American Express charges the highest average fees of any card network and  Amex’s rules prevent retailers from taking steps to reduce those costs, the Department of Justice argued in court on July 7.

“American Express does not have to worry that a competitor is going to come along with a lower price and take away a lot of its business,” Justice Department lawyer Craig Conrath said during opening arguments at a trail in U.S. District Court in Brooklyn. “American Express’ rules are roadblocks to the path of any merchant who wants to take advantage of competitors’ low prices.”

The rules at issue in the suit prevent merchants from providing a discount to consumers who pay with a particular card, unless the retailer provides the same discount to Amex customers. They also bar retailers that accept Amex from using other methods—by saying, “I’d prefer that you pay with MasterCard”—to steer their customers.

The rule changes being sought by the Justice Department would be a boon for MasterCard and Visa, said Evan Chesler, a partner at Cravath, Swaine & Moore who’s representing Amex. He noted that consumers have fewer than 55 million Amex cards, whereas more than 1 billion cards in the United States carry the Visa or MasterCard logo. Retailers are aware that whenever they discourage the use of American Express, customers are likely to have an alternative plastic card in their wallets, Amex argues.

“If steering were the order of the day, it would go in one direction and only one direction,” Chesler said. “You can steer virtually every single one of our card members away.”

While Amex casts the lawsuit as a fundamental threat to its ability to compete against its larger rivals, analysts note that merchants are often wary of steering their customers to a particular card, for fear of losing business.

“Merchants’ inclination is generally to defer to what the cardholders want to do,” says Eric Grover, the principal at Intrepid Ventures, a payments industry consulting firm.

Still, if the Justice Department prevails in its lawsuit, some retailers may offer incentives to their customers to swipe a specific card, Grover says. That could hurt American Express, given that its average fees are higher than those of its competitors.

“I think the million-dollar question is: how many merchants will offer meaningful incentives to offer Visa or MasterCard instead of Amex? And then, how much do you shift behavior?” Grover asks.

The Justice Department’s lawsuit is “negative” for American Express  but “not catastrophic,” Grover said.

American Express and the Justice Department frame their legal dispute in starkly different terms.

The government portrays its lawsuit as an effort to level the playing field for merchants, which have endured a series of hikes in interchange fees. It also argues that if retailers pay lower swipe fees, those savings will be passed on to consumers as a result of competitive forces.

“In a free market, price competition among the networks would help protect merchants from high prices,” the Justice Department argued in a pretrial memo. “Amex’s rules have plain anticompetitive effects: they restrain the price competition that would otherwise discipline card networks from charging merchants higher fees – fees that merchants’ customers ultimately pay as higher retail prices.”

Ninety-eight of the 100 largest U.S. retailers accepted credit cards in 2010, and all 98 of them took Amex, according to the government.

Because American Express has strong retail acceptance, prosecutors say that the rule changes they forced at Visa and MasterCard are essentially meaningless. As the situation stands today, merchants that accept Amex are still barred from steering consumers to any particular card.

Meanwhile, American Express casts the dispute as pitting a smaller competitor against two giant card networks that benefit from their longstanding ties to the banks that once owned them, as well as the many retailers that feel compelled to accept their cards.

“Nearly every American Express card member carries and uses at least one Visa or MasterCard product—and often more than one—in his or her wallet,” Amex’s lawyers argued in a pretrial memo. “The reverse is not true: most Visa and MasterCard cardholders do not have an American Express card.”

Amex acknowledges that the rule changes being sought by the government will lead to lower prices for retailers in the short term, but it says that consumers will also receive fewer benefits, as the card issuers reduce their rewards offers.

“And in the long-term Visa and MasterCard will have even more market power over prices than they do today,” Amex argues in the court filing. “The only direction for prices then to go will be up.”

One of the legal questions in the case is whether American Express has market power, a legal concept that is central to U.S. antitrust law. Amex, which says that it lacks market power, argues the relevant market for evaluating that question includes debit cards as well as credit cards, while Justice officials contend debit cards should be excluded.

If debit cards are included in the relevant market, American Express currently has approximately 15% market share, the company stated in its court ruling. If debit cards are not counted, Amex’s market share is slightly over 26%, according to the company.

During the trial, which is expected to stretch into September, the two sides will point to different parts of the card industry’s history in an effort to bolster their cases.

The Justice Department plans to call Roger Hochschild, the president and chief operating officer at Discover Financial Services (DFS), as a witness. He’s expected to testify that Discover tried to win business from merchants by charging lower interchange prices but Amex’s rules effectively blocked Discover from reaping the benefits of that strategy.

Eventually, Discover gave up and decided to raise its own prices, according to the Justice Department. “Discover’s price competition did not cause credit card prices to go down,” the Justice Department’s Conrath said July 7.

American Express will point to the early 1990s, when Visa, which was then owned by banks, gave merchants materials with the Visa logo or the phrase “We prefer Visa.” Between 1990 and 1995, American Express lost 20% of its U.S. card business, according to Amex.

Amex eventually changed its rules to prohibit merchants from stating a preference for any particular card network. Defense attorney Chesler called Visa’s early-‘90s campaign “an effort to kill a competitor so you can in fact completely dominate a market that you’re close to dominating already.”

Other potential witnesses in the case, which will be decided by U.S. District Judge Nicholas Garaufis, include American Express Chief Executive officer Kenneth Chenault, former Visa executive Bradford Morgan, and executives from retailers including Home Depot, Best Buy and Southwest Airlines.

Merchants are hoping that the Justice Department prevails in the suit.

“American Express has no business limiting what merchants do in their pricing,” argues Doug Kantor, a lawyer who represents the National Association of Convenience Stores. “And they should live with the market results of that. Then they would at least have to think about what they did with their pricing.”

The trial follows the settlement in December of a private class action brought by retailers against American Express. That agreement made it easier for merchants that take Amex to impose surcharges on credit card transactions, but only if they do so for all the credit cards they accept.

The hearing followed earlier settlements with Visa and Mastercard. In October 2010, when the Justice Department announced a legal settlement with Visa and MasterCard, Attorney General Eric Holder took the unusual step of acknowledging the deal was toothless.

The settlement was designed to allow U.S. retailers to steer their customers toward lower-cost payment cards, but even the agreement’s government architects expected its impact to be trivial without the additional cooperation of American Express.

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