Money Stuff: Feds Find a Chicken Conspiracy

Money Stuff
Bloomberg

Chicken Libor

I started reading yesterday's federal indictment of four chicken-company executives for antitrust conspiracy, and I got excited when I got to paragraph 7:

Prices for broiler chicken products were sometimes tied to a market index, such as the Urner-Barry Index ("UB"), as an alternative. For example, cases of wings sold in bulk were sometimes priced at the UB per-pound price ("market") and cases of pre-counted wings were sometimes priced at the UB per-pound price plus a specified number of cents per pound ("market plus").

Aha, I thought, I know this one. There are indexes that report the market price of chicken. Long-term chicken supply contracts are often priced off of an index: A restaurant chain will agree to pay a chicken producer "market" (the index price), or "market plus 10" cents, or whatever. The indexes are calculated by, essentially, calling up buyers and sellers of chicken and asking them how much they are paying or receiving for chicken.[1] If you are a chicken producer with a contract to sell chickens at the index price, and someone from the index provider calls you up asking you what the price should be, you have an incentive to quote a high number. If the index price goes up, the price you are paid on your contract will go up. Quoting the high number doesn't cost you anything—you are just saying a number over the phone to someone who is writing it down—and it makes you money, so you'll be tempted to do it. 

This is precisely the mechanism that led, in the financial industry, to the Libor manipulation scandal: Trillions of dollars of loans and interest-rate derivatives were priced off of Libor, the London interbank offered rate, which was calculated by calling up banks and asking them what the price of money was that day. If you were a bank that was set to receive Libor on a lot of swaps and loans, you would be tempted to quote a high number—higher than your actual cost of borrowing—to manipulate Libor and make more money. Banks regularly succumbed to this temptation, and there were huge fines and prison sentences. And there have long been claims that the same thing has happened in the chicken business. "Chicken Libor," I have called this theory.

And now there is a federal criminal antitrust case, and it mentions chicken indexes! But, sadly, no. These guys are not accused of chicken index manipulation. They're just accused of regular old antitrust conspiracy:

In approximately the autumn of 2012, Cooperative-1 was negotiating prices with Suppliers for dark meat and wings supply for calendar year 2013. …

On November 13, 2012, at approximately 4:37 p.m. (EST), BRADY texted FRIES: "I talked to roger [AUSTIN] and this month he is .03 higher than us on 8 piece."

On November 13, 2012, at approximately 4:45 p.m. (EST), BRADY texted FRIES: "he [AUSTIN] said to raise our prices, on wings he is market and market plus .10[.]" FRIES responded, "Tell him we are trying!" BRADY responded, "Will do[.]"

That sort of thing. Mikell Fries and Scott Brady are the president and a vice president of Claxton Poultry Farms; Roger Austin is a former vice president of Pilgrim's Pride Corp. (They were charged in the indictment along with Jayson Penn, the chief executive officer of Pilgrim's Pride.) You are not supposed to chat with your competitors about what you're planning to charge a customer; you're not supposed to tell your competitors to raise their prices; if your competitor does tell you that, you're not supposed to do it. Basic regular antitrust stuff, no index manipulation in sight. There is "a still-open Justice Department investigation involving several other major chicken producers," though, so perhaps another producer manipulated indexes.

As in the Libor scandal, though, there are bad emails and texts. Here's an alleged text message exchange between Jayson Penn and an unnamed employee of Pilgrim's Pride ("Supplier-1") about a negotiation with a fast-food restaurant ("QSR-3"):

PENN: Who is negotiating with [QSR-3]?

Supplier-1-Employee-3: [Supplier-1-Employee-4] and Roger [AUSTIN]

PENN: Ok. Thanks

Supplier-1-Employee-3: We know [Supplier-7], their biggest supplier is 0.02 higher than us and they are not going to negotiate.

PENN: Good deal. Last time they did cave a cent or two with [QSR-1]

Supplier-1-Employee-3: They are listening to my direction

PENN: Who is they?

PENN: If they is illegal don't tell me

Supplier-1-Employee-3: "Was referring to roger [AUSTIN] listening. Sorry, thought you were referring to roger [AUSTIN] caving. Got you on [Supplier-7] caving on [QSR-1]. [Supplier-7] might cave but I wouldn't think for our volume and their current.

All of that is fine, really; Penn is discussing a competitor's pricing, and his own, with an employee, and speculating about what might happen competitively. The only problem is "if they is illegal don't tell me." It wasn't! A Pilgrim's Pride employee was telling the Pilgrim's Pride CEO that other Pilgrim's Pride employees were following his directions in price negotiations, which is fine. But from these texts it seems like Penn thought something else was happening—that the competitors were following his employee's directions—and was cool with that, as long as no one told him explicitly. That's one of those things that you maybe don't put in writing.

This text exchange would look better if it ended "Penn: Who is they? Employee: By 'they' I meant our competitors; I've told them what prices to bid and they agreed." That would be  blatantly illegal, but it doesn't sound so bad. "Oh I didn't know that was illegal," you could say to a jury. Or: "My employee was just boasting that our competitors fear him, he didn't really mean it." Or something, I don't know. It just sounds bland and business-y and you can try to spin it. But once you are like "Penn: Who is they? If they is illegal don't tell me. Employee: No in this particular case we are following the law," it's much harder to explain, and it makes all your other actions look worse.

By the way, while chicken contracts are sometimes priced based on market indexes, they often aren't. Here are paragraphs 5 and 6 of the indictment:

Some purchasers of broiler chicken products used a "cost-plus" pricing model for 8-piece bone-in broiler chicken products (alternatively called "8-piece COB" for 8-piece chicken-on-the-bone) that varied month-to-month or period-to-period depending on the price of chicken feed and that also provided Suppliers with a per-pound margin and an "adjustment" that was effectively an additional per-pound margin. 8-piece COB consisted of two breasts, two wings, two thighs, and two drumsticks.

The price of 8-piece COB often served as a base price for other broiler chicken products. Dark meat was often priced at a certain number of cents per pound less than, or "back" from, the price per pound of 8-piece COB.

One way to quote a price in a chicken supply contract is like "the index price of chicken plus X cents." Another way to quote it, though, is essentially "the price of chicken feed plus Y cents": You add some fixed margin (or margins) to the variable price of the main input, chicken feed. The model here is not "chicken supply contracts are like a derivative on an index of spot chicken prices"; the model here is "chickens are a derivative on corn and soybean prices."

I suppose this means that you can manipulate chicken prices by trading corn, though it might not be economical (and no one suggests anyone has done it). But it also means that you can build a replicating portfolio for chickens; that you can manufacture chickens synthetically—in financial markets—out of corn and soybean futures. You cannot eat the synthetically manufactured chickens, but financially they are roughly equivalent to the edible ones. 

Here's a famous story about Ray Dalio, the founder of Bridgewater Associates, the world's largest hedge fund, from "The All Weather Story" on Bridgewater's website:

Ray founded Bridgewater in 1975 in his New York City brownstone apartment. At the time, he actively traded commodities, currencies and credit markets. His initial business was providing risk consulting to corporate clients as well as offering a daily written market commentary titled Bridgewater Daily Observations that is still produced. The competitive edge was creative, quality analysis.

Among his clients were McDonald's and one of the country's largest chicken producers. McDonald's was about to come out with Chicken McNuggets and was concerned that chicken prices might rise, forcing them to choose between raising their menu prices or having their profit margins squeezed. They wanted to hedge but there was no viable chicken futures market. Chicken producers wouldn't agree to sell at a fixed price because they were worried that their costs would go up and they would then take a loss on their supply contracts. After some thought, Ray went to the largest producer with an idea. A chicken is nothing more than the price of the chick (which is cheap), corn, and soymeal. The corn and soymeal prices were the volatile costs the chicken producer needed to worry about. Ray suggested combining the two into a synthetic future that would effectively hedge the producer's exposure to price fluctuations, allowing them to quote a fixed price to McDonald's. The poultry producer closed the deal and McDonald's introduced the McNugget in 1983.

I have heard this story in garbled form as "Ray Dalio invented the Chicken McNugget." As you can see, he didn't, but he invented the synthetic Chicken McNugget that made the real one possible. The next time someone tells you that the only good modern financial innovation was the ATM, you can reply "well, also the Chicken McNugget."

Everything is securities fraud

Everything bad that a public company does, and everything bad that happens to it, can also be securities fraud, as I often say around here. By failing to disclose the bad thing, the company induced investors to buy its stock, and then when the bad thing was disclosed the stock went down; a modestly creative lawyer can easily transmute any bad thing you like into securities fraud.

Without getting into any details I think we can agree that WeWork either did something very bad, or something very bad happened to it, or both; it was worth $47 billion in early 2019, $8 billion in late 2019, and rather less than that now. Depending on how you count, WeWork has erased something like 90% of its value. So: securities fraud!

Except that WeWork is not a public company, and never has been. It got close; it filed documents for an initial public offering last August, but then investors read those documents, had a good laugh and declined to buy the stock. At the time and afterwards, people argued that various disclosures in WeWork's offering documents were untrue or misleading or incomplete, but clearly no one was induced to buy the stock by those disclosures. Quite the opposite! WeWork was worth $47 billion or $65 billion or some other purely notional number the minute before it filed for an IPO; its value evaporated over the course of a few weeks specifically because people read WeWork's own description of its business and said "lol no." WeWork's public disclosures didn't pump up its stock; its first public disclosure immediately deflated the stock.

So widows and orphans and public pension funds who bought WeWork stock in its IPO can't sue for securities fraud, because there aren't any of them.[2]

But while WeWork was never a public company, it was for a while a big famous buzzy private unicorn, and another thing that I often say around here is that "private markets are the new public markets." Big buzzy private unicorns look and at a lot like public companies, raising billions of dollars from public-type investors and supporting liquid secondary markets; the difference between being public and private has eroded. WeWork's shares didn't trade publicly, but they did trade privately, and people did buy WeWork stock in the years before its failed IPO. 

Now they are suing:

In the latest lawsuit over WeWork's scuttled IPO, investors say the company hoodwinked them by promoting a transformation of the concept of workspace in order to sell hundreds of millions of dollars worth of stock.

The complaint was filed as a class action on behalf of investors who bought shares in the privately held company for 2 1/2 years before the IPO was canceled in September and the value of WeWork plummeted. They allege that WeWork executives and board members overhyped the business plan and downplayed its losses as "strategic investment spending that would lay the foundation for profitability."

Here is the complaint. There are a lot of allegations in it but they mostly strike me as pretty thin, less "WeWork fudged its accounting" and more "WeWork was more optimistic about the future than it should have been." It is not so much a securities fraud lawsuit as it is an "everything is securities fraud" lawsuit: People bought stock, the stock went down, they're mad, so they sued.[3]

But here I want to mention one weird thing. The lawsuit was filed as a class action "on behalf of purchasers of WeWork securities between May 15, 2017 and September 30, 2019." As far as I can tell there was exactly one purchaser of WeWork stock from WeWork during that period: SoftBank Group Corp.'s Vision Fund, which pumped in the money that inflated WeWork's valuation in its later years.[4] But SoftBank isn't suing; in fact it is a defendant in the case, since it is WeWork's controlling shareholder.

Everyone who is suing because they were allegedly tricked into buying WeWork stock did it on the open market, not from WeWork.[5] They weren't relying on WeWork's SEC filings, because there weren't any. So how did WeWork deceive them?

The complaint says that "throughout the Class Period, defendants continuously solicited investment in WeWork securities," and that their "misrepresentations were deliberately published to investors in order to amplify defendants' solicitation efforts," including in media interviews, quarterly investor updates, investor presentation materials that were "provided to media organizations and widely disseminated and reported on," "quarterly calls for investors, prospective investors, securities analysts, and market-making financial institutions to discuss the Company's financial results," and "regularly updated financial, business and operational information regarding WeWork made available to Company investors at the time of their purchase during the Class Period via an online portal maintained by WeWork."

WeWork wasn't public, but it sort of acted like it was. You could buy and sell its stock in the open(-ish) market; it released quarterly earnings and did earnings calls; it didn't file financials on the SEC website, but it filed them on its own website.[6] "Everything is securities fraud" is the rule for U.S. public companies, but it is also apparently the rule for private companies that are practically public. 

One possible interpretation of "private markets are the new public markets" is that private companies can get most of the benefits of being public—raising lots of money, getting a huge valuation, being a household name, having an acquisition currency, giving employees and early investors liquidity, etc.—without the drawbacks of actually going public. But it is probably more accurate to say: No, actually, they get most of the drawbacks too. If you don't want to go public because you don't want activist shareholder campaigns or pesky securities fraud lawsuits, but you do want your shares to trade privately, guess what, the bad stuff will find you too.

Boredom

The US Global Jets exchange-traded fund, known by its ticker symbol "JETS," had $33 million of assets in early March; now it has over $1 billion. To what does JETS's CEO attribute his fund's runaway success? Boredom:

Much of that explosive growth in assets can be credited to day traders looking to "catch the bottom" in airline stocks, according to Frank Holmes, chief executive officer of JETS issuer U.S. Global Investors. After speaking with newly minted JETS holders, he says the boredom of being stuck at home and the strong rebound in carriers after the 2001 terrorist attacks and the 2008 financial crisis are luring young traders.

"All these millennials, being stuck at home with no bars to go to and no beaches to travel to, took their money and became day traders," said Holmes. "They're bored, they want to make money."

In particular, the growing popularity of JETS on retail trading platform Robinhood has "shocked" Holmes. The number of users holding JETS surged to nearly 30,000 this week, according to Robintrack, a website unaffiliated with the site that uses its data to show trends in positioning. That compares to 500 at the beginning of March.

We have talked before about the boredom markets hypothesis, the idea that one important explanatory factor in the stock market is boredom. "The basic theory," I wrote, "is that ordinary people will do more trading (1) if trading is entertaining and (2) if other things are less entertaining: The more bored they are, the more they will trade stocks." When people are locked down due to the coronavirus, they have fewer fun things to do, so day-trading stocks starts to seem more fun. If they are trading for fun, they will prefer fun stocks, gambles, volatility, weird stories. The point is not to make a long-term investment that maximizes their return for a given quantity of risk; they point is to have something entertaining to do during quarantine. Buying airline stocks when global air travel is nearly halted seems like a good gamble, so I agree with Holmes that the BMH probably explains JETS's run.

Also it is nice that he feels free to say this? JETS is not a company; it's an ETF, a basket of airline stocks. Holmes does not manage an airline; he manages a company that offers people conveniently packaged groups of stocks with memorable tickers. "We put airline stocks in a box and slapped the name 'JETS' on it, and people bought the box because they were bored" is a reasonable thing for him to say. He offers a consumer product, and his business is about trying to understand why consumers like it.

It's different if you manage a company whose stock is up due to boredom. When people ask the CEO of, say, an airline about her company's strategy and financial position, she can't really be like "well a lot of people are bored at home and buying our stock, so that's helpful." Elon Musk has come pretty close to talking like that, and people got mad at him for it. If you work for a real business, you have to mostly talk about the real business and ignore the sillier epiphenomena of financial markets. If you work for a financial business you can lean into the silliness.

Genius

I don't know about this, man:

Shares of Genius Brands International Inc. blasted off Wednesday on record volume, to extend the mind-boggling rally over the past month, ahead of the imminent release of "important news" and the launch of its network brand "Kartoon Channel" later this month. ...

As an example of the rapid trading of the stock, the stock has been halted briefly three times Wednesday for volatility.

The stock has climbed 338.1% amid a 4-day win streak, and has skyrocketed nearly 26-fold, up 2,440.0%, since it closed at 31 cents a month ago. That has boosted Genius Brands's market capitalization to $763.9 million from about $9.2 million as of May 1, according to FactSet.

"We are delighted to see the market reacting to our mission, and we look forward to sharing important news in the coming days," Chief Executive Andy Heward said in an emailed statement to MarketWatch.

Yeah. Uh. Okay. I would have preferred if he said "I dunno, I guess people are bored." "We look forward to sharing important news in the coming days," during a 2,440% rally that has led to trading halts, is distinctly less good than "no comment," or sharing the news I guess.

You may not be surprised to learn that Genius has been selling quite a bit of stock into this rally. Normally companies do not sell stock just before sharing important news; the normal move is to share the big news and then sell stock. (If the news is good, you can sell stock at a higher price after sharing it; if the news is bad, you will get extremely sued for selling the stock first.) Perhaps selling stock before disclosing the news is the genius move?

By the way, Genius's content library includes "Warren Buffett's Secret Millionaires Club, created with and starring iconic investor Warren Buffett which is distributed across our Genius Brands Network."

Souvenirs

I am sorry to tell you this too late for it to do you any good, but the assets of Zume Pizza Inc. were auctioned off yesterday, and you could have bid on an assortment of pizza machinery, including this custom Zume pizza party bus. We have talked about Zume before. It was a startup that wanted to deliver pizzas made by robots in the delivery trucks; its co-founder went around saying things like "I want to be the Tesla of fresh food, the Amazon of fresh food," and it raised $375 before imploding in a morass of cheese:

Eventually, [co-founder Julia] Collins's team gave up on the dream of baking the pies while driving to customers, according to two people familiar with the matter. The cheese tended to run everywhere as the trucks turned or hit bumps in the road.

So, you know, be warned, if you bought the party bus. Maybe park it before baking the pizzas.

In a … less overstimulating world, Zume would be a good symbol of the venture-fueled excesses of the unicorn boom of the 2010s, and owning Zume swag would confer some tech hipster cred. I don't know who bought the party bus, but I hope it was the technology equity capital markets group at Morgan Stanley or Goldman Sachs. It could give them a comfortable way to transport their team to pitch meetings, and when it showed up in a startup's parking lot it might trigger wry smiles of recognition. Also it would be a nice sort of memento mori for the founders they pitch: "You may think that life is good and you are invincible with your SoftBank money, but remember Zume Pizza." I don't know if that would win any IPO mandates but it would be funny.

Things happen

Silver Lake's coronavirus bets: a make-or-break moment for Egon Durban. Fed Promised to Buy Bonds but Is Finding Few Takers. Europe May Relax Controversial Free Research Ban to Lift Economy. Ex-Enron CEO Skilling launching new digital marketplace for oil investors. "Evercore Partners Inc. is offering to pay incoming junior bankers up to $25,000 to delay starting their jobs during the coronavirus pandemic." Wall Street Warning to Corporate America: Get Cash While You Can. Investors Channel Over $150 Billion Into Coronavirus Bonds. Vanguard's Eight-Year Quest to Crack $1 Trillion Market Drags On.  The biggest US mall owner Simon Property sues Gap over skipped rent payments. Japan Warns Its Banks About Risky U.S. Debt. Spain porn star held after man dies in toad venom ritual. Behold the star-tipped reindeer — Canadians' top pick for a national lichen.

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[1] In discussing "chicken Libor," we have mostly talked about the Georgia Dock index, which was compiled by a state agricultural department employee named Arty Schronce calling up chicken producers and asking them what they were charging. The Urner-Barry index is apparently compiled by calling "processors, retailers, wholesalers, distributors, exporters, importers, traders and brokers," so it ought to be more robust: If you only ask sellers they will have incentives to quote you high prices, but if you ask buyers and sellers then the incentives will balance out. And in fact the manipulation claims apply mostly to Georgia Dock, which produced higher index prices than other comparable indexes (like Urner-Barry) and was eventually suspended. 

[2] The U.S. Securities and Exchange Commission could still examine WeWork's disclosures and sue if it decides they were misleading; there is not *really* a "no harm no foul" rule for securities fraud, though the lack of harm makes it hard for private plaintiffs to sue. In fact there are apparently governmental investigations of WeWork, including by the SEC. I have trouble believing they'll come to much, though, because there's *kind of* a "no harm no foul" rule: Misstatements are only fraud if they are material, and it's hard to see how WeWork's could have been if they never convinced anyone to buy.

[3] This is a broad generalization about a long complaint, and you'll probably find some claims more compelling than others. Like a lot of people I remain baffled that WeWork consistently claimed it had plenty of cash, and then was forced into a desperate bailout to stay afloat within weeks after the failed IPO. The complaint does a good job of arguing that *that* was fraud. Paragraph 85:"Defendants represented to investors that the Company had sufficient cash flow to support its growth initiatives and utilized a recession-resistant business model. For example, in a January 14, 2019 CNBC television interview, defendant Neumann claimed: 'Our balance sheet has north of $6 [billion] on it. It's above and beyond what we need to fund the company for the next four to five years.'"  Paragraph 88: "WeWork desperately needed to raise cash throughout the Class Period, and it was only by generating continuous injections of outside capital that defendants could maintain the illusion of sustainable growth and a profitable business model. Indeed, when the Project Fortitude deal with defendant Softbank fell through in late 2018, WeWork did not have sufficient cash flow to last one year, let alone 'four to five years,' as defendant Neumann had represented, despite the infusion of billions more in capital in January 2019. In fact, without an IPO to bail defendants out, the Company would be forced to effectively halt all growth initiatives, lay off thousands of workers, divest non-core assets, and drastically cut costs." Yeah I mean that is fishy.

[4] WeWork did sell *bonds* in 2018, and those bonds have lost about half their value, so *those* investors have an obvious grievance, and are included in the putative class action. Also WeWork did some acquisitions (including Meetup Inc. and Flatiron School Inc.) that it paid for in stock (see pages F-30 and F-31 of the IPO prospectus); if you sold your company to WeWork for stock you too might complain. And of course employees got stock or options. But see e.g. page 206 (and page II-2) of the prospectus, "Preferred stock financings," for the actual cash sales, and pages 202-203 for the SoftBank relationship: The latest non-SoftBank financing seems to have been in 2016. 

[5] The named plaintiff in the case, the representative of the class, is someone named Malakyar Vernet, and all the information we get about Vernet is that "On April 30, 2019, plaintiff Malakyar Vernet purchased shares of WeWork Class A common stock and was damaged thereby." WeWork was not raising money in April 2019, certainly not by selling common stock. 

[6] We talked the other day about allegations that Kylie Jenner inflated the value of her private company, and I said that even if that's true it doesn't matter: Jenner's company was private, and if she lied to the press about it no one bought or sold stock on her statements. "If you tell a reporter 'we made a billion dollars last year," I wrote, "and then you go sell stock to investors with disclosure documents saying how much money you actually lost—meh, seems fine?" But that only works for purely private companies that don't have active secondary markets.

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