An Analysis of the Proposed Interchange Fee Litigation Settlement

8/20/2019 An Analysis of the Proposed Interchange Fee Litigation Settlement

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GEORGETOWN LAW Faculty Publications

Georgetown Law and Economics Research Paper No. 12-033

Georgetown Public Law Research Paper No. 12-125 August 21, 2012

An Analysis of the Proposed Interchange FeeLitigation Settlement

Adam J. LevitinProfessor of Law

Georgetown University Law Center [email protected]

This paper can be downloaded without charge from:SSRN: http://ssrn.com/abstract=2133361

Posted with permission of the authors

mailto:[email protected]:[email protected]://ssrn.com/abstract=2133361http://ssrn.com/abstract=2133361http://ssrn.com/abstract=2133361http://ssrn.com/abstract=2133361http://ssrn.com/abstract=2133361mailto:[email protected]


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AN ANALYSIS OF THE PROPOSEDINTERCHANGE FEE LITIGATION SETTLEMENT

ADAM J. LEVITIN†

ABSTRACT

This paper is a brief analysis of the proposed class settlement in

In re Interchange Fee and Merchant Discount Antitrust Litigation, MDL1720 (E.D.N.Y.). The analysis concludes that the relief plaintiff class

members would obtain from the proposed settlement is largely illusory.

The settlement does not result in meaningful reform of the interchange

fee system and appears to provide less relief than would likely result

from continued litigation. In short, the settlement is a bad deal for

merchant plaintiffs and the public at large.

I. THE CLASS SETTLEMENT ................................................................................... 3

II. A NALYSIS ......................................................................................................... 5

A. Cash Payment and Interchange Fee Reduction........................................... 5

B. Injunctive Relief .......................... .............. .............. ............... .............. ........ 6

1. Surcharging ............. .............. .............. .............. .............. .............. ........... 7 2. All-Outlets ............................................................................................... 10

3. Collective Bargaining (Group Buying) .................................................. 11

4. What’s Missing: Honor All Cards, Default Interchange, and Routing . 12

C. The Release .............. .............. ............... .............. .............. .............. ........... 14

D. The Individual Settlements .............. .............. .............. .............. ............... . 19

III. WHAT TO MAKE OF IT ALL? ......................................................................... 19

A. Is This Meaningful Relief? ............. .............. .............. .............. .............. .... 19

B. Comparison with Potential Relief from Continued Litigation ............. ...... 20

C. The Public Interest .............. .............. .............. ............... .............. ............. 23

CONCLUSION ........................................................................................................ 24

† Bruce W. Nichols Visiting Professor of Law, Harvard Law School; Professor

of Law, Georgetown University Law Center. Professor Levitin has no financial stake inthe interchange litigation except as a consumer and is not employed by any partyinvolved in the litigation or lobbying on interchange issues. This version has beenrevised to account for comments from plaintiffs’ Class Counsel.


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8/21/2012] I NTERCHANGE S ETTLEMENT A NALYSIS

© 2012, Adam J. Levitin

2

BACKGROUND

Seven years after merchants filed antitrust litigation relating to

the setting of credit card interchange or “swipe” fees,1 defendants

MasterCard, Visa, and fourteen of their largest member banks

(collectively the “card networks” or “Defendants”) have agreed in principle to a settlement, both with counsel representing a putative

merchant class (“Class Counsel”) and with several individual plaintiffs.

The proposed settlement comes months before trial was scheduled to begin, and also before any rulings on class certification and dispositive

pre-trial motions.

The proposed class action settlement, which must be approved

by the court, promises to put an end to the over decade long struggle between merchants and banks over interchange fees. Is the settlement a

good deal for merchants? Is it in the interest of the public at large? This brief paper first considers the settlement from the merchant perspectiveand then from the public interest.

2

This analysis considers the proposed settlement from two

metrics. First, does the settlement result in meaningful reform of theinterchange fee system? That is, does the settlement leave the existing

system largely intact or does it reshape the economics of payments?This metric matters for merchants, for if the settlement does not result in

real reform, then the litigation approach to interchange has been a failure.While the case is private antitrust litigation, antitrust is not private law,

even when it is privately enforced—it is a public policy concern.

1 In re Payment Card Interchange Fee & Merchant Discount Antitrust

Litigation (MDL 1720, E.D.N.Y. 2005).2 Whatever one thinks of the proposed settlement, it is important to note what

the litigation has already accomplished. The litigation may have sped up the MasterCardand Visa IPOs (which appear to have been planned before the litigation), and it alsodeveloped the factual record for the Department of Justice’s suit against MasterCard,Visa, and American Express, and subsequent settlement with MasterCard and Visa.

Whether or not these developments have ultimately been positive for merchantsor the public is open to debate. The IPOs are themselves challenged and sought to beunwound in the First and Second Amended Supplemental Amended Class Actioncomplaints as violations of the antitrust laws. The IPOs ended concerns about explicit

interchange pricing fixing between competing card issuers through the networks, butcreated a new mouth to feed at the interchange table—the public investors in the cardnetworks. The result appears to have been higher total costs of interchange plus networkfees for most merchants. Similarly, the Department of Justice suit, resulted in little

meaningful relief for merchants, and the settlement has largely sidelined the Departmentof Justice from the interchange issue. Neither of these developments goes to the merits ofthe settlement, but instead toward the efficacy of the litigation approach to theinterchange issue.


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Accordingly, it is appropriate to judge an antitrust settlement by anabsolute reform metric.

Second, does the settlement result in greater relief for the plaintiffs than they would likely have obtained through continued

litigation? This metric is the traditional litigation measure for evaluating

settlements. It is a relative, rather than an absolute metric, and does notspeak to the overall success of the litigation approach to the interchange

problem.

This analysis concludes that the proposed class settlement doesnot result in a meaningful reform of the current interchange fee system.The proposed settlement also likely provides plaintiffs with far less value

than would be obtained through continued litigation. Merchants wouldreceive only minimal benefits under the proposed settlement in exchange

for a broad release that absolves the card networks of liability for the

current interchange system now and in the future.

Not only will the settlement end all current and future merchantinterchange litigation if approved, but approval may well preclude efforts

to further reform the interchange system legislatively. In other words, if

the class settlement is approved, it may permanently freeze theeconomics of payments, to the detriment of innovation and competition.

The United States will remain stuck with the most expensive paymentsystems in the developed world, a deadweight loss on every transaction.Accordingly, the settlement is of particular importance, not just to

existing merchants, but also to all users of payments systems—that is the public at large.

The analysis proceeds as follows. Section I provides anoverview of the settlement. Section II undertakes a more detailedanalysis of the major components of the settlement. Section III steps

back to consider the settlement overall, both from an absolute reform perspective and from a baseline of the relief merchants would likely

obtain through continued litigation.

I. THE CLASS SETTLEMENT

The proposed settlement envisions two classes of plaintiffs. First,is a monetary damages class, known as a Rule 23(b)(3) class after a

Federal Rule of Civil Procedure. Individual plaintiffs can opt out of thisclass.

3 The other class is an injunctive relief class known as a Rule

23(b)(2) class. The (b)(2) class is mandatory for all US merchants that

3 Proposed Settlement, ¶ 2(a).


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currently or in the future accept any MasterCard or Visa-brand products;there is no ability for merchants to opt-out of the (b)(2) class.

4

The monetary damages (b)(3) class would receive a one-time payment of $6.05 billion in cash. The $6.05 billion number assuming no

opt outs and is gross of attorneys’ fees, expenses, and settlement

administration costs; in other words, the actual settlement payment will be substantially lower. Moreover, the funds will not be fully disbursed

for a few years.

The monetary damages (b)(3) class will also receive theequivalent of a 10 basis point reduction in interchange fees for eightmonths.5 This reduction is to be translated into an additional cash

payment.

6

The interchange reduction is assumed, but not guaranteed to be worth up to $1.2 billion, although again, it will be reduced for opt-

outs, attorneys’ fees, etc. In total, then, the most the (b)(3) class could

receive, gross of fees and expenses, is $7.25 billion.

The injunctive relief (b)(2) class would receive three types ofinjunctive relief. First, MasterCard and Visa would alter their no-

surcharge rules, which currently prohibit any surcharging by merchants.

The altered rules would permit merchants to surcharge by either brand or by product (e.g., Visa Signature Plus or Visa Signature card lines).

Surcharges would be capped, however, and merchants would be requiredto surcharge any more expensive cards they accept. The surcharging provision is theoretically the most significant provision in the settlement

in terms of effecting payment system economics.

Second, MasterCard and Visa would alter their “all-outlets” rules,

which currently require merchants that accept cards to accept them at allof their stores on identical terms. Under the settlement, the all-outletsrule would only apply to stores within a brand or trade name. A holding

company with related retail subsidiaries operating under different namescould have different card acceptance practices at each theme.

Third, MasterCard and Visa would agree to engage in good faith

negotiations with appropriately constituted groups of merchants,

essentially enabling merchants to bargain collectively (or through tradegroups) over interchange fees.

This relief is in exchange for a release that covers all merchantclaims relating to interchange or card network rules. It covers not only

4 Proposed Settlement, ¶ 2(b).

5 Proposed Settlement, ¶¶ 12-13.

6 Id.


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claims arising from the past effect of the interchange system, but alsoclaims arising from the future effects of the system,

7 including claims

that plaintiffs do not know they have.8 The release does not cover

potential claims by government or consumers or competing networks,

although it is unlikely that any of these groups would successfully

litigate the current interchange system.

II. ANALYSIS

A. Cash Payment and Interchange Fee Reduction

The cash payment plus the cash equivalent of a 10 basis point

interchange reduction for eight months is assumed to be worth up to$7.25 billion. This combined cash payment is an enormous settlementfrom one perspective. It is more than twice as large as the largest prior

antitrust settlement in history, the 2003 Wal-Mart interchange litigation

over the card networks’ honor-all-cards rule, and is among the largest private litigation settlements ever.

Yet in many ways the payment is paltry. $7.25 billion amountsto around only three months’ worth of interchange fees. Merchants willnot even receive the full $7.25 billion, which is a gross figure. It’s

necessary to net out attorneys’ fees and expenses, settlement

administration costs, and reduce the amount for class opt-outs. Whatever

amount is left then has to be divided among an enormous class of

merchants, so any individual merchant’s compensation is much morelimited.

The cash payment will not be immediate. It will probably take atleast a year and a half for the settlement to be confirmed (if it is

confirmed), and then a few years to disperse the funds. Realistically,

funds will not be fully dispersed for 3-4 years.

Critically, the value of the interchange fee reduction is not

guaranteed. The cash payment in lieu of the fee reduction depends onthe level of opt-outs. Indeed, structuring this part of the settlement as a

cash payment in lieu of an actual fee reduction shifts the risk of feeincreases to the merchants. Nor does a fee reduction guarantee a

particular level of interchange fee. The fee reduction is more like acoupon or a rebate. There is nothing in the settlement that prohibits a feeincrease. If that happens, the merchants have no recourse.

7 Proposed Settlement, ¶ 33(g)-(h).

8 Proposed Settlement, ¶ 34.


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Given the history of debit interchange fee increases that occurredafter the 2003 Wal-Mart settlement in the previous round of interchangelitigation, it is surprising to see a settlement propose that merchants incurthis risk. As it stands, it is quite possible that the defendants will manage

to recoup the entire $7.25 billion through higher interchange fees before

the final disbursement of the settlement cash.

Normally, settlement payments are compared with the damages

that could be obtained through continued litigation. In this case,however, the damages possible through continued litigation are particularly speculative. In theory, damages could have been

astronomical, upwards of $300 billion.9 It’s inconceivable, however, that

a court would actually award damages in that range, even divided among

14 banks and the two card networks; doing so would cause a globalfinancial crisis by impairing the capital of major banks. Indeed, it is hardto imagine greater than perhaps $30 billion possibly being awarded as

damages—although there’s no basis for a jury to arrive at that particularnumber—but if so, then the cash component of the settlement would be

about 25%.

Were the interchange litigation solely about damages, a 25%settlement figure would be reasonable. But the case has never been principally about damages. (Indeed, if it were, the case would be of little

interest to anyone other than the litigants.) The interchange litigationhas always centered on the reform of the interchange fee system. It has

been one prong in a multi-part reform strategy. Accordingly, thesettlement must be viewed as a total package of monetary damages andinjunctive relief, even if there are separate classes proposed for damagesand injunctive relief, as all plaintiffs opting into the damages class are

necessarily part of the injunctive relief class. Thus, while the cash

component appears reasonable as a settlement, when viewed as part ofthe total package, it is much less impressive.

B. Injunctive Relief

By far the most important part of the settlement is the injunctiverelief. There are three principal features to this. First, the card networkswill alter their prohibitions on merchant surcharging.10 This does not

necessarily mean that merchants are allowed to surcharge—state law

may still prohibit it—but the card networks, at least, will permit

9 One can arrive at such a figure by assuming that around half of annual

interchange fee revenue for the past ten years is monopoly profits, and then trebling thatfigure for antitrust damages.

10 Proposed Settlement, ¶¶ 42, 55.


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surcharging in certain circumstances. Second, the all-outlets rule, whichmandates that merchants that accept cards accept them on the same termsin all of their stores, will be relaxed. And third, merchants will havesome rights of collective bargaining over interchange fees (group

buying). While each of these reforms could potentially be significant, as

the settlement is structured, there are major limitations to the reforms thatsignificantly reduce their value to merchants.

1. Surcharging

Surcharging, or even the threat of surcharging, would impose powerful market discipline on interchange fees. Yet, as a general matter,merchants never want to surcharge. Consumers don’t like being hit with

surcharges, and merchants do not want to anger their customers.Merchants would all like the benefit of surcharging without having to

actually surcharge; better that their competitors do it. Merchants,

therefore, are only likely to surcharge if the benefits clearly outweigh thecustomer relations downside. The terms of the proposed settlement putnumerous restrictions on surcharging that make the right illusory and

reduce the likelihood that many merchants will in fact surcharge or even

credibly threaten to do so.

First, the proposed settlement caps permissible surcharges at the

lower of the merchant discount fee or 1.8 times the average interchangeon the brand.11 Second, merchants must provide customers with noticeof the surcharge at point of entry, point of sale, and on the receipt.

12 And

third, merchants are limited to surcharging either by brand or by product, but not by issuer.

13 The choice is the merchants.

14 If the merchant

surcharges by brand, the merchant must also surcharge for every other brand (including PayPal) that has the same or higher average interchange

fee.15

A merchant could, in theory, surcharge by product, but it is hardto see how this could work in practice, given the notice requirements.

The proposed settlement does not give merchants the tools necessary to

distinguish between card products (and the proposed settlement neverdefines “product,” instead merely giving some examples). How can amerchant tell what is a Visa Signature versus Signature Plus card or

11 Proposed Settlement, ¶¶ 42(a)(iii); 42(b)(iii), 55(a)(iii), 55(b)(iii).

12 Proposed Settlement, ¶¶ 42(c), 55(c).

13 Proposed Settlement, ¶¶ 42(a)(i); 42(b)(i); 42(d), 55(a)(i), 55(b)(i), 55(d).


15 Proposed Settlement, ¶¶ 42(a)(iv)-(v), 55(a)(iv)-(v).


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some new type of product before the sale total is presented to thecustomer for authorization?

Visa has a “Product Eligibility Inquiry Service” that identifies products for merchants in response to electronic queries.16 Currently the

service is offered to merchants free of charge from Visa, although

acquirers may apply their own fees. To use such a service, however, themerchant needs to obtain the card information prior to consummating the

transaction so that a surcharge, if applicable, could be levied. It is notclear how this could be done in most cases—the card is swiped at POSafter the consumer is presented with the transaction total, not before. For

mobile or contactless transactions, it is even less clear how a pre-

authorization product check could occur. An extra swipe or confirmation

would add costly delay at the checkout, offsetting some of surcharging’s benefit. As a result, there is no easy way for the merchant to tell whichcards should be surcharged.

Even if the merchant could determine product type in advance, product-level surcharging is likely to result in aggrieved consumers.

Consumers are generally unaware of product-level differences in

general-purpose cards (most consumers think of their card as a “Visa” orMasterCard” despite having no contractual relationship with thenetworks, only with their issuer bank). Thus, even if a merchant posted

conspicuous notices that “We surcharge all Visa Signature Plus cards3%,” the merchant would likely take Visa Signature Plus cardholders by

surprise with the surcharge and have to deal with angry customers.Between the customer relations problem and the technical cardidentification problem, product-level surcharging is unlikely.

Surcharging by brand also presents challenges for merchants. If

the merchant surcharges by brand, the merchant will have to lump

together products it wants to accept with those it does not. So, in orderto discipline the pricing on the ultra-premium cards (“black cards”), the

merchant must also surcharge all consumers, including those with plain

16 Visa apparently offers some for of electronic inquiry service for identifying

the product type and MasterCard is developing such a product. Response of PlaintiffUnited States to Public Comments on the Proposed Final Judgment (Tunney Act

response), United States v. Am. Exp. Co. et al., 10-cv-4496 (E.D.N.Y. June 14, 2011), at18-22. See also Declaration of Judson Reed, athttp://www.justice.gov/atr/cases/f269200/269252.pdf . Such services may not beavailable to all merchants with current POS terminals. Id. at 18-19. While Visa and

MasterCard have indicated that they do not currently charge for the service, merchantsobtain it through their acquirers, which may charge merchants a fee. Id. at 21-22. Unlesssuch a service is easily available for merchants, product-based surcharging is unlikely to

be widely used.


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vanilla credit cards. Thus, if Visa’s overall credit interchange fees werehigher on average than MasterCard’s, but its Visa Classic Card fees werelower, the merchant would either have to surcharge all Visa credit products—Classic Cards, Traditional Rewards Cards, Signature Cards,

and Signature Plus Cards—or none of them. This all-or-nothing

requirement reduces the value of surcharging by penalizing consumerswho use low interchange cards together who those who use highinterchange cards and forces deadweight loss when merchants do

surcharge.

The presence of Amex and its higher prices will functionally

frustrate brand surcharging. Amex is the most expensive brand. Amex

also has a no-surcharge rule. Therefore, to surcharge Visa, a merchant

would also have to surcharge Amex, which it cannot. This means thatthe merchant must either drop Amex or not surcharge Visa. It is likelythe latter for most merchants, but either way, Visa wins. For certain

retail sectors, such as retailers of high-end goods, Amex acceptance isessential. For these merchants, the ability to surcharge is of no use.

(This suggests that these merchants should be placed in a separatesubclass for settlement purposes, as they cannot realistically partakeratably in the relief.) MasterCard and Visa can rely on Amex to defeat

most brand surcharging, while product surcharging is simply not feasible

given merchant’s lack of information and the notice requirements.17

On top of this, the surcharging will be policed by the card

networks, which must be notified of surcharging in advance.

18

Thenetworks are free under the settlement to add additional rules that affectsurcharging. While minor rule changes could frustrate surcharging, it isunlikely that merchants would litigate over those rule changes alone. As

this currently stand, card network rules already frustrate discounting by

requiring things like both the cash and credit price to be displayed onitems.

Finally, it is important to emphasize that ten states (California,Colorado, Connecticut, Florida, Kansas, Maine, Massachusetts, New

York, Oklahoma, and Texas) have no-surcharge statutes. These statutescontrol over the settlement. While MasterCard and Visa may permit

surcharging, that right is of no value in these dozen states (and it is not

clear what state’s laws would apply to an Internet or mobile transaction).

17 PayPal too has a no-surcharge rule, but it is usually cheaper. To the extent it

is not, PayPal is likely to get dropped by merchants. It is not clear if PayPal ACHtransactions are a “Competitive Brand” under the settlement.

18 Proposed Settlement, ¶¶ 42(c)(1), 55(c)(1).


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And there is no guarantee that more states will not pass no-surchargelaws; the settlement does not commit the banks and card networks torefrain from seeking or supporting such legislation (or from opposing therepeal of no-surcharge statutes in the dozen states with them.)

19

Thus, because of no-surcharge laws, approximately 40% of

merchants, based on state population, will not benefit from the change inthe no-surcharge rules. (Indeed, this suggests that merchants from states

with no-surcharge laws should not be placed in the same class as othermerchants as they do not share in the settlement ratably.) An additionaland likely large percentage of merchants will not surcharge because it is

not practical given the constraints imposed by the settlement. In short,

the changes in the no-surcharge rule are of value only to a limited

number of merchants—those merchants that do not take Amex and thatoperate in states that permit surcharging.

2. All-Outlets

The second type of injunctive relief is a loosening of the “all-outlets” rule.20 The all-outlets rule currently requires a merchant that

accepts a card brand to accept it on the same terms at all of its outlets.

The effect of the all-outlets rule is to prevent merchants from testingacceptance patterns and discounting (or surcharging) on a low-risk,

limited basis. For example, Les Wexner’s strategy at The Limited was totest out new apparel in very small batches in a few stores. A handful ofcable-knit sweaters would be placed on a table in a store in a trendy

locale, with a couple of sweaters in each of several colors. The Limitedwould watch to see which ones sold in a few days. The Limited would

then place orders for thousands of sweaters in those colors, and consignthe other test models to the bargain bin. Banks do the same thing, testing

19 The Department of Justice interprets its 2012 settlement with MasterCard

and Visa to permit “two-tiered” pricing, in which the merchant displays “separate pricesat the point of sale for purchases made on various methods of payment”. Response ofPlaintiff United States to Public Comments on the Proposed Final Judgment (Tunney Act

response), United States v. Am. Exp. Co. et al., 10-cv-4496 (E.D.N.Y. June 14, 2011), at26. Putting aside the practical limitations on two-tiered pricing (found mainly at retailerslike gasoline stations that carry only a few products) and that it side-steps the problematicsurcharge/discount distinction, this provision in the DOJ settlement, however, brings no

succor to merchants in states with no-surcharge laws because the settlement does not preempt state no-surcharge laws, which enable consumer and state attorney general suitsagainst surcharging merchants. This two-tiered pricing only enables discrimination

between credit and cash (or non-credit payment methods). Merchants, however, want to

be able to discriminate between high-cost and low-cost credit cards, more than betweencredit and non-credit transactions. The DOJ settlement does not enable discrimination

between credit cards.20

Proposed Settlement, ¶¶ 41, 54.


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out new fees, such as the post-Durbin Amendment account fees, in singlestates, rather than in all of their markets. It is a sensible, low-riskapproach to business experimentation that is prevented by the all-outletsrule.

The settlement would loosen this to an “all-concept” rule,

requiring merchants to accept a card product or brand at all of their stores“that operate under a given trade name or banner”. Thus, Nordstrom’s

and Nordstrom’s Rack could have different acceptance, but all Nordstrom’s would have to accept on the same terms. This isundoubtedly an improvement, but it is not clear how much it really gets

merchants. As an initial matter, the all-outlets rule is probably the least

important of the major merchant restraint rules. Even if it were entirely

eliminated, it is simply not a game-changer. But consider how useful theamendment of the rule really is. Nordstrom’s is a different businessmodel than Nordstrom’s Rack. A strategy that works at Nordstrom’s

Rack doesn’t necessarily translate to Nordstrom’s or vice-versa. An “all-concept” rule doesn’t allow for meaningful experimentation because

there’s no control group except in cases where a holding companyoperates basically identical business lines under different names, such asa variety of grocery stores (and then, it is not clear that these would

qualify as different “concepts.”). One concept doesn’t indicate how a

payments policy will play elsewhere, making this concession of little practical value.

3. Collective Bargaining (Group Buying)The final type of injunctive relief is a provision permitting

merchants to bargain collectively with the card networks overinterchange fees.21 Again, the relief is subject to an important limitation,

namely that the merchants acting as a group is consistent with

Department of Justice antitrust guidelines on collective action.22

Thismeans merchants will have to obtain counsel to ensure that they are

permitted to engage in group buying, and this provides the card networkswith grounds to refuse to deal.

More importantly, perhaps, nothing in the provision requires thenetworks to accept the merchants’ collective bargaining positions. The

card networks merely commit to:

exercise [their] discretion and business judgment in goodfaith: (a) in determining whether a proposal sets forth




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commercially reasonable benefits to the parties; (b) innegotiations related to such proposals; and (c) in making[their] determination whether to accept or reject a proposal.

23

In other words, the card networks agree to listen to the merchants and

then make their decision based on the same business judgment theywould have otherwise exercised, as the “commercially reasonable

benefits to the parties” includes benefits to the card networks.

Thus, it is not clear how much additional leverage collective bargaining gives merchants. If a trade association such as the NationalFoosball Table Association were to bargain on behalf of its members,

what additional leverage would it have? The NFTA could not crediblythreaten that its members would stop taking Visa or MasterCard. The

primary value of collective bargaining in labor negotiations derives from

the threat of a coordinated strike. There is no such stick here toencourage a deal. Indeed, The impracticality of collective bargainingwithout a device forcing the parties to accept reasonable terms can be

seen from comparing it to the Conyers Bill (Credit Card Fair Fee Act of

2009, H.R. 2695), which would have enabled collective bargaining. TheConyers deal, critically, would have enforced the bargaining through baseball salary-style arbitration. Absent the arbitration stick, collective

bargaining is of very little value.

4. What’s Missing: Honor All Cards, Default Interchange, and

Routing

It is also notable what sort of injunctive relief is not included in

the settlement. The settlement leaves the honor all cards ruleuntouched.

24 Thus a merchant cannot refuse to take certain product lines

within a brand. At best, the merchant can surcharge for those products,

but subject to the limitations set forth above. While it is not clearwhether merchants could win an injunction against the honor all cards

rule, there is nothing that prevents a settlement—a negotiated contract—

from including such relief.

A second type of relief—conceivably obtainable in a judgment— is a prohibition on default interchange rates as price-fixing. The under

the current interchange system, the card networks set one-size-fits-allinterchange rates for the transactions between their issuers and acquirers,

23 Proposed Settlement, ¶ 43 (Visa). See also Proposed Settlement, ¶ 56

(MasterCard).24



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rather than having issuers and acquirers individually negotiate theinterchange fee based on the risk of non-payment by the acquirer (or theissuer). The settlement leaves this system, in which the fees are basednot on the risk-profile of the issuer or acquirer, but on that of the level of

rewards on a card and the profile of the individual merchant in a separate,

non-segregated25

transaction. Put another way, interchange rates are set based on risk pass-thru of individual merchants and cardholders, but theobligation of acquirers and issuers to pay each other is not based on

individual transactions; instead, issuers and acquirers assume eachother’s overall credit risk.

26 While there are efficiencies from default

interchange rates for small banks, the vast majority of the market is

covered by a handful of issuers and acquirers for whom the efficiency

arguments do not hold. An antitrust judgment could potentially that prohibit the networks from setting default interchange rates for larger

market participants or even entirely. The settlement does nothing to

change the way interchange rates are set.

Similarly, the settlement does not affect the exclusive routing

requirements for credit transactions. This contrasts with the debit cardsituation under the Durbin Amendment, where routing competition ismandated. While surcharging can affect which card a consumer chooses

to use, it is less likely to affect what cards are in the consumer’s wallet.

If a consumer only has two Visa cards, it is going to be a Visatransaction.

27 Routing competition would mean that it wouldn’t matter

which cards were in the wallet, as there would still be competition for the

routing every transaction regardless of what card was presented at POS.In other words, the networks would have to compete not just for the business of the banks in order to get their cards into wallets, but also for

merchants’ business in order to ensure routing on their cards.

The settlement does nothing for routing.28

Instead, it leavesintact the basic design of the interchange system in which the networks

25 By this I mean that the risk that the issuer incurs on the transaction is not

distinct from the overall risk of the acquirer; the transaction is fully recourse to theacquirer.

26 One would, therefore, expect interchange rates to reflect something close to

the spread between credit default swaps on an issuer and on an acquirer, as that is the real

measure of risk being exchanged, not that of individual merchants and consumers.27 MasterCard does not currently mandate exclusive routing, but givenFirstData’s ill-fated attempt to route Visa transactions, there seems to be little appetite toattempt rerouting for MasterCard products.

28 Ironically, during the debates of the Durbin Amendment and the rulemaking

thereunder, the banks argued against routing competition by emphasizing the differences between the networks, such as security and clearance speed. Yet the settlement is draftedas if none of those differences exist. Instead, it is drafted as if the networks vary only by


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are likely to be responsive solely to the interests of banks. While creditcards are a two-sided market, the current system, and the one that wouldcontinue under the proposed settlement, leaves the system imbalancedtoward one side of the market.

C. The Release

The proposed settlement contains broad release. The releasecovers all claims relating to interchange or card network rules. It covers

not only the past effect of such rules, but also apparently the future

effects of card network interchange and rules behavior,29

includingclaims that plaintiffs do not know they have.

30 The release does not

cover potential claims by government or consumers, although it is

unlikely that government or consumers would successfully litigate thecurrent interchange system.

The release does not directly cover competing networks, but it

may well do so in fact. Payment card networks often have affiliatedcompanies that accept MasterCard and Visa credit card transactions. Assuch, these affiliated companies are part of the (b)(2) and (b)(3) classes.

The release applies not only to the actual members of the (b)(2) and

(b)(3) classes, but also their “parents, subsidiaries, divisions, affiliates”.31

By virtue of their affiliation with these companies, the release also

appears to cover competing payment card networks. Thus, AmericanExpress, Discover, PayPal, and ATM networks are unlikely to be able tochallenge the interchange system going forward.

While a broad release for claims that could arise from the

defendants’ past behavior is reasonable to include in a settlement, the

proposed settlement’s release of the defendants from liability based onthe continuation of their behavior, including the application of the releaseto yet-to-exist merchants, is more problematic. As it happens the

drafting of the release is unclear regarding coverage of future claimsfrom future harms.

On the one hand, the active language of the release says that it is

a release of claims plaintiffs:

interchange (and other associated fees). Therefore, if Visa had a lower averageinterchange rate than MasterCard or Amex, but a merchant wanted to surcharge for Visa because of security concerns or for slower clearing times, the merchant could not do sowithout also surcharging MasterCard and Amex, even if the merchant found Visa

acceptance to be overall the most expensive (fees + security + time).29

Proposed Settlement, ¶¶ 33(g)-(h), 68(g)-(h).30

Proposed Settlement, ¶¶ 34, 69.31



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now ha[ve], or hereafter can, shall, or may in the futurehave, arising out of or relating in any way to….conduct,acts, transactions, events, occurrences, statements,omissions, or failures to act of any [Defendant] that are

alleged or which could have been alleged from the

beginning of time until the date of the Court’s entry ofthe Class Settlement Preliminary Approval Order in anyof the Operative Class Complaints or Class Action

complaints, or in any amendments to the Operative ClassComplaints or Class Action complaints.

32

While the first emphasized phrase would seem to include future

claims, the second emphasized phrase placed a temporal limit on the

release. The second emphasized phrase and the subsequent languagewould seem to limit the release to claims that were ripe by the latest possible date for amending the complaints. Thus, claims that ripen in the

future—claims based on future harms caused by Defendants’ futureactions, even if identical to the past actions covered by the settlement are

not covered.

Yet, the release goes on to provide a non-exclusive list of claimsthat are released, and these include claims arising in the future based onDefendants’ future actions, namely:

(g) the future effect … of the continued imposition of oradherence to any Rule of any Visa Defendant or

MasterCard Defendant in effect … as of the date of theCourt’s entry of the Class Settlement Preliminary

Approval Order, any Rule modified or to be modified pursuant to this Class Settlement Agreement, or any

Rule that is substantially similar to any Rule in effect …

as of the date of the Court’s entry of the ClassSettlement Preliminary Approval Order or any Rule

modified or to be modified pursuant to this ClassSettlement Agreement;

(h) the future effect … of any conduct of any …

Settlement Class Released Party substantially similar to

the conduct of any … Settlement Class Released Partyrelated to or arising out of interchange rules, interchangefees, or interchange rates, any Rule of any Visa

Defendant or MasterCard Defendant modified or to be



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modified pursuant to this Class Settlement Agreement,any other Rule of any Visa Defendant or anyMasterCard Defendant in effect as of the date of theCourt’s entry of the Class Settlement Preliminary

Approval Order, or any Rule substantially similar to any

of the foregoing Rules…33

The inclusion of these specific examples that clear related to

future claims arising from future actions by the Defendants would seemto indicate that the release is intended to cover more than just claims thatwould be ripe for adjudication by the last possible date for filing an

amended complaint.

If that is in fact what the release means and it is enforceable assuch, then the release will preclude any future challenges to the

interchange system as it currently stands, even by parties that do not yet

exist. In other words, this will be the last bite at the apple; the proposedsettlement would not only resolve existing liability, but would bless thecard networks’ practices prospectively, giving the defendants more than

they could have won at trial. If the system is prospectively blessed, the

defendants will have little reason to change the system given itscomfortable profitability.

As it stands, it is not clear whether the release is enforceable aswritten. While there is some uncertainty about the enforceability of therelease, it should bring little succor to merchants—if the settlement is

approved by the District Court, any latter attempt to challenge it would be an uphill fight.

There are two intertwined issues that arise with the scope of therelease. The first is the Due Process problem involved with the use of amandatory (b)(2) class that includes future merchants. The (b)(2) class is

not entitled under the Federal Rules of Civil Procedure to receive noticeor the right to opt-out. It is an unsettled question whether these

limitations on a (b)(2) class are consistent with constitutional Due

Process, particularly when they involve future parties who cannot, bydefinition, receive notice. No court has held there to be a Due Process problem, but the Supreme Court recently and delicately side-stepped the

question in its ruling in Dukes v. Wal-Mart:

Similarly, (b)(2) does not require that class members begiven notice and opt-out rights, presumably because it is

thought (rightly or wrongly) that notice has no purpose

33 Proposed Settlement, ¶¶ 33(g)-(h), 68(g)-(h).


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when the class is mandatory, and that depriving peopleof their right to sue in this manner complies withthe Due Process Clause. In the context of a class action predominantly for money damages we have held that

absence of notice and opt-out violates due

process. [Citation omitted.] While we have never heldthat to be so where the monetary claims do not predominate, the serious possibility that it may be so

provides an additional reason not to read Rule23(b)(2) to include the monetary claims here.

Moreover, the combination of two classes a (b)(2) and a

(b)(3) class in the same action may not solve the problem addressed in Dukes in which notice was

required for a single class that was seeking monetary and

injunctive relief.34

Thus, the inclusion of future merchants in a class absent notice may pose

a problem for the settlement. Adequate representation of the futuremerchants might resolve Due Process concerns, but there is a reasonablequestion of whether Class Counsel can adequately represent the interests

of both present and future merchants, particularly as future merchants

cannot benefit from the package deal of the (b)(2) and (b)(3) classes, butonly receive the relief assigned to the (b)(2) class. Thus, if the (b)(3)

class were relatively generous and the (b)(2) class were relatively stingy

in the relief given, a merchant might find the overall package acceptable,even if it would not have taken the (b)(2) relief as part of a stand-alonedeal.

The potential conflict between present and future merchants

suggests that if a settlement is to bind future merchants, there should besome independent representation of those merchants, meaning separatecounsel that would have the opportunity to evaluate the record and make

a fully informed, independent evaluation of the settlement. Such

representation would likely delay settlement, but not materially, givenhow long the litigation has already dragged out and the likely multi-year

timetable to full disbursement under the settlement.

The second issue is that the settlement purports to releasedefendants not only from claims based on their past behavior, but alsofrom future claims based on their future behavior. This sort of release of

future claims based on future behavior may pose an issue, as courts have

34 Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2558 (2011).


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previously refused to approve settlements that include releases fromfuture antitrust violations as against public policy.

35

Co-Lead Class Counsel has indicated that it believes that therelease is circumscribed by the Second Circuit’s Identical Factual

Predicate (IFP) doctrine.36

Thus, according to Co-Lead Class Counsel,

despite what is actually written in the settlement agreement (and whichwould be part of the settlement order), the release only actually covers

future claims based on the identical factual scenario.37

Thus, a merchantthat opens business a year after the settlement would be barred from bringing suit if the card networks have not changed their behavior, but if

the card networks changed their rules, the merchant would be able to

bring suit based on the new rules.

The IFP doctrine has always been used as a shield to protect

defendants, not as a sword for plaintiffs to limit the extent of a release.

While it is reasonable to apply the doctrine as a limitation, it means that plaintiffs are relying on a novel use of a doctrine criticized for itsinconsistency

38 in the face of explicit settlement language to the contrary

to protect them against an overly broad release. This strategy is not

without risk for the plaintiffs, and is particularly concerning given theinterpretation of the settlement in the Wal-Mart litigation, which washeld to be much broader than merchants had believed.

While future claimants and future claims raise potential issueswith the settlement, the combination of the two may be, as a recent

scholarly article on the subject is entitled “A Bridge Too Far”.39 Thecritical Second Circuit case on the IFP doctrine, Wal-Mart v. Visa,

involved existing claimants,40

and the IFP doctrine has never been usedto grant more protection to defendants than would be available under

collateral estoppel against individual merchants.

35 See, e.g., Schwartz v. Dallas Cowboys Football Club, Ltd., 157 F. Supp. 2d

561, 578 (E.D. Pa. 2001).36

Wal-Mart Stores, Inc. v. Visa U.S.A. Inc., 396 F.3d 96, 107 (2d Cir. 2005)(“The law is well established in this Circuit and others that class action releases mayinclude claims not presented and even those which could not have been presented as longas the released conduct arises out of the ‘identical factual predicate’ as the settled

conduct.” ).37 This may very well be intentional on behalf of the defendants, as it allows forthem to make some public “concessions” prior to finalization of a settlement, withoutconceding any enforceable legal rights.

38 See James Grimmelman, A Bridge Too Far: Future Conduct and the Limits

of Class-Action Settlements, 91 N.C.L. R EV. (forthcoming 2012).39

Id.40

Wal-Mart Stores, Inc. v. Visa U.S.A. Inc., 396 F.3d 96, 110 (2d Cir. 2005).


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All in all, then the releases as written appear extremely broad.While they may not be enforceable as written, merchants assume asignificant risk if they rely on Constitutional or judicial doctrine to limitthe negotiated terms of the settlement.

D. The Individual Settlements

In addition to the class settlement, the card networks have alsoreached settlements with individual plaintiffs in related litigation. The

terms of these individual settlements are not public, but supposedly the

individual plaintiffs will receive $550 million. It is not clear if that is acash or in-kind payment, or if it is cash, if it is in addition to other relief,such as interchange fee reductions. It seems unlikely that the individual

settlements provide for injunctive relief other than as a piggyback on theclass settlement.

Presumably the individual settlements are subject to

confidentiality agreements, but to the extent that individual plaintiffs arereceiving a better deal, the terms of that deal seems material to classmembers’ consideration of whether to take the deal offered to the class,

not least if there is a piggyback provision that allows the individual

plaintiffs to free-ride on the class’s injunctive relief. In particular, if theindividual plaintiffs are receiving interchange fee reductions going

forward, that may give them a competitive advantage over classmembers with whom they compete. Before a class member signs off onthe class deal, it should know if it is taking a deal that will put it at a

competitive disadvantage. In other words, in order to gauge the value ofthe class deal, it is necessary for class members to know the terms of the

individual deals, as the value of the class deal is both an absolute and arelative.

III. WHAT TO MAKE OF IT ALL?

A. Is This Meaningful Relief?

The question that any merchant should be asking of the

settlement, is “is this really going to change things?” It is hard to seehow the answer could be yes. Consider what the proposed settlement

means for a California merchant—that is a retail establishment operating

in California. The settlement means getting some cash a few years in thefuture, getting a slight loosening of the all-outlets rule, and getting theright to bargain collectively over interchange against a network that cansay, “if you don’t like our deal, then just don’t take cards.” While the

cash is real, there won’t be very much of it, and the other two rights are


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illusory. Because California has a state law no-surcharge law, thesurcharging rights, whatever one thinks of them, cannot be exercised.

This small gain will be in exchange for an incredibly (and perhaps unconstitutionally) broad release that will bind not only the

merchants who receive notice, but their grandchildren’s businesses fifty

years in the future. There will be no second bite at the apple, no possibility of going back to court if and when interchange fees rise again.

The merchant still has almost no ability to influence interchange rates,which will remain the highest in the developed world.

These are humongous risks for merchants given that thesettlement leaves in place the basic fee setting and rule setting structure.

Nor will there be a realistic political solution, as the interchange issue isalready dead on the Hill, and will be even more so if the settlement is

approved. Congress found itself in an uncomfortable position during the

Durbin Amendment debate, caught between two heavyweightconstituencies—banks and retailers. Few in Congress want to run backinto this crossfire, so any excuse, such a litigation settlement, will be

readily embraced as a reason to avoid legislative action. Moreover, to

the extent that surcharging under the settlement is effective, it would not be surprising to see the card networks make a push post-settlement formore states to enact state no-surcharge rules, thereby undermining the

impact of the settlement.

B. Comparison with Potential Relief from Continued Litigation

A settlement is, of course, always a compromise. Neither side is

likely to get exactly what they want, and a settlement must be judged

against the yardstick of what result would obtain if the case went to trialand through the appellate process. It is inherently difficult for anoutsider—or indeed a court—to judge the adequacy of a settlement. The

parties themselves know the record far better than anyone else, and muchof the record is not public or even submitted to the court. In the case of a

class action like this, not even the named plaintiffs know the record.

Instead, they are forced to rely on the representations of Class Counselabout the strength of the record.41

41 That said, it is hard to imagine that there is much in the record that is in fact

exculpating of the Defendants. There is little factual debate over network rules (thereappears to be some over the Class’s allegations of collusive pricing). Most of the debate

centers on whether the various features of the interchange system are on balance pro-competitive or anti-competitive. This is turn is likely to feature a battle of expertwitnesses, but the basic contours of the argument have been well-known in the publicscholarly debate over interchange for some time.


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In this case, however, there is a fairly simple, if imperfect baseline available: a judgment that entirely abolished the no-surchargerule and enjoined the card networks and member banks from takingactions to discourage surcharging. Such an injunction is the sort of relief

that a court could realistically grant in an antitrust action. It is also relief

that plaintiffs would have a good chance of obtaining if they went totrial. An injunction banning the no-surcharge rule entirely is far moremodest than the total relief plaintiffs would probably receive if they

prevailed at trial (for example, there are no damages included). Still, wecan attempt to value such relief and then compare it against that provided

by the proposed settlement. If the proposed settlement’s value is less

than or even close to that of this modest baseline, then the settlement

would appear to be a bad deal for merchants.

42

Laying odds on litigation is necessarily speculative, but the

plaintiffs appear to have an especially strong case on the anticompetitive

effect of no-surcharge rules. The economic justifications for a no-surcharge rule for a mature payment network are fairly weak.

Nonetheless, let’s say that plaintiff’s chance of success through trial andappeal is 50%. We also have to account for time delays. Let’s says thatit will take another five years for all appeals to be exhausted and for

plaintiffs to actually get relief, so relief only occurs in year six. Let’s

also say that as a result of a complete prohibition on no-surcharge rules,interchange rates would drop by 50%, much as occurred in Australia

when no-surcharge rules were prohibited by regulation.

In other words, we would be looking at credit card interchangedeclining from $30 billion to $15 billion. So, we’d be looking at a 50%chance of $15 billion after five years. If we assume a 5% discount rate,

the relief from one year of such an injunction would have a present value

of $5.88 billion today.

But remember, this is just the expected present value benefit to

plaintiffs from one year of an elimination of a no-surcharge rule. Weneed to net the present values extending out into the future. It’s hard to

know how long there would be value from such an injunction given the possibility of changes in the market, but it seems reasonable to anticipate

at least five years worth of benefits. If we simply sum years 6-10 (from

now) without accounting for changes in market size, etc., then the

42 From the public interest perspective, of course, the question involved is

different. The real interest from the public perspective is ensuring that the paymentsindustry has vibrant competition that fosters innovation both in products and pricingefficiency. This paper will analyze this question separately.


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injunction would have an expected net present value of $26.72 billion.(This figure need not be reduced for opt-outs, but it is of course, gross ofattorneys’ fees, but under a Lodestar formula, like that used in theSecond Circuit, the fees will basically be a flat amount. On the other

hand, to the extent the market grows, as it likely will if only through

population growth, the expected net present value would be higher.)

Reasonable minds could certainly differ about the assumptions

used in the above calculation.43

The above calculation is merely meantto provide a ballpark, back-of-the-envelope baseline. It starts from anassumption of a very limited type of injunctive relief without monetary

damages, and it obviously doesn’t account for the growth of the card

market or possibility of other changes in the payments eco-system that

might affect the value of the injunction.

Nonetheless, the hypothetical injunction worth $26.72 billion in

expected net present value (again, this represents plaintiffs having a 50%chance in obtaining limited relief that results in a 50% decline ininterchange rates for years 6-10) is an instructive baseline for comparison

with the proposed settlement, which is worth at most $7.25 billion plus

the largely illusory value of the injunctive relief. The various injunctiverelief would have to produce $1.9 billion in net present value a year formerchants for ten years to make the settlement values equivalent.

Perhaps the limited surcharging that is available and group buying willhave this sort of downward pressure on interchange rates. $1.9 billion is

approximately 6.3% of current annual interchange fees.Will the injunctive relief in the proposed settlement result in

interchange fees falling by 6.3% on average? That is will a 180 basis point interchange fee decline to 168 basis points?44 I am skeptical that

the settlement will produce even this sort of modest change, but it is a

point for speculation. If one is more bullish on plaintiff’s litigation

43 To illustrate the range of outcomes with a more conservative (more

optimistic) estimate for the likelihood and value of injunctive relief, let’s lower (raise) thechance of success to 25% (75%), reduce interchange fees by 25% (reduce them by 65%),and use a discount rate of 8% (3% if optimistic). The more conservative figures yield anexpected net present value of a very limited possible relief for years 6-10 of $5.5 billion,

still quite close to the monetary figure in the proposed settlement, while the moreoptimistic figures yield an expected net present value of $54.95 billion.44

To yield the same present value, the annual value of the injunctive reliefunder the proposed settlement would need to increase. Thus, with a 5% discount rate, it

would take $3.09 billion in value in year 10 to have a present value of $1.9 billion.Assuming that total interchange fee income increases more slowly than the discount rateused, the future values would be an increasingly large percentage of interchange income,rather than a steady 6.3%.


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prospects, the value of the injunctive relief in the settlement would ofcourse have to be higher to provide equivalent value. And none of thisaccounts for the barrier that the interchange fee system—left largelyintact—poses to the adoption new cheaper payment technologies.

Unless the injunctive relief in the proposed settlement actually

translates into real value, then the proposed settlement appears to be a bad deal for merchants, and especially so for merchants in industries

where Amex acceptance is essential or located in states with no-surcharge laws. While merchants might lose if they proceeded withlitigation, the gains from the settlement are so small as to make the risks

of litigating worthwhile. Indeed, if the release is in fact as broad as it

purports to be, merchants may well be better off taking their chances

litigating and losing and preserving the possibility of having futuremerchants litigate the issue again in a few years with different counsel.

C. The Public Interest

Finally, how does the settlement look from a public interest perspective? The public’s interest in payments is to have a system that

encourages innovation, efficiency, and transparency. From such a

perspective, the settlement comes up way short. It leaves in place aninterchange system with little transparency and that has been incredibly

hostile to innovation and efficiency. Surcharging, to the extent feasible,may improve transparency, but MasterCard and Visa will still setinterchange rates and those rates will be largely shielded from market

discipline by network rules.45

The current interchange system creates little incentive for the

major players in the payments world to engage in transformationalinnovation—they have a good thing, so why rock the boat? The currentsystem also makes it very difficult for new entrants to break into the

market. Thus, despite the constant cheerleading of the payments trade press and the buzz about mobile payments, there has been precious little

real innovation in US payment systems in recent years. The US still has

not adopted EMV or chip-and-pin, leaving our security the weakest inthe developed world. Our mobile payments lag years behind those inEurope and Asia. There have been experiments with contactless and

decoupled debit, but they’ve been sideshows, not transformational

technologies. To date, the mobile platforms are much the same, justusing a handheld rather than a mag stripe card as the authorization device

for transactions that run over the same rails. PayPal is starting to offer its

45 Proposed Settlement, ¶¶ 51, 47, 48.


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own set of rails as a settlement system, but it has a long way to go;currently it is still primarily an arbitrage between high and lowinterchange fees. Arbitrage isn’t the same as innovation. It short, it ishard to see anything much changing with the current entrenched system,

and with the proposed settlement’s broad release, litigation is unlikely to

be the tool to bring competition and innovation to payments. From the public interest perspective, the proposed settlement is deeplydisappointing.

CONCLUSION

The proposed interchange litigation settlement neither achieves

meaningful reform of the interchange fee system nor even greater value

than plaintiffs would likely obtain if the case were litigated through trialand appeal. The proposed settlement results in precious little for any

individual merchant, even if in aggregate the numbers look large, and thestructural relief that should be at the heart of the deal is illusory.

To be sure, there is a real chance that if the merchant plaintiffswent to trial that they would lose. But at least they would have had their

day in court, and the relief they would have foregone in the proposedsettlement is so limited that there is little downside in continuing to

litigate. To accept this settlement is short-sighted to the point of near blindness, and will leave merchants and ultimately the US economy’s

payments infrastructure at the mercy of the card networks’ profit motive,rather than subject to the competitive dynamics of the marketplace.

An Analysis of the Proposed Interchange Fee Litigation Settlement

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Transcript of An Analysis of the Proposed Interchange Fee Litigation Settlement