Routing Wars

How EMV is fueling a new merchant-network fight over which electronic highways debit card transactions will travel.

War has broken out again between big retailers and the bank card networks. Earlier courtroom fights involved everything from honor-all-cards rules to interchange to merchants’ attempts to steer customers away from high-cost credit cards. Those themes echo today in a new conflict raging over the crucial issue of transaction routing. At stake is the question over which network debit transactions generated by the new EMV chip cards will flow.

Retailers want unfettered access to the PIN-debit networks to get what they believe is the best pricing and service choices. That’s their right, they maintain, under the Durbin Amendment to 2010’s Dodd-Frank Act. They allege Visa Inc. and MasterCard Inc., in the name of consumer choice, are brushing aside merchant preferences to route debit traffic onto their networks.

That, the merchants allege, generates more fee revenue for Visa and MasterCard and higher interchange revenue for their card-issuing bank and credit-union clients, especially the big ones that produce the most transactions.

Recent lawsuits filed by The Kroger Co., the biggest standalone supermarket chain, home-improvement giant The Home Depot Inc., and the world’s biggest retailer, Wal-Mart Stores Inc., lay out the merchants’ case in detail.

These merchant actions “should suggest to you that there’s a great deal of discontent with EMV,” says Mark Horwedel, chief executive of the Merchant Advisory Group, a Minneapolis-based association of 105 big merchants concerned with payments issues.

Montvale, N.J.-based consultant Paul Tomasofsky, executive director of a group of PIN-debit networks called the Debit Network Alliance, says he wouldn’t be surprised if more such lawsuits were filed and eventually consolidated into a class action.

“It seems to be coming to a head now,” he says. “EMV has done that.”

Even the Durbin Amendment’s chief sponsor, U.S. Sen. Richard Durbin, D-Ill., has gotten into the act. This past spring, Durbin criticized obscure network fees, and then in July mentioned the routing issue while voicing opposition to two Republican-backed bills in the House of Representatives. One bill would specifically repeal the Durbin Amendment; the other would wheel Dodd-Frank into the operating room for major surgery.

“While the big banks and card networks may want to reopen a battle they lost six years ago, Congress’s time would be better spent investigating and reining in the new anti-competitive fees that keep popping up in the credit and debit card industries,” the senator said in a statement.

“Recently, I pointed out that Visa and MasterCard had created blatantly anti-competitive fees to penalize small banks and credit unions and deter them from doing business with other card networks,” Durbin added. “Continued vigilance by Congress and regulators is necessary to help expose these rigged schemes and ensure that the credit and debit card systems operate fairly for all Americans.”

Visa, the biggest network, draws most of the fire when it comes to transaction-routing disputes. Visa is a defendant in all three of the recent lawsuits, while only Home Depot’s case names MasterCard.

“The card networks have really overplayed their hands,” says the MAG’s Horwedel. “I think the merchants in this country are treated very poorly by the card networks, Visa especially.”

Visa’s PIN-debit network, Interlink, was especially hard-hit after the Federal Reserve Board’s rule implementing the Durbin Amendment took effect in 2011-12, losing more than half its volume. The rule outlawed exclusive network-issuer deals and required debit cards to offer merchants a choice of at least two unaffiliated networks for transaction routing.

But the routing issue isn’t the only payments pot boiling over lately and threatening to scald the big networks. On June 30, a federal appellate court overturned the $5-billion-plus settlement in a huge credit card interchange and network-rules case whose origins stretch back more than a decade (box).

These latest disputes reflect the growing influence of big merchants in the payments world, according to James Sinegal, a senior analyst at Chicago-based investment-research firm Morningstar Inc. who follows payments companies.

“The background is that merchants have gotten a lot more powerful than they were 20 or 30 years ago,” he says. “The payment systems were set up to favor the big banks over the merchants.”

Debit routing so far has been a fight between networks and national merchants, and it looks like it will remain that way, according to merchant-acquiring executives polled by Digital Transactions at July’s MidWest Acquirers Association annual conference in Cleveland.

Unlike big retailers, small merchants worry much more about running their businesses than cutting a few basis points off their card-acceptance costs. For the chains, though, such increments can translate into millions in savings when spread over billions in sales volumes.

Indeed, small merchants are “barely aware of EMV, other than the fact that they have to change their terminal,” says Donna Embry, chief payments advisor at Payment Alliance International, a big independent sales organization based in Louisville, Ky., with 20,000 mostly small and mid-sized card-accepting merchants and a network of 70,000 ATMs.

But the size and resources of big PIN partisans like Wal-Mart guarantees that debit routing will be a hot issue for the foreseeable future.

“It will keep the lawyers busy for a very, very long time,” says payments-industry analyst Lawrence Berlin, a vice president at Chicago-based First Analysis Securities Corp.

This latest dispute broke into the open in May when Wal-Mart accused Visa in a New York state court of trying to force the retailer to route some chip transactions onto Visa’s network by having customers sign for debit card purchases rather than enter a PIN. Typing in a PIN would move the transaction onto the retailer’s preferred PIN-debit network (“Wal-Mart’s Visa Suit Uncorks a Long-Festering Controversy,” June).

In late June, Visa filed a counterclaim alleging that Wal-Mart’s lawsuit is not an issue involving violations of federal debit card regulations, as Wal-Mart cast it, but rather a contract dispute. Visa said Wal-Mart “fraudulently induced” it to sign an acceptance contract last November but “in bad faith” went on to violate terms in the agreement that required Wal-Mart to give customers a choice to sign for purchases with Visa debit cards.

The lawsuit Kroger filed in late June paints a picture of managers at the Cincinnati-based supermarket giant glumly contemplating the possibility of Visa cutting off acceptance of its debit cards at Kroger stores unless the chain agreed to Visa’s terms for EMV routing.

The dispute dates to a phone call a Kroger executive had with several Visa managers on Feb. 11, 2015. The executive outlined Kroger’s plan to have its new chip-enabled POS terminals prompt customers to enter a PIN whenever the terminal detected a Visa chip debit card. Kroger was embarking on a multimillion-dollar project to deploy 54,000 EMV readers in 3,200 stores to meet the card networks’ Oct. 1, 2015, EMV liability shifts. The shifts would force merchants to cover counterfeit card fraud losses if their terminals didn’t read chip cards.

Kroger said it wanted PIN authentication because PIN transactions cost merchants less to accept and are much less prone to fraud than signature debit. Visa signed off on that plan, according to Kroger.

But Visa eventually realized that PIN-debit networks were coming out with new “PINless” services that could route signature-based transactions and provide new competition to Visa, according to the suit (“Debit Diversification,” July).

A year after approving Kroger’s plans, Visa informed the chain’s merchant acquirer, Vantiv Inc., that Kroger’s POS practices violated Visa’s honor-all-cards rules because “they were not allowing [Visa] cardholders to select a Visa transaction,” the suit says.

Kroger calls that stance a violation of the Fed’s Durbin rule because it infringes on a merchant’s transaction-routing choice.

In addition, Visa wanted to enforce technical specifications in its so-called Transaction Acceptance Device Guide that Kroger claims would cause POS terminals to display application identifiers (AIDs) for transaction types that would be confusing to consumers.

“In a sudden and drastic change of direction seemingly motivated by an intention to restrain competition,” Visa declared that Kroger was violating the network’s rules, according to the suit filed in U.S. District Court in Cincinnati.

Thus began a series of phone calls, letters, and meetings between Visa and Kroger executives. Kroger claims Visa stepped up the pressure by fining it $7 million, $3.1 million of which it had paid by the time it filed the lawsuit, and threatening more fines of $100,000 per day for alleged non-compliance.

In a March 17 letter to Vantiv, Visa reportedly said it might refuse to let Kroger continue accepting Visa-branded debit cards, only credit cards. The lawsuit calls that threat “no small matter” that could have “catastrophic consequences” for customer relations since Visa debit cards accounted for $29 billion of Kroger’s sales last year— “including about $10 billion [in] Visa signature debit transactions and about $19 billion [in] Visa PIN-debit transactions,” the complaint says.

Based on the grocer’s $109.8 billion in total sales in fiscal 2015, Visa debit transactions accounted for 26% of Kroger’s revenues.

Visa also “suspended a pricing agreement with Kroger and informed Kroger that Visa is going to increase the prices that Visa charges Kroger to process debit and credit card transactions,” the suit says.

The back-and-forth between Kroger and Visa went on until June, when Kroger said it decided “to capitulate to Visa’s demands.” That came after Visa reportedly said it would stop the fines and remove the threat of no debit card acceptance if the retailer eliminated the PIN requirement and stopped PINless routing.

On June 20, Kroger duly instructed Vantiv to stop routing Visa signature debit transactions to third-party debit networks. The next day, Vantiv confirmed to Kroger that it had stopped doing so.

“This lawsuit follows,” says the complaint. Kroger is seeking unspecified damages and court declarations that Visa’s rules and technical specs cannot interfere with routing choice.

Visa denies the allegations and says it is guarding cardholders’ rights to choose how to authenticate a debit transaction.

“Visa does not require Kroger to route its transactions only through the Visa network,” an emailed statement from Visa says. “Visa is focused on protecting a cardholder’s right to choose whether to sign or enter a PIN when completing their payment with a Visa debit card at checkout.”

Home Depot’s lawsuit preceded Kroger’s by only about two weeks. Besides naming MasterCard as well as Visa as a defendant, the suit is notable for singling out Visa’s Fixed Acquirer Network Fee (FANF) in addition to taking aim at EMVCo, the international chip card standards body owned by global networks Visa, MasterCard, American Express, Discover, Japan’s JCB, and China’s UnionPay.

Atlanta-based Home Depot’s suit accuses Visa and MasterCard of price fixing and conspiring with banks not to compete in the general-purpose credit and debit card network markets. The networks hamstring merchants through restrictive acceptance rules and by setting “supracompetitive” interchange rates, according to Home Depot, which says it paid nearly $750 million to accept bank cards in 2015.

The suit, filed in federal court in Atlanta, asserts violations of the federal Sherman Act and of state competition laws in Georgia, California, and other states. It seeks treble damages.

Like other retailers, Home Depot alleges that the global networks prefer higher-margin signature authentication with chip credit and debit cards rather than more secure PIN authentication, which is common elsewhere in the world. And, as Sen. Durbin has done, Home Depot claims Visa and MasterCard enforce their will through EMVCo.

“Under the rubric of EMVCo, Visa and MasterCard established specifications favoring their own less secure chip-and-signature cards over more secure chip-and-PIN transactions,” the suit says. “Visa and MasterCard refused to prioritize PIN authentication despite requests from consumers, merchants, and regulators, and guidance from independent studies and think tanks.”

In a statement, MasterCard says it was not surprised by the Home Depot lawsuit because the retailer had opted out of the credit card interchange settlement.

“We’ve been working with our merchant and issuer customers to migrate to EMV, or chip card, technology in the U.S. since we introduced our [EMV] roadmap back in 2012,” MasterCard says. “With respect to comments around the use of PIN or signature for EMV transactions, our liability shift rewards the entity with the more secure system—be it merchant or issuer—by holding the other party responsible for counterfeit card fraud. MasterCard leaves the decision on how to verify the cardholder identity—PIN or signature—up to the merchant and the issuer.”

The statement also says that “regardless of how the cardholder’s identity is confirmed, the chip makes data much more secure, rendering it almost useless to create fraudulent cards or transactions.”

Home Depot goes on to target FANF, which has been controversial since Visa introduced it four years ago (“What’s This FANF Thing All About?” September, 2012). The fee rewards merchant acquirers with lower pricing for routing more transaction volume Visa’s way.

But Home Depot calls it an access fee for using the Visa network, and that the more locations a merchant has, the more it pays.

“In fact, because the merchant must pay Visa’s fixed fee whether it routes the transaction to Visa or not, the merchant will, in effect, pay twice for transactions routed over competing PIN-debit networks—an up-front payment to Visa simply to be a part of the Visa network, and a second payment to a competing PIN-debit network for any particular transaction not routed to Visa,” the complaint says.

Apart from asking for antitrust damages and a jury trial, the only specific request Home Depot makes is that the court enjoin FANF.

The networks have a request pending with the Atlanta court to transfer the case to the federal court in Brooklyn, N.Y., for consolidation with the big merchant credit card class action.

Home Depot isn’t the first plaintiff to take a shot at FANF. A lawsuit filed against Visa and MasterCard by a group of more than 50 retailers, including 7-Eleven Inc., objecting to the credit card interchange settlement claims “FANF maintained Visa’s monopoly power by compromising the PIN-debit networks’ ability to compete and by neutralizing the competitive dynamic that should have been introduced by the Durbin Amendment.”

One such network, Houston-based Pulse, challenged the rule in a November 2014 antitrust suit in which the Discover Financial Services subsidiary calls Visa “a long-time monopolist.”

Pulse also takes issue with another component of Visa’s post-Durbin recovery plan, the so-called PIN-Authenticated Visa Debit (PAVD) program, an issuer-oriented feature that takes advantage of the Visa backbone network’s previously underutilized ability to process PIN as well as signature transactions.

Pulse’s suit is grinding its way through pre-trial proceedings in federal court in Houston. The network declined comment.

In a recent earnings call, Visa chief executive Charles W. Scharf said Visa isn’t the only network that uses incentives to attract transactions from merchants. He said Interlink’s volumes “are very volatile,” depending on what’s going on in the market.

“That is the way the business works, and I think that’s the way the Durbin Amendment intended it to work,” he said. Scharf also said that “ultimately we just want our consumers to have the ability to use the cards.”

But if merchants have their way, consumers indeed will have the ability to use their chip debit cards, yet what goes on behind the scenes will be the result of what merchants want, not what networks and issuers want.