June 19 (Bloomberg) -- Former Bear Stearns Cos. hedge fund managers Ralph Cioffi and Matthew Tannin were indicted for mail fraud and conspiracy in the first prosecution stemming from a federal investigation of last year's mortgage-market collapse.
The two men were charged with misleading investors about the health of two Bear Stearns hedge funds whose implosion ignited the subprime mortgage crisis. Cioffi was also charged with insider trading in the indictment, which cites a series of e-mails between the two men. They both face as much as 20 years in prison if convicted of conspiracy, and Cioffi faces an additional 20-year term if found guilty of insider trading.
The U.S. government has been investigating possible fraud by banks and mortgage firms whose investments in subprime loans and securities plunged in value, causing losses that now total $396.6 billion. Cioffi and Tannin were also sued today by the Securities and Exchange Commission.
``The e-mails tell a damning story of these managers' awareness of the dire state of the funds, even as they talked them up among investors,' said Dan Richman, a former federal prosecutor and now a professor at Columbia Law School in New York. ``There is a lot of political pressure on the Justice Department to move forward in this area.'
Arrested in Tenafly
Cioffi, 52, was arrested at 7 a.m. at his Tenafly, New Jersey, home. Tannin, 46, was arrested at the same time at his Manhattan apartment, said James Margolin, a spokesman for the Federal Bureau of Investigation. The two men were fingerprinted at FBI headquarters in lower Manhattan, then taken in handcuffs by six FBI agents across the East River to Brooklyn federal court. They were released on bail this afternoon and are scheduled to appear again in court July 18.
Cioffi's lawyer criticized Brooklyn U.S. Attorney Benton Campbell for ordering the arrests, saying it was an effort by the government to make an example of innocent men. The case was filed in Brooklyn because of the location of a Bear Stearns facility in that judicial district, prosecutors said.
``Because his funds were the first to lose might make him an easy target but doesn't mean he did anything wrong,' said defense lawyer Edward Little.
Susan Brune, a lawyer for Tannin, also said her client is innocent and that he ``is being made a scapegoat.'
Three months after Cioffi left Bear Stearns in December, 85-year-old Bear Stearns was purchased by JPMorgan Chase & Co. for about $1.4 billion in stock. Demands by clients and lenders for payment had threatened bankruptcy on the firm, which was worth almost $25 billion as recently as January 2007.
Federal Probe
In a separate move today, the U.S. government said more than 400 people were charged in a federal mortgage-fraud sweep called ``Operation Malicious Mortgage.'
At a press conference today in Brooklyn, Campbell said the Bear Stearns investigation is continuing.
``Hedge fund managers cannot lie to their own investors,' Antonia Chion, an SEC attorney overseeing the agency's lawsuit, said in a statement. ``Even sophisticated investors look to fund managers to speak truthfully.'
Cioffi managed the two funds that collapsed, and Tannin served as his chief operating officer. The investment bets by the funds, which put most of their assets in subprime-mortgage- related securities, failed last June when prices for collateralized-debt obligations linked to loans fell amid rising late payments by borrowers with poor credit or heavy debt.
The indictment described e-mails allegedly sent by the two men suggesting they knew the funds were headed for trouble while they told investors they were ``comfortable' with the holdings.
Informal Meeting
On March 2, 2007, Cioffi hosted a meeting attended by Tannin and other members of the funds' portfolio management team, according to the indictment. Cioffi said ``the funds had averted disaster and led a vodka toast to celebrate surviving the month,' according to prosecutors.
He directed those at the meeting ``not to talk about the funds' difficulties with others, including other members of the funds' team,' who weren't present, the indictment alleged.
The indictment alleged that, throughout March 2007, Cioffi ``consistently acknowledged' to Tannin and others that he was ``deeply concerned' about the state of the funds, particularly because of their exposure to the subprime mortgage market.
On March 15, 2007, Cioffi allegedly wrote an e-mail to an unnamed colleague saying, ``I'm fearful of these markets. Matt said it's either a meltdown or the greatest buying opportunity ever. I'm leading toward the former.'
Bond Securities
Tannin e-mailed Cioffi in April saying he was afraid the market for bond securities they had invested in was ``toast,' and suggested shutting the funds, prosecutors alleged.
On April 25, three days after that e-mail, Tannin told investors on a conference call he was ``very comfortable with exactly where we are,' adding, ``there's no basis for thinking this is one big disaster.'
On that call, Cioffi omitted any reference to $67 million in fund redemption for April and May 2007, according to the indictment. He said June redemptions were only ``a couple million' when in fact they totaled $47 million, including part of a $57 million redemption by an unnamed major investor, prosecutors alleged.
``By March 2007, Cioffi, Tannin and others believed the funds were in grave condition and at risk of collapse,' Campbell said. ``Cioffi and Tannin agreed to make misrepresentations in the ultimately futile hope that the funds' bleak prospects would change.'
`Their Scheme'
``The defendants lied about what investors called `skin in the game,' namely whether they had personally invested their own money in the funds,' Campbell said. He added that, ``in the hedge fund world, `skin in the game' is vitally important to investors because it shows the manager's faith in the funds.'
Columbia Law School professor Richman said the defendants will likely ``say that they were acting in good faith, based on a faulty understanding of the market.'
Cioffi, now with Tenafly-based RCAM Capital LP, left Bear Stearns amid inquiries by prosecutors and the SEC into whether he withdrew $2 million from two funds before their collapse in July, three people with knowledge of the matter said at the time. He was relieved of his duties as a fund manager in June, when his funds' subprime investments began to unravel.
Cioffi was born in 1956 and grew up in South Burlington, Vermont, a city of 16,500 that borders Lake Champlain. He went to Rice Memorial High School and St. Michael's College, three miles from each other in South Burlington and Colchester.
Running Back
He was a running back, fullback and offensive guard on the Rice football team and a bodybuilder while at St. Michael's, according to a Rice official. An A student in math and economics in high school, Cioffi studied business administration in college and graduated with honors in 1978.
Tannin had been with Bear Stearns since 1994, according to a company prospectus. He spent seven years on the CDO structuring desk, and from 2001 to 2003, followed the CDO market as a research analyst in Bear's asset-backed research group.
A lawyer, Tannin has a Juris Doctor from the University of San Francisco and was a clerk for a California appeals court.
``Dozens of banks around the world have lost over $300 billion,' Little said after his client appeared in court. ``Why is Ralph Cioffi being charged in this case? Is it because his fund was coincidentally the first fund to have losses?'
Two Hours
Two hours after they were arrested, both men were walked out of FBI headquarters looking straight ahead with their hands cuffed behind their backs. More than two dozen reporters, photographers and television cameramen watched as Cioffi, wearing a blue blazer, tan slacks and no tie, and Tannin, wearing a blue suit and tie, were led into separate vehicles. Neither man made any comment.
Today wasn't the first time that New York prosecutors paraded Wall Street executives in ``perp walks' before cameras. In 1987, agents arrested risk arbitrage chief Robert Freeman in his office at Goldman Sachs & Co. and escorted him past waiting reporters to face insider trading charges. He pleaded guilty in 1990.
Blocks away, federal agents slapped handcuffs on Kidder, Peabody & Co. trader Richard Wigton and walked him past colleagues. Prosecutors dismissed the charges months later.
Cioffi and Tannin made their initial court appearances this afternoon before U.S. Magistrate Judge Steven Gold. They didn't enter pleas.
$4 Million Bond
Cioffi was released on $4 million bond secured by his home in Tenafly and property in Naples, Florida. Little said both properties were worth more than $1 million. Tannin was released on $1.5 million bond, secured by his apartment on Manhattan's Upper West Side. The case has been assigned to U.S. District Judge Frederic Block.
Since the failure of the two funds, investors claimed in lawsuits that banks and financial companies such as New York- based Bear Stearns knew their underlying investments weren't worth what they were telling shareholders.
CDOs are created by packaging assets including bonds and loans and using their income to pay investors. The securities are divided into different portions of varying risk and can offer higher returns than the debt on which they are based.
Two Funds
The two Bear Stearns funds are part of Bear Stearns Asset Management Inc. They were the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd. and the Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd.
Investors in the two funds, which filed for bankruptcy in July, lost $1.6 billion. Barclays Plc said in a lawsuit that the funds once held a total of about $20 billion in assets.
Cioffi pulled $2 million of his own money, one third of the amount he'd invested in one of the funds, before March 2007, so he could commit it to another fund he set up, Campbell said. The withdrawal occurred before the funds ran into trouble, he said.
As the securities dropped in value, the funds' creditors demanded more collateral. Bear Stearns extended $1.6 billion in credit to one of the funds before seizing its assets in July. Both funds sought court protection two weeks after the firm told investors they would get little if any money back.
The funds tried to liquidate in the Cayman Islands before a U.S. judge held that New York was a more appropriate jurisdiction and that they can't shield their U.S. assets from lawsuits.
Barclays, the U.K.'s third-biggest bank, claimed in its lawsuit, filed last year in Manhattan federal court, that it was misled about the health of Bear's so-called enhanced fund.
Lawsuit Defendants
Bear Stearns, Cioffi and Tannin are named as defendants in London-based Barclays suit. The bank accused Cioffi of withdrawing his $2 million at the same time Bear persuaded Barclays to double its investment.
The suit cites a February e-mail to Barclays in which Tannin allegedly said the fund is ``having our best month ever' and that our ``hedges are working beautifully.'
By then, the fund was having ``severe' liquidity problems, said Barclays, which added that it lost ``hundreds of millions of dollars' as a result. Internally, Cioffi and Tannin discussed the ``wipe out' of the fund, according to the complaint.
Elizabeth Ventura, a spokeswoman for New York-based Bear Stearns, didn't return a call seeking comment.
Reliance on E-Mail
The reliance in part on e-mail as evidence in the federal indictment didn't come as a surprise to defense attorney James Batson, who said people often forget or disregard how easily messages can be retrieved.
``They think they're on the phone,' said Batson. ``There's a conversational aspect of e-mail that sucks one into thinking they're having a psychological conversation,' he said, adding ``there's none of the indicia that you're doing something that's permanent.'
In the case of former Credit Suisse Group banker Frank Quattrone, who was accused in 2003 of hindering a government probe of his Zurich-based employer, the chief piece of evidence was an e-mail.
Quattrone advised employees to ``clean up' their files. Prosecutors alleged he sent the message to suggest subordinates destroy records, after learning a grand jury was probing how Credit Suisse doled out shares in initial public offerings.
The government dismissed the case against him in August after one jury failed to reach a verdict and a second panel's conviction was overturned by an appeals court.
``The Department of Justice has been asleep at the wheel,' Reverend Jesse Jackson, president of the Rainbow PUSH Coalition, said in a statement of today's arrests. ``The government has bailed out Bear Stearns and other Wall Street firms; it must take comprehensive measures to bail out America's homeowners.'
While he praised the indictment of Cioffi and Tannin, he said not enough has been done to help consumers and homeowners.
``The victims of the sub-prime, sub-crime mortgage crisis must have immediate relief; the victimizers must meet their day in court.'
The case is U.S. v. Cioffi, 08-00415, U.S. District Court for the Eastern District of New York (Brooklyn).
To contact the reporters on this story: Patricia Hurtado in U.S. District Court for the Eastern District of New York in Brooklyn at pathurtado@bloomberg.net; Thom Weidlich in U.S. District Court for the Eastern District of New York in Brooklyn at tweidlich@bloomberg.net.
News 
Market Data 
Discover 
AI
