The SEC says John Paulson won't be next

(Fortune) -- The Securities and Exchange Commission's civil fraud charges against Wall Street giant Goldman Sachs includes information that could damage another titan of finance: John Paulson.

Paulson does not appear as a defendant in the SEC's lawsuit, which hones in on whether Goldman Sachs (GS, Fortune 500) disclosed conflicts of interest. But if the allegations in the suit are true, then Paulson had inside, perhaps non-public, and very material knowledge about a security that made him money -- and lost Goldman clients $1 billion.

"Paulson's fund is a private entity and his records are not public, which is probably why you haven't seen charges brought against him," says Keith Springer, president of Capital Financial Advisory Services. "The government may still be gathering information, but I can't imagine them not going after him."

Springer added that the revelations about Paulson likely pushed down gold prices Friday, since Paulson's funds are heavily invested in gold. Emails sent to Paulson's media relations team were not returned.

In the government's complaint against Goldman, the SEC alleges that the bank structured a synthetic collateralized debt obligation (CDO) called Abacus 2007-AC1 in 2007 with Paulson's help. Paulson also allegedly paid Goldman approximately $15 million for structuring and marketing the deal.

"Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. ["Paulson"], with economic interests directly adverse to investors in the [CDO], played a significant role in the portfolio selection process," the complaint said.

According to the SEC, a Goldman vice president named Fabrice Tourre knew that Paulson had chosen the collateral for the CDO had misled market participants to believe that Paulson wanted Abacus to perform well because he had invested $200 million in the CDO.

According to the Wall Street Journal, the SEC's head of enforcement, Robert Khuzami, said at an unrelated conference today that Paulson wasn't charged because he hadn't ever made representations about the collateral in the CDOs, according to the evidence the government has. It's unknown how much information Paulson has provided to the SEC for its case.

CNBC has reported that Paolo Pellegrini, a former fund manager for Paulson, was the SEC's source in the case, which indicates the government may not have full knowledge of Paulson's individual actions relating to the investment.

But Tourre knew that Paulson had an undisclosed short interest in Abacus. This gave Paulson incentive to choose risky mortgages during the portfolio selection process. And Paulson profited more than handsomely when the market ultimately blew up. His funds gained $15 billion in 2007 and according to newspaper reports Paulson took home $3 billion to $4 billion. The SEC says that Paulson made about $1 billion by betting against Abacus. Investors in Abacus lost over $1 billion.

Let's put Abacus into context. Abacus came to market on April 26, 2007, and by October 24, 2007, 83% of the residential mortgage backed securities (RMBS) in the CDO had been downgraded. By January 29, 2008, 99% had been downgraded.

According to a 2008 Wall Street Journal story, Paulson's early bets against the housing market bubble -- conceived in 2005 -- were losers; but he had done enough research to know that lenders were getting sloppy and aggressive, increasing the likelihood that mortgages were being overvalued by the market and would fall in value.

Paulson launched a hedge fund dedicated to betting against risky mortgages in 2006, according to the Journal, and after profits rose about 20% he launched a second fund to short mortgages in 2007, about when he would have been working on the Abacus deal with Goldman.

In early 2007, when sub-prime lender New Century was restating its prior results, the Journal reported, "as his gains piled up, Mr. Paulson fretted that his trades might yet go bad," adding that Paulson was convinced that Bear Stearns was manipulating the mortgage market to keep values high. He told the paper that homeowners had been victimized and that he had given $15 million to the Center for Responsible Lending.

In light of today's SEC's allegations, it seems inevitable that questions will arise regarding whether Paulson was manipulating the subprime market for his hedge fund's gain, and what lengths he went to in order to make sure his big bet against the American economy came up a winner.

Update 4:54 p.m.: Paulson & Co.issued a response stating that: "While Paulson purchased credit protection from Goldman Sachs on securities issued under the ABACUS ABS CDO program, we were not involved in the marketing of any ABACUS products to any third parties. ACA as collateral manager had sole authority over the selection of all collateral in the CDO, securities of which were subsequently rated AAA by both S&P and Moody's. Paulson did not sponsor or initiate Goldman's ABACUS program, which involved at least 20 transactions other than that described in the SEC's complaint."