The star witness in the Securities and Exchange Commission’s civil fraud case against Fabrice Tourre told jurors that Goldman Sachs Group Inc. misled her into helping construct a doomed investment that the Paulson & Co. hedge fund was betting would fail.
Laura Schwartz, who headed ACA Management LLC’s asset management business in early 2007, testified today that Goldman and Paulson, which is run by billionaire John Paulson, led her to believe that the hedge fund wanted to invest, rather than take a short position, in a mortgage-backed security that lost $1 billion in the crash of the credit markets.
“Our understanding was that Paulson was the equity investor,” Schwartz said in federal court in Manhattan.
That statement, the SEC claims, persuaded ACA to lend its prestige to the deal and to make a disastrous bet that the mortgage-backed securities underlying the investment would perform well. Paulson, which helped ACA pick the securities, was secretly betting they would fail, the SEC says.
Goldman Sachs and Paulson never corrected ACA’s misimpression through e-mails, phone conversations and meetings, including a chance encounter between Schwartz and a top Paulson executive in a Jackson Hole, Wyoming, hotel bar, she said.
Schwartz’s testimony comes just before Tourre, who has sat silent through more than a week of trial, is scheduled to testify in his own defense.
Schwartz testified that a Jan. 8, 2007, meeting at Paulson’s Manhattan offices was part of a “beauty pageant” to select a third-party agent to pick the residential mortgage-backed securities underlying the Goldman Sachs investment, a synthetic collateralized debt obligation called Abacus 2007-AC1.
She believed from discussions with Goldman Sachs that Paulson was acting as sponsor of Abacus and was investing in its equity, she said.
ACA’s former chief executive officer, Alan Roseman, testified yesterday that Paulson’s long position was “critical” to ACA’s participation in Abacus. The SEC claims Tourre and Paulson misled ACA, believing the firm’s presence on the transaction would lend Abacus credibility and attract investors.
Paulson hasn’t been charged with any wrongdoing in connection with the Abacus deal.
An SEC lawyer last week played a recorded Jan. 17, 2007, telephone call in which Gail Kreitman, a Goldman Sachs saleswoman, told Lucas Westreich, who worked with Schwartz, that New York-based Goldman Sachs planned to place “a hundred percent of the equity” in the transaction with Paulson.
Kreitman, who said she worked with Schwartz at Merrill Lynch before moving to Goldman Sachs, testified she can’t remember who told her Paulson intended to invest in the equity stake. She said she got most of her information on the deal from Tourre.
Schwartz said Goldman Sachs sent her a draft term sheet for the deal, which said that the equity tranche was “pre-committed” to Paulson. The SEC claims that Paulson, which made $15 billion making massive short bets against the residential mortgage market in 2006 and 2007, never considered investing in the equity, or “first-loss” tranche.
Schwartz also said that Tourre failed to correct an e-mail she sent referring to “Paulson’s equity perspective” on the deal.
And she testified about running into Paolo Pellegrini, the Paulson executive, in Jackson Hole, where she was attending a dinner for managers of collateralized debt obligations. Over drinks in a hotel bar they discussed the Abacus transaction, Schwartz said.
Pellegrini didn’t disclose that the hedge fund was shorting the portfolio that it was helping ACA assemble, she said.
Pellegrini, who testified earlier in the trial, said he believed ACA knew that Paulson was taking a short position on Abacus.
On cross-examination by Tourre’s lawyer, John “Sean” Coffey, Schwartz told jurors that ACA wouldn’t have changed its standards for selecting a portfolio of mortgage-backed securities whether it was getting input from a long or a short investor. She also said she had worked on deals in which investors took both long and short positions on portfolios.
Tourre’s lawyers are trying to show that Paulson’s participation didn’t increase the risk that Abacus would fail and that it didn’t make a difference to ACA.
The case is SEC v. Tourre, 10-cv-03229, U.S. District Court, Southern District of New York (Manhattan).