By Patricia Hurtado and David Scheer
June 19, 2008 (Update1)
SourceJune 19 (Bloomberg) -- Former Bear Stearns Cos. hedge fund managers Ralph Cioffi and Matthew Tannin, arrested early this morning at their homes in New Jersey and Manhattan, were indicted for mail fraud and conspiracy to commit securities fraud, the first prosecution in a U.S. crackdown on subprime fraud.
The two men were charged with misleading investors about the health of two Bear Stearns hedge funds whose collapse last year ignited the subprime mortgage crisis. Cioffi was also charged with insider trading. The Securities and Exchange Commission sued the men today, claiming they duped investors before the funds imploded.
Federal prosecutors and regulators have 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.
``The arrests are appropriate given the magnitude and the egregiousness of their alleged misconduct,'' said attorney Steven Caruso, who is representing investors in arbitration claims against the funds. Cioffi and Tannin engaged in a ``gross violation of the public trust.''
Cioffi, 52, was arrested at his Tenafly, New Jersey, home and Tannin, 46, at his Manhattan apartment, said James Margolin, a spokesman for the Federal Bureau of Investigation's New York office. The two men were fingerprinted at FBI headquarters in Manhattan, then taken in handcuffs by six FBI agents to be transported across the East River to Brooklyn federal court for an appearance later today in connection with an indictment.
`Credit Crisis'
The collapse of the hedge funds began a credit squeeze that led to lawsuits against Countrywide Financial Corp., American Home Mortgage Investment Corp., Citigroup Inc. and JPMorgan Chase & Co.
After demands by clients and lenders for payment threatened Bear Stearns with bankruptcy, the 85-year-old firm agreed to sell itself to New York-based JPMorgan in March.
If convicted of conspiracy to commit securities fraud, wire fraud or mail fraud, the defendants face as long as 30 years in prison. Cioffi's lawyer attacked the arrests, triggered by an investigation by U.S. Attorney Benton Campbell, as an effort by the government to make an example of innocent men.
``Because his funds were the first to lose might make him an easy target but doesn't mean he did anything wrong,'' said Edward Little, Cioffi's lawyer, in a statement. ``Cioffi had no motive to do anything wrong. He did not and could not have profited by doing anything the government now claims he did.''
Susan Brune, a lawyer for Tannin, also said her client is innocent and that he ``is being made a scapegoat for a widespread market crisis.''
SEC spokesman John Nester declined to comment.
Cioffi, Tannin
Cioffi managed the two funds that collapsed, and Tannin served as his chief operating officer. The hedge funds invested almost all of their assets in subprime-mortgage-related securities. Their investment bets failed last June when prices for collateralized-debt obligations, called CDOs, linked to loans plummeted amid rising late payments by borrowers with poor credit histories or heavy debt.
U.S. prosecutors are focusing on an e-mail allegedly sent by the two suggesting that their funds were headed for trouble, four days before they told investors they were comfortable with their holdings, the Wall Street Journal reported today, citing people familiar with the situation.
Tannin allegedly e-mailed Cioffi saying he was afraid that the market for bond securities they had invested in was ``toast,'' and suggested shutting the funds, the Journal said. The two have told colleagues that they quickly were convinced that Tannin's concerns were misplaced, according to the Journal.
`Floodgates'
Indictments against Cioffi and Tannin might lead to a cascade of criminal cases and civil suits, said former prosecutor Robert Bunzel, a white-collar criminal defense lawyer in San Francisco.
``The floodgates could open,'' Bunzel said.
In a separate move today, two government officials said more than 400 people have been charged in a U.S. Justice Department mortgage-fraud sweep.
Called Operation Malicious Mortgage, the arrests are to be announced this afternoon by FBI Director Robert Mueller and Deputy Attorney General Mark Filip at the Justice Department in Washington. A number of arrests were made earlier this week and the FBI is still tallying the final numbers, said the officials who requested anonymity.
New Job
Cioffi, now with Tenafly-based RCAM Capital LP, left Bear Stearns in December 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 mortgage investments began to unravel.
Cioffi was born on Jan. 5, 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 down the road from each other in the neighboring towns of South Burlington and Colchester.
He was a running back, fullback and offensive guard on the Rice football team and worked at bodybuilding at St. Michael's. He was an A student in math and economics in high school, a Rice official said. At St. Michael's, he studied business administration and graduated with honors in 1978.
Tannin
Tannin had been with Bear Stearns since 1994, according to a company prospectus. He spent seven years on the CDO structuring desk focusing on emerging markets, high grade and market value transactions. From June of 2001 through February 2003, he followed the CDO market as a research analyst in Bear's asset- backed research group.
Tannin, a lawyer, has a Juris Doctor from the University of San Francisco and served as a clerk for a California appeals court. He was also a Preston Warren scholar in philosophy at Bucknell University.
Today, both men walked out of FBI headquarters in lower Manhattan 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.
Since the failure of the two Bear Stearns hedge funds, investors claimed in lawsuits that banks and financial companies such as the New York-based securities firm knew their underlying investments weren't worth what they were telling shareholders.
New Chapter
Today's arrests ``signal a new chapter in the subprime debacle,'' defense lawyer Bunzel said.
Investors in the two Bear funds, which filed for bankruptcy in July, lost $1.6 billion. Barclay's Bank PLC said in a lawsuit that the funds once held a total of about $20 billion in assets.
Cioffi allegedly pulled the $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, said a person familiar with the investigation. The withdrawal occurred before the funds ran into trouble, the person said.
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.
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.
More Collateral
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 filed for bankruptcy protection two weeks after the firm told investors they would get little if any money back.
The hedge funds tried to liquidate in the Cayman Islands before a U.S. judge held that New York was a more appropriate jurisdiction, ruling they can't shield their U.S. assets from lawsuits.
Barclays PLC, the U.K.'s third-biggest bank, claimed in its lawsuit, filed last year in federal court in New York, that it was misled about the health of Bear's so-called enhanced fund.
Bear Stearns, Cioffi and Tannin are named as defendants in London-based Barclays suit. The British bank accused Cioffi of withdrawing his $2 million at the same time Bear persuaded Barclays to double its investment, according to the complaint.
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.''
Liquidity Problems
By then, the fund was having ``severe'' liquidity problems, said Barclays, which said 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.
Prosecutors relied on e-mail in another high-profile case. Former Credit Suisse Group banker Frank Quattrone was accused in 2003 of hindering the government's probe of Zurich-based Credit Suisse. The chief piece of evidence was an e-mail Quattrone wrote advising employees to ``clean up'' their files. Prosecutors said he sent the message, suggesting 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 Quattrone in August 2007, after one jury failed to reach a verdict and a second jury's conviction was overturned by an appeals court. Quattrone said in March that he is starting his own firm focused on technology companies.
Elizabeth Ventura, a spokeswoman for New York-based Bear Stearns, didn't return a call seeking comment.
The case is U.S. v. Cioffi, 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; David Scheer in New York at
dscheer@bloomberg.net.
Last Updated: June 19, 2008 12:40 EDT