite you to attend the conference. There will be no charge for attending. The Frances Lewis Law Center is a licensed Virginia Continuing Legal Education provider which will supply Virginia CLE credit for those attending.

Mallory A. Sullivan
Symposium Editor, Washington and Lee Law Review

Christine M. Shepard
Editor in Chief, Washington and Lee Law Review

-JSM

Performance Marketing Association Files Lawsuit Challenging Illinois Affiliate Nexus Law

Performance Marketing Association, Inc. (“the PMA”), the leading trade association in the United States representing the interests of businesses, organizations, and individuals using and supporting performance marketing methods, filed a lawsuit yesterday in Federal District Court in Chicago against the Director of the Illinois Department of Revenue, Brian A. Hamer. The lawsuit challenges the constitutionality of the Illinois affiliate nexus law, HB 3659.  Brann & Isaacson attorneys George Isaacson and Matthew Schaefer are counsel to the PMA in connection with the suit.

The case is captioned Performance Marketing Association, Inc. v. Hamer, Federal District Court, Northern District of Illinois, case no. 1:11-cv-03690. A copy of the PMA’s Complaint is available here.

In its complaint, the PMA asserts that HB 3659 unlawfully targets the business of online performance marketing in order to expand Illinois’ regulatory authority beyond its borders. We have previously written about HB 3659 several times, including here and here. The PMA alleges that the law, which goes into effect July 1, 2011, violates the Commerce Clause of the United States Constitution, and the federal Internet Tax Freedom Act (“ITFA”), by using the relationships between Illinois publishers of online advertisements and out-of-state advertisers as grounds for imposing use tax collection and reporting obligations on Internet retailers located outside the state. The enactment HB 3659 has damaged thousands of Illinois publishers through the loss of advertising contracts with Internet retailers.

Under the Commerce Clause, and in accordance with the United States Supreme Court decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), a retailer without a “substantial nexus” with Illinois, defined as a business location or some other physical presence in the state, has no obligation to collect Illinois use tax. HB 3659 purports to make the mere display of online advertisements through an Illinois publisher sufficient “physical presence” in the state to require out-of-state retailers to register and collect Illinois use tax. Retailers using other forms of non-local advertising, however, are not similarly required to register and collect Illinois use tax.

In response to the enactment of the bill, many out-of-state Internet retailers have terminated their relationships with Illinois publishers to avoid the effect of HB 3659. As a result, HB 3659 has caused thousands of Illinois publishers to lose valuable contracts and advertising revenue. No additional use tax revenue will be collected and remitted by retailers who terminate their advertising contracts, although they can continue to reach Illinois consumers through other forms of advertising.

The PMA challenges the Illinois affiliate nexus law on the three separate grounds, asserting that HB 3659: (1) violates the Commerce Clause’s “substantial nexus” requirement, by attempting to impose tax obligations on out-of-state Internet retailers based solely on the display of online advertising by Illinois publishers; (2) improperly seeks to regulate interstate commerce occurring entirely outside of Illinois, by including within its sweep transactions between non-Illinois retailers and non-Illinois consumers, thus creating a per se violation of the Commerce Clause; and (3) discriminates against electronic commerce in violation of the federal Internet Tax Freedom Act by imposing an obligation to collect Illinois use tax on retailers who complete sales through online performance marketing, but not imposing a similar obligation on retailers who accomplish transactions through other forms of non-local advertising.  The PMA has asked the federal District Court to declare HB 3659 unconstitutional and in violation of the ITFA. Under the applicable rules, the State has 21 days to file an answer to the PMA’s Complaint.

We will keep you posted on further developments.