The clearinghouse that paid itself first
Visa, Mastercard and several major banks are now defending themselves in a new lawsuit alleging that their interchange‑fee arrangements violate antitrust law. The pattern that makes such litigation possible—and that often leaves the purported victims with little of any eventual payout—is the same one that turned a journalist’s discovery about Google Maps tracking into a settled class action whose proceeds never reached the people whose data was allegedly misused.
The mechanism begins with a discoverer who uncovers a deviation between a promised rule and actual practice. In the Google Maps case a journalist, not a lawyer, found that turning off location tracking in the app did not stop the service from transmitting the data to Google’s servers. The discoverer brings this information to a state attorney general, who treats it as evidence of a violation and threatens enforcement. The defendant, faced with the prospect of a protracted injunction, chooses to settle rather than risk a court order that would force a costly redesign of its data‑flow architecture. The settlement is negotiated by the defendant’s lawyers and the state’s counsel, who agree on a monetary penalty and a commitment to cease the offending behavior.
At the same time, a separate class action is assembled on the basis of the journalist’s research. The class is defined as all Google Maps users who had turned off tracking and believed their location data remained private. The plaintiffs’ counsel files the complaint, names a few representative users, and begins discovery. Because the alleged harm is diffuse—each user’s loss is a fraction of a cent—the class members have little incentive to monitor the litigation or to challenge the lawyers’ decisions. The plaintiffs’ counsel, however, stand to earn a fee that is a percentage of any settlement or award, a fee that grows with the size of the payout but does not depend on how much of that payout actually reaches the class members.
When the parties reach a settlement, the defendant agrees to pay a lump sum that covers both the state’s fine and the class action’s demand. The settlement agreement allocates a portion of the lump sum to pay the plaintiffs’ counsel’s fees, another portion to cover administrative costs of the settlement fund, and the remainder to be distributed to the class. Because the administrative entity that manages the fund is typically retained by the defendants or by a third‑party vendor that charges a percentage of the fund for its services, a non‑trivial share of the settlement money is siphoned off before any distribution occurs. The class members receive either a pro‑rata cash amount that is often negligible after fees and administrative costs are subtracted, or they receive non‑monetary benefits such as coupons or service credits that are worth far less than the cash equivalent.
The same sequence of actions appears in other domains where a rule is violated, a regulator or enforcer steps in, and a settlement is negotiated. In the early twentieth century, patent‑medicine manufacturers advertised curative claims that the Food and Drug Act of 1906 prohibited. When state attorneys general threatened prosecution, the manufacturers often settled by agreeing to cease the offending advertisements and to pay a modest fine. The fines went into state treasuries, while the consumers who had purchased the ineffective remedies received no compensation. The lawyers who negotiated the settlements collected fees based on the size of the fine, not on any restitution to the purchasers.
A century later, the credit‑rating agencies Moody’s, Standard & Poor’s and Fitch were sued by investors who alleged that the agencies had inflated ratings on mortgage‑backed securities before the 2008 financial crisis. The investors’ claims were similarly diffuse: each investor’s loss was a small fraction of their portfolio, making collective action costly and individual monitoring unlikely. The agencies, faced with potentially damaging discovery, opted to settle with the federal government and with several state attorneys general. The settlements required the agencies to pay hundreds of millions of dollars to the government and to adopt new internal controls, but the investors received no direct payout. The law firms that represented the investors earned contingency fees calculated on the settlement amounts, while the investors’ recoveries remained limited to whatever indirect benefits the regulatory reforms might produce.
In the financial‑industry realm, the manipulation of the London Interbank Offered Rate (LIBOR) produced another example. Traders at several banks colluded to submit false rates that benefited their trading positions. When regulators uncovered the scheme, the banks entered into settlements that imposed billions of dollars in fines. The fines were paid to the relevant authorities—primarily the United States Department of Justice, the United Kingdom Financial Conduct Authority, and various European agencies—and were deposited into general government funds. The traders who had profited from the manipulated rates were often disciplined or fired, but the counterparties who had entered into loans or derivatives indexed to LIBOR received little or no restitution. The law firms that represented the affected parties negotiated the settlements and collected fees proportional to the fines, while the ultimate victims of the manipulation saw their losses remain uncompensated.
The pattern also shows up in the world of digital platforms. When Facebook introduced the Beacon advertising service, it broadcast users’ purchases to their friends without explicit consent. Users protested, and the Federal Trade Commission threatened enforcement. Facebook settled by agreeing to disable Beacon, to pay a modest civil penalty, and to offer affected users a coupon for a free movie rental. The coupon’s cash value was a fraction of the penalty Facebook paid, and the majority of the settlement money went to the Federal Trade Commission’s coffers or to the lawyers who negotiated the deal. Users who had suffered a privacy intrusion received a token benefit that did not reflect the scale of the harm.
Across these cases the underlying causal chain is constant: a discoverer identifies a breach of a stated rule; an enforcer threatens sanction; the defendant prefers settlement to the risk of an injunction; the settlement is negotiated by lawyers whose compensation rises with the settlement size; the class or affected public is large, diffuse, and poorly positioned to monitor the negotiation; the settlement fund incurs administrative charges that are paid before any distribution; and the final distribution to the class is often minimal or non‑monetary. The mechanism does not depend on the particular technology, the specific industry, or the historical period; it depends on the alignment of incentives between the parties who negotiate the settlement and the parties who are supposed to benefit from it.
Because the mechanism is rooted in the structure of repeated‑play litigation—where one shot settlements are cheaper for defendants than prolonged discovery, and where lawyers’ fees are tied to the size of the settlement rather than to the welfare of the class—it will continue to produce the same outcome whenever the same conditions arise: a rule violation, a regulator’s threat, a diffuse class of claimants, and a settlement process that allows the negotiating parties to capture a disproportionate share of the proceeds.
The only way to break this loop is to alter the incentives that drive the settlement negotiation. If lawyers’ fees were capped at a fixed hourly rate or tied to the actual amount delivered to class members, the incentive to inflate the settlement would diminish. If class members were given a legally enforceable right to audit the settlement fund or to receive a guaranteed minimum payout before fees are taken, the diffusion problem would be alleviated. If regulators were required to allocate a portion of any fine directly to the harmed parties rather than to general treasuries, the settlement would more closely reflect the injury. Until such changes are made, the clearinghouse that paid itself first will continue to operate, turning discoveries of misbehavior into settlements that enrich the negotiators while leaving the purported victims with little more than a symbolic gesture.