Still Unsettled

A divided Supreme Court says American Express Co.’s anti-steering rules for merchants don’t violate antitrust law. What does that mean for card payments, especially with another big card-related court case heading for a settlement?

The U.S. Supreme Court’s recent 5-4 decision upholding American Express Co.’s anti-steering rules for merchants has lots of implications, but the big takeaway is that despite the high profile of the case, not much will change for relations between merchants and the payment card networks—yet.

A likely more important issue for most merchants is just what lies ahead for their relations with the Visa Inc. and Mastercard Inc. networks. The state of those relations could be determined by the outcome of a massive case known as MDL 1720, which involves merchant challenges to Visa and Mastercard credit card interchange and card-acceptance rules. This case could be getting close its second settlement.

The litigation, which dates back to 2005 and has had countless twists and turns, including an appellate court’s 2016 rejection of a $5.7 billion class-action settlement struck four years earlier, is pending in U.S. District Court in Brooklyn, N.Y. The class merchant plaintiffs are now divided into two groups. One seeks monetary damages, while another seeks changes in acceptance rules.

But many large merchants had opted out of the now-moot 2012 class settlement—merchants representing slightly more than 25% of Visa and Mastercard purchase volume—and some of them then sued the card networks on their own. These merchants are now clustered into several different groups with different lawyers, and their claims also are being adjudicated under the MDL 1720 umbrella.

Mastercard disclosed in a July regulatory filing that negotiations with merchants were moving along and that a new settlement could be reached by Sept. 30. Some reports in the financial press pegged the settlement value at possibly $6.5 billion. But as of mid-August, it was unclear to what extent each of the major groups, particularly the opt-out merchants, would be covered by any settlement.

A Wild Card

So, while the AmEx case settled some issues, MDL 1720 remains a wild card.

“I don’t see the Supreme Court decision as something that gives the [bank card] networks a pass on the conduct that’s been challenged, far from it,” says attorney Jeffrey I. Shinder, managing partner at Constantine Cannon LLP in New York who is representing a group of 65 large opt-out merchants.

“I think the future of this industry will be determined by two broad forces,” Shinder continues. “One, the outcome of these [large-merchant] cases, and the manner in which the digitization of the industry as technology changes the way people pay—how that’s going to affect the prevailing paradigm.”

The AmEx case, however, marks a milestone in how courts view payment card networks. The Supreme Court endorsed a view held by many economists that card markets are two-sided affairs with merchants and consumers each playing essential roles, and, more importantly, that network price increases to merchants do not necessarily harm consumers. As such, the court said AmEx’s rules that ban merchants from steering customers to cheaper forms of payment do not violate antitrust law.

Retailer trade groups quickly signaled their disappointment when the high court’s ruling came down June 25.

“It’s certainly a setback,” says Mark Horwedel, chief executive of the Merchant Advisory Group, a Minneapolis-based association of mostly large merchants concerned with payments issues. “The merchant alternatives to hold down the cost of payment cards have gotten fewer as a result of this decision.”

A Big Winner

American Express clearly is a big winner in the seemingly endless legal battles between merchants, card networks, and government over payment card acceptance costs and rules.

At the direction of now-retired chief executive Kenneth I. Chenault, the travel-and-entertainment card network took a major risk in 2010 when it chose to fight the U.S. Department of Justice and 17 states that challenged the anti-steering rules of not only AmEx, but also those of Visa and Mastercard. The DoJ and the states said such rules were anti-competitive.

Rather than fight what looked to be yet another lengthy court battle, Visa and Mastercard immediately settled and changed their rules to allow steering. But AmEx insisted its so-called non-discrimination provisions were essential to its business model.

In February 2015, AmEx lost a seven-week bench trial before U.S. District Judge Nicholas G. Garaufis in the Brooklyn court, but appealed to the Second U.S. Circuit Court of Appeals in New York and won. Eight states led by Ohio then took the fight to the Supreme Court, with the DoJ no longer playing the lead but a supporting role.

Associate Justice Clarence Thomas, joined by the court’s three other conservatives and swing vote Associate Justice Anthony Kennedy (who recently retired), upheld the Second Circuit’s decision that AmEx’s rules did not violate the Sherman Act, one of Congress’s main antitrust laws. The court’s four liberals dissented in an opinion written by Associate Justice Stephen G. Breyer.

“This was a long battle, but well worth the fight because important issues were at stake: consumer choice, fair market competition, and the ability to deliver innovative products and services to our customers, both consumers and merchants,” Chenault’s successor, AmEx chairman and CEO Stephen J. Squeri, said in a statement.

‘The Optimal Balance’

In his 20-page opinion, Thomas wrote that “unlike traditional markets, two-sided platforms exhibit ‘indirect network effects,’ which exist where the value of the platform to one group depends on how many members of another group participate.”

“Two-sided platforms must take these effects into account before making a change in price on either side, or they risk creating a feedback loop of declining demand,” Thomas’s opinion said. “Thus, striking the optimal balance of the prices charged on each side of the platform is essential for two-sided platforms to maximize the value of their services and to compete with their rivals.”

Thomas noted that AmEx’s business model depends on relatively high merchant fees to fund its rich rewards programs for cardholders. In contrast, he wrote that Visa and Mastercard “have significant structural advantages over AmEx.”

Most of the nation’s banks belong to their networks, translating into a card base about eight times bigger than AmEx’s. And, relying on 2013 numbers, he said that about 6.4 million merchants accepted Visa and Mastercard cards compared with only 3.4 million for AmEx.

The DoJ and the states failed to prove that AmEx’s behavior was anticompetitive, according to Thomas. He wrote that AmEx actually spurred network competition, pointing out that AmEx inspired Visa and Mastercard issuers to come out with premium cards of their own, and that when AmEx raised merchant fees between 2005 and 2010, “some merchants chose to leave its network.” Merchants’ fees to accept cards have declined by about 50% since the 1950s, Thomas said.

Thomas’s opinion essentially says the card market is one entity, not two separate ones comprised of merchants and consumers, respectively, and concluded that AmEx didn’t have the market power to raise merchant pricing above what would be expected in a normal market.

A law professor and former DoJ attorney who worked on a high-profile earlier card case believes the Supreme Court majority made the right call.

“There’s big difference between American Express and Visa and Mastercard,” says Steven Semeraro, director of the Intellectual Property Fellowship Program at the Thomas Jefferson School of Law in San Diego. Merchants believe “they have no alternative” but to accept Visa and Mastercard cards, but not AmEx, he says.

“From my perspective, merchants like credit cards, they just want to pay less,” says Semeraro. “They’re looking for a legal avenue that might enable them to do that, but I don’t see how this [case] hurts them. If they don’t like AmEx, they can stop taking it.”

‘Nonsensical’ Argument

Back in 1998, the DoJ sued Visa and Mastercard over their rules prohibiting their bank and credit-union members—both were financial-institution-owned associations at the time—from issuing cards on other networks such as AmEx or Discover. The DoJ also wanted to untie the governance structures of the two associations, which the feds claimed were not true competitors.

Semeraro was the DoJ’s lead attorney during the investigative phase of that case, but he left before it was adjudicated. The bans on issuer participation in other networks were overturned, and a few banks then began issuing AmEx-branded cards.

The DoJ, however, failed in its bid to unscramble network governance. But Semeraro says the DoJ ultimately “won as a practical matter” a few years later because both networks held initial public offerings and become investor-owned companies.

Payments consultant Eric Grover of Minden, Nev.-based Intrepid Ventures says “any argument that AmEx had market power was nonsensical.” He also applauded Thomas’s close attention to the interplay between the consumer and merchant sides of payment networks.

In contrast, regulators in the European Union and Australia, as well as the U.S. merchant lobby, have mostly focused on the cost of card acceptance for merchants, Grover says. “In almost every case where it’s framed that way, it [results in] some sort of regulation, price cap, or restriction on what networks can mandate around acceptance of their products,” he says.

‘Premium Business Model’

In his dissent, however, Breyer said the court majority “devotes little attention to the district court’s detailed factual findings.” It came out at trial that beginning in 2005 AmEx raised its merchant rates 20 separate times over five years, but, thanks to the non-discrimination provisions, “it did not lose the business of any large merchant,” Breyer wrote. “Nor did American Express increase benefits (or cut credit card prices) to American Express cardholders in tandem with the merchant price increases.”

Breyer also highlighted the trial court’s findings about Discover Financial Services, the youngest and smallest of the four U.S. general-purpose card networks, when it tried to attract merchants by charging them less than Visa, Mastercard, and AmEx.

“The court determined that these efforts failed because of American Express’ (and the other card companies’) ‘nondiscrimination provisions,’” Breyer wrote, quoting from Garaufis’s decision. “Because the provisions eliminated any advantage that lower prices might produce, Discover ‘abandoned its low-price business model’ and raised its merchant fees to match those of its competitors. This series of events, the court concluded, was ‘emblematic of the harm done to the competitive process’ by the ‘nondiscrimination provisions.’”

For AmEx, the Supreme Court’s decision means the company can continue a policy forged when it was much more of a T&E brand whose primary cardholders were business travelers and upscale consumers.

“It preserves AmEx’s ability to preserve its premium business model,” says Thomas McCrohan, managing director and senior analyst for financial technology and payments at Mizuho Securities USA LLC in New York City.

AmEx still markets heavily to that core base of upscale consumers and merchants, but it also has been working for years to get “everyday” merchants such as discount retailers, grocery stores, and small, local merchants to accept its cards, and to broaden its cardholder base.

“This [decision] allows them to go forward with their strategy,” says Semeraro. “I don’t really understand it, but I guess they’ve been doing okay with it.”

One element of AmEx’s recent strategy has been a gradual reduction in its average discount rate to attract merchants, especially small ones.

‘Loath To Surcharge’

While possible settlements in the MDL 1720 case could generate damage awards and potentially loosen rules for merchants over surcharging and other acceptance rules, the Supreme Court opinion in the AmEx case still could raise hurdles for merchants in future legal challenges over such rules.

“They [merchants] need to prove that consumers are being harmed by the fees merchants are paying,” and that prices are higher because of those fees, says McCrohan. “How the heck do you prove that? They just can’t look at it through one lens.”

While the AmEx case and a final end to the lengthy MDL 1720 litigation could give merchants more clarity about what’s permitted and not permitted regarding card acceptance, merchants are restrained by their overarching desire to please customers. Pleasing customers usually includes accepting whatever payment form they present. As such very few big merchants surcharge card transactions, according to the MAG’s Horwedel.

“Not much of it is going on among large merchants who are very much loath to surcharge because of potential consumer backlash,” he says. But he adds: “I run into it all the time at small merchants, often restaurants that have minimums to accept, or surcharges to accept, and even though they may not be operating within the rules of the networks.”

Analyst McCrohan notes that despite all the litigation, “the bigger merchants have learned how to navigate the interchange world, because they’ve all cut side deals” with the networks. He estimates that the largest merchants are probably paying only 70 to 100 basis points (0.70% to 1%) of the transaction to accept cards. “They get a lot of value for that,” he says.

And maybe when the networks and merchants can all agree on what’s fair value for everybody, the court fighting will end.