Paulson & Co., the world's third- largest manager of hedge funds, may face civil litigation for its role in the collateralized debt obligations that led to the fraud charges against Goldman Sachs Group Inc., according to Christopher Whalen.
Billionaire John Paulson's hedge fund made $1 billion on the CDOs that contributed to the worst financial crisis since the Great Depression. Mr. Whalen, a banking analyst at Institutional Risk Analytics in Torrance, Calif., said that allegations the firm helped shop a package of debt they were actively betting against opened it up to litigation in the wake of the suit by the Securities and Exchange Commission.
“I'm not sure they will escape civil litigation arising from this,” Mr. Whalen said in a Bloomberg Radio interview on Friday. “You can bet the parties who lost money here are going to be seeking redress.”
While buy-side firms don't often sue their dealers or advisers, the SEC suit will have done most of the legwork and attracted publicity, opening the door for other parties to claim damages, Mr. Whalen said.
Paulson & Co. said Friday it had no authority over the selection of assets linked to the Goldman Sachs mortgage security from whose decline it later profited. Paulson oversees about $32 billion in hedge funds, third in the world behind J.P. Morgan Chase & Co. and Bridgewater Associates LP.
Goldman Sachs created and sold CDOs tied to subprime mortgages in early 2007, as the U.S. housing market faltered, without disclosing that Paulson's hedge fund helped pick the underlying securities and bet against them, the SEC said in a statement. Goldman told investors that ACA Management LLC, a firm that analyzes credit risk, selected the portfolio and didn't disclose that Paulson helped pick the underlying debt, according to the SEC.
The banking system has too many firms with conflicts of interest such as Moody's Investors Service Inc. and other credit rating companies that signed off on the CDOs, Mr. Whalen said.
“The old duty of care, know your customer, suitability, all the rules that made our market the envy of the world have been cast aside,” he said. “We've got to go back to the old- fashioned rules and say if you're a banker and you sell somebody a security, you can't knowingly work against their interests.”