First Data's 'Net' Dreams Fade with Settlement

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Visa U.S.A. Inc. and First Data Corp. have agreed to settle a long-running legal dispute over whether transactions initiated with Visa cards must be routed across Visa's payment network.

First Data, of Denver, has long processed a small number of Visa transactions using its own network rather than Visa's, but under the settlement, announced Wednesday, it agreed to shift those transactions to the San Francisco card association.

In the short term, analysts said the settlement reflects First Data's recognition that it could be hard to generate meaningful volume on its network. But the settlement may also have broader strategic implications suggesting that the company has scaled back one of its former chief executive's most ambitious plans - the creation of a First Data payments network that would compete with Visa and MasterCard Inc.

For observers hoping for clarity on the question of who owns the transaction, the settlement falls short. Some said it indicates that the two companies have agreed that the transactions are owned by the association. But they also said that because the issue never went to trial, it remains unresolved and First Data could try to use its network for transactions initiated with other card companies' cards.

Neither First Data nor Visa would discuss the settlement Wednesday, but in a joint press release they said that "new leadership at both companies recognized a mutual interest in resolving legal differences." First Data will shift the contested transactions to Visa's network, VisaNet, and Visa will "provide financial support to pursue mutual business initiatives." The release gave no details of the financial arrangements.

The settlement ends a series of lawsuits dating back to 2002 about so-called "on-us" transactions - when First Data processes for both the card issuer and the acquirer.

Because it controls both ends of these payments, First Data has said that moving the transactions across its own network is the most efficient and least expensive way to process them. It has done so for a small number of payments for decades with Visa's knowledge.

But in June 2001, when First Data bought a majority stake in the NYCE debit network, Charles Fote, First Data's president and chief operating officer at the time, said that he planned to expand this practice considerably and that First Data would create a new network, First Data Net, to handle them.

"We're introducing a revolutionary payment system here that will go from the merchant terminal to the cardholder bank using the least number of stops. And my definition of a stop is all the middle people who are not necessary to complete the transaction," Mr. Fote told American Banker then. "For 30 years we've been doing that for some of our transactions. We just woke up and said, 'If it works for some, why not for as many as we can make it work for?' "

His words sent a tremor through the payments world. The idea that the industry's largest processor, also wanted to carry transactions on its own network made some people wonder whether the card associations, and their networks, would someday become irrelevant.

Edward Neumann, the managing director of the banking practice for the consulting firm CC Pace said that if First Data Net had taken off, it could have spurred other processors to start similar ventures. "There was always the potential for Visa to become less significant" in point of sale transactions, he said.

Visa responded in April 2002 by filing a lawsuit alleging that First Data was illegally bypassing the Visa network; and First Data countersued later that year accusing Visa of abusing its market power.

Mr. Neumann said that the agreement "definitely sets a precedent and ensures that Visa transactions will continue to be processed by Visa" and that Visa "will remain significant."

However, he also said that the deal does not mean that "First Data Net is dead forever." He said that the ability to handle on-us transactions for payments made with Visa's rivals, such as MasterCard, American Express Co., or Morgan Stanley's Discover Financial Services, could give First Data "leverage" in future negotiations.

Eric Grover, a consultant with Intrepid Ventures, said that on-us transactions are becoming more common among issuing banks that also operate merchant acquiring businesses. "Large banks like JPMorgan Chase, Citigroup, and Bank of America are currently doing on-us transactions now, and always have," he said. "The more consolidation you have in the banking industry, the more on-us transactions you'll get." Bank of America is also rumored to be interested in creating its own card processing network.

Tim Sloane, the director for debit advisory service for Mercator Advisory Group Inc. of Waltham, Mass., said the settlement is a potential slight to Mr. Fote's legacy. Mr. Fote resigned last year and was succeeded by his predecessor, Henry C. Duques, who has since begun to dismantle First Data through a planned spinoff of the money transfer business Western Union Financial Services Inc.

Mr. Fote "lost on his vision, but gave First Data a nice negotiating chip," Mr. Sloane said. "From a negotiating perspective it worked pretty well. You can say they lost because they gave up" First Data Net, but Visa is giving the company something in return. "It's not clear what, but it's something."

First Data's legal suit appeared to get a boost in March. It had argued that because Visa represented many banks, its efforts to quash First Data Net represented restraint of trade. Visa had argued that it was a single business enterprise, but the U.S. District Court for the Northern District of California disagreed.

Still, First Data's notion of operating a payment network depends on having a good number of on-us payments, and the company has lost several major processing agreements in the past few years.

In 2003, Bank One Corp. said it would move its 50 million card accounts from First Data to Total System Services Inc. The following year, JPMorgan Chase & Co. bought Bank One and said it would shift its card processing business - about 35 million accounts - to TSYS. Also in 2004, Bank of America Corp. said it would move the 12 million accounts it acquired by purchasing FleetBoston Financial Corp. from First Data to TSYS.

Tien-tsin Huang, an analyst with JPMorgan Securities Inc., wrote in a research note issued Wednesday that "the benefit and promise of First Data Net has significantly diminished in the last four years with FDC losing major card issuing business. The opportunity for First Data Net was longer-term in nature anyway, and we believe the near-term financial impact is minimal."

Robert J. Dodd, an analyst with Regions Financial Corp.'s Morgan Keegan & Co. Inc., said that the settlement was not surprising, because First Data was probably not doing many on-us transactions, and its motivation to pursue litigation was "significantly diminished."

And though the settlement said that Visa would support First Data financially, he said, "I wouldn't imagine it would be very much."

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