Judge Richard Leon of the U.S. District Court for the District of Columbia ruled on Wednesday that the Federal Reserve had ignored the intent Congress when it capped the fees banks can charge retailers when their customers use debit cards.
The 2010 Dodd-Frank law called for limits on those fees. Retailers have since argued that the Fed's cap of 21 cents per transaction was higher than Congress intended.
"Today's decision ... is a victory for consumers and small business around the country and will lead to lower interchange rates for billions of debit card transactions each year," said Senator Richard Durbin, an Illinois Democrat who introduced the swipe fee provision to Dodd-Frank.
The ruling caused the shares of the two largest payment network operators to plunge. Visa and MasterCard set the fee level that banks charge retailers for using their networks.
Visa's shares fell as much as 11 percent and ended 7.5 percent lower, while MasterCard, which reported stronger-than-expected earnings earlier in the day, dropped as much as 6 percent before recovering to end 1.5 percent higher.
Both companies declined to comment on the ruling.
The shares of other major credit card companies, American Express Co and Discover Financial Services, also dropped by 1.9 percent and 1.3 percent, respectively.
The 21-cent cap likely will remain in place until the Fed rewrites its rules or appeals the decision.
Fed spokeswoman Barbara Hagenbaugh said the regulator was reviewing the judge's ruling.
In his opinion, Leon wrote that the Fed disregarded the statutory intent of Congress by "inappropriately inflating all debit card transaction fees by billions of dollars."
The so-called Durbin amendment was introduced near the end of the Dodd-Frank negotiations and was intended to reduce burdens on retailers, and hopefully trickle down to consumers in the form of lower prices.
It was praised by retailers, but aggravated banks, which said they might have to charge consumers extra for debit cards to make up for the lost revenue.
When the Fed announced its cap, which was higher than the regulator initially proposed, retail groups protested that it let banks charge higher fees than the law intended. The amendment called on the Fed to consider certain costs to banks of providing debit cards when it set the fee cap.
When the rule was issued in June 2011, the National Retail Federation and other groups said the Fed inappropriately looked at bank costs beyond those the Durbin amendment wanted considered. Roberta Torian, a partner at law firm Reed Smith, which represents some banks, said the Fed considered costs for things such as network connectivity that were not explicitly listed in Dodd-Frank.
"They exercised their discretion in looking at any costs that were not prohibited by Congress," Torian added. Claiming the Fed had bowed to pressure from financial industry lobbyists, the merchant groups sued the regulator in November 2011.
Various retail lobby groups on Wednesday applauded the judge's decision to throw out the Fed's rule.
"From the very beginning, retailers and restaurants knew the Federal Reserve Board of Governors had grossly misapplied the swipe fee law," Mallory Duncan, general counsel at the National Retail Federation, said in a statement after the ruling. "They failed to heed Congress' call to set fee standards that were 'reasonable' and 'proportional' to the actual cost of a transaction."
The head of a banking group warned of "even more chaos ahead for consumers and small banks."
"Congress ought to save families from this uncertainty by repealing this government mandated price-fixing," said Richard Hunt, president of the Consumer Bankers Association, a trade group that represents retail banks.
The case is in Re: NACS v. Board of Governors of the Federal Reserve System, 11-cv-02075, U.S. District Court, District of Columbia.
(Reporting by Emily Stephenson in Washington and Tanya Agrawal and Aman Shah in Bangalore; Editing by Andre Grenon, Robin Paxton and Richard Chang)