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"Bear Stearns hit by fraud charges, losses
Jennifer Levitz and Kate Kelly | November 16, 2007
BEAR Stearns, seeking to put its mortgage-trading woes behind it, faces a double dose of bad news.
The Wall Street securities firm has warned investors it will take a writedown of $US1.2 billion ($1.3 billion) for the fourth quarter related to mortgage securities - creating the first quarterly loss in its 84-year history. Separately, Massachusetts regulators accused Bear of fraud for improperly trading mortgage-backed securities with two internal hedge funds that collapsed this northern summer.
Regulators in the office of Secretary of State William Galvin, say Bear employees improperly made "hundreds" of principal trades for the firm's own account with the hedge funds without notifying the funds' independent directors in advance.
Bear declined to comment.
The parallel developments underscore the rough shoals facing Bear, a high-profile trading firm that long has been known for making calculated bets in the bond markets.
Since June, when the two funds began melting down, Bear has been buffeted by a combination of turbulence in the market for mortgage-related securities and internal disarray, capped by the August ouster of the firm's long-time co-president, Warren Spector. Bear's chief financial officer, Samuel Molinaro, disclosed the writedown, which relates to the firm's positions in collateralised debt obligations, complex mortgage-backed securities known as CDOs, and other like-holdings.
The size of the writedown might change during the last two weeks of the quarter, which ends on November 30. Bear's stock, which had shed more than 30 per cent this year, was up $US2.40, or 2.4 per cent, at $US103.27 on the New York Stock Exchange. Some analysts are negative. Fitch Ratings cut Bear's short-term credit rating, and Moody's Investors Service said it may cut Bear's long-term rating.
At issue in the Massachusetts case, is a federal securities law that requires financial firms making principal trades with affiliated funds to notify the fund's investment advisers in advance of such trading. According to the Bear funds' offering documents, the sign-off of two independent directors was required before the entities could make trades with Bear to ensure the fairest prices.
According to the administrative complaint, 47 per cent of the principal trades conducted by the less risky of the two funds between 2003 and 2006 didn't secure such approval.
Investors lost $US1.6 billion when the funds collapsed in July. Unauthorised trades between Bear's two hedge funds and its brokerage firm abounded during the three-year period after the less-risky fund was opened in 2003, according to the complaint.
On July 19 last year, the filing states, a Bear sales assistant sent an email to the compliance officer for the independent directors, requesting approval for 88 principal trades that had occurred since January of that year. Later, realising it had run afoul of its own rules, Bear put a moratorium on all trades between the brokerage and the fund, which extended, with some exceptions, until May or June this year, the complaint alleges.
The current independent directors, both executives at Walkers SPV - a fund administrator in the Cayman Islands, where both funds were incorporated - refused to respond to a subpoena with questions about potential conflicted trades, according to Mr Galvin.
Mr Galvin said, "This is a recurring theme in the financial-services industry - conflicts of interest - and part of the reason we got to this," referring to the mortgage area.
The complaint doesn't say that the trades hurt the value of the funds. In May of this year,
Everquest Financial, a company backed by Bear and the two hedge funds, filed with regulators to go public, with Bear as underwriter. In creating Everquest in preparation for the offering last northern autumn, Bear transferred hedge-fund assets to Everquest.
The offering was eventually cancelled. According to the Massachusetts complaint, some of these assets were marked down, or valued at a lower price, by Bear during their transfer."
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*IMPORTANT* Notice to the Naive: Although Bear Stearns’s squeak-toy EMC is essentially out of business for all practical purposes and the Bear Stearns mortgage fraud unit will likely fail in early 2008, this does NOT mean you will be off the hook if you are currently in mortgage hell with EMC/Bear Stearns. You can't be sure the sun will rise tomorrow but this much you can be sure of: EMC and Bear Stearns WILL COLLECT all legit debts and many invalid debts.
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