Chickens and Slot Machines

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Chicken Libor!

My favorite recent financial scandal may be chicken Libor, in which critics accuse chicken producers of price manipulation. What I like about chicken Libor are its (alleged) parallels to the actual Libor scandal: The Georgia Dock, an index of chicken prices maintained by the Georgia Department of Agriculture and used to set prices, is a survey-based index, and so it can be manipulated by just making up numbers, without going to the effort of manipulating any transactions. (Georgia has fixed the index by making producers certify that they have not made up numbers.) But, as with real Libor, just making up numbers was apparently not enough, and there are claims that chicken producers -- like the Libor banks -- also conspired with each other to move prices.

Like any good financial scandal, this one has attracted the attention of the SEC:

Tyson Foods Inc. said the Securities and Exchange Commission is investigating its chicken-pricing practices, following allegations that top meat companies conspired to raise the cost of poultry.

Now, chickens are not a security. The SEC regulates securities. It does not regulate chickens. But the thing to remember is that the SEC has a sort of meta-jurisdiction over every bad thing a public company does. The SEC does not regulate murder, but if your CEO murders someone and doesn't tell anyone about it (as one does), and the SEC finds out, it can fine you: Shareholders would have wanted to know about your CEO's murdering, and if you didn't tell them then you failed in your disclosure duties. Similarly, if you manipulated chicken prices in a way that could lead to an antitrust investigation, the SEC can penalize you for not disclosing the risk of an antitrust investigation. It gives the SEC power as a sort of ancillary antitrust regulator. Or environmental regulator. Or whatever else you've got. 

By the way, the best parallel between chicken and real Libor is this:

“We’re anxious to defend ourselves in court and feel we have a great story to tell,” said Tom Hayes, Tyson’s chief executive.

You might remember Tom Hayes from being the alleged ringleader of the real Libor scandal. I mean, that's a different Tom Hayes. That one is serving 11 years in prison right now, not running Tyson. But I like to imagine "Tom Hayes" not as a person (well, persons) but as sort of a generic character name, a Libor Zelig, an immortal spirit who pops up in a new form -- but the same name! -- every time there are accusations that someone is manipulating an index. 

Pseudorandom slots.

The way a modern slot machine works is that you push a button and some symbols appear on the screen. Most combinations of symbols mean that you lose money; some mean that you win. If you just push the button a bunch of times, you'll probably end up losing. The trick to winning is to push the button when the winning symbols are going to come up, and also not to push the button when the losing symbols are going to come up. It is easy to do one or the other -- pushing the button constantly will give you some wins but an overall loss, while never pushing the button at all will leave you flat -- but hard to get the combination right. 

The way the symbols appear is that, inside the machine, a computer algorithm generates symbols according to patterns that are as random as its little computer heart can manage. But, being a computer, the machine can never generate truly random patterns; it just tries to be as unpredictable as possible. If you can figure out its pattern, though, you can solve the slot machine.

Here is a delightful Wired story about how some "Russians Engineer a Brilliant Slot Machine Cheat -- And Casinos Have No Fix." The cheat is, in simple terms, that they wait until the slot machine is going to generate a win, and then they push the button. When it's going to generate a loss, they don't push the button. You can call that "cheating," or you can just call it correct play.

Of course in order to know when to push the button, they have to record video of the machine's operation on their phones, upload it to a central server, run it through an analysis based on what they know (from what source?) about the machine's pseudorandom-number generator, and then produce predictions of what that generator will do next. I guess you are not supposed to do that. Observing how a computer program operates, reverse-engineering the code of that computer program, and then using that knowledge to make the program do what you want to do -- I guess that is what one would call "hacking." The idea of "hacking" is that it is using a computer system, not in a way that it wasn't designed for (if you can use it that way, it was designed for it!), but in a way that some human observer did not expect. 

Those Russians were indicted for fraud, back in 2014, and several pleaded guilty and have gone to prison. It's an odd kind of fraud; they never exactly lied to the casinos. I suppose they used a "manipulative device," but that is to some extent in the eye of the beholder; is it a "manipulative device" to count cards at blackjack? (Don't answer that!)

Remember "the DAO"? It was a smart-contract-based company run on the Ethereum blockchain, and it imploded in acrimony after a hacker took most of its money. Or: after a user voted to give himself most of its money. To blockchain purists at Ethereum, there was essentially no such thing as hacking: If something was allowed by the code of the smart contract, then it was allowed, period, even if it surprised everyone. Only the code mattered.

I made fun of that idea, when the DAO got its money stolen: Here in the human world, reasonable expectations matter, and things can be allowed by the rules without actually being allowed. But in this computerized age, you can see its appeal. Who knows what the slot machines, or their designers, expected? Who knows what is hacking and what is just good strategy? The best evidence of what you're allowed to do with a slot machine might just be what the machine allows.


The paradigmatic scandal in electronic trading is this:

  1. I set up a place to trade things electronically.
  2. I tell you that it is just a neutral forum, where anyone can buy or sell, except me: I don't trade on my forum; I am the neutral referee who runs things fairly for everyone.
  3. But I am lying, and really, whenever you try to buy on the forum, I'm the one selling to you.

That is essentially the story of the ITG Inc. dark-pool enforcement action, and the Pipeline Trading Systems LLC one before that. It's a little bit the story of the Barclays dark-pool action, though there instead of favoring itself Barclays was accused of favoring a few high-frequency traders. And in a sense, angst about this pattern underpins worries about payment-for-order-flow in retail stock trading. Retail brokerages don't actually pretend that they send your order to some neutral venue -- they're pretty up-front about how orders are internalized -- but people seem to expect it anyway, and to be scandalized that their orders are sent directly to an internalizer rather than going to the stock exchange.

Anyway here's another one:

The CFTC Order finds that, between September 4, 2009 though at least 2014 (the Relevant Period), FXCM engaged in false and misleading solicitations of FXCM’s retail foreign exchange (forex) customers by concealing its relationship with its most important market maker and by misrepresenting that its “No Dealing Desk” platform had no conflicts of interest with its customers. The Order finds FXCM, FXCM Holdings, and Niv responsible for FXCM making false statements to the National Futures Association (NFA) about its relationship with the market maker.

That's from a Commodity Futures Trading Commission action against Forex Capital Markets, LLC, which agreed to pay $7 million. (There's also an NFA action.) The "No Dealing Desk" platform just had a dealing desk. It was the highest-volume market maker on the platform. It was first run internally at FXCM, but later it spun out into a separate company that, according to the CFTC, shared 70 percent of its profits from the platform with FXCM.

One question is why this keeps happening. Like, one thing that could happen is that I could really set up a neutral electronic venue, and you could trade on it, and we'd both be happy. Another thing that could happen is that I could openly hold myself out as a dealer who would trade with you, and you could come to me as a customer, and we'd both be happy. But what happens over and over again is that you find dealers pretending to be exchanges. Customers want exchanges; they want the sense of fairness and competition that comes from a neutral platform. But ... dealers just seem to work better? The reason retail brokers route orders to internalizers is that the internalizers pay better prices. Even in the FXCM case, the CFTC doesn't exactly say that FXCM's own market maker was bad, or competed unfairly; for all we know it had the highest market share on the platform because it offered the best prices. But people don't just want the best prices. They want fairness, too, and dealers keep giving them the illusion of fairness instead.

Undoing Dodd-Frank.

Here's a weird place for the Securities and Exchange Commission to start on undoing Dodd-Frank:

Republican Michael Piwowar, who took over shortly after the inauguration, signaled Monday that the commission would take a fresh look at new requirements that companies disclose the pay gap between chief executives and their employees. The move shows the extent to which officials under the Trump administration could press at the agency level to ease Obama-era initiatives they oppose without waiting on Congress to act.

The pay-ratio disclosure rule became final in August 2015, implementing a direct order from Congress in section 953(b) of the Dodd-Frank Act. Dodd-Frank went into effect in July 2010. It took the SEC five years to make a rule saying what Congress told the SEC to say because ... the SEC didn't like the rule, basically. (To be fair, Congress didn't love the rule either, after passing it!) And now it may un-make it.

But ... how? The SEC does not have independent power to just make new U.S. law. It is a regulatory agency tasked with implementing the securities laws. It needs statutory authority for its actions. The statutory authority for the pay-ratio rule is pretty obvious: Congress explicitly told the SEC to make exactly this rule. It took five years, but it happened. The statutory authority for repealing the pay-ratio rule is less obvious. (To be fair, Piwowar's announcement doesn't say that he'll repeal the rule; it's much softer than that, directing "the staff to reconsider the implementation of the rule based on any comments submitted and to determine as promptly as possible whether additional guidance or relief may be appropriate.")

We've talked a little recently about "Chevron deference," the idea that courts are supposed to defer to regulatory agencies' interpretations of the laws they're charged with enforcing. Chevron deference is generally thought to be pro-regulatory: Agencies have more power to produce more rules if courts decline to second-guess them. And so people who want less regulation dislike Chevron deference, and are excited by the nomination of Neil Gorsuch, a Chevron skeptic, to be a Supreme Court justice. Get rid of Chevron, the thinking goes, and there will be less regulation.

But there might also be less deregulation. If the courts are more robust about second-guessing regulatory agencies, and demanding clear reasons and statutory authority for those agencies' decisions, then those decisions will take longer and some of them will be rejected. That includes deregulatory decisions too. The SEC can't arbitrarily repeal a rule any more than it can arbitrarily enact one:

“Whether you amend or adopt a new rule, you will be subject to judicial review, and that may limit the ability of the SEC on its own to do anything,” said Joel Seligman, president of the University of Rochester.

If the courts are carefully scrutinizing regulators' decisions, it will take a lot longer for them to dismantle regulations.

Elsewhere, here is Peter Henning on Chevron deference and insider trading. This is a popular theme -- the late Justice Scalia wrote a notable mini-opinion about how the courts shouldn't defer to the SEC's interpretations of insider-trading law in criminal cases -- but one that I think is overstated. There just isn't that much insider-trading law that turns on the SEC's regulatory interpretations. The weird thing about insider trading law isn't that it is SEC-made. It's that it is judge-made. 

We'll always have Paris.

Ahahaha burn: 

“When was the last time you took your partner off for a weekend in Frankfurt?” said Valerie Pecresse, president of the Paris region, at a press conference in London following a private meeting with 80 financiers and asset managers on Monday.

Paris is pitching to replace London as the post-Brexit European hub for financial services, and it has competition from other cities (Frankfurt, Warsaw) that are less expensive but also less romantic. You might think that a bank, being a relentlessly capitalistic enterprise, would focus on cost, and would choose the boring efficiency of Frankfurt over the bubbly profligacy of Paris. (See, e.g., Goldman Sachs Group Inc. in Salt Lake City.) But of course banks are not relentlessly capitalistic; they are socialist collectives run for the benefit of their workers, and if their workers would have more fun in Paris then that is a powerful consideration.

People are worried about unicorns.

Here is Matt Klein at Alphaville on a paper finding that "companies with a history of negative return on assets, high valuation multiples, previous capital raises, and 'positive price momentum' are the likeliest to issue stock," but also tend to have large negative returns on assets after they issue stock. Klein points to this as a warning sign for potential investors in the initial public offering of Snap Inc., which is a money-losing company as well as "an experiment in corporate governance in sync with the world’s authoritarian turn." (Ha!) In some sense it is weird that someone felt the need to do a study to find that companies with high valuations and a pattern of losing money would continue to lose money. And yet! Those are the companies that raise money. They're just impossible for investors to resist. Markets are only very loosely efficient.

Elsewhere, flying Ubers!

Uber’s vision is a seductive one, particularly for sci-fi fans. The ride-hailing company envisions people taking conventional Ubers from their homes to nearby “vertiports” that dot residential neighborhoods. Then they would zoom up into the air and across town to the vertiport closest to their offices. (“We don’t need stinking bridges!” says Moore.) These air taxis will only need ranges of between 50 to 100 miles, and Moore thinks that they can be at least partially recharged while passengers are boarding or exiting the aircraft. 

People are worried about stock buybacks.

Here is Aswath Damodaran on dividends and buybacks:

This post is about dividends and cash return, the Rodney Dangerfield of Corporate finance, a decision that gets no respect and very little serious attention from either academics or practitioners. In many companies, the decision of how much to pay on dividends is made either on auto pilot or on a me-too basis, which is surprising, since just as a farmer’s payoff from planting crops comes from the harvest, an investor’s payoff from investing should come from cash flows being returned. The investment decisions get the glory, the financing decisions get in the news but the dividend decisions are what complete the cycle.

Oh it's worse than that. In a lot of political and media circles, buybacks are treated as a Bad Thing, proof that a company is out of ideas or is manipulating earnings or is too focused on the short term. (That's why people worry about them!) I suppose sometimes they can indicate all of those things. But the very basic simple fact of buybacks (and dividends) is that they are how the investors get their money back. If they didn't exist -- if there was no way for investors who put money into a company ever to get it out again -- then why would anyone invest?

People are worried about bond market liquidity.

My Bloomberg Gadfly colleague Lisa Abramowicz thinks that Gary Cohn should not be using worries about bond market liquidity to justify repealing the Volcker Rule. I don't know. I kind of feel like repealing the Volcker Rule is overdetermined at this point; Congress is going to repeal the Volcker Rule because it is part of the old regime, and that is that. Probably when they get around to it, they'll say things like "this will let banks lend again" or "we will free American innovation from stifling regulation" or "this will make banks safer so they don't need government bailouts" or some other non sequitur. Frankly I'd be thrilled if the national conversation about repealing the Volcker Rule focused on bond market liquidity. We need more national conversations about bond market liquidity is what I always say.

Things happen.

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(Corrects to delete reference to enforcement action involving LeveL ATS in third item, replaced with reference to Pipeline Trading Systems LLC.)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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Matt Levine at

To contact the editor responsible for this story:
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