Goldman Claimed ‘Duty’ To Paulson In CDO Case

Apr 20 2010 | 6:54pm ET

Warned last fall that it was likely to face a civil lawsuit over its marketing of a collateralized debt obligation, Goldman Sachs said that it couldn’t tell investors that hedge fund Paulson & Co. was shorting the CDO.

In response to a Wells notice it received in July, Goldman told the Securities and Exchange Commission that “as a broker-dealer acting as an intermediary on behalf of a client, Goldman Sachs had a duty to keep information concerning its client’s trades, positions and trading strategy confidential.” The SEC contends that Goldman had a duty to ACA Management, which took the other side of the bet on the residential mortgage-backed securities contained in the CDO, about Paulson’s plans.

The SEC suit accuses Goldman of hiding Paulson’s role in choosing the securities that would go into the CDO. But Goldman, trying to fend off the lawsuit that came Friday, said that the parties involved were “highly sophisticated institutions” that knew “someone had to take the other side of the portfolio risk.” What’s more, when the deal closed in April 2007, Paulson was “relatively unknown.” It was its success betting against the subprime mortgage market that helped make it one of the largest hedge funds in the world.

Indeed, Goldman introduced ACA and Paulson, its general counsel said today.

“I’m sure we would have put them in contact with each other,” Gregory Palm said during the firm’s first-quarter conference call. According to the SEC, Paulson suggested 123 RMBS be part of the ABACUS-2007-AC1 CDO. ACA accepted only 55 of those securities.

In addition to being a major investor in the CDO, ACA also served as a third-party selecting the securities. That was unusual for a Paulson-Goldman transaction, according to former Paulson portfolio manager Paolo Pellegrini.

Pellegrini, who left Paulson in 2008 to found his own hedge fund, told the SEC that the Abacus deal was the only one that involved a third party choosing securities, CNBC reports. Pellegrini said that the hedge fund was only able to suggest securities for the deal, and that the system was to Paulson’s disadvantage.

Paulson has not been charged with any wrongdoing in the case.

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