Cutting Their Own Deals

  The settlements Visa and MasterCard struck with merchants last year by no means ended the feuds between the associations and retailers. Several merchants opted out of the class action in hopes of getting better deals on their own. CCM assesses their prospects.
  Despite the settlements last year of a seven-year-old, class-action antitrust lawsuit brought by merchants against Visa USA and MasterCard International, the associations remain on the legal hot seat.
  When Visa and MasterCard agreed to pay retailers $3 billion over 10 years, the largest settlement in U.S. antitrust history, a major obstacle to their operations was removed. As part of the agreements, the associations eliminated their honor-all-cards rules, enabling merchants to choose whether to accept the payment networks' signature-based, or offline, debit products, and they resulted in the lowering of offline debit interchange rates, especially for large retailers. Interchange is the amount of a card sale that the merchant acquirer must pay the card issuer, which acquirers typically pass on to their merchant customers.
  But a number of major merchants-including Best Buy Co., CVS Corp., Darden Restaurants Inc., Giant Eagle Inc., Home Depot Inc. and Toys "R" Us Inc.-that opted out of the class action and subsequently filed their own antitrust suits are pressing their cases. U.S. District Court Judge John Gleeson, who presided over the class action from his Brooklyn, N.Y., courtroom, on March 29 ordered the parties to submit to mediation in an attempt to work out a resolution. Another large retailer that opted out of the class suit, Meijer Stores LP, subsequently settled with the associations.
  While most of the merchants will not discuss the suits, Craig Wolfang, a partner in the Minneapolis office of Robbins, Kaplan, Miller and Ciresi LLP and the attorney for Best Buy and Darden Restaurants, says the opt outs' complaints were amended to include alleged price fixing by Visa and MasterCard in the setting of interchange rates for both credit and debit cards, a claim that was not pursued in the class-action suit.
  "We believe the setting of uniform, fixed interchange fees by Visa and MasterCard is illegal under the federal antitrust laws, and there are a variety of alternate ways that interchange fees might be set more competitively," Wolfang says.
  The plaintiffs, he adds, haven't pinpointed the preferred way for interchange to be determined, but "we do know those fees seemed to have increased significantly in recent years in ways that seem unrelated to costs or other forces of competition that might drive those fees."
  Though the retailers have individually filed antitrust suits, Wolfang says they are cooperating in the litigation and sharing much of the administrative work. He says that the merchants and associations "remain significantly far apart" and it is too soon to determine if settlements eventually will be reached.
  "The price-fixing claim is significantly larger in terms of potential damages than in the claims that were settled," Wolfang says. "The claims of the opt outs collectively are going to be in the hundreds of millions of dollars."
  Some legal experts, however, say the opt outs face a long, expensive and arduous road in pursuing their claims without a guarantee that they eventually will reap benefits that are at least as lucrative as those received by plaintiffs in the class-action suit.
  "The idea that you can do better than the largest settlement in the history of antitrust boggles the mind," says Robert Lande, an antitrust professor at the University of Baltimore School of Law. "That settlement was for an immense amount of money. By not settling, the retailers are sort of saying, 'I don't want to go with Michael Jordan because I think I can find a better basketball player.'''
  Also by not settling, the opt outs may have to wait several more years before going to trial, and then take their chances with a jury that-judging by recent antitrust history-is likely to be pro-defendant, Lande says.
  "Lloyd Constantine (lead attorney for the class merchants) worked like a dog for seven years with a huge team of people, and was able to convince MasterCard and Visa that he was going to go all the way if they didn't settle on favorable terms," Lande says. "He is one of the best antitrust lawyers in the country. Are you now going to do better than that?"
  Still, the potentially severe consequences of a defeat at trial might spur Visa and MasterCard to also settle with the opt outs. Some analysts estimate that the associations could have been liable for up to $100 billion in actual and punitive damages if the class suit had gone to trial.
  Yet, as they deal with the opt outs, the associations still are awaiting the full repercussions from their earlier settlements. Wal-Mart Stores Inc., the lead merchant in the class suit that subsequently stopped accepting debit MasterCard, still reportedly is the only major retailer to drop a signature-based debit product following the elimination of the honor-all-cards rules. MasterCard and Visa say that only a handful of unidentified smaller retailers have done likewise.
  More Legal Challenges?
  But another ramification is the prospect of further legal challenges. Retailers that have long been unhappy with the associations' card pricing and acceptance policies will be less likely to put up with them if they realize that it is possible to prevail in litigation, says Mallory Duncan, senior vice president and general counsel for the Washington, D.C.-based National Retail Federation, a plaintiff in the class suit.
  That, he says, could lead to additional changes in association operating rules. "Visa and MasterCard are going to be somewhat gun-shy after the class settlements and the Department of Justice matter," Duncan says. "In those two big cases they are batting zero."
  In a 2001 ruling in an antitrust lawsuit brought by the U.S. Department of Justice, a federal judge ordered the associations to eliminate rules that prohibited member banks from also issuing American Express and Discover cards. MasterCard and Visa appealed to a federal appellate court and lost, and now are appealing to the U.S. Supreme Court. Many observers predict the high court will not take the case.
  Other recent Visa litigation includes its 2002 suit against Greenwood Village, Colo.-based First Data Corp. to prevent the payments behemoth from leveraging its connections with issuers and acquirers to create a closed-loop processing system. Such a system could enable clients that send transactions through the First Data Net network to bypass Visa's VisaNet authorization, clearing and settlement system and avoid some of the association's fees.
  Scrutiny
  Visa claimed the First Data Net transactions are at greater risk for fraud and other problems. First Data counter-sued, charging anticompetitive practices, breach of contract and trade libel. The situation has not yet been resolved.
  "There now will be scrutiny of the associations from private parties and the government that Visa and MasterCard might have been able to avoid in the past," says Henry Polmer, a payments attorney in the Washington, D.C., office of Piper Rudnick LLP.
  Visa's rules and regulations may be increasingly under attack, but association executives say they still intend to defend their practices. And they point to a 20-year success rate against legal challenges-prior to the recent reversals-as evidence that their positions are solid.
  Such victories include a 1984 putdown of a challenge to interchange from National Bancard Corp. (NaBanco) in which the non-bank acquirer was unsuccessful in pursuing a claim that Visa's setting of interchange constitutes price fixing.
  A court ruled that interchange did not harm competition.
  "The results of the recent controversies do not tell much about what's going to happen tomorrow," says M. Laurence Popofsky, Visa's senior litigator and a partner in San Francisco-based Heller Ehrman White & McAuliffe LLP. "They might whet the appetite of folks who are looking to bring claims because they think there may be an attorney's fee in it. But the legal rules which underlie the associations are reasonable, clear and defensible."
  Popofsky says Visa was prepared to try the class-action case, and is ready to use the same defensive tactics against the retailers that opted out of the settlement. (MasterCard would not discuss the suits for this story.)
  "If the opt outs want to spend the kind of time, money and resources to prepare a case to challenge the defense that is already there, I can only say, 'good luck and God bless,'" he says. "But it does strike me as a very strange allocation of resources from a business point of view."
  While the plaintiffs may have the deep pockets necessary to pursue their claims, analysts say their resources still are relatively small compared to the class, which included Wal-Mart, Circuit City Stores Inc., Limited Brands and Safeway Inc., as well as three merchant associations and more than 4,000 other retailers.
  Pooling Efforts
  Yet, because the opt outs-who have virtually identical claims against Visa and MasterCard-are pooling their efforts and expect to leverage many documents that were prepared for and used in the class action, their workload is reduced, Wolfang says.
  "It is not a question if the companies have the financial wherewithal to carry the suit, but if they're willing to slog it out for the length of time that it takes," the NRF's Duncan adds.
  Many observers, however, including Polmer, say they expect the parties to settle before a trial begins. But it is unclear when that might occur.
  "It all depends on what the merchants are going to be seeking and how aggressive they are going to be in trying to reach a settlement," Polmer says. "But I would not think that MasterCard, Visa and their member institutions would relish the idea of another seven years of litigation."
  But in addition to the opt outs' claims, the associations over the next several years likely will face additional challenges to their practices, including more that center on interchange. While signature-based debit rates temporarily were cut by about one-third as part of the class settlements, and recent fee changes give further breaks to high-volume merchants, interchange rates for many smaller retailers-most of whom must continue to accept debit cards to remain competitive-are rising.
  "The pricing adjustments from the settlement didn't go far enough," says John H. Hamby, senior vice president and manager of the Merchant Services Center for Savings Bank of Manchester, a Manchester, Conn.-based acquirer and a division of New Haven-based NewAlliance Bank. "MasterCard and Visa handled the situation on a temporary basis to settle a lawsuit."
  Hamby, who says acquirer-paid interchange is too high and that the fee for a $300 debit card transaction should be in cents, not dollars, speculates that issuers are unjustly using debit card revenues to cover credit card losses and expenses. "We're not dealing effectively to what is a mammoth change in the complexion and profile of our business from that of credit cards to electronic payments."
  What that means is that besides new legal issues, the associations also might be facing a growing movement by retailers to get their customers to use lower-cost payment products, including automated clearinghouse debits and electronic checks, instead of offline debit and credit cards, analysts say.
  "You might as well just paint a target on Visa and MasterCard in terms of future problems," says James A. Hanisch, executive vice president of Ontario, Calif-based CO-OP Network, the fourth-largest electronic funds transfer network. "Two years ago we would have thought that a class settlement would be the end of the situation. But I'm afraid it's just a beginning."
  But while attacks on Visa/MasterCard practices and products may ultimately lower merchant expenses, changes that weaken the associations' operating structure could greatly damage the payment sector by causing processing inefficiencies, says Liam Carmody, president of Carmody & Bloom Inc., a Ridgewood, N.J.-based payments-industry consulting firm.
  "Retailers are going to hurt themselves in the long run if they threaten Visa and MasterCard or make it difficult for them to do business," Carmody says. "There is a synergy among the associations, banks, merchants, acquirers and processors. If there is unfairness, you can pursue it. But it is a large and complex tapestry and you don't want to wreck the system."
  A Volatile Situation
  Still, the situation could become even more volatile as debit activity-and retailer expenses-increase. At the same time that Visa and MasterCard are reporting that debit volumes are up more than 20% in 2004, Duncan says additional large and mid-size merchants-whom he declines to identify-are considering dropping signature-based debit because of the pricing.
  "There will be more assertive action from retailers, and it is likely they will seek to change the face of things," Polmer says. "At the same time, there are some very progressive financial institutions that are thinking of new ways in which the (payments) world can operate. There likely will be a figuring out of the situation that will work to the benefit of retailers, consumers and banks."
  While the various payment-industry partisans may eventually reach an agreement about what constitutes proper association pricing and practices, there is likely to be much conflict before the situation is resolved.