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Was Goldman Sachs' Hedge Fund Partner An Investor Warning Sign?

One of Wall Street's richest men, hedge-fund manager John Paulson, was associated with Goldman Sachs in the investment vehicle laden with subprime mortgages at the heart of the Securities and Exchange Commission's fraud lawsuit against the investment bank.

But the SEC's enforcement chief, Robert Khuzami, said Friday that Paulson escaped being charged with any wrongdoing because for lack of evidence he did anything wrong by betting against instruments called collateralized debt obligations or CDOs.

Attending a conference in New Orleans, Khuzami explained the agency's thinking, according to a report in The Wall Street Journal:

"Goldman was responsible for the representation to the investors, and Paulson was not,'' Khuzami told a group of deal makers gathered in New Orleans at the 22nd annual Corporate Law Institute sponsored by Tulane University Law School.

Paulson, according to the SEC complaint, bet against the CDO—a position that wasn't disclosed to ACA.

Still, the very fact that Paulson, who was famously bearish on subprime mortgages, was involved in the deal maybe should have been a warning to would-be investors that they might have wanted to look twice at the investment.

At least that's a takeaway from All Things Considered host Robert Siegel's discussion with Gregory Zuckerman of the WSJ who wrote a book about Paulson, "The Greatest Trade Ever."

ZUCKERMAN: ... "What's interesting is, he wanted to bet against as much as he could. And he went to some of these banks, it wasn't just Goldman, he went to Deutsche Bank, Credit Suisse Bear Stearns and he said, 'Hey, if you create some of this toxic mortgage product, I can bet against it.' So he never had anything to do with the actual sale of these products to investors."

ROBERT: According to the SEC complaint, ACA a firm that actually selected securities for this investment instrument called Abacus, thought that John Paulson, who was invited in on the selection process, was investing in it, not investing against it. In early 2007, how widely known was Paulson's interest in shorting the subprime market?

ZUCKERMAN: It's a good question. Frankly, on Wall Street it was pretty well known that he was betting against housing. And, not just that, he was sort of dismissed as something of a fool, a little bit of a Cassandra at the time.

So one could argue they maybe should have known that he actually was betting against it, not betting on it. That said, in some of these customized deals where he went to a mess of banks and had them create it for him, he did buy some of the riskiest tranches, the riskiest slices of these mortgage products. So maybe that's the kind of suggestion they were making — 'Yeah he's buying part of this' although they didn't tell them the whole story, that he was betting against most of it.