Visa and MasterCard Take Their Lumps in Court

I n a long-awaited decision, Judge Barbara Jones of U.S. District Court for the Southern District of New York has ordered Visa and MasterCard to abolish their policies that prevent banks from issuing other card brands, stating that their policies "do weaken competition and harm consumers."

The landmark resolution represents a substantial victory for American Express Co. and Discover Financial Services and could shift the balance of power in the highly competitive card industry, taking away market share from Visa and MasterCard and giving it to American Express and Morgan Stanley Dean Witter's Discover unit.

In a 157-page decision, Jones ruled that American Express and Discover have been unable to prevail upon U.S. banks to issue cards over their networks because of the Visa and MasterCard's exclusionary rules. Jones further said that these rules have the effect of "limiting output of American Express and Discover cards in the United States, and of restricting the competitive strength of American Express and Discover by restraining their merchant acceptance levels and their ability to develop and distribute new features such as smart cards. As a result, the types and number of American Express and Discover cards have been limited and consumers have been deprived of the ability to obtain combinations of the unique features of their preferred bank and each of the four networks."

Government officials also argued that Visa and MasterCard should be forced to alter their practice, known as "dual governance," whereby directors of one association were permitted to hold substantial portfolios in the other association. Jones concluded that "even if market forces had not already all but ended dual governance, since the government has failed to prove that adverse affect, no remedy altering the governing structures of Visa and MasterCard is justified."

Before the decision, banks that were members of the Visa USA/ MasterCard networks were essentially "blocked" from offering cards from rival companies. Visa and MasterCard control a combined 75% of the $1.3 trillion in credit card transactions made annually in the U.S. and are owned by a consortium of roughly 6,000 major U.S. banks.

The government sued Visa and MasterCard in 1998, accusing them of breaking antitrust laws. American Express, Discover, Diner's Club and a host of other smaller issuers were forced to develop their own payment networks. And, American Express, in particular, has been successful at developing co- branding relationships.

Even so, Amex found that it was not restricted from doing business with any of the banks that are members of, and sometimes owners in, the Visa or MasterCard networks. A Bank of America customer, for example, could not get a Discover card linked to her checking account.

Jones' decision abolishing Visa and MasterCard's exclusionary rules might motivate more banks to issue smart cards to differentiate themselves in an increasingly competitive credit card market.

Jones wrote that the restrictive rules1 "effectively foreclose American Express and Discover from competing to issue offline debit cards, which soon will be linked to credit card functions on a single smart card." Furthermore, she wrote, the rules "deprive consumers of the ability to obtain credit cards that combine the unique features of their preferred bank with any of the four network brands, each of which has different qualities, characteristics, features and reputations."

Shares of American Express Co., lackluster for much of the session, jumped $1.56, or nearly 6%, to $29 in the final few minutes of trading immediately following the release of the verdict. Morgan Stanley Dean Witter shares climbed $1.50, or a little more than 3%, to $49.26.

"This a victory," said Frank Torres, legislative counsel for Consumers Union, a nationwide consumer advocacy group. "Consumers eventually will be the real winners and experience the rewards of increased competition in the marketplace and hopefully lower prices and interest rates as banks can now offer a whole panoply of other debit and credit cards and not have to rely on the Visa and MasterCard network."

"This decision has the potential to change the way the card business looks in the United States," said David Hochstim, a credit card industry analyst for Bear Stearns. "If Visa and MasterCard don't appeal, it could be a big positive for American Express and alter the competitive landscape."

Both Visa and MasterCard have said they intend to appeal the parts of Jones' preliminary order that would require them to rescind rules that keep U.S. banks from issuing American Express and Discover cards. In separate legal filings, both associations asked Jones not to force them to open their banks' doors to these companies until, in Visa's words, "a final order of the highest-level appellate court" has been issued.

They have asked the judge to add a provision to her final judgment that would require banks to have firm deals with American Express or Discover before canceling a contract with Visa or MasterCard. In other words, the associations still want banks to have to make an either/or choice.

"As anyone with a mailbox surely knows, the credit and debit card businesses are intensely competitive, offering unmatched choice and value to consumers. Therefore, we are dismayed that the court has seen fit to change the structure of the business with untested remedies and unknown consequences," said Kelly Presta, Vice President, Visa USA.

Noah J. Hanft, General Counsel for MasterCard International, said, "We maintain our belief that the court's decision to repeal this policy will seriously disadvantage American consumers and that we have a strong legal basis to challenge Judge Jones' decision on this count."

The ruling could benefit American Express at a time when the company is unable to occupy its Manhattan headquarters after the terrorist attacks toppled the World Trade Center. Moreover, Amex has stated that it will not be able meet Wall Street estimates because of the attacks, which have decreased travel and spending money among consumers.

"The final decision is a win for the American consumer," said Kenneth I. Chenault, Chairman and CEO of American Express. "It will ultimately lead to more competition and a broader choice of innovative products. ... This decision is consistent with similar decisions from competition authorities around the world."

David Nelms, President, Discover Financial Services, said, "We look forward to the additional consumer choice that will result from the elimination of all their anticompetitive rules and practices, which have been selectively applied only to Discover Card and American Express but not to each other or to Citibank Diners Club."

1 Visa's bylaw 210 (e) 2.10(e) and MasterCard's "Competitive Programs Policy."