PAYMENT AND THE LAW

October has been an eventful month for electronic payment processes used by retailers.On Oct. 4, the Supreme Court ruled that Visa and MasterCard can no longer block partner banks from issuing competitive cards like American Express and Discover, which could lead to more competition and conceivably lower rates for retailers.This week, on Oct. 28, the Check Clearing for the 21st Century Act ("Check

October has been an eventful month for electronic payment processes used by retailers.

On Oct. 4, the Supreme Court ruled that Visa and MasterCard can no longer block partner banks from issuing competitive cards like American Express and Discover, which could lead to more competition and conceivably lower rates for retailers.

This week, on Oct. 28, the Check Clearing for the 21st Century Act ("Check 21"), signed by President Bush a year ago, takes effect. The new law states a copy of an original check, called a substitute check (or Image Replacement Document), will hold the same legal status as the check itself. The substitute check can be created from an electronic image of a check, so that checks can, in effect, be transferred electronically between banks. (See sidebar, Page 62.)

These are two of the many recent legal and legislative changes impacting the way consumers pay and retailers process payments. Indeed, retailers now have to focus as much attention on the legal changes affecting payments as they do the technological changes.

Best practices for managing these changes to the payment landscape were discussed during Washington-based Food Marketing Institute's Electronic Payment Systems Conference, held Oct. 5 to 7 in Lake Buena Vista, Fla., at Walt Disney World Swan Hotel. Despite the flurry of activity this month, the case that has had the greatest significance for retailers was one settled in April 2003: the well-known Visa/MasterCard lawsuit. The class-action suit was filed by 4 million U.S. retailers against MasterCard International, Purchase, N.Y., and Visa USA, San Francisco.

The suit was initiated to address the "honor all cards" rule, by which Visa and MasterCard required a retailer accepting their credit cards to also accept their debit cards, as well as "the high cost of signature debit transactions," noted Jacki Snyder, former chairwoman of FMI's Electronic Payment Systems Committee and director of electronic payments for Supervalu, Minneapolis. She spoke during the Electronic Payment Conference's opening keynote session, "Litigation and the Interchange Structure."

The settlement's terms included changes to the "honor all cards" policies, damage payments totaling $3 billion, and a reduction of signature debit fees.

Although Wal-Mart Stores began to exercise its right to deny acceptance of MasterCard signature debit cards in December 2003, many retailers are still grappling with how to best exercise their rights a year-and-a-half after the settlement.

"It's difficult to tell customers that we won't accept their tender types," said Snyder. "The decision must be balanced with meeting consumers' needs."

Receipt of damage payments may be a source of some relief. According to Snyder, distribution of funds is planned for next year. "There are about five appeals pending that need to be resolved before it's distributed, and it'll be based on historical signature debit sales," she said. Retailers will receive claim forms in the mail 120 days after the appeals' resolution.

In the meantime, retailers are keeping a close watch on signature debit and other interchange fees. "After experiencing an initial [signature debit] interchange decrease, we're seeing it start to creep back up," said Snyder.

She explained that creation of "pricing tiers" by Visa and MasterCard affects the impact of interchange fees on a particular organization. "From a merchant's perspective, the individual cost will vary based on the tier you qualify for," said Snyder. These pricing tiers "give larger retailers smaller fees than lower- and mid-sized retailers. For instance, credit interchange fees are up for everyone, but smaller retailers have experienced a larger increase than larger retailers."

Fees for PIN-based debit transactions are also on the rise. "In the last five years, they are up 267% across all network bases and all prices," said Snyder. "In the year following the settlement, there have been 11 credit/debit fee increases, so there's been a lot of jockeying for position amongst the networks and banks. From a retailer's perspective, we like to think that as overall volume goes up, we might see a little positive decrease [in interchange fees] due to leveraging the infrastructure. But we've seen fees go up just the same."

Yet the Supreme Court's Oct. 4 ruling that Visa and MasterCard can no longer block banks from issuing competitive cards may produce favorable results for retailers. "We're hopeful that the introduction of new products will lead to lower interchange fees," said Snyder. However, she explained that the odd dynamics of competition in the banking world could actually drive interchange rates up. "We'll watch it very closely," she said.

Help From Retailers

According to David Balto, an antitrust attorney with Robins Kaplan Miller & Ciresi, Minneapolis, keeping a close eye on the networks is a merchant's best line of defense in the war on interchange fees.

"We're entering a new period of merchant sovereignty," he said. "We need to help the networks out. They are addicted to interchange fees and living on interchange fee highs. Only merchants that are informed and aggressive can help them to understand how to get over this addiction."

Renata Hesse, chief of networks and the technology section of the antitrust division of the U.S. Department of Justice, acknowledged that retailer participation in the First Data/Concord antitrust suit led to a settlement.

First Data and Concord ran into antitrust opposition after First Data announced its plans to acquire Concord. The Department of Justice was concerned that the deal would result in too much debit card processing market strength because at the time, First Data owned 64% of NYCE, which operates the NYCE PIN debit and ATM network. Concord owned the Star debit and ATM network.

"[Retailers'] participation in the investigation and your willingness to testify was critical to our ability to pursue the case," said Hesse. "It resulted in First Data's willingness to settle, so you're really important to [the Department]. You know what is happening with fees, you know the impact of consolidation of banks and networks, and you know how the market works. If you see something going on that you think the Department might want to take a look at, let us know."

Retailer willingness to take a proactive approach could result in greater negotiating ability. "Some merchants might ask, 'Why should I stick my neck out?"' said Balto. "My merchant clients who stuck their necks out have been receiving regular friendly visits from [networks]. The fact that they were willing to put their names on a witness list sends a signal that they are sophisticated buyers who know what their alternatives are."

Large retailers generally have similar negotiation capabilities, too. "A new phenomenon is the negotiation abilities of large retailers with greater volume," said Snyder.

Some retailers have opted for a different approach. To gain some control over interchange fees, Piggly Wiggly Carolina Co., Charleston, S.C., installed a biometric payment system from Pay By Touch, San Francisco, that's used to promote checking transactions that are less expensive for the retailer than debit and credit transactions. (SN, Oct. 18, 2004, Page 73.)

"We decided that we needed to do something to address the escalating costs of debit and credit transactions," said Rich Farrell, director of information systems for Piggly Wiggly Carolina, during the session, "Biometrics, Smart Cards, RFID -- Payments Fad or Future?" "We saw alternatives at the conference last year and decided to invite Pay By Touch in."

Although enrolled customers can execute debit and credit card transactions after they've scanned their finger and entered an access code at the POS, they are first given the option of completing a checking transaction. If they opt into paying this way, then funds are drawn from their checking account through use of the Automated Clearing House (ACH), an electronic payment transfer system.

"We've compared the payment methods of customers that used ACH payments with Pay By Touch to the method they used prior to its installation," said Farrell. "The biggest conversion took place with customers that had paid with PIN debit cards and checks. A few credit card customers have begun paying with ACH transactions. It's promising since we want to motivate customers that pay by credit card to use ACH transactions."

According to Farrell, 15% of customers have enrolled in the biometrics payment program in four stores, and 18% of non-cash payment transactions in those stores are being handled via the program.

Piggly Wiggly, which launched the program about three months ago, plans to install biometrics in additional stores in the near future.

Dealing With Check 21

Electronic check conversion is becoming an increasingly popular method of processing checks at retail. However, retailers should not confuse it with the new Check 21 law taking effect on Oct. 28.

"There is a lot of confusion surrounding this issue," said Joe Keller, president and chief executive officer, Solutran, Minneapolis, during the "Check 21 101" session at Food Marketing Institute's Electronic Payment Systems Conference. "ACH [check conversion] transactions are not the same thing. They are on a different track."

Check conversion is used by retailers to collect funds electronically by using account information from a customer's paper check payment. Check 21, short for Check Clearing for the 21st Century Act, allows banks to transfer electronic images of checks between themselves. The electronic image can then be turned into a copy of the original check, called a substitute check (or Image Replacement Document), which will hold the same legal status as the original check.

Still, Check 21 is important for supermarkets, given the role checks play at retail. "Checks comprise a large amount of sales, between 20% to 40% based on location," said Bryan Croteau, senior business analyst for Hannaford Bros. and Sweetbay-Kash 'n Karry Supermarkets, all divisions of Delhaize USA, Salisbury, N.C. "Although check use is declining, it's still significant."

One way Check 21 will affect consumers and retailers is by causing less float, or the time it takes for checks to clear. Yet it will probably be awhile before they notice a significant difference.

"Oct. 28 can probably be compared to Y2K," said Keller. "We're going to wake up, and clearing is not going to be that different from what it was the day before."

The reason is that, although banks must begin accepting substitute check images this week, they don't have to begin making images of checks yet. For some banks, obtaining imaging capabilities will take time.

"As a bank, we hope to be imaging at 80% by 2006," said Gary Kolk, vice president and product manager, global trade and treasury solutions, National City, Cleveland. "A lot of the smaller banks will take a very long time to begin [imaging checks]."

There are still steps that retailers can take in preparation for the changes. Merchants should make sure their treasury department, as well as accounts payable and receivable departments, are kept informed, said Kolk. Cashiers should also be notified about how to answer customers' questions.

"Retailers should probably count on less float. But as far as extra labor required for returns, it's still too premature to say," said Kolk.

Credit/Debit Card Transaction Fees

Fee on a $42 order:

Credit Card: $0.61

Signature Debit Card: $0.39

PIN Debit Card: $0.195-$0.245

Source: Food Marketing Institute