AllianzGI's unprecedented fall ends with U.S. ban

A little more than two years after its Structured Alpha strategies suffered catastrophic losses, Allianz Global Investors finds itself completely shut out of the U.S. after a Securities and Exchange Commission investigation discovered what the agency called a "massive fraudulent scheme" perpetuated by the strategy's three portfolio managers.

It represents a nearly unprecedented fall for the Allianz SE money management subsidiary, which announced May 17 it had pleaded guilty to SEC charges, agreed to pay a total of more than $6 billion as a result of the charges, and agreed to sell most of its U.S. business to Voya Financial after that plea activated an automatic 10-year disqualification from providing investment advisory services for U.S.-registered funds. Voya will acquire about $120 billion in assets under management in exchange for an up to 24% stake in Voya Investment Management.

The settlement includes more than $1 billion to settle the SEC charges and over $5 billion in restitution to investors who lost a total of $7 billion due to the collapse of Structured Alpha.

The magnitude of that restitution is unprecedented, said Arthur G. Jakoby, New York-based partner and co-chairman, securities litigation and enforcement at law firm Herrick Feinstein LLP and a former SEC prosecutor, in a phone interview.

"That's a 71.4% recovery," Mr. Jakoby said. "That's huge. Recoveries are usually investors get 50 cents on the dollar back. Here, the SEC achieved an incredible result."

According to the SEC, a total of about $11 billion had been invested in the Structured Alpha strategies.

Daniel Celeghin, New York-based managing partner at manager strategy consultant Indefi, said in a phone interview that when it comes to penalties in the asset management business, "the only precedent that I think of off the top of my head is Bernie Madoff. I'm not equating the two frauds. The scale of Allianz is much smaller ... it literally seems to have been limited to a few bad actors."

The leader of those bad actors, according to the SEC's complaint filed May 17 in U.S. District Court in New York, was Gregoire P. Tournant, AllianzGI's lead portfolio manager for its Structured Alpha strategies. Following the announcement of the SEC's charges, Mr. Tournant surrendered to authorities from his home in Colorado and now faces a federal trial.

His two top portfolio managers, Stephen G. Bond-Nelson and Trevor L. Taylor, pleaded guilty and cooperated with authorities' investigation into the massive losses the Structured Alpha strategies suffered in February and March of 2020 when the emergence of the COVID-19 pandemic roiled the markets.

The Allianz Structured Alpha strategies historically had been designed to be both long and short volatility and to identify "areas of systematic disagreement with option prices about the probability distribution of future index moves," according to a September 2016 AllianzGI presentation.

Its investment process consisted of taking range-bound spread positions, to sell options that were most likely to expire worthless (short volatility); hedged positions designed to protect against market crashes (long volatility); and directional spread positions designed to generate returns when equity indexes rise or fall more than usual during multiweek periods (long/short volatility).

Among the investors in the Structured Alpha strategies were Blue Cross Blue Shield's national employee benefits committee, which oversees the National Retirement Trust of the Blue Cross and Blue Shield Association, Chicago. That trust had $2.9 billion invested in three Structured Alpha strategies as of Jan. 31, 2020, according to a Form 5500 filing, and the combined losses in those strategies exceeded $2 billion.

Other investors included the Teamster Members Retirement Plan, New York, which lost nearly $1 billion; $21.2 billion Arkansas Teacher Retirement System, Little Rock, which lost $924 million; and one of Waltham, Mass.-based Raytheon Technologies Corp.'s pension funds, which lost $280 million.

As of Dec. 31, 2020, the BCBS and Teamsters plans had $2.4 billion and $852 million in assets, respectively, according to their most recent Form 5500 filings, and Raytheon Technologies had $55 billion in defined benefit plan assets as of Sept. 30, according to Pensions & Investments data.

Those pension funds, which were among a dozen others, all filed lawsuits in 2020 and settled for undisclosed amounts earlier this year.

In those lawsuits, the funds said the manager had purchased hedging puts "further out of the money" than the manager had represented in order to save on costs and failed to conduct adequate stress tests.

According to the SEC's complaint, however, Mr. Tournant did conduct adequate stress tests. He just lied about them.

From at least January 2016 through March 2020, according to the SEC complaint, Mr. Tournant had consistently misled investors about the strategy's downside risk.

For example, the complaint cites AllianzGI marketing materials claiming that hedging positions included put options that were "laddered for various market outcomes to the downside" with "strike distances from -10% to -25%."

The materials said the hedging positions' primary objective was to protect the strategy from a "short-term equity market crash," which was defined as a decline of 10% to 15% in less than five days.

However, the complaint said the portfolio management team, at Mr. Tournant's discretion, generally purchased cheaper put options with significantly lower strike prices, averaging from -30% to -50%, beginning in February 2018. That same month, according to the complaint, Mr. Tournant and his team began altering risk reports by manually reducing losses in stress-test scenarios.

One such alteration the complaint cites is Mr. Tournant changing actual maximum losses in a stress-test scenario to no more than between 34% and 38% in a scenario that included a 10% negative return in equities and between a 100% and 200% change in the Cboe Volatility index.

However, in March 2020, the largest five-day percentage change in the Cboe Volatility index was 151.7%, greater than the largest five-day change of the VIX of 55% during the global financial crisis in the 2008-2009 period, and it resulted in losses of as much as 90% in the most aggressive Structured Alpha strategies.

Those strategies were the Allianz Structured Alpha 1000 and Allianz Structured Alpha 1000 Plus strategies, which AllianzGI quickly liquidated following the enormous losses. Numerical designations of the Structured Alpha strategies refer to the additional alpha in basis points above an equity index the portfolio is expected to return.

What followed was what the SEC terms as "multiple efforts to conceal their misconduct," which included Mr. Tournant urging Mr. Bond-Nelson to give false testimony, and Mr. Tournant meeting with Mr. Taylor at a vacant construction site to discuss their false risk reports and how to respond to government investigators' questions.

The misconduct and the cover-up for that misconduct not only resulted in SEC charges, but the U.S. attorney's office for the Southern District of New York also announced criminal charges for similar conduct against AllianzGI and Messrs. Tournant, Taylor and Bond-Nelson. As part of the parallel criminal proceeding, AllianzGI and Messrs. Taylor and Bond-Nelson have agreed to guilty pleas.

Daniel R. Alonso, partner at Buckley LLP, and Seth L. Levine, co-founder of Levine Lee LLP, co-counsels for Mr. Tournant, said in a joint statement that Mr. Tournant "has been unfairly targeted despite the fact that he was on extended medical leave during these market events, and the funds had thrived under his leadership for the previous 14 years. The losses resulting from these market events were suffered by sophisticated institutional investors — including Greg himself who had a considerable investment in the fund. While the losses are regrettable, they are not the result of any crime."

An Allianz spokesman referred questions to a statement from the company that said the criminal misconduct "was limited to a handful of individuals in the Structured Products Group of AGI U.S. who are no longer employed by the company, and that the DOJ's investigation did not otherwise find any knowledge of, or participation in, the misconduct at Allianz SE or any other entity of the Allianz Group."

Herrick Feinstein's Mr. Jakoby, who once represented victims of Bernard L. Madoff Investment Securities and was formerly a special trial counsel in the SEC's division of enforcement, said that in his opinion the SEC and the U.S. attorney's office pursued Mr. Tournant with fury, primarily because of his cover-up.

"He lied and obstructed the government's investigation," Mr. Jakoby said. "Very often, the cover-up is often much worse than the crime itself. You know, cover-ups, investigation obstructions, manipulation of data, falsification of evidence, it's the kind of stuff that invigorates prosecutors."

For Allianz SE, the developments of May 17 brought an end to more than two years of legal headaches that have engulfed the German insurer, but the repercussions could only be beginning for the rest of the financial services industry.

Indefi's Mr. Celeghin cited an unnamed European insurer client that is mulling over expanding into the U.S., calling him and telling him the Allianz news that had just broken has "basically terrified our board."

European firms benefit in their home countries from a friendly regulatory environment that stems from a "national champion mindset," Mr. Celeghin said. "I (Allianz) would like to have a friendlier relationship with the German regulators because there's a mutual co-dependence. If I'm the German regulator, I obviously want to keep the biggest German insurer on the straight and narrow, but I don't want to go overboard (with strict regulation)."

The U.S. regulatory environment, on the other hand, can be challenging, and while that has not been a roadblock for European parents of U.S. money management businesses, the Allianz news might cause those companies to reconsider the nature of the oversight they have over those businesses.

"If I'm in Europe and I have a U.S. subsidiary, for me sitting in Europe, I have to give that U.S. business a lot of autonomy," Mr. Celeghin said, "and yet there is some balance when it comes to risk management — legal and compliance — that has been very hard to strike. Where do you draw the line? Where do you want to have a much tighter leash, if you will, but not stifle that foreign business?"

Mr. Jakoby said a major takeaway from the AllianzGI penalty is that "large Wall Street financial institutions which fail to supervise their employees are targets of the SEC and the U.S. attorney's office."

"What often happens when the SEC goes after an employee of the financial institutions," Mr. Jakoby said, "the financial institution very quickly starts to cooperate, throw the employee under the bus, the employee is forced to plead guilty and is enjoined by the SEC from further violating the law."

This time, however, the SEC investigation resulted in the corporate entity being forced to plead guilty to the charges.

"I think this is a loud and clear message to financial institutions that the days of prosecuting the employees of financial institutions and letting the financial institution itself get off with a fine or a mere slap on the wrist is over," Mr. Jakoby said.

Bloomberg News contributed to this story.