NEW YORK (AP) — A former hedge fund executive testified Tuesday at a New York securities fraud trial that the fund purposely bet against investments tied to high-risk mortgages as the housing market teetered on the edge of a meltdown — a strategy that the Securities and Exchange Commission says allowed the fund to make $1 billion.
Paolo Pellegrini, formerly of Paulson & Co. Inc., was called to the witness stand in the SEC civil case against Fabrice Tourre, a former Goldman Sachs trader accused of misleading other investors who lost a fortune by betting that the same investments would rise in value.
At the time Paulson & Co. Inc. sought to invest in the mortgage-based bonds in 2006, the U.S. housing market "had appreciated excessively," Pellegrini testified. The hedge fund decided to take short positions based on its belief that "there would be a lot of mortgage defaults," he added.
The testimony of Pellegrini, who no longer works for Paulson, got off to a strange start under questioning by an SEC lawyer about collateralized debt obligations, or CDOs — a type of investment that are central to the case. CDOs lose money if borrowers stop making mortgage payments and default on loans.
Asked what CDO stands for, he first said, "I'm not sure" before coming up with the answer. Later when asked if he could explain to the jury how a CDO works, he hesitated before saying, "I can try."
The SEC has accused Tourre of scheming to market CDO transactions to investors that were purposely designed to fail and give Paulson and its billionaire president, John A. Paulson, an advantage. No one is facing criminal charges.
In opening statements Monday, prosecutors accused Tourre of using "lies, trickery and deception" to help his hedge fund client make a killing.
"In the end it was Wall Street greed that drove Mr. Tourre to lie and deceive," said SEC lawyer Matthew Martens.
Defense attorney Pamela Chepiga told jurors her client "never misled anyone," and suggested authorities were trying to make him a scapegoat in the housing market collapse in 2007.
Tourre was born in France and moved to the United States in 2000 to study at Stanford University. He obtained a graduate degree in science before going to work for Goldman Sachs.
The suit seeks a declaration that Tourre violated securities laws, along with a disgorgement of profits and unspecified penalties and damages.
In July 2010, Goldman Sachs settled charges brought against it in the matter and agreed to pay $550 million. The bank still faces private litigation, including a federal securities class-action lawsuit.
Pellegrini was to resume testifying Wednesday. The trial is expected to last three weeks.