Life After the Wal-Mart Case

  After seven years, the titanic battle between more than five million merchants, led by Wal-Mart Stores Inc., and Visa USA and MasterCard International has been resolved. Visa and MasterCard agreed to eliminate their honor-all-cards rules ("HACRs"), pay over $3 billion in damages and substantially reduce their offline debit card interchange fees. The settlements are not yet final, but it is useful to consider their long-term impact on the card associations, other payment-system competitors, merchants, banks and consumers.
  * HACRs. The centerpiece of the settlement is the elimination of the HACRs, which required merchants to accept the associations' offline (signature-based) debit cards as a condition of accepting their credit cards. With no HACRs, merchants can decide whether to accept offline debit cards. This will give merchants greater leverage in negotiating for lower offline interchange.
  Longer term, eliminating the HACRs creates a more level playing field for future network competition. The HACRs gave Visa and MasterCard a significant advantage because with them they could compel merchants to accept any branded product at any price.
  Without the HACRs, competition at the network level will become much more open and vibrant. As new markets arise, Visa and MasterCard no longer will have the ability to leverage their credit card market power to give them a substantial incumbency advantage over other network rivals. We can expect far more competition from networks such as Star, Pulse and NYCE, or new payment systems. Product innovations likely will increase.
  A word of caution: the proposed acquisition of the Star electronic funds transfer network by First Data Corp., which has controlling interest in NYCE, may, by creating one dominant online (personal identification number-based) debit network, deter the potential growth and innovation of rival networks.
  * Interchange. Although the litigation did not directly attack interchange fees, they were clearly the greatest source of harm from the merchants' perspective. By showing the potential competitive harm of these fees, the litigation opened a Pandora's Box that may result in future high-stakes antitrust disputes.
  The most immediate effect of the settlements will be an instant reduction in interchange by about one-third. The long-term future of interchange seems somewhat less certain, since merchants will now have the power to reject offline debit cards and that may lead to substantially lower interchange fees.
  On the other hand, the card associations may increase interchange to continue to provide a value proposition for issuers. The ultimate resolution will depend upon the associations satisfying the interests of two different constituencies-banks and merchants.
  What will effectively restrain the card associations from increasing offline interchange? The online debit networks offer some restraint and their fees traditionally have been far lower. In the past few years, however, some of those networks have significantly increased interchange.
  * Online versus Offline. Some people have predicted that, with the elimination of the HACRs, offline debit cards will become an antiquated artifact like the hand-dial telephone. Such predictions, like the reports of Mark Twain's death, may be very premature. Visa and MasterCard have extraordinarily strong franchises and only 25% of all merchants accept online debit cards. Though the settlements should lead to some short-term upsurge in online debit, its continuation will depend significantly on the degree of competition among regional EFT networks and their willingness to be "merchant-centric" in pricing.
  * Merchant Power. A major aspect of the Wal-Mart litigation was the decision by the court to certify a class of merchants as plaintiffs. One of the reasons merchants have been less effective in negotiating with the card associations in the U.S. has been their inability to act collectively. By bringing this case and having a class of merchants certified, the plaintiffs overcame this problem. The certification of the class serves as a precedent for future merchant antitrust actions.
  * The Court as a Long-Term Regulator. One of the most intriguing aspects of the litigation is that the court retained jurisdiction and now sits as a long-term regulator of the debit card industry. Antitrust courts have served this role often, with mixed results. The telephone industry lived through more than a decade of supervision by Judge Greene after the settlement in U.S. v. AT&T. One can expect that future debit card disputes will find their way to U.S. District Judge John Gleeson, who presided over the Wal-Mart case.
  Once in a generation an antitrust case offers a chance to restructure an industry. Twenty years ago the settlement of the Justice Department suit against AT&T Corp. led to a proliferation of consumer choice, more innovation, dramatically lower prices, and major telecommunications-industry restructuring.
  The Wal-Mart settlements offer the promise of many of those benefits. Whether those objectives will be achieved will depend a great deal on whether firms respond to these new challenges by focusing on consumers, innovating and competing aggressively rather than trying to build new barriers to competition. Only time will tell.
  David A. Balto is a partner at the Washington, D.C., law office of White & Case LLP, focusing on mergers, technology and intellectual property. Previously he headed the policy office at the Federal Trade Commission's Bureau of Competition. He can be reached at dbalto whitecase.com.