Big Banks’ Underwriting Firewalls at Risk in Archegos-Tied Suit

Wall Street giants fear a New York appeals court decision could upend the entire process for underwriting stock offerings.

The decision allows ViacomCBS Inc. investors to sue Morgan Stanley, Goldman Sachs Group Inc., and Wells Fargo & Co. over alleged conflicts in the media company’s offerings that weren’t disclosed. It puts under a microscope the firewalls inside the banks that are supposed to prevent investment bankers and underwriters from sharing information.

Legal scholars say the case also risks creating fuzzy obligations for banks to disclose their own potential trading when they facilitate offerings of new securities to investors. Offering documents typically focus on the company that is selling the securities, said Andrew Vollmer, a scholar at the Mercatus Center at George Mason University and former SEC deputy general counsel.

“The wider consequence here is altering the nature of the disclosure document,” said Vollmer, who joined an amicus brief in the case.

The banks can pursue further appeals of last week’s ruling, which upheld a lower court’s decision not to dismiss the case against Morgan Stanley, Goldman, and Wells Fargo. Investors allege they violated federal securities laws by failing to disclose their own investment bankers were preparing to dump Viacom stock — while underwriters at the same banks helped bring the stock to market.

Investment banks’ fire sale of Viacom stock was meant to avoid further losses tied to the demise of Archegos Capital Management. Archegos, Bill Hwang’s former powerhouse investment firm, collapsed in 2021 after plummeting shares of Viacom, one of his big holdings.

Archegos’ downfall led to about $10 billion in losses for the various banks that helped structure Hwang’s trades.

Investor Harm

The lawsuit, led by the Camelot Event-Driven Fund and the Municipal Police Employees’ Retirement System in Louisiana, followed an offering of Viacom common and preferred stock in March 2021.

Morgan Stanley and Goldman Sachs helped underwrite the offerings, which raised $2.65 billion. Unbeknownst to investors, the banks at the same time were planning to dump billions of dollars’ worth of the media company’s stock linked to Archegos trades, Camelot and MPERS allege.

The banks’ sell-off, which occurred just days after the Viacom offering, cratered the company’s stock price and contributed to “enormous losses” for Camelot and other investors, the lawsuit alleges.

A New York trial court in February 2023 said the case against Morgan Stanley and Goldman could move forward, with banks warning the decision would upend capital markets.

Upholding much of that decision, the state appeals court this month found investors could be misled by a statement in the offering documents that said underwriters “may” conduct transactions that affect the stock price, if the banks were in fact already planning to sell their shares.

Investor claims against Wells Fargo, which underwrote the Viacom offerings and provided brokerage services to Archegos, can also move forward, the appeals court said.

Peeking Over Walls

Banking groups, legal scholars, and former SEC officials are all interested in what happens.

Some say the New York courts created new requirements for underwriters who, until now, didn’t have to disclose their own potential transactions in an issuer’s securities.

The courts imposed a disclosure obligation “that goes beyond what the SEC normally requires,” said Ronald Colombo, a Hofstra University law professor focused on securities fraud. He and others argue the court mandates threaten to disrupt the roles of Congress and the SEC.

What’s more, the American Bankers Association said in court filings, banks are required to have ethical walls designed to prevent confidential information from flowing between investment bankers and underwriters. Securities laws require broker-dealers to have procedures in place to prevent misuse of such information.

“We have these walls up to prevent conflicts of interest and now they’re saying, you need to peek over them to prevent conflicts of interest,” said Colombo, who signed on to an amicus brief supporting the banks.

‘Understanding the Consequences’

Other legal scholars don’t anticipate the sea change that banks predict.

Material conflicts of interest “go to the heart of an underwriter’s role,” Columbia Law School securities professor John Coffee and three former SEC commissioners said in an amicus brief. They say the trial court’s ruling in the case, which involves one of the “most pointed conflicts possible,” is consistent with New York federal court decisions..

“Underwriters are not allowed to not know about their own material conflicts of interest,” Allison Herren Lee, one of the former commissioners who signed on to the brief, said in an interview.

There are reasons to believe higher-ups at the banks did know about the alleged Archegos conflict, investors and their supporters say. Court filings note comments from Morgan Stanley’s then-CEO James Gorman, who in 2021 said the Archegos situation was complicated “by the fact that one of the large single stock positions related to a security in which we have been an underwriter.”

The state appeals court acknowledged banks’ concerns about eroding ethical walls in its opinion, but said that at “the pleading stage, the mere possibility that such barriers may have existed does not warrant dismissal of the complaint.”

The language seems to suggest that Morgan Stanley, Goldman Sachs, and Wells Fargo might win the case if they could prove sufficient barriers existed. That could make such walls a focal point in the trial court.

The potential that banks could still win hasn’t alleviated concerns. It’s unclear, for example, when a conflict rises to the level of requiring disclosure, the banks supporters’ say. Given the size of the banks, there may be no quick way to do the kind of conflict check that appears to be required, they added.

The court is “jumping into disclosure obligations in registered offerings of very technical, highly relegated areas without really understanding the consequences,” the Mercatus Center’s Vollmer said.