November, 1999

Cover & Feature Stories

Produce Payola: Inspection Reform Needed

Public officials’ acceptance of money under the table erodes the foundation of society. It undermines the assumption of honesty and trust that is a prerequisite for both a capitalist economy and a republican government.

The recent Hunts Point Market bribery scandal is a black mark on the industry’s reputation. But the industry should be grateful for the scandal, as it brought to the surface a serious problem.

BACKGROUND

After a lengthy investigation of the Hunts Point Market in the South Bronx, NY, officials arrested half the area’s U.S. Department of Agriculture inspectors and many employees of wholesalers, including the principals of some firms, on charges of receiving and paying bribes. Typical allegations are that cash was paid to inspectors to throw loads out of grade.

The bribes represent the falsifying of an inspection certificate – a PACA violation – so PACA licenses probably will be lost and companies may go out of business. The IRS will weigh in as well since it’s doubtful the crooked inspectors declared the money used to pay the bribes.

Now that arrests have been made and charges filed, suspects likely will sing like canaries to get lighter sentences. More arrests may be forthcoming, and surely other parts of the country have corrupt inspectors as well. At this moment, someone probably is cooperating with authorities by explaining how the corruption works in other terminal markets.

To attribute bribery only to the crooked nature of these individuals and go back to the status quo would be a mistake. The United Fresh Fruit and Vegetable Association is pushing for a delay in the planned increase in the inspection fee, explaining that trust in the system needs to be rebuilt before prices are raised. Such a strategy may save the industry cash in the near term, but it does nothing to solve the problems of the inspection service. To develop proposals to restore confidence to the produce trading system, the industry must analyze what happened on Hunts Point and why.

NATURE OF CORRUPTION

The industry would be remiss in focusing only on outright bribes. Though obviously wrong, cash passed in paper bags is relatively rare, yet the system is corrupt with informal bribery.

Night work at Hunts Point is miserable. Company owners who must be there hold their noses and do it and try to get to their home in the suburbs whenever possible. Sales reps, paid well into the six figures, lower their heads and do what they must, taking pride in buying their children a better life.

But for an inspector at Hunts Point, entry level work pays a mere $24,704 (see table on page 15). Those who manage to make it to the top of the pay scale clear a grand total of $44, 715. In the 90th Street Area on the East Side of Manhattan, a middling neighborhood just south of Harlem but close to Hunts Point, a large one-bedroom apartment in a modern high rise with a doorman is renting for $3,000 per month. This does not excuse accepting bribes, but it explains why so many felt they had relatively little to lose.

The tight budgets of inspectors in New York give the informal culture of corruption a place to grab hold. Many a vendor who wouldn’t dream of paying out a penny in bribes might have a nice room upstairs with hot dogs on the grill waiting every day for buyers, inspectors, whomever. On cold nights, it takes a strong inspector to pass up the hospitality.

A sales rep might confide to the inspector he sees every weekday that he has two tickets for Saturday’s game going to waste. The inspector might have a 10-year-old boy who loves the Yankees but is precluded from seeing many games by a slim family budget. It takes a strong inspector to pass up tickets.

Even if one is strong and doesn’t take food, go out drinking with his friends or accept tickets, he or she sees the same people every day. They can all get along, or the inspector can be alienated. Shippers are faraway strangers, so the natural human inclination must be to lean a bit toward one’s friends during inspections.

This pervasive form of corruption is not limited to Hunts Point or receiving points in general. Inspectors living in the growing regions, working out at the gym with the growers and their sons, meeting up at the town picnic or belonging to the same church group must be inclined to bend a bit in favor of their friends, the local boys.

This tendency toward shipping-point favoritism is restrained only by two factors: the knowledge that a receiving point inspection is more than likely and the better knowledge base of shipping-point inspectors than receiving-point inspectors.

Many inspectors are abysmally ignorant of the industry. With little training, they are far from authorities on produce. Shipping-point inspectors tend to be better for several reasons: The salary, slightly lower than what is earned by inspectors at Hunts Point, is a better living in a rural area, so it attracts a better quality employee. Rural areas also have a reserve of people who know something about agriculture; perhaps they grew up on a farm themselves. Finally, most shipping areas concentrate on a few crops, so even a greenhorn can pick up knowledge quickly.

But such is not the case at Hunts Point. The salary does not attract qualified applicants, the pool of agriculturally knowledgeable people is scarce, and the inspectors are required to inspect all varieties of product.

I witnessed the short-comings of an inspector’s lack of product knowledge firsthand years ago when I was new in my family’s business. Left in charge while my father was on vacation, I had to await inspection for a load of President Plums that had arrived.

The inspector declared that the plums did not make grade because they had little wrinkles. Having sold the plums in advance to a European customer, I had to disappoint that customer. I later learned that President Plums are supposed to have wrinkles, and I had disappointed a customer and upset a shipper for no reason. But knowing I could not ship the plums without a clean inspection, I had assumed the inspector would know if the plums were good. But why would he? He did not train on any loads of President Plums or have to pass any tests on President Plum nature to get the job.

Picture an inspector who doesn’t know much about the subject living with the same receivers day in and day out but never seeing a shipper and earning well below everyone he is dealing with. You can imagine how the weak can start taking sandwiches and the envious can start wanting cash.

WHY DID WHOLSALERS PARTICIPATE?

It takes two to tango, so why would business-owning wholesalers and their prosperous employees – people who have a lot to lose – participate? Doubtless, some will claim crooked inspectors compelled them to pay bribes under threat of deciding claims against the receiver – possible, but lacking evidence. Others will say it was a matter of competition. This has some basis in fact.

Once a buyer can get loads thrown out of grade, he or she can offer any price to secure the best product because the wholesaler knows the agreed price won’t be paid. And the buyer can undersell the market on good quality product. An honest competitor will have a tough time competing.

Since the Hunts Point investigation took more than two years, presumably, the alleged bribery went on for at least that long. For a shipper, dealing with a corrupt market for two years is a problem. But the products can be shipped to other customers and other markets. But two years of unfair competition would put an honest wholesaler out of business. Some who might prefer an alternative universe might feel the need to do what is necessary to compete with less scrupulous competitors in the existing universe.

WHAT COMES NEXT?

Growers would benefit if corruption among inspectors could be eliminated. But most events have unintended consequences, and a true purging of corruption, eliminating all inspector bias, would necessitate structural change in the way produce is sold.

Few wholesalers have substantial predictable chain-store business. These few can purchase product on a pre-sold basis and are less affected by fluctuating markets at receiving point. So this is not an issue at most wholesalers nationwide; they specialize in retail and chain restaurants or selling to service wholesalers. But most wholesalers in New York and on other major terminal markets are without this kind of customer base; they must sell at current market conditions.

It is unlikely the New York wholesalers who paid off the inspectors were cleaning up. A well-operated wholesale operation should make 4 percent before taxes. Most make much less.

Desperation, not greed, is most often the catalyst to throw things out of grade for an opportunity to renegotiate price. Wholesalers cannot buy product for $10 and sell if for $5 because they miscalculated the market volumes. The margins are too low. They will never make the money back. One small incidence of miscalculation will close them up.

This is a matter of concern for a grower because of the role of terminal markets in general and Hunts Point in particular for most growers. Precious few are growers that turn down Safeway to sell to Hunts Point. The opposite is more typical. Usually, growers first sell chain stores every box the chains will buy, foodservice distributors every box they will buy, service wholesalers every box they will buy – every credit-worthy company every box it will buy. Then if they still have product to sell, they turn to terminal markets. Especially to the biggest volume terminal market: Hunts Point.

The necessity for this outlet is illustrated by shippers’ encouragement of the bribery investigation. Normally, if one were experiencing unsatisfactory results with a customer, one would change customers. The decision to urge a corruption investigation is in part testimony to the necessity of the Hunts Point outlet for many growers.

The continued shipment of product to Hunts Point by shippers, even those who felt they were being ripped off by phony inspections, shows they found the returns at Hunts Point – even knowing a lot of loads would be knocked out of grade – preferable to any readily available option.

Despite sanctimonious claims by government officials that the corrupt inspectors were hurting small farmers, systematically paying one’s suppliers lower prices than they could earn elsewhere is impossible because they would stop supplying you.

In this situation, throwing things out of grade and renegotiating the price became, for many firms, the market-adjusting mechanism to keep supplies flowing and shippers satisfied with the volumes moved.

Most legitimate methods pose legal and marketing difficulties for shippers and wholesalers alike. Wholesalers cannot bear the market risk. Not only are their margins too slim, but economic theory would hold that market risk should be borne by those best able to project it. The two elements of market risk are supply and demand. Demand is highly predictable, but supply varies enormously. Growers/shippers best know if production is high and inventories are building up – conditions that likely will lead to heavy product arrival in Hunts Point.

Just as wholesalers who have pre-ordering chain-store businesses at fixed prices don’t feel the pressure to engage in corruption, neither do those who own farms and are serving as their own marketing agents. Those that have formalized arrangements to represent shippers on the market through consignment or institutionalized price-after-sale practices also can play things straight.

Most imported produce arrives in the United States via some arrangement other than an outright sale. The dynamic that has led to this is instructive. The shipper needs a constant market for the crop. Bargaining doesn’t meet the need because, in the end, the shipper can’t say no. Instead, the shipper agrees to accept the U.S. market price, whatever that might turn out to be.

Most shippers sending product to Hunts Point consistently need the volume, so they won’t be happy in a post-corruption world with receivers refusing to buy or offering low prices to protect themselves against any eventuality. The logical solution to this dilemma is the revival of an old institution – the commission merchant.

Consignment has fallen into disfavor, partly due to a legal problem. Many produce shippers market on a commission basis. They are not permitted to re-consign product without specific agreements to the contrary. It is viewed as if the grower is paying a double commission. This is foolishness squared.

It is one thing to say that an FOB marketing agent shouldn’t turn over its deal to another FOB marketing agent and thus collect a commission for doing nothing. This is entirely different than consigning product to a terminal market wholesaler whereby the FOB marketing agent preserves for his growers the upside and the marketing agent must do just as much work, maybe more, to monitor the situation than if he sold outright to a wholesaler.

The practical consequence of banning consignments is that many deals will be made on a price-after-sale basis. But this process of engaging in negotiation after the produce has been received and at least partially sold usually offers growers significantly lower levels of protection than an outright consignment that would legally entitle vendors to scrupulously accurate accountings for every box sold.

If growers led the initial move away from consignment, today, many reputable wholesalers won’t go near a consigned load. Some have their own brand of ethical concerns. If they are paying off buyers, for example, the account sale will overstate the firm’s profit on each load.

But most wholesalers object to it on the grounds that consignment selling is subject to so many legal challenges; instead of being risk-free for a wholesaler and thus worthy of the best rates, it’s a subject for PACA suits. If some other wholesaler sold for a better price, for example, a wholesaler must worry about being accused of negligence or incompetence. So many reputable wholesalers insist that suppliers sign complicated forms before they will help out with distressed loads. The forms, which say the wholesaler can pay anything it wants for the product, allow the wholesalers to enter into a particular type of relationship by working around current PACA law.

POSSIBLE ANSWERS

Reasonable reform proposals require thinking out of the box. Proposals fall into three categories: “professionalize” the inspection services, supplement the public inspection function with private inspectors or privatize the inspection function.

1. Professionalizing the inspection service is daunting and expensive. It would necessitate:

  • A licensure examination process for inspectors.
  • Significantly higher salaries to attract qualified applicants. In urban areas, salary leaps of 100 percent or more might be necessary. Federal policy normally allows for only modest differences in salary across the country.
  • Professionalization of procedure. In the Hunts Point scandal, an assigned inspector allegedly sent bribe-accepting inspectors to bribe-paying firms in exchange for a kickback. Random computer assignment of inspectors would make corruption less convenient, but it’s easier said than done since speed is often of the essence with inspection work. Rotting peaches wait for no one.
  • Improved facilities for inspectors. Pleasant work environments would discourage fraternization with the employees of the firms they are inspecting.

While these measures can help, they’re unlikely to be implemented or to solve the problems. Inspectors still must live with local produce company employees. And the higher costs necessitated by professionalizing the inspection corps is incompatible with the enormous number of inspections.

2. A hybrid public/private inspection system might do some good.

Sunkist has always insisted that products pass a Sunkist inspection as well as the USDA. Though USDA certificates would be stronger in court, the Sunkist inspector’s report is more important in working with Sunkist.

The Western Growers Association, perhaps building on Sunkist’s efforts and perhaps in alliance with the Florida Fruit and Vegetable Association and other interested grower groups, could maintain its own inspection staff at Hunts Point and other terminal markets. Member firms could instruct their receivers to always get a WGA/FFVA inspection on a problem load.

These inspectors might lean toward the grower – that is where their bread will be buttered – but they also will have to live with the wholesalers. And a grower’s interest isn’t to force wholesalers to overpay for poor-quality product. Done properly, the service could provide valuable, credible feedback for growers and packers. However, it would at least double the cost of inspections due to the additional cadre of inspectors.

3. Privatization offers pros and cons.

Consider the export business. It has no USDA inspectors, yet billions of dollars in business get conducted, none the less, often with private-sector surveys. Both sides do not necessarily trust private surveyors, but each side can hire its own surveyor and they can fight the issue out. In general, private surveyors do a decent enough job, partly because their position is inherently more balanced. Although they may live among receivers, they may be hired by shippers. And not being a government monopoly, each firm must build credibility.

Most overseas surveys are obtained to demonstrate something to the shipper. Almost always, the receiver would like to keep the shipper. So it does the receiver little good to hire a surveyor whose work the shipper considers suspect or of low quality.

More importantly, a smaller percentage of surveys are done on export loads than on domestic loads, especially if surveys designed to establish steamship liability are excluded. This can be explained by the perverse behavior a universal inspection system encourages. Those who ship overseas don’t trust inspectors there and know that collecting damages in the face of customer opposition is difficult in foreign countries.

So exporters carefully evaluate clients and business associates. When the receiver says the product has a problem, the exporter is often inclined to believe it and settle to save the cost of the surveyor. Much overseas surveying is done not to satisfy the exporting company, but to either allow the exporter to claim against a domestic shipper or, as a result of a CYA mentality driven by PACA in which the shipper/exporter wants paperwork in order to guard against any future challenge by a grower as to why a customer was granted a price reduction. This inspecting drives up costs and reduces grower returns.

CONCLUSION

Much of our produce industry infrastructure – PACA, the inspection service and the like – are designed in some way to insulate growers from the necessity of making various kinds of business judgments – careful credit evaluations, moral evaluations of the receiver, etc. Perhaps at one time, the concept of the city slicker and the country rube had enough truth to justify such an attitude. Today, growers are as likely to have MBAs as to be high-school dropouts. Maybe a privatization regime that required more attention would have virtue.

However the inspection system winds up being reformed, to the extent many receivers no longer feel comfortable that they can get a load thrown out of grade, they will not be able to buy as freely. So shippers who need the volume of the terminal markets will have to become comfortable with something other than outright sales at a fixed price.  pb