Paulson & Co. may be sued by investors who lost more than $1 billion on a mortgage-linked deal that regulators say was sold by Goldman Sachs Group Inc. without disclosing the hedge-fund firm’s role, lawyers said.
Goldman Sachs yesterday was accused of fraud by the U.S. Securities and Exchange Commission for failing to tell clients that Paulson, run by billionaire John Paulson, helped pick the mortgage-backed securities that underpinned the investment, known as a collateralized-debt obligation. Neither Paulson nor his firm was accused of any wrongdoing in the SEC’s complaint.
Paulson & Co. shorted the CDO, a bet its value would fall, meaning the New York-based firm stood to profit by choosing securities it expected to default, the SEC said in its civil complaint. Goldman Sachs told clients the securities included in the deal were selected by ACA Management LLC, an independent third party, according to the SEC.
“If Paulson was intentionally putting dreck into the CDO, and doing so for the purpose of shorting it, then that could constitute fraud,” said Ross Intelisano, a lawyer at Rich & Intelisano LLP in New York who has represented clients in fraud lawsuits against hedge funds. While the case against Goldman is stronger, he said, “if I were repping a Goldman client, I’d likely include Paulson in a suit.”
The SEC said that it didn’t sue Paulson & Co. because it was Goldman Sachs’s job to disclose to investors how the CDO was constructed.
‘Opens the Door’
“It was Goldman that made the representation to investors, Paulson did not,” Robert Khuzami, enforcement director at the SEC, said yesterday in a conference call with reporters.
“There haven’t been many investor lawsuits on these kinds of deals,” said Thomas Adams, a partner at New York-based Paykin Krieg & Adams LLP. “This opens the door to civil claims across a number of transactions,” including the Goldman CDO, he said.
Paulson & Co. wasn’t involved in the marketing of the investment, called Abacus 2007-ACI, and didn’t have authority over selecting the portfolio of residential mortgage-backed securities on which it was based, the firm said yesterday in a statement.
“Paulson did not sponsor or initiate Goldman’s Abacus program, which involved at least 20 transactions other than that described in the SEC’s complaint,” the firm said. Thomas Walek, a spokesman for Paulson, declined to comment beyond the statement.
Paulson & Co. provided input into the underlying securities of the CDO, along with ACA and investor IKB Deutsche Industriebank AG, New York-based Goldman Sachs said yesterday in a statement. Such discussions were “entirely typical of these types of transactions,” and ACA, which also invested in the CDO, chose the portfolio, according to the statement.
The SEC’s accusations are “unfounded in law and fact,” Goldman Sachs said.
Paulson & Co. is the world’s third-biggest hedge fund, with $32 billion in assets, thanks in large part to its bet that subprime mortgages would tumble. The trade earned the firm roughly $3 billion in fees in 2007.
Paulson’s Advantage Plus fund, its largest, jumped 160 percent that year on the back of the subprime wager. The firm’s Credit Opportunities funds, which held the biggest chunk of Paulson’s bet, were up 600 percent.
Paulson, 54, started the New York-based firm in 1994, after stints at Bear Stearns & Co. and Gruss Partners. His initial focus was betting on the shares of merging companies.
One Paulson investor said he isn’t worried about the firm’s involvement with the Goldman Sachs CDO.
“So far there’s no cause for concern for us with regards to Paulson because he hasn’t been indicted or shown to have done anything wrong,” said Jean Keller, chief executive officer of 3A SA, a Geneva-based firm that invests in hedge funds on behalf of clients.