Nov. 9 (Bloomberg) -- Jurors in the securities fraud prosecution of former Bear Stearns Cos. hedge-fund managers Ralph Cioffi and Matthew Tannin began deliberations following a month-long trial, one of the first tests of whether the U.S. can prove criminal conduct in the subprime mortgage collapse.

The two men are accused of defrauding customers by allegedly misleading them as to the health of their funds, which contained subprime mortgage-related securities and failed in 2007, costing investors $1.6 billion. The death of the funds was followed less than a year later by the near-implosion of Bear Stearns and its purchase by JPMorgan Chase & Co.

Cioffi, 53, the portfolio manager, and Tannin, 48, the funds’ chief operating officer, went on trial Oct. 13 in federal court in Brooklyn, New York, on charges of conspiracy, securities fraud and wire fraud. Each faces as much as 20 years in prison if convicted of the most serious count of securities fraud. The jury verdict may have wide-reaching effect on future prosecutions of similar cases related to the subprime collapse.

“Any time the government undertakes a major prosecution in a new area, the outcome certainly influences its thinking about the prosecutability of other potential defendants,” said Jacob Frenkel, a former U.S. Securities and Exchange Commission lawyer now in private practice. “Convictions always embolden prosecutors. Acquittals force prosecutors to rethink their theories and charges.”

First Note

The jury of eight women and four men sent a note shortly after beginning deliberations, asking for further explanation on the issue of venue. Bear Stearns was based in Manhattan, part of the U.S. court system’s Southern District of New York. Brooklyn U.S. Attorney Benton Campbell brought the case in his jurisdiction, the Eastern District of New York, because some of Bear Stearns’s back-office facilities are located there, as are some investors in the funds.

The jury also requested to see exhibits and testimony before leaving for the day.

Both defendants have pleaded not guilty. Their indictment in 2007 began the biggest prosecution stemming from the collapse of the subprime mortgage market, and the subsequent global recession. A few months after Bear Stearns was sold, Lehman Brothers Holdings Inc. filed the largest bankruptcy in U.S. history, and the federal government took over Fannie Mae and Freddie Mac and rescued AIG Inc.

While both sides say Cioffi and Tannin weren’t responsible for the demise of Bear Stearns, theirs is the first major trial stemming from a U.S. probe of banks and mortgage firms whose losses in subprime loans and related securities total at least $396 billion.

Conspired to Defraud

Prosecutors said the two men conspired to defraud their customers by publicly touting their hedge funds in e-mails and conversations, telling investors they were adding their own money to the funds between March and June 2007. Neither man added any money to them, once valued at $20 billion, the U.S. said during the trial.

Cioffi and Tannin’s lawyers told the jury that they had remained honestly optimistic about the health of the funds during the time of an alleged conspiracy, and insisted the e- mails which the men sent were more ambiguous than prosecutors alleged. U.S. District Judge Frederic Block, who is presiding over the case, gave the panel legal instructions today before sending them into the jury room to begin deliberations.

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

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

Last Updated: November 9, 2009 17:10 EST