In the spring of 2007, as the mortgage market came unglued, two Bear Stearns executives shared their growing fears in a series of e-mail messages to each other about the perilous condition of the giant hedge funds they oversaw.
“I’m fearful of these markets,” one wrote.
The other said later, “Believe it or not — I’ve been able to convince people to add more money.” He concluded that “I think we should close the funds now.”
But three days later, the pair, Ralph R. Cioffi and Matthew M. Tannin, presented an upbeat picture to worried investors without disclosing that the two funds were plummeting in value and that Mr. Cioffi had already pulled some assets from one of them.
A little more than a month later, the funds, filled with some of the most explosive and high-risk securities available, imploded, evaporating $1.6 billion of investor assets and setting off a financial chain reaction that has rattled global markets, caused more than $350 billion in write-downs, cost a number of executives their jobs and culminated in the demise of Bear Stearns itself.
On Thursday, Mr. Cioffi and Mr. Tannin surrendered to federal agents at 7 a.m. They were fingerprinted and taken in handcuffs to the federal courthouse in Brooklyn where they were charged with nine counts of securities, mail and wire fraud.
The two men, who were forced out of their jobs last year, are the first senior executives from Wall Street investment banks to face criminal charges stemming from the credit mess, and the investigation by federal prosecutors based in Brooklyn is likely to become a test case of the government’s ability to make successful prosecutions of arcane financial transactions.
“This is not about mismanagement of a hedge fund investment strategy,” said Mark J. Mershon, the head of the New York office of the Federal Bureau of Investigation, at a news conference Thursday. “It is about premeditated lies to investors and lenders.”
Yet, despite the drama, there is no guarantee that cases that rely on e-mail exchanges and unclear states of mind result in jail time. In one prominent case involving e-mail exchanges, for example, charges were ultimately dropped against Frank P. Quattrone, the high-level Credit Suisse banker accused of interfering with a government investigation.
Despite the publicity surrounding the Enron scandal, some high-profile cases, which like this one were based on e-mail exchanges and complicated financial arrangements, were successfully challenged.
“We have to be wary of a rush to judgment,” said Robert A. Mintz, a former federal prosecutor and a lawyer at McCarter & English. “The question is whether these managers crossed the line from permissible spin to willful misrepresentation.”
Mr. Cioffi posted bail of $4 million, secured by his house in Tenafly, N.J., property in Naples, Fla., and a $600,000 individual retirement account. Mr. Tannin’s bail was $1.5 million, to which he attached an apartment on West End Avenue in Manhattan.
Despite the highly complex nature of the subprime investments, the government’s base claim is simple: Mr. Cioffi and Mr. Tannin, in a desperate bid to keep fretful investors from heading for the exits, deceived investors by not disclosing how badly the two funds were doing.
In an indictment made public Thursday, prosecutors relied heavily on e-mail exchanges between Mr. Cioffi and Mr. Tannin in trying to paint a picture of fear and desperation inside Bear Stearns as the firm grappled with a crisis that would eventually lead to its end.
In a statement, Edward J. Little, a lawyer for Mr. Cioffi, said that the credit market had spread losses throughout Wall Street. “Ralph Cioffi’s funds lost money in exactly the same way,” Mr. Little said. “Because his funds were the first to lose might make him an easy target, but doesn’t mean he did anything wrong."
Susan Brune, a lawyer for Mr. Tannin, said her client had been made a scapegoat for the wider market crisis.
The two funds had names as abstruse as the complex subprime securities in their portfolios — High Grade Structured Credit Strategies Fund and its riskier sister offering, the High Grade Structured Credit Strategies Enhanced Leverage Fund.
Overseen by Mr. Cioffi, a well-regarded executive with more than 22 years of experience at Bear Stearns, the funds were in essence a symbol of the frenzy and greed that characterized the booming subprime mortgage market from 2003 through 2006. The funds were highly leveraged, in some cases borrowing as much as $20 for every dollar invested and were sold to Bear’s most exclusive clients.
Through 2006, the High Grade fund did well, gaining as much as 40 percent in one year. In August, to satisfy demand from clients, Bear started a second fund at what would prove to be the top of the market.
According to the indictment, Mr. Cioffi and Mr. Tannin became aware of the funds’ difficulties in March. Mr. Cioffi gathered his team and led a vodka toast in celebration of their overcoming a rocky February. But as the markets got worse, Mr. Tannin became increasingly worried about the funds’ exposure to securities backed by subprime mortgages.
Mr. Cioffi calmed him: “We are not 19 year olds in Iraq,” he said in an e-mail message that was part of the indictment. But his own worries were growing. After a bad March, he told a colleague, “I’m sick to my stomach over our performance in March.”
The indictment claims that the two men hid their concerns from investors, lenders and even Bear’s own brokers. “We have an awesome opportunity,” Mr. Cioffi said to a Bear Stearns broker. Mr. Tannin congratulated himself: “Believe it or not I’ve been able to convince people to add more money,” he said to a colleague.
In late March, the indictment claims that the funds’ decline prompted Mr. Cioffi to transfer $2 million out of the $6 million he had in the Enhanced Fund and put it in a less risky fund that was showing better performance.
Prosecutors claim that the move — which he never disclosed to outside investors who themselves were desperate to exit — was proof that he was putting his interests ahead of clients.
Bear Stearns and Mr. Cioffi’s lawyers say that there was no such motive and that Mr. Cioffi’s investment was done in support of the other fund in which he was not previously invested and that he managed.
In late April, investors were becoming concerned. One investor tried to pull $57 million. Mr. Cioffi, in a bid to keep the investor in the fund, said that he himself had $8 million invested. The indictment says that was a lie.
A few days later, Mr. Tannin, who was known within the group as a worrier, sent an e-mail message to Mr. Cioffi in which he suggested closing down the funds after a report showed that the securities they were holding were rapidly losing value. “If the report was true, the entire subprime market was toast,” he wrote to Mr. Cioffi. The subprime market looked “pretty dam ugly,” he wrote from his home, early Sunday morning.
It was a radical proposition from one of the funds’ managers, and Mr. Tannin took the precaution of not using Bear’s e-mail system, prosecutors said. He sent the note to the e-mail account of Mr. Cioffi’s wife.
A few days later, on an April 25 conference call, Mr. Cioffi and Mr. Tannin presented a sanguine face to investors, arguing that the funds were in good shape.
The two managers did all they could to right their sinking funds, even going so far as to pitch to their group’s pricing team that the securities should receive higher values, thus mitigating the funds’ decline, according to the indictment. Their request was rejected.
In June, as the market continued its descent, Mr. Cioffi told investors that they could not withdraw funds. Despite a last-ditch effort by Bear Stearns to bail the funds out by offering a $3.2 billion loan, clients in both funds lost 100 percent of their investments.Just before the funds’ collapse, Mr. Cioffi, who just a year earlier was making an eight-figure salary, gave voice to his fears. “I’ve effectively washed a 30-year career down the drain,” he said.
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