Wall Street faces day of reckoning over Bear StearnsPaul Radvany in The Telegraph (UK), October 03, 2009
Ralph Cioffi Jnr and Matthew Tannin were once masters of the universe – now they face trial for their role in the collapse of Bear Stearns.
By James Quinn, US Business Editor 11:16PM BST 03 Oct 2009 Comment
It was the diamond anniversary party Carmela and Ralph Cioffi Snr deserved. After 60 years of marriage, the retired restaurant owners ate, drank and chatted with family and friends at their daughter Sharon's home in Glen Carbon, a small village in rural Illinois.
The date was October 27, 2006 and, among their large extended family, including five children and 13 grandchildren, stood grown-up sons Ralph Jr, a hedge fund manager for Bear Stearns, and brother Chris, a Florida property developer and part-time restaurant investor.
But, as the red wine flowed into the early hours, Ralph Jr and his brother had something other than family on their minds. For the pair's multi-million dollar condominium development in Sarasota had, like so much of Florida's property market, begun to turn sour.
As of that night, they had just 17 days to rustle up about $4m in collateral for a faltering loan from lender Busey Bank, which was threatening to foreclose on their "La Firenza" development project.
Around the same time, Ralph Jr was having problems at work. Approximately six weeks before his parent's anniversary party, Cioffi, a senior managing director at Bear Stearns Asset Management (BSAM), received an email from colleague Matthew Tannin.
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Together the pair ran two highly-leveraged hedge funds stuffed full of sub-prime mortgages and other soon-to-be toxic assets. They were called the High Grade Structured Credit Strategies fund and the High Grade Structured Credit Strategies Enhanced Leverage fund.
Tannin's email sounded desperate: "I think we need to have a very specific idea of how we would raise $100m in liquidity over a 60-day period."
He wasn't wrong. Within seven months of writing that email, the two funds – containing $1.4bn (£874m) of investors' money – had collapsed.
Nine months later, Bear Stearns, a leading Wall Street bank with a proud 85-year history, was all but finished, limping into the arms of its saviour, JP Morgan Chase. Cioffi and Tannin were the Masters of the Universe that faltered.
Next Tuesday, October 13, the two men stand trial for their alleged role in the collapse of the two funds, a collapse which many in the financial community pinpoint as the beginning of the crisis of confidence that ended in the credit crunch.
After an investigation that has spanned more than two years, the two former bankers will be pitted against the might of the US government in the austere surroundings of courtroom 10C in Brooklyn's district courthouse.
Before Justice Frederic Block, the duo, who both strongly deny all charges against them, will be tried not only for securities fraud but of "conspiracy to defraud the United States". Cioffi alone will be tried for insider trading.
"Mortgage fraud poses a significant threat to our economy and to the peace of mind of millions of Americans," said Deputy Attorney General Mark Filip at the time of the pair's arrest.
In essence, the trial will be the People vs Wall Street, as Cioffi and Tannin become the first senior executives of any Wall Street bank to be tried for criminal charges linked to the cataclysmic series of events of the past two years.
The case will be closely watched, not only by those within the financial fraternity, fearful for what might have been, but also by the wider American and global community, some desperate for scapegoats, others seeking reasons for, and answers to, why the world financial meltdown happened in the first place.
The nub of the case will be that while the men admitted in private the problems the two funds faced, in public they retained a stiff upper-lip, even attempting to get investors to plough more money in as things started to head south.
Filings from a since-dismissed lawsuit from Barclays, a liquidity partner in one of the funds, have been said to demonstrate the attitude of the two men, holding a "vodka toast" at the end of one month to celebrate the funds' survival.
Even when investors tried to get their money out, as the US housing market on which most of their bets were based worsened, time and time again the accusation is that the pair did not tell investors what they appeared to know, talking, according to court documents, of their "best month ever" and that the funds "continue to do well, quite well, in fact".
From the documents filed in court and from speaking to those close to the long-running case, it is clear that the prosecution's argument will largely hang on a series of emails, one in particular, between the two men. The key email, as detailed in prosecution filings, was sent on April 22, 2007 by Tannin to the personal email account of Cioffi's wife, thereby circumventing Bear Stearns' email logs. In it, Tannin allegedly admitted that the "sub-prime market looks pretty damn ugly" and that he believed that the funds should either be closed or "get very, very aggressive".
"If we believe the [CDO (collateralised debt obligation) report is] anywhere close to accurate I think we should close the funds now.... if it's correct then the entire sub-prime market is toast. If AAA bonds are systematically downgraded then there is simply no way for us to make money – ever."
He went on to claim that the funds were in "bad bad shape" and openly asked who within the bank they should talk to about the situation.
According to court documents, three days after the mail was sent the two men hosted an investors conference call when Tannin said they were "very comfortable with exactly where we are," adding that "there's no basis for thinking this is one big disaster."
Key prosecution witnesses include John Geissinger, BSAM's former chief investment officer, and Barbara Keller, then BSAM's chief compliance officer.
The second plank of the prosecution's case will focus on the supposed intent by the two men to deceive and, on Cioffi's part, to use his knowledge of the funds' faltering performance for his own financial benefit.
Court papers show that Cioffi transferred $2m of his approximate $5.7m investment in the Enhanced fund in late March 2007 to another, successful Bear Stearns hedge fund he also managed.
In recent weeks, prosecutors have also attempted to place Cioffi's Florida property development in the frame, alleging that the pledging of $4.25m of his investment in the Enhanced fund in November 2006 to Busey Bank is "direct proof" of the crimes he is charged with. The intent here is to show that Cioffi had a strong motive to commit insider trading, arguing in court filings that "avoiding foreclosure proved to be a strong motive for Cioffi to tell lie after lie to his investors" to keep the funds "in business".
Importantly, however, like much of the case the prosecution is attempting to try, this line of evidence, based on the La Firenza pledge, has yet to be admitted by Judge Block.
In the past two weeks, the trio of assistant US attorneys heading the prosecution – Ilene Jaroslaw, James McGovern and Patrick Sinclair – have bombarded the judge with batches of new evidence. It takes the total number of pages filed to more than nine million – in an apparent attempt to widen the scope of the trial and reinforce the original indictment, which many feel was flimsy, in order to ensure successful prosecution.
In the past week alone there has been an extraordinary series of exchanges between the trio and the pair's defence lawyers, led by white collar crime defence aficionado Ed Little for Cioffi, and Susan Brune, a former federal prosecutor, for Tannin.
Brune has accused the attorney's office of attempting to introduce irrelevant issues into the case in an attempt to smear her client.
Jaroslaw – who specialises in securities cases – and her team want to inform jurors that Tannin's tablet computer and one of Cioffi's notebooks, both of which were used to make notes in the last six months of the funds' life, have both since disappeared. The defence, based on court filings to date, is keen for such details not to be put to the jury.
The trio also want Judge Block to allow details of Cioffi's lavish lifestyle to come to light, homing in on the fact that he reputedly took home $10m-plus bonuses year after year, allowing him to further his love of Ferrari's, of which he has three, and houses, of which he has four.
While he has yet to make a final decision on these matters, the judge seems less than impressed by the prosecution's efforts, telling them he thought the inclusion of the La Firenza loan pledge to be "a stretch" at a recent pre-trial hearing.
He is however likely to rule on these 11th-hour issues tomorrow, when he addresses both sides during a status conference following the start of jury selection, a process which itself could last a number of days given the 300 potential juror candidates that have been corralled.
Although being run by two separate legal teams, the two men's defence will largely centre around one key construct, that in spite of the obvious concern highlighted in Tannin's mail to his colleague about the state of the market, neither man had any criminal intent to mislead. Instead, that email, along with many others which form part of the prosecution's case, will be presented as a running commentary on a dire situation which was changing by the day.
The defence is expected to argue to jurors that in the midst of a volatile market, the pair were attempting to work out what to do for the best, contending further that it is the job of a fund manager to worry, to discuss both sides of a conundrum, and to come up with the best solution for investors.
That the funds collapsed does not make them criminals, the defence is likely to argue, as it broadens out the context in which the emails were exchanged.
Part of the defence's case will also be to place the funds in context, saying their collapse was part of a wider failure of institutions, rather than individuals, who knew of the potential for losses, and indeed signed up to that potential from the outset.
Another key argument to be levelled, one with more political overtones, will be the fact that Cioffi and Tannin appear to have been positioned to take the fall for the sub-prime mortgage crisis and the ensuing fallout in the financial community.
The way in which the two men were indicted in June 2008 – manacled and marched from their respective homes at the crack of dawn by the FBI even though lawyers had offered to surrender them days earlier – will be raised.
On that day, the FBI revealed that more than 400 people had been arrested as part of "Operation Malicious Mortgage". Cioffi and Tannin, the defence will argue, were made to be the US government's star performers that day, with their arrests designed to coincide with propaganda from the Bush administration that it was taking the mortgage market meltdown seriously.
Whatever the outcome of what is likely to be a two-month trial, however, the implications are far wider than whether or not Cioffi and Tannin go to jail.
As the first high-profile trial stemming from the sub-prime crisis, one which will have the eyes of the financial world upon it, civil prosecutors and class action lawyers will closely follow not only the outcome but also the jurors' and the judge's approach towards the two men.
One of the key underlying issues likely to stem from the case is the use of email by bankers. To date, there have been a number of high profile Wall Street cases centred on emails, not least that of the US government's prosecution of former CSFB banker Frank Quattrone which centred on a reply he sent to an earlier email that contained the words "clean up those files" in the subject line. This was initially interpreted by prosecutors as the banker telling his staff to destroy evidence. But Quattrone, who was initially sentenced to 18 months in prison for obstructing justice, later managed to overturn the government's case, proving that the only message he conveyed was to encourage his staff to follow the company's document retention policy which was in force at the time.
Paul Radvany, a former federal prosecutor in New York, argues that in spite of the fact banks are now keeping a closer eye on email usage, people will always find ways to get around rules: "This is a warning to others that using private email doesn't mean you will escape detection."
A more important issue at stake is the role of a banker as a salesman who gives advice, and to what extent private thoughts on the market or products have an impact on advice given to investors or clients.
Professor Jim Cohen notes that although the term "puffing" is often used in such cases, it does not apply here.
Instead Cohen, who is associate professor of law at Fordham University, argues that when the two defendants were supposed to be updating investors on the performance of the fund at various intervals, they should have done so based "on current and recent historical events". "There appears to be a clear case" that they did not do so, he argues, with reference to the evidence available to date.
"This theory of prosecution really turns on prosecutors' ability to convince jurors that Cioffi and Tannin crossed the line between acceptable Wall Street salesmanship and wilful misrepresentation," Rob Mintz, a former assistant US attorney turned white collar litigator argues.
"Regardless of the outcome of this trial, among the lessons here is that those giving advice to investors should be wary of overselling their investments and that trying to keep their funds afloat cannot be an end unto itself," says Mintz, partner at McCarter & English.
As for whether practices will change on Wall Street as a result of the case, it remains to be seen.
"It's too early to tell," admits Radvany, who believes that a mindset change is really more dependent on the Securities and Exchange Commission (SEC) stepping up its investigation and enforcement divisions.
"This case, per se, has some deterrent value and if convicted, some bankers will wake up and realise what they should not be doing. But whether Wall Street will tighten its oversight of investment bankers in the future will also depend on what Congress and the SEC does."
The other obvious development and one that is already happening even before the trial has started, will be a slew of litigation, class actions and otherwise surrounding not only the two men but the banks and its directors.
Bank of America has been given leave to sue Cioffi and Tannin and Bear Stearns, in spite of protestations from Bear's new owner JP Morgan, over more than $2bn in losses.
Just last week, Bruce Sherman, whose Private Capital Management owned a 5.9pc stake in Bear, filed a suit against former chief executive Jimmy Cayne, co-president Warren Spector and accountants Deloitte for the loss of his investment.
As in Cioffi and Tannin's case, Sherman alleges that both men personally assured him that their "risk management strategies" would protect "his investment in Bear from the growing housing crisis." Who is responsible, legally, for what will be the fulcrum around which many of these cases will be settled.
Brooklyn's district courthouse will be the venue for a trial that the financial world will be watching, knowing that its outcome will have an impact far beyond that building's court 10c.
It is all a long way from that diamond anniversary party in 2006 when the world was awash with funds and investment banking appeared a one way bet to huge profits.