The mortgage-securities deal that led to fraud charges against Goldman Sachs was a one-time transaction, and John Paulson's hedge fund actually had a limited role in selecting the securities for the failed $1 billion deal, a former top lieutenant of Paulson claims.
According to sources who have read Paolo Pellegrini's deposition in the Goldman fraud case and spoken with him, the former Paulson hedge fund manager told government attorneys that the mortgage securities deal—called Abacus—was the only one Paulson arranged with Goldman Sachs that had a third party selecting the securities.
The revelation raises questions about how widespread the alleged fraud is on Wall Street. While reports suggest the government is looking into other such deals, Pellegrini’s testimony suggests this particular transaction was limited.
The SEC filed a civil suit against Goldman on Friday, accusing the Wall Street investment bank of misleading investors by not disclosing that Paulson's hedge fund picked securities for the deal and then shorted—or bet against—them. Goldman denied the allegations (click here to read Goldman's response.) Paulson and Pelligrini have not been accused of any wrongdoing.
In fact, according to Pellegrini, Paulson was only able to suggest what securities would go into Abacus. Instead, ACA Capital Management—a unit of financial insurer ACA Financial Guaranty—was the primary agent in deciding what securities were included in the deal, as Goldman claims.
ACA rejected many of the securities that Paulson's hedge fund wanted to include in the deal, Pellegrini told investigators. A source close to Pellegrini said he contends that the deal was actually stacked against Paulson—not rigged for the hedge fund's benefit—because of ACA's ability to throw out any securities it didn't like.
For example, Paulson initially proposed 123 mortgage-backed securities to be part of the deal, of which ACA accepted only 55. The process was repeated several times until a minimum deal size was achieved that was acceptable to ratings agencies.
The SEC complaint, however, contends that ACA thought Paulson was actually investing in Abacus—not shorting it. But in its response to the SEC, Goldman said it "never represented to ACA that Paulson was to be a long investor."
Goldman said ACA not only selected the securities but was the largest investor in the transaction, with $951 million of the $1 billion deal.
In addition, Goldman itself lost more than $90 million from the transaction. "We certainly did not wish to structure an investment that was designed to lose money," Goldman said.
Paulson did other mortgage-securities deals with Goldman, but only one collateralized debt obligation that claimed to have neutral third party picking the securities.
Pellegrini told investigators that Paulson approached other banks about doing similiar deals, But ACA was the only manager who agreed to do such a deal.
Pellegrini was one of a number of sources in the SEC complaint.