Two former hedge fund managers at investment bank Bear Stearns defrauded investors by concealing problems that led to the $1.4 billion collapse of funds linked to subprime lending, a federal indictment unsealed on Thursday charged.
The indictment by a New York federal grand jury also said the two, Ralph Cioffi and Matthew Tannin, touted the funds as an "awesome opportunity" to investors as they were privately discussing grave concerns over the prospects of two funds they managed.
The two were charged with eight counts of wire and securities fraud in the highest profile case brought to date in connection with the collapse of the subprime lending industry. Cioffi also was charged with insider trading.
The indictment says the two also concealed the funds' problems from their superiors at Bear Stearns.
Their lawyers said they were innocent.
The indictment said, "Starting at least by March 2007, Cioffi, Tannin and others believed that the funds were in grave condition and at risk of collapse.
"Rather than disclosing the true state of the funds to investors and lenders, thus allowing an orderly wind-down of the funds, Cioffi and Tannin agreed to make representations in the ultimately futile hope that the funds' bleak prospects would change and that their incomes and reputations would remain intact."
In June of last year investors in the two funds were told they could not redeem their investments. "Eventually, investors were told that the funds had both lost 100 percent of their respective values, resulting in a total investor loss of approximately $1.4 billion," the indictment said.
It quoted Cioffi as telling Tannin on March 3, 2007 "the worry for me is that subprime losses will be far worse than anything people have modeled." Soon after he predicted a "meltdown" in the subprime sector and told a colleague he was "sick to my stomach" over the funds' March performance.
Nevertheless, the indictment said, Cioffi and Tannin promoted their funds as a buying opportunity. "We have an awesome opportunity," Cioffi told a Bear Stearns broker with clients invested in the funds.
Tannin gave a similar message to the same broker, and told investors he was going to add money to his own investments in the funds. But Tannin never did add money and Cioffi transferred $2 million of his $6 million investment in one of the funds to another Bear Stearns fund with a higher return and failed to tell investors who asked that he had done so, the indictment said.
The fallout from defaults on U.S. mortgages has rattled the global economy and the American housing market. Subprime mortgages, those issued to people with shaky credit, were repackaged as securities and sold across the globe.
The implosion of the hedge funds foreshadowed Bear Stearns' own demise, with the Federal Reserve having to intervene earlier this year to bail out the beleaguered bank. Their collapse revealed how much damage had been done to the companies that bought, repackaged and sold the loans.
Cioffi, 52, and Tannin, 46, already have been named in lawsuits brought last year by hedge fund investors, including Barclays Bank, who allege they were purposely misled.
Barclays accused Bear Stearns of knowing for months that certain assets in the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund were worth "far less" than their stated values.
The bank alleged Bear Stearns managers "hatched a plan to make more money for themselves and further to use the Enhanced Fund as a repository for risky, poor-quality investments."
The complaint said Bear Stearns told Barclays that the enhanced fund was up almost 6 percent through June 2007—when "in reality, the portfolio's asset values were plummeting." Last month, Bear Stearns shareholders approved $2.2 billion buyout at about $10 a share.
Back in January 2007, before mortgage defaults began clobbering banks and draining demand from the debt markets, Bear Stearns had traded at $171 a share.
Fund Managers Are Innocent, Attorneys Say
Attorneys for Cioffi and Tannin said in a statement Thursday that their clients were innocent.
"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,'' Ed Little, an attorney for Cioffi, said 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, an attorney for Tannin, echoed his sentiments.
"Matt Tannin is innocent,'' Brune said in a statement. "He is being made a scapegoat for a widespread market crisis. He looks forward to his acquittal.''
- Wire services contributed to this report.