American Express Co. rules barring businesses from asking customers to use lower-cost credit cards violate U.S. antitrust law, a federal judge said in the first definitive decision on practices that allow card firms to collect about $50 billion a year in merchant fees.
The U.S. Justice Department’s victory on Thursday in its lawsuit against the credit card company might give merchants more leverage in their effort to cut such costs, which are largely hidden from consumers. The ruling is the latest blow to the New York-based firm after partnerships with Costco Wholesale Corp. and JetBlue Airways Corp. ended. Shares fell as much as 2.8 percent in New York trading.
American Express failed to show that its so-called non-discrimination provisions, imposed on merchants who agree to accept its card, don’t harm competition, U.S. District Judge Nicholas Garaufis in Brooklyn said in his ruling. He said he would decide remedies later, which could include lifting or changing rules used to require merchants to pay higher processing fees. The U.S. isn’t seeking money damages.
The company has “the power to repeatedly and profitably raise” its merchant prices “without worrying about significant merchant attrition,” Garaufis said. “The result is an absence of price competition among American Express and its rival networks.”
The rules have also “foreclosed the possibility of a current network or new entrant” differentiating itself by imposing lower fees, he said.
American Express will appeal, spokesman Andrew Johnson said in an e-mailed statement.
“The court’s ruling will not provide any benefit to consumers and will, in fact, harm competition by further entrenching the two dominant networks,” he said. “We continue to believe that the Department of Justice’s arguments are flawed and believe we should prevail on appeal.”
American Express argued in court that the rules promote competition by allowing it to coexist with more widely used card brands Visa Inc. and MasterCard Inc. American Express said the higher fees also help it fund generous services that set it apart from competitors, and that customers might be less likely to use the card if merchants express preference for others.
American Express is accepted at approximately 3 million fewer merchant locations than Visa, MasterCard and Discover.
The ruling comes as legal battles continue between merchants and card firms over discount and interchange fees, also known as “swipe” fees, which are subtracted from the amount businesses collect when customers pay with credit cards.
Garaufis is considering whether to grant final approval to an American Express accord with merchants allowing them to add surcharges to credit card transactions in some circumstances. Visa and MasterCard agreed to allow limited surcharges as part of a separate $5.7 billion settlement with U.S. merchants.
That settlement has been challenged by dozens of large retailers including Wal-Mart Stores Inc., Amazon.com Inc. and 7-Eleven Inc, which said it wasn’t big enough and unfairly forced them to surrender rights to sue in the future.
The U.S. case against American Express went to trial in July and was held without a jury. More than 30 witnesses testified, including representatives from airlines, retailers and hotel companies.
American Express Chief Executive Officer Kenneth Chenault took the stand and said the rules were needed to protect the company’s brand from discrimination.
Chenault, who joined the company as a director of strategic planning in 1981, testified that American Express struggled to expand in the 1980s and 1990s because of a “double chokehold” of pressure from competitors, including a campaign by Foster City, California-based Visa to encourage merchants to ask customers to use its card instead.
Visa and Purchase, New York-based MasterCard together have about 1 billion cards in the U.S., compared with about 55 million American Express cards, according to American Express.
In his court decision, Garaufis said American Express rules protecting the card from “unfair denigration,” such as merchants disparaging the brand or rejecting it at the check-out counter, will likely remain in place.
“Plaintiffs do not challenge, and the court does not find unlawful,” aspects of rules which prohibit merchants from mischaracterizing American Express products, engaging in activities which harm the brand or “requiring customers to pay a fee when using their American Express card that is not also charged when using another card brand,” he said.
Fees collected from merchants are the single largest source of American Express’s revenue, according to company regulatory filings. As much as 12 percent of total revenue may be at risk due to the decision, RBC Capital Markets analyst Jason Arnold said in a note on Thursday.
John Newman, a former Justice Department lawyer who worked on the case, said merchants may use the prospect of steering customers to other cards as “negotiating leverage” to help lower American Express fees.
The company may be “forced to streamline its operations or cut costs or lower its rewards to cardholders” to make up for loss in revenue, said Newman, now a professor at the University of Memphis Cecil C. Humphreys School of Law.
The Justice Department said American Express imposes the highest merchant fees on average among card networks. The company said its average merchant fee in 2011 was three basis points higher than MasterCard’s and eight basis points higher than Visa’s. A basis point is one-hundredth of 1 percent.
The company said its rates have fallen from an average merchant fee of 2.52 percent in 2012 to 2.51 percent in 2013.
Garaufis said the ruling will benefit consumers even if they’re largely unaware of fees when they use their cards.
“The court expects that merchants will pass along some amount of the savings associated with declining swipe fees to their customers in the form of lower retail prices,” he said.
The case is U.S. v. American Express, 1:10-cv-04496, U.S. District Court, Eastern District of New York (Brooklyn).