Federal prosecutors may not be done with former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin, who were charged on June 18 with lying to investors about the precarious state of their once-giant portfolios. BusinessWeek has learned that authorities are examining the funds' dealings with Wall Street banks to determine whether the managers misled them as well.
Investigators are gathering more evidence about possibly false statements Cioffi and Tannin made to major lending and trading partners, according to people close to the probe. Among them: Bank of America (BAC), Barclays (BCS), Dresdner Bank, and Merrill Lynch (MER).
Prosecutors are particularly interested in the toxic $4 billion collateralized debt obligation that the pair enlisted BofA to guarantee and sell in the spring of 2007—when the market for such risky mortgage-backed securities teetered on the brink of implosion. A spokesman for Cioffi and Tannin declined to comment.
Putting on the Pressure
If prosecutors bring additional charges, it could help them win convictions. "The more you can show that there was a concerted plan, the more you can demonstrate they had criminal intent," says Paul Radvany, a professor at Fordham University School of Law. The risk is that a broader case would be more difficult to explain to jurors.
It's not unusual for prosecutors in a securities fraud case to file a so-called superseding indictment, replacing a previous indictment with new and expanded charges. Federal prosecutors in Manhattan filed three such addenda in the case involving three former top executives of Refco, the commodities broker that collapsed in October, 2005. The tactic put added pressure on the defendants: Two pleaded guilty to accounting fraud on the eve of the trial earlier this year, while a third was convicted in April.
The current indictment of Cioffi and Tannin offers insight into new charges prosecutors may be pursuing. It alleges, for example, that Tannin lied to a bank lender by understating the growing number of investors who wanted to pull their money out of the funds in May 2007. People familiar with the matter say the unidentified lender is Germany's Dresdner Bank, a key firm from which the funds borrowed money. The prosecutors' team, led by Assistant U.S. Attorneys Sean P. Casey and John A. Nathanson, is also talking to Merrill, another big lender to the Bear funds. A spokesman for Benton Campbell, the U.S. Attorney for the Eastern District in Brooklyn, N.Y., whose office is handling the case, said the investigation continues but declined to comment further.
Allegations in the civil lawsuit filed by the Securities & Exchange Commission on June 19 could also point to additional criminal charges. The SEC claims that the ex-Bear executives persuaded Barclays—referred to as "Bank No.1" in the suit—to sink $100 million into one of the ailing funds in February 2007. The suit by the SEC, whose team is spearheaded by Daniel Chaudoin, assistant director of the SEC Enforcement Div., and Antonia Chion, associate director of enforcement, contends the hedge fund managers provided the British bank with false performance figures for the portfolios. Barclays, in a lawsuit it filed against Cioffi and Tannin in December, says it was the victim of "a series of misrepresentations."
The SEC suit also highlights a $4 billion CDO deal the funds had with BofA. Cioffi and Tannin recruited the Charlotte (N.C.) bank to market and guarantee this complicated pool of largely subprime securities, the biggest of 2007. The investment, named High Grade Structured Credit CDO 2007-1, issued short-term debt and used the proceeds to buy mortgage-backed bonds exclusively from the Bear funds.
Cioffi and Tannin then used the money from that deal to purchase additional securities and bolster the Bear funds' cash reserves. In an Apr. 25, 2007, conference call with investors in the Bear funds, Cioffi bragged about the BofA deal, saying it would add "significant liquidity" to the hedge funds. But the SEC claims that Cioffi's statements were misleading because, according to the suit, "there were essentially no buyers for new CDOs in the market" and the money from "the deal would not actually be available to the [Bear] funds until late May or early June, at the earliest."
The CDO never provided the salvation that Cioffi and Tannin hoped for. The Bear funds crashed just weeks after the deal was completed in May 2007. Since then, the CDO has followed much the same path as the hedge funds. Earlier this year it fell into technical default, an indication that a large percentage of the underlying assets soured. BofA is bearing the brunt of the financial pain, taking a $2 billion writedown on the CDO and other such investments. If prosecutors can assign blame to Cioffi and Tannin, it would prove that even Wall Street sophisticates can get fooled.