This weekend, the lead editorial in the Wall Street Journal was about the Credit Card Fair Fee Act, legislation sponsored by John Conyers (D-MI) and Chris Cannon (R-UT) that would create a special administrative law judge panel to set credit card network interchange fees.
The Journal came out against the legislation, as a simple fee setting regime. Whether an ALJ panel is the best way to fix the interchange problem is certainly a fair issue for debate…once we all acknowledge that there is a serious problem and that a legislative fix might be in order.
I was pleased to see that the Journal recognized that there might be some problems in the card market, even if I am less sanguine that a fix will emerge from the market itself. Still, I want to address a few points in the WSJ editorial, though, that should not go unchallenged.
First, the Journal implied that it is established that credit cards cause higher sales volumes. While credit cards correlate with larger sales, the direction of the causation is still very much an open question. Credit cards might cause people to spend more, or people might choose to use credit cards when they have already decided to make a larger purchase (and these are not in any way exclusive causations and may vary by consumer, merchant, and transaction). If the former is the causation, then cards are a benefit to merchants. If the later, then they are an unneeded expense. This is a fascinating issue that needs a lot more research.
Second, the Journal say that there's a case that MasterCard and Visa have their dominate market position because of the quality of their products. Perhaps. But this ignores the enormous barriers to entry in the card network business. The cost involved in creating an international payment system is staggering—the scope of the venture is alone a huge obstacle. It is also complicated by the two-sided network nature of the card market. Even if a new rival could offer merchants a lower price, MC and Visa’s merchant restraint rules would prevent these prices from being passed on to consumers at the register. The result is that the new card would be attractive to merchants, but not consumers, and to succeed in the card business, a product must appeal to both.
Third, the WSJ also points to the card networks’ recent litigation victory in Kendall v. Visa U.S.A. as evidence that the card networks’ play fair and square. It’s worthwhile discussing the case at length to point out what it does and does not tell us about the validity of antitrust allegations against the credit card networks and their member banks related to interchange fees. Kendall, the owner of a hair salon, sued MC, Visa, and a trio of member banks, alleging an antitrust conspiracy to fix the interchange rate, under section 1 of the Sherman Act. The District Court granted the defendants motion to dismiss under F.R.C.P. 12(b)(6), and the Ninth Circuit affirmed. The standard for a 12(b)(6) motion is that the suit must be dismissed even if everything the plaintiffs alleged were true because it would be insufficient to establish liability.
First, it’s important to note that Kendall has been the sideshow interchange litigation—the main event is MDL 1720, consolidated in the Eastern District of New York. So the outcome in Kendall might not be a good predictor of the MDL outcome(s).
Second, it’s frightening how poorly the Ninth Circuit understands the basic economics of credit card networks. The blame for this lies primarily on the shoulders of the parties, but still, how the Ninth Circuit came out believing that the interchange fee is retained by the card association rather than the issuer, in spite of the District Court’s finding that the issuer keeps the fee, is disturbing. The Ninth Circuit claims that this didn’t affect the outcome, but I’m not so sure, as I’ll explain below.
Also, the Ninth Circuit seems to imply that merchant discount fees are waived entirely if the merchant leaves a sufficient amount of cash in the account. I’ve never heard of such an arrangement—perhaps a lower discount fee, but never a complete waiver of the fee. This seems to feed in to the Ninth Circuit’s unwillingness to accept that the interchange fee sets a base for the merchant discount fee. (But more careful pleading could have helped with this).
Third, the Ninth Circuit held that the plaintiffs had failed to plead sufficient facts against the banks to overcome the standard the Supreme Court laid out in 2007 in Twombley, namely that parallel conduct and a bare assertion of conspiracy alone was insufficient to overcome a 12(b)(6) motion to dismiss.
Here, the Ninth Circuit’s confusion about who gets the interchange fees might actually matter. Twombley dealt with a situation involving only parallel pricing; no mechanism for the conspiracy to set prices was alleged. Kendall, however, alleged such a mechanism—the card associations. The Ninth Circuit greatly overread Twombley to support the propositin that “merely charging, adopting or following the fees set by a Consortium is insufficient as a matter of law to constitute a violation of Section 1 of the Sherman Act.” Simply put, Twombley does not support such a proposition. Twombley dealt with parallelism without a consortium; Twombley had nothing to say about parallel pricing by members of a consortium (a/k/a cartel).
The Ninth Circuit also relies on one of its own precedents, Kline v. Coldwell, Banker & Co.(9th Cir. 1974) for the point that “membership in an association does not render an association's members automatically liable for antitrust violations committed by the association.” That’s true, but Kline involved a suggested fee schedule for LA area realtors. It wasn’t clear from Kline if these were inter-broker fees or fees charged to clients. If the later, it is quite different from interchange; most consortiums do not set the fees paid by one member to another. Consortium membership (and serving on the board) looks different when one is setting the consortium’s own fees (which would be the authorization, clearing, and settlement fees that the 9th Circuit does seems to know about) versus when one is setting the fees to be paid to members of the consortium.
Also, the suggestive nature of the fee in Kline seems distinguishable from the interchange fee. Every acquirer bank pays every issuer bank in a card association the same interchange fee. I can’t say for certain whether it is required, but the whole point of interchange is that it is because it isn’t practical for banks to negotiate thousands of contracts with each other. And Kline merely held that for officers and directors to be co-conspirators in an association’s illegal activities, they must knowingly participate in an individual capacity. These are facts that could have easily been pled: Bank X served on the board of Visa and took an active role in the setting of the interchange fee schedule, to which it then adhered. As an old 8th Circuit case cited in Kline notes, to the “extent that it carries on unlawful activity, [an association] is itself a sort of continuing agreement by which the fixing of prices might be effectuated.”
I haven’t gone through the Kendall pleadings recently, so I can’t say for sure what they pled, but they definitely dropped the ball on the best evidence of a conspiracy—the network rules that enforce parallel pricing. The agreement to be bound by the network rules is the contract/conspiracy/combination in restraint of trade because these network rules set the price of each issuer’s payment—the same. This is a point I’ve emphasized repeatedly in various forums—the winning antitrust issue isn’t interchange, it’s the merchant restraint rules that isolate interchange from market discipline. Current antitrust doctrine, which is designed to screen out fishing expeditions, makes it very hard to win on interchange.
Fourth, as against the card associations themselves, the suit was barred by the old warhorse of Illinois Brick, which prevents indirect purchasers from recovering damages in antitrust suits.
But are merchants really indirect purchasers? Merchants’ contract is with acquirers. The acquirers are selling the networks’ services, and the acquirers are part of the network. But even if we parsed the transaction differently and said that merchants pay the merchant discount fee, not the interchange fee, we still have to ask why interchange fees are set by merchant category, by merchant transaction volume, etc.? This isn’t just the “cost of eggs set[ing] a floor for the price of an omelette on a menu.” This is the chicken farmer setting the price of eggs to vary depending on each individual restaurant customer. The eggs would cost the same restaurant different amounts depending on whose eating the meal. There is no reason for the merchant's profile to affect the interchange fee if the fee is not a fee on the merchant.
And why are some large merchants able to negotiate interchange rebates directly with the networks (or get their own interchange fee categories established)? This doesn’t sound like a classic indirect purchaser. Of course, not alleging these facts was a pleading failure, but a Rule 12(b)(6) motion is as much a judgment on lawyering skills as on the merits of a suit.
Fifth, there is an exception to Illinois Brick for cases in which the direct purchaser will not realistically bring a suit itself. The Kendall plaintiffs should have been able to plead sufficient facts for this exception. What chance is there that an acquirer would sue the networks for the collective setting of the interchange rate? What possible benefit would accrue to the acquirer? And what would the acquirer’s damages be? Because interchange is pass-thru into the merchant discount fee and applies to all acquirers, the acquirer would have to allege that but for interchange, there would be more merchants giving it business. That’s one whopper of a speculation.
Kendall could probably have been better pled. But it illustrates how current antitrust doctrine creates a lot of problems for suits that focus on the collective setting of the interchange rate. Still, that doesn’t mean that the banks and card associations are out of the woods. Even if they’re allowed to set the interchange rate collectively, it is another thing to impose restraints on how merchants can pass along the price. Merchant restraints should have an easier time passing 12(b)(6) scrutiny because they are not just parallel pricing; they are a set of rules, adherence to which is a condition for membership in the card networks. And if they survive a 12(b)(6) motion, it gets much tougher for the card associations because rule of reason analysis will kick in, and it’s awfully hard to show a pro-competitive effect (much less one that outweighs the anti-competitive effect) of most merchant restraint rules.
Like with WSJ, I’m all for a market solution to excessively high interchange fees. But I’m doubtful that the market will solve the problem if left solely to its own devices. Court or legislative intervention is necessary.