The managers of two Bear Stearns hedge funds that collapsed last year have been arrested on charges of securities fraud. Prosecutors allege that Ralph R. Cioffi, 52, and Matthew Tannin, 46, knew that their funds were losing money but kept that information from large investors.
The hedge funds, the High Grade Structured Credit Strategies Fund, and its sister offering, the High Grade Structured Credit Strategies Enhanced Leverage Fund invested in securities backed by sub-prime home loans. Both funds crashed last summer, ushering in the sub-prime mortgage crisis and spelling the end of Bear Stearns.
According to The New York Times, as early as March 2007, Cioffi and Tannin began receiving worried calls from investors and their lending banks as the subprime mortgage market began to fall apart. The Times reports that Cioffi, according to transcripts reviewed by prosecutors, told investors on several occasions that he was optimistic about a recovery, culminating with a conference call on April 25 last year.
According to another report in The Wall Street Journal, prosecutors are focusing on an e-mail allegedly sent by the two suggesting that their funds were headed for trouble, four days before 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, the Journal said.
“Rather than disclosing the true state of the fund to investors and lenders, thus allowing an orderly wind-down of the funds, Cioffi and Tannin agreed to make misrepresentations in the ultimately futile hope that the funds’ bleak prospects would change and that their incomes and reputations would remain intact,” the indictment against Cioffi and Tannin reads.
Cioffi was also charged with insider trading, stemming from his decision to move $2 million of the $6 million of his own money that he had invested in one of the funds to a less risky Bear Stearns fund. Prosecutors allege he did so because he feared a meltdown. According to prosecutors, Cioffi never told investors he was removing the funds.
Bear Stearns, once the fifth-largest U.S. investment bank, faced a run on the bank in March and was forced to sell itself to JPMorgan Chase & Co. After the hedge funds collapsed last July, Bear’s investors became increasingly reluctant to do business with the company. The buyout of Bear Stearns by JPMorgan Chase – termed a “shotgun marriage” by some – was consummated after the Federal Reserve agreed to provide up to $30 billion in non-recourse financing to JPMorgan, with Bear Stearns’ illiquid mortgage and other securities as collateral.