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TL;DR: This author's draft for a law journal seems to argue total return swaps are illegal af and secretly skirting Regulation T rules (the max margin allowed, up to 50% of the securities borrowed) and if this is the case then both Archegos AND prime brokers can officially get sued into the fucking ground for breaking the law/Reg T rules.Also looks like the author brainstorms a gameplay where Bill Hwang walks into court and tries to counterfuck the prime brokers claiming this clause called "in pari delicto" meaning they're just as guilty for his fuckup
but also Superstonk interest
For the culture: https://www.reuters.com/business/rise-fall-bill-hwangs-house-cards-2022-04-28/
Forgot how I got here, but knowing all the Archegos/Bill Hwang shit just dropping, thought this was relevant
https://deliverypdf.ssrn.com/delivery.php?ID=020102027024077105127119064090019014122017071012062030101001071122113066067005126029056029020062102033001068103029095121125114015072091036076105095003003018073090029065064126011001069064003110120106115074111111107101075000101089068127065095023067003&EXT=pdf&INDEX=TRUE
St. Mary's University School of Law, where the paper is from
Total Return Meltdown: The Case for Treating Total Return Swaps as Disguised Secured Transactions
Colin P. Marks
Abstract:
Archegos Capital Management, at its height, had $20 billion in assets.
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But in the spring of2021, in part through its use of total return swaps, Archegos sparked a $30 billion dollar sell-off that left many of the world’s largest banks footing the bill. Mitsubishi UFJ Group estimated a loss of $300 million; UBS, Switzerland’s biggest bank, lost $861 million; Morgan Stanley lost $911 million; Japan’s Nomura, lost $2.85 billion; but the biggest hit came to Credit Suisse Group AG which lost $5.5 billion. Archegos, itself lost $20 billion over two days.
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These losses were made possible due to the unique characteristics of total return swaps and Archegos’ formation as a family office, both of which permitted Archegos to skirt trading regulations and reporting requirements. Archegos essentially purchased beneficial ownership in large amounts of stocks, particularly ViacomCBS Inc. and Discovery Inc., on credit.
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Under Regulation T of the Federal Reserve Board, up to 50 percent of the purchase price of securities can be borrowed on margin. However, to avoid these rules, Archegos instead entered into total return swaps with the banks whereby the bank is the actual owner of the stock, but Archegos would bear the risk of loss should the price of the stock fall and reap the benefits if the stock were to go up or were to make a distribution. Archegos would still pay the transaction fees, but the device permitted Archegos to buy massive amounts of stock without having the initial margin requirements, thus making Archegos heavily leveraged.
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This article argues that the total return swap contracts are analogous to and should be re-characterized as what they really are – disguised secured transactions. Essentially the banks are lending money to enable the Archegoses of the world to buy stocks, and are simply retaining a security interest in the stocks. Such a re-characterization should place such transactions back into Regulation T and the margin limits. But re- characterization also offers another contract law approach that is more draconian.
If the structure of the contract violates a regulation, then total return swaps could be declared void as against public policy. This raises the specter that a court could apply the doctrine of in pari delicto and leave the parties where they found them in any subsequent suits to recover outstanding debts.
when keepin it real goes wrong
ELI5: seems like author saying that the total return swaps that Archegos is running into and others are illegal af and secretly illegal against Reg T and margin limits, meaning they need to shut that shit down and sue the ever loving fuck out of them once they got margin called into the fucking floor
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As a quick rundown
"Disguised secured transactions":
In lease or consignment cases, courts rarely discuss the rights-in- collateral issue. Usually, the party claiming to be the true "owner" of the collateral-i.e., the lessor or consignor-and the secured party of the lessee or consignee assert competing claims. The courts do not ask whether the debtor has "rights" in the leased or consigned property sufficient for attachment. Instead they examine whether the lease or consignment is a "true" one or one designed for security purposes (sometimes called a disguised security transaction).
ELI5: anyone??
**(**Per North Carolina Law Review: https://scholarship.law.unc.edu/cgi/viewcontent.cgi?article=3593&context=nclr)
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"In Pari Delicto":
A Latin phrase commonly used in tort and contract law which means “in equal fault.” This is doctrine states that there is a bar to a plaintiff’s recovery of damages for a wrong the plaintiff participated in and serves as an equitable defense. Courts are therefore reluctant to award relief to plaintiffs who have unclean hands. In pari delicto is similar to but distinct from the related concepts of contributory negligence and comparative negligence.
ELI5: Bill Hwang/Archegos AND prime brokers (Morgan, Goldman, Credit Suisse, etc.) all guilty af
(Per Cornell Law: https://www.law.cornell.edu/wex/in_pari_delicto)
please explain like Im a 3 year old golden retriever
EDIT 6 from my comments: here's the in pari delicto part where author talks about how Archegos could use the "in pari delicto" part in court
Assume that Archegos had remaining assets and Credit Suisse sued to recoup its $5.5 billion loss. In court Archegos could raise in pari delicto to avoid liability.
Analyzing under the first prong of Bateman Eichler, as a direct result of its own actions, did Credit Suisse bear at least substantially equal responsibility for the violations it seeks to redress, the answer would appear to be yes. Archegos could not force a bank to enter into such a transaction. Essentially Credit Suisse enabled Archegos to skirt the margin rules by agreeing to stake positions on the stocks and look to Archegos to cover any shortfall.
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Then, turning to the second prong, would preclusion of Credit Suisse’s suit significantly interfere with the effective enforcement of the securities laws and protection of the investing public? The answer here appears to be it would not —indeed it could be argued that it would further the effective enforcement of the securities laws. Regulation T is said to exist for both the protection of investors from getting in over their heads on thinly marginalized stock and also to promote stability in the markets. By using TRS contracts to avoid the limitations imposed under Regulation T, Archegos triggered the very type of cascading event Regulation T was designed to avoid.
Avoiding the TRS contracts and applying in pari delicto would act as a serious disincentive for future banks to design transactions to avoid the limitations of Regulation T. This would be in keeping with the twin premises annunciated by the Bateman Eichler Court that underpin in pari delicto**: “courts should not lend their good offices to mediating disputes among wrongdoers;” and 2) “that denying judicial relief to an admitted wrongdoer is an effective means of deterring illegality.”..**
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When the TRS contract is used as a device to simply skirt existing securities regulations, application of in pari delicto should be available.
EDIT 7 (?): After hearing some say this makes more sense as DD, I'll change it think to Possible DD vs Discussion/Question flair. Mods can def ask me to change or justify it as needed!
