Ralph Cioffi and Matthew Tannin, ex-Bear Stearns hedge fund managers, were arrested today and charged with mail fraud and conspiracy to commit securities fraud.
The first prosecution in U.S. regulators' crackdown on sub-prime fraud (which has a total loss close to $400 billion so far), Cioffi and Tannin are charged with misleading investors about the prospect of two Bear Stearns hedge funds whose collapse last year started the sub-prime mortgage crisis. Cioffi was also charged with insider trading and the SEC is also suing the men for duping investors before the funds imploded.
The collapse of the Bear Stearns hedge funds ignited the credit crisis and many lawsuits against Countrywide Financial, American Home Mortgage Investment, Citigroup and JPMorgan Chase have followed. Some lawsuits against Bear Stearns are accusing the firm of knowing the investments in the two failed hedge funds weren't worth what they were telling shareholders. Bear Stearns was forced to sell itself at a discount to J.P. Morgan to avoid bankruptcy this past March.
If Cioffi and Tannin are convicted of conspiracy to commit securities fraud, wire fraud or mail fraud, they can face up to 30 years in prison.
Cioffi was the manager and Tannin was the chief operating officer of the two failed Bear Stearns hedge funds (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.) The funds invested close to all of their assets in sub-prime-mortgage-related securities. Their investment bets imploded last June when prices for collateralized-debt obligations (CDOs) linked to loans plummeted amid default by borrowers who shouldn't have qualified for the loans in the first place.
According to the Wall Street Journal, the smoking gun is in an e-mail allegedly sent by Cioffi and Tannin suggesting that their funds were headed for trouble when four days later, they told investors they were comfortable with their holdings. 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. But Cioffi and Tannin have told colleagues that they quickly were convinced that Tannin's concerns were misplaced.
Cioffi left Bears Stearns last December amid prosecutors and the SEC's investigation into whether he withdrew $2 million of his money from the two hedge funds before their collapse in July. Investors lost $1.6 billion in the two Bear Stearns funds which once held $20 billion in assets. The funds filed for bankruptcy last July.
Barclays PLC, the Britain's third-biggest bank, claimed in its lawsuit against Bear Stearns that it was misled about the health of Bear's so-called enhanced fund. Barclays suit is also accusing Cioffi of withdrawing his $2 million at the same time Bear Stearns persuaded Barclays to double its investment in the hedge funds. Barclays suit cites a February e-mail from Tannin to Barclays in which Tannin allegedly said the fund is "having our best month ever'' and that our "hedges are working beautifully.'' However, Barclays said at the time, the fund was having "severe'' liquidity problems and had lost hundreds of millions already. Plus, internally, Cioffi and Tannin had discussed the "wipe out'' of the fund.
Cioffi and Tannin's indictment may open the floodgates and lead to a flood of criminal cases and civil suits against brokerage firms and their brokers. Separately today, the U.S. Justice Department already charged more than 400 people in a mortgage-fraud sweep they're calling Operation Malicious Mortgage.
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