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Another Class Action Suit Shakes Up Payment Processing

March 5th, 2012

 

The payment industry, banks, merchants, and ultimately consumers are likely to see some changes from yet another looming class-action lawsuit against Visa and MasterCard. A class of nearly 5 million retailers, including heavy hitters like the National Restaurant Association and National Association of Convenience Stores, have filed a suit claiming antitrust violations due to collusion between Visa and MasterCard (card brands) and the member banks. Some of the notable banks named in the suit are Bank of America, Citigroup, Wells Fargo, JP Morgan Chase, Fifth Third, and HSBC.

This case is quite similar to a 1996 suit in which another class of 7 million retailers, spear-headed by Walmart and Limited Brands, accused the card networks of a monopoly because their merchant agreement forced acceptance of branded debit cards along side of credit cards under the “honor all cards rule”. The case was settled in 2003 when the defendants agreed to pay more than $3 billion in monetary damages. In addition to the cash payout, Deutsche Bank analyst Bryan Keane estimates resulting changes in business practices cost another $25 billion conservatively.

More recently, Visa and MasterCard saw two other significant blows to their practices and profits this past October. First, provisions from the Durbin Amendment went into effect capping the fees merchants would have to pay to accept debit cards. Next, the card brands announced a settlement agreement with the U.S. Department of Justice and the attorneys general of seven states to resolve antitrust investigations into the companies’ merchant acceptance rules in the U.S. As part of the settlement, Visa will allow U.S. merchants to offer discounts or other incentives to steer customers to a particular form of payment including to a specific network brand or to any card product, such as a “non-reward” Visa credit card. While the second settlement hasn’t meant much in terms of direct monetary damages yet, the Durbin Amendment “is expected to cost banks about $6.6 billion a year in revenue,” according to Javelin Strategy and Research.

So what can we expect from the pending suit slated to be tried this September?

First, we can expect that there won’t be a trial at all. The case will be settled. Why? Because the circumstances are eerily similar to the 2003 settlement: both were antitrust cases, both brought by a similar plaintiff class of merchants, and both are under the supervision of U.S. District Judge John Gleeson. Yes, the same judge that approved the 2003 settlement. And as Yale law professor George Priest stated in his Wall Street Journal essay about the 2003 case, “MasterCard and Visa could have had Oliver Wendell Holmes and Clarence Darrow on their legal teams and it still would have been foolish to try the case.”

Second, we can expect the damages to Visa, MasterCard, and the member banks to amount to the largest antitrust settlement in U.S. history. One claim of the suit is that when Visa and MasterCard spun off into public companies through initial public offerings in 2006 and 2008, the action was “disingenuous” and only to avoid the appearance of a monopoly. The suit seeks compensation for alleged overcharges “for the fullest time period permitted” by statutes of limitations. This “fullest time period” goes all the way back to 2004.

JPMorgan notes that, “based on publicly available estimates, Visa and MasterCard branded payment cards generated approximately $40 billion of interchange fees industry-wide in 2009.” According to Dan Free in his article for Mainstreet.com, “Those numbers cited by JPMorgan would appear to point the way to a very large settlement, since the case covers at eight years and counting… even if one assumes an overcharge of just 10%–the figure used by the Justice Department in its antitrust cases–that would suggest $32 billion of overcharges over eight years. That number, however, would be trebled, as is the rule in antitrust cases, meaning damages could conservatively be estimated at $96 billion.”

Third, we can expect serious shockwaves in the banking industry resulting from potential revenue shortages. Another allegation of the suit is that interchange costs are too high due to lack of sufficient competition. If credit card interchange rates were capped in a manner similar to debit card rates under the Durbin Amendment, it would mean a 75% reduction in fees to merchants and revenue to the banks.

But what exactly does “too high” mean?  To put things in perspective we can look at how the same fees work in other parts of the world.  In the United States the overall average cost to a merchant to accept a credit card is 2%. Mexican merchants pay 1.66%, Canadians and Germans pay 1.50%, merchants in the U.K. pay an average of .79%, Australians pay .5%, and EU member merchants pay around .30%.

As bank analyst Matt O’Connor states in his January 4 report, reducing credit card interchange fees by 75% would cost US Bancorp about $1.2 billion of 2012 revenues, would cost JPMorgan Chase $5.38 billion, and would cost Bank of America $3.68 billion. These losses in revenue are between 2 and 5 times the total impact of the Durbin Amendment.

So come this September we will see what the final price tag is likely to be. Regardless of the final settlement amount, look for Visa and MasterCard to remain dominate players in the game, for the banks to scramble to replace lost revenue, and for consumers to see little to no change at the register.

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