Paulson started a fund in 2006 with the public and explicit intention of shorting the housing market, which may have given ACA a clue about his intentions. But let's say ACA somehow missed this, and was under the impression that Paulson would be long the equity tranche, as the SEC contends. So, did they still have this idea when the deal presentation--leaked to Naked Capitalism, you can see it here--came out on February 26, 2007? Surely that presentation, which makes very clear that the equity tranche would not be "sold or marketed" would have disabused them of this idea.
Was ACA misled by the word "sponsor," perhaps? The SEC certainly thinks so, and Reuters's Felix Salmon agrees with them, saying that "sponsors are invariably equity investors." Well, not quite. Backwards as it seems, that just ain't the case for all CDOs. On the contrary, for certain kinds of CDOs, the "sponsor" in fact the buyer of protection and so short the CDO. Check out this spectacularly useful plain language guide to bespoke CDOs from Nomura Bank, just scroll to the second page.
Which all leads to the additional question of whether even if ACA believed that Paulson would be long on the equity tranche that meant he was not also the buyer of the CDS and so short the mezzanine tranche. Why is this in any way unlikely? Even the quotes from ACA that the SEC manages to dredge up in the complaint show that ACA didn't see their interests as aligned with Paulson's:
"... the structure looks difficult from a debt investor perspective. I can understand Paulson’s equity perspective but for us to put our name on something, we have to be sure it enhances our reputation."The implication here is that ACA knew very well that their goals and Paulson's could be opposed. The SEC massively simplifies things here, assuming that Paulson had to be simply "long" or "short" on mortgage bonds. That ain't how structured finance works. Buying the equity tranche and selling the mezzanine is not unique; it's a typical hedge fund play.
I'm going to write more on this soon at The Big Money, but right now it's looking to me increasingly like the SEC's presenting ACA as the wronged and misled party here is something they will regret.