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Connections in the payment industry run deep. I met Tracey Kitzman the day that I reported to work in the chambers of a recently appointed judge to the United States Court of Appeals with the Seventh Circuit, Hon. Diane P. Wood.
Neither of suspected at that first meet that we would end up on opposite sides the fight about who should pay for payments. But divided we are, and as much as I enjoyed reading her piece, it leaves at least one unanswered question - what makes the moment after a consumer selects a form of payment so critical to competition among various forms of payment?
- Tom Brown, Law and Regulation Editor
In 2009, $2.87 trillion of business was transacted using payment cards issued in the United States by American Express, Visa and MasterCard.  For each transaction, a merchant typically pays between 1-3 percent of the charge, depending on whether a debit card or high-reward charge card is used. These fees are higher yet if the merchant transacts business via the Internet, mail or telephone order. 
Yet despite dramatically decreased processing costs from the days when transactions were settled using carbon copies and manual data entry, merchant discount fees have been trending upward. Interchange rates, which form the basis of swipe fees for Visa and MasterCard, have risen every single year since 1997.  Between 2000 and 2006, the average swipe fee increased by 24 percent.  American Express, Visa and MasterCard have never offered a cost-based justification for the increase in these fees. Nor could they, given the average interchange rate for U.S. merchants is more than double the rate in the United Kingdom and almost four times the rate in Australia. 
The rising cost of payment card transactions has been disastrous for U.S. merchants. In 2009 alone, U.S. merchants paid more than $62 billion in interchange fees and billions more in total swipe fees.  These costs are passed along to all consumers by way of higher retail prices, regardless of whether the consumer pays with a check, cash or high-cost American Express Platinum Rewards Card®. It is against this background that the Antitrust Division has challenged the merchant rules of American Express, Visa and MasterCard that prohibit merchants from promoting or encouraging a customer's use of a cheaper, more efficient form of payment.
Far from being a case "about nothing," the merchant restraints that the Antitrust Division and 18 states' attorney generals have challenged insulate American Express, Visa and MasterCard from price-based competition for their payment acceptance services and directly fuel the escalation of swipe fees. These restraints include prohibitions against offering customers a discount or rebate at the point of sale to induce them to use a less expensive card product, such as a Discover credit card, debit card or a new card product that is designed to compete based on price. The challenged restraints further prohibit a merchant from using any form of verbal prompting or signage. Thus, a merchant may not say to a customer, "Excuse me sir, but would you mind paying with something other than that American Express card, as their fees are 3 percent and cause us to raise our prices?" Likewise, the challenged restraints prohibit a merchant from striking a deal with a rival payment network (e.g., Discover) whereby the merchant receives a reduced rate or other consideration in exchange for advertising, "We Prefer Discover."
Notably, the Division chose not to challenge, at this time, the rules of either Visa or MasterCard that explicitly prohibit merchants from imposing a surcharge as a means of incenting consumers to use a less expensive, more efficient form of payment. This decision is understandable. Visa and MasterCard can certainly argue that they would be sorely prejudiced if merchants were free to impose a fee (or surcharge) for using their cards but not for using American Express' cards.
While American Express does not have an explicit rule relating to surcharges as such, it prohibits merchants trying "to dissuade Cardmembers from using" an American Express card or from trying "to persuade or prompt Cardmembers to use any Other Payment Products or any other method of payment," whether by surcharging or any other means.  Under American Express' rules, a merchant could only impose a surcharge on an American Express transaction if it imposed the exact same surcharge on all other payment cards, including debit cards, thereby negating any ability for the merchant to incent customers to use a cheaper payment card.
In the Antitrust Division's Proposed Final Judgment with Visa and MasterCard, which was filed contemporaneous with its complaint, the Division went out of its way to expressly reserve the right to challenge no-surcharge rules in the future.  The Division is therefore free to stage its attack on the defendants' merchant restraints. If it is successful in rescinding American Express' rules, the Division can take on Visa's and MasterCard's surcharge rules safe in the knowledge that a victory would permit merchants to surcharge all payment card transactions and not just Visa and MasterCard transactions. Here, the Division's instincts appear dead on. Moreover, private litigation by both a nationwide class of merchants, trade associations and 18 of the largest merchants in the United States, including Walgreens, Publix, and Rite Aid, have placed Visa's and MasterCard's surcharge rules directly under attack since 2005. 
The merchant restraints imposed by American Express, Visa and MasterCard thwart interbrand competition at two distinct levels: (i) among merchants, and (ii) among networks. First, on their very face, the challenged restraints flatly preclude merchants from competing on the dimension of whether and how they price for payment card acceptance. This aspect is often overlooked by lawyers, economists and foreign regulators in explaining why the merchant restraints are anticompetitive, but it should be front and center. Merchants can decide whether and how much to charge for parking, Wi-Fi, shipping or anything else. This is all protected competition. But these merchant restraints prohibit the merchant from engaging in similar price-based competition for payment acceptance services.
In Australia, where the merchant restraints have been largely banned by a competition authority that recognizes their anticompetitive effects, merchants compete vigorously on the dimension of whether and when to charge for payment acceptance services. Advertising free card acceptance is like advertising free shipping. The merchant restraints of American Express and others in the United States are naked prohibitions against inter-merchant price competition for the payment acceptance services they provide their customers.
Second, the challenged merchant restraints also thwart interbrand competition among networks. They ensure that price-based competition will not meaningfully break out in the markets for the provision of network payment services to merchants and acquirers. The purpose and effect of the restraints is to prohibit the merchant from responding to high swipe fees by shifting costly transactions from one brand or type of network services to another.
In the absence of the merchant restraints, a card network that dropped its fees could expect to gain share from rival networks, provoking genuine interbrand price competition. The restraints, however, restrict interbrand competition: by prohibiting a merchant from offering a discount for the use of a competitor's card, by banning surcharges and by preventing the merchant from even asking if the consumer can use something other than her expensive American Express card product.
The merchant restraints ensure that when the cardholder selects which product to use in processing a transaction, she will make that decision totally ignorant of, and indifferent to, the cost of her choice. Under the merchant restraints, the cardholder neither knows nor cares how costly the transaction is on her chosen product. She has no incentive to avoid the deadweight expense of supracompetitive fees that the merchant then passes on in full to all of its consumers, including debit users and cash payers, in the form of elevated prices. As the Federal Reserve Bank of Boston noted, most consumers do not know or understand that "their decision to pay by credit card involves merchant fees, retail price increases, a nontrivial transfer of income from cash to card payers, and consequently a transfer from low-income to high-income consumers."  Indeed, the challenged merchant restraints incent the consumer to make the least efficient choice and use the products that carry the highest discount fees, due to the supracompetitive revenues derived from merchants fund cardholder rewards programs. As a result, the least affluent U.S. consumers (cash payers) are forced to subsidize the most affluent consumers as they accrete frequent flier points and other perquisites.
As part of the legislative process culminating in the Dodd-Frank Wall Street Reform and Consumer Protection Act, Sen. Dick Durbin proposed an amendment that, among other things, addressed some of the networks' rules relating to the offering of discounts for payment cards at the point of sale (POS). While the Durbin Amendment boldly provided for much-needed regulatory interventions into the price-setting mechanism for debit card interchange rates, the Durbin Amendment as adopted fell far short of providing meaningful relief to merchants and consumers with respect to POS rules. In its final iteration, the Durbin Amendment prohibits the networks from imposing restraints barring merchants from offering consumers discounts or in-kind incentives to use a less expensive payment card provided that - and this is a big proviso - the discount does not differentiate on the basis of issuer or the payment card network.  This proviso - that the merchant may not discriminate based on brand - was the product of late-stage lobbying by American Express and others. Thus, a merchant may not provide a discount or in-kind incentive to encourage an American Express cardholder to use a Discover card, a new low-cost Visa card or any other credit card.
The Division's Proposed Final Judgment with Visa and MasterCard is a meaningful first step in closing the discounting gap of the Durbin Amendment. In the Proposed Final Judgment, Visa and MasterCard agreed not to maintain any rules that prohibit merchants from offering a discount, rebate or in-kind incentive for the use of a particular form of payment, regardless of issuer, brand or payment network.  For the overwhelming majority of U.S. merchants, however, the Proposed Final Judgment offers little actual relief, because those merchants accept (as they must, in order to be competitive) American Express, as well as Visa and MasterCard cards. Under American Express' rules, a merchant still may not offer any discount or incentive that promotes the use of any other branded card over the use of an American Express card.
So, let's say that Discover wants to arrange a promotion with Marriott Hotels, under which Discover will drop its discount rate to zero in exchange for Marriott offering consumers a 1 percent discount if they use a Discover card. Sounds pro-competitive right? It is. But even after the Durbin Amendment and Proposed Final Judgment, the merchant cannot run that promotion unless it is willing to drop American Express. For a major hotel chain, that means going out of business, pure and simple. Again, the upshot here is that in order to obtain substantive relief for merchants, American Express' merchant restraints must also be removed.
The Division and 18 state attorneys general suing with it are not alone in challenging American Express' merchant restraints. The first filed case challenging these rules was a nationwide class action of merchants (of which the author is among the lead counsel), followed by individual actions on behalf of some of the nation's largest merchants.  Recently, a MDL petition was filed that will coordinate all of these proceedings in the Eastern District of New York. 
The true "something about nothing" in this litigation is the proffered justification for the merchant restraints - namely protecting an allegedly delicate consumer at the point of sale in his choice of payment form. The irony of American Express, Visa and MasterCard claiming to be arbiters of consumer rights is lost on few. Even putting aside the big-ticket consumer welfare effect that rescission of the challenged merchant restraints will have - lower prices to all consumers as merchants pass along savings from reduced swipe fees - allowing merchants to communicate with customers at the point of sale and to offer incentives to use a particular form of payment will present consumers with greater choices at check out, or at least more knowledge about the costs of their chosen payment method. One wonders whether the payment card companies feel that their card holders also need to be protected from a merchant asking if a consumer wants to supersize his order or would like a croissant with his latte. Don't these POS communications also "interfere" with the consumer's originally intended purchase?
A growing number of regulatory authorities outside of the United States have challenged the networks' merchant rules prohibiting discounting and surcharging at the point of sale. One country where we can see the impact of regulatory reform is Australia, where American Express joined Visa and MasterCard in rescinding its surcharge prohibitions. Following these reforms, a substantial number of merchants chose to impose surcharges only on American Express transactions or surcharge American Express transactions at a higher rate than Visa and MasterCard transactions, which resulted in American Express dropping its swipe fees by 56 basis points. 
While economists and lawyers may disagree about the extent to which swipe fees will drop when merchants are allowed to encourage the use of cheaper, more efficient payment products, there is absolutely no economic or legal rationale for continuing to ban merchants from informing consumers about the costs associated with their chosen payment form and trying to incent them to use a cheaper form of payment. Consumer information, like sunshine, can have amazing curative powers.
* Tracey practices law in New York as a partner at Friedman Law Group, LLP. Her practice focuses on antitrust and consumer protection class action litigation, including litigation challenging the merchant restraints discussed in this article. The views expressed in this article are Tracey's alone. Tracey thanks her colleague, Scott Levy, for his excellent research assistance.
 The Nilson Report, Issue 957, Sep. 2010 at 1.
 Catherine Clifford, Retailers Score In Swipe Fee Fight, CNNMoney.com, Jun. 23, 2010, http://money.cnn.com/2010/06/23/smallbusiness/small_business_interchange_fees/index.htm.
 David Breitkopf, Visa Holds Most Credit Interchange Rates Flat, American Banker, Vol. 171, Mar. 1, 2006, at 40.
 The Nilson Report, Issue 878, Apr. 2007 at 7.
 Credit Card Interchange Fees Act: Hearing on H.R. 2382 Before the H.R. Fin. Servs. Comm., 111th Cong. at 9, Fig. 3 (2009) (statement of Mallory Duncan, Senior Vice President, General Counsel, National Retail Federation and Merchants Payments Coalition).
 Clifford, supra note 2.
 American Express, Merchant Reference Guide - U.S. at 8 (2010) https://www209.americanexpress.com/merchant/singlevoice/singlevoiceflash/USEng/pdffiles/MerchantPolicyPDFs/Oct2010_US_%20RefGuide.pdf.
 Proposed Final Judgment As To Defendants MasterCard Inc. And Visa Inc., United States, et al. v. American Express Co., et al., 1:10-cv-04496 (E.D.N.Y. Oct. 4, 2010), Docket No. 4 ("Proposed Final Judgment") Sec. IV.B.1-8.
 In re Payment Card Interchange Fee And Merchant Discount Antitrust Litigation, MDL-1720 (JG)(JO) (EDNY).
 Scott Schuh et al., Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations, Federal Reserve Bank of Boston, No. 10-03, at 1 (2010).
 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 1075, 124 Stat. 1376 (Durbin Amendment codified as amended at 15 U.S.C.A. § 1693o-2(b)(2)).
 Proposed Final Judgment, supra note 8.
 In re American Express Anti-Steering Rules Antitrust Litigation, 06-CV-2974 (WHP) (S.D.N.Y.) and Rite Aid Corp., et al., v. American Express Travel Related Services Co., et al., Consolidated Case No. 08-cv-2315 (NGG) (RER) (E.D.N.Y.).
 Motion for Transfer of Actions Pursuant to 28 U.S.C. § 1407, In re American Express Anti-Steering Rules Antitrust Litig., MDL No. 2221 (J.P.M.L. Dec. 6, 2010), DE 1.
 Reserve Bank of Australia, Merchant Fees for Credit and Charge Cards, http://www.rba.gov.au/payments-system/resources/statistics/index.html.
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