By Gregory Zuckerman and Serena Ng
Of THE WALL STREET JOURNAL
Paolo Pellegrini, a former top executive at hedge-fund Paulson & Co., told investigators at the Securities and Exchange Commission that he had informed ACA Management LLC that his firm was betting against the transaction at the center of a lawsuit the SEC brought against Goldman Sachs Group Inc. (GS), according to a person familiar with the matter.
The testimony, in late 2008, could undermine the government’s case against Goldman, which is accused of misleading ACA, the deal manager, about Paulson’s bearish position on the deal.
Pellegrini and the Paulson team worked with both Goldman Sachs and ACA to structure the deal.
(This story and related background material will be available on The Wall Street Journal Web site, WSJ.com.)
SEC spokesman John Nester said, “Our case is built on a thorough evidentiary record that includes testimony, documents, handwritten notes and emails that will be presented in court at the appropriate time.”
Details of Pellegrini’s testimony were reported earlier by CNBC.
The SEC in its complaint alleges that Goldman “misled ACA into believing” the Paulson firm “shared a long interest with CDO investors.” Goldman has denied wrongdoing and is fighting the charges.
ACA Management, an asset-management company set up under the umbrella of bond insurer ACA Financial Guaranty Corp., earned fees for overseeing investment portfolios of mortgage securities, corporate loans and other credit assets. Goldman engaged the firm when Paulson approached it looking for a way to extend its bearish bet on the housing market, the SEC complaint alleges. The CDO management business at ACA was headed by Laura Schwartz, a former Merrill Lynch investment banker who previously worked in divisions of the bank that originated securities backed by U.S. subprime loans and commercial mortgage debt.
Ms. Schwartz was a main point person in the discussions between ACA and Goldman and was at an early 2007 meeting with representatives of Paulson and Goldman, according to Goldman’s responses to the SEC’s “Wells” notice of possible civil charges, regarding the issue. After that meeting, Ms. Schwartz emailed a Goldman employee to ask for feedback on the meeting and said she wasn’t clear about how Paulson wanted “to participate in the space,” the Goldman papers said.
Ms. Schwartz, when reached on her cellphone, did not stay on the line. She no longer works for ACA. A representative for ACA Financial didn’t comment.
Last fall, when Goldman responded to the SEC’s Wells notice, the securities firm argued that whether ACA perceived Paulson to be the so-called “equity” investor in the CDO–and therefore having a “long” position–was “of no moment.” ACA, Goldman has argued, was supposed to be an independent expert on selecting mortgage assets.
Goldman argued in documents it submitted to the SEC that Ms. Schwartz, who was deeply involved in selecting the assets for the Abacus deal, should have known from previous ACA-managed deals that hedge funds could have both long and short positions in a CDO. Goldman cited an ACA-managed CDO that closed in late 2006 whose equity investor was a hedge fund called Magnetar Capital that also took short positions in the same deal. “Certainly, ACA could have questioned Paulson about its interests if the information was significant to it,” Goldman’s Wells response to the SEC said.
At ACA, Ms. Schwartz’s roles included reviewing and approving securities that would be part of investment pools the firm oversaw. In presentations to investors, she often talked about her extensive experience analyzing residential mortgage-backed securities and ACA’s expertise and ability to select mortgage securities, according to people familiar with the matter.
ACA Management managed CDOs put together by several Wall Street firms including Bear Stearns Co. and UBS AG (UBS), according to records reviewed by The Wall Street Journal. At the end of 2007, ACA Management was overseeing around $19 billion in CDOs, the bulk of them bundles of mortgage-backed or asset-backed securities. Of about 30 CDOs managed by ACA, more than half were issued during 2006 and 2007, according to the company’s financial statements.