I just returned from attending the opening statements of one of the most important criminal trials on Wall Street in quite a long time. Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin officially started their campaign to stay out of jail for allegedly committing: securities fraud, wire fraud, conspiracy and insider trading while managing Bear Stearns’ High-Grade Structured Credit Strategies Fund and High-Grade Structured Credit Enhanced Leveraged Fund.
Prosecutor Patrick Sinclair began yesterday by charging that Cioffi and Tannin committed securities fraud by lying to investors on an April 2007 conference call by telling investors that (1) investors had requested few or no redemptions from the funds, and (2) that the mortgage-backed securities market was fine and the hedge funds were on track.
In addition, Sinclair argued that Tannin told investors 11 different times that he was putting more of his own money into the fund, but in reality had not. At one point he allegedly said, “This is the silliest time to redeem. I am putting more money into the fund.” Finally, Sinclair told jurors Cioffi did not tell investors that he transferred $2 million of his own money to another fund. In fact, he said to colleagues, “at least this other fund is making money,” according to the government.
The government cited what it claims are smoking-gun e-mails between the two fund managers. In at least one case, the government says Tannin wrote from his private Gmail account to Cioffi’s wife’s Hotmail account, declared the subprime mortgage market was going to “toast” and that its managers should “close the fund.” Prosecutors alleged these e-mails show that the defendants’ views internally were very negative at the same time they presented an optimistic front to investors.
As opening statements go, the prosecution’s was short at 45 minutes. By contrast, Cioffi’s lawyer, Dane Butswinkas, talked for two hours and used multiple charts and exhibits that sought to explain the complexities of Bear Stearns’ management structure, hedge funds and how the collateralized debt obligation market operated.
Butswinkas argued that the e-mails referenced by the prosecution were taken out of context and that the government’s charges suffer from the warped perspective of hindsight. “Ralph Cioffi did not know how things would turn out,” his lawyer said. “He didn’t have hindsight like the government has today.”
Tannin’s attorney, Susan Brune, echoed that argument. She spent two hours giving a primer on hedge funds, market risk and CDOs. She admitted that Tannin was “worried” about the market but argued that worrying is not a crime.
More specifically, Tannin’s attorney blamed the hedge funds’ collapse on a “run on the bank.” She argued that the funds were so levered that margin calls and investor redemption demands caused the funds to fail. She showed little sympathy for investors and argued that the risks were disclosed.
“I lost my money, therefore there has to be a fraud,” she said of the thinking the prosecution believes is behind the government’s case.
My own view is that the government did an excellent job of keeping the case simple and focused, stressing that “the defendants are not on trial because the hedge funds collapsed or because of the market meltdown. The defendants are on trial because they lied to investors.”
The defense, on the other hand, chose to educate the jury on hedge funds, leverage and CDOs. Their strategy appear to be to blame their clients’ behavior on the fog of war.
We saw similar strategies in the Enron trial. In that case, prosecutors kept it simple by pounding home the idea that former bosses Ken Lay and Jeffrey Skilling lied to investors; the defense focused on off-balance sheet partnerships and other financial complexities.
In the Enron case, Lay and Skilling were both convicted on all charges. Lay’s conviction was vacated by his sudden death prior to his reporting for prison. Skilling is serving 24 years and waiting for his legal team to make its final appeal for a reversal to the U.S. Supreme Court.
Jacob H. Zamansky is a principal at the firm Zamansky LLC. He is representing individual investors in claims against Bear Stearns and the firm’s High-Grade Structured Credit Strategies Fund and High-Grade Structured Credit Enhanced Leveraged Fund.