NEW YORK (Reuters) - Two former Bear Stearns hedge fund managers were arrested and indicted on conspiracy and securities fraud charges on Thursday following a federal criminal probe into the collapse of two funds they oversaw.
Former managers Ralph Cioffi, 52, and Matthew Tannin, 46, surrendered to officials and were paraded in handcuffs in front of reporters and onlookers en route to their arraignment. The two pleaded not guilty and their attorneys said they will fight the charges.
The disintegration last summer of the two funds helped kick off a credit crisis that persists today by stoking widespread fears about investments linked to risky subprime mortgage loans.
According to the indictment, the fund managers lied about the funds’ prospects, despite concerns over liquidity and the outlook for the market.
In a April 22 e-mail included in the indictment, Tannin warned Cioffi the subprime market could be “toast” — while at the same time both men were touting their funds as an “awesome opportunity” for investors.
Cioffi is facing an additional insider trading charge for transferring a portion of his own investments from one of the funds without telling investors, prosecutors said.
The crumbling of the two funds, the High Grade Structured Credit Strategies Master Fund and the Enhanced Master Fund, also spurred questions about the oversight and risk management operations at Bear Stearns, which was sold in March to JPMorgan Chase & Co in an emergency takeover deal brokered by the U.S. Federal Reserve.
The indictment by a New York federal grand jury quoted Cioffi as telling Tannin on March 3, 2007, that “the worry for me is that subprime losses will be far worse than anything people have modeled.”
Soon after, he forecast a “meltdown” in the subprime sector and told a colleague he was “sick to my stomach” over the funds’ March performance.
Nevertheless, the indictment said, Cioffi and Tannin continued to promote their funds as a buying opportunity.
“We have an awesome opportunity,” Cioffi told a Bear Stearns broker with clients invested in the funds, the indictment said.
Tannin gave a similar message to the same broker and told investors he was going to add money to his own investments in the funds, it said.
But Tannin never did add money and Cioffi transferred $2 million of his $6 million investment in one of the funds to another Bear fund with a higher return and failed to tell investors who asked if he had done so, the indictment said.
“Hedge fund investors, like all investors in the securities markets, are entitled to rely on those to whom they entrust their money,” Benton Campbell, U.S. Attorney for the Eastern District of New York, said at a news conference on Thursday.
“These defendants chose to breach that trust and today they are being held accountable.”
In a statement, Cioffi’s attorney Edward Little, from law firm Hughes Hubbard and Reed, said: “The subprime crisis took everyone by surprise, including the Fed and Treasury, and dozens of the largest financial institutions have lost over $300 billion to date on the same investments.
“Ralph Cioffi’s funds lost money in exactly the same way. Because his funds were the first to lose might make him an easy target but doesn’t mean he did anything wrong.”
Susan Brune, an attorney at Brune & Richard LLP representing Tannin, said: “Matt Tannin is innocent. He is being made a scapegoat for a widespread market crisis. He looks forward to his acquittal.”
The U.S. Securities and Exchange Commission also filed civil securities fraud charges against the pair, accusing them of misrepresenting the funds’ investments.
The Eastern District of New York and the FBI’s New York Field Division were to announce the filing of conspiracy and wire and securities fraud charges against the two.
Cioffi met authorities at an agreed location and Tannin surrendered after waiting for officials outside his residence, according to a person familiar with the matter.
If convicted of securities fraud, Cioffi and Tannin face maximum sentences of 20 years of imprisonment. If convicted of conspiracy, they each face a maximum sentence of five years.
Both men were granted bail.
Cioffi’s bail was secured by a $4 million bond, guaranteed by residences in Tenafly, New Jersey, and Naples, Florida. Tannin’s bail was secured by a $1.5 million bond, guaranteed by his Upper West Side apartment in New York. Both men’s wives also appeared in court to accept the bail conditions.
Law officials escorted the two men in handcuffs past media and photographers as they walked out of the Federal Plaza building in Manhattan, where the FBI has its local offices.
Additional reporting by Phil Wahba, Randall Mikkelsen, Ellen Wulfhorst, Joseph A. Giannone, Chip East, Emily Chasan and Patrick Fitzgibbons; Editing by Andre Grenon and Gary Hill