Former Fund Managers Face Fraud Charges In Credit Crisis
Friday, June 20, 2008
Two former Bear Stearns hedge fund managers were arrested yesterday and charged with fraud related to the collapse of a pair of investment funds that helped usher in the current financial crisis that grew out of the meltdown of the subprime mortgage market. They are the first top Wall Street executives to face criminal charges in connection with the crisis.
Federal agents arrested Ralph Cioffi, 52, and Matthew Tannin, 46, at their New York-area homes before marching them in handcuffs to their arraignment in federal court in Brooklyn, where they were formally charged with mail fraud, wire fraud and conspiracy. The charges capped a nearly year-long investigation into the management of the hedge funds.
The indictment alleges that the two men misled investors by offering upbeat assessments of the fiscal health of two Bear Stearns hedge funds, even as these executives harbored deep doubts about their viability. Cioffi was also charged with insider trading for allegedly moving $2 million of his personal money out of one of the funds, which were heavily invested in subprime-mortgage-backed securities, and into a better-performing fund he managed. The two men each face as much as 25 years in prison if convicted.
When the two funds run by one of Wall Street's most venerable firms crashed last June, it sent tremors through the financial world and became a harbinger of the chaos that followed as the mortgage problems roiled credit markets across the world. The arrests now symbolize the newest chapter of the crisis, in which law enforcement officials and regulators are beginning to seek accountability from those they accuse of fanning the crisis.
The indictments yesterday could well be followed by others, as federal officials announced they were conducting 19 corporate-fraud investigations of firms that had a role in the subprime debacle. "The majority of these corporate-fraud investigations address accounting fraud, insider trading and, with criminal intent, the failure to disclose the proper valuation of the securitized loans and derivatives," said FBI Director Robert S. Mueller III.
In a separate civil complaint, the Securities and Exchange Commission yesterday alleged that in the first five months of 2007, Tannin and Cioffi "deceived their own investors, as well as the fund's institutional counterparts, by fraudulently concealing from them the full extent of the fund's deepening troubles."
The indictment relies heavily on e-mails from the two men to make the government's case. The e-mails cited in the indictment are offered as evidence of Tannin and Cioffi's concerns about the funds' performance and their desire to conceal those worries to protect "their incomes and reputations."
In an e-mail written from his personal account on a Sunday in April 2007, two months before the two funds imploded, Tannin recommended to Cioffi that they either shut the funds or change their investment strategies, the indictment alleges. "[T]he subprime market looks pretty damn ugly. . . . If we believe [our internal modeling] is ANYWHERE CLOSE to accurate I think we should close the funds now. The reason for this is that if [our internal modeling] is correct then the entire subprime market is toast."
The next day, Tannin cautioned Cioffi against disclosing any information to other fund employees that would indicate the dire straits they could be in, the indictment says. Days later, the two told senior managers at Bear Stearns that the funds were in good shape and would continue to be successful. In a conference call with investors a day after that, Tannin said: "We're very comfortable with exactly where we are."
Cioffi and Tannin were named in lawsuits brought last year by hedge fund investors, including Barclays Bank, that alleged they were intentionally misled by the fund managers.
Lawyers for the two indicted men said their clients were caught off guard by the collapse of the subprime market. "The subprime crisis took everyone by surprise, including the Fed and Treasury, and dozens of the largest financial institutions have lost over $300 billion to date on the same investments," said Cioffi's lawyer, Edward Little, in a statement. "Ralph Cioffi's funds lost money in exactly the same way. Because his funds were the first to lose might make him an easy target but doesn't mean he did anything wrong. Indeed, Mr. Cioffi had no motive to do anything wrong. He did not and could not have profited by doing anything the government now claims he did."
Susan Brune, Tannin's lawyer, said: "Matt Tannin is innocent. He is being made a scapegoat for a widespread market crisis. He looks forward to his acquittal."
The collapse of the hedge funds run by Bear Stearns was the first indication of how widespread the subprime mortgage crisis had become and how exposed some of the financial world's most respected players could be. The tremors started by the collapse of the funds began to erode faith in Bear Stearns, which crashed three months ago and was sold to J.P. Morgan Chase. Last month, Bear Stearns shareholders approved J.P. Morgan Chase's $2.2 billion buyout at about $10 a share. In January 2007, Bear Stearns traded at $171 a share.
The indictment of the two Wall Street players coincides with a broad federal investigation of mortgage brokers, credit-repair firms and others who federal officials say contributed to the crisis by brokering fraudulent loans or attempting to fleece homeowners who were behind on their mortgages.
During a Washington news conference yesterday, Mueller said the FBI had since March charged more than 400 people involved in the mortgage and real estate industry -- and arrested 60 people Wednesday and more yesterday -- in a crackdown on mortgage fraud. The people were from across the country and were charged with fraud either in making loans or in swindling distressed homeowners under the guise of trying to save them from foreclosure. Officials put the losses to victims at more than $1 billion.
Four Maryland residents were among those charged. They are Michael K. Lewis, 56, and Cheryl Brooke, 51, who lived together in Upper Marlboro; Earnest Lewis, 59, of Takoma Park; and Winston Thomas, 42, of New Carrollton. They were charged with wire fraud and conspiracy in connection with a scheme in which they offered to save people from foreclosure but instead defrauded them and mortgage companies.
In some cases, the group would rent homes back to people they were purporting to bail out and charging more than the original mortgage payments, according to the indictment unsealed in federal court in Greenbelt.