Navigating the antitrust straits will become increasingly risky for the bank card associations, according to a long-time observer of payment-industry competition.
The year 2003 was the year of living dangerously for the card associations. Antitrust enforcement and litigation led to regular headlines in the national press. The significance of the cases and decisions involving payment card competition cannot be understated.
Let's briefly review the results. In 2003, the Second U.S. Circuit Court of Appeals upheld the U.S. Department of Justice (DOJ) case against Visa and MasterCard challenging their rules that barred their members from issuing American Express and Discover cards. Although the prospect of banks issuing these cards might not appear to be an epochal change, the case focused on the importance of banks being able to force networks to compete for their loyalty.
After years of a docile enforcement attitude towards automated teller machine and debit card network mergers leading to massive consolidation, the DOJ and state attorneys general challenged the proposed merger of First Data Corp. and Concord EFS Inc. that would have led to a single dominant network in the world of personal identification number-based (online) debit. After months of pretrial sparring, the parties settled on the morning of trial, with First Data agreeing to completely divest its 64% share in the NYCE online debit network.
And after seven years, the titanic battle between practically every merchant in the United States and Visa and MasterCard over those associations' "honor-all-cards" rules resulted in the greatest award in antitrust history, over $3 billion, and significant prospective relief that limited the ability of the associations to compel merchants to accept signature-based (offline) debit cards.
Finally, in Europe, Australia and other countries, government antitrust and banking regulators are increasingly attacking credit, debit card and ATM interchange fees, seeking to regulate them in a very refined fashion and effectively limiting them to a certain measure of cost.
Perhaps the most intriguing aspect is the start of antitrust litigation between Visa and MasterCard. Throughout history the associations have been on the same side of the courtroom, defending nearly identical rules against an onslaught from private antitrust lawyers, government antitrust enforcers, merchants and rival networks.
Now that the associations are taking on distinctly different membership, competitive philosophy and governance, they find themselves at odds, particularly in the debit environment. Visa's recent efforts to restrict its offline debit card issuers from defecting to MasterCard (MasterCard asked the judge in the DOJ case to quash the rule) seem to raise the same type of competitive concerns struck down in the Justice Department suit.
In this increasingly complex environment, what can we expect the role of antitrust enforcement and litigation to be regarding the future development of payment systems?
First, the long-term effects of the merchant debit card settlements cannot be understated. Now, for the first time, merchants have the option of declining to accept Visa and MasterCard offline debit products. Rather than being faced with a take-it-or-leave-it offer, merchants can now negotiate over the price and aspects of service.
Wal-Mart Stores Inc.'s decision to refuse to accept MasterCard's offline debit card (and probably securing particularly favorable rates from Visa) suggests the potential for far more vigorous negotiations between merchants and card associations over the terms and conditions of card acceptance, especially interchange fees.
Second, the Second Circuit's decision ultimately will affect the ability of the associations to engage in strategic conduct. The court affirmed that Visa and MasterCard both have market power and that the associations' rules that limited bank network participation were anticompetitive.
The holding dramatically affects the ability of Visa and MasterCard to compete, because firms that possess market power are held to a higher standard of liability under antitrust laws. A much greater range of conduct by the card associations will begin to receive more intense antitrust scrutiny. Thus, other types of rule-making by the associations will face increasing government review and expensive private litigation.
One example is the ongoing litigation between First Data Corp. and Visa over First Data's efforts to bypass Visa's network and route Visa transactions over its First Datanet system. Visa claims that this conduct violates trademark laws, and First Data claims that the denial of network bypass would violate antitrust laws. If First Data is successful, the litigation ultimately could remake the balance of power in the card world, making merchant acquirers perhaps as powerful as the networks.
From a more practical perspective, unless the Supreme Court reverses the appellate-court decision, sometime in 2004 banks can begin issuing American Express or Discover cards. In the short term, that may make for a more competitive card-issuing environment. Commentators have suggested that this will lead to significantly higher interchange fees.
Third, the renewed involvement of the states through their attorneys general and the re-emergence of their Payment Systems Working Group in the First Data/Concord merger signal a new activism by this important group of antitrust enforcers. The states play a key role since they often take a more aggressive stance than their federal counterparts, such as the states' 1990 challenge to the Visa/MasterCard online debit joint venture called Entree.
Fourth, the successful challenge of the First Data/Concord merger demonstrates the importance of network competition and the impact of such competition on merchants. The challenge was based on a mountain of testimony from merchants that past online debit network mergers led to higher prices, reduced innovation and less choice. Now that the merchants have the DOJ's and states' attention on network competition issues, one cannot expect them to be silent.
One area that may raise future concerns would be efforts by First Data post-merger to act strategically to harm competition in the merchant-acquiring or online debit markets. Practices such as tying or bundling, exclusivity and mandatory routing may face increasingly critical antitrust scrutiny. The DOJ focused on these practices in the merger investigation. The Justice Department and states successfully challenged similar practices in the landmark Microsoft Corp. case.
More generally, what are some of the practices that will receive increased antitrust scrutiny in debit? The DOJ case was predicated upon the importance of merchants being able to force networks to compete. Efforts to restrict merchant choice or limit network competition, such as routing rules or limitations on cobranding, may raise competitive concerns, especially if dominant networks use such tactics.
But all of these cases are the playoffs-the Super Bowl is the battle over interchange fees. Although competition for banks seems to lead to higher interchange fees, competition for merchants leads to the opposite result. The damages in the debit card case were over $3 billion in interchange.
From a legal perspective interchange rests on shaky grounds. Antitrust laws rarely permit collective price setting by competitors. Although an antitrust decision from the early 1980s permits interchange fees, that decision was premised on fees being set on a cost basis, a basis the card associations no longer use.
Moreover, the decisions that Visa and MasterCard have market power raise a much greater likelihood of antitrust liability. The central concerns raised in both the merchant debit card suit and the First Data/Concord merger involved the constant increase in interchange fees. If antitrust litigation is not effective in providing greater balance to the interchange question, one can expect merchants to begin to look to the examples set before the European Union and other countries on regulating interchange fees.
Antitrust has become part of the lifeblood of competition for the card associations. Navigating these straits will become increasingly risky.
David Balto is a partner in the Washington, D.C., office of White & Case LLP, specializing in antitrust law. Before going into private practice in 2001, he was director of policy at the Federal Trade Commission. He can be reached at dbalto
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