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Former Bear Stearns Fund Managers Arrested by FBI

Date: Thursday, June 19, 2008
Author: Patricia Hurtado and David Scheer, Bloomberg

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Bear Stearns Cos. former hedge fund managers Ralph Cioffi and Matthew Tannin were taken into custody at their homes this morning over their roles in the collapse of two funds that ignited the subprime mortgage crisis last year.

The arrests are the first from a federal probe of possible fraud by banks and mortgage firms whose investments in subprime loans and securities plunged in value, causing losses that now total $396.6 billion. The Securities and Exchange Commission may sue the two men as early as today, claiming they committed fraud by falsely telling investors the funds they managed were in good condition, people with knowledge of the case said.

Cioffi, 52, was taken into custody at his Tenafly, New Jersey, home and Tannin, 46, at his Manhattan apartment, said James Margolin, a spokesman for the Federal Bureau of Investigation's New York office. The two men were processed at FBI headquarters in Manhattan, then taken out in handcuffs by six FBI agents to be transported across the East River to Brooklyn federal court for an appearance later today in connection with an indictment.

``The arrests are appropriate given the magnitude and the egregiousness of their alleged misconduct,'' said attorney Steven Caruso, who is representing investors in arbitration claims against the funds. Cioffi and Tannin engaged in a ``gross violation of the public trust.''

`Credit Crisis'

Edward Little, the lawyer for Cioffi, said in a statement that ``the credit crisis took everyone by surprise, including the Fed and Treasury, and dozens of the largest financial institutions in the world have lost over $300 billion dollars to date on the same investments.'' Little previously declined to comment on the arrests or indictment.

A call to Tannin's lawyer, Nina Beattie, wasn't returned.

Cioffi was a senior portfolio manager of the two funds that collapsed and Tannin served as his chief operating officer. The hedge funds invested almost all of their assets in subprime- mortgage-related securities. Their investment bets failed last June when prices for collateralized-debt obligations, called CDOs, linked to loans plummeted amid rising late payments by borrowers with poor credit histories or heavy debt.

U.S. 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, the Wall Street Journal reported today, citing people familiar with the situation.

Bond Securities

Tannin allegedly e-mailed Cioffi saying that he was afraid that the market for bond securities they had invested in was ``toast,'' and suggested shutting the funds, the Journal said. The two have told colleagues that they quickly were convinced that Tannin's concerns were misplaced, according to the newspaper.

SEC spokesman John Nester declined to comment.

Indictments against Cioffi and Tannin might lead to a cascade of criminal cases and civil suits, said former prosecutor Robert Bunzel, who is now a white-collar criminal lawyer with Bartko, Zankel Tarrant & Miller in San Francisco.

``The floodgates could open,'' he said.

More than 400 people have been charged in a separate U.S. Justice Department mortgage-fraud sweep, two law enforcement officials said today.

Called Operation Malicious Mortgage, the arrests are to be announced this afternoon by FBI Director Robert Mueller and Deputy Attorney General Mark Filip at the Justice Department in Washington. A number of arrests were made earlier this week and the FBI is still tallying the final numbers, said the officials who requested anonymity so as not to overshadow the formal announcement.

RCAM Capital

Cioffi, now with Tenafly based RCAM Capital LP, left Bear Stearns in December amid government inquiries by prosecutors and the SEC into whether he withdrew $2 million from two funds before their collapse in July, three people with knowledge of the matter said at the time. He was relieved of his duties as a fund manager in June, when his funds' subprime mortgage investments began to unravel.

Cioffi was born on Jan. 5, 1956, and grew up in South Burlington, Vermont, a city of 16,500 that borders Lake Champlain. He went to Rice Memorial High School and St. Michael's College, both Catholic schools, three miles down the road from each other in the neighboring towns of South Burlington and Colchester.

He was a running back, fullback and offensive guard on the Rice football team and worked at bodybuilding at St. Michael's. He was an A student in math and economics in high school, a Rice official said. At St. Michael's, he studied business administration and graduated with honors in 1978.

Two Funds

Since the failure of the two Bear Stearns hedge funds, investors claimed in lawsuits that banks and financial companies such as the New York-based securities firm knew their underlying investments weren't worth what they were telling shareholders.

The indictments ``signal a new chapter in the subprime debacle,'' Bunzel said.

Investors in the two Bear funds, which filed for bankruptcy in July, lost $1.6 billion. Barclay's Bank PLC said in a lawsuit that the funds once held a total of about $20 billion in assets.

Cioffi allegedly pulled the $2 million of his own money, one third of the amount he'd invested in one of the funds, before March 2007, so he could commit it to another fund he set up, said a person familiar with the investigation. The withdrawal occurred before the funds ran into trouble, the person said.

CDOs are created by packaging assets including bonds and loans and using their income to pay investors. The securities are divided into different portions of varying risk and can offer higher returns than the debt on which they are based.

The two Bear Stearns funds are part of Bear Stearns Asset Management Inc. They were the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd. and the Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd.

Dropped in Value

As the securities dropped in value, the funds' creditors demanded more collateral. Bear Stearns extended $1.6 billion in credit to one of the funds before seizing its assets in July. Both funds filed for bankruptcy protection two weeks after the firm told investors they would get little if any money back.

The credit crunch led to lawsuits against other lenders including Countrywide Financial Corp., American Home Mortgage Investment Corp., Citigroup Inc. and JPMorgan Chase & Co.

Bear Stearns agreed to sell itself to New York-based JPMorgan in March after a run by clients and lenders threatened it with bankruptcy.

The hedge funds tried to liquidate in the Cayman Islands before a U.S. judge held that New York was a more appropriate jurisdiction, ruling they can't shield their U.S. assets from lawsuits.

Barclays, the U.K.'s third-biggest bank, claimed in its lawsuit, filed last year in federal court in New York, that it was misled about the health of the so-called enhanced fund.

Bear Stearns, Cioffi and Tannin are named as defendants in London-based Barclays suit. The British bank accused Cioffi of withdrawing his $2 million at the same time Bear Stearns persuaded Barclays to double its investment, according to the complaint.

February E-Mail

The suit cites a February e-mail to Barclays in which Tannin allegedly said the fund is ``having our best month ever'' and that our ``hedges are working beautifully.''

By then, the fund was having ``severe'' liquidity problems, said Barclays, which said it lost ``hundreds of millions of dollars,'' as a result. Internally, Cioffi and Tannin discussed the ``wipe out'' of the fund, according to the complaint.

Elizabeth Ventura, a spokeswoman for New York-based Bear Stearns, didn't immediately return a call seeking comment.

The Barclay's case is Barclay's Bank PLC v. Bear Stearns Asset Management Inc., 07-11400, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporters on this story: Patricia Hurtado in U.S. District Court for the Eastern District of New York in Brooklyn at pathurtado@bloomberg.net; David Scheer in New York at dscheer@bloomberg.net.