Opinion ID: 2793872
Heading Depth: 2
Heading Rank: 1

Heading: The Pyxis CDO

Text: This case arises out of Putnam’s role as collateral manager of the Pyxis CDO. A CDO is a special purpose vehicle that purchases, or assumes the risk of, a portfolio of assets. To buy their portfolio of assets, CDOs raise money from investors by issuing notes and equity interests. The assets that comprise the CDO generate cash, which is then paid out to the CDO’s investors. Investors in a CDO are not necessarily all subject to the same level of risk. Rather, CDO notes may be issued in “tranches” representing different levels of risk and potential reward. Generally, senior tranches carry the lowest risk, whereas investors in the equity tranche assume the greatest risk in the event of a default. Pyxis was a “hybrid” CDO, in that its $1.5 billion portfolio included both “cash” assets (i.e., assets that Pyxis actually purchased) and “synthetic” assets (i.e., assets created through ‐5‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. transactions that referenced securities not actually owned by Pyxis). About 23% of Pyxis’s assets were cash assets and 77% were synthetic assets created by credit default swaps that referenced other asset‐ backed securities. In these credit default swaps, Pyxis sold credit protection to counterparties in exchange for premium payments to Pyxis. If the assets referenced in the swaps performed well, Pyxis would enjoy the premium payments without having to make credit protection payments. If the assets performed poorly, however, Pyxis would have to make credit protection payments to the credit default swap counterparty, potentially up to the full notional amount of the referenced obligation. Calyon Corporate and Investment Bank (“Calyon”), the structuring bank1 for Pyxis, paid premiums to Pyxis under a credit 1 A bank structuring a CDO transaction is responsible for financing and facilitating the purchase of the CDO’s assets, constructing the CDO, and interacting with rating agencies. See Loreley Fin. (Jersey) No. 7, Ltd. v. Credit Agricole Corporate and Inv. Bank, Index No. 650673/2010 (N.Y. Sup. Ct. June 9, 2011); J.A. 1151‐61. ‐6‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. default swap in exchange for protection payments in the event that a portfolio asset experienced a “credit event,” such as a default or failure to pay a defined obligation. For most of the specified assets, Calyon acted only as an intermediary, meaning that the ultimate short positions were held by other market participants. II. Putnam’s Representations and the Pyxis Guaranty In July 2006, Calyon contacted FGIC to solicit credit protection for the Pyxis CDO. Under the deal that Calyon proposed to FGIC, FGIC was to insure all payments owed by its subsidiary FGIC Credit Products LLC under a credit default swap which would provide credit protection on the $900 million “super senior” Pyxis tranche (“the Pyxis Guaranty”). Without the Pyxis Guaranty, Pyxis would not have closed. Calyon represented that the CDO would be managed by Putnam, which would select the Pyxis asset portfolio independently, in good faith, and in the best interests of the investors. ‐7‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. FGIC alleges that it and investors were heavily dependent on Putnam’s experience, independence, and integrity as collateral manager. Putnam represented to FGIC, orally and in writing, that it was an experienced and reputable collateral manager and that it would select the assets for the Pyxis portfolio diligently and independently. Putnam provided documents, such as a 52‐page marketing pitchbook and an offering memorandum, containing extensive representations about Putnam’s role as a “global leader in asset management” and the rigorous selection process by which it would select the assets for the Pyxis portfolio. SAC ¶¶ 69‐71, 86‐87; J.A. 210, 217. Putnam made similar representations to FGIC in the course of FGIC’s extensive due diligence for Pyxis, which included an on‐ site review of Putnam’s operations at Putnam’s Boston offices. During a face‐to‐face meeting of representatives from FGIC and Putnam, Putnam represented that it would select and manage the ‐8‐ FIN. GUAR. INS. CO. V. PUTNAM ADVISORY CO. assets in the Pyxis portfolio and described in detail its expertise and strategy for doing so. In a follow‐up call, Putnam again made clear that it would select and manage the assets for Pyxis and that it had considerable experience in the residential mortgage‐backed securities (“RMBS”) market, particularly in the market for subprime RMBS, of which the Pyxis portfolio would primarily be composed. Putnam represented that it performed extensive due diligence with respect to prospective RMBS investments, including conducting on‐ site visits to most of the servicers of the loans underlying these investments, and, more importantly, that it maintained ongoing interactions with all servicers to keep tabs on their servicing strategy and performance. [Id.] As a result of these representations, FGIC provided the Pyxis Guaranty.