02/22/2012 10:17 am ET

John Paulson Hedge Fund Sued For Negligence

Hedge fund manager John Paulson has been hailed as a finance sage for making billions betting against the subprime mortgages beloved by Wall Street in the run-up to the financial crisis. Lately the accolades have died down. His fund is facing losses and he's now the target of a lawsuit alleging incompetence.

As the Wall Street Journal reported, a lawsuit filed in federal court early Tuesday by Hugh F. Culverhouse (who happens to be a former U.S. prosecutor and son of longtime Tampa Bay Buccaneers owner Hugh Culverhouse Sr.) accuses Paulson of gross negligence for pumping roughly $800 million of investors’ money into a company called the Sino-Forest Corporation -- which operates huge farms in China that grow and harvest trees for commercial use.

The suit claims that Paulson’s hedge fun, Paulson Advantage Plus, failed to conduct a thorough investigation of Sino-Forest before deciding to buy up a 14 percent stake in the company -- an investment that, according the suit, ultimately cost its backers (including Culverhouse) roughly $460 million.

“This investment should never have been made,” Harvey Gurland, Culverhouse’s lawyer and a partner at the law firm Duane Morris, told The Huffington Post. “People invest millions of dollars with Paulson because he’s supposed to be one of the best if not the best in the world. That’s why we say [his investment in Sino-Forest] was gross negligence and it’s egregious."

Sino-Forest first came into the national spotlight this past June after the release of a damning report by research firm Muddy Waters Research, accusing the company of, among other things, being an “institutional fraud” and a multi-billion dollar Ponzi scheme. The Muddy Waters report prompted a massive drop in the company’s share price and led Paulson’s fund to sell its entire stake in the company (a subsequent report questioned some of Muddy Waters’ most incendiary accusations, but still raised doubts about the company’s valuation).

The Sino-Forest disaster contributed to a very bad year for Paulson, whose Advantage Plus hedge fund lost roughly 52 percent of its value in 2011.

The lawyers hope the suit will gain class action status so as to include all of Paulson’s investors who lost money in Sino-Forest.

Paulson famously made between $3 and $4 billion in 2007 by betting against the subprime mortgage market at around the same time that fervor for these loans (and the fancy bundles of securities that they were converted into by Wall Street banks) was at its peak.

Repeated calls to Paulson's fund went unanswered, but in an update to its original story, the Journal reports that late Tuesday, the fund sent a letter to its investors addressing the suit's allegations.

"We firmly believe that the lawsuit is completely without merit and that there is no basis in law or fact for the action," the Journal reported the letter as saying.