Federal agents exit 26 Federal Plaza with handcuffed former Bear Stearns hedge fund manager Matthew Tannin, Thursday, June 19, 2008, in New York. Indictments will be handed down on Tannin and ex-manager Ralph Cioffi, both accused of securities fraud in the wake of the collapse of the subprime mortgage market which foreshadowed Bear Stearns' own demise.
Two former Bear Stearns hedge fund managers were hauled into jail Thursday and charged with lying to investors about the collapse of the subprime mortgage market, perhaps signaling the start of a wave of prosecutions arising from the housing meltdown.
Ralph Cioffi and Matthew Tannin were accused of encouraging investors to stay in their hedge funds, heavily exposed to subprime mortgages, even as they knew the credit market was in serious trouble.
They were indicted on conspiracy and fraud counts, the first criminal charges to hit Wall Street in the housing market meltdown.
The eventual implosion of their two hedge funds cost investors $1.8 billion and started the domino effect that led the demise of Bear Stearns itself, which barely avoided bankruptcy in a rescue buyout by JP Morgan Chase & Co.
"This is not about mismanagement of a hedge fund," Mark Mershon, head of the New York FBI office, told reporters. "It is about premeditated lies to investors and lenders."
The arrests came as the Justice Department in Washington announced the indictments of more than 400 players in the real-estate industry since March in a crackdown on mortgage fraud. Sixty were arrested on Wednesday alone.
That alleged fraud includes misstatement of income or assets, forged documents, inflated appraisals and misrepresentation of a buyer's intent to occupy a property as a primary residence.
The Bear Stearns case against Cioffi and Tannin appears to be based heavily on a series of e-mails that reveal panic and disorder behind the scenes at the hedge fund as its investments began to slide.
"The subprime market looks pretty damn ugly," Tannin wrote to Cioffi in April 2007. If Bear's internal reports were accurate, Tannin suggested, "I think we should close the funds now," and "the entire subprime market is toast."
The situation became so dire that Cioffi pulled $2 million of his own cash from the fund, but the pair still told investors that they should stay in and that the outlook was good, prosecutors said.
Cioffi, 52, was arrested by FBI agents at his Tenafly, N.J., home Thursday morning, and Tannin, 46, was taken into custody outside his Upper West Side apartment building.
Both men pleaded not guilty at an afternoon arraignment and were released on bond. Cioffi's bond was set at $4 million, Tannin's at $1.5 million; both were secured by their homes and other property.
The men, who face up to 20 years in prison, left court with their wives and without speaking to reporters. They are due back in court July 18.
The mortgage market crisis "took the whole financial world by surprise," said Cioffi's attorney, Edward Little. "So our question is, why is Ralph Cioffi being charged in this case?" Tannin's lawyer, Susan Brune, said he was "being made a scapegoat for a widespread market crisis. He looks forward to his acquittal."
Legal experts said more Wall Street figures would probably be charged in the credit crisis, the latest front for white-collar prosecutors who brought - and in most cases won - high-profile cases earlier this decade after the fall of Enron.
"There is no doubt the government is always looking to go as high as they can," said Bill Leone, a former U.S. Attorney in Colorado. "Any time you get losses into the billions, the likelihood that higher-level executives participated in decisions increases."
Subprime mortgages were sold to people with less-than-ideal credit. Many of them began defaulting on their loans when the housing market fell and their introductory "teaser" interest rates shot up, making their payments unaffordable.
Because many of those mortgages were sliced and repackaged as securities that could be bought and sold, the mass defaults caused widespread pain among large U.S. banks.
The collapse of the two Bear Stearns funds is just a small part of the subprime crisis, which is still rippling through the economy.
Amid the fallout for banks, prominent CEOs have lost their jobs, including Citigroup Inc.'s Charles Prince, Merrill Lynch & Co.'s Stanley O'Neal and Bear Stearns Cos.' own James Cayne, who was stripped of his CEO title.
Hedge funds cater to large investors and the very wealthy and use complex, speculative investing methods in hopes of winning enormous gains. They operate with little government supervision and have lately come under fire from regulators.
In the Bear case, the internal e-mails provide a window into the trouble that began to engulf the hedge funds in 2007.
The indictment describes a meeting of Cioffi, Tannin and two unnamed colleagues in which Cioffi confided the hedge funds had narrowly "averted disaster" in February 2007 - news that "led to a vodka toast to celebrate surviving the month."
The complaint says Tannin expressed doubt about Cioffi's management in an one e-mail last March to a third fund manager with only question marks in the subject line. The e-mail said, "Is Ralph doing what he should be doing right now?"
Around the same time, Cioffi wrote to a Bear Stearns economist: "I'm fearful of these markets. ... As we discussed it may not be a meltdown for the general economy but in our world it will be. Wall Street will be hammered with lawsuits."
Tannin and Cioffi were repeatedly telling investors and Bear Stearns brokers responsible for selling funds that the outlook was good.
In once instance, prosecutors said, Tannin encouraged an investor to add money to the fund and said he would do the same, but never did.
At the same time, prosecutors say, Cioffi pulled $2 million of his own money out of the fund, about a third of his stake, and put it into a separate fund without telling investors. He was charged with insider trading in addition to fraud.
The Bear Stearns hedge funds had more than $20 billion in assets before collapsing in June 2007. Just before the collapse, Cioffi fretted in an e-mail that "I've effectively washed a 30-year career down the drain" if he couldn't turn things around, the indictment said.
The case demonstrates yet again how e-mail can trip up Wall Street executives.
Prosecutors used e-mail exchanges against former Credit Suisse Group banker Frank Quattrone and famed stock analysts Jack Grubman and Henry Blodget. But prosecutors struggled to win and maintain convictions in all of those cases.
Cioffi and Tannin have already been named in lawsuits brought last year by hedge fund investors who allege they were purposely misled.
The fortunes of Bear Stearns began to crumble around the same time that the fund collapsed, getting so bad that the Federal Reserve and JPMorgan had to intervene to save the once-mighty institution from bankruptcy earlier this year.
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