Following a calculated risk in uncharted territories, Paulson & Co. is being held to account
Hedge fund manager, John Paulson, has come under scrutiny since Chinese-based timber company Sino-Forest, one of Paulson’s hedge fund buys last year, lost 70 percent of its stock value in just a few months. The massive shortfall has resulted in the first lawsuit being brought against him by an investor. Hugh Culverhouse, one of the fund’s investors, has filed a class-action suit against Paulson & Co., seeking damages for the investment’s disastrous return.
Overview of the lawsuit
In 2011, Paulson & Co.’s hedge fund lost over $468m on the Sino-Forest deal alone. The class-action suit filed by Culverhouse claims that Paulson did not perform the necessary due diligence or investigation of the fund’s investment risk before purchasing shares in Sino-Forest. In total, Paulson & Co. purchased 14 percent of Sino-Forest stock, totaling around $800m worth of shares.
Prior to June, there had already been rumblings that Sino-Forest was not a good investment, but the real damage came when Muddy Waters LLC claimed that Sino-Forest had overstated its assets. This claim caused Sino-Forest’s stock price to fall by 72 percent in the next 48 hours, leaving Paulson & Co. with a massive loss.
Culverhouse’s class-action suit seeks compensation for the losses on behalf of the fund’s investors, along with punitive damages. In his complaint against the hedge fund, Culverhouse stated, “Defendants (Paulson and his staff) breached their fiduciary duties by conducting a grossly negligent due diligence analysis of Sino-Forest’s business operations that did not analyse the substantial risks of holding a near-billion dollar investment in a forestry company based in China.” The suit cites China’s business environment and the country’s timber industry operations, which vary greatly from those in the US, as factors in the collapse.
Allegations of fraud and mismanagement
In its defence, Paulson & Co. has issued a statement, declaring that the losses were due to the failure of its advisers to conduct appropriate due diligence. “The lawsuit filed by Hugh Culverhouse against Paulson & Co. is without merit. 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.” According to Culverhouse, though, Paulson himself admitted he had made a mistake in not listening to concerns about Sino-Forest’s possible fraud, telling investors, “I should have been more receptive to this information.”
Paulson & Co. also claims that it was not alone in believing that Sino-Forest was a good bet, saying that many other financial agencies had given the company a stamp of approval, including Ernst & Young, the Toronto Stock Exchange, Morgan Stanley, Credit Suisse, and Moody’s. The company also says that the actual losses from the Sino-Forest deal have been much lower than the lawsuit claims, totalling only $105m from the time it originally purchased the share until it sold the full stake in Sino-Forest. For its part, Sino-Forest admitted, “there remain issues which have not been fully answered,” but declined to explain further.