Two mortgage-linked investments tied to hedge-fund firm Magnetar Capital LLC had better disclosures about conflicts of interest than a Goldman Sachs Group Inc. transaction, Securities and Exchange Commission staff told the bank’s lawyers in a meeting.
The SEC sued Goldman Sachs for fraud on April 16, saying it improperly failed to disclose that Paulson & Co., a hedge-fund firm betting that subprime-mortgage defaults would climb, helped choose securities for a so-called synthetic collateralized debt obligation with a plan to wager it would collapse.
The agency told Goldman Sachs at the Sept. 15 meeting that other deals providing better disclosure than the firm’s Abacus 2007-AC1 included two CDOs, Auriga and Norma, that were created for Magnetar, according to a statement to the SEC staff from the bank’s lawyers. The Evanston, Illinois-based firm profited in 2007 as defaults on subprime-housing debt soared.
“At our meeting, the staff suggested that at least some market participants disclosed the involvement in the portfolio selection process of third parties that took short positions with respect to the CDO’s portfolio and referenced as examples the Auriga, Norma and Sorrento transactions,” Goldman Sachs attorneys wrote in the Sept. 25, 2009, statement obtained by Bloomberg News.
John Nester, an SEC spokesman in Washington, declined to comment on the submission, which didn’t discuss any other Magnetar deals or say whether the regulatory agency found the information provided on the CDOs, underwritten by Bank of America Corp.’s Merrill Lynch unit, to be sufficient.
Goldman Sachs didn’t agree with the SEC’s assessment of the disclosures, which it said may not have mentioned Magnetar by name, according to the statement from the firm’s attorneys at New York-based Sullivan & Cromwell LLP.
“We have indentified no evidence of any such general market practice,” the lawyers wrote.
Magnetar, which manages $7 billion in assets, told investors yesterday it didn’t help banks create CDOs that were “built to fail” on a bet that homeowners with bad credit would default on their loans. The firm offered limited input on the creation of CDOs, and made bets that would pay off if they soured as part of a “market neutral” portfolio designed to profit no matter what happened, Magnetar said in a letter to clients.
“There was no embedded view regarding the direction of housing prices, the rate of mortgage defaults or the subprime mortgage market generally,” the company said.
Groups of Stars
Citigroup Inc. and UBS AG are among at least nine banks that underwrote more than 20 CDOs whose riskiest slices were bought by Magnetar, according to data compiled by Bloomberg. Those CDOs, named for constellations including Aquarius and Carina, totaled at least $32 billion.
Claims made last year by Utrecht, Netherlands-based Rabobank Nederland in a lawsuit against Merrill Lynch over the Norma CDO, involving actions similar to those in the Goldman Sachs case, are “unfounded,” Bill Halldin, a Merrill Lynch spokesman, said today in a telephone interview. The suit is filed in New York State Supreme Court.
‘Built to Fail’
Magnetar’s 11-page letter came in response to an April 9 article on the Web site of ProPublica, an independent, nonprofit investigative journalism project based in New York. The article suggested Magnetar’s CDOs were “built to fail,” according to the letter.
“The facts in our story should allow readers to reach their own conclusions,” ProPublica said in a statement to Bloomberg News. “We see nothing in the story to correct.”
Paulson, who wasn’t accused by the SEC of any wrongdoing, said in a statement that ACA Management LLC chose the assets for Abacus 2007-AC1, as Goldman Sachs disclosed to investors. Paulson suggested some individual holdings, according to the SEC’s complaint. Goldman Sachs has said the SEC’s allegations are unfounded.
Magnetar said in its letter that it didn’t select specific securities to be included in its CDOs. Collateral managers for the firm’s CDOs included State Street Corp., Marsh & McLennan Cos.’s Putnam Investment Management LLC, GSC Partners and Harding Advisory LLC, Bloomberg data show.
In its September statement to the SEC, Goldman Sachs said it wasn’t sure which Auriga and Norma disclosures the agency was referring to, adding that none that it found said anyone other than the managers of the CDOs played a role in selecting their collateral.
The SEC “may have had in mind” disclosures made in offering documents for the deals that said buyers of the junior- most slices “may enter” into bets against the holdings of the CDOs or a “short” position that “hedges certain of the risks to which” the security is exposed, the bank said. As a result, the interests of that buyer “may not be consistent with those of” other investors, according to language quoted in the statement.
Magnetar bought the riskiest pieces of a series of CDOs, known as the equity, which it expected to return 20 percent annually over six to eight years if mortgage defaults remained low, according to the letter. It also hedged those positions with bets against its CDOs and others at a cost of less than 6 percent annually, the firm said.
‘Expression of Confidence’
The purchase of a CDO’s equity class is usually taken as “an expression of confidence in the structure,” said Thomas Adams, a partner at New York-based law firm Paykin Krieg & Adams LLP who worked in the CDO groups for two bond insurers. “It would definitively have been relevant” to other investors that Magnetar wasn’t simply making a bullish bet, Adams said in a telephone interview.
While Magnetar said its portfolio was designed to make money no matter what happened to the value of subprime mortgages, its executives have expressed negative views on the market.
“Magnetar has been concerned about the excesses in the subprime-housing market since early 2006,” David Snyderman, Magnetar’s head of global fixed income, said in an interview with Bloomberg News in March 2007. “As a result, we have positioned our structured-credit portfolio such that we are profiting from the recent volatility.”
Magnetar was started in late 2005 by Alec Litowitz, who previously worked at Ken Griffin’s Citadel Investment Group LLC. He specialized in trading the stocks of merging companies. Snyderman also worked at Citadel before joining Magnetar.