Bear Stearns' Trail of 'Lies'

An unearthed filing reveals the prosecutors' playbook against the two $1.5 billion hedge fund managers whose indictment helped expose the mortgage crisis.

The government’s case against two Bear Stearns hedge-fund managers, Ralph Cioffi and Matthew Tannin, got a lot more clear this month, courtesy of a prosecutor’s document quietly filed in federal court in Brooklyn.

In a May 8, 2009, letter to Judge Frederick Block, who is presiding over the case against Cioffi and Tannin, Benton Campbell, the U.S. Attorney for New York’s Eastern District, highlights some 18 pages of evidence—under the heading “Summary of Lie”—that describes the additional “fraudulent statements or activities” the two men allegedly engaged in during the months leading up to the collapse of two hedge funds in June and July 2007. Campbell’s letter is essentially the prosecution’s binding roadmap for the upcoming trial.

In a March 15, 2007, email, Tannin allegedly wrote “I’m very serious—if you have clients who believed in what we could do in ’03 they should invest now. There are not many real reasons to think the mortgage market is going to implode.”

The failure of the two hedge funds, which together had around $1.5 billion of investors' money in them, is considered to be the first tangible evidence of the fissures in the market for mortgage-backed securities, and helped to expose the dangers lurking on balance sheets all across Wall Street. Since the funds’ collapse, Bear Stearns was sold to JPMorganChase, Lehman Brothers filed for Chapter 11 bankruptcy and Merrill Lynch sold itself to Bank of America just days shy of filing for bankruptcy itself. To put it mildly, the country and financial markets are still grappling with the consequences of these huge tectonic shifts in the world of finance.

Here’s a peek into the government’s playbook. All of the following points are allegations, of course, whose veracity will be determined at the trial:

• Between March 4 and March 23, Cioffi allegedly “lied” to BSAM management and investors “about his personal view of the performance and results of the [f]unds and, based on these lies, he encouraged investors to increase their positions in the [f]unds.” To Rich Marin, the head of BSAM, Cioffi wrote on March 4: “Rich I feel very good about our results given the meltdown this week…” Two days later, to both Marin and Warren Spector, then Marin’s boss and the co-president of Bear Stearns, Cioffi wrote: “We are in very good shape and given the turmoil I feel very very good about our performance.”

• On March 22 Cioffi allegedly told George Buxton, a senior managing director at BSAM, that “really what we should be talking to [an unnamed investor] about is increasing their investment [in the two hedge funds] and not redeeming” and then added the next day, “that being said they should probably invest more in [the two hedge funds] and start a position in [a third hedge fund Cioffi was soon to be managing]. I think that April will be a good time…”

•On March 2, to one investor—M. Moghadam—Tannin allegedly wrote, “All the news is good here, please give me a call so I can give you a full update. We are in GREAT shape—and I’d love for our investors to be as excited as we are.” On March 6, to “K. Chavanne,” another investor, Tannin wrote: “We are in great position. I think you guys should add some money for April 1st. We are seeing a lot of very good opportunities.”

• To Shelly Bergman, a former broker at Bear Stearns now at Morgan Stanley who had his own and his clients’ money invested in the doomed hedge funds, Tannin allegedly wrote on March 7, “…and I think Ralph and I are in agreement that we are looking at some great possibilities for the coming months. I don’t know where you are putting your money now but I would suggest we speak about adding more to the fund. That’s what I’m thinking.” On March 15, even though the fund had lost value in February and March was not looking good, Tannin wrote to Bergman: “Shelley—I’m very serious—if you have clients who believed in what we could do in ’03 they should invest now. There are not many real reasons to think the mortgage market is going to implode. In my mind the risk to the market is recession and I simply do not see that happening for the next six months.”

• To Cioffi and two of his other partners, Tannin allegedly wrote on March 11: “I am really really [sic] not worried . . . We have never lived by mark to market returns—these numbers are close to meaningless—what is not meaningless is Carry CARRY CARRY”—meaning the difference between what the funds paid to borrow money and what the fund managers thought they could earn on that money by investing in risky securities.

• On March 15, Tannin allegedly wrote to his two colleagues “...I think I have an even better idea [than talking about the opportunities for the third hedge fund as well]. This is a very very important time in the markets. Each of our funds is very well positioned to act decisively here. I think the best thing would be for you to identify six or seven of your accounts to whom we have spoken in the past and who you think could invest this month.. There is really nothing more important to us right now.”

• According to Campbell’s letter, Tannin reserved special ire for those investors who wanted to redeem their money from the funds after the losses started to show up. On March 30, to an investor—“B. Schliemann”—Tannin wrote “I think you are being silly…We are now experiencing volatile times. The fund has performed substantially better than I believe I have told you the fund would perform in a situation like the one we are having. You have chosen the absolutely silliest time to redeem.”

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• One of the prosecution’s main contentions is that Cioffi and Tannin “lied or caused others to lie” about the two hedge-fund managers’ investments in the funds. At one point, the government alleged in its indictment, Cioffi took out $2 million from the hedge funds without informing the outside investors, supposedly with the intention of investing that money in the third hedge fund he was put in charge of on April 1, 2007. “Well I planned on doing it [i.e. investing in third hedge fund] for December and forgot and for each of the last 3 [months] I just never got around to it,” Cioffi allegedly wrote Tannin on April 2, 2007.

* The prosecutors point out that Tannin kept saying he would invest more of his own money in the hedge funds but never did. The prosecutors state one investor was told by Tannin that “Ralph and I each have about 40% of our non-real estate net worth in the fund. I am adding more this month. We both hold our entire position in the levered fund.” At other times, Campbell wrote that Cioffi and Tannin told investors the portfolio managers had “about $8 million in the funds and this represented 1/3rd of their liquid net worth” and that Cioffi “represented he had $5.5 million” in the second, “enhanced” hedge fund and that Cioffi spoke about Bear Stearns having “$32 million in the fund and that BSAM employees had another $8 million in the fund.” (In the end, Bear Stearns had $45 million invested in the funds as an equity investor.)

“My goal is to convey my thoughts to our investors—they should ALL be adding to their positions,” Tannin wrote Cioffi on March 11, 2007. “I am. It is the perfect time. Where else would one go?’

* The prosecutors also contend that Cioffi and Tannin misrepresented to investors the extent of the redemption requests from investors as the funds’ performance soured in April and May 2007. Between May 8 and May 10, Cioffi and Tannin told Shelly Bergman, the Bear broker, that “there were insignificant redemptions and if any significant redemptions came in, the [f]unds would just close the gate.” Cioffi wrote an “A. Kugler” on May 31, 2007, that “so far we have talked any June redemptions of note (other than about $5 million) to pull their redemptions. So we are good for another month.” BSAM closed the funds off from investor redemptions in June 2007. Lawyers for Bear Stearns told prosecutors on October 10, 2007, that “Cioffi claimed he did not have 100% knowledge of what was being redeemed on June 30[, 2007,] and does not remember what he did know. Cioffi said he may have ‘pulled out of thin air’ his ‘couple of million dollars’ reference.”

The U.S. Attorney’s Office in Brooklyn did not want to respond on the record for a comment about Campbell’s letter other than to say the letter was “a good faith” effort to present to the defense what they should be prepared to defend against at trial. Attorneys at Hughes, Hubbard & Reed or Williams & Connolly or Brune & Richard that represent the defendants did not return calls seeking a comment. In the past, defense attorneys have argued that the government has taken Cioffi and Tannin’s emails out of context and failed to quote from the entire emails, which would cast the culled information in a very different light.

William D. Cohan, a former senior-level M&A banker on Wall Street, is the author of The Last Tycoons: The Secret History of Lazard Freres & Co. Cohan's House of Cards: A Tale of Hubris and Wretched Excess on Wall Street, was published by Doubleday on March 10.