Monday, June 23, 2008

Bear Stearns Emails Detail Hedge Fund Losses

Email messages allegedly sent by two ex-Bear Stearns Cos. hedge fund managers indicted for fraud show even sophisticated professionals disregard the dangers of putting sensitive information in e-mails.

Ralph Cioffi, 52, and Matthew Tannin, 46, were charged last week with misleading investors by saying two funds were thriving while knowing subprime-mortgage investments threatened their collapse. Investors in the funds lost $1.6 billion. The indictments cited e-mails from both business and personal accounts in which the men described looming problems.

Cioffi and Tannin are the first to be indicted over charges relating to last year's subprime mortgage crisis. The government is continuing its probe of banks and mortgage firms whose losses in subprime loans and related securities total $397 billion.

The men were each charged in federal court in Brooklyn, New York, with conspiracy, securities fraud and wire fraud. Cioffi also was charged with insider trading. They face as much as 20 years in prison if convicted on the most serious counts. Both men denied the charges and vowed to win at trial.

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 indictments brought to light e-mail conversations that allegedly took place between the two men and others about the health of the funds, including a March 15, 2007, message from Cioffi to a team economist with the subject line ``Fear.''

"As we discussed it may not be a meltdown for the general economy but in our world it will be,'' the indictment quotes Cioffi as writing. "Wall Street will be hammered with lawsuits. Dealers will lose millions and the CDO business will not be the same for years.''

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.

"E-mail is very stark; it's something you put up on the screen in front of a jury and you can center your whole case around that language,'' Hochberg said.

Using a personal e-mail account, rather than a business account, can still implicate a defendant, ex-prosecutors said.

According to the indictment, Tannin sent an e-mail from a personal account to the personal e-mail account of Cioffi's wife.

"The subprime market is pretty damn ugly,'' Tannin wrote in the message, according to the indictment. "I think we should close the funds now.''

While e-mails can be easily retrieved from business or commercial Internet service-providers, many defendants use the medium with the belief that it's private communication, prosecutors said. Just using e-mail itself can be used by the government as evidence of guilt, one former prosecutor said.

"If you have one or a handful of damning e-mails on a personal account, prosecutors will argue that use of e-mail is consciousness of guilt because they took a route to communication that they thought wouldn't be discovered,'' said Daniel Horwitz, a former assistant district attorney in Manhattan, now a partner at the law firm Dickstein Shapiro.

Cioffi acknowledged in a private e-mail that certain types of CDOs, which included subprime debt, rated AAA or AA were "not really AAA,'' because they were subject to heightened risk of defaults, according to the indictment.

Differences between defendants' public and private communications can help prosecutors show that they were telling the truth when their guard was down, legal experts said.

Cioffi said in another e-mail that a fund's loss in February was the result of a failure to properly hedge market volatility, prosecutors said. The following month, he told investors "we were effectively able to hedge.''

The case is U.S. v. Cioffi, 08-00415, U.S. District Court, Eastern District of New York (Brooklyn).

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