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Trustbusters at the U.S. Department of Justice say the relationship between Visa and MasterCard is so incestuous that competitors are unfairly hurt, innovation is restricted and the consumer is left with fewer choices. For their part, the credit cards giants say that policies and bylaws that prevent their member banks from issuing American Express or Discover/Novus Cards have been a boon to the consumer because they have allowed Visa and MasterCard to build efficient national networks replete with new products and energized by competition among banks. Beginning on Monday, both sides will present their dramatically different views of the markets and current antitrust law when opening arguments are presented to Southern District of New York Judge Barbara S. Jones in U.S. v. Visa U.S.A. Inc., 98 Civ. 7076. At the heart of the case is the concept of “duality”: the fact that, since 1975, virtually all significant card-issuing banks have become owners of both Visa and MasterCard. MEMBER CORPORATIONS Visa and MasterCard are organized as membership corporations, or associations, that operate on a not-for-profit basis and are financed through fees and assessment on member banks such as Citicorp and Chase Manhattan. Voting on the boards of these associations is roughly weighted to reflect the volume of business the banks do using Visa and MasterCard. The problem, Justice Department officials say, is that the member banks have a seat on one credit card association’s board of directors while simultaneously having a representative on an important committee of the other’s association. The result, they argue, is that Visa and MasterCard have a virtual stranglehold on general purpose credit cards, representing 86 percent of the market and about 8,500 member banks, and the two have the power to stymie innovations, ranging from a method of ensuring secure transactions over the Internet to the use of so-called “smart cards.” In a trial that participants expect will last at least 16 weeks, Justice Department officials want Judge Jones to fashion essentially three remedies. With the nation’s 45 largest banks controlling 62 percent of Visa’s volume and 82 percent of MasterCard’s — they want the judge to split up governance by barring banks from having a seat on one association’s board of directors while also having a seat on the other’s key committees. They also want Jones to stop the sharing of confidential information between associations, and order that Visa and MasterCard drop their exclusionary policies or bylaws. Visa and MasterCard say the Justice Department’s five-year investigation has ended with an antitrust case that is wrong on the law and the facts. DUALITY Brent N. Rushforth of San Francisco-based Heller Ehrman White & McAuliffe, who represents Visa USA along with Heller partner M. Laurence Popofsky, said that the government has missed the boat on the “duality of governance” issue. “The marketplace has moved, because many of the banks have agreed to become more dedicated to one or another of those brands — that is not a consequence of the lawsuit, it’s a consequence of the marketplace,” he said. “We think the issue is moot. Banks are choosing up sides.” The associations also argue that it was an opinion by the department itself in 1975 that paved the way for duality. In 1974, Visa’s predecessor, NationalBankAmericacard Inc., asked the Justice Department for its opinion on a proposed bylaw that would have barred any bank in its system from participating in another credit card system. Rushforth said that the Department expressed reservations on the proposal, but took no position and reserved the right to change its mind. The government’s inaction, he said, paved the way for Visa to team up with MasterCard. “The government was there for the birth of duality,” he said. But the government believes that Visa undermined its own position when its board voted to permit member banks to own and participate in the governance of MasterCard, a move, the government’s complaint said, was made “over the objection of its general counsel.” And whatever the initial rationale for duality may have been, the government says, the associations have gone too far. “The foundation of the defendants’ position here is that you need some consistent rules,” said Professor William E. Kovacic of George Washington University Law School. “The paradox is that, in order to have competition you have to have restrictions to enhance the quality and effectiveness of the brand. They are going to argue that if you prevent restrictions, networks will not form in the first place.” The government, Kovacic said, “will accept the principle that some restrictions are needed, but that the associations’ restrictions are excessive.” EXCLUSIVITY Government antitrust lawyers say the restrictions have not only barred entry by Amex and others into the general purpose card network, but have also saved Visa and MasterCard the displeasure of competing with one another. The restrictions, the government argues, also relieved them from having to offer new products because it would merely shift profits from one card to another. The associations argue that market efficiencies were improved, without sacrificing meaningful competition, when Visa’s board adopted bylaw 2.10(e) in 1991, which mandated automatic termination for any member that issued Discover Cards or American Express Cards, or any other card deemed competitive by the board of directors. MasterCard followed suit when it adopted its Competitive Programs Policy (CPP) in 1996. The Justice Department said both associations have been somewhat honest about the impact of these changes on the competition, with presidents of both associations at one point conceding that were it not for the exclusionary rules, some of their member banks in the United States would issue Amex cards. In its complaint, the government says that “each network’s staff and management have sought at various times to increase their network’s independence and enhance network competition. The banks that control Visa and Mastercard have resisted these efforts.” Professor Harvey Goldschmid of Columbia Law School, who declined an invitation to lead the prosecution against Visa and MasterCard, said the problem for Jones is whether bylaw 2.10(e) and the CPP can be justified in the current environment. “A pivotal issue in this case is whether an exclusivity provision was reasonable when it was made and, more importantly, whether it’s reasonable now,” he said. “The key is whether the efficiency rationale and reasonable necessity of the provision continues now.” Jones, he said, will have to engage in a balancing act, weighing the anti-competitive impact of the bylaw and CPP versus the pro-competitive advantages and applying “the rule of reason.” Professor Jonathan B. Baker of the Washington College of Law at American University calls the focus on high-tech and innovation “the signature emphasis of the Clinton Administration’s” antitrust policy. “Not that innovation didn’t come up before,” he said. “It did, but it was the economy that made these issues salient.” And Assistant Attorney General Joel Klein has said that impediments to innovation are playing an increasing role in the antitrust division’s analyses, with the obvious example being the case against Microsoft Corp. So it is no surprise that innovation is at the crux of the case against Visa and MasterCard, providing the link between barriers to entry in the general purpose credit market and the lack of meaningful competition between the two defendants and the consumer. For example, the government says that, in the 1980s, MasterCard wanted to introduce the smart card, which in addition to standard data, would store information such as airline and hotel preferences. MasterCard and Visa explored the idea of introducing the new product jointly, but Visa ultimately vetoed the plan and MasterCard’s board killed the idea. In court papers, MasterCard answered that, in the 1980s smart cards “were a solution in search of a problem.” Since that time, MasterCard has made “significant investments” to develop a smart card by purchasing an ownership interest in a company called Mondex International and its United States franchise, a company in which Discover/Novus is also invested. Visa, it says, “is pursuing a fundamentally different technical solution.” Another area in which collusion has stifled innovation, the government claims, is a self-imposed bar to competition between Visa and MasterCard in commercial cards, or corporate cards and others issued to businesses. In 1993, Justice Department lawyers say, Visa’s staff believed that barring member banks from issuing both Visa and MasterCard commercial cards, an exception to duality, would help Visa innovate and promote its commercial cards, giving it the lead over MasterCard as well as a chance to make inroads into a market dominated by American Express. The Justice Department charges that member bank opposition killed the plan. Finally, the Department of Justice points to Visa’s aborted scheme for insuring secure transactions over the Internet. In 1995, Visa announced a deal with Microsoft Corp. to use encryption software, and MasterCard responded by telling its member banks it would forge alliances with other software makers. The government says that member banks “pressured Visa to abandon the agreement” and develop a cooperative effort with MasterCard instead. TRIAL STRATEGY At trial, the government intends to show that competing systems for secure transactions would have been on the market by 1995 had the member banks not insisted on maintaining duality in this forum. But MasterCard plans to show that Visa cancelled its plans with Microsoft because the software giant wanted to require all financial institutions to operate only within Microsoft’s operating standards, and because Microsoft wanted to charge a “toll” for every transaction. If the government is unable to prove that these specific innovations were suppressed, said Baker, they must show that the companies “took steps to make it less likely that firms would innovate in ways that would undermine each other.” Baker, who was the Director of the Bureau of Economics at the Federal Trade Commission from 1995 to 1998, said that the government would also try to strengthen its case by showing that the associations “take steps that could have the effect of stifling innovation and have no other explanation.” The defense, he said, will focus as much as possible on the how innovative the industry has become. Lawyers for MasterCard and Visa say they will do just that, showing how the associations developed, for example, supermarket swipe cards. But in a broader retail context, the government said that Visa and MasterCard, despite making advances in swipe cards, insisted that merchants maintain separate swipe machines at the cash register. When merchants howled in protest, they accepted single machines, but then required that all transactions be initially processed through their computer networks, and then charged merchants a higher fee for processing Amex and other cards. Another example is in advertising, where Visa’s prominent “It’s Everywhere You Want To Be” marketing campaign has distinguished itself from MasterCard. Antitrust experts believe that one argument the associations will make is that exclusivity provisions such as the Visa bylaw ensure member bank loyalty and allow Visa to establish and maintain a separate identity. Visa and MasterCard say these exclusionary rules are needed to build a large and consumer-friendly network. They say that never in history have consumers been given more choice between as many cards as possible and point to the flood of offers from different banks we all receive in our mailboxes. Government lawyers, however, say things could be better, and argue that, outside the United States, where Visa bylaw and MasterCard’s CPP do not apply, consumers are given a broader range of choice. The antitrust case comes some six months before trial is scheduled to begin in the Eastern District of New York on a class action brought in 1996 against Visa and MasterCard by thousands of retailers who charge, among other things, that the associations are forcing them to accept debit cards at exorbitant rates as a quid pro quo for accepting the credit cards. Before class action status was granted in February, Judge John Gleeson, in In re Visa Check/Mastermoney Antitrust Litigation, 96-CV-5238, granted the Justice Department leave to intervene earlier this year to seek a modification of a protective order to allow plaintiff’s counsel to share their analyses of discovery documents without waiving any privilege. As for the instigation of the case before Jones, Visa and MasterCard point the finger directly at American Express, which filed the initial complaint that led to a five-year investigation by the Department of Justice, and to a lesser extent, Discover/Novus. Lead counsel for the Justice Department in this case is Special Counsel for Civil Enforcement Melvin A. Schwarz. Kevin J. Arquit, James C. Egan Jr., Kenneth Gallo and Aimee H. Goldstein, of Clifford Chance Rogers & Wells, represent MasterCard International Inc., while Noah Hanft is in house counsel for MasterCard.

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