Court Revives Fraud Case Against Goldman Sachs

(CN) - An insurer left on the hook by a hedge fund's short-selling persuaded a federal judge to let it go after Goldman Sachs for fraudulent inducement.

ACA Financial Guaranty Corp. brought the case back in 2011 over its financial guaranty of a synthetic collateralized debt obligation known as ABACUS.

The insurer says the deal exposed it to significant financial liability because Goldman Sachs hid plans by Paulson & Co., a hedge-fund client that had selected most of the portfolio investment securities in ABACUS, to take a "short" position.

With ACA seeking $90 million in treble damages, Goldman Sachs moved to dismiss on the plaintiff's purported failure to plead the "justifiable reliance" element of the fraud claim.

Though a three-judge appeals court in New York sided with Goldman, the state's highest court reversed 5-2 Thursday.

"In its complaint, plaintiff alleges that it sought assurances from defendant about Paulson's role in ABACUS," the unsigned majority ruling by the New York Court of Appeals states. "Specifically, plaintiff alleges that it emailed defendant asking how Paulson intended to 'participate' in the transaction.

"Plaintiff further alleges that defendant affirmatively misrepresented to plaintiff that Paulson would be the equity investor in ABACUS. Thus, at this pleading stage, plaintiff has sufficiently alleged justifiable reliance."

Judge Sheila Abdus-Salaam joined a dissent by Judge Susan Philips Read that says "it is not enough for a sophisticated party like ACA to plead that it relied on Goldman's alleged misrepresentations."

"ACA manifestly took no steps to safeguard its interests," Read wrote. "And there was an obvious and easy step that ACA might have taken; ACA might have simply asked Paulson directly what its investment position was in ABACUS."

ACA signed no contract confirming Paulson's long position, the dissent states.

"If assurance that Paulson was taking a net long position in ABACUS was as critical to ACA's commercial decision-making as it now claims, ACA surely could have and would have conditioned its financial guaranty on Goldman (or Paulson, for that matter) entering into an agreement containing written representations and covenants," Read wrote (parentheses in original).

The dissent also faults ACA for failing to question Paulson about its position.

"ACA, a sophisticated financial entity, protests that it was not reasonable to query Paulson about its investment position in ABACUS because Paulson most likely would have lied, and, in any event, whether Paulson would have disclosed the truth is a factual issue that cannot be resolved on a motion to dismiss," Read wrote. "But whether Paulson would have lied or not is irrelevant."

Neither Goldman nor Paulson has returned a request for comment.

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