Archegos Case Offers Cautionary Tale, Compliance Resources for Users of Alternative Data and DOL PTE 2020-02 Insight: Lessons Learned & Worth Reading for May 2022 | Foreside

Lessons Learned

  • Archegos Case Provides Cautionary Tale for Firms that Ignore Risks. The SEC filed a complaint against Bill Hwang, the owner of family office Archegos Capital Management, LP (“Archegos”), for orchestrating a fraudulent scheme that resulted in billions of dollars of losses. The facts of the case are complicated, but at its core, the complaint charges Hwang, Archegos, and its firm principals with defrauding the banks that lent them money and acted as counterparties in total return swaps. Unlike other big frauds, the losers in this case were Hwang, since he was playing with his own and his family’s money, and the banks that dealt with him. So, although there may be some outcry for further regulation of family offices and the derivatives market, at least some of these losses were caused by a lacking compliance culture at one of the banks involved, Credit Suisse, where losses totaled around $5.5 billion.

    By way of background, Archegos founder, Bill Hwang, was a famous hedge fund manager, having worked with Tiger Asia Management, LLC and Tiger Asia Partners. In 2012, Hwang became infamous after pleading guilty to wire fraud related to illegal trading of Chinese stocks and paid $44 million to settle U.S. insider trading charges. Tiger Asia subsequently rebranded as Archegos, a family office. Two years later, Hwang and Archegos were banned from trading securities in Hong Kong for four years. During this entire time, Credit Suisse continued to do business with Archegos without imposing any heightened scrutiny on the relationship.

    Obviously lying to business partners is wrong and can result in fraud charges. But from a compliance perspective, the teachable moments in this case come from the fallout at Credit Suisse. Credit Suisse’s board of directors appointed a special committee and retained a law firm, Paul, Weiss, Rifkin, Wharton & Garrison LLP (“Paul Weiss”) to conduct an investigation, culminating in a report about what went wrong. The report makes fascinating reading, but the big takeaways include:

  1. Short-term profits should not override long-term sustainability. For Credit Suisse, the Prime Services business unit focused on revenue and failed to rein in risk-taking. Allowing the sales team to run the show can result in regulatory trouble.
  2. Monitoring and testing are meaningless without accountability and consequences. As discussed in the Paul Weiss report, the buck did not stop anywhere when it came to managing risk within the Prime Services unit. Despite the many red flags being raised, no one was held accountable when the risks were not addressed. Moreover, there were no consequences for taking undue risks — until the failed margin call at the end of March 2021.
  3. The tone at the top emphasized revenue over managing risk. When employees who raise questions about risk are consistently ignored by management, the firm sends the message that risk is unimportant.

This quote from the Paul Weiss report sums up Credit Suisse’s failures: “[t]he Archegos default exposed several significant deficiencies in CS’s risk culture, revealing a Prime Services business with a lackadaisical attitude towards risk and risk discipline; a lack of accountability for risk failures; risk systems that identified acute risks, which were systematically ignored by business and risk personnel; and a cultural unwillingness to engage in challenging discussions or to escalate matters posing grave economic and reputational risk. The Archegos matter directly calls into question the competence of the business and risk personnel who had all the information necessary to appreciate the magnitude and urgency of the Archegos risks but failed at multiple junctures to take decisive and urgent action to address them.” Contributed by Jaqueline Hummel, Managing Director.

Worth Reading, Watching, and Hearing

  • Recent Foreside thought leadership:
  • Alternative Data Compliance Considerations for Investment Advisers. Jane Jarcho from Promontory IBM Consulting addresses how firms can establish procedures to prevent misuse of MNPI in connection with alternative data.
  • SEC Division of Examinations (Finally) Speaks on Alternative Data. Akin Gump offers this Financial Regulatory Alert to make some sense of the SEC’s focus on the risks associated with alternative data.
  • Fred Reish, Partner with Faegre Drinker Biddle & Reath LLP maintains a prolific blog where he has been digging into the nuances and nitty gritty of the DOL’s Prohibited Transaction Exemption (“PTE”) 2020-02. We feel comfortable saying “prolific,” as we share these recent posts numbered 87, 88, and 89, respectively.

Photo Credit: Photo by Claire Anderson on Unsplash.