What Amazon Isn't Telling Investors, or Congress

Congress and the Securities and Exchange Commission both asked Amazon for details it won't give them.

Hi,

Welcome to BIG, a newsletter about the politics of monopoly. If you’d like to sign up, you can do so here. Or just read on…

Today I’m writing about:

• How Amazon’s lack of disclosures to Congress and to investors masks monopoly power.

• Potential political corruption around the Charles Schwab/TD Ameritrade merger.

• A Congresswoman striking at internet monopolies through trade agreements.

• Banking analyst Karen Petrou’s analysis of inequality as a major systemic risk.

• How private equity firms are juggling insolvencies.

• A shift in disclosure requirements for mergers.

First, some house-keeping. One, my write-up two weeks ago on cheerleading was featured in the New York Times Dealbook. I’ll have more on Varsity soon. Two, I’ll be speaking at an event on Section 230 of the Telecommunications Act tomorrow at 11am with Congresswoman Jan Schakowsky, put on by my organization the American Economic Liberties Project, as well as the American Prospect. You can RSVP here.

And now…

Amazon’s Disruptive Accounting

The most coveted real estate in online retail is the top left slot on Amazon’s search result page. If you can get your product onto that slot when a customer searches your product category, you are far more likely to be the product that sells. Last week, ProPublica’s Renee Dudley reported on a new tactic Amazon is using to fortify its market power. The corporation preferences its own private label products in that most plum position on its site.

There are an endless set of tactics Amazon uses to undermine small competitors, and this tactic is just one more. These kinds of activities present an interesting question for a corporation like Amazon, as well as its investors. Amazon is a public company, and it has to tell investors about how it operates, including disclosing material information. It’s not just investors, Congressional investigators has also asked Amazon how it makes money. How does Amazon answer these questions about its business? The answer is that Amazon structures its accounting and investor disclosures so as to ensure that investors and enforcers can’t tell how it generates revenue from its activities. And I’m going to show how.

First, let’s talk about this specific tactic. According to Dudley, when some customers do a search through Amazon, Amazon will simply place its own product in the top left slot. According to this story, a search for “ground coffee” tends to return AmazonFresh Colombia and a search for “melatonin” returns the Amazon brand Solimo. A consultant who helps brands navigate the site, Jason Boyce, noted that Amazon used to allow brands to bid for that slot, and his client who sold natural supplements paid up to $6 to Amazon’s advertising business line for a click on its product. But recently, Amazon just gives its own product top billing, no matter what.

“The domino effect of Amazon’s new strategy has demoted competitors’ listings for products including diapers, copy paper, kids’ pajamas, mattresses, trail mix and lightbulbs,” wrote Dudley. “By putting its own private brands in some of the most valuable slots, Amazon is sacrificing short-term ad revenue to build up sales of its private brands over time, consultants said.” Hal Singer, a well-known industrial organizational economist, tweeted these actions are a red flag for antitrust enforcers. Foregoing revenue to capture market share, or “profit sacrifice,” is not necessary to prove a monopolization case, but it certainly helps. Singer also notes that brands have to pay a 15% commission, plus third party merchants often use Amazon’s expensive fulfillment and logistics service, Fulfillment by Amazon, on the hopes they get better placement. Competing with Amazon on these terms is impossible.

To understand what is going on, we have to unwrap different layers of anti-competitive conduct. First there’s the actual manipulation of search results to capture ad revenue. Most customers actually don’t know that many of the results they are seeing are ‘sponsored’ because the font size isn’t big enough, they mostly believe they are getting an organic result from Amazon offering them the best product and the best price. The Federal Trade Commission issued agency guidance in 2013 barring these kinds of deceptive search engine practices, but it’s obvious the FTC doesn’t enforce. And second, there’s the foregoing of this ad revenue to self-preference its own private label products. Third, there’s a tying aspect, of what looks like coercing merchants to use a logistics service to get better marketplace service (though Amazon denies tying these products). That tying has to do with which products are Prime Eligible, which is to say, able to be shipped quickly and for free to Amazon' Prime customers.

Now, with all that said, let’s go to the questions that the House Judiciary Antitrust Committee asked Amazon last July about Amazon’s accounting, and how Amazon responded. The committee asked the corporation to break out its revenues, costs, and profit markets for several lines of business . For four lines of business, Amazon simply refused to answer (see questions 14, 41, 59, and 75). It refused to give information on its private label, Advertising, Fulfillment by Amazon, and Prime. These lines of business are precisely what are at issue in the ProPublica article. Chairman David Cicilline asked for revenues, costs, and profit margins, and for all four cases, Amazon said it would not separately break out information about those business lines.

For its private label products, the company said investors should look at its overall retail sales to get a sense of what’s happening there. Similarly, for advertising, the company points to its “other” revenue category. For fulfillment, Amazon gives its entire third party seller category, and for Prime, the company says just look at the overall ‘subscription'' category. In other words, Amazon is constantly burying its meaningful lines of business in larger categories, so that no one except insiders can tell what is going on. For instance, in its first quarter investor call, analyst John Blackledge from Cowan asked Amazon’s chief financial officer Brian Olsavsky about the corporation’s advertising business, since the ‘other’ category seemed to be doing well despite a pandemic-related slowdown. Olavsky responded by largely avoiding the question, saying that the ‘other’ category also includes non-advertising revenue.

Now, keep in mind that Amazon is refusing to divulge this information to a subcommittee of Congress. I hope that Congress issues a subpoena, because that’s the only tactic Amazon *might* respond to with disclosure.

But refusing to give basic information to Congressional investigators is not the first run-in the corporation has had with the U.S. government over its accounting for these business segments. In 2018, the Securities and Exchange Commission asked Amazon to provide more information about the amount of sales that come from its Prime members. Amazon said it wouldn’t comply, telling the SEC that it simply doesn’t see that information as relevant to its business. That is of course a ridiculous response, information on costs, revenues, and profit margins for Prime is obviously material information investors need to evaluate Amazon. Bezos brags all the time about Prime, it is literally the first business line mentioned in the Amazon’s 2019 holiday quarter investor press release.

So why won’t Amazon disclose? My guess is that the reason Amazon doesn’t disclose costs, revenues, and profit lines for Prime in isolation is that it is wildly unprofitable, cross-subsidized by other lines of business, such as its Fulfillment by Amazon line or its its merchant fees. It seems likely Prime was never meant to make money as a product in its own right, but as a way of acquiring and fortifying market power. As Bezos put it at the start, the purpose of Prime was to “draw a moat around our best customers” and to get people to stop looking at price differences between Amazon and other sites. How does one account for such a product? I don’t know, but my guess is that accounting for it might reveal truths Amazon wants to keep out of sight. There are likely similar reasons the corporation doesn’t disclose financial information around private label brands, advertising, and fulfillment.

Still, if this information is important to investors, why doesn’t Amazon have to disclose it to investors? After all, our securities laws say that corporate executives have to tell investors how their business operates and reveal critical financial data so they can evaluate how to allocate capital. I called up a number of former Securities and Exchange staff to find out what kind of authority the SEC has to get this information.

The gist of the response was that the SEC likes to be fairly deferential, especially to large corporations. It has a lot of power to require disclosure overall through its ability to set the rules on corporate disclosure and through its general anti-fraud authority, meaning its authority to make sure companies aren't misleading investors. It also has a bunch of other legal levers, like industry guides, delisting, fines, etc, but it has to go to court to really wield power, so it almost never uses most of its more important tools against large respected corporations. That said, the commission can be quite aggressive if it wants to be, especially if the commission takes the position that Amazon is refusing to disclose material information to investors to hide the risk of an antitrust suit.

Amazon’s ability to hide major swaths of its business reflects a dangerous weakness for our capital markets. As SEC Commissioner Robert Jackson put it last year, the SEC was formed in 1934 to in part to address the problem of financial concentration, a problem I would argue Amazon now represents. And it did so using one of the great reforms of the 1910s and 1920s, which was as scholar Gerald Berk notes in his book on Brandeis and Regulated Competition, to formulate modern accounting standards. The Securities and Exchange Commission used these accounting standards to force disclosure of business structures to investors, to both clean up the corrupt stock market, to prevent fraud, and to enable public enforcement of rules and laws over large corporations, which had been opaque institutions. That Amazon, and for that matter, a host of corporations, can choose to avoid explaining to investors what its various critical lines of business are doing, suggests that we have a serious problem with financial concentration. And that the corporation refuses to tell the Antitrust Subcommittee when asked directly how it makes money, well, that should indicate just how close to the mark Renee Dudley got in the ProPublica piece about Amazon’s self-preferencing of its own products through lines of business whose accounting is opaque to anyone except Amazon.

Here’s hoping for a Congressional subpoena, and soon.

Charles Schwab/TD Ameritrade and Corruption in Mergers? Back in February, I noted that Charles Schwab’s attempted purchase of Ameritrade looked sketchy. Schwab had cut its brokerage fee to zero, crushing margins for its competitor Ameritrade, which it then bought. Such a move looks a bit like predatory pricing, but there’s a bit more to the problem than a simple attempt to acquire market share.

Schwab made its money from commissions, but it made a lot more money encouraging clients to buy Schwab mutual funds and money market funds, charging high and hidden fees for those products. It is buying Ameritrade to get more customer assets, especially in the market for registered investment advisors managing less than $100 million, where it has 49% share and Ameritrade is the #2 player.

The Capitol Forum, which is a subscription based speciality service focused on mergers and business law, reported that the Department of Justice Antitrust Division closed its investigation abruptly and quite early. This is not an easy merger to clear. In 2019, Schwab’s CFO said that the corporation’s “competitive position both allows us to take share from a wide range of competitors and makes it hard for new competitors, new entrants to enter our business and quickly gain traction.”

There are plausible reasons to let the deal through, but the quick clearance suggests something else may be at work. Here’s what the Capitol Forum reported.

Charles Schwab, founder and chairman of the eponymous brokerage, donated $1 million to the Trump inaugural committee. In July 2017, he gave $101,700, the maximum amount allowed, to the Republican National Committee fund that paid Trump’s legal expenses related to Robert Mueller’s Russia probe.

On May 27, Vice President Mike Pence tapped Schwab’s granddaughter, Samantha Schwab, to be his deputy press secretary.

TD Ameritrade founder and former Chairman Joe Ricketts also is closely connected to the White House. As head of one of the most powerful families in Republican politics, Ricketts in 2016 pledged at least $1 million to elect Trump president, reversing his previous opposition to the candidate.

Trump in November 2016 also nominated Ricketts’ son Todd as deputy secretary of the Commerce Department, although the nomination ultimately foundered over conflict of interest issues. Todd sits on TD’s board and is the finance chairman of the Trump Victory Committee, which is jointly run by the RNC and the Trump for President Campaign.

Another of Joe’s sons, Pete, is the first-term GOP governor of Nebraska and a staunch Trump supporter.

Joe Ricketts stepped down as TD Ameritrade CEO in 2001 and relinquished his board seat in 2011. He still holds about 8.6% of the company’s shares, and his children are significant shareholders in the company, as well.

I’m not someone who claims corruption on a regular basis, because the Antitrust Division does have institutional integrity. That said, there is a pattern with the Department of Justice Antitrust Division chief Makan Delrahim consistently shading merger and antitrust decisions in directions that he suspects Trump would favor. This is yet another such choice.

Big tech and trade agreements: There’s a bitter dispute over liability for internet platforms, over a law called Section 230 of the Telecommunications Act. This law says that platforms aren’t liable for what third parties say or do on the platform, even if third parties edit or filter and even if they profit off third party content. Trump has put out an executive order trying to limit the scope of this rule, supported by conservatives who see the law as protecting Google, Facebook, and Twitter from having to contend with conservative bias on their platforms. But liberals often don’t like it either, because they think it’s a subsidy for a monopolistic business model. Still, big tech’s campaign to encourage the expansion of the law is on autopilot; Trump’s trade chief, Robert Lighthizer, put it in the new NAFTA (as well as an agreement with Japan), and is trying to get it into agreements all over the world. Trade agreements, where few pay attention, are often where unpopular policies get embedded into legal concrete and made harder to repeal. I got ahold of response by Congresswoman Jan Schakowsky, who wrote a letter demanding Congress cut off funds for Lighthizer so he can’t extend Section 230 into any more agreements. It’s an under-the-radar move, and we’ll see where it goes.

Inequality and Financial Crises: Karen Petrou is a highly respected banking analyst at Federal Financial Analytics, one of the sharpest minds out there focused on finance. She recently wrote a memo passed to me by a contact, titled “You Can't Have Sound Finance in the Midst of Profound Inequality.” What creates financial fragility? I’ve excerpted a paragraph and put the relevant sentence in bold.

Research from the Federal Reserve Bank of San Francisco shows still more clearly the link between economic inequality and financial-crisis risk. This paper deploys exhaustive research across decades in 17 countries based on statistical correlations of inequality, productivity, credit growth, and crises. Although productivity has a strong impact on crisis risk, a widening income share for the top one percent is the most predictive antecedent to a crash even when controlling for an array of other possible causes, including the asset-price bubbles that gave the Fed so much pause yet again in its latest financial-stability report.

Juggling Insolvencies? According to CNBC, private equity firm Sycamore Partners in talks to buy JC Penney. I’ve written about Sycamore in my piece on private equity’s Minsky moment. The firm specializes in retail, specifically finding ways of extracting cash and assets from corporations like Staples by convincing lenders to buy junk bonds on its portfolio companies so it can pay out dividends to itself.

Interestingly, JC Penney is also talking to its landlords, “including Brookfield Asset Management and Simon Property Group, about possible transactions.” That’s not a surprise, landlords have become key creditors during the pandemic as businesses stop paying rent. Interestingly, “under one scenario being explored, Sycamore, Brookfield and Simon would join forces on a bid for J.C. Penney, two of the sources said.” Brookfield is a large and secretive firm that was investigated by the SEC in 2013, and Simon Property owns shopping malls over the country. All three firms, Brookfield, Simon, and Sycamore, have an incentive to prop up JC Penney so it can go back to the capital markets and borrow money, which it will then return to them in the form of rent and dividends. We are of course getting to the trying to squeeze blood from a stone territory, but the Federal Reserve’s backstopping of financial assets may give investors confidence they can profit regardless.

SEC Reducing Disclosure for Mergers: Securities and Exchange Commissioner Allison Herren Lee dissented on a little noticed disclosure change at the commission. Corporations needed to provide up to three years of financial statements for major acquisitions, now they only have to provide up to two years. This will, according to the SEC majority, involve no loss of information to investors. Lee’s dissent is basically a polite version of an eyeroll. When we decide to start enforcing the law again, this will be yet another thing to fix.

Thanks for reading. If you liked this essay, you can sign up here for more issues of BIG, a newsletter on how to restore fair commerce, innovation and democracy. If you want to a book to learn more about the anti-monopoly roots of American society, read my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.

cheers,

Matt Stoller

P.S. Koch Industries bought ON Semiconductors. If you are in the hardware or tech space, do you know why? I’m looking for background on the company and the industry.