Priceless: The Case That Brought Down the Visa/MasterCard Bank Cartel (4 page)

By 1987, it was already clear to many people that debit card transactions would eventually far surpass credit cards. Predictions made throughout the 1970s and 1980s of the coming “cashless society” were shorthand for expectations of an enormous debit card market.
By 1987, the explosive growth in the credit card market had begun to slow down. Despite the fact that most consumers had one or more credit cards and most merchants accepted them, more than 90 percent of retail purchases were still paid for with cash and checks. Almost all utility, mortgage, rent, insurance, and other recurring payments were made with checks. It was foreseeable that most of these paper transactions would eventually be replaced by safer, faster, and more convenient electronic debit transactions. So the fact that Visa and MasterCard were barely competing in the credit card market was less important to me than their efforts to merge their debit card operations under the banner of the new Entree debit network.

In 1987, there were more than a hundred regional and local ATM networks operating in the United States. Many, such as PULSE, STAR, Most, NYCE, Honor, Avail, Cactus, Accel, and Yankee 24, had already, or would soon, become debit card networks by allowing their ATM cards to be used at stores with a personal identification number, or PIN, to purchase goods.

My office, joined by a dozen other state AGs, began an investigation of Entree. We issued investigative subpoenae to Visa and MasterCard under the authority of New York’s antitrust law and got the networks to agree that the information they produced could be shown to any other attorney general’s office that wanted to see it. Throughout the 1980s, AGs used such multi-state antitrust investigations as a way of pooling scarce resources and collectively acting as a de facto national antitrust agency, without any statutory authority to do so.

Companies like Visa and Master-Card usually complied with the states’ sharing procedure because, if they didn’t, they could be forced to produce documents under separate subpoenae issued by twenty, thirty, or even all fifty states. For years, because states actually did little antitrust enforcement, the possibility of facing so many state probes (a legal possibility throughout the twentieth century) was only theoretical.
After a series of well-publicized efforts, in the 1980s, companies decided that it was better to submit to a coordinated multi-state investigation than to battle numerous separate state inquiries. In the case of Entree, Visa and MasterCard seemed to submit passively.

But what I initially perceived as passivity by Visa and MasterCard was actually a blend of arrogance and condescension toward the states. That became clear as meetings with our adversaries became frequent. The bank associations were implicitly saying, “We’re not afraid of you.” They were going to teach us about the wonderful things Visa and MasterCard and their member banks had done for the world. They told us that they were the most efficient organizations ever conceived and that we would come to believe this just like our more important counterparts at the Reagan FTC and Antitrust Division. I had obtained portions of the Department of Justice’s antitrust file on Visa/MasterCard under a law that made this confidential material available to state AGs. The file showed that the Antitrust Division knew what Visa and MasterCard were doing, and it demonstrated the federal government’s tacit approval.

Visa was relying not just on the Department of Justice’s laissez-faire attitude, but, in particular, on the
Nabanco
antitrust case in which Visa defeated a price-fixing claim made by a processor of its credit card transactions. Nabanco and other processors installed terminals at checkout counters and routed payment transactions to networks like Visa, MasterCard, Discover, American Express, STAR, and NYCE for the network’s permission to accept the card (“authorization”) and for transferring funds to the merchant as payment (“settlement”). In 1979, Nabanco challenged Visa’s practice of fixing the price of a fee that was paid by every merchant in every Visa credit card transaction. (Though the suit charged only Visa, MasterCard had the same practice of fixing the fee.) This fixed fee—paid to the bank by the processor, who then passes the charge along to the store—is called the “interchange fee.”
Regardless of the store, the processor, the merchant’s bank, or the shopper’s bank, this interchange fee was set by Visa. Nabanco claimed this was price-fixing, a basic antitrust violation. Nabanco also claimed that fixing these prices eliminated competition that otherwise would have occurred in the credit card market, with thousands of banks negotiating with hundreds of processors and millions of stores over the prices of accepting Visa credit card transactions. The artificially high prices for the credit transactions were raising the prices paid by the stores and their shoppers by hundreds of millions of dollars annually.

After five years of litigation, Visa prevailed in the
Nabanco
case. The U.S. District Court in Florida and the U.S. Court of Appeals for the Eleventh Circuit found that although Visa was fixing prices, an antitrust sin of the first magnitude, this particular price-fixing was not only benign but also a necessity for the Visa network to survive. The court lauded Visa for the imaginative way in which it formed a payment system among competing banks, as contrasted with the American Express and Diners Club systems, which were each owned by a single financial institution. The court said that this acceptable form of price-fixing couldn’t harm competition in the credit card market because there was no such market. The court opined that credit cards competed with cash, checks, money orders, traveler’s checks, and debit cards in one big payment market, which the industry called the “Wampum” market.

Battles over market definition are often the most crucial contests in antitrust cases. The plaintiff defines the market narrowly. The defendant tries to broaden it. So, when the NFL was charged with monopolizing the professional football market, as it often was by competitors like the old AFL and USFL, it would respond (and has responded in many cases) that it competes with Major League Baseball, the NBA, the WNBA, the NHL, and even the Professional Bowlers Association for the hearts and minds of sedentary people. In
Nabanco
, the endorsement of the
Wampum market was tantamount to a court not merely accepting the NFL’s claim that it competes with professional bowling but also with movies, TV, radio, live theater, and all other forms of entertainment. Visa and MasterCard waved
Nabanco
around like a cross at those who would dare attack them.

Thirteen state attorneys general sued Visa and MasterCard on July 26, 1989. Utah joined later. The states’ complaint alleged that Visa and MasterCard jointly monopolized the credit card market and that they were jointly attempting to monopolize the emerging market for debit card transactions. The complaint detailed MasterCard’s previous acquisition of the Cirrus national ATM network, Visa’s previous acquisition of the Plus national ATM network, and Visa’s control of the Interlink debit card network. We alleged that, under the banner of the new Entree network, Visa and MasterCard intended to monopolize and control the development of the debit card market.

Prior to the complaint, Visa and MasterCard had already eliminated their most important competition by buying or controlling the Cirrus, Plus, and Interlink networks. When Visa and MasterCard acquired Plus and Cirrus, they knew that these national ATM networks were planning to make their ATM cards function at stores as debit cards, using the cardholder’s same PIN. Visa and MasterCard prevented Plus and Cirrus from doing that and becoming integrated ATM/debit networks. Limited to ATMs, these networks were uniquely inefficient. They were like telephone companies whose lines couldn’t be used for Internet access.

Visa’s co-option of Interlink was the flip side of what MasterCard and Visa did to Cirrus and Plus. Interlink was a debit-only network, and by far the biggest. Interlink had more than half of all the
PIN- authorized debit transactions in the United States. Visa bought control of Interlink and never allowed the system to become an ATM network. Years later, Visa took other actions to suppress Interlink and use it as a baseball bat to clobber the regional ATM/debit networks such as STAR, NYCE and PULSE. But I am getting ahead of the story.

In July 1989, all that we knew was that Visa and MasterCard had already picked off the three most important competitors in the debit card market: Cirrus, Plus, and Interlink. In the
Entree
complaint, the combination of these four debit mergers, (1) Visa with MasterCard in Entree, (2) MasterCard with Cirrus, (3) Visa with Plus, and (4) Visa with Interlink, were collectively alleged to be an attempt and conspiracy to monopolize the debit card market. These are violations of Section 2 of the Sherman Antitrust Act, the basic federal antitrust law passed in 1890, called the “Magna Carta” of free enterprise by the U.S. Supreme Court. We also alleged that these mergers violated Section 7 of the Clayton Act, the anti-merger provision of the federal antitrust laws.

The
Entree
complaint explained how these mergers would not only stifle competition in the future but were already doing so. In a harbinger of the
Merchants’
case that I would file seven years later, the 1989 complaint explained that Visa and MasterCard each had a debit network operating over its credit card system with transactions authorized by signature instead of a PIN. It asserted that these so-called “off-line” debit transactions were much slower, much less secure and much more expensive for stores than so-called “online” PIN debit transactions. The complaint also alleged that most stores incorrectly believed that these off-line signature debit card transactions were credit card transactions.

Visa and MasterCard and their banks charged merchants the same price for signature debit card transactions as for credit card
transactions—without the loan provided in a credit transaction, and with only a tiny portion of the risk. The complaint asserted that the Visa and MasterCard debit cards looked exactly like their credit cards and that this design choice was intended to fool stores so they wouldn’t get mad about paying high-risk credit card prices for low-risk debit card transactions.

The stores that did know about these signature debit cards paid these high prices because they were coerced by so-called “tying arrangements,” that force a person to buy a group of products, in order to get the one desired product. When Microsoft says, “If you want my operating system, you have to buy my web browser, or my media player,” that is tying. Under the guise of Visa’s and MasterCard’s virtually identical “Honor All Cards” rules, any store that accepted Visa and MasterCard credit cards was forced to accept their debit card transactions at the same price as credit.

The complaint also outlined how the Visa/MasterCard joint debit venture would extend beyond the Entree network into the transaction-processing business, where Visa and MasterCard maintained separate systems. If Entree was not stopped, these competing systems would eventually be connected, and one of the few remaining ways that Visa and MasterCard competed would be eliminated.

The complaint also outlined the regrettable history and effects of duality. Duality, also called the “virtual” or “creeping” merger of Visa and MasterCard, was prohibited in other parts of the world. In Canada and Europe, banks had to choose either Visa or MasterCard in order to maintain competition. In the rest of the world, there was no joint Visa/MasterCard debit network under any name. Visa and MasterCard, which were born and bred and had well over half of their business in the U.S., didn’t compete here but did everywhere else, with a predictable result: better products and lower prices everywhere but home.

The
Entree
complaint was filed in July 1989. The judge assigned to the case was Pierre Leval, ironically a former partner of Terry Cone, one of the witnesses to MasterCard’s expensive dinner at Rusty Staub’s. The complaint had several goals and faced several obstacles. The basic objective was to terminate Entree and lay the basis for a debit card market with much more competition than existed in the credit card market. A broader goal was to undercut duality and begin to force MasterCard and Visa to compete.

The major obstacles to these objectives were bad legal precedents and bad antitrust policy and enforcement by the federal antitrust agencies. The worst of many bad legal precedents was
Nabanco.
If Judge Leval were to adopt the overly broad Wampum market definition like the judge in the
Nabanco
case had, we would lose. We would not be able to show that Visa/MasterCard seriously threatened to dominate a payment market that included cash and check transactions, whose dollar value then far exceeded the comparable numbers for credit and debit cards combined.

Another obstacle that not only hampered the states but to some extent also created the competitive problems we were trying to fix, emanated from errors made by the United States Department of Justice in 1975. In that year, the Antitrust Division helped to create the competitive abomination of Visa/MasterCard duality. During their formative years, Visa and MasterCard actually competed. Visa had a rule that prohibited a bank from simultaneously issuing Visa credit cards and MasterCard credit cards. This rule resulted not only in competition between the two credit card associations but also in competition between Visa banks and MasterCard banks. The Worthen Bank from Arkansas, which wanted to issue both brands of cards and wanted to own a piece of both associations, helped eliminate that competition. It challenged Visa’s anti-duality rule under the antitrust laws. Visa won an important
appellate court decision in the
Worthen
case and appeared headed for total vindication. However, Visa went to the Antitrust Division seeking support and approval of its anti-duality rule and was turned down. The Antitrust Division didn’t condemn the rule outright but voiced its concern of whether prohibiting banks from joining and owning a piece of both associations harmed competition.

At least one state helped the Federal Antitrust Division create this competitive nightmare. Arkansas filed a “friend of court” brief supporting Worthen. The brief was written by a young University of Arkansas law professor named Bill Clinton, who soon would become Arkansas’s attorney general. Clinton’s legal brief in support of Worthen’s anticompetitive position was apparently the beginning of a long and mutually beneficial relationship between the lawyer and the bank. Later highlights included a crucial loan to the Clinton gubernatorial campaign in 1990 that was orchestrated by Worthen owners at a time when the governor’s re-election was in jeopardy; a $2 million loan in 1992 to his presidential campaign, funding a media blitz to counter the Gennifer Flowers revelations; a 1994 fire in Worthen headquarters, where some Whitewater documents were stored; and persistent allegations that Worthen received special treatment during Clinton’s terms as governor.