Archegos-Tied Investor Suit Against Banks Weighed by N.Y. Court

A New York appeals court is weighing whether to allow ViacomCBS Inc. investors to continue with a lawsuit arguing big banks that underwrote the media company’s 2021 secondary stock offerings had conflicting roles that should’ve been disclosed.

Morgan Stanley, Goldman Sachs, and other banks are challenging a New York Supreme Court decision allowing the investors’ case to proceed. Investors say they weren’t told that some underwriting banks were also counterparties in Archegos Capital Management swap transactions, a “debilitating conflict” since those banks were preparing to dump Viacom stock as Archegos imploded.

The trial court’s decision not to dismiss the lawsuit has raised alarms among banks, who argue it will saddle underwriters with novel duties, causing a sea change in the underwriting process. Morgan Stanley and Goldman have said the decision will upend capital markets.

During arguments Thursday, at least some judges on the five-member panel appeared willing to let the lawsuit continue, at least against banks that both underwrote Viacom’s offerings and were involved in the swaps.

“Wouldn’t a reasonable investor want to know that the same entities that were the underwriters also had enormous positions in Viacom stock that were the subject of swaps and as a result of this offering, that could very well set off a large sale of that?” Justice Cynthia Kern said.

“That’s information that a reasonable investor could arguably want to know when deciding to purchase” the Viacom stock, Kern said.

‘Free-Floating’ Duty

Camelot Event Driven Fund and Municipal Police Employees’ Retirement System filed the lawsuit in November 2021, in the aftermath of Archegos’ spectacular collapse, alleging violations of federal securities laws.

A complex type of derivative, swaps let investors make bets on stocks without owning them. Archegos had swap agreements with the trading divisions at various banks, including Morgan Stanley and Goldman Sachs, involving Viacom stock.

During Archegos’ meltdown, those banks unloaded their corresponding stock, causing Viacom’s stock price to crater, according to court filings. Some of the same banks, including Morgan Stanley and Goldman, were also among the group that underwrote a pair of offerings of Viacom stock that took place the same week, which investors argue was a conflict of interest.

Refusing to dismiss the case, the trial court said the underwriters should’ve told investors about the Viacom stock held in relation to Archegos swaps. The court said the disclosure obligation reached more than a dozen underwriters, like JPMorgan, that weren’t involved with the swaps.

The banks argue the court made up a new “free-floating” duty to investigate and disclose conflicts of interest. Morgan Stanley and Goldman warn the decision will “fundamentally upend the functioning of the capital markets in New York and beyond.”

Kannon Shanmugam of Paul Weiss Rifkind Wharton & Garrison LLP, an attorney for Morgan Stanley and Goldman, told the appeals court Thursday that banks have ethical walls set up between underwriters and traders to prevent insider trading and protect client confidences.

“There can be no doubt that a ruling in plaintiff’s favor here would severely disrupt that wall, it would blow a hole in it,” Shanmugam said.

‘Everyone’ Liable

The case has drawn interest from law professors, industry groups, and ex-SEC officials, including former Chair Jay Clayton, who have filed friend-of-the-court briefs.

Camelot and MPERS argue the banks present a “parade of self-serving policy arguments designed to mislead this Court into believing that the Trial Court’s decision is a Pandora’s Box.” By not disclosing the alleged conflict, the underwriters made misleading statements to investors, violating a basic tenant of securities law, they argue.

“Everyone involved with the offering becomes liable,” John Rizio-Hamilton of Bernstein Litowitz Berger & Grossmann LLP, an attorney for the investors, told the court.

Camelot and MPERS argue that includes Viacom, which was dismissed from the case by the trial court. Some judges, however, appeared reluctant to hold responsible Viacom and underwriters that weren’t involved in the swaps.

“How could Viacom or the non-conflicted defendants have known what was going on at Morgan Stanley or Goldman Sachs?” Kern asked Rizio-Hamilton, adding that “even if they asked, they would not have provided that information that they were doing swaps.”

Jonathan Youngwood of Simpson Thacher & Bartlett LLP, arguing for many of the so-called non-conflicted defendants, said they haven’t found a single case in federal law that requires underwriters to conduct due diligence on one another.

“Certainly, absent a red flag, what would you ask? Who would you ask?” Youngwood said.

The case is Camelot Event Driven Fund v. Morgan Stanley & Co. LLC, N.Y. App. Div., 1st Dep’t, No. 2023-00983, argument held 3/14/24.