Discover Bank Ordered to Return Over $1.2 Billion to Merchants

In a landmark regulatory enforcement action, Discover Bank has been directed to return over $1.2 billion to merchants. This decision comes after a thorough investigation revealed that the bank had systematically misclassified millions of consumer credit cards as commercial accounts. This misclassification resulted in inflated interchange fees being charged to merchants over a 17-year span.

Higher Commercial Interchange Rates

The Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve have found that Discover had incorrectly applied higher commercial interchange rates to transactions involving consumer credit cards from 2007 to 2023. This misclassification affected nearly 5 million cards, with federal regulators estimating that 98% of cards marked as commercial at the end of 2022 were actually consumer cards.

Interchange fees, commonly known as “swipe fees” in the United States, are payments made by merchants to card issuers for each transaction. These fees tend to be higher for commercial card products. Discover's misclassification led to an overcharge of more than $1.2 billion to merchants. The financial institution has agreed to fully compensate affected merchants and merchant acquirers and has since stopped this practice.

Civil Money Penalty and Regulatory Reforms

In addition to the restitution order, the FDIC has imposed a $150 million civil money penalty on Discover Bank. The Federal Reserve has also levied a $100 million fine on Discover Financial Services and its subsidiary, DFS Services LLC. As part of the enforcement action, both agencies have issued consent orders requiring Discover to reform its card classification and fee oversight practices.

Discover is required to submit a comprehensive plan within 60 days to enhance its governance and compliance regarding interchange fees. This directive aligns with the Federal Reserve's recent conditional approval of Capital One’s $35 billion acquisition of Discover. Capital One is expected to complete the acquisition by May 18, 2023, and must adhere to all remediation commitments related to this misclassification issue.

Future Implications and Discover's Response

Discover has committed to fully cooperating with regulators and reiterated its promise to repay affected merchants. In a joint statement, Capital One and Discover emphasized that the enforcement action demonstrates "significant progress" in resolving the issue and completing restitution.

This case is one of the largest interchange-related enforcement actions in recent history and highlights the increasing regulatory scrutiny over transparency in card network fee structures. The issue of interchange fees has been a point of contention among merchants and lawmakers, and this ruling underscores the importance of transparency and compliance in the financial services industry.

Conclusion

The enforcement action against Discover Bank serves as a pivotal moment in the ongoing conversation about interchange fees and transparency in financial services. With over $1.2 billion set to be returned to merchants, this case underscores the critical importance of accurate card classification and compliance with regulatory standards. Discover's cooperation and commitment to rectifying the situation signal a move towards greater accountability and transparency within the industry. As the financial landscape continues to evolve, adherence to regulatory frameworks remains essential to maintaining trust and integrity in merchant services.