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Key witness bolsters SEC case against Fabrice Tourre

PUBLISHED : Wednesday, 24 July, 2013, 12:04pm
UPDATED : Wednesday, 24 July, 2013, 12:11pm

The US Securities and Exchange Commission called its top witness in the fraud trial of Fabrice Tourre on Tuesday, a day before the former Goldman Sachs trader himself takes the stand.

The testimony of Laura Schwartz, a former managing director at ACA Capital Holdings, bolstered the US Securities and Exchange Commission’s case that Tourre misled investors in a 2007 deal tied to subprime mortgages.

Schwartz stopped short of saying Tourre misled her about the role the hedge fund of billionaire John Paulson planned to play in the deal, known as Abacus 2007-AC1.

But she said she believed Paulson & Co planned to invest in a 2007 mortgage deal rather than entirely betting against it.

“I believed Paulson would be the equity investor in the transaction,” she told the court on Tuesday.

The Tourre case, which began last week in federal court in New York and is expected to last three weeks, is one of the biggest brought by the SEC over the events leading up to the financial crisis of 2008.

The trial follows setbacks in similar cases the SEC has brought against people on Wall Street tied to complex mortgage investment products linked to the 2008 financial crisis.

The SEC accuses Tourre of failing to tell investors that Paulson & Co intended to bet against Abacus. It also claims Tourre misled ACA into thinking Paulson was investing in the deal.

Tourre, who is expected to testify Wednesday afternoon, is on trial alone after Goldman Sachs settled for US$550 million without admitting or denying the allegations soon after the case was filed in 2010.

According to the SEC, Paulson & Co came to Goldman Sachs looking for a way to bet against the subprime mortgage market. They came up with a US$2 billion synthetic collateralized debt obligation tied to mortgage securities the SEC says was designed to fail.

When Goldman brought on a subsidiary of bond insurer ACA to help select the mortgage securities underlying Abacus, Tourre allegedly misled ACA into believing Paulson intended to invest in the transaction.

ACA went on to not only help select the assets for the CDO but also bought US$42 million of securities in Abacus and agreed to insure a US$909 million slice of it via its then-subsidiary ACA Financial Guaranty Corp.

Schwartz, who now works at the broker-dealer Seaport Group, was the main point of contact with Tourre and Paulson & Co, the SEC says.

She said her belief that Paulson had invested in the equity of the CDO was based in part on discussions with people at Goldman and a document Tourre emailed her summing up the investment.

Had she known Paulson was a short investor, Schwartz said, ACA would not have participated in the Abacus deal.

“ACA would not overall want to work with an investor who was purely betting against the portfolio we selected,” she said.

Her testimony mirrored that of former ACA chief executive Alan Roseman, who on Monday told the court that ACA would have stopped the Abacus deal “in its tracks” if Paulson’s real role had been known.

Schwartz’s testimony, meanwhile, contradicted that of a former executive at Paulson & Co, Paolo Pellegrini, who testified that he believed he told Schwartz over drinks in January 2007 at a conference in Jackson Hole, Wyoming, about Paulson’s strategy of betting against the US housing market.

On Tuesday, Schwartz said she recalled the drinks meeting but said Pellegrini never told her Paulson was going to short Abacus.

ACA had never worked on a deal with a purely short investor, she said, adding it “would have been something very different for us.”

Matthew Martens, a lawyer for the SEC, asked Schwartz about a recently closed investigation of Schwartz related to a different CDO, a probe that Tourre’s lawyers have repeatedly said they wanted to ask her about.

Schwartz received a so-called Wells notice in February indicating that SEC was considering recommending a case against her over that transaction.

Then, a week before Tourre’s trial, Schwartz’s lawyers notified the court that the SEC staff had decided against bringing a case against her.

Tourre’s lawyers did not ask Schwartz on Tuesday about the probe but have said they would seek to question her credibility on the basis of the probe being closed so close to the trial.

On cross-examination, Sean Coffey, a lawyer for Tourre, focused much of his questioning on the extent Schwartz knew hedge funds generally were taking short positions against CDOs in 2006 and 2007.

He played audio recordings ACA took of a December 2006 conference call where Schwartz discussed the possibility of Gulf Investment Corp both investing in and shorting a CDO in combination.

Schwartz on the call called the idea of both investing in and shorting a CDO an “excellent strategy.”

She also said the “trade is available for me from lots of people to be honest in the market,” a remark Schwartz testified meant the combo strategy.

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