EDNY Finds that American Express's Anti-steering Rules Violate Sherman Act Section 1 | Practical Law

EDNY Finds that American Express's Anti-steering Rules Violate Sherman Act Section 1 | Practical Law

The US District Court for the Eastern District of New York found that American Express's non-discriminatory provisions (NDPs) in contracts with its merchants violate Section 1 of the Sherman Act.

EDNY Finds that American Express's Anti-steering Rules Violate Sherman Act Section 1

Practical Law Legal Update 3-601-2825 (Approx. 5 pages)

EDNY Finds that American Express's Anti-steering Rules Violate Sherman Act Section 1

by Practical Law Antitrust
Published on 20 Feb 2015 • USA (National/Federal)
The US District Court for the Eastern District of New York found that American Express's non-discriminatory provisions (NDPs) in contracts with its merchants violate Section 1 of the Sherman Act.
On February 19, 2015, the US District Court for the Eastern District of New York held in United States v. American Express Company that non-discriminatory provisions (NDPs) in American Express's contracts with its merchants are an unreasonable restraint of trade in violation of Section 1 of the Sherman Act (No. 10-CV-4496 (E.D.N.Y. Feb. 19, 2015)). In American Express, the Department of Justice (DOJ) and 17 state attorneys general alleged that the NDPs harmed competition by forbidding merchants that accept American Express cards from steering customers towards using other cards with lower discount rates (the rate credit card companies and their networks charge to merchants when their credit card is used). As part of its business model, American Express charges a higher discount rate than its competitors, including Visa, MasterCard and Discover. However, the NDPs expressly prohibit merchants that accept American Express from:
  • Implying that it prefers other cards to American Express.
  • Dissuading customers from using American Express in favor of other credit card brands or payment methods.
  • Promoting other credit cards over American Express, except, in certain circumstances, when the merchant has its own private label card.
Though American Express has allowed certain merchants to amend the NDP, those merchants number less than one thousand out of 6.4 million. Plaintiffs alleged that by forbidding merchants from steering customers to cards with lower discount rates, the NDPs block merchants from using competition to keep discount rates low, resulting in higher costs to the consumer.
The court analyzed whether the NDPs were an unreasonable restraint of trade under Section 1 as non-price vertical restraints under the rule of reason. In holding that the NDPs violated Section 1, the court held that:
  • Plaintiffs adequately alleged:
    • a relevant market;
    • defendant's market power; and
    • an adverse effect on competition in the relevant market.
  • The defendant's procompetitive justifications were not persuasive, including the argument that NDPs are necessary to prevent:
    • harm to its unique and innovative business model; and
    • free-riding.
Earlier in the case, both Visa and MasterCard entered consent decrees to remove similar NDPs from their merchant contracts.

Relevant Market

The court held that plaintiffs adequately alleged that the relevant market was general purpose credit and charge (GPCC) card network services. GPCC card network services are services that facilitate credit card purchases and are offered by a range of credit card brands and accompanying banks. GPCC card network services include two levels of competition:
  • Card issuance, where cards compete to attract customers to use their card.
  • Network services, where cards compete to offer credit services to merchants.
The court held that because NDPs do not directly affect card issuance competition, network services was an appropriate and distinct product market for NDP antitrust analysis. The court further held that though debit cards have risen in popularity, debit card services are not reasonably interchangeable with credit card services from a merchant's perspective and are not included in the market definition because:
  • Merchant acceptance of debit cards does not affect the price GPCC card networks charge merchants.
  • Consumers do not view debit and credit cards as interchangeable at the point of sale.
  • Merchants do not view debit and credit card acceptance services as interchangeable, and there is no evidence to suggest merchants would switch from GPCC card acceptance in favor of debit.
  • Debit acceptance does not constrain GPCC card network pricing.

Market Power

The court held that the defendant possessed sufficient market power in the GPCC card network services market to have an adverse effect on competition. The court held that plaintiffs adequately alleged:
  • That the defendant had a significant market share at 26.4% of the market, the second-largest market share in the GPCC card network market.
  • High barriers to entry in the GPCC card network market, including:
    • large setup costs; and
    • difficulty in attracting merchants to accept a new credit card that is not carried by many consumers.
The court found that new payments methods such as PayPal, Square and Google Wallet are not threats to the market as those services are viewed as GPCC-accepting merchants, not as rivals.
Though the defendant controls a large percentage of the GPCC card network services market, the court held that alone was not sufficient to prove market power. However, the court reasoned that the defendant's market share coupled with its cardholder loyalty and pricing practices was sufficient to prove market power. The court noted that the defendant's cardholders are fiercely loyal due to the defendant's robust rewards program, and have historically been seen to take business elsewhere if a merchant ceases to accept American Express, making it difficult for merchants to drop American Express. As further evidence of its market power, the court noted that the defendant was able to steadily raise its discount rates between 2005 and 2010 and retain nearly all merchants.
Therefore, the court held that the defendant possessed sufficient market power to cause adverse effects on competition in the GPCC card network services market, and proceeded to determine whether the defendant's NDPs cause actual harm to competition.

Adverse Effects on Competition

The court held that plaintiffs adequately alleged that NDPs caused actual harm to competition. The court reasoned that, by limiting a merchant's ability to steer customers to other, lower-cost credit card payment methods, the NDPs impede horizontal interbrand competition because:
  • Merchants lose their ability to control or reduce consumption of the defendant's network services in response to change in discount rates.
  • The defendant has little to no incentive to compete for lower discount rates.
Additionally, the court reasoned that NDPs prevent:
  • The defendant's competitors' procompetitive efforts to gain market share through preference relationships with merchants.
  • New entrants that may attempt to enter the market by offering a low-cost alternative to current discount price network offerings.
The court noted that NDPs have allowed all four major GPCC card network service providers to raise their discount rates, as merchants are not able to steer their customers to the lowest-cost option. That price increase is ultimately passed on to the consumer in the form of higher retail prices, regardless of whether they use American Express or not.
The court also noted that the NDPs prevent GPCC card network service innovation by preventing development of merchant-owned payment solutions put forward by its competitors.

Procompetitive Justifications

The court was not swayed by the defendant's procompetitive justifications for its NDPs. The defendant argued that the NDPs are necessary to:
  • Preserve American Express's unique business model and ability to promote competition in the network services market.
  • Prevent merchants from free-riding on the defendant's merchant and cardholder value drivers.

Unique Business Model

The defendant argued that if steering is allowed, consumers would be less likely to use the American Express card, which would eventually lead to a decreased customer base, endangering the defendant's unique business model that currently promotes market competition. The defendant further argued that because it has a narrower acceptance network, it must use NDPs to successfully compete with other brands for banking and other co-brand relationships.
However, the court noted that antitrust laws are intended to protect competition, not competitors, and that protecting the defendant's business strategy would be the latter. The court reasoned that point-of-sale merchant preference is an important aspect of competition in the card network services market, and that the defendant's procompetitive justification inhibits that competition.

Free-riding

The defendant argued that NDPs are necessary to prevent merchants from free-riding on the defendant's:
  • Analytics-based services and other market intelligence products provided to merchants. However, the court noted that the defendant often prices and sells those products separately from its network services, which is a more efficient way to prevent free-riding. The court therefore held that the is not reliant on its network services to recover the cost of analytics and market intelligence products, and did not establish a legitimate procompetitive justification for NDPs.
  • Cardholder rewards program. The court did not find that argument persuasive because card-use investments are not subject to free-riding, as the network does not incur a cost if consumers do not use those benefits.
  • Brand value investments. American Express argued that merchants benefit from being associated with its brand. However, the court noted that brand recognition is an effect of the defendant's business model, and free-riding on brand recognition would not decrease the defendant's incentive to promote its brand.
Therefore, the court held that plaintiffs established that NDPs have adverse effects on competition not supported by any procompetitive justification and that the NDPs are an unlawful restraint of trade in violation of Section 1. The court has yet to release a remedial order or remedy.