When the tide recedes, as it appears to be doing now with the market down 20% from its January highs, the bad actors will be exposed for all to see. Simply put, as the market goes down, companies hiding behind high stock prices and astronomical crypto values will be scrutinized to see if financial fraud and white collar crime were behind this activity.
The Department of Justice recently presented two important and complex cases that illustrate this point when markets fall. On May 17, 2022, the US Attorney’s Office for the Southern District of New York filed a lawsuit against a US subsidiary of Allianz (Allianz Global Investors, US LLC), which pleaded guilty to securities fraud and agreed to pay $6 billion to settle the issue.
This case, which involved only a few actors from a subsidiary, is one of the largest criminal transactions brought by the DOJ in recent memory. The company has also resolved the matter in a civil settlement with the SEC.
The scheme was implemented by three portfolio managers who caused billions of dollars in losses to pension funds that managed the pension plans of teachers, bus drivers, religious organizations and others. The company made false and misleading statements to investors that significantly underestimated the risks taken by the funds and the level of fund oversight.
Investors were led to believe that the funds were protected from a sudden stock market crash by various hedging strategies employed by the fund. The company’s control failures have further allowed portfolio managers to mislead investors about fund risk for many years. The fraud came to light in March 2020, when financial markets briefly crashed at the start of the pandemic, causing funds to lose more than $7 billion in value, according to the Criminal information.
The other case, just as complex, was also brought before the Southern District. A federal grand jury has returned an indictment against Bill Hwang, the founder and director of Archegos Capital, and Patrick Halligan, the company’s chief financial officer. The indictment accuses them and others of participating in interconnected schemes to illegally manipulate the prices of publicly traded securities in Archegos’ portfolio and of lying to banks to obtain billions of dollars that were then used to inflate the price of shares held in the company’s portfolio.
The indictment alleges that Hwang and others invested in the stocks by entering into derivative contracts called “swaps” with banks. These contracts allowed them to cause massive purchases of certain shares of the company, allowing Archegos to dominate trading and artificially increase the price of the shares.
When the market turned and prices fell last year, Archego’s positions were liquidated, making it impossible to manipulate stock prices. According to the indictment, more than $100 billion in market value disappeared within days for nearly a dozen companies.
The indictment alleges that Hwang and his accomplices deceived banks about the size of Archego’s positions and the amount of money his company had. The banks, according to the indictment, lost billions of dollars, and market participants who bought the stocks at artificial price levels also lost substantial value when manipulated stock prices fell.
Why is this important:
- In the spring of 2022, the Attorney General re-emphasized during his speech at the ABA White Collar Conference that prosecuting corporate crimes is a department priority and announced plans to hire 120 prosecutors this year. and 900 FBI agents to fight white-collar crime. With the recent market downturn, the Department will likely have ample opportunity to investigate and prosecute misconduct.
- Additionally, an economic downturn, which we may be heading towards, also creates more pressure to generate business and further increases the likelihood of bad actors taking risks to keep their businesses afloat.
And after: Businesses that may be concerned about inappropriate conduct should take the time to conduct fraud risk assessments now to uncover financial fraud and to assess and strengthen their fraud-related controls and procedures. For example, the accuracy of documents shared with investors must be verified to prevent fraud such as that which occurred in the Allianz case, where fraudulent and altered risk reports were routinely distributed to investors to appease risk fears.
Hiring a third-party consultant to perform an independent valuation may be warranted to prevent insiders from covering up their own wrongdoing. Unless there is a return to the market, which seems unlikely at the moment, we can expect more fraudulent activity to be uncovered as the tide recedes.