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Feds Crack Down on Gift Cards
October 21, 2006
By Leo Jakobson
It's a frightening time to have a gift card or prepaid card product on offer. In July, Darden Restaurants revealed that the Federal Trade Commission had taken issue with the way the company, which owns four restaurant chains including Red Lobster and Olive Garden, discloses information to consumers about the fees it levies on unused gift card balances. The FTC has demanded the company pay $31 million in penalties.
Darden has clammed up about the issue—its only public statement was a legally required filing made on July 27 with the Securities and Exchange Commission, giving notice that the Federal Trade Commission (FTC) staff "concluded that we had violated Section 5 of the FTC Act, which prohibits unfair or deceptive acts and practices. The staff asserts that we did not give adequate notice to consumers that our gift cards, if not used for 24 consecutive months, are subject to a gradual reduction in value by a dormancy fee" of $1.50 per month. In the filing, Orlando-based Darden asserts that it complied with all applicable laws, and says it is discussing the case with the regulators. The FTC, for its part, has refused to comment publicly on an unresolved enforcement action.
The FTC and Darden are about the only ones not commenting on it, however. At a meeting of the Incentive Gift Card Council (IGCC) at the Incentive Marketing Association's 2006 Executive Summit, which took place three days after the Darden filing, talk was dominated by the FTC's action. "We are taking it as a message … to other companies in similar situations that there could be repercussions," says Nancy Serrato, president of the IGCC and director of corporate gift cards for Blackhawk Network/Safeway. "Obviously this message is, let's get away from dormancy fees and expiration dates on gift cards." The IGCC is a special interest group formed by the Incentive Marketing Association.
While Darden does not put an expiration date on its gift cards, many in the industry believe the FTC is taking aim at a broad variety of practices in the gift card and debit card industry, notably shipping fees, dormancy fees and expiration dates on cards, issues that have been garnering more and more complaints from consumers, and from Congress, as gift cards have exploded in popularity over the past few years: Sixty-four percent of respondents to Incentive's 2006 Merchandise FACTS Report said they use gift cards in their programs, and consumers spent nearly $18.5 billion on gift cards during the 2005 holiday season alone.
"The FTC wants to show Congress that it is going after this," says George Delta, the legal counsel to the Incentive Federation. He adds that Darden was simply unlucky to be singled out by government regulators. "It could have been anybody," he adds. "[Darden's] disclosures are no worse than anybody else's. And there are others [card issuers] I could have nominated way ahead of them. In these cases, there is always a guinea pig."
Who will be next?
In fact, there will be more than one guinea pig, predicts Rich Olson, director of sales for Optimum Card Solutions, an Addison, Ill.–based manufacturer of magnetic-striped gift cards and director of communications for the IGCC. "I think what the FTC has done so far is the tip of the iceberg," Olson says. "The FTC will be looking at other companies' policies, but they'll also be looking at more than dormancy fees and expiration dates. They will look at exchange policies, the ability to cancel and reissue lost or stolen cards, etcetera."
The FTC's action will likely accelerate an existing trend away from fees and expiration dates among retailers that issue gift cards, Serrato says. "Four years ago, we [Safeway] had a dormancy fee on our gift card, but we pulled them from circulation and never enforced it."
Safeway's reason was twofold. First, every state has different, and often conflicting, laws regulating fees and expiration dates on gift cards. "In the corporate sales business, you are not selling to the end user," she says. "We don't know where [the gift card] will be used," and thus which rules will apply.
Second, Serrato points out that the effectiveness of an incentive award is dependent upon the end user's experience. "If an end user has a negative experience, it could hurt the entire program's effectiveness," she adds. That in turn could hurt sales. Much the same argument applies to a gift card bought as a holiday present in the consumer market. "A lot of [gift card issuers] have eliminated dormancy fees and expirations for branding reasons," Olson adds.
While she is troubled by the action taken against Darden, Michelle Smith, vice president of business development at Salt Lake City–based incentive house O.C. Tanner, does see a silver lining for incentive houses.
"It becomes critical for us to stay informed about what the laws are and what the rulings are, or we and our clients could get hurt," she says. "But for the industry, this is good news, like when Sarbanes-Oxley came out. It makes the case for engaging an incentive professional who can navigate these waters for [the client company's] program manager."
The FTC's ultimate settlement with Darden will likely give a sense of what the feds want in terms of disclosure, but some federal guidance is available now. About two weeks after the FTC's action against Darden, the federal Office of the Comptroller of the Currency (OCC) released a formal statement of guidance about the type and method of disclosure it expects on gift cards issued by institutions that fall under its control—specifically, prepaid cards issued by national banks using the MasterCard, Visa, American Express or Discover Card networks.
The OCC believes disclosure should include the following: any expiration date, which should appear on the front of the card; the amount or existence of any monthly maintenance, dormancy, usage or similar fees; a phone number or Web site from which to obtain additional information and customer service. The fee and contact information should be printed on the card or affixed to it with a sticker or tape. The OCC also advises national banks to avoid practices that could mislead consumers, like advertising "no expiration date" on a card with monthly maintenance fees.
And the law won
The Darden case isn't the only legal issue that has participants in the gift card and debit card industry buzzing. On August 1, Justice Steven McAuliffe, chief judge of the U.S. District Court's District of New Hampshire, threw out a case brought by the state attorney general accusing Simon Property Group, a national mall developer, of violating a state law forbidding the imposition of expiration dates and dormancy fees on gift cards.
The ruling was based on a technical matter, but it is one that a number of lawyers and gift and prepaid card issuers say goes to the heart of a broad misunderstanding of the differences between gift cards and prepaid cards on the part of consumers as well as by legislators and regulators around the country.
The technical issue is this: The Simon Visa Giftcard is branded in a way that encourages recipients to use it at stores in Simon's malls, but it is in fact a prepaid Visa card, usable anywhere Visa is accepted. As such, it is issued by banks Simon has partnered with. The court found that because national banks are supervised by federal regulatory agencies, state law does not apply.
"There is a disturbing trend in federal law, where laws put in place by states to protect the health, safety and welfare of their citizens are being repeatedly overwritten," says New Hampshire Attorney General Kelly Ayotte, who has appealed the ruling.
While the Simon Mall ruling "was more or less expected," says the IGCC's Delta, he is no fan of companies that issue cards that charge end users handling, dormancy and reloading fees. "[The Simon Visa Gift Card] is made to look like a gift card," but it is not, he adds.
The problem is that "people don't understand the difference," says Rebekka Rea, vice president of education for the IGCC. That's one of the reasons the group recently relaunched its Web site, adding information and current articles about gift cards.
What is, and, isn't a gift card?
That difference is the basic reason behind the formation, in May, of the Network Branded Prepaid Card Association, says Judith Rinearson, a partner in the law firm of Bryan Cave LLP, in New York, and chair of the six-month-old nonprofit's government relations working group.
In the broader gift card market, there are essentially two types of cards, she says. One is closed-network cards, which include the various retailer cards. These are issued by a company and can be used only to purchase its products or services. The second is open-network cards, formally known as network-branded prepaid cards. These are essentially prepaid credit cards, issued by networks such as MasterCard and American Express. The differences between the two, and the economics behind them, are often misunderstood.
Issuers of closed network cards like Darden, Best Buy and Starbucks make their money the same way they do on cash sales: by selling products at a markup over wholesale. Best Buy doesn't charge a fee on the card, or place an expiration date on it, because it is essentially a pre-made sale.
Open-network cards like the Simon Visa Giftcard are usually issued by banks, regardless of how they are branded. They can be used anywhere, and the issuing institution does not profit when the cards are used to buy something. Instead, the only profit comes from fees. "Issuers of network branded cards are providing a service," Rinearson says. The card can be used anywhere credit cards are accepted, and it can be replaced if lost or stolen.
That means the biggest complaints consumer advocates and regulators have about gift cards—expiration dates—make sense only when pointed at closed-network cards. But, Olson says, "States lump them all together."
Other misunderstandings include the fact that, "open-network cards must have an expiration date or they will not work on the [card] network," Rinearson says. And a number of states mandate that small card balances—$2 to $5 is common—be given to the consumer in cash at the register. But, she adds, with an open-network card, a cashier would not have access to the remaining balance any more than they would be able to tell the credit limit on your Visa card.
The biggest complaint closed-network gift card issuers have is that they are facing 50 different sets of rules in 50 states. "Those rules change frequently, and at times on very short notice," says Jim Menadier, general manager of American Express Incentive Services' (AEIS) corporate incentive group. The St. Louis–based firm charges corporate buyers an up-front fee on one-use cards, or a reloading fee on reloadable cards. Menadier says he would welcome federal preemption, noting that the state laws change so frequently, AEIS has trouble printing up marketing materials. "It's challenging to plan communications when we need to revise the terms and conditions as often as we do."
AEIS isn't the only one with that problem. When asked by Incentive if he had a state-by-state breakdown of gift card regulations, Delta said no. He is currently revising the Incentive Federation's documents because, he says, at a year-and-a-half old they are thoroughly out of date.
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