U.S. v. Visa and MasterCard

1. U.S. v. Visa and MasterCard Eric Emch, OECD eric.emch@oecd.org

2. Outline • Background • The allegations & theory of the case • Relevant markets • Duality • Exclusionary rules • The court’s decision • The Visa/MC case and joint venture policy generally

3. Visa/MC and Joint Ventures • Some issues to consider while listening to this presentation: • Would Visa and MasterCard have been treated differently had they each been a unified firm rather than a joint venture? • Should they be treated differently? Why or why not? • What are the economic and legal implications of disparate treatment of ongoing joint ventures compared to single firms?

4. Background: History • In 1950, Diner’s club produced the first "general purpose“ charge card, which required the entire bill to be paid with each statement it was followed by American Express and Carte Blanche • 1958: Bank of America launches the BankAmericard in Fresno, Calif., with an innovative “revolving credit” feature. • 1966: MasterCard founded as Interbank Card Association • 1970: Visa is incorporated in the state of Delaware in 1970 as National BankAmericard Inc. (NBI). Changes its name to Visa in 1976 • Since 1975, virtually all significant card-issuing banks in United States have become owners of both Visa and MasterCard, though this may change with their IPOs. • Associations experienced rapid growth in 1980s, 90s, and 00s, through combined efforts of issuing banks and acquiring banks.

5. Structure of Visa in 1999 Visa Network Services Visa Joint Venture “Interchange” Member Issuing Banks Member Acquiring Banks Merchants Consumers

6. United States v. Visa and MasterCard Allegations & theory of the case

7. The Complaint • Count 1: “Dual Governance” • Governors of each association that have significant revenue stream from other association have reduced incentive to sponsor competitive initiatives • Count 2: Associations’ Exclusionary Rules • Association rules prohibiting members from issuing cards on a “competitive network” thwart network-level competition by denying scale to Discover and American Express • Each count had to do with improving network competition: • Count 1: Competition between the associations • Count 2: Competition against other networks such as Amex/Discover

8. Relevant Markets • General purpose credit and charge cards • Issuer (bank) level services • Not included in the market: proprietary cards, debit cards, cash • General purpose credit and charge card network services • Issuers earn margins of 26%, network fees are <2% of issuing costs. US argued that therefore there was room for a SSNIP from network monopolist.

9. General Purpose Card Market Visa Network Services Visa Joint Venture Member Issuing Banks Member Acquiring Banks Merchants Consumers

10. Network Services Market Visa Network Services Visa Joint Venture Member Issuing Banks Member Acquiring Banks Merchants Consumers

11. Count 1: Dual Governance • U.S. attacked “dual governance” of the associations • Governance = decision-making authority • Includes board of directors and influential advisory committees • Decision-making banks in each association typically had substantial portfolios of cards issues on the network of the other association. • Did not attack dual issuance directly • Theory was that if governing banks has undivided loyalty, divided loyalty of membership was not as harmful to competition

12. Overlapping Interests of Associations • From complaint: “The banks that govern Visa earn substantial profits from issuing MasterCard cards. For example, as of year-end 1997, Visa U.S.A.'s Board of Directors included representatives of First Union Corporation and Associates First Capital Corporation, both of which had issued nearly 40% of their general purpose cards on the MasterCard network.” • “The banks that govern MasterCard earn an even greater percentage of their profits from issuing Visa cards… The most pronounced examples among MasterCard's 1997 board members were Providian Bancorp Inc. and Capital One Bank, which had issued more than 95% and more than 66% of their cards on the Visa network, respectively.”

13. Alleged Effects of Dual Governance • From complaint: “Because of these significant overlapping financial interests, the banks that govern each association have rejected investments in, and implementation of, competitive initiatives that might lead consumers to switch from one association's brand of card to the other's. From the banks' perspective, these innovations would merely shift their profits from cards issued on one of their networks to cards issued on the other.”

14. Associations Themselves Had Noted Negative Effects • In 1992, Visa International's Executive Vice President and General Counsel testified (in a different case) that "it is very difficult for us to take a step, an aggressive step that hurts MasterCard because the same banks who sit there on the board, who are in Visa are also in MasterCard." In response to the question whether "duality has led to a decrease in intersystem competition between Visa and MasterCard," he replied, "Absolutely,"

15. Alleged Effects of Dual Governance • Restraint in share-shifting competitive initiatives by each association directed against the other, it’s largest competitor • Examples cited by government of how dual governance restrained competition: • Smart Cards • Internet Encryption • Premium Cards • Advertising

16. Effects on Advertising • 1992 • Consultant: MC must name Visa • Member reaction vetoed • 1996 • In Canada (non-dual), MC names Visa • 1997 • “Can’t … discuss or refer to … Visa” {note to self: get full quote, reference}

17. Government’s Proposed Relief • Relief • Require dedication of board members (100% going forward, 80% overall). • Why Not Seek Complete Exclusivity? • Dual issuance pro-competitive • Benefits from banks offering a variety of cards • Facilitates network competition, especially in harmony with count 2.

18. Increasing Dedication Since Complaint Filed • Visa by-law requiring Board members to maintain a 70% skew • Prevalence of dedication agreements of board members requiring skew • This was very relevant to the court’s ultimate decision on the duality count

19. Count 2: Exclusionary Rules • A brief history of the exclusionary rules • Visa’s rule 210(e), passed in 1991, provides that “the membership of any member shall automatically terminate in the event it … issues, directly or indirectly, Discover Cards or American Express Cards, or any other card deemed competitive by the Board of Directors.” • American Express begins partnering with foreign banks attempts to partner with American banks. • Visa International considers global rule, but not adopted after doubts about the legality of such a rule expressed by DG-COMP. • American Express begins encouraging major MasterCard banks to issue AMEX cards, holding discussions with some. MasterCard adopts its Competitive Programs Policy (CPP), similar to Visa’s rule 210(e). Six board members voted against. • Discussions between Amex and MC member banks cease in wake of CPP/210e

20. Exclusionary Rules • Government alleges rules are anticompetitive because: • Inhibit network competition by denying scale to competitors (Amex, Discover) • Deny consumers benefits of new combinations of network services and issuer attributes • Pro-competitive justifications not valid • Not required for association “cohesion” • No valid free-riding concerns

21. Evidence on Exclusionary Rules • Several banks testified that they would have partnered with American Express but for the rules • Evidence that scale of American Express and Discover inhibited merchant acceptance which inhibited card issuance • Experience overseas showed that associations didn’t unravel simply because some partnered with Amex • DOJ alleged partnerships with banks would create unique new products: banks not simply distributors

22. Government’s Proposed Relief • Abolish 210e/CPP and prohibit similar bylaws in the future applying to debit and credit • Allow issuers to rescind dedication agreements with Visa/MC signed before the final judgement went into effect

23. U.S. v. Visa and MasterCard Court Decision

24. Decision on Duality • The court concludes that with the exception of the associations’ failure to name each other in advertising…The government’s examples fail to prove dual governance has significantly diminished competition • Defendants’ admissions relate to dual issuance, or are dated or too general • Active competition between Visa and MasterCard • Lots of innovation in the industry • Influence of major dual issuers may be cause of blunted innovation competition • Duality may be moot with move towards dedication agreements

25. Decision on Exclusionary Rules • Associations’ exclusionary rules are anticompetitive • Inhibit network competition by denying scale to competitors (Amex, Discover) • Deny consumers benefits of new combinations of network services and issuer attributes • Pro-competitive justifications not valid • Not required for association “cohesion” • No valid free-riding concerns

26. Decision on Exclusionary Rules (2) • Exclusionary rules effectively prevented banks from issuing American Express or Discover cards • Limited access to banks reduced the “competitive vitality” of American Express and Discover as network competitors. • “Network services output is necessarily decreased and network price competition restrained by the exclusionary rules because banks cannot access the American Express and Discover networks; conversely American Express and Discover cannot access the issuing competencies and segmented marketing expertise of the banks, nor their more profitable relationship customers with checking accounts…”

27. Relief on Exclusionary Rules • Visa and MC shall repeal 210e/CPP as applied to issuers • “Each Defendant is enjoined from enacting, maintaining, or enforcing any by-law, rule, policy, or practice that prohibits its issuers from issuing general purpose or debit cards in the United States on any other general purpose card network. • Dedication agreements previously signed can be terminated without penalty up to two years after judgement goes into effect if a bank wants to partner with American Express or Discover • Limitations: Judgement does not prohibit individually-negotiated agreement for exclusivity

28. U.S. v. Visa and MasterCard MC/Visa case and Joint venture policy

29. Case Postscript • Parties were granted a stay on the decision, appealed and lost at the Court of Appeals. Final appeal for the Supreme Court to hear case but Supreme Court refused. • Final judgement went into effect in 2004 • American Express has since started issuing cards partnering with Citibank and Bank of America, among others • Meanwhile, there has been a proliferation of lawsuits against the associations, including • Merchant class action against existence of interchange • “Wal-Mart” class action against tie of credit and debit (settled) • American Express and Discover private suits for anticompetitive behaviour (Amex settled)

30. Visa and MC Restructure • Shortly after initial trial, MasterCard announces a plan to change its structure from a not-for-profit association to a for-profit, privately held company • Multi-stage process culminating in IPO in mid-2006 • Banks still hold majority of shares • In 2006, Visa announces similar plans • IPO scheduled for early 2008 • One oft-cited reason is to lessen liability from competition law • Is this a good thing?

31. The DOJ Legal Line of Attack • Alleged violations of Section 1 of Sherman Act (like EU Art. 82), having to do with conspiracies between associations and among member banks in associations. • Defendants tried to frame the case, legally, as a Section 2 exclusive dealing case – higher burden of proof for plaintiff. • Effectively, then, part of DOJ case depended on JV structure of associations, and would not have been argued the same way had they been single firms • What can a single firm do that a joint venture can’t, and why?

32. Defense Complaints • Defense alleges: By pleading this as a Section 1 case, DOJ penalizes the joint venture form, which has served the industry well. • Should allow a joint venture the same rights as a unified firm, including the right to refuse to deal under most circumstances. After all, Amex can choose to partner with whomever it wants. • DOJ counter: competitors in an industry are not allowed to use a joint venture as cover for anticompetitive horizontal agreements. They are not allowed to get together and effectively vote on how to compete with one another, even under cover of a JV. • Competition law would not allow a full merger or even partial merger of major issuing banks, so should not allow joint venture of banks to necessarily have all of the freedoms of a merged firm.

33. Texaco Inc. v. Dagher et. al. (2006) • U.S. Supreme Court weighed recently in on how antitrust should treat joint ventures, and sets what seem to be reasonable bounds, in Texaco v. Dagher case. • Texaco and Shell Oil collaborated in a joint venture, Equilon Enterprises, to refine and sell gasoline under both brand names. Joint venture was approved by FTC. • Equilon set a single price for both brands. Service station owners sued, alleging illegal price fixing as a per se violation of Section 1. District Courts rules for defendants but overturned by appellate court. • Supreme court overturned again, finding that it is not per se illegal for a lawful, economically integrated joint venture to set the prices at which the JV sells its products

34. Ancillary Restraints Doctrine • Under the ancillary restraints doctrine, courts must determine whether a restriction that is part of a joint venture or association is a naked restraint on trade, or one that is ancillary to the legitimate and competitive purposes of the association. The former can be condemned as anticompetitive. • Supreme Court “That doctrine governs the validity of restrictions imposed by a legitimate business collaboration, such as a business association or joint venture, on nonventure activities.” (emphasis added)

35. “Core” vs. “Non-core” JV Activities Supreme Court decision seems to divide JV activities into two categories: core and non-core • “Core activities” : treat same as single firm • “Non-core activities”: Ancillary restraints doctrine applies. May weight potential harms against pro-competitive justifications • Seems to allow two routes for challenging joint venture’s activities • Challenge a non-core activity that is not ancillary • Challenge the entire JV as anticompetitive

36. Final Thoughts • Though Dagher case was decided after DOJ case in Visa/MC, the DOJ case seems to fit within this framework • Alleges exclusionary rules were not core activities and had no pro-competitive justification • This seems to provide an answer to the question of when are JV’s treated like single firms: legitimate JV’s are allowed to perform “core activities” like single firms • At the same time, other activities of JV are not protected in the same way, which prevents a JV from becoming a shelter for anticompetitive agreements.

37. Some References • Complaint, U.S. v. Visa USA, Visa International, and MasterCard Int’l. Available at http://www.usdoj.gov/atr/cases/f1900/1973.htm • United States v. Visa U.S.A., Inc., et. al. 98 Civ. 7076 (S.D.N.Y. October 9, 2001)) Available at http://www.usdoj.gov/atr/cases/f9800/9857.htm • Texaco Inc. v. Dagher et al., 547 U.S. (2006) • “Antitrust Guidelines for Collaborations among Competitors,” issued by the Federal Trade Commission and the U.S. Department of Justice, April 2000. Available at http://www.ftc.gov/os/2000/04/ftcdojguidelines.pdf • “Competition and Efficient Uses of Payment Cards,”” proceedings of June 2006 OECD competition committee roundtable. OECD Document DAF/COMP(2006)32 . Available at: http://www.oecd.org/dataoecd/0/30/39531653.pdf