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Look, a lot of people took up hobbies in the early stages of the pandemic. People were making pasta,
they were cutting their own hair, buying dogs that they could clean up after – things like that. Now,
one of the most popular hobbies was (of course) retail trading in meme stocks,
and that exact hobby turned out to be the undoing of Bill Hwang.
I can’t help but think that all was going well for Bill, and then he fell
under the influence of Dave Portnoy, and decided it was time to go all in. Stonks
only go up – as Bill probably used to say... So anyhow, this week, US federal authorities
arrested and charged Bill, the founder of Archegos Capital Management -which is a family office – not
a hedge fund as is often reported, with executing a vast scheme to manipulate stocks. He has been
arrested on federal racketeering, fraud and market manipulation charges. Which is bad…
It would appear that Bill’s core investment strategy was to pick a basket of around ten
stocks, and then using leverage from around a dozen prime brokers buy an awful lot of
them. As his buying pushed up the prices of these stocks, he had mark to market profits.
He would then use these profits, to get even more leverage from the banks, to buy even more of these
stocks. This made the prices go up even more, which created more profits, which gave our hero
more money to buy more of the same stocks. I guess the idea was that this could continue on forever
in an infinite loop, but sadly for Bill, that is not what happened, but he did have a great run.
Bill used total return swaps and lots of leverage, all of which were kindly provided by his prime
brokers to build ginormous positions in stocks including ViacomCBS, Discovery and a number
of Chinese companies listed on US exchanges. Over the course of less than a week in late March
2021, the whole house of cards collapsed leading to huge losses at many of the prime brokers.
So what went wrong? Well, on March 22, 2021. Viacom CBS whose stock Bill had pushed up a lot,
announced a secondary stock offering – basically to take advantage of the high stock price and
raise some additional capital. This new supply of stock caused the stock price to sink the next day.
This was Bills largest position and according to the indictment, he mounted a massive offensive to
boost Viacom, attempting to overpower the market. The $2.6 billion in trading that he did that day
consumed all of Archegos' cash meaning that they would not be able to meet
their margin calls if the offensive failed. And (of course) Viacom continued to fall.
Over the next two days, according to the complaint, Hwang and his team scrambled
to stall the banks from calling in their margin loans. On March 26, he ran out of time. The banks
began unwinding the trades, sending the shares tumbling. The game was over.
When we look at the complaints you can see that in March 2020, Archegos had $1.6bn in capital
and $10.2bn in gross stock market exposure. So, he was trading big to begin with, but those figures
exploded to $36bn and $160bn, respectively just before the collapse in March 2021.
There is no mention of Dave Portnoy, or Wall Street Bets in the charges and Bill has said
nothing about his boredom during the pandemic, but I think we can all guess what happened.
Among the victims, according to the criminal and civil complaints, are the Wall Street banks that
Archegos deceived concerning its liquidity and trading positions. Hwang’s attorney states that
Bill is entirely innocent of any wrongdoing. The biggest loser in this whole debacle was
of course Credit Suisse, and I’m not sure that it is entirely fair to blame Bill for that. In
many ways it could be argued that being involved in scandals and taking losses in this manner was
Credit Suisse’s hobby during the pandemic. I have heard that at Credit Suisse they initially wanted
to take up making homemade pasta, but there was a shortage of pasta machines early on,
and so huge losses it was. In truth, the losses at Credit Suisse can reasonably be blamed on supply
chain disruptions as much as anything else. Now, before I go any further, let me quickly
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The SEC and the CFTC have brought parallel civil cases against Archegos and Hwang.
The SEC complaint says that in March 2021 Archegos’s derivative and stock positions
in ViacomCBS accounted for more than half of the company’s freely tradeable stock. He owned
70% of the outstanding shares of GSX Techedu and 60% of the outstanding shares of Discovery
This is what lockdown boredom did to Bill. Anyhow, when we look at the various accusations
possibly the most significant one is that Bill is accused of deceiving his counterparties to
extend leverage well beyond what their risk tolerance would have otherwise permitted
had they known the truth.” He was allegedly able to get
away with this this because of his use of derivatives. According to the complaints,
Archegos would typically first invest in the common stock of a company it wanted to bet on.
And only when their ownership approached 5 per cent of the overall business — a threshold that
would trigger regulatory disclosures, they would switch to using total return swaps.
With these swaps, Archegos could make or lose money depending on if a stock rose or fell,
but the bank they entered the swap agreement with, would show as the actual owner of
the of the shares – the bank would have to buy the shares to hedge their exposure to the swap.
The bank would own the shares but pass on their return to Archegos.
This trading style allowed Archegos to not only hide its ownership,
but they also provided leverage. Bill went from assets of $1.6bn to more than to $36bn
in just 12 months. At one point, Archegos owned or had derivative exposure to more than 50 per cent
of the outstanding shares in the media company ViacomCBS, now known as Paramount Global.
Taking large positions like this in a stock, and avoiding the disclosure rules
is most likely illegal whether he used swaps or not. I pointed out in a recent video that Elon
Musk broke the law by waiting ten days longer than is legally permitted to disclose his 5%
stake in Twitter, which allowed him to accumulate an additional stake at a cheaper price,
saving him – and costing shareholders who sold to him $150 million dollars. What Hwang is accused of
doing here is significantly worse. I’m not sure, but I don’t believe the use of derivatives allows
you to avoid disclosure like this. We will have to see how the court case works out.
The SEC complaint points out that “from January through March of 2021,
Archegos’s trading of the equities of and “securities based swaps”
referencing its Top 10 Holdings frequently exceeded 20%, often reached 30%,
and even surpassed 40% of certain issuers’ daily trading volume. They go on to say that Hwang knew
that trading in large volumes on a given day would create upward pressure on the share prices and
would often result in the share price increasing. It is not necessarily obvious that this is
actually market manipulation though. Anyone who buys a lot of stock will
push up the price and there is not really any rule that says that your trading has to have
no market impact. Additionally, there is no rule as to what percentage of daily
volume you are allowed to trade. Most traders typically aim to minimize their market impact,
simply because it reduces your returns to move a stock much when buying and selling it.
Amusingly, when the SEC describe the manipulative trading that occurred,
they say he would buy in the premarket, when liquidity was low, in the middle of the day,
to keep the price up, and at the close to “mark the close.” When we sum that up, it essentially
tells us that he would buy all the time. What you doing Bill? I’m buying stonks!
The SEC later say that “None of this trading was based on a principled view of the true value of
a particular issuer and instead was intended to artificially inflate share prices.” Once again,
I’m not sure that you have to show that you bought a stock based on good and thorough research.
According to the complaint, in June 2020, when asked by a colleague whether the relative
resilience in ViacomCBS shares “was ‘a sign of strength’” on a day when the broader stock
market was falling, Hwang texted: “No. It is a sign of me buying.” He added the emoji for tears
of joy or laughing, according to the complaint. Now, I’m not a lawyer, but it would appear that
the SEC view this emoji as being possibly key to at least part of their case, as the statement “No.
It is a sign of me buying.” Is just a statement of fact – buying a lot of a stock will push its price
up – but maybe the SEC feel there is something that can be read into the emoji – after all they
do include it. It is lucky for Hwang that he didn’t send a text saying – The price is rising
because I am illegally manipulating the stock to make money - and adding a devil emoji, as that
statement might be more difficult for his lawyers to defend. If nothing else, we must commend Bill
on his texting restraint and diplomacy. I should add, that Bill is a 58 year old,
deeply religious man, so I’m guessing that his lawyers can get around any emoji related charges
using what I believe is known as “The Boomer defense.” They can put forth that 58-year-old
men have no idea what any emojis mean – other than maybe the happy face and sad face ones.
It is a bit like when it came out years ago that David Cameron signed off all of his
text messages with LOL Dave, apparently, he thought LOL stood for “Lots of Love”.
Like I said though, I’m not a lawyer, and I know nothing about emoji precedents.
Now, it would appear that the most serious allegations against Archegos
is that they lied to their banks and brokers about their stock positions and their overall
finances. Whether you are manipulating stock prices or not, it is illegal to lie to your
banks in order to get them to lend you money. The SEC complaint says that Archegos claimed
to representatives of Credit Suisse, in substance, that as of November 30, 2020,
the largest gross position in Archegos’s portfolio made up 35% of Archegos’s capital, and this was
untrue according to the complaint. At the time, Archegos’s largest long position ViacomCBS made
up approximately 96% of their overall capital. In fact, according to the SEC, as of that date,
Archegos had six positions that were greater than 35% of capital. – These numbers sum to more than
100% because of the leverage involved. The Department of Justice allege in their
indictment that while trying to persuade UBS to increase their trading limits,
Hwang’s team claimed that Archegos could unwind their entire portfolio in around a month without
serious market disruption. In reality, according to the Department of Justice, Archegos would
have needed well over 100 days to do this. Archegos is additionally accused of claiming
in substance, that the portion of their portfolio held at UBS
was not representative of their overall portfolio with other counterparties, and that their largest
portfolio positions were large, liquid technology socks, like Amazon, Google, Microsoft, and Apple.
In truth – according to the complaints - none of these stocks ranked in their top ten positions.
UBS, which lost $861mn from the debacle, ended up raising Archegos’s trading limits by around $2bn
“based in part on these misrepresentations”, according to the DoJ.
A central problem here is that each bank only knew about Archegos's positions that were held
at that specific bank. For this reason, it might have seemed sensible for Archegos to
have a billion dollar position in a single stock, but not if they have an identically large position
in that stock at every other major bank or brokerage. In such a situation, if Archegos
defaulted – like they eventually did, all of the counterparties would be selling the same stocks
all at once and in size, tanking the stocks. Banks were very aware of this risk, and asked Archegos
about it, and Archegos is accused of lying. Now, we can’t ignore the fact that the banks,
that ended up taking a hit, were shot with a weapon that they had provided to Archegos.
They created these swaps and provided access to them, knowing that they could be used to conceal
outsize positions and provide an insane amount of leverage.
The mess that ensued has led to calls for better disclosure of swap holdings which currently avoid
the tough rules that apply to ordinary shares. At the start of the COVID pandemic, one of the
biggest fears of bank and hedge fund executives was that if staff were allowed to work from home,
there might be a lot of “rogue trader” style losses.
The theory was that a lack of effective compliance oversight combined with cabin fever could lead
to people losing their sense of proportion and taking foolish and inappropriate risks.
This is possibly what happened with Hwang. Before the pandemic, he used to hold
regular strategy meetings and talk to his analysts, arguing about investment cases and
valuations. The complaints state that once he was confined to his home, he began “essentially
ignoring his analysts recommendations” and “spent almost all of his workday with the traders”.
This seems to be when he started believing far too much in his own ability and took
on an investment strategy that a moment’s reflection would have shown to be insane.
It’s notable, that the other big losers in trading during the pandemic were retail options investors,
the other group of people who had nobody advising them, and who formed online
communities that were informationally airtight against any disagreement.
The thing with this whole story is that I still have no idea what
Hwang was thinking? He is a bright guy, and he must have understood how this would end.
The SEC’s and Justice Department’s story is that he bought a lot of stock to make the stock go up
so he’d have paper profits to plow into buying more of the same stock. Fine, but,
what then? If he was doing this to manipulate the price, what was his overall plan – was there
a point where he was supposed to run away with the money leaving the banks holding the bag?
He was doing this with his own money and appears to have lost it all. We have to wonder what the
end game was? The strategy, as laid out by the SEC and DOJ, inevitably ends in ruin, and it did.
How was he planning to make money? Based on the complaints, Bill Hwang is accused
of trying to manipulate these stocks up as high as they could go, essentially to achieve a high
score, knowing that shortly thereafter he would be entirely wiped out and go to prison for fraud.
He would not be the first person to do something crazy like this I guess, but he would be the first
to do it in this kind of size. It’s a strange idea and it doesn’t make an awful lot of sense.
I don’t have a great alternative for you either though. Maybe “He just liked the stock”
Don’t forget to check out our sponsor The Daily Upside, by clicking on the
link in the video description. It’s a great newsletter that I can firmly recommend.
If you haven’t watched it yet, here is a link to my video on the top ten
Rogue Traders. Hwang didn’t make that list, as the video predated his losses,
but there are a lot of funny stories in there. See you later, bye.