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From Antitrust Law Daily, December 13, 2013

Court approves $7.25 Billion retail credit card fee settlement

By Peter Reap, J.D., LL.M.

The federal district court in Brooklyn, New York, has given its approval to a settlement valued at $7.25 billion of the claims brought by a putative class of approximately 12 million merchants that alleged that, among other things, defendants Visa U.S.A. Inc. (“Visa”) and MasterCard International Incorporated, as well as issuing and acquiring banks (collectively the “defendants”), conspired to fix interchange fees in violation of Section 1 of the Sherman Act (In re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation, December 13, 2013, Gleeson, J.). In addition to the cash recovery in excess of $7 billion (before reductions for opt-outs), the settlement calls for certain reforms of the defendants’ rules and practices to benefit the members of the class.

Background. A Visa or MasterCard credit card transaction involves five parties: (1) the customer; (2) the merchant; (3) the “acquiring bank”; (4) the “issuing bank”; and (5) the network itself, that is, Visa or MasterCard. The acquiring bank is the link between the network and the merchant that accepts the card for payment. The issuing bank is the bank that issued the credit card to the customer. When the cardholding customer presents a credit card to pay for goods or services, the accepting merchant relays the transaction information to the acquiring bank. The acquiring bank processes the information and transmits it to the network. The network relays the information to the issuing bank, which approves the transaction if doing so is consistent with the cardholder’s account status and credit limit. The approval is conveyed to the acquiring bank, which in turn relays it to the merchant.

The issuing bank then transmits to the acquiring bank the amount of the purchase price minus the “interchange fee.” The acquiring bank withholds an additional fee, called the “merchant discount fee,” for its processing services. Thus, the total amount the merchant receives for the transaction is the purchase price minus the sum of the interchange fee and the merchant discount fee.

Interchange fees vary based on factors that include the type of card used and the type of merchant. Many Visa and MasterCard credit cards provide rewards to the cardholders. Those rewards cost money, and thus these cards, referred to in the industry and here as “premium cards,” are associated with higher interchange fees.

The competitive problem that gave rise to this case, according to the plaintiffs, is the result of a combination of network rules. The Honor-all-Cards rules require merchants who accept any Visa- or MasterCard-branded credit cards to accept all cards of that brand, no matter what bank may have issued them and no matter the interchange fee. The Honor-all-Cards rules created what the merchants term the “hold-up problem.” Unlike checks, which are redeemed by the drawee banks “at par,” that is, without the drawee bank charging a fee for acceptance, the issuing bank of a Visa or MasterCard credit card is free to demand whatever interchange fee it chooses (“hold-up”) in order to accept the transaction from the merchant who is required to accept the card.

As the merchants describe them, the default interchange rules are the networks’ “solution” to the hold-up problem. Those rules establish mandatory interchange fees that apply to every transaction on the network unless the merchant and the issuing bank have entered into a bilateral interchange agreement. However, the merchants complain that the combination of the Honor-all-Cards rules and the anti-steering rules, which are discussed further below, strips the issuing banks of any incentive to accept interchange fees lower than the default interchange fees. And obviously merchants have no incentive to negotiate ahigher interchange fee. Thus “default interchange,” the merchants assert, becomes a fixed rate that applies to every credit card transaction (with the narrow exception of transactions by very large merchants who have sufficient volume that they can negotiate their own private interchange fees).

A linchpin to the problem, as far as the merchants are concerned, is the package of anti-steering restraints that prohibit merchants from using price signals at the point of sale to steer customers to less costly forms of payment. The no-surcharge rules prohibit merchants from adding a surcharge to a transaction involving either of the networks’ credit cards. Thus, for example, a merchant who must pay a 2% interchange fee upon accepting a Visa or MasterCard credit card is prohibited from adding a 2% surcharge (or any surcharge at all) to either discourage the use of that card or to recoup the cost of acceptance. Other anti-steering regimes prohibit merchants from informing customers about higher-cost payment cards, incentivizing customers to use lower-cost cards or other forms of payment, or recouping the acceptance costs of the cards the merchants are required to honor.

In 2005, the merchants brought suit. They allege that Visa and MasterCard adopted and enforced rules and practices relating to payment cards that had the combined effect of unreasonably restraining trade and injuring merchants. Those rules and practices include:

  • Rules regarding the setting of default interchange fees.

  • A number of “anti-steering” rules - including “no surcharge” rules, “no discounting” or “non-discrimination” rules, and “no minimum purchase” rules - that restrict merchants from steering customers to lower-cost credit cards and/or forms of payment other than Visa or MasterCard payment cards.

  • A number of “exclusionary” rules - including “all outlets” rules, “no bypass” rules, and “no multi-issuer” rules - that restrict merchants in accepting and processing payments made with Visa and MasterCard cards.

  • ”Honor-all-Cards” rules, which required merchants to accept all the network’s credit cards or all the network’s debit cards when proffered for payment, regardless of which bank issued the card.

The Class Plaintiffs allege that these rules insulate the Visa and MasterCard networks from competition with each other, from other brands and from other forms of payment, allowing Visa and MasterCard and the issuing banks to set supracompetitive default interchange fees.

The Class Plaintiffs allege that these rules were adopted pursuant to unlawful agreements among the banks and Visa, and among the banks and MasterCard. Specifically, they allege that the defendant banks were members of Visa or MasterCard and were represented on their boards, and thus determined the networks’ rules and practices.

Based on these allegations, the Class Plaintiffs seek damages to compensate merchants for supracompetitive default interchange fees in the past. They also seek injunctive relief to restructure the networks’ rules and practices in the future.

Terms of the Settlement

The proposed settlement agreement provides for, among other things:

  • The creation of two cash funds totaling up to an estimated $7.25 billion (before reductions for opt-outs).

  • Visa and MasterCard rule modifications to permit merchants to surcharge on Visa- or MasterCard-branded credit card transactions at both the brand and product levels.

  • An obligation on the part of Visa and MasterCard to negotiate interchange fees in good faith with merchant buying groups.

  • Authorization for merchants that operate multiple businesses under different “trade names” or “banners” to accept Visa and/or MasterCard at fewer than all of its businesses.

  • The locking-in of the reforms in the Durbin Amendment and the DOJ consent decree with Visa and MasterCard, even if those reforms are repealed or otherwise undone.

Reasons for Approval

Specifically, although the settlement either obtains or locks in place an array of rules changes, at its heart is an important step forward: a rules change that will permit merchants to surcharge credit cards at both the brand level (i.e., Visa or MasterCard) and at the product level (i.e., different kinds of cards, such as consumer cards, commercial cards, premium cards, etc.), subject to acceptance cost and limits imposed by other networks’ cards, the court reasoned. For the first time, merchants will be empowered to expose hidden bank fees to their customers, educate them about those fees, and use that information to influence their customers’ choices of payment methods. In short, the settlement gives merchants an opportunity at the point of sale to stimulate the sort of network price competition that can exert the downward pressure on interchange fees they seek.

The proposed settlement seeks to empower merchants to steer cardholders to lower-cost payment alternatives, according to the court. The goal is to incentivize the networks to compete for the merchants’ credit card volume through lower fees of all kinds, including interchange fees, and to allow merchants to recoup their costs when their efforts to steer customers to lower-cost means of payment do not succeed.

The objections to the proposed settlement are numerous, but in the main, they failed for one of two reasons, the court explained. First, the objectors complain about the failure of the proposed settlement to eliminate other Visa and MasterCard rules, such as the default interchange and Honor-all-Cards rules. But those rules undeniably have significant procompetitive effects, and they lay at the heart of Visa’s and MasterCard’s efforts to build the successful networks they now have, the court noted.

Class Counsel had good reason to believe that even if the default interchange and the Honor-all-Cards rules are characterized as horizontal restraints (despite the IPOs), they will still receive only Rule-of-Reason antitrust scrutiny, which they could quite easily withstand. Perhaps most telling of all was that the Department of Justice, which recently conducted a thorough investigation of these networks’ operating rules, declined even to challenge either rule. In short, it was hard to persuasively challenge a compromise on the ground that it fails to eliminate rules that even a complete success on the merits might not eliminate, in the court’s view.

Second, the objectors complain about factors that they say will limit the usefulness of their newfound ability to surcharge credit cards that carry costly interchange fees. Those factors, which include the merchant restraints imposed by American Express and the laws prohibiting surcharging in approximately ten states, are real, and they in fact undermine to an extent the immediate utility of the rules reforms in the proposed settlement, the court observed.

But the virulent objections—based on those and other practical limitations on the relief the proposed settlement affords—failed to take sufficient account of the fact that, in the end and despite its outsized proportions, this is just an antitrust lawsuit, according to the court. Even if the plaintiffs spent several years pursuing this unwieldy case to a successful conclusion (despite substantial odds against such a result), the court would be in no position to grant the sweeping relief the objectors seek. It cannot regulate interchange fees or enjoin nonparties or preempt state laws or reform network rules that do not violate the antitrust laws. The Sherman Act affords relief only from certain proven anticompetitive business practices. And the agreed-upon relief here, which has the potential to unleash a new competitive force on interchange fees, fell squarely in the wheelhouse of what this lawsuit was all about, the court decided.

The parties’ negotiation process, the reaction of the class to the proposed settlement, the stage of the proceedings, the risk of a trial and especially the various risks of establishing damages, and the risks associated with the certification of classes all weighed in favor of the settlement, the court determined. Moreover, the settlement was both procedurally and substantively fair.

Finally, the plan of allocation was fair, reasonable and adequate, the court held. The Class Administrator will distribute a $6.05 billion Cash Fund to Authorized Cash Claimants, on a pro rata basis, depending on the amount of actual or estimated interchange fees they paid during the class period. Payments to Authorized Interchange Claimants from the estimated $1.2 billion Default Interchange Payments Fund will be made pro rata, and will be based on one-tenth of one percent of the claimant’s Visa and MasterCard transactions during the eight-month period as compared to total of all claim values for that fund. The amount of interchange fees paid by each authorized cash claimant will be determined or estimated from data obtained by Class Counsel from Visa, MasterCard, the bank defendants, non-defendant acquiring banks and independent service organizations subpoenaed by Class Counsel, and from the Authorized Cash Claimants themselves.

The case is No. 05-MD-1720 (JG) (JO).

Attorneys: Brian R Strange (Strange and Carpenter) for Cox Communications Inc. and Manheim Inc. Donald R. Hall , Jr. (Kaplan Fox & Kilsheimer LLP) for E-Z Mart Stores Inc. and Jacksons Food Stores, Inc. Jason A. Zweig (Hagens Berman Sobol Shapiro LLP) for DSW Inc. Jay W. Eisenhofer (Grant & Eisenhofer, PA) for CVS Pharmacy Inc. Anthony D. Boccanfuso (Arnold & Porter) for Visa USA Inc. Peter Edward Greene (Skadden, Arps, Slate, Meagher & Flom LLP) for Chase Bank USA, NA and JP Morgan Chase & Co. Robert P. LoBue (Patterson, Belknap, Webb & Tyler LLP) for Wells Fargo and Co.

Companies: Cox Communications Inc.; Manheim Inc.; E-Z Mart Stores Inc.; Jacksons Food Stores, Inc.; DSW Inc.; CVS Pharmacy Inc.; Visa USA Inc.; Chase Bank USA, NA; JP Morgan Chase & Co.; Wells Fargo and Co.

MainStory: TopStory Antitrust NewYorkNews

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