CFTC stands by allegations in lawsuit against Archegos, Patrick Halligan
On January 6, 2023, the Commodity Futures Trading Commission (CFTC) filed a response to a motion to dismiss by Archegos Capital Management, LP and Patrick Halligan. The document, submitted at the New York Southern District Court, says that the defendants’ motion to dismiss should be denied.
Over the course of a year, the defendants allegedly engaged in a fraudulent scheme to mislead swap counterpartiesof Archegos Fund, LP regarding the risk of Archegos Fund’s portfolio. The goal of the scheme was to convince the Swap Counterparties to repeatedly allow Archegos Fund to expand its highly leveraged swap positions in a concentrated handful of illiquid securities. To accomplish this goal, Archegos made a series of misrepresentations to its Swap Counterparties regarding the size and concentration of its largest long positions, amount of unencumbered cash, and liquidity. And, in order to induce the Swap Counterparties to continue to allow Archegos’ expansion, it purchased large volumes of Broad-Based Security Index Swaps.
During the week of March 22, 2021, Defendants’ scheme collapsed. The value of several of Archegos Fund’s core long positions declined, triggering $13 billion in margin calls that Archegos Fund did not have sufficient capital to meet. As a result, Swap Counterparties lost over $10 billion.
The CFTC notes that the defendants do not contest these basic allegations of Archegos’s fraud. Instead, Archegos argues only that the CFTC lacks the authority to prosecute it. And Halligan, the Chief Financial Officer of Archegos who the CFTC alleges orchestrated key aspects of the fraud, argues that he cannot be held responsible for it. The CFTC says the defendants are wrong, and their motions should be denied.
The CFTC has authority to prosecute fraud in connection with any “swap,” including swaps that are based on broad-based security indexes. A broad-based security index is a group of ten or more securities that are not disproportionately weighted—like, for example, the S&P 500. The CFTC alleges that Archegos Fund, in connection with the fraud, entered into two kinds of broad-based security index swaps: (1) ETF swaps based on existing broad-based security indexes, like the S&P 500, and (2) swaps based on custom portfolios (or “baskets”) of hundreds of different securities.
Both defendants conceded in their motions to dismiss the CFTC’s original complaint that the Broad-Based Security Index Swaps are subject to the CFTC’s antifraud rules. Now, the CFTC says, the defendants are relying improperly on documents and purported facts outside the scope of the complaint and are walking back their concession.
The CFTC argues that it has plausibly alleged that both the ETF Swaps and Custom Basket Swaps are based on broad-based security indexes and thus within the CFTC’s regulatory purview. The regulator says the documents relied on by the defendants cannot be appropriately considered for decision on a motion to dismiss, and even if they are, they do not refute the CFTC’s authority to prosecute the defendants’ conduct.
The CFTC has also alleged that Defendants engaged in fraud “in connection with” the Broad-Based Security Index Swaps. Defendants argue that for this standard to be met, the fraud must relate to the “value” of the swap, but this argument was expressly rejected by the Supreme Court. Instead, the fraud and swap need only “coincide,” such that they “were not independent events.” This may occur where the misconduct and the swap are part of the same fraudulent scheme.
The first amended complaint (FAC) alleges that the Broad-Based Security Index Swaps were essential to the defendants’ scheme because Swap Counterparties required those swaps as a condition to allowing Archegos to continue to increase its long positions. Archegos thus placed large volumes of these swaps to induce Swap Counterparties to enable this continued growth, which was the object of the defendants’ fraud. The Broad-Based Security Index Swaps therefore were an essential part of the scheme.
Halligan’s arguments similarly fail, the CFTC says. For instance, Halligan argues that the CFTC has not alleged that Halligan—a purported “back-office” CFO—acted with scienter. But the FAC alleges multiple particularized instances in which Halligan directed Becker to make material misstatements to Swap Counterparties, either knowing the information was false or with reckless disregard for the truth. The FAC also pleads instances in which Halligan directly misrepresented to Swap Counterparties the amount of Archegos’s combined exposure, largest positions, or available cash. Finally, it alleges that Halligan admitted his knowing participation in the scheme by commenting to Becker, about Archegos’s deceived counterparties, “if they only knew.”
For these reasons, the CFTC says, the defendants’ motions to dismiss should be denied in their entirety.
The first amended complaint alleges that, in the span of a year, between March 2020 and March 2021, Archegos and Halligan, and others acting on their behalf or under their direction, engaged in a scheme whereby they intentionally and/or recklessly made and disseminated false or misleading material information and/or omitted to make and disseminate such material information to their trading swap counterparties and took steps to deliberately conceal the true nature and extent of this scheme from their Swap Counterparties.
During this period, the value of Archegos’s portfolio increased fifteen-fold before it abruptly collapsed, causing its Swap Counterparties to suffer losses totaling billions of dollars.
The CFTC complaint alleges that Archegos’s rise and fall arose from a pattern of deceit in which Defendants and their Accomplices routinely led Archegos’s Swap Counterparties to falsely believe that the portfolio of Archegos Fund, LP, a fund managed by Archegos, was far less risky than it actually was.
Beginning in March 2020, Archegos Fund embarked on a new long/short trading strategy that was materially different from its historical practice. The portfolio for this new trading strategy consisted, in large part, of: (1) long total return swaps (“TRS”) referencing single-name securities; and (2) short TRS designed to partially hedge the risk of the long swaps, based on exchange-traded funds and custom baskets.
Under this new strategy, Archegos, as investment manager of Archegos Fund, caused Archegos Fund to enter into hundred million-dollar long single-name TRS on a daily basis that focused on a concentrated group of securities. Due to the size of Archegos Fund’s positions, they could not easily be liquidated. These trades were spread across at least eight different counterparties, and therefore each Swap Counterparty saw only a fraction of Archegos Fund’s total exposure. Swap Counterparties thus engaged in frequent oral and written communications with Archegos’s representatives to try to understand the aggregate composition of Archegos Fund’s holdings and to gauge the risk associated with Archegos Fund’s whole portfolio.
During the course of these communications, Defendants and their Accomplices repeatedly misrepresented material facts or omitted to state material facts relevant to assessing the risk of Archegos Fund’s portfolio, including the size and concentration of its largest long positions, amount of unencumbered cash, and liquidity. Defendants and their Accomplices misrepresented and/or hid material facts in order to conceal the true risk of Archegos Fund’s portfolio so that Archegos Fund could obtain additional capacity to trade even greater volumes of highly leveraged, concentrated, and illiquid long positions, while maintaining favorable margin rates.
Accordingly, Archegos misled its Swap Counterparties into believing that they had truthful information regarding Archegos’s portfolio.
The Swap Counterparties tried to mitigate the risk posed by Archegos Fund’s long single-name TRS by requiring Archegos Fund to maintain sizable short swap positions. Archegos Fund met these short requirements primarily through Broad-Based Security Index Swaps that referenced large and liquid sections of the market. These Broad-Based Security Index Swaps were designed to act as hedges to mitigate the risks imposed by the long single- name TRS positions in Archegos Fund’s portfolio. Due to Archegos’s misrepresentations, Archegos Fund’s Swap Counterparties relied on material false information and in turn could not accurately assess the risk posed by Archegos Fund’s aggregate positions and could not accurately calibrate the appropriate level of risk controls. .
Starting on Tuesday, March 23, and continuing through the rest of the week, virtually all of Archegos Fund’s largest long positions sharply declined, triggering a cascade of margin calls from its Swap Counterparties totaling over $13 billion. The margin calls far exceeded Archegos Fund’s available cash, causing it to collapse, dismiss employees, and cease operations. During this week, Defendants took steps to conceal the true nature and extent of the scheme from its Swap Counterparties.
Many of Archegos Fund’s Swap Counterparties suffered the consequences of Archegos Fund’s trading strategy, which was based on repeated lies. This is so because to hedge Archegos Fund’s long single-name swap positions, its Swap Counterparties typically took cash positions in the same referenced asset.
As a result, one of Archegos Fund’s Swap Counterparties lost over $5 billion; another lost almost $3 billion; and in total, Archegos Fund’s Swap Counterparties lost over $10 billion.
The CFTC argues that the defendants have engaged, are engaging in, or are about to engage in practices that violate the provisions of the Commodity Exchange Act (“Act”) and the Commission’s regulations (“Regulations”), including Section 6(c)(1) of the Act, 7 U.S.C. § 9(1), and Regulation 180.1(a)(1)–(3), 17 C.F.R. § 180.1(a)(1)–(3) (2021).
Archegos is also liable for the actions of its officers, employees, or agents pursuant to Section 2(a)(1)(B) of the Act, 7 U.S.C. § 2(a)(1)(B), and Regulation 1.2, 17 C.F.R. § 1.2 (2021). Halligan aided and abetted Archegos’s violations and is therefore also liable for those violations pursuant to Section 13(a) of the Act, 7 U.S.C. § 13c(b).