oint control of card Associations and exclusionary rules, as decided in "U.S.A. vs. Visa and MasterCard," U.S. Court of Appeal, Second Circuit (344 F3d 229), Sept. 17, 2003.

In most of my columns, I try to provide "nuts and bolts" practical advice for the ISO/MLS or processor on common legal issues that arise, but for this column, I decided to take a bird's eye view of some of the issues facing card Associations in the payment processing industry.

These issues might seem distant from the concerns of the processor or ISO/MLS that slogs it out everyday on the pavement, but the outcomes of decided cases involving the Associations can actually have a dramatic impact on the entire payments industry, from Visa and MasterCard to Chase to giant retailers such as Sears, Roebuck and Co. and Wal-Mart, Inc., down to the mom-and-pop merchants.

Consider a fairly recent case: "U.S.A. vs. Visa and MasterCard," U.S. Court of Appeal, Second Circuit (344 F3d 229), Sept. 17, 2003. This case addresses the anti-competitive issues arising from MasterCard's and Visa's exclusionary rules that prevented their member banks from issuing cards from Associations other than Visa or MasterCard.

The Antitrust Division of the U.S. Department of Justice (DOJ) brought the case against Visa and MasterCard. The DOJ alleged the Associations violated Section 1 of the Sherman Antitrust Act, which reads: "every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States ... is declared to be illegal."

In ordinary English, this means that any two or more parties that make an agreement with the intention of restraining trade and then do restrain trade are in violation of the law.

The U.S. District Court in the Southern District of New York first decided on the case in 2001 in a 157-page judgment. The U.S. Court of Appeals affirmed that ruling in 2003 in a much shorter judgment ("American Express Seeking U.S. Bank Partners," The Green Sheet, Oct. 13, 2003, issue 03:10:01). Following are some of the important parts of the case:

The Associations: General Background

According to the facts reported in the case, approximately 20,000 member banks own MasterCard, and approximately 14,000 member banks own Visa U.S.A. Both Visa U.S.A. and MasterCard operate an acquiring network in the United States through their respective member banks.

Visa U.S.A. and MasterCard are non-profit corporations, which means that in principle, at the end of each financial year, whatever funds they receive they must spend or distribute among their members.

The Associations themselves, in principle, are not supposed to accumulate capital. The Associations use any funds not redistributed to their members for the expenses of the Association, such as maintaining their respective networks.

Many people have a hard time believing that the Associations are non-profit corporations, but they are. Just because they receive very large amounts of money, does not mean that they are for-profit. The profits generated by the issuing and acquiring businesses are accrued to the member banks and not the Associations.

In contrast to the indirect channeling of earnings through the non-profit Visa and MasterCard Associations, American Express Co. and Morgan Stanley's Discover Financial Services issue their cards directly.

Principal Legal Issue: Is the Exclusionary Rule Illegal?

Visa's and MasterCard's exclusionary rules prevented their members from issuing cards other than those with Visa or MasterCard brands. For example, if the Utah Savings Bank is a Visa issuer, it could also become a MasterCard issuer, but it could not become an American Express or Discover card issuer.

In this case, the market for the supply of network services to banks was at issue. There are four principal credit card network suppliers: Visa, MasterCard, American Express and Discover.

If the Utah Savings Bank served as Visa issuer and acquirer, and Visa's rules prevented it from becoming an American Express issuer or acquirer, then the rule preventing American Express from providing its issuing and acquiring network to the Utah Savings Bank could be considered an illegal restraint of trade.

That was essentially the conclusion of the court in this case. After analysis of the legal criteria for an illegal restraint of trade, such as market power, and actual restraint on competition, the court concluded that the rule harmed competition. According to the court's decision, Visa and MasterCard were obliged to repeal the rule.

Commentary

For the ordinary ISO/MLS or processor, I think it's important to view this case and others like it as good examples of how the "buck" does stop somewhere in this industry. As much as it might surprise readers, banks and their Associations are bound by the law and are occasionally corrected when their rules go outside the bounds of the law.

There are frequent occurrences of unfair or illegal activity in the merchant acquiring business; however, speaking from my experience as a lawyer, I would like to remind readers that the letter of the law usually sides with the ethically correct conclusion to a dispute.

In the case summarized above, the court found that the card Associations were unduly restraining trade by not allowing their members to use other issuers' networks, such as those of American Express or Discover.

Other legal questions arose from the dominant position of the two Associations in the issuing and acquiring markets. For example (and this was noted in the case), merchants don't really have a choice to use some other acquiring network if they find that the Visa or MasterCard interchange rates are too high.

Experts testified in the case that changes in Visa and MasterCard interchange rates do not generally result in merchants no longer accepting cards of the Associations.

PSW Sues Visa, MasterCard and First Data,

Most likely inspired by the court's decision in "USA vs. Visa and MasterCard," Rhode Island-based PSW, Inc., a credit card processor for Internet merchants, filed a new claim in August 2004 against Visa, MasterCard, and First Data Corp.'s First Financial Bank and First Data Merchant Services for restraint of trade, seeking more than $240 million in damages.

The 12-count complaint alleges the defendants used monopoly power to employ policies that unreasonably excluded competition and restrained trade in the credit card and credit card processing markets. The complaint alleges interference with contractual relations, breach of good faith and fair dealing, embezzlement and breach of contract.

PSW claims that it was forced to pay higher prices for network services and excessive fees, and comply with unknown, continuously changing rules. PSW also claims that the defendants usurped PSW's profits and forced it out of business. The PSW case brings to light the fascinating point that interchange pricing is organized to levy the highest fees from those merchants who need credit card processing the most: Internet businesses.

The "official" justification for those higher fees is that there is a higher level of risk associated with Internet merchants. However, PSW alleges in the case that 80% of Internet chargebacks are not from fraud through stolen cards, but rather from "friendly fraud" instigated by customers who change their minds after making a purchase.

This leaves the acquiring bank with no ability to determine whether the cards were truly stolen or whether the cardholders simply changed their minds.

PSW argues that the Associations could easily implement monitoring systems to ferret out friendly fraud and thereby reduce the overall amount of fraud, which is used to justify higher fees for Internet merchants.

PSW also argues that it was ultimately put out of business by a combination of high fees and fines that it says were unjustified. The PSW case raises a very interesting anti-trust legal issue that is on the minds of all participants in the business.

The purpose of this edition of "Legal Ease" is to remind readers that no one is above the law; it's important to exercise your right to challenge any adverse party, whether it be an ISO, processor, bank or card Association. Both the "U.S.A. vs. Visa/MasterCard" case and the PSW case serve as good examples of this kind of advocacy.

In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. For further information on this article, please contact Adam Atlas, Attorney at Law by e-mail at atlas@adamatlas.com or by phone at 514-842-0886.