June 25 (Bloomberg) -- Every scandal needs a scalp.

In the aftermath of the 1929 stock market crash, it was Richard Whitney, president of the New York Stock Exchange and convicted embezzler, and Samuel Insull, the public utilities magnate who was tried three times (and acquitted) after his holding company collapsed in the Great Depression.

The bursting of the technology and Internet stock bubble 70 years later had its own poster children for everything that was wrong with the era: from stock analysts Henry Blodget and Jack Grubman to investment banker Frank Quattrone to folks who ran real businesses with cooked books, such as Enron's Ken Lay and Jeffrey Skilling.

The subprime mortgage crisis, which has been elevated to prime and is still going strong, finally has a name and a face: Ralph Cioffi and Matthew Tannin, former hedge fund managers at Bear Stearns Cos. The duo was indicted last week for allegedly conspiracy to commit securities fraud and misleading investors (Cioffi was accused of insider trading as well.)

According to the indictment, Cioffi and Tannin made ``material misrepresentations'' to investors about their personal investments in the funds, expected redemptions, the perilous state of the two portfolios and available liquidity in early 2007.

The thing about liquidity is, it's adequate until it isn't.

On March 12, two days before Bear Stearns was saved from collapse by a loan from the Federal Reserve via JPMorgan Chase & Co., chief executive officer Alan Schwartz said ``our liquidity position has not changed at all'' from the $17 billion the bank had on hand at year-end.

Distinction Without Difference

``What's the difference between what Cioffi and Tannin are accused of and what a CEO or CFO might say'' suggesting the worst of the crisis is behind us? wrote Joan McCullough, macro strategist at East Shore Partners, a brokerage in Hauppauge, New York, in her June 20 daily commentary.

This isn't hypothetical. Some Wall Street CEOs made rosy comments just weeks before they reported huge losses and headed to the market (sometimes more than once) for more capital.

What Cioffi and Tannin allegedly did is pretty much standard operating procedure on Wall Street. Which doesn't make it right; it just means that it's hardly unique.

Wall Street, after all, is about sales: about selling something -- a security, a company, an idea -- to someone else at a profit. Most internal Wall Street communications wouldn't hold up under scrutiny, especially at a time when the feds are looking for a scapegoat.

Hedge fund managers typically gloss over questions about expected withdrawals. They are vague about how much of their own money is invested in the fund, saying something like ``X percent of my liquid assets are in the fund.''

Diligence Due

Does anyone check? Would managers provide their tax returns to satisfy investors? Probably not.

Managers have been known to count the fees -- the 2 percent they charge annually for assets under management -- as their investment, according to analysts at funds of funds, which select hedge fund managers for their investors.

Everything I've heard about Ralph Cioffi suggests he's a decent guy who made some bad choices after he got caught in the collateralized debt tsunami. He was not unaware of the illiquidity and inherent risks of CDOs.

``The defendants and others led investors to believe that the High Grade Fund was only slightly riskier than a money market fund,'' according to the indictment.

Enumeration of Risks

Really? That's not the sense one gets from the delineation of ``additional risk factors'' in the marketing material, or ``pitch book'' -- the standard PowerPoint presentation managers use to pitch their fund to investors -- for the Bear Stearns High-Grade Structured Credit Strategies Fund, one of the two funds Cioffi managed that went under in July, with investors losing $1.6 billion.

``The Fund is speculative and involves a substantial degree of risk.''

``The Fund is highly illiquid. There is no secondary market for the investors' interest in the Fund and none is expected to develop.''

``An investor could lose all or a substantial amount of his or her investment.''

Does that sound like an investment that's ``only slightly riskier'' than a money market fund?

Cioffi seems to have anticipated everything that happened. If he's guilty of anything, it's of putting too much faith in the rating agencies, which have a long and distinguished history of being late to the party.

Pack of Lies

A jury isn't about to convict him for that crime.

``The bigger issue to make securities fraud stick is the mispricing of assets,'' said Janet Tavakoli, president of Tavakoli Structured Finance in Chicago.

In late May, early June, the hedge funds' creditors (Wall Street investment banks) ``challenged the April prices and asked for more margin,'' she said. ``Yet they failed to mark down their own books that quarter.''

Instead, Wall Street's finest continued to bring CDOs to market backed by the same distressed and depressed collateral. ``They basically lied,'' Tavakoli said. ``They knew or should have known'' the CDOs they were packaging were ``over-rated and overpriced. They were obliged to disclose'' that to investors.

If she's right, Cioffi and Tannin will turn out to be the tip of the iceberg, with more investigations and indictments to come. The Securities and Exchange Commission has already filed a civil lawsuit accusing the pair of fraud.

The bigger the carnage, the more scalps needed as a suitable sacrifice.

(Caroline Baum, author of ``Just What I Said,'' is a Bloomberg News columnist. The opinions expressed are her own.)

To contact the writer of this column: Caroline Baum in New York at cabaum@bloomberg.net.

Last Updated: June 25, 2008 00:05 EDT