When the federal government filed fraud charges last month against executives of Archegos Capital Management, the charging documents gave the impression that the brokerage firms that lost a collective $10 billion in the fund’s 2021 collapse lacked sufficient information to avoid the losses.
Four hedge fund veterans, who weren’t involved, say the government’s portrait of Wall Street brokers as unwitting victims doesn’t fit with their experience in the business.
In Manhattan’s U.S. District Court, the Justice Department, the Securities and Exchange Commission, and the Commodity Futures Trading Commission allege in three parallel cases that Archegos chief Bill Hwang and his three co-defendants lied and kept Wall Street brokers in the dark to get tens of billions of dollars in trading credit that Hwang allegedly used to prop up prices of stocks like
(ticker: VIAC) and
Tencent Music Entertainment Group
(TME) in accounts at nine different brokerage firms—until the concentrated bets imploded in March 2021.
The victims of Archegos’ alleged lies were the fund’s “prime brokers,” the institutional trading desks that service hedge funds and sometimes family offices, like Archegos, which manage family money of the ultrawealthy.
Credit Suisse Group
(CS) lost $4.7 billion.
(8604.Japan), $2.9 billion.
(UBS) lost $774 million. The world’s biggest prime brokerage operation, at
(MS), lost $911 million.
Proving the government’s cases against the Archegos defendants hinges on showing that Hwang and his colleagues deceived their prime brokers. “The conspirators repeatedly made materially false and misleading statements,” says the indictment of Hwang and his chief financial officer, Patrick Halligan. “These lies and misrepresentations disguised the true—and grave—risks associated with Archegos’s portfolio.”
Hwang and Halligan deny the charges and have pleaded not guilty. Two former traders at Archegos are cooperating with the government after agreeing to plead guilty to racketeering and securities and wire fraud.
Prime desks are some of the toughest, most savvy operators in the brokerage industry. They are also the most profitable part of a big bank’s brokerage business. That’s why several hedge fund managers say they wonder if a trial of Hwang and Halligan will show that Wall Street brokers were making so much money from Archegos that the brokers ignored the obvious risks until Hwang’s concentrated bets crashed.
“Good for the Justice department and the SEC in going after Hwang,” says a longtime hedge fund manager who has done business with most of the prime desks named in the indictment. “But did the bankers know? They had to know.”
Risk managers at most prime brokers probe a fund’s financials unsparingly, in the experience of the fund veteran. Trading credit is hard to get without documenting a fund’s exposures, the manager says. Credit Suisse’s investigation into its Archegos losses concluded that its risk managers should have spotted clues of undue risk.
Wall Street’s prime desks wield great power, and public complaints about them are rare. No fund manager would speak on the record to Barron’s about Wall Street’s prime brokers. Nor would any of the Wall Street firms mentioned as Archegos victims speak about the case, or answer detailed questions from Barron’s about their Archegos revenue and risk practices. On earnings calls, the banks have told investors that investigations and litigation prevent detailed discussion.
A suit filed April 22 in New York state court by the Providence, R.I., city pension fund alleges that Credit Suisse directors invited catastrophes like Archegos by understaffing the bank’s risk units and allowing warnings to go unheeded. Credit Suisse shut its prime business after its losses. The directors have yet to respond in court. After publishing a lengthy investigation last year on the Archegos losses, Credit Suisse directors issued a statement that said they shared in “the concerns raised” by the law firm Paul, Weiss, Rifkind, Wharton & Garrison, which conducted the inquiry.
Morgan Stanley and
(GS) are fighting nearly a dozen shareholder suits in Manhattan’s federal district court concerning the brokers’ dealings with Archegos. The suits accuse the prime brokers of unloading blocks of shares held by Archegos after secretly learning of the fund’s plight—shifting billions in losses to the investing public. Morgan Stanley and
have yet to file responses.
Before the deluge, the money was good. A person familiar with the Archegos matter tells Barron’s that in the March 2021 quarter of Archegos’s collapse, the firms handling the fund’s trades made over $200 million in revenue.
Prime desks have grown in importance to institutional brokers, with the erosion of trading commissions and research revenue. Hedge funds and family offices pay fees to a prime desk to pursue aggressive trading strategies: margin loans that leverage a bet; stock loans to make short sales; and stock swap arrangements like those that Hwang allegedly used to control more than 35% of the free-trading shares in a few stocks, without publicly disclosing his stakes. Yet another way that a bank profits from its prime operation is by lending a hedge fund’s shares in a stock to another hedge fund that wants to sell the same stock short.
Brokers often fully hedge the swaps they write, with offsetting positions that leave them with neutral exposure to a stock’s moves. Someone with knowledge of the Archegos situation raised the possibility that Archegos’ primes chose not to fully hedge their swaps.
In the April 2021 earnings call that followed the Archegos blowup, Morgan Stanley Chief Executive James Gorman estimated that the bank had generated close to $40 billion in revenue from its prime brokerage business in the past decade. Even the bank’s loss of over $900 million on Archegos didn’t make him doubt Morgan Stanley’s role as the world’s No. 1 prime broker. “This is a gem of a business,” Gorman said. “It’s a core part and backbone of the equities business.”
Primes that say they avoided material loss in their dealings with Archegos include
(WFC), and Goldman Sachs. Growth in prime brokerage is a “strategic imperative,” Goldman executives said in earnings calls last year. Revenue and balance-sheet items related to prime brokerage have grown at double-digit percentage rates in Goldman’s recent earnings reports.
The Archegos debacle drove some firms out of the prime business, including
and Credit Suisse. For all the billions it lost on the Archegos account, Credit Suisse said in its July 2021 report that it made just $16 million in 2020 revenue from Archegos, and was on track to make $40 million in 2021 if Archegos’ positions hadn’t crashed.
The 172-page report by Credit Suisse supplies some of the strongest evidence that the pursuit of prime brokerage profits may have led banks to ignore the clear risks posed by Archegos’s leveraged, concentrated bets. In the months before the fund’s meltdown, says the report, Credit Suisse risk analysts told their supervisors that Hwang’s fund likely held similar bets across eight prime brokers—as evidenced by the large holdings in Archegos stocks reported in the names of other primes. The warnings were ignored by prime brokerage managers who wanted the Archegos business, the report said.
“The credit departments at these firms are not dummies,” says a hedge fund veteran. To allow one $300,000 position, he remembers his prime’s credit department hounding him about his finances for three weeks. “Yet these guys were lending Archegos tens of billions to buy a handful of stocks?”