Paulson and Co. Inc. Is Not A Subject of SEC Probe

The Internet has been absolutely buzzing since news of the SEC's civil lawsuit against Goldman Sachs and Fabrice Tourre surfaced yesterday.

There has been plenty of incorrect information circulating about the SEC's action against Goldman Sachs over the past 24 hours.

One of the biggest pieces of misinformation is that John Paulson (and his firm, Paulson & Co. Inc.) is also being targeted by the Securities and Exchange Commission. This is not true.

The two defendants are:

1. Goldman Sachs & Co.
2. Fabrice Tourre (employee of Goldman Sachs)

While John Paulson is certainly a central figure in the 22-page SEC complaint, he is not actually accused of doing anything wrong.

What the SEC is alleging is that Paulson & Co. Inc. cherry-picked the residential mortgage-backed securities (RMBS) for the ABACUS 2007-AC1 CDO that were most likely to have "credit events", because he was actually betting AGAINST the CDO through the use of credit default swaps.

Paulson, who ended up banking billions of dollars in profits when the subprime mortgage market fell apart, did nothing wrong in helping to select the securities that would form the basis of this particular CDO.

The SEC is alleging that Goldman Sachs and Fabrice Tourre:

1. Misrepresented to investors in the CDO that ACA Management LLC had independently selected the RMBS underlying the CDO (in fact, John Paulson played a very big role in this process, according to the SEC, and investors in the CDO would have likely passed on putting money in if they had known that Paulson was intending to short)

2. Let ACA Management LLC believe that John Paulson was going to be an equity investor in the CDO, which was obviously not the case

The gist of the SEC's complaint is that investors in ABACUS 2007-AC1 wouldn't have put their money in if they had known John Paulson's true bias or role in formulating the CDO. The SEC also alleges that Goldman and Tourre (who was instrumental in setting these deals up) had ample opportunity to clear up any misconceptions over Paulson's role or equity position in the CDO, but didn't take it.

When the marketing materials for the CDO were presented to perspective investors, Paulson's role in the portfolio selection process wasn't mentioned at all (allegedly). This, according to the SEC, is what led them to filing the complaint against Goldman and Fabrice Tourre.

John Paulson, for his part, did nothing illegal. He wanted to bet against the subprime mortgage market and DID bet against the subprime mortgage market. The fact that Paulson helped in setting up this CDO does not mean that he did anything wrong. If Goldman did, in fact, misrepresent John Paulson's involvement and true bias in the CDO to investors, then that's their problem, not his.

John Paulson and his many billions are safe.

Filed under: Hedge Fund News