By Pam Martens and Russ Martens: May 6, 2021 ~
The House Financial Services Committee will hold its third hearing today at noon on the GameStop and other meme stock trading fiascos of January. It will be the first time that the newly sworn in Chair of the SEC, Gary Gensler, gives testimony to Congress. Thus, the written statement that Gensler provided to the Committee has been eagerly awaited by the denizens (and charlatans) of Wall Street for insight into his plans for reining in market abuses and regulatory dodges.
While Gensler was just as ambiguous on most fronts in his statement for today’s hearing as he was in his testimony at his confirmation hearing, he did provide a strong hint that he may use the SEC’s authority to force the mega banks to accurately report the beneficial owners of stocks held under tricked-up derivative contracts.
The public learned from the implosion of the Archegos Capital Management family office hedge fund in late March that Archegos was the beneficial owner of an estimated $100 billion in stocks, for which it had provided just $10 billion in collateral. The banks had allowed Archegos to keep its identity hidden as the beneficial owner of the stocks because the banks were reporting those stocks as if the banks actually owned them on their publicly-disclosed 13F filings with the SEC.
Gensler wrote this in his statement for today’s hearing:
“Additionally, I wanted to mention briefly the events in late March related to the failure of the family office Archegos Capital Management and the significant losses incurred by several global financial institutions that provided prime brokerage services to Archegos. At the core of that story was Archegos’ use of total return swaps based on underlying stocks, and significant exposure that the prime brokers had to the family office. Under Dodd-Frank, Congress gave the SEC rulemaking authority to extend beneficial ownership reporting requirements to total return swaps and other security-based swaps. Among other things, I’ve asked staff to consider recommendations for the Commission about whether to include total return swaps and other security-based swaps under new disclosure requirements, and if so how.”
Just how important this disclosure issue is to the integrity of U.S. markets and the confidence of companies to continue to list their shares on U.S. exchanges is best explained by what Archegos’ secret derivatives contract did to the shares of New York Stock Exchange listed ViacomCBS – a company in the S&P 500 and owner of one of the largest television networks in the U.S.
According to reporting in the New York Times, one of the stocks held by Archegos was “$20 billion in shares of ViacomCBS,” which were “held through complex financial instruments, called derivatives, created by the banks.”
Assuming that the New York Times report is correct, by the middle of March, according to our own math, Archegos held approximately 208 million shares of ViacomCBS, or a stunning 34 percent of its total outstanding shares. But because the global banks were claiming technical ownership of the shares for reporting purposes, Archegos was able to avoid making SEC filings that would have alerted both public investors and the Board of ViacomCBS that an insanely leveraged hedge fund, operated by a man with a shady regulatory past, Sung Kook (Bill) Hwang, had acquired this huge stake.
As a result of margin calls that Archegos could not meet, shares in ViacomCBS went on a roller-coaster ride in March, crashing from a closing price of $100.34 on March 22 to a closing price of $48.23 just four days later on Friday, March 26. The stock has yet to recover. It closed trading yesterday at $39.10.
This is certainly not the kind of stock market that engenders confidence among some of the largest companies in the world that have chosen to list their shares here and trade in U.S. markets.
The tricked-up secret derivative contracts were not simply dodging disclosure obligations with the SEC, they were also dodging other essential rules that protect market integrity.
The Federal Reserve’s Regulation T, codified in 12 CFR § 220.12, restricts margin lending on stock trades as follows:
“50 percent of the current market value of the security or the percentage set by the regulatory authority where the trade occurs, whichever is greater.”
But by using private, bilateral derivatives contracts, the banks believed (rightly or wrongly) that they could offer as much as 90 percent margin loans on 10 percent collateral.
The Wall Street firms also violated their own internal rules for providing high leverage on concentrated stock positions. ViacomCBS was just one of numerous stocks in which Archegos owned a deeply concentrated position.
And as we previously reported, there is the unanswered question as to whether the derivative contracts were also a tax dodge to avoid paying capital gains taxes. (See Did Archegos, Like Renaissance Hedge Fund, Avoid Billions in U.S. Tax Payments through a Scheme with the Banks?)
There may have been yet another dodge being used by these derivative contracts. Another witness set to testify today is Michael Bodson, President and CEO of a major clearing organization in the U.S., the Depository Trust & Clearing Corporation (DTCC), which is owned by the major trading houses on Wall Street.
In Bodson’s written testimony today, he explains how firms that take on excessive leverage are hit with a “capital premium charge.” Bodson explains it like this:
“This charge was adopted in 2006, following market disruptions caused by the failure of a clearing member of NSCC and other clearinghouses. The capital premium charge is intended to discourage clearing members from taking on more risk in their portfolios at NSCC than their capital levels can reasonably support. Because a clearing member may be obligated to quickly provide funds to NSCC and other clearinghouses, a clearing member that is over-leveraged presents a heightened risk of default.”
But if clearing houses can’t see this excessive leverage because it is hiding out in private derivative contracts between two parties – a federally-insured mega bank and a hedge fund – it can’t assess that capital premium charge, thus weakening market integrity for all players.
Archegos presented just a tiny peek at a giant roach motel. As we reported last Friday, equity derivative contracts held by federally-insured banks have exploded from $737 billion to $4.197 trillion since the crash of 2008 and not one federal regulator has any clue as to what’s in these private bilateral contracts.
While today’s hearing will focus more on the GameStop fiasco than Archegos and its derivative contracts, we are hopeful that when the mega bank CEOs are hauled before the Senate Banking and House Financial Services Committees on May 26 and May 27, respectively, the public will get more answers on these dangerous derivative contracts that threaten not only the integrity of trading in U.S. markets but the safety and soundness of the largest federally-insured banks in the U.S.