john paulson image

Not long ago, hedge fund manager John Paulson was one of Wall Street’s “Masters of The Universe.” He earned billions on the housing market collapse and on gold’s rise. But all good things come to end and in 2011, his fund lost 50 percent of its value.

Now, an investor lawsuit has been filed against his firm, Paulson & Co.

On Tuesday, a Florida investor accused the firm of conducting improper due diligence for the Sino-Forest investment. After a little-known investment firm came out with a damaging report of the company, comparing it to a “Ponzi scheme,” Sino-Forest saw its market value tank.

In the complaint filed by Hugh F. Culverhouse, it accused Paulson & Company of “reckless indifference” and “failure to conduct the required proper due diligence in this foreign environment, amounts to gross negligence and breach of defendant’s fiduciary duties,” according to The New York Times.

The firm responded via a statement and said it wasn’t the only firm to miss Sino-Forest’s negative signs. It said, “As in all our investments, Paulson has access to the same information that everyone else in the securities markets does. Like other public market investors, we must rely on audits and underwriter due diligence for comfort that financial statements and disclosures are accurate and reflect the true state of affairs at companies with publicly traded securities.”

Paulson also said the following:

The fact is that Sino-Forest apparently passed numerous legal and institutional controls and scrutiny, such as:
• Listing on the Toronto Stock Exchange, where companies must meet specific financial, legal, auditing and other standards, since 1995;
• Clean audit opinions on financial statements from Ernst & Young and other major auditors for fifteen fiscal years;
• Independent review and valuation of forest assets by international consultant Poyry for eleven of the past twelve years;
• Eight securities offerings from 2004 to 2010 led by major securities firms (including Morgan Stanley, Credit Suisse, Bank of America Merrill Lynch, Toronto-Dominion Securities and Dundee Securities), each of which undertook due diligence on the company as part of underwriting;
• Independent board majority with seven of nine directors, including four businessmen (including Simon Murray, non-executive chairman of Glencore International, who was also previously chairman of Deutsche Bank in Asia and Group Managing Director of Hutchison Whampoa), one former senior investment banker, and two former senior accountants; and
• Wide following among sell-side research analysts (10 for equity, 10 for fixed income) and ratings agencies (S&P, Moodys, Fitch), with one of those analysts having been to China to visit Sino-Forest for each of the past seven years.

So what exactly happened with the Sino-Forest investment to provoke Culverhouse to file a suit?

Paulson has said he lost almost $500 million from the transaction. Investors questions arose as to why he had invested in a company (14 percent) that traded infrequently.  How was the firm unaware of the questions regarding Sino-Forest’s timber holdings?

According to Culverhouse’s complaint, in an investor call, Paulson said that appropriate Sino-Forest due diligence had not been conducted by the hedge fund and yes, traders had overheard concerns about the company prior to the damaging report.

But in response to Tuesday’s complaint, Paulson sang a different tune: the net losses were smaller than the alleged $500 million total losses.

A firm statement said, “Because Paulson & Co. sold a substantial portion of its Sino-Forest shares from early 2010 through May 2011, the net realized loss to the portfolio for the full life of the position was C$105 million.

The C refers to Canadian dollars, which is close to $105 million.