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Another Bear Stearns Lawsuit

Apr 9, 2008 | Parker Waichman Alonso LLP

Bear Stearns, the investment bank that nearly collapsed last month, is the subject of another lawsuit.  This time, liquidators of two Bear Stearns' hedge funds that failed last year are accusing the company of concealing that the two funds were "never designed to withstand even a slight downtick in the housing market.''  Bear Stearns is in the process of being acquired by JPMorgan Chase & Co, a transaction made possible by a massive bailout engineered by the Federal Reserve.

Before its near-collapse, Bear Stearns was once one of the biggest investment banks on Wall Street. But  two of its hedge funds, heavily invested in subprime mortgages, folded in July. Bear’s investors became increasingly reluctant to do business with the company. Despite the company’s assurances that it had plenty of cash on hand to continue operations, the company was near to filing bankruptcy until the JPMorgan deal was struck.  JPMorgan is purchasing Bear Stearns for $10 a share, or roughly $2.4 billion - a fraction of what the stock was worth just before the bank's collapse.  The sale is backed by  $30 billion  non-recourse funding provided by the Federal Reserve to JPMorgan.  Non-recourse funding means that if the collateral goes bad, the Fed can’t come after JP Morgan for other assets.  In the end, taxpayers could be on the hook for the Bear Stearns debacle.

Bear Stearns is already the subject of shareholder lawsuits and various federal investigations.  Now,  the liquidators for Bear Stearns High-Grade Structured Credit Strategies (Overseas) Ltd. and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage (Overseas) Ltd. - the hedge funds that went bust over the summer - are suing the investment bank.  The liquidators, Geoffrey Varga and William Cleghorn of consulting firm Kinetic Partners, were appointed March 28 by unnamed investors to pursue legal claims on behalf of investors who suffered around US$1.6-billion in losses when the two funds collapsed. Their complaint alleges fraud, breach of contract, gross negligence and other legal claims.

The liquidators claim that Bear Stearns  understated the risk of the funds, overstated the funds' performance, and used the funds "as dumping grounds for toxic investments held on Bear Stearns' books.''  The lawsuit also states that the funds yielded "substantial fees'' for Bear Stearns and left investors "holding grossly overvalued mortgage derivatives." Also named in the suit is Bear Stearns Asset Management and former Bear Stearns fund manager Ralph Cioffi.

The funds' auditor, Deloitte & Touche LLP, is also named as a defendant in the lawsuit.  The claim alleges the firm "further assured investors that it was conducting independent, thorough, and objective audits,'' adding that the auditing firm failed to live up the assurance and instead acted in its own interests "to the catastrophic detriment'' of investors.