Tan v. Goldman Sachs Group Inc.

Background

The opinion addresses several coordinated investor actions involving Goldman Sachs Group Inc. and Morgan Stanley. Each plaintiff represents a proposed class of investors in Vipshop, Gaotu, Tencent Music, ViacomCBS, iQIYI, Baidu, or Discovery. The claims concern Archegos Capital Management and Archegos Fund (collectively, “Archegos”), which allegedly built large, undisclosed economic positions in those issuers through total return swaps.

A total return swap is a financing arrangement in which a broker funds the purchase of an asset while the client receives economic exposure to the asset. The complaint alleged that the defendants and other prime brokers hedged their exposure by buying shares in the issuers. Archegos’s positions and trading allegedly inflated the issuers’ stock prices. After stock-price declines left Archegos unable to meet margin calls, the defendants terminated their agreements, issued default notices, and sold stock connected to the swaps and hedges.

The plaintiffs alleged that Goldman Sachs and Morgan Stanley possessed material nonpublic information about Archegos’s impending collapse and traded before that information became public. They asserted claims under Section 10(b) of the Securities Exchange Act and Rule 10b-5, Section 20A, and Section 20(a).

Rule 12(b)(6) standard

The defendants moved to dismiss for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6). At this stage, the court accepts well-pleaded factual allegations as true and draws reasonable inferences for the plaintiffs, but securities-fraud claims must satisfy heightened pleading requirements. The plaintiffs had to plead the alleged fraud with particularity and allege facts creating a strong inference that the defendants acted with the required intent, known as scienter.

Misappropriation theory

The plaintiffs first alleged that the defendants misappropriated material nonpublic information that Archegos provided during discussions about its financial problems. Under this theory, a trader violates Section 10(b) and Rule 10b-5 by using confidential information in breach of a duty owed to the information’s source. Trading on material nonpublic information alone is not enough; the complaint must plausibly allege a duty and a deceptive or manipulative breach of that duty.

The court did not decide whether Goldman Sachs and Morgan Stanley owed Archegos a duty of confidentiality. Instead, it held that the complaint did not adequately allege deception. The complaint stated that Goldman Sachs executed a block trade at Archegos’s request, that Morgan Stanley had Archegos’s consent to shop stock, and that both defendants gave default notices before unwinding the swap positions. According to the court, these allegations showed that Archegos knew about, and sometimes participated in, the relevant trading. The plaintiffs therefore did not plausibly allege that the defendants deceived Archegos when they traded.

The court also concluded that the defendants had a contractual right to trade away securities held as collateral after Archegos defaulted. The plaintiffs’ theory therefore depended on trades involving the defendants’ hedges rather than collateral. But the complaint did not identify a specific hedge trade that was undisclosed to Archegos. The court distinguished a prior case involving a different swap arrangement, where the defendant had acted both as a disposal agent and as a hedging bank while a loan restructuring was being negotiated.

Tipper and tippee theory

The plaintiffs also characterized Archegos as a person who improperly disclosed confidential information and the defendants as recipients who traded on it. A tipper-and-tippee claim generally requires allegations that the tipper breached a fiduciary duty by disclosing confidential information for a personal benefit, that the recipient knew of that breach, and that the recipient used the information to trade.

The court found the allegations deficient because the plaintiffs did not allege that Archegos shared the information to obtain a personal benefit or expected the defendants to trade on it. Instead, the complaint alleged that Archegos expected the defendants to keep the information confidential and refrain from trading while pursuing a managed liquidation. The court dismissed this theory without prejudice and with leave to amend because the dismissal rested on pleading deficiencies.

Sections 20A and 20(a)

Section 20A requires an underlying insider-trading violation and contemporaneous trading by the plaintiff. Because the plaintiffs failed to state a primary insider-trading claim, the Section 20A claims also failed. The court separately held that the lead plaintiffs in the related Felix and Scully cases had not alleged contemporaneous trading because they purchased shares on March 24, while the complaint alleged that the defendants began trading on material nonpublic information on March 25.

Section 20(a) imposes controlling-person liability when a controlled person committed a primary violation and the defendant controlled that person and the relevant transaction. The court found that the complaint did not identify a specific employee of either defendant who traded on material nonpublic information or meaningfully connect the named employees to the alleged conduct. The court dismissed the Section 20(a) claims without prejudice because the dismissal was based on pleading deficiencies.

Disposition

The court granted the defendants’ motion to dismiss. It dismissed the claims without prejudice and allowed the plaintiffs 30 days to file Second Amended Complaints consistent with the order. The order also directed the clerk to close the motion in the main case and the motions in the related coordinated cases.