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John Paulson, Paulson and Co

Philanthropist sues NY hedge fund

A prominent Miami investor and philanthropist has filed a lawsuit against the adviser and the administrator of one of the world's largest hedge funds, claiming that they 'recklessly' bought a large position in a Chinese timber company that has been exposed as a 'potential fraud'.

Hugh F Culverhouse brought the lawsuit against Paulson & Co, Inc and Paulson Advisers LLC of New York, claiming that they caused the Paulson Advantage Plus fund to purchase stock in Sino-Forest Corporation.

Culverhouse's lawyers, Harvey Gurland of Duane Morris LLP and Lawrence Kellogg of Levine Kellogg Lehman Schneider + Grossman LLP – both in Miami – intend to expand the suit into a class action, the lawyers said, as other investors suffered similar losses when the company's stock plummeted 70 per cent in June 2011. They estimate that there may be hundreds or even thousands of such investors.

"With just the basic due diligence, the Paulson companies could and should have foreseen Sino-Forest's problems," Gurland said after filing the lawsuit in US District Court for the Southern District of Florida. "Instead, Paulson simply threw money at the company with a shocking disregard for the financial well-being of its investors."

Gurland said that the flaws in the approach of Sino-Forest – which has undergone both internal and external investigations and is battling two of its own class actions – should have been obvious to a sophisticated hedge fund manager, and that the Paulson companies are culpable for the drastic deterioration in share value that its investors suffered as a result of Sino-Forest.

In a statement released to Hedgeweek, Paulson & Co says: “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. 

“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. 

“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 CAD105 million.”

Gurland notes that according to a Reuters news story, John Paulson (pictured) took responsibility for the failure of his research in an investors' conference call on 21 July, 2011, and said at the time that he needed to strengthen his Asian research arm.

"It's painful to read that," Gurland says. "It's a classic case of shutting the proverbial barn door after the horses are gone."

Kellogg observed that Sino-Forest's main problem is its ownership claims to the forest lands. Sino-Forest does not obtain registered title to plantations purchased through its offshore subsidiaries, and the company's rights to the tree plantations therefore may be open to challenge. The scheme to capitalize on Chinese wood may even be illegal under the laws of the People's Republic.

"In China, land generally can only be owned by the government and farmer collectives," Kellogg says. "It is questionable whether Sino-Forest could ever have laid claim to any land, or the trees on it."

An independent investigation demonstrated that the company's documents are not officially recognised by the government and do not reflect any legal interest in, or title to, land or timber, Kellogg said. And neither the nature nor the legality of the company's business model, or its use of certain "third-party intermediaries," could be confirmed after an eight-month inquiry.

"One of the killer facts is this," Kellogg says. "To this day, Sino-Forest itself cannot confirm the extent or value of its timber holdings."

Securities research firm Muddy Waters released an investigatory report in June disclosing these and other problems, the lawyers said, leading to the stock price tumble. It has not recovered and the investment community expects the company to fail.

The report was initially greeted by the Paulson funds with support for the company, but within days Paulson had sold its entire 14 per cent stake in the forest company.

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