PART of the US government’s fraud case against Goldman Sachs appeared to be undermined yesterday when testimony from a former Paulson & Co hedge fund trader was leaked.
Paulo Pellegrini, a key figure at Paulson in 2007, reportedly said the third party firm used by Goldman to put together a doomed mortgage-backed derivative was aware of Paulson’s intention to sell the instrument short.
The claim contradicts a major part of the allegations put forwards by the Securities and Exchange Commission. The SEC accuses Goldman of misleading investors and ACA, which marketed the collateralised debt obligation (CDO), by helping Paulson pick ill-fated subprime mortgage securities for the derivative’s portfolio without disclosing that he was planning to bet against it.
But a document passed to CNBC suggests ACA’s then-manager Laura Schwartz was made aware of Paulson’s role as a short investor in the CDO, which was named “Abacus”. Asked by a government official whether Schwartz was told of Paulson’s intentions, Pellegrini said: “Yes, that was the purpose of the meeting.”
Legal experts described the development as a blow to the securities watchdog, which has effectively staked its reputation on a heavyweight clash with Goldman.
Samuel Winer at Foley & Lardner said: “There’s definitely a risk to the SEC here. Perhaps Paulson’s involvement [as a short seller] was more widely known than we have been led to believe.”
Scott Meyers of Ulmer & Berne said the government’s case would be weaker if Pellegrini’s testimony was proved true, but said the revelation was not a “game-changer”. He pointed out the main thrust of the SEC’s charge – that Goldman deceived the long equity investors who bought the CDO – would remain unchanged.
The SEC told City A.M. its case was based on “thorough evidentiary record” including handwritten notes, understood to show ACA’s commitments committee believed Paulson was an equity investor.
EX-PAULSON & CO MANAGER
PAULO Pellegrini was at the heart of Paulson’s multi-billion dollar bet against the US housing market.
After years of low interest rates, American homes were priced jubilantly in 2006. It was the Italian engineering graduate who first suggested the potential for an almighty crash to Paulson, who had little prior experience in trading property assets.
The Manhattan-based hedge fund launched two funds, Credit Opportunities I and II, to bet against the mortgage market. Through tools like Abacaus they infamously earned $3.5bn (£2.3bn) in 2007’s collapse.
Pellegrini is known as a cerebral man by his friends. A former jazz disc jockey with a penchant for blasting classical music from his desk, he is also said to be a charming negotiator.
According to testimony passed to the press yesterday, Pellegrini was surprised to learn ACA was under the impression Paulson would go long Abacus. The hedge fund wanted a portfolio based on weak securities, he said, so it would “have been a little difficult to sort of miss the fact that we were trying to short this stuff”.
Pellegrini parted ways with Paulson in January last year. Itching to launch his own hedge fund, the 53-year-old struck out and opened PSQR. The macro project was seeded with $100m of his own money.
When City A.M. called his New York office yesterday, Pellegrini would not comment on the SEC’s Goldman case. But neither would his spokesperson deny the reported testimony.