Camelot v. Morgan Stanley

Underwriter Duties
Camelot Event Driven Fund v. Morgan Stanley Co.
Date: Sept. 15, 2023

Issue: Whether securities underwriters have a duty to conduct due diligence on other underwriters in a security offering to determine whether they have conflicts of interest.

Case Summary: ABA filed an amicus brief urging a New York appellate court to reverse a trial court decision holding Morgan Stanley and Goldman Sachs, in their role as underwriters of the Viacom Offerings, had a duty to publicly disclose that their trading divisions had a separate role as swap counterparties providing a client synthetic exposure to Viacom stock.

Archegos is an investment fund that entered into total return swap agreements with the trading components of several investment banks. Under these agreements banks buy stock and the parties make periodic payments based on the difference between the stock’s market price and a preselected price point. If the market price was above the preselected price point, the bank would pay Archegos the gain. If it fell, Archegos would pay the bank the loss. If the market price fell below a certain threshold, the agreement authorized the bank to issue a margin call, which required Archegos to give the bank cash. If Archegos could not pay, the bank would have the right to liquidate the underlying security holding.

In March 2021, Archegos went into financial distress because the price dropped for many stocks underlying its swap agreement. The banks issued margin calls, and Archegos failed to pay which led the banks to sell their corresponding holdings in Viacom stock. The influx of Viacom stock into the market caused its price to drop, causing losses for participants in the Viacom secondary offering that week. Some of the same banks that underwrote the Viacom offerings also had trading components which entered total swap return agreements with Archegos.

Archegos sued Viacom CBS Inc. and the banks (defendants) alleging the organizations violated the Securities Act of 1933. Archegos alleged the offering documents contained material misstatements or omissions with respect to the collapse of Archegos. The underwriters moved to dismiss. The trial court denied the motion and ruled for Archegos. The trial court identified a conflict of interest based on the banks that had underwriters involved in the Viacom offering and traders involved in the swap agreements with Archegos. The court determined the offering materials should have disclosed that conflict—specifically the banks’ Viacom holdings and the risk that those holdings would be liquidated during the offering given Archegos’ financial condition. Defendants appealed the trial court’s decision.

In its brief, ABA argued the trial court’s order on review misunderstand how financial institutions operate. ABA explained modern financial institutions are full-service firms, and this case involves two kinds of investment-banking services: underwriting and prime brokerage. Underwriting is a service where an investment bank agrees to pre-purchase a set number of securities a firm intends to issue and then resell those securities on the open market. Prime brokerage is a group within a bank that provides a range of services to sophisticated investment clients. ABA emphasized full-service banks—with the diversity of services they offer and the clients they service—are likely to be exposed to a wider range of potential conflicts of interest. ABA contended the trial court’s order disregards this framework and context. In the trial court’s view, the trading underwriters needed to disclose the specific terms of their positions in Viacom securities (via their swap agreements with Archegos) and the possibility that movement in those positions could affect the value of the securities. Still, ABA emphasized the lower court cited no case imposing such a duty and several courts have held in analogous circumstances that no such duty exists.

ABA also argued the trial court’s order on review misunderstands the role of underwriters. ABA contended the lower court erred in assuming an underwriter has a duty to investigate other underwriters. ABA asserted no securities law creates a freestanding duty for underwriters to investigate one another for hypothetical conflicts of interest, and the lower court cited no case recognizing one. Moreover, ABA argued imposing a duty to investigate co-underwriters is irrational. The brief explained large securities offerings are underwritten by a syndicate of underwriters, and responsibility for the offering is not evenly divided among the underwriters, but the lead underwriter oversees the function. ABA emphasized it cannot be the case that underwriters—some of whom do not even conduct due diligence on the issuer – must investigate each other for potential conflicts of interest.

Bottom Line: The court has not scheduled oral argument.

Download the amicus brief to read the full text.