DOJ's Antitrust Suit Against American Express Will Steer Profits to Merchants, But Won't Help Consumers
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DOJ's Antitrust Suit Against American Express Will Steer
Profits to Merchants, But Won't Help Consumers
Stephen J. Shapiro and Levi E. Jones, Schnader Harrison Segal & Lewis LLP
Introduction the money is distributed and what percentage of
purchases goes to the different players in the
Picture three customers standing in line at an network vary from merchant to merchant and
electronics store. All three happen to be buying the network to network. As card companies have
same type of computer. The first customer plans to offered increasingly generous reward programs to
pay for his purchase with an American Express their customers, they have insisted upon an
Premier Rewards Gold Card, which will earn him increasingly large share of the purchase price
reward points that can be redeemed for travel, collected by merchants when their customers use
shopping, dining, or entertainment perks. The these reward cards. Some cards collect more than 3
second customer plans to pay for her purchase with percent of the purchase price from merchants.1
a Citi Dividend Platinum Select MasterCard from
Citibank. That card will give her 1% cash back on the What is true for all merchants is that it costs them
purchase. And the third customer plans to pay for more to accept payment by card than it does to
his purchase with cash. He will not get anything accept cash. Indeed, of our three hypothetical
extra in return for his purchase – just the computer. computer purchasers, the customer paying cash is
All three customers will be charged the same the preferred customer as the merchant keeps the
amount at the register, but those paying with entire purchase price. But other than offering cash
plastic will get a little something extra. Most customers a discount (which would make the cash
customers presumably never have thought about customer less attractive to the merchant),
why this is so, but the U.S. Department of Justice merchants are prohibited from steering customers
has been looking into this very question for some toward forms of payment that are less costly to the
time. And the DOJ's conclusion seems to be that merchants. In fact, their contracts with the card
what goes on in the checkout line is unlawful. networks forbid merchants from doing anything to
encourage customers to use one card over another.
How can this be so? The answer lies in the So what merchants do instead is raise prices for
relationships between retail merchants, the credit everyone to cover the increased cost of accepting
card networks, and the banks that issue credit cards. In this "market system," the cash customer is,
cards. Merchants that accept Visa, MasterCard, in effect, subsidizing the perks going to the credit
American Express (Amex), and Discover cards agree card customers, all because of contracts between
to share a portion of every sale with the banks and the card networks and the merchants to which the
card networks that operate the systems for cash buyer is a stranger.
processing credit card payments. The details of how
________________
© 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 1 edition of the Bloomberg Law
Reports—Antitrust & Trade. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.
The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications, exceptions and other
considerations that may be relevant to particular situations. These discussions should not be construed as legal advice, which has to be addressed to
particular facts and circumstances involved in any given situation. Any tax information contained in this report is not intended to be used, and cannot be
used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. The opinions expressed are those of the author.
Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content contained in this report and do not make any representation or
warranty as to its completeness or accuracy.This is where the Department of Justice comes in. MasterCard used to prohibit banks that issued their
The DOJ claims that the contracts prohibiting cards from also issuing Amex and Discover cards.
merchants from steering customers toward cards From 1998 to 2003, Visa and MasterCard did battle
that take a lower percentage of the purchase price with the DOJ over whether this prohibition
are anticompetitive. Therefore, in October 2010, constituted an anticompetitive practice. The Second
the DOJ filed an antitrust action against Visa, Circuit affirmed a decision by the United States
MasterCard, and Amex. The stated goal of the DOJ District Court for the Southern District of New York
action: force the card companies to let merchants holding that Visa and MasterCard's prohibition
steer customers to whatever payment method violated Section 1 of the Sherman Act.2 Visa and
allows merchants to keep more of the sale price so MasterCard were required to drop their exclusivity
that merchants can pass those savings along to requirements and allow their issuing banks to also
consumers. Visa and MasterCard negotiated a issue Amex and Discover cards.
settlement with the government whereby they
agreed to allow merchants to use various steering As a result of the Second Circuit's 2003 decision,
methods. As a result, the only remaining defendant card networks were forced to work harder to
in the antitrust case is Amex. attract banks to issue their brand of cards. Issuing
banks that had previously been locked into
What the DOJ holds out as a straightforward blow in exclusivity arrangements with Visa and MasterCard
the name of consumer rights, however, likely will now could entertain offers to join the Amex and
not have its intended effect. In fact, the DOJ's Discover networks. One of the tools that the credit
antitrust suit looks likely to produce a result that is card companies use to woo issuing banks is
actually worse for consumers than the allegedly "interchange," which is a fee, usually a percentage
"anticompetitive" system it is meant to replace. of the sale price, that banks collect on every card
Allowing merchants to steer consumers toward transaction. The interchange fee makes up the
cards with lower merchant fees will result in higher largest portion of the chunk of the purchase price
annual fees and fewer rewards for customers. that merchants pay on each purchase made using a
Merchants, not consumers, will be the real winners card, and it has been growing. The Government
as they pocket a portion of the purchase price that Accountability Office recently found that the
used to go to the card networks. This is exactly what interchange fees charged by banks have increased
has happened in other countries where the significantly since 2003. The GAO study found that
government has tried to intervene in the card Visa had introduced 46 percent of its current
services market; merchants pay lower fees for interchange fees since 2003, and MasterCard
accepting cards, but do not pass those savings on to introduced 89 percent of its current interchange
consumers. Indeed, consumers end up paying more fees during that time. In addition, Visa's post-2003
because they make up for the card network's rates are 18 percent higher than its pre-2003 rates,
declining revenues by paying higher fees on their and MasterCard's rates are 11 percent higher.3 Visa
cards and receiving fewer rewards. If the goal of the network officials explained to the GAO that "they
DOJ's suit is to lower prices for consumers, the actively compete to retain issuers on their network
experiences of countries that have attempted to do and interchange fees play a role in that effort."4
the same thing show that the experiment has so far
been a failure. The DOJ postulates that this increase in interchange
fees, when combined with card network contracts
Yesterday's Solutions Become Today's Problems forbidding merchants from steering customers to
cards with lower fees, has resulted in higher prices
The genesis of the DOJ's current suit can be traced for all consumers without a corresponding benefit.
back to an earlier action by the DOJ. Visa and Of course, this purported problem appears to have
been a side effect of the DOJ's earlier lawsuit
© 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 1 edition of the Bloomberg Law
Reports—Antitrust & Trade. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.against Visa and MasterCard. Put differently, the are not likely to benefit from a forced change in the
DOJ is attempting to tackle a problem – the rates merchants pay to accept cards.
increasing interchange fees charged to merchants –
that its previous antitrust litigation helped to Amex directly negotiates fees with merchants.
create.
On the first point, Amex stresses that it negotiates
Amex in the DOJ's Crosshairs directly with merchants who accept its cards. Visa
and MasterCard, on the other hand, negotiate only
The DOJ began investigating the anti-steering with their issuing banks. Because most Amex
policies of Visa, MasterCard, and Amex in 2008.5 On customers also carry Visa and MasterCard, Amex
October 4, 2010, the DOJ filed simultaneously a claims that it has to make highly competitive offers
complaint against all three card networks and a to merchants who know that they likely will not lose
proposed final judgment that it had negotiated with business if they cannot come to terms with Amex.
Visa and MasterCard. The proposed final judgment In contrast, merchants have little choice but to
would require Visa and MasterCard to allow accept Visa and MasterCard at whatever terms the
merchants in their networks to steer their banks dictate, lest they risk losing business from the
customers towards other cards. Merchants vast majority of credit card holders.9 In short, Amex
accepting Visa and MasterCard would be allowed to claims that it lacks market power to impose supra-
use a number of tactics to steer customers, competitive fees on merchants and instead has to
including offering rebates, discounts, and enhanced work out those fees in individual, even-handed
services to those who use a card the merchant negotiations with merchants. In fact, by negotiating
prefers. The merchants would also be allowed to with merchants, Amex already does what some
express a preference for a certain card and tell members of Congress have proposed requiring Visa
customers how much they have to pay to accept and MasterCard to do to increase competition.10
different cards.
In an effort to counter Amex's defense, the DOJ
With this settlement and proposed final judgment claims that Amex has outsized market power in the
for Visa and MasterCard in place, the only travel and entertainment sector and has used that
remaining defendant is Amex. The DOJ alleges in its power to increase fees on travel-related companies
complaint that Amex has violated and continues to above competitive levels.11 Amex responds by
violate Section 1 of the Sherman Act by enforcing arguing that the travel and entertainment sector is
"Merchant Restraints" in its agreements with not really a separate market over which it has
merchants.6 Specifically, the DOJ claims that power. Rather, it is just one segment of a large
"American Express' point-of-sale rules on merchants market in which it has little power compared to Visa
restrict competition more than the rules of its rival and MasterCard.12
networks."7 For example, the DOJ denounces
Amex's rules prohibiting merchants from criticizing Steering only will benefit the dominant card
Amex or expressing a preference for other cards.8 networks.
In public statements, Amex has responded to the Amex's second defense, that allowing steering will
DOJ's complaint by defending its practices and actually harm competition, appears to be well-
stressing three main points: (1) Amex's business founded. Amex points out that few people carry
model is significantly different from that of Visa and only an Amex card, while many carry only cards
MasterCard; (2) the current antitrust settlement will from Visa or MasterCard. Practically speaking, this
hinder, not expand, competition; and (3) consumers means that merchants are highly unlikely to steer
customers away from Visa and MasterCard and
© 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 1 edition of the Bloomberg Law
Reports—Antitrust & Trade. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.toward Amex because a large number of their policy harm consumers, and will the steering
customers simply do not carry Amex. It is much techniques the DOJ is supporting help consumers?
more likely, Amex quite logically predicts, that This question also lends itself to empirical
merchants will steer customers toward a card that measurement. Governments around the world have
they are confident their customers actually carry.13 used various means to alter the interaction
In other words, if merchants are permitted to steer between card networks and merchants in the hope
customers toward a particular brand or type of of benefiting consumers. There has so far been little
card, they likely will steer customers toward one of in the way of empirical evidence showing that these
the two dominant card networks and away from interventions in the market have helped consumers.
Amex, a much smaller card network. If anything, the evidence indicates that it has shifted
profits from banks and card networks to merchants,
Moreover, allowing merchants to steer Amex not to consumers. This outcome may be desirable
customers towards Visa and MasterCard seems from some perspectives, but it is not one that will
unlikely to accomplish the DOJ's intended effect of right the legal wrong that the DOJ claims it is
reducing prices for consumers. According to Amex, attempting to cure, nor is it an outcome that would
its reward program is one of the main reasons why comport with the economic theory underlying the
its customers use their Amex cards. Such customers DOJ's complaint. The best empirical data seem to
– those who value reward programs – likely also suggest that the DOJ's efforts will not achieve their
carry a Visa or MasterCard reward card. If a intended effect.
merchant successfully steers an Amex customer to
Visa or MasterCard, that customer likely will pull a For instance, in early 2003, the Reserve Bank of
Visa or MasterCard reward card out of his or her Australia eliminated credit card no-surcharge rules,
wallet. But, according to Amex, those Visa and thereby allowing merchants to charge customers
MasterCard reward cards cost merchants no less extra to cover the costs of accepting cards. Later
than Amex.14 So, even assuming for the sake of that year, Australia mandated that credit card
argument that merchants passed lower credit card interchange fees be cut nearly in half.15 In response
fees along to consumers, steering will not reduce to these new rules, Amex was required to reword
the merchant's fees, and there will be no savings to certain restrictive clauses in its Australian merchant
pass along. agreements to allow steering practices.
Amex can thus make a convincing argument that Officials at the Reserve Bank of Australia predicted
the DOJ's effort to encourage steering will result in that these changes would result in noticeably lower
long-term anticompetitive results that are worse prices for consumers. In 2005, the Reserve Bank of
than the current conditions in which Amex at least Australia predicted that the Consumer Price Index
has a fighting chance of competing, and, in any would decrease between 0.1 percent and 0.2
event, that the proposed "solution" will not cure percent as a result of interchange fee regulation.16
the alleged problem. In the years since Australia embarked on this
experiment in regulating the card network services
Government regulation is unlikely to reduce costs to market, though, there has been no conclusive proof
customers. that the Reserve Bank's predictions were accurate.17
Moreover, two years after interchange fees were
Amex's third argument, that government tinkering lowered by regulation, economists found credit
with the card networks' business models will not card customers paying higher annual fees, receiving
actually benefit consumers, is particularly shorter interest-free periods, and receiving fewer
compelling. It gets at the heart of what this rewards, while "the incentives that cardholders face
litigation is really about: does Amex's anti-steering to use cards at the point of sale do not seem to
have changed radically."18 As of 2009, about one-
© 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 1 edition of the Bloomberg Law
Reports—Antitrust & Trade. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.third of Australian merchants characterized as "very Netherlands use debit cards much more frequently
large" imposed a surcharge for credit cards. Less than credit cards, and Dutch retailers are allowed to
than one-fifth of merchants characterized as "very impose a surcharge on debit card transactions. The
small" imposed a surcharge.19 In other words, the original economic theory behind allowing
Australian experience demonstrates that lowering surcharges for debit card use was that, for very
interchange fees and allowing merchants to steer inexpensive purchases, the convenience benefits of
does not appear to benefit consumers. using a debit card did not outweigh the cost of
conducting the transaction – cash was more
Australia is not the only country to try its hand at efficient.23 But over the years, as the cost of
lowering prices for consumers by encouraging more transacting a purchase using the debit system has
competition among card networks. In Israel, the declined dramatically, the surcharges assessed by
government has tried for years to encourage more merchants have not decreased. Merchants have not
competition in a highly concentrated card network passed on to consumers the reduction in processing
market. Merchants in Israel are free to impose fees and are now in many cases steering customers
surcharges for credit card use, but have voluntarily toward cash when the use of plastic would be more
adopted a no-surcharge rule and do little to efficient. Research shows that doing away with this
discourage card use or steer customers toward Dutch surcharge would result in a social cost savings
particular cards.20 Regulatory intervention by the of €110 million.24
Israeli Antitrust Authority in 2002 and the near-
doubling of merchant fees for supermarket chains Merchants in the United States have themselves
have not caused supermarkets to steer customers declined to commit to passing on to consumers
away from credit cards. There are many differences savings resulting from lower card network fees. At a
between the Israeli and American markets, but the 2009 hearing before the U.S. House of
utter dearth of proof that the Israeli Antitrust Representatives Committee on Financial Services
Authority's heavy regulation has produced benefits discussing interchange fees and card reform, the
for consumers counsels caution for the United Senior Vice President and General Counsel of the
States. National Retail Federation made it clear that
merchants would not commit to lowering their
Mexico has taken a different approach to regulating prices if card fees were reduced.25 Rather, the
the card networks operating in that country, but Federation indicated that some merchants may
those efforts also have failed to produce choose to expand their services or improve their
measurable benefits for consumers. Rather than stores. One representative remarked that it is likely
directly setting interchange rates, Banco de Mexico that some merchants might simply pass higher
has pressured banks by threatening to use its legal profits on to their shareholders.
capacity to do so. Mexico's Bank Association
responded by setting standardized country-wide Burdens and Goals
rates for merchants that are significantly lower than
those previously charged. In 2008, the Mexico Bank It remains to be seen whether the DOJ or Amex will
Association further reduced credit and debit card have the burden of proving whether Amex's
interchange fees an average of 12.5 percent and 9 merchant restrictions have an anticompetitive
percent respectively.21 No studies have shown that effect. If a company's conduct is not deemed a per
these reductions resulted in lower prices for se violation of antitrust laws, the plaintiff must
Mexican consumers.22 show that it violates the rule of reason. This rule of
reason analysis can be one of two types: "full-
The experience in the Netherlands also provides blown" or "quick look." To satisfy a "full-blown rule
lessons for the United States. Consumers in of reason" test, the plaintiff bears the burden of
© 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 1 edition of the Bloomberg Law
Reports—Antitrust & Trade. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.producing evidence that the defendant's conduct
has anticompetitive effects and that those effects
outweigh any procompetitive effects.26 To satisfy a Stephen J. Shapiro is a partner in Schnader Harrison
"quick-look rule of reason" test, the defendant's Segal & Lewis LLP's Philadelphia office and is co-
conduct is deemed from the beginning to be chair of the Firm's Financial Services Litigation
anticompetitive on its face unless justified by Practice Group. Levi E. Jones is an associate in the
efficiencies or otherwise. The defendant bears the firm's Washington, D.C. office and is a member of
burden of justifying its actions in that case.27 the Litigation Services Department.
If the court treats the case against Amex as a "full-
1
blown rule of reason" case, the DOJ will bear the U.S. Gov't Accountability Office, GAO-10-45,
burden of producing evidence both that Amex's Credit Cards: Rising Interchange Fees Have Increased
conduct has anticompetitive effects and that those Costs for Merchants, but Options for Reducing Fees Pose
effects outweigh any procompetitive or Challenges, 17-18 (2009).
2
See United States v. Visa U.S.A., Inc., 344 F.3d
competitively benign effects. If the court treats the
229 (2d Cir. 2003), aff'g, 163 F. Supp. 2d. 322 (S.D.N.Y.
case as a "quick-look rule of reason" case, Amex will
2001) and cert. denied, 543 U.S. 811 (2004).
bear the burden of justifying its anti-steering 3
GAO-10-45 at 21
practices.28 4
GAO-10-45 at 20.
5
The 10-K annual reports of Visa and American
Regardless of who bears the burden, the examples Express for 2008 mention DOJ's investigation.
6
of other countries that have grappled with card Complaint at 3, U.S. v. American Express Co.,
network fees should help Amex's case. Amex can No.1:10-cv-04496 (E.D.N.Y. filed Oct. 4, 2010).
7
point to these countries to show that, as far as we Complaint at 9-10. Amex's Merchant Reference
can tell, government-imposed mechanisms for Guide for October 2010 is available at
https://www209.americanexpress.com/merchant/single
lowering card network fees for merchants have not
voice/USEng/FrontServlet?request_type=navigate&page
produced benefits for consumers. Indeed, there is =merchantPolicy
nothing to inspire confidence that the DOJ's suit 8
Complaint at 10
against Amex will achieve its goal of helping those 9
Statement of Louise Parent, Executive Vice
customers standing in line at checkout counters President and General Counsel, American Express
across the country. Company, Conference Call (October 4, 2010).
10
Credit Card Fair Fee Act HR 2695 Reintroduced in
The irony in all of this is that the alleged problem US House, Payments News, June 5, 2009,
that the DOJ is attempting to resolve – what it sees http://www.paymentsnews.com/2009/06/credit-card-
fair-fee-act-hr-2695-reintroduced-in-us-house.html (last
as excessive credit card payment processing fees –
visited Dec. 13, 2010).
arose as result of the DOJ's efforts to reduce Visa 11
Complaint at 14-17.
and MasterCard's market power. Yet the proposed 12
Statement of Louise Parent, Conference Call
solution – allowing merchants to steer Amex (October 4, 2010).
customers to Visa and MasterCard – will only 13
Kenneth I. Chenault, Op-Ed., Why Amex is
increase Visa and MasterCard's already dominant fighting Justice's bad deal for credit card holders, Wash.
market share and reduce competition in the credit Post, Oct. 8, 2010, at A17.
14
card market, without creating any benefit for Statement of Ed Gilligan, Vice Chairman,
consumers. The last time the DOJ attempted to American Express, Conference Call (October 4, 2010).
15
resolve this supposed problem, it made matters Howard Chang, David S. Evans, and Daniel D.
Garcia Swartz, The Effect of Regulatory Intervention in
worse. If the DOJ prevails in its suit against Amex, it
Two-Sided Markets: An Assessment of Interchange-Fee
may well do so again.
Capping in Australia, 4 Rev. of Network Econ. 328 (2005)
© 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 1 edition of the Bloomberg Law
Reports—Antitrust & Trade. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.16
Philip Lowe, Assistant Governor, Reserve Bank T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36 (1977)
of Australia, Comments at the Federal Reserve Bank of (abandoning the per se rule against non-price vertical
Kansas City International Payments Policy Conference restraints and applying the rule of reason).
27
(May 4-6, 2005), available at Id.
28
http://www.kansascityfed.org/publicat/pscp/2005/Lowe. See Polygram Holding, Inc. v. FTC, 416 F.3d 29
pdf (D.C. Cir. 2005) (describing the quick look rule of reason
17
Henry Ergas, Panel on Competition Policy in analysis).
Card-Based Payment Systems: Commentary, 4 Rev. of
Network Econ. 415 (2005).
18
Howard Chang et al., The Effect of Regulatory
Intervention in Two-Sided Markets: An Assessment of
Interchange-Fee Capping in Australia, 4 Rev. of Network
Econ. 328 (2005); Stuart E. Weiner and Julian Wright,
Interchange Fees in Various Countries: Developments and
Determinants, 4 Rev. of Network Econ. 290 (2005).
19
Kylie Smith, Manager - Payments Policy, Reserve
Bank of Australia, Comments at the Federal Reserve Bank
of Kansas City International Payments Policy Conference
(Nov. 9-10, 2009).
20
David Gilo and Yosi Spiegel, The Credit Card
Industry in Israel, 4 Rev. of Network Econ. 266, 270
(2005).
21
Sujit Chakravorti, Externalities in Payment Card
Networks: Theory and Evidence, in The Changing Retail
Payments Landscape: What Role for Central Banks? 99
(Nov. 9-10, 2009); José L. Negrín, The Regulation of
Payment Cards: The Mexican Experience, 4 Rev. of
Network Econ. 243 (2005).
22
World Bank, Balancing Cooperation and
Competition in Retail Payment Systems: Lessons from
Latin America Case Studies 193 (2008) available at
http://siteresources.worldbank.org/EXTPAYMENTREMMI
TTANCE/Resources/BalancingCooperationCompetitionRe
tailPaymentSystems.pdf
23
Wilko Bolt, Nicole Jonker, and Corry van
Renselaar, Incentives at the counter: An empirical
analysis of surcharging card payments and payment
behaviour in the Netherlands (De Nederlandsche Bank,
Working Paper No. 196, 2008).
24
See id.
25
H.R. 2382, The Credit Card Interchange Fees Act
of 2009; and H.R. 3639, The Expedited Card Reform for
Consumers Act of 2009 Before the H. Comm. on Fin.
Serv., 111th Cong. 28-31 (2009) (questioning of Mallory
Duncan, Senior Vice President and General Counsel,
National Retail Federation, on behalf of the Merchants
Payments Coalition).
26
Thomas Rosch, Chairman, Fed. Trade Comm.,
Address at the EU Competition Law and Policy
Workshop: Observations on Evidentiary Issues in
Antitrust Cases (June 19, 2009); see, e.g., Continental
© 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 1 edition of the Bloomberg Law
Reports—Antitrust & Trade. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.You can also read
