The origin of the word credit is in the Latin credo, translated as "I believe." Credo is a religious, absolute faith. When applied to the profane world of business, it reflects the faith between the lender and the borrower. It's ironic then that the consumer credit card industry, taking its name from this sacred expression of faith, is so riddled with allegations of fraud and conspiracy.
If you used a Visa or MasterCard any time in the past eight years, you very likely were party to, and perhaps even a victim of, the biggest antitrust conspiracy in U.S. history involving the theft of tens of billions of dollars by the two dominant credit card companies.
In 2005, a group of retailers, along with trade groups like the National Restaurant Association, filed suit against Visa and MasterCard. The retailers alleged that the card companies used their duopolistic power to extract arbitrarily high swipe fees charged to purchases.
Together, Visa and MasterCard dominate the credit card market. Visa runs roughly 40 percent of all credit card transactions in the United States, MasterCard about a quarter. The lawsuit proceeded through a fact-finding phase with the plaintiffs gathering evidence that the credit card companies rigged swipe fees to extract billions of dollars from several million merchants and their consumers.
As with most complex white-collar cases, the one against Visa and MasterCard seemed destined to avoid a jury verdict. Last year, Visa and MasterCard bargained a pretrial settlement that won a judge's approval. The agreement garnered headlines that used phrases like "biggest ever," and "record payout." Under terms of the settlement, the credit card companies agreed to hand over $7.25 billion to the plaintiffs and their lawyers to make the lawsuit go away. The credit card companies admit to no criminal wrongdoing. The agreement "releases [Visa and MasterCard] from all claims that 'are alleged or could have been alleged' in the litigation," language that effectively immunizes the companies from future anti-trust lawsuits.
Even so the monetary settlement is substantial. So, case closed, justice done?
Not quite. The credit card companies are passing on part of the cost of their alleged crime to shoppers. It's all there in the fine print, written partly by Visa's white shoe lawyers, and tempered by a U.S. legal system the financial industry itself helped reshape over the past two decades.
The settlement payout, as big as it is, is only a fraction of the vast fortune amassed by Visa and MasterCard from millions of U.S. retailers. Now, many of the named plaintiffs that brought the lawsuit are steadfastly rejecting the settlement.
"Retailers overwhelmingly view this proposal not as a settlement, but as surrender," said Sandy Kennedy, president of the Retail Industry Leaders Association.
Merchants Object, a coalition of the retailers, say that the settlement locks in the Visa and MasterCard duopoly and requires no reorganization of the credit card industry, as would normally be the case when an anti-trust lawsuit is settled in favor of the plaintiffs.
"The settlement provides no relief from interchange rate setting or other rules," explains a spokesperson for Merchants Object. The coalition of restive retailers has grown to more than 500 companies, including giants like Amazon, Walmart, and Starbucks. The retailers say that the agreement "includes a mechanism for surcharging consumers to pay for Visa and MasterCard's anticompetitive behavior."
And there's another, more immediate means by which the credit card titans are passing on the massive cost of the alleged price fixing scam: tax deductions.
Based on Visa's most recent annual disclosure report filed with the Securities and Exchange Commission, it appears that its effective tax rate last year was 3 percent, thanks in large part to the deduction of $4 billion from the credit card company's gross income. The $4 billion was Visa's share of the settlement agreed to in the swipe fee lawsuit.
A spokesperson for Visa said the company "can't comment on specific tax deductions beyond what is in our public filings," but acknowledged that Visa has paid $8.4 billion in legal settlements since 2007, and that these are tax deductible expenses.
Surprising as it may be, the federal tax code allows businesses to deduct all "ordinary" and "necessary" expenses from their gross income to arrive at their taxable income. The terms ordinary and necessary are generally interpreted to include almost every expense a corporation incurs, including even punitive damages awarded in private lawsuits, and virtually all pretrial settlements, regardless of the alleged crime.
Three years ago, the Obama Administration resurrected a proposal to disallow deductions for punitive damage awards, but the law has gotten nowhere in Congress. Tax scholars Gregg Polsky and Dan Markel say that juries should become "tax aware," which would allow courts to craft bigger punitive fines so that damage awards have the punishing sting they're supposed to. But even under this reform, the costs of corporate crimes would continue to be shouldered by the public as companies subtract huge sums from their tax bills.
Companies can legally carry forward damages or settlement expenses twenty years into the future, and carry them backward two years prior if they so choose, utilizing these deductions in years when they earn more, and deferring deductions when they incur losses and won't have to pay taxes anyhow. This allows corporations to strategically time when they claim a tax deduction so as to maximize their after-tax cash earnings, all to the detriment of the federal treasury.
"Taxpayers should not subsidize BP's recklessness and deception in the Gulf, big banks' costly tampering with interest rates in the Libor scandal, or other wrongdoing," say Phineas Baxandall and Ryan Pierannunzi, researchers with the U.S. Public Interest Research Group who have studied how corporations reduce their tax bills by subtracting court awards and settlements from their gross income.
"Settlements are often touted as a win-win for everyone," note Baxandall and Pierannunzi in a report on the subject. "But typically there are hidden downsides to taxpayers and the general public from these settlements."
Baxandall and Pierannunzi point to BP's deduction of $37.2 billion after the oil spill in the Gulf as a case where taxpayers were effectively forced to shoulder half the cost of BP's restitution fund. "Companies that have committed wrongdoing can shift part of the burden of their penalty onto taxpayers by taking advantage of the ambiguities in the law," they say.
In Visa's case, the antitrust settlement award of just over $4 billion translates into an equally large deductible expense, and therefore tax savings of probably $1 billion for the San Francisco-headquartered company, and a $1 billion loss for the federal government.
Visa has claimed similar, if smaller, deductions on several settlements applying to a few of the dozens of lawsuits filed against the company in the past ten years. Many of these other lawsuits allege, like the massive antitrust swipe fee case settled last year, that Visa engaged in illegal and collusive price fixing practices to steal millions or billions from countless consumers, retailers, and smaller competitors.
This is where Visa's case differs in quality and degree from cases like BP's. BP's crime was negligence; the company did not intend to lay waste to the Louisiana and Florida shorelines and surely would have preferred that the Deepwater Horizon rig had not disastrously exploded. In Visa's case, the damages of the alleged conspiracy were not only intended, if we believe the plaintiffs' complaint, they were the central point of the action itself.
That Visa has been allowed to deduct these settlement payments surprised none of the tax experts I consulted with for this story, in spite of the fact that these were deductions stemming from an antitrust lawsuit. Tax professors and practitioners alike note that there are virtually no distinctions under the law as to which settlements are eligible for tax deduction: Categorically, all settlements are deductible because legal expenses are seen as an ordinary and necessary cost of doing business.
But are the credit card companies ordinarily and necessarily in the business of engaging in fraud and price fixing? That is, after all, what the plaintiffs alleged. Of course, the main reason that companies strike pretrial settlements, besides the tax advantages, is that these deals do not require the firm to admit guilt. Thus, in Visa's case, the alleged theft melts away into an indistinguishable flow of litigated expenses culminating in settlement payments -- all tax deductible, all of which works out in favor of the corporation.
Stephen Franklin is a freelance writer. The Pulitzer Center for Crisis Reporting supported this story.