Opinion ID: 2793872
Heading Depth: 2
Heading Rank: 2

Heading: Magnetar’s Alleged Scheme

Text: FGIC contends that, contrary to its representations, Putnam abdicated control of the selection of Pyxis’s assets to Magnetar, a hedge fund that had a financial interest in Pyxis’s failure. ‐9‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. According to the SAC, in early 2006, the hedge fund Magnetar worked with collateral managers to launch a series of CDOs. By supplying the funds for the equity tranche, the riskiest stake, Magnetar made it possible to secure investors (and insurers like FGIC) willing to take long positions in those CDOs. But unlike an ordinary investor, Magnetar purchased the equity tranche of Pyxis and other similar CDOs not because it thought the CDO was a sound investment but because the investment permitted Magnetar to simultaneously bet against the more senior tranches in the same deal. These short positions were much greater (often six‐to‐one) than Magnetar’s long equity position. In other words, Magnetar stood to gain significantly more if the CDO failed than if it succeeded. As collateral manager of Pyxis, Putnam was responsible for selecting the assets for inclusion in the portfolio, monitoring the credit status of the underlying assets, reinvesting payment proceeds ‐10‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. from maturing assets, and making substitutions in the portfolio of assets. But, according to the SAC, Putnam was well aware of Magnetar’s “hedged equity” strategy of betting against the assets included or referenced in Pyxis, and Putnam allowed Magnetar to secretly control the composition of those assets. FGIC alleges that Magnetar made a “behind the scenes” arrangement with Calyon, of which Putnam was aware, requiring Calyon or Putnam to notify Magnetar of any proposed acquisition for the Pyxis portfolio and giving Magnetar veto rights over any such proposed acquisition. SAC ¶ 95; J.A. 221. Magnetar also designated which collateral it wanted to include in the Pyxis portfolio, which Putnam accommodated. For example, the SAC alleges that in July 2006, James Prusko of Magnetar emailed Carl Bell at Putnam to suggest that Putnam increase the synthetic portion of Pyxis by entering into more credit default swaps referencing low‐rated RMBS, which would allow Magnetar to short more of the Pyxis assets. Prusko ‐11‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. explained that it was “very hard to get off sizable CDO CDS trades unless they’re done against a deal, and this is a natural delta hedge against our equity.” Bell wrote back: “Got it. So when we find a deal we want to buy, we shouldn’t put in an order with the syndicate desk but have Calyon broker a synthetic trade between you and [Pyxis] at an agreed upon level?” Prusko replied: “That would be preferable . . . .” SAC ¶ 98 (alteration in complaint); J.A. 223. FGIC alleges that Magnetar’s long position on Pyxis by the time Pyxis defaulted was approximately $21 million. Magnetar’s short position on the CDOs in which it invested averaged approximately 7% of the aggregate assets of those CDOs. If Pyxis were an average Magnetar CDO, therefore, Magnetar’s short position on Pyxis, a $1.5 billion CDO, would have totaled $105 million. ‐12‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. For its role in cooperating with Magnetar’s scheme, Putnam received a fixed fee of fifteen basis points (i.e., 0.15% of the outstanding principal of Pyxis each year) and an additional “incentive” fee of five basis points. Due to Pyxis’s size, this was a substantial sum; Putnam’s fixed fee was $2.25 million for the first year alone, and by 2012, Putnam had received cumulative total fees of $5,707,429. The SAC also alleges that Putnam saw Pyxis as an opportunity to “establish a foothold in the market” for managing similar CDOs in the future. SAC ¶¶ 6, 51; J.A. 186, 203. Indeed, Putnam was selected by Magnetar to serve as collateral manager for a second Pyxis CDO, Pyxis ABS CDO 2007–1, which closed a few months after Pyxis. IV. Magnetar’s Control Over the Pyxis Portfolio and Pyxis’s Default FGIC alleges that the assets Magnetar directed Putnam to include in the Pyxis portfolio were, on their face, more likely to default than the assets Putnam would have selected had it acted ‐13‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. independently. Putnam invested half of Pyxis’s cash allocated to CDO investments in four other Magnetar CDOs, even though there were over two hundred asset‐backed CDOs issued in 2006 alone in which Putnam could have invested. According to the SAC, Putnam concealed the extent to which Pyxis sold protection on the ABX Index of low‐rated RMBS. The ABS Index is an independent benchmark designed to measure the overall value of mortgages made to borrowers with subprime or weak credit. Magnetar pushed Putnam to circumvent the limit represented to Pyxis investors on investment in the ABX Index to a level more than three times the specified concentration limit, which increased the risk profile of the Pyxis portfolio. Putnam also provided FGIC with a “target portfolio” for Pyxis that included $145 million of prime RMBS, but then, without alerting FGIC, replaced all of the prime RMBS with subprime RMBS, which were more likely to default. ‐14‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. On April 30, 2008, only eighteen months after Pyxis closed, Fitch Ratings Ltd. downgraded the credit rating of the Pyxis Super Senior tranche from AAA to C. Ultimately, Pyxis defaulted and FGIC incurred liability of up to $900 million under the Pyxis Guaranty.