Paulson's investors are concerned

by Gregory Zuckerman and Jenny Strasburg

John Paulson hasn't been accused of any wrongdoing. But the hedge-fund billionaire has gone on the offensive to reassure investors that his huge firm will emerge unscathed from a case that has drawn him into a political and legal vortex.

The steps, including a conference call with about 100 investors late Monday, come amid indications from some clients that they might withdraw money from his firm after a lawsuit brought by the government against Goldman Sachs Group Inc. related to an investment created at his firm's request.

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Investors have indicated they are concerned that scrutiny over the firm's deals may spread, including to overseas regulators. They said they wanted to protect themselves in case new information emerges that could damage the hedge fund, they say. Another issue, they say: The legal case could simply prove a distraction for Mr. Paulson.

"Some of the callers asked pointed questions, almost like a court inquisition, but most people were supportive," said Brad Alford, who runs Alpha Capital Management. "I felt reassured that he did nothing wrong."

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"It's not a rush for the doors," said another investor in Paulson & Co. who has communicated with larger Paulson investors since Friday, when the government unveiled its Goldman case.

Mr. Paulson sent a letter to investors Tuesday night saying that in 2007 his firm wasn't seen as an experienced mortgage investor, and that "many of the most sophisticated investors in the world" were "more than willing to bet against us."

Mr. Paulson's firm focuses on largely liquid investments, or those that are relatively easy to sell without pushing prices much lower. Even if a number of investors ask out, the firm likely will be able to sell investments without crippling their holdings, investors say.

Some traders have been examining Mr. Paulson's top holdings and positions in which filings indicate he has been a substantial holder since the news, they say. When the news of the lawsuit broke on Friday, some of these stocks, including Conseco Inc., Cheniere Energy Inc. and AngloGold Ashanti Ltd., fell sharply.

The case has delayed the planned initial public offering of a Canadian investment fund, Propel Multi-Strategy Fund, which was formed to give individual investors exposure to two funds advised by Paulson, according to people familiar with the offering. Propel didn't respond to requests for comment.

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• Recap: Goldman's Conference Call

On the Monday night conference call, some investors asked if Mr. Paulson or anyone at the firm had received a government notice of potential civil charges, called a Wells notice, according to people familiar with the call.

Mr. Paulson said no. Mr. Paulson said the case wasn't a distraction that was affecting the firm's investments, and that he was confident the public glare would abate.

On the conference call, Mr. Paulson calmly explained the trade with Goldman, which involved a "short" bet on mortgage bonds. He said that the very nature of the transaction required both a "long" and "short" investor, suggesting that investors knew that a bearish investor had bet against the deal.

Mr. Paulson suggested to clients that the large investors who purchased the Goldman deal and others relied on rating firms, and didn't do enough of their homework, investors say.

The hedge-fund firm has a deadline next Friday for investors who want to withdraw money on June 30. Paulson allows most investors to pull out four times a year, but they need to give at least 60 days notice. Investors can cancel redemptions before the end of June.

Magnetar Capital LLC, another hedge-fund firm that, like Paulson, was heavily invested in collateralized debt obligations in 2007 also has been working to reassure investors that it believes its mortgage-linked investment strategy was sound and can withstand regulatory scrutiny.

Investors in Magnetar, which oversees some $7 billion in assets, also have a deadline next week to request June withdrawals of money. The Evanston, Ill.-based firm sent an 11-page letter to investors Monday saying that it didn't control which individual assets went into CDO deals in which it invested.

It isn't clear whether ongoing scrutiny of Magnetar will rattle its investors, who have known some details of the firm's strategy for several years. An article earlier this month in news outlet ProPublica was the latest to assert that Magnetar designed deals built to fail that caused cascading losses for investors on the other side of the trades. The hedge fund's strategy was also the subject of a January 2008 Wall Street Journal article. Magnetar told investors this week that it based its mortgage-CDO strategy on statistical models, not a fundamental belief that the housing market would slide.

A Magnetar spokesman said, "Our communications with investors have been very positive and supportive."

(from WSJ, April 21, 2010)

Mangling Magnetar

by Paul Murphy

The FT’s John Gapper has copy of the letter dispatched to Magnetar clients in the wake of the ProPublica investigation. In short, the hedge fund (as Gapper put it) has came out fighting against the accusations levelled against it. More…

The FT’s John Gapper has copy of the letter dispatched to Magnetar clients in the wake of the ProPublica investigation. In short, the hedge fund (as Gapper put it) has came out fighting against the accusations levelled against it.

The letter contains this chart:

On the subject of which, Magnetar states (emphasis ours):

From the inception of the strategy through to its conclusion, Magnetar believed that its overall portfolio, including macro hedges, would be profitable independent of the direction of the housing and subprime mortgage markets. We clearly explained this fact, and the reasoning behind it, to ProPublica. The graph (above) represents the average portfolio payoff profile over time, and clearly demonstrates that the payoff profile in respect of CDOs in which Magnetar invested was long-biased. Of particular note is the lower, darker line which represents the payoff profile of our long investments in these CDOs plus only those hedges referencing tranches in these same CDOs (that is, excluding the performance of hedges we purchased that related to transactions in which we had no long interest).

Got that?

Thought not.

(from FT, Apr 20 2010)

[Abacus] The experience of Laura Schwartz

by Tracy Alloway

Laura Schwartz is a name that appears in Goldman Sachs’ defence documents — the bank’s counter-arguments against the SEC’s allegations of civil fraud in its Abacus CDO — and the pitch-book for the deal. More…

Laura Schwartz is a name that appears in Goldman Sachs’ defence documents — the bank’s counter-arguments against the SEC’s allegations of civil fraud in its Abacus CDO — and the pitch-book for the deal.

From 2004 to 2007 she was head of ACA Capital’s CDO Asset Management business, earning a salary of $275,000 in 2006, according to Bloomberg data. ACA was at the time a monoline insurer and CDO manager — running some 26 deals, worth $17.5bn, by May 2007.

In early 2007 Schwartz began working with Goldman Sachs on the Abacus 2007-AC1 deal, a $2bn synthetic CDO, referencing subprime mortgages. ACA’s role was to act as selection agent for the portfolio of securities the CDO would reference, but it was also an investor in the deal.

Part of the SEC complaint against Goldman alleges that one of the bank’s employees — Fabrice Tourre — misled investors into believing that hedge fund Paulson & Co was buying Abacus’ equity.

The equity tranche is the riskiest portion of a CDO, so being an investor in the tranche might suggest one had some confidence in the deal’s performance. The idea is that by believing that Paulson was going long Abacus, the CDO would be more marketable to the investors; ACA and German bank IKB.

The following is gleaned from Part I of Goldman’s defence documents:

* Laura Schwartz of ACA’s January 8, 2007 e-mail to Gail Kreitman in which she wrote “I have no idea how [the Paulson meeting] went – I wouldn’t say it went poorly, not at all, but I think it didn’t help that we didn’t know exactly how they want to participate in the space. Can you give us some feedback?” (GS MBS-E-003499710);

* Fabrice Tourre’s January 10, 2007 e-mail to Ms. Schwartz containing the “Transaction Summary” in which he stated that the transaction was “sponsored by Paulson” and included the line: “[0] – [9]%: pre-committed first loss,” (GS MBS E-003504901) which the Staff stated described the equity tranche; and

* Ms. Kreitman’s e-mail exchanges with Ms. Schwartz on January 14 and 28, 2007 in which Ms. Kreitman did not correct Ms. Schwartz’s apparent misunderstanding that Paulson was an equity investor (GS MBS-E-007980762; GS MBS-E-007992234).8

Goldman’s defence centres around a few things. For a start, the banks says that, under confidentiality requirements, it could not have disclosed Paulson’s role in the deal even if it wanted to. Furthermore, the bank never intended for ACA to infer that Paulson was investing in the equity tranche.

When it comes to those e-mails, the bank says that it doesn’t know what Tourre meant by “[0] – [9]%: pre-committed first loss,” and “sponsor” doesn’t necessarily mean equity investor. Meanwhile, Kreitman’s communiques were largely irrelevant, Goldman says, as she was simply the bank’s relationship manager for ACA, and did not participate directly in the creation of Abacus.

One of the over-arching themes of Goldman’s defence, however, is that it was not actually materially important for ACA to know that Paulson was or was not the equity investor. Thus it was under no obligation to disclose the position.

And here’s where things get really interesting.

From the defence document:

Similarly, the fact that ACA may have perceived Paulson to be an equity investor is of no moment. As a threshold matter, the interests of an equity investor would not necessarily be aligned with those of ACA or other noteholders, and holders of equity may also hold other long or short positions that offset or exceed their equity exposure. Indeed, Laura Schwartz of ACA understood this from her work on a transaction that closed in December 2006 in which Magnetar, a hedge fund that bought equity and took short positions in mezzanine-level debt, participated. (See GS MBS-E-007992234 (“Magnetar-like equity investor”).) Certainly, ACA could have questioned Paulson about its interests if it that information were significant to it.

Chicago-based hedge fund Magnetar is another name that has been hurled into prominence in recent months.

ProPublica ran a very detailed series about how the hedge fund created subprime CDOs to short in the years before the financial crisis. The Magnetar Trade, according to ProPublica, involved investing in the equity tranche, and then shorting its own position.

ProPublica also said some people have alleged that the hedge fund also helped stuff the CDOs with riskier mortgages — an allegation Magnetar strenuously denies. The hedge fund says it was arbitraging between the different layers of securities and was “net long”, rather than engineering a short.

Magnetar closed at least 26 subprime deals in 2006 and 2007, according to ProPublica.

Schwartz’s work was on ACA Aquarius 2006-1, a $2bn CDO which closed in September 2006.

Her name and biography appear in the prospectus for the deal, and ACA is listed as CDO manager — a similar role to the one it had on Goldman’s Abacus 2007 project.

Thus it looks like, in one sense, Schwartz’s experience on the construction of Abacus could well lie at the heart of a legal battle between Goldman and the SEC. Proving whether ACA was misled into believing Paulson was a long investor in the deal will no doubt involve her perspective.

In another sense, Schwartz’s overall experience as a CDO manager, including her role in Magnetar’s Aquarius CDO, could act as a litmus test for the sophistication of Abacus investors — something Goldman refers to in its defence documents over and over again:

Like other transactions of this type, all participants were highly sophisticated institutions that were knowledgeable about subprime securitization products and had both the resources and the expertise to perform due diligence, demand any information that was important to them, analyze the portfolio, form their own market views and negotiate forcefully at arm‟s length.

As for Schwartz, she appears to have left ACA in late 2007 — shortly before the firm divested itself of its CDO business.

Article Series - Abacus

1. SEC charges Goldman Sachs with subprime fraud
2. The case involving ABACUS 2007-AC1
3. Markets Live transcript - Goldman/SEC special - 16 Apr 2010
4. Formerly The Greatest Trade Ever
5. Paulson: 'It's our money now'
6. SEC/Goldman linkfest
7. Introducing Fabrice "fabulous Fab" Tourre
8. 'Goldman Sachs is disappointed...'
9. This CDO is a Democrat
10. ACA's rather disastrous CDO forays
11. The analysts react
12. A Goldman blogger round-up
13. A CDO litigation risk league table
14. Fisking Goldman's latest rebuttal
15. The Goldman defence documents
16. Fabrice Tourre scores an indefinite paid holiday
17. Der Abakus
18. Is this the sound of a bandwagon?
19. The experience of Laura Schwartz

(from FT, Apr 20 2010)