Once rarely noticed by lawmakers, the payments industry has become a minefield of litigation and legislation, especially in the last 18 months. On state and federal levels, lawyers and legislators have taken direct aim at interchange, tax reporting and the revenues generated by payments. The courts and Capitol Hill have made our business their business. In the end, it will change the way we do business.
Therefore, the livelihoods of ISOs, merchant level salespeople, acquirers and processors are on the line. Many payment professionals believe solidarity within the industry - now more than at any time in the past - is crucial to future success. The feet on the street must join with industry leaders to present a united front to legislators regarding industry regulation. As in any conflict, there is safety and strength in numbers.
"That's the message - reach out to your associations and legislative representatives," said Mary Dees Griffith, President and Chief Operating Officer of medical payment processor Preferred Health Technologies Inc. "This activity in the courts and on the Hill could affect the flow of how every transaction occurs and have disastrous consequences for the fluidity of our systems. We need to educate our people on all the issues.
"What is being lost in translation here is that we need to cry out in a very loud voice that some of what they [legislators] are changing is the very basis of what makes the payments system operate effectively and efficiently today."
Adam Atlas, Toronto-based Payments Attorney and contributing writer to The Green Sheet, agreed the rules and pricing of the card networks are under threat like never before. But Atlas also recognized the power of federally chartered banks as a counterbalance to the proposed legislation.
"The banks are the biggest shareholders in the card networks, and the government has to save the banks," Atlas said. "The Feds have enough to worry about, so credit card regulation won't be high on the agenda anytime soon. Saving the banks is saving their [the U.S. governments'] income, and payments are part of that income for the banks. So why should they get in our way?"
The government first drew battle lines against the industry in 1998, when the U.S. Department of Justice brought an antitrust lawsuit against Visa Inc. and MasterCard Worldwide. It accused the card brand titans of collusion against American Express Co. and Discover Financial Services.
DOJ argued the networks were trying to restrain competition by illegally preventing their member banks from issuing debit and credit cards from the two smaller rivals.
In October 2004, the U.S. Supreme Court ruled that, by attempting to limit AmEx's and Discover's ability to expand their brands during a period of tremendous growth in the payments industry, the top two card companies violated antitrust laws and the spirit of free market competition.
Shortly thereafter, Discover and AmEx filed suit, claiming losses in the billions because of the card giants' anti-competitive practices.
Both suits were settled within the past 12 months. Visa paid AmEx $2.25 billion in November 2007; MasterCard settled with AmEx in June 2008 for approximately $1.8 billion. And both companies resolved the Discover suit for a total of $2.75 billion in October 2008.
"With these settlements, American Express and Discover will be accepted at more and more places because Visa and MasterCard can no longer preclude merchants from accepting these cards," said Dan Fisher, President and Chief Executive Officer of payment consulting company The Copper River Group Inc. This, he added, has "opened up competition. "And no, you are not going to see higher interchange fees or interest rates. That's just throwing fuel on the fire. It would create a public relations debacle."
Since Visa and MasterCard have gone public, Fisher said market forces will compel the card networks to focus on operational efficiencies - including fraud management - to cut costs.
Now, at the end of a decade-long fight, AmEx and Discover have established the right to compete in a fair market against the bigger players. But many other courtroom battles have also reshaped the payments world.
A patent infringement lawsuit filed by AdvanceMe Inc. in September 2007 was one legal affair that, if successful, would have directly impacted cash advance businesses. It was seen by industry analysts as a threat to the entire payments industry.
AdvanceMe accused six cash advance companies of patent infringement on a method the company claimed it had invented for securing debt using the future credit card receivables of merchants. In August 2007, the U.S. District Court, Eastern District of Texas, ruled against the Kennesaw, Georgia-based plaintiff.
In May 2008, the U.S. Federal Circuit Court of Appeals upheld the lower court's ruling, invalidating AdvanceMe's patent. According to Atlas, the ruling prevented AdvanceMe from charging licensing fees to other cash advance companies to use its patented method for merchant funding.
But zero hour for the payments wars could arguably be 1996, when Wal-Mart Stores Inc. - along with millions of retailers - filed a class-action suit against Visa and MasterCard. The suit alleged that as part of their "honor all cards" policy, the two card brands violated antitrust laws by forcing merchants to accept credit, PIN debit and the more costly (from an interchange rate perspective) signature debit cards.
The Merchants Payments Coalition, representing approximately 2.7 million merchants with 50 million employees, accused Visa and MasterCard of attempting to monopolize the debit market. "The MPC is a strong political organization that is dedicated to changing the status quo relative to payment services," said Paul Martaus, President of payments consultancy Martaus & Associates.
"They are the singular reason we are faced with all these issues today," he added. "They know it's difficult to impact a national agenda and get America's attention, so they've also adopted a state-by-state agenda, trying to enact legislation there as well." Martaus said additional legislative initiatives promulgated by the MPC throughout the country have only served to "muddy the waters."
However, according to Mallory Duncan, Chairman of the MPC, retailers are not seeking regulation in legislation. They merely want to open up competition through negotiation and to participate in how interchange fees are set.
"If by being responsible for these legislative issues, they mean that we have shown the light on the credit card industry's bad practices, then yes we are," Duncan said. "But those familiar with the credit card industry have been aghast at the behavior they are engaging in."
The Wal-Mart suit was settled in 2003. As a result, Visa and MasterCard agreed to throw out the honor all cards policy, pay the retailers $3 billion and reduce debit transaction fees.
In 2003, First Data Corp. wanted to acquire its competitor Concord EFS Inc. - which owned the STAR debit network - to expand its own debit footprint.
The DOJ and seven states filed suit to block the $7.8 billion purchase. First Data's accusers alleged the acquisition would reduce competition among PIN debit networks and increase transaction fees. The DOJ settled the suit in 2004, on precondition that First Data sell much of its stake in another debit network - NYCE.
In 2005, four trade groups, representing 130,000 merchants and several major supermarket and drugstore chains, sued Visa. The retailers accused the card network and its member banks of "conspiring to eliminate merchants' ability to negotiate interchange fees and engage in price fixing and other practices to stifle competition." That case is still pending.
"We are simply asking to negotiate the same as any other vendor providing a service," said Craig Shearman, Vice President of Government Affairs for the National Retail Federation.
"According to a Diamond Consulting report a couple of years ago, only 13 percent of interchange goes to the cost of processing. The rest goes into marketing, rewards programs and profits. We feel they're basically asking us to fund their marketing programs."
"There has been considerable litigation activity, no doubt, but eventually, I think these lawsuits will settle down," said Dennis Moroney, TowerGroup Inc.'s Research Director, Bank Cards Division. "And since Visa and MasterCard are now publicly traded companies, any lingering lawsuits create uncertainty with investors, and no public company wants that." The dust of litigation appeared to be settling in 2007, but the government was just ramping up its efforts to expand its oversight and regulatory powers over an industry that had gone unregulated for 20 years. "In my opinion, all this new attention is the Fed's way of saying, 'Somewhere along the line the piper has to be paid,'" Moroney said.
Allegations by merchants and consumer protection organizations of price fixing and collusion by the card networks were becoming all too familiar in Washington. Alarm bells sounded. Congress pulled out its long-range scope and drew a bead on the payments industry's back.
What followed was a chain reaction of federal and state regulatory bills introduced against the financial services sector. Martaus suspects the MPC - along with the National Association of Convenience Stores, the NRF and other organizations - told Congress the payments industry was out of control.
"These guys are pointing out all these lawsuits to legislators and saying to them, 'Where there's smoke there's fire - this stuff needs to be controlled, and you are the guys to do it,'" Martaus said.
The government countered with a frontal assault of legislation unprecedented in the financial services and payments industries. "Understand that our industry has never had this kind of force marshaled against us before," Martaus added. According to Fisher, financial institutions didn't recognize the magnitude of the issue until it was too late. "You don't start looking for landmines after you're in the middle of the field," he said.
Enter HR 5546, the Credit Card Fair Fee Act of 2008, introduced on March 6 by Reps. Chris Cannon, R-Utah, and John Conyers, D-Mich., on March 6. Passed by the House Judiciary Committee on July 16, 2008, by a 19 to 16 vote, the bill is currently on the floor of the House. A companion bill, SB 3086, was introduced by Sen. Dick Durbin, D-Ill., that summer. SB 3086 is in the Senate Judiciary Committee.
If the bills become law, merchants will be able to negotiate interchange fees with Visa and MasterCard. SB 3086 also allows for a three-judge arbitration panel appointed by the DOJ and the Federal Trade Commission to determine interchange rates if the parties cannot agree on fee structures.
Many payments industry experts see these companion bills as a knee-jerk reaction to a manufactured problem and say there are too many unresolved issues in the bills for appropriate implementation.
"First of all, with the meltdown on Wall Street and the mortgage crisis, everything changes, and there may be a new and different call for regulation of financial institutions," Martaus said. Regarding interchange fee negotiation, Martaus said, "They're going to take the largest processors, force them to negotiate with the largest merchants - and that's going to be the discount rate? If that happens, the little guys - the smaller ISOs, processors, acquirers and the mom and pops - are going to get killed."
Duncan's frustration stems from what he perceives to be the credit card industry's "take it or leave it" attitude toward interchange. "We went to Congress to say that if they are not willing to engage in one-on-one negotiations, at least give us the same bargaining power. There are really only two things we are looking for here: transparency and some semblance of competition, which I believe is achieved only through genuine negotiation."
Naturally, the Internal Revenue Service noticed all the litigation and legislation and decided to get a piece of the action. It came on July 29, 2008, when President Bush signed into law HR 3221, the American Housing Rescue and Foreclosure Prevention Act. Beginning Dec. 31, 2010, the new law will require processors and acquirers to report merchant credit and debit card transactions to the IRS. Additionally, the reports must be filed using merchants' taxpayer identification numbers (TINs). Currently, the industry's reporting mechanisms are based on merchant account numbers, not TINs. Reports based on TINs will require costly industry-wide application upgrades.
"The IRS believed that small businesses were not reporting revenues accurately, hence this law," Dees Griffith said. "We [the ETA] fought this actively, but failed to defeat it. But it wasn't the heightened attention on the credit card industry so much as it was that Congress needed money to pay for other things. And the way they get money? By looking at untapped revenue sources, like us."
Even as pundits say there is no hope for a payments panacea to this legislative throw down, Fisher sees efforts to regulate the industry as ultimately healthy.
"The banks need to start looking for more diversified income, and the industry as a whole needs to sue for peace and say, 'Look, we're all going to lose on this if we continue on this path, so let's back up, regroup, and find a better way,'" Fisher said.
"And, in my opinion, I think the legal process is changing the dynamics of the industry and is forcing the competition to evolve in a direction they would not have gone without a legal nudge."
Moreover, Martaus is confident not only of the payments industry's ability to work through the current morass of legislation and litigation, but to survive and thrive despite it. "Sales professionals who understand the merchant services business and are serious about it will continue to find a way to make money.
"Understand that the independent sales organizations represent one of the singularly most entrepreneurial spirits in the world. These folks are driven by greed - and I don't mean that in a bad way. Maybe we have to be regulated, but in my estimation the entrepreneurship in our industry is so strong that our people will find a way to work around it no matter what gets thrown at them. They always find a way."
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