A key participant in the notorious Abacus investment knew that hedge fund Paulson & Co planned to bet against the deal, a former Paulson managing director said on Wednesday, potentially undercutting part of the case against Fabrice Tourre.
Former Goldman Sachs bond trader Tourre has been accused by the US Securities and Exchange Commission of misleading investors in the subprime-mortgage-linked deal called Abacus 2007-AC1.
In testimony Wednesday, Paolo Pellegrini, the former Paulson & Co managing director, said he made clear to ACA Capital Holdings Inc that Paulson wanted to bet against the deal.
“As I told all collateral selection agents, we were interested in shorting a CDO, shorting subprime securities in a CDO,” said Pellegrini, one of the architects of hedge fund manager John Paulson’s bet against subprime mortgages in 2006 and 2007.
A lawyer for the SEC said Pellegrini’s testimony, on the third day of Tourre’s trial, seemed to contradict depositions taken before the trial. The SEC claims Tourre deliberately misled ACA into thinking that Paulson planned to invest in Abacus rather than bet against it.
ACA was hired by Goldman to select the mortgage securities behind Abacus. According to SEC documents in the case, the securities were in reality chosen by Paulson & Co, which selected securities that it expected to fail.
The SEC says Tourre misled investors in Abacus by failing to disclose Paulson’s role in selecting the securities and failing to disclose the hedge fund’s intention to bet against the deal.
Goldman Sachs Group Inc was initially sued when the case was filed in 2010. It later settled for US$550 million without admitting or denying the allegations.
Tourre, who is on trial in federal court in New York on charges of securities fraud, denies the allegations. His lawyers have indicated they will seek to show Paulson’s plan to bet against the subprime market was widely reported and ACA knew that.
Pellegrini’s testimony, if found credible by the jury, could help Tourre’s defence.
Abacus, a so-called synthetic collateralized debt obligation, was part of Paulson’s audacious bet against the US housing market in 2007, a wager that earned his hedge fund US$15 billion.
Pellegrini, one of two people who worked on Paulson’s strategy to take the stand so far, testified Wednesday he believed he told the principal employee at ACA working on Abacus, Laura Schwartz, about Paulson’s strategy over drinks during a “shindig” for people in the CDO industry.
“I think there was some discussion of the portfolio and what we were trying to accomplish by shorting the market,” he said.
Pellegrini later testified, though, that he had no actual knowledge that he or Tourre ever told Schwartz that Paulson planned to short the CDO.
Questioning by the SEC of Pellegrini, who left Paulson & Co in 2008, has been testy since he took the stand Tuesday, when he denied even knowing what “CDO” stands for despite his work in the area.
After Pellegrini several times said he thought he had told ACA that Paulson was shorting CDOs, Matthew Martens, the lead lawyer for the SEC, pulled out a 2008 deposition in which Pellegrini said he didn’t remember.
Pellegrini said he testified that way because he thought the SEC was trying to get him to contradict an earlier answer and “nail me” and “trick me in some way.”
“I was scared,” he said.
During a break when jurors and Pellegrini were out of the room, Martens called that suggestion “garbage.”
He instead suggested a lawsuit by onetime ACA Capital subsidiary ACA Financial Guaranty against Pellegrini’s former employer over Abacus was a factor in what he called a change in testimony.
The three-week trial has been highly technical in nature, with lots of financial jargon, something US District Judge Katherine Forrest expressed concern about during a lunch break Wednesday.
“I’m going to tell you what I think is obvious, which is we’re losing some of the jurors here who are trying valiantly to follow and stay awake,” she said.