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Credit Card Fair Fee Act

posted by Adam Levitin

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.


Your post and the WSJ directly conflict in one area I don't think you address. The WSJ claims that retailers can charge lower prices for cash or credit card purchases on a store card. You write that MC and VC preclude lower prices for competing credit cards.

I was wondering, which is right. I tend to think you are. I used to see discounts for paying cash, e.g., at gas stations, but no more. And I think it is because of the credit card rules.

Could you clear this up? Thanks.

Allan, great question. The WSJ and I are both right. A federal law from the early 1980s, called the Cash Discount Act, as well as some state laws, gives merchants a right to offer discounts to consumers who pay with cash. But card network rules (and state law in a number of states) prohibit a surcharge for paying with credit.

Mathematically this is nonsensical. A discount and an surcharge are the same ($98 cash price plus $2 surcharge is indistinguishable from a $100 credit price and a $2 cash discount). But the economic effect is quite different. Consumers have a much stronger reaction (negative) to a credit surcharge than they do (positive) to a cash discount. That's why the card industry pushed to preserve the right to ban surcharges, when it looked like some legislation was going to pass. (If you want more details, see Edmund Kitch's 1990 JLEO piece or any of my credit card merchant restraint rules pieces).

Cash discounts have never been big in the US outside of gas stations, in part because merchants like credit cards for a host of reasons--shifted credit risk, speed of transaction, correlation (and often assumed causation) with larger purchases, accounting ease, less theft risk, etc.. The problem for merchants is that the cost of accepting credit cards has been going up, while the benefits of accepting them has been static. This is squeezing merchants.

The problem for merchants is that they don't want to drive consumers away from credit cards. Instead, they want to drive them to cheaper credit cards. The right to discount for cash is a worthless tool in this regard. The tool merchants need is the right to price discriminate among credit cards brands and especially among cards with brands (a Visa Signature Plus card can cost the merchant more than 2x a regular Visa cards). But even this right might not be enough--merchants sufficient information to price card payments accurately. Currently, merchants do not know what any particular card transaction costs (unless they have a flat rate merchant discount fee). The info (interchange info, bank ID number) that they need to do effective price discrimination is encoded on the cards, but not available to merchants.

I'm not so sure that a retailer can offer a lower price for payments with a store card. The Cash Discount Act only guarantees a right to discount for payments by "cash, check, or similar means." It isn't clear if credit cards are included in that and the major networks' rules (to the extent they are public) do not permit such a discount. Of course some retailers certainly offer a discount for opening the card, or periodic sales for cardholders. I'm not sure how these fit into card network rules.

I disagree with your first point but I agree with the rest although I'm not a lawyer and I can't comment on the cases. Card acceptance does bring an economic benefit to the stores. The stores know about the cost of accepting cards. If they can get the same level of sales without accepting credit cards, they will not accept credit cards and save some cost. American Express is known to charge more than Visa and MasterCard but many stores still accept American Express. Why can't they get by with accepting Visa and MasterCard only? Don't all customers who want to pay with American Express also have a Visa or MasterCard? The stores accept American Express because the they get higher sales when they do so.

If nothing else, the no-discount rule should be struck down. Then the consumers will have a true economic choice to make at checkout. Want miles or delayed payment? Pay more with a credit card. Don't care about miles and have money in the bank? Pay with an ATM card.

Professor, et al, I don't know anywhere else to go with these questions so I'll lob them out here:

What if a retailer simply refuses/does not give a consumer the option TO pay in cash?

Additionally, what if a consumer is charged an additional fee FOR paying in cash?

The reason I ask is that I dealt with just this situation for the better part of two years with one retailer in particular.

In an earlier post you suggested that the enormous size of contemporary banks, coupled with the lower costs of networking, made it possible for major players like BofA, Citibank, and Chase to construct their own independent credit card operations. (It was in your Visa IPO post.)

Do you still believe this? And would this legislation have an impact on the economics of such a move? We are all familiar, I think, with large players and their lobbyists working the refs to shape new regulations to their advantage. Would setting interchange fees by law make the market unattractive to new entrants by making it impossible for them to set a lower fee than existing players? Worse, is it possible that Congress might cushion the blow to Visa and Mastercard by adding regulations that create other barriers to entry?

I find this aspect of the legislative process very interesting, the more so since, in this case, the card networks may have interests at odds with their member banks, the merchants and, of course, the consumers. It's hard to say who will come out on top, but the realist in me says it won't be the consumers.

For TFB--I don't think we disagree. I was only making a narrow point about whether or not consumers spend more because of using credit cards. Merchants get all sorts of other benefits from accepting credit cards, and it is quite reasonable to have to pay for these benefits. The problem is that normal market forces are not affecting the price merchants pay.

Also, there are plenty of merchants who accept MC/Visa, but not Amex precisely because of the costs. But these days there are Visa and MC cards that can cost just as much as an Amex. I'm willing to believe that consumers might spend more because of purchasing with credit cards, but I just don't think the rather meager literature on the topic proves it.

For Mike Dillon--a federal reserve note is legal tender for all _debts_, public and private. A merchant can always refuse to accept cash in a simultaneous exchange in which no debt is created. You could also contract with a merchant for payment to be limited to specific forms that exclude cash. I don't know of any rule that prohibits a merchant from charging _more_ for cash.

For James--whatever comes of interchange legislation, I would be surprised if it had much of an effect on new entries to the market. It might result in lower interchange revenue, which would make entry into the market less attractive. But interchange is not the bulk of card issuer revenue (Amex is different on this). The major barriers to entry--sheer size/cost and merchant restraint rules--remain untouched by the proposed legislation in its current form.

Re: cash discounts and Regulation Z.

Question: Do cash discounts cause the advance of credit to violate Regulation Z? Ever since learning about consumer affairs in law school, I have wondered this.

Hypo: On a grander scale than retail, there are vehicle sales. Very simplified. Assume I want to buy a car and have $10,000 left to pay after the down payment. The car company offers me a loan of $10,000 at 10%. As an alternative, the car company offers to sell me the car for $9,000 additional cash.

In this scenario, the cost of credit is not only the $10%, but also the extra $1,000 for not paying by cash. The $1,000, however, is not reflected on the paperwork. How does this not violate TLA or Regulation Z.

This ties into the original. If a gas station offers to sell me gas for $3.00 if I use a credit card and $2.97 if I pay cash, is the $.03 a cost of credit for which I should receive notification?

I must be wrong, for I have neither seen nor heard of any litigation on this topic.

Allan, as essentially written up in an earlier comment, the simple answer is: "it's nonsensical, but that's the way it was legislated." It is legal so long as the credit (non cash price) is the list price, with the cash price being a modification of the actual price. You do bring up a good secondary point of how this silly rule can be used to take advantage of people. The real price the dealer wants is the cash price, but by claiming it is not so, they can increase what some consumers pay.

We are living in a free market, not a fair market. Every business is entitled to make as much money as possible. Visa should be allowed to set a rate that will benefit it the most. If merchant finds the credit card fees unreasonable. Very simple, quit taking it. Or just take Discover Card, it's the cheapest.

The best market solution will be quting taking credit cards.

Why whining about fees? it's a free country, Visa never forced merchants taking Visa cards. Anti-trust, there's no case here.

Merchants spent over 160 Billion in advertising vs. 40 B in interchage last year. If you don't like advertising, don't advertising, if you don't like to pay Visa, just don't take it.

Visa has the right to set a rate to benefit it the most. If the profits are high enough, there will be more competition in Card Networks.

Kevin, it's not so easy to stop accepting credit cards if you are a merchant, especially since Visa, MasterCard and Discover Network started offering debit cards and pre-paid cards as well. Now, anyone can get a Visa, MasterCard or Discover Network card, even those with bad credit.

If merchants are already losing business by not accepting Discover Network and American Express, they will lose considerably more by not taking Visa and MasterCard. I know that if a place does not take my Discover Network Card, I never go there again. I go to their competitor across the street who does take my card. And thousands of Discover Network and American Express cardholders do the same everyday. Stop taking Visa and MasterCard, and it is even worse.

Some people don't even carry cash anymore. All businesses where I live take Visa or MasterCard, and usually Discover Network and American Express too. The only thing I don't pay with a card is my rent, and that I use my bank to ACH it directly to their bank account. I don't even write checks anymore. All payments are made electronically either by ACH or card.

The days of paper payments (cash, checks, etc.) are coming to an end. You have to take cards these days in most markets to survive. Sure, there are some hold-outs, but at some point they will be hurting enough to start taking cards. Every McDonald's and Burger King take credit and debit cards now.

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