1st Wall St. indictments

A criminal indictment of two former Bear Stearns Cos. executives unsealed Thursday relies on a story line that may reemerge in future prosecutions of Wall Street figures in the wake of the sub-prime mortgage meltdown.

The indictment of hedge fund managers Ralph Cioffi and Matthew Tannin alleges that they knew the market for bonds backed by home loans given to people with bad credit was beginning to capsize in early 2007 but hid it from investors in two Bear Stearns hedge funds that held billions of dollars of such securities.

“Rather than disclosing the true state of the funds to investors and lenders . . . they lied in the futile hope that the funds would turn around and that their incomes and reputations would remain intact,” Benton J. Campbell, the U.S. attorney who brought the charges in Brooklyn, said at a news conference.

The outline of that account -- an easily understandable narrative designed to strike an emotional chord with juries -- is likely to form the basis of many cases that the government is expected to bring in the aftermath of the historic sub-prime meltdown, experts said.

“All the government investigations are feeding on the public perception that banks, brokers and other insiders knew of, and profited by, information about the reality of the sub-prime mess prior to official public disclosures,” said John Hueston, a partner at Irell & Manella in Los Angeles who led the federal prosecution against former Enron Corp. executives Kenneth L. Lay and Jeffrey K. Skilling.

In the first criminal charges against Wall Street players stemming from the sub-prime collapse, prosecutors charged Cioffi and Tannin with securities fraud, wire fraud and conspiracy. Cioffi also was charged with insider trading. Each defendant could face a maximum sentence of 20 years.

In addition, the Securities and Exchange Commission filed civil fraud charges against the pair Thursday.

The collapse in June 2007 of the now-infamous funds cost investors $1.4 billion, sent a shudder through global financial markets and helped trigger a credit crunch that still afflicts the U.S. economy and housing market.

Rather than reveal their mounting concerns, the men pitched the woes of the sub-prime market as an “awesome” buying opportunity so that investors would shovel in more money and prop up the funds, according to the indictment.

In an e-mail exchange that is likely to be central to the case, Tannin told Cioffi in late April that an internal study showed that “the sub-prime market looks pretty damn ugly.” He urged that the funds be closed because there may be “simply no way for us to make money -- ever.”

Yet the two men reassured investors about the condition of the portfolios in a conference call three days later, according to the indictment.

“There’s no basis for thinking this is one big disaster,” Tannin said on the call.

The indictment says the defendants took numerous steps to avoid revealing the depth of the funds’ problems to their bosses or investors.

The indictment also alleges that Cioffi sought to limit his personal losses by withdrawing $2 million of the $6 million he invested in one of the funds. He hid the move from investors even though they repeatedly asked him about his personal holdings, the indictment says.

Cioffi also didn’t disclose that a large investor was pulling its money out of the funds, fearing that word of the withdrawal would trigger other redemptions, according to the filing.

It is typically difficult for prosecutors to prove that insiders purposely deceived investors, legal experts said.

Even e-mails that appear to be smoking-gun evidence of wrongdoing can be explained away as part of the routine fear and skepticism that investment managers experience, they said.

“Showing criminal intent on investments that at the time were the rage will be difficult,” said Joshua Hochberg, a partner at McKenna Long & Aldridge in Washington.

The government hopes to make the Bear Stearns case simple to avoid confusing jurors with the sort of financial complexity that was a hallmark of Enron and other cases that emerged from the collapse of the late-1990s stock market bubble, experts said.

The defense, meanwhile, must explain the e-mails casting doubt on the sub-prime market.

“There are some very troubling e-mails with which the defense lawyers are going to have to contend,” said Maria Galeno, a former prosecutor and now a partner at Pillsbury Winthrop Shaw Pittman in New York.

Lawyers for Cioffi and Tannin disputed the charges.

“We are shocked and disappointed that the government has seen fit to fix blame on these two decent men,” said Cioffi’s attorney, Ed Little. “Because [Cioffi’s] funds were the first to lose [money] might make him an easy target, but doesn’t mean he did anything wrong. Indeed, Mr. Cioffi had no motive to do anything wrong.”

Tannin’s attorney, Susan Brune, also denied any misconduct by her client.

“Matt Tannin is innocent,” she said in a statement. “He is being made a scapegoat for a widespread market crisis.”

Cioffi and Tannin were arrested at their homes in the New York area early Thursday. Both pleaded not guilty at an afternoon court hearing and were released after posting bond -- $4 million for Cioffi and $1.5 million for Tannin.

During the hearing, Cioffi held his wife’s hand as she agreed to use their New Jersey home as collateral for the bond.

Wall Street investment banks piled into the mortgage business in the early half of this decade by repackaging home loans as tradable securities and selling them to investors.

Bear Stearns and other firms focused on the highly lucrative sub-prime business, which peddled loans to home buyers with scuffed credit.

Bear Stearns opened the first fund in 2003 and the second one in 2006, raising more than $1.5 billion from investors. Both funds borrowed heavily to boost returns and initially posted gains as the sub-prime frenzy ramped up.

But the funds began unraveling in early 2007 as sub-prime defaults surged.

The funds’ collapse was the first phase of a financial disaster that culminated in March with the disintegration of Bear Stearns itself, as investors yanked their money from the firm because of concerns about its stability.

The investment bank was forced to sell itself to rival JPMorgan Chase & Co. in a rescue engineered by the Federal Reserve.

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walter.hamilton@latimes.com

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(BEGIN TEXT OF INFOBOX)

Your e-mails may be used against you

A federal indictment of former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin alleges they knew that two funds that invested in sub-prime mortgage securities were in trouble long before the funds collapsed in June 2007 -- but didn’t warn investors.

“I’m fearful. . . . It’s either a meltdown

or the greatest buying opportunity ever,

I’m leaning towards the former.”

-- Ralph Cioffi

in a March 15, 2007, e-mail to a colleague

“The sub-prime market looks pretty damn ugly. . . . Caution would lead us to conclude . . . we’re in bad bad shape.”

-- Matthew Tannin

in an April 22, 2007, e-mail to Cioffi

Source: The indictment