The protracted litigation battle between
Discover Financial Services and Visa and MasterCard, which has been
running since 2004, is over following a $2.75 billion settlement
agreed between the three card schemes. The long-running anti-trust
lawsuit was scheduled to go to trial on 14 October, but Visa and
MasterCard have opted to bring to a close any further legal battles
in much the same way they did with American Express in late
2007.

Discover had originally accused Visa and MasterCard of blocking
Discover’s access to the bank-issued card market in the US, with
Discover alleging that its two bigger rivals had engaged in
anti-competitive business practices by refusing to allow their
member banks to issue Discover-branded cards. Discover and American
Express both filed suit in 2004 after the US Supreme Court upheld a
lower court ruling that found Visa and MasterCard violated
anti-trust laws by banning their member banks from issuing cards
from rival firms. American Express settled with Visa for up to
$2.25 billion last November. This was followed by a $1.8 billion
deal with MasterCard this June. The $4 billion Amex settlement was
the largest of its kind in US history.

According to Sanjay Sakhrani, an analyst at Keefe, Bruyette &
Woods, Discover’s $2.75 billion settlement was better than
expectations and a win for the company.

“Clearly, MasterCard and Visa’s settlement with Amex provided some
leverage for Discover and resulted in an amount not far from the
amount Amex ended up receiving when arguably Amex had a stronger
case,” he told CI.

The settlement will also help to cushion Discover’s capital base
during a tough period for credit quality and funding costs, along
with supporting continued investment in boosting its acceptance,
network volume and deposit franchise.

Sakhrani added: “The proceeds are expected to trickle in over a
critical period of time and shore up its already relatively strong
capital position.”

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By GlobalData

MasterCard remained defiant following the announcement of the
settlement.

“We believe Discover’s lack of success resulted from decisions that
created a business model that is not attractive to bank issuers.
Nonetheless, we chose to settle this lawsuit to avoid the
uncertainty and distraction of a lengthy jury trial. This result,
which is in no way an admission of liability, is in the best
interest of our shareholders, our customers and our company,” said
MasterCard general counsel Noah Hanft.

Visa to pay bulk of damages

The $2.75 billion settlement figure is lower than the $6 billion
Discover initially sought, reflecting its size in comparison to its
larger network rivals. As with the Amex settlement, Visa will be
paying the bulk of the damages, given that it is the largest card
network in the US.

Under the terms of the agreement, Discover will receive $862.5
million from MasterCard in the fourth quarter of 2008, and $1.89
billion from Visa over four quarters in 2009. At the time of Visa
Inc.’s IPO earlier this year, an escrow account was established to
pay any future settlements or judgments relating to various
anti-trust litigation. Visa’s portion of the settlement comprises
$1.74 billion from the escrow account, $80 million from Visa Inc.
to obtain releases from MasterCard, and an additional $65 million
which will be refunded by Morgan Stanley under a separate agreement
related to the settlement.

Discover’s former owner, Morgan Stanley, is likely to receive some
of the settlement proceeds as per an agreement entered into at the
time of Discover’s spin-off from Morgan Stanley. However, in a
statement, Discover said that Morgan Stanley “is in breach of the
agreement and the amount of Morgan Stanley’s special dividend is a
matter of dispute.”

According to Sakhrani, the breach may be related to a separate
agreement Morgan Stanley has with Visa and MasterCard.

“Morgan Stanley will ‘refund’ Visa and MasterCard an amount related
to a separate agreement related to the settlement ($65 million to
Visa and $35 million to MasterCard). It would appear the breach may
be related to this separate agreement. Obviously, we would not hold
our breath for Discover receiving more than its agreed share, but
there is a chance it can capture a little more of the economics,”
he told CI.