Paolo Pellegrini, a former top Paulson & Co employee, testified to the Securities and Exchange Commission that he told collateral agent ACA that his hedge fund would short the security at the center of the Goldman Sachs lawsuit, reports CNBC. This is hugely significant. If true, it significantly weakens the government's case against the investment bank, because it implies that Goldman could not have misled ACA about Paulson's involvement. Indeed, one of the hedge fund's own managers may have told the collateral manager that a short interest was the fund's goal.

Here's an excerpt from CNBC's report:

In one part of Pellegrini's testimony, a government official asked him: "Did you tell (Schwartz) that you were interested in taking a short position in Abacus?"

"Yes, that was the purpose of the meeting," Pellegrini responded.

"How did you explain that to her?" the government official said.

"That we wanted to buy protection on traunches of a synthetic RMBS portfolio." Pellegrini said.

The SEC does not mention this exchange in its complaint against Goldman.

In the exchange above, Laura Schwartz was a manager at ACA. Pellegrini indicates that the entire purpose of this meeting that took place in Jackson Hole, WY was to discuss the short position that Paulson desired. Unless the SEC intends to say that Pellgrini is lying, it's hard to imagine how this doesn't virtually dismantle its case.

You may recall that the one clear dispute of fact from the start between Goldman and the SEC centered on what the bank told ACA about Paulson's intent. Goldman claims that it never led ACA to believe that Paulson would be an equity investor. The SEC says it did. Pellegrini's reported testimony provides strong support for Goldman's side of the story.

If the SEC loses the battle in attempting to show that Goldman misled ACA, it's left only with its claim that the bank misled investors. That, however, is more a question of law. It's not at all clear that whoever helped choose the collateral pool is material to investors. As explained earlier, so long as an investor has accurate information with which to perform statistical evaluation of a security, it's hard to see how the details of its portfolio's origin matter.

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