Former Bear Stearns investment bankers charged with fraud

June 19, 2008 6:30:23 PM PDT
Two former Bear Stearns hedge fund managers were hauled into jail Thursday and hit with the first criminal charges to arise on Wall Street from the subprime mortgage debacle, signaling what could be a wave of prosecutions related to the meltdown in the housing market. Ralph Cioffi and Matthew Tannin were indicted on conspiracy and securities and wire fraud charges alleging they lied to investors in a hedge fund that tanked last year as the subprime market collapsed. The implosion of the hedge funds cost investors $1.8 billion and foreshadowed Bear Stearns' own historic demise.

"This is not about mismanagement of a hedge fund," said Mark Mershon, head of the New York FBI office. "It is about premeditated lies to investors and lenders."

The case comes as the federal government has launched a national crackdown on fraud related to the mortgage crisis that has sent shockwaves through the global economy. The Justice Department said that more than 400 real estate industry players have been indicted since March - 60 of them on Wednesday alone.

The case against Cioffi and Tannin is based heavily on a series of e-mails that revealed intriguing behind-the-scenes disorder at the Bear Stearns hedge fund as its investments began to slide last year, setting off a state of panic among the defendants.

"The subprime market looks pretty damn ugly," Tannin wrote in an April 2007 e-mail to Cioffi. "If we believe the (report) is ANYWHERE CLOSE to accurate I think we should close the funds now. The reason for this is that if (the report) is correct then the entire subprime market is toast."

The indictment claims that at a meeting involving Cioffi, Tannin and two unnamed colleagues, Cioffi confided that the hedge funds had narrowly "averted disaster" in February 2007 - news that "led to a vodka toast to celebrate surviving the month."

Prosecutors said that at one point the situation became so dire that Cioffi pulled $2 million of his own money from the fund. But at the same time, the defendants advised investors to hold onto their positions and told them that the outlook was indeed positive, authorities said.

Cioffi, 52, was arrested by FBI agents at his home on the Upper West Side on Thursday morning, and Tannin, 46, was taken into custody outside his New Jersey home.

Both defendants were released on bond during an arraignment in which they pleaded not guilty; if convicted each faces up to 20 years in prison. The left court with their wives and without speaking to reporters.

Tannin "is innocent," said his attorney, Susan Brune. "He is being made a scapegoat for a widespread market crisis. He looks forward to his acquittal."

The mortgage market crisis "took the whole financial world by surprise," said Cioffi's attorney, Edward Little. "So our question is, why is Ralph Cioffi being charged in this case?"

Experts said that Tannin and Cioffi will likely not be the last Wall Street figures to be charged in the credit crisis - the latest front for white-collar prosecutors who brought several high-profile cases earlier this decade after the collapse of Enron and the burst of the dot-com bubble.

"There is no doubt the government is always looking to go as high as they can," said Bill Leone, a former U.S. Attorney in Colorado. "Anytime you get losses into the billions, the likelihood that higher-level executives participated in decisions increases."

For Cioffi and Tannin, their internal e-mails provide a window into the troubles that began to engulf the hedge fund in 2007.

Tannin, the complaint says, expressed his doubts about Cioffi's management in an one e-mail last March to a third fund manager with only question marks in the subject line. The e-mail said, "Is Ralph doing what he should be doing right now?"

Around the same time, it adds, Cioffi wrote to a team economist, saying, "I'm fearful of these markets. ... As we discussed it may not be a meltdown for the general economy but in our world it will be. Wall Street will be hammered with lawsuits."

But Tannin and Cioffi repeatedly told investors and Bear Stearns brokers responsible for selling funds that the outlook was good.

In one instance, prosecutors say Tannin told an investor that they "are seeing opportunities now ... I am adding capital to the Fund. If you guys are in a position to do the same I think ... this is a good opportunity." But prosecutors say Tannin never invested more of his own money.

At the same time, prosecutors say Cioffi moved $2 million of his roughly $6 million investment in the fund to a separate fund, never telling investors of the move. As a result, he was charged with insider trading in addition to the fraud counts.

On June 9, with collapse imminent, Cioffi wrote in an e-mail said that if he couldn't turn the funds around, "I've effectively washed a 30 year career down the drain," the indictment said.

The Bear Stearns hedge funds failed in June 2007. The funds had more than $20 billion in assets before crashing.

The case also demonstrates yet again how e-mail can trip up Wall Street figures in white-collar cases.

Prosecutors used e-mail exchanges in other cases against Wall Street bankers, such as former Credit Suisse Group banker Frank Quattrone and famed stock analysts Jack Grubman and Henry Blodget. But prosecutors struggled to land and maintain convictions in all of those cases.

Cioffi and Tannin already have been named in lawsuits brought last year by hedge fund investors who allege they were purposely misled.

Hedge funds cater to institutional investors and very wealthy individuals and employ complex, speculative investing methods with hopes of obtaining enormous gains. They have come under fire from regulators in recent years because they operate with little government supervision.

The fortunes of Bear Stearns began to crumble around the same time that the fund collapsed, getting so bad that the Federal Reserve had to intervene to save the once-mighty institution from bankruptcy earlier this year.

Last month, Bear Stearns shareholders approved JPMorgan Chase & Co.'s $2.2 billion buyout at about $10 a share. Back in January 2007, Bear Stearns had traded at $171 a share.