Bear Stearns Funds Were ‘Heavily’ Subprime, Broker Tells Jury

Date: Friday, October 30, 2009
Author: Patricia Hurtado and Thom Weidlich, Bloomberg.com

Bear Stearns Cos. told investors after two of its hedge funds collapsed that the funds’ exposure to subprime-related securities was 10 times what a broker believed them to have been, the man testified at a fraud trial.

Prosecutors displayed brochures and data given in 2006 and 2007 to investors in hedge funds managed by Ralph Cioffi and Matthew Tannin that said about 6.2 percent of assets were invested in subprime residential mortgage-backed securities. Shelley Bergman, the former Bear Stearns broker, said yesterday in the fraud trial of the two men in federal court in Brooklyn, New York, that after the funds unraveled in June 2007, the company issued talking points to employees, telling them to inform investors the subprime exposure was actually 60 percent.

“In June we found out that the fund had imploded and that it was invested heavily in subprime,” Bergman said. “Over 60 percent was invested in subprime.”

Cioffi, 53, the portfolio manager, and Tannin, 48, his chief operating officer, are accused of misleading investors about the health of the funds, which cost investors $1.6 billion when they collapsed, prosecutors have told the jury. The government alleges that by March 2007, both men knew the funds were in danger of failing and kept touting them to clients.

The two are charged with conspiracy, securities fraud and wire fraud, and face as long as 20 years in prison if convicted of the most serious count. Both have pleaded not guilty.

The trial ended its third week yesterday and is scheduled to resume Nov. 2.

‘A Perfect Storm’

Cioffi’s lawyer, Dane Butswinkas, contends the failure of the funds was the result of “a perfect storm” brought on by the financial crisis and that investors whom he described to the jury as “ostriches” didn’t pay close attention to what his client was telling them about the funds.

Butswinkas previously questioned Bergman on cross- examination about statements he made to the FBI that he was surprised to hear in June 2007 that the funds were invested in subprime-related securities. The defense lawyer continued yesterday to press the government’s witness on how much he knew about the subprime exposure and when.

Bergman, who first invested in one of Cioffi’s funds in 2003, testified he would have avoided a fund that was so heavily exposed to subprime-related securities because he was wary of real estate-linked assets in 2007.

Butswinkas showed Bergman a “Performance Profile” for one of Cioffi’s funds dated Nov. 30, 2004, that listed one-quarter of the fund’s collateral in subprime residential mortgage-backed securities.

‘Performance Portfolio’

“Well, you reviewed this performance portfolio, didn’t you, and you didn’t withdraw your investment in the fund, did you?” Butswinkas asked.

“No, I did not,” Bergman said.

Butswinkas asked Bergman if he hadn’t heard Cioffi tell an investor on a January 2007 conference call that the fund had subprime securities embedded in collateralized debt obligations, or CDOs, that the fund held.

“No, there was a lot of stuff that was talked about in those calls that were above my expertise in the fixed-income area,” he said. “There was a lot of terms used and jargon that were over my head.”

Over objections from Cioffi’s lawyer, U.S. District Judge Frederic Block, who is presiding over the trial, interrupted and asked Bergman to specify what he learned, and when, about the magnitude of the funds’ exposure to subprime assets.

‘In the Dark’

Bergman said he was “in the dark as to where we really stood” until the funds collapsed and Bear Stearns issued brokers a document explaining the subprime exposure and what to tell investors.

Amy Cohen, a former investment manager at Rye, New York- based Tremont Advisers Inc., which lost $100 million in the funds, testified that Tremont decided to pull its investment after a May 15, 2007, meeting with Bear Stearns in which it discussed a trade it was making that she deemed to be a deviation from the funds’ focus.

“It was more of an arbitrage trade in the sense you were going long and short,” she said. “It was not a tranche of a CDO.”

Tremont invested in the Bear Stearns funds to get exposure to “investment-grade tranches in CDOs,” Cohen said.

Cohen also testified that she was on the April 25, 2007, investor conference call when Cioffi said there were no significant redemptions from the funds.

Total Redemptions

Cioffi lawyer Margaret Keeley asked Cohen on cross- examination whether she was aware of other total redemptions from the funds, such as $98 million in July 2005 and $64 million in October 2006.

“Off hand, no,” she said.

Tremont lost its investment before it could be redeemed.

The Bear Stearns funds failed when prices for CDOs linked to home loans fell amid rising late payments by borrowers. Bear Stearns sought bankruptcy protection for the two funds on July 31, 2007.

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

The case is U.S. v. Cioffi, 08-CR-00415, U.S. District Court, Eastern District of New York (Brooklyn).

To contact the reporters on this story: Patricia Hurtado in Brooklyn Federal Courthouse at pathurtado@bloomberg.net; Thom Weidlich in New York at tweidlich@bloomberg.net.