Risk Management

A Hedge Too Far: Bear Ex-Managers Arrested

U.S. attorney in New York expected to explain case today against two who led a failed fund heavy with subprime mortgage investments.
Stephen TaubJune 19, 2008

Former Bear Stearns hedge-fund managers Matthew Tannin and Ralph Cioffi were arrested, and are expected to be indicted on securities fraud charges after a year-long federal investigation that looked into the collapse of their subprime-mortgage-investment-heavy fund.

Separately, after their arrest the Securities and Exchange Commission charged the pair with fraudulently misleading investors about the financial state of the firm’s two largest hedge funds and their exposure to subprime mortgage-backed securities before the collapse of the funds in June 2007. The SEC said the action was conducted through its Enforcement Division’s subprime working group, “which is aggressively investigating possible fraud, market manipulation, and breaches of fiduciary duty that may have contributed to the recent turmoil in the credit markets.”

The two were arrested at their homes, according to press reports, and NPR said the U.S. attorney’s office is expected to call a press conference today to discuss details. The NPR website said that the two are the highest-level Wall Street executives to be charged so far in connection with the mortgage crisis.

Prosecutors are expected to allege that the two told investors that two of their funds were doing well, while privately telling colleagues they were worried about the funds’ prospects, according to the reports. The key to the case will be a number of E-mails between the two men, in which they worried about the downturn in the mortgage market just four days before telling investors all was well, according to The Wall Street Journal.

According to the paper, Tannin used his private account to E-mail his more senior colleague Cioffi that he feared the market for complex bond securities in which they had invested was “toast.”

NPR noted that when the two hedge funds collapsed, investors lost about $1.6 billion. According to the Associated Press, an attorney for Tannin said he was “was being made a scapegoat for a widespread market crisis,” and “looks forward to his acquittal.” The wire service said Cioffi’s attorney declined comment.

The SEC’s complaint alleges that when the hedge funds took increasing hits to the value of their portfolios during the first five months of 2007 and faced escalating redemptions and margin calls, Cioffi and Tannin deceived their own investors and certain institutional counterparties about the funds’ growing troubles until they collapsed and caused investor losses of approximately $1.8 billion.

The Commission is seeking permanent injunctive relief, disgorgement of all illegal profits plus prejudgment interest, and the imposition of civil monetary penalties.

“Hedge fund managers owe serious obligations to investors in their funds, and the Commission will be unyielding in its commitment to vigorous investor protection by enforcing the securities laws against them whenever warranted,” said SEC Chairman Christopher Cox. “Hedge funds are by no means unregulated when it comes to fraud. Those who commit fraud at the expense of investors will always be the target of a relentless SEC.”

Lawyers for Cioffi and Tannin did not immediately respond to requests by CFO.com for comment. However, according to the AP, Tannin attorney Susan Brune said her client “is innocent,” and added that he “is being made a scapegoat for a widespread market crisis. He looks forward to his acquittal.” The wire service said that Cioffi’s attorney had declined comment.