Did John Perry Take The "Perceived" Paulson CDO Cap Structure Arbitrage To A Whole New Level In 2007?
Courtesy of Tyler Durden
One of the critical observations that have emerged as a result of the SEC action into Goldman is the realization that various investors would take full advantage of perceived capital structure arbitrage, not directly, but by implication: if fund X was seen as an equity investor in a given product, be it structured in the form of a CDO, or a boring corporation, with publicly traded equity, that would imply to everyone else curious, that fund X was implicitly comfortable with every tranche in the balance sheet above the equity: whether the mezz tranche, the deeply subordinated debt, and obviously the very top or the supersenior debt tranche (secured or otherwise). The ruse, the SEC claims, is that said Fund X would invest a token equity amount, and make it plain for all to see, all the while shorting the bejeezus out of securities above the equity tranche, knowing full well that the equity would be wiped out, yet with partial or full losses on the debt above, the shorts would end up making a profit multiples of times larger than the equity tranche loss. This is among the key points in the SEC complaint – we will not discuss it much, suffice to say that it is more than obvious that when dealing with other (not all that sophisticated) investors, this ruse would certainly work, as the rest of the world would be logically satisfied that investor X would not assume there would be impairments above the equity tranche, absent further disclosure. Yet what is interesting, and what we would like to touch upon, is a curious tangent of this "ruse" – as blog LittleSis points out, one entity that could have taken the "Fund X" scheme to a whole new level may be the hedge fund run by former Goldman Robert Rubin arb desk protege Richard Perry. Perry, who made billions in 2007 by shorting subprime, and most likely was involved in shorting CDOs (Goldman underwritten or otherwise) in the same vein that Paulson and others were doing, did not buy equity stakes in CDOs (that we know of). Instead what he did was amass an equity stake directly in the CDO wraparound company du jour: ACA Capital. Should Perry have wanted to convey an impression to everyone else that ACA (and its holdings) were safe (and his anonymous and Goldman conveyed bids on ACA CDO protection were sufficiently low) what better way than to telegraph to the world in his most recent 13F that he was building up a stake in ACA? Which as we disclose below, between December 31 2006 and September 2007, is precisely what he was doing.
Below we demonstrate the holdings of ACA Capital shares by Perry Corp., as highlighted by the firm’s public 13F filings.
Now it is no secret that Perry made billions shorting subprime. As the attached article points out:
Perry was one of a few on Wall Street, for instance, to start betting against subprime mortgages in late 2006. "We could see there was a lot of bad behavior by financial institutions," he says. Perry Capital shorted $3 billion in subprime securities, a bet that yielded $1 billion last year. His fund was up 11.7% after fees, according to investors, more than double the S&P 500’s 5.5% gain. (He charges a 1.5% management fee, less than the 2% charged by most hedge funds, and the typical 20% of profits.)
Putting two and two together leads to the very critical questions that LittleSis present: "Which subprime securities did Perry short to score $1 billion? Were they Goldman Sachs CDOs? Was ACA involved?"
We have some of our own:
1. Did Perry (and other Goldman diaspora hedge funds – we are currently conducting an extensive analysis of all hedge funds that may have held "long" positions in firms like ACA in late 2006 and 2007) short ACA CDOs, even while holding a nearly 8% stake in the firm’s common equity?
2. Was Goldman, or any other originator, using the Perry name (certainly much better known in 2007 than that of Paulson) to calm potential CDO longs (aka "lambs for the slaughter") by disclosing that the ex-Goldmanite was so bullish on ACA he not only had 2 million in long share holdings in Q1 and Q2 of 2007, a time when he was massively short CDOs and other synthetic instruments, but also doubled his ACA common holdings in Q3 of 2007 (the dollar value of his 3,625,000 shares on Sept. 30, 2007 was just $22 million – an amount that could be easily sacrificed if Perry would make billions by an implosion in ACA).
3. Did Perry, by dint of his ACA minority stake, have special insight into the CDO holdings of ACA, all the while taking the opportunity to short the firm? This would be a flagrantly illegal practice.
All in all, if people are confused and impressed by the Paulson trade, they should be in awe of the Perry "mother of all cap structure trades" if indeed it turns out that he was shorting ACA (or other wrap firm held CDO) even as he was adding to ACA common. Let’s not forget that Perry, in addition to having exquisitely close ties to Goldman, was also a nehpew of Bear Stearns CEO Jimmy Cayne – Bear was the biggest shareholder of ACA before it imploded.
