Bear Stearns Cos. hedge fund manager Ralph Cioffi raised a vodka toast to his own survival on March 2, 2007, after posting a 0.08 percent loss in one of the subprime mortgage securities portfolios he was managing, according to a federal criminal indictment filed yesterday.
“We have our health and families,” Cioffi told fellow portfolio manager Matthew Tannin and two other co-workers the next day. “We are not a 19-year-old Marine in Iraq.”
It was the first monthly loss in the 3 1/2 years that Cioffi had managed the Bear Stearns High Grade Structured Credit Strategies funds, which he founded in October 2003. Even as Cioffi celebrated, he worried in an e-mail that a “meltdown” was coming in the subprime mortgage market.
By June 2007, the funds collapsed, touching off broader subprime mortgage-related losses that now total $396.6 billion worldwide. Cioffi and his deputy Tannin were arrested yesterday and charged with mail and securities fraud. The indictment portrays a pattern of misleading investors as losses mounted. Civil suits further allege incomplete record-keeping and conflicts of interest going back to the summer of 2006.
Attorneys for Cioffi, 52, and Tannin, 46, said their clients were guilty of no wrongdoing.
“Because his funds were the first to lose might make him an easy target, but doesn’t mean he did anything wrong,” said Cioffi’s attorney, Edward Little.
The nine-count indictment filed in New York by U.S. Attorney Benton Campbell adds detail to the Bear Stearns manager’s unsuccessful efforts to rescue the funds. He allegedly transferred $2 million of his personal wealth out of the fund three weeks after the vodka salute.
The criminal complaint shows “damning evidence,” says lawyer Ryan Bakhtiari, whose Beverly Hills, California, law firm of Aidikoff, Uhl & Bakhtiari represents hedge funds and institutional investors that allegedly lost tens of millions of dollars after putting money into Cioffi’s funds in March 2007.
The two Bear funds filed for bankruptcy in July 2007, at a cost to investors of $1.6 billion, according to a securities- fraud lawsuit filed in U.S. District Court for the Southern District of New York by Barclays Bank Plc against Cioffi, Tannin and Bear Stearns. The London bank helped finance the funds.
The Massachusetts Securities Division, the first regulator to act, alleges in a November administrative complaint that the Cioffi-managed funds pushed through thousands of trades without legally required approvals and documentation. Many of the transactions were Bear Stearns investments and other deals Cioffi managed.
By September 2006, Cioffi’s bet on subprime mortgage securities was falling short of the 10 to 12 percent annual returns he’d promised, and he faced the threat of investor withdrawals, according to the federal lawsuit.
That month, Cioffi carved off 37 percent of the fund’s $1.53 billion in assets into the newly created Enhanced Leverage fund, according to the Barclays suit.
“What I was thinking was to build up six (months) of returns and then send a letter to all the remaining investors and tell them we are closing the (high-grade fund) and ask everyone to convert to the Enhanced Fund,” Cioffi said in a Sept. 17, 2007, e-mail to Tannin that is included in the Barclays lawsuit.
Almost immediately, Cioffi discovered he didn’t have the independent directors needed to sign off on some of the related- party trades he wanted to make, according to e-mails attached to the Massachusetts complaint.
The state alleges that the directors hired by the Cioffi funds, Scott Lennon and Michelle Wilson-Clarke, both senior vice presidents at Walkers Fund Services Ltd. in the Cayman Islands, routinely approved trades for which Cioffi and his staff produced insufficient documentation, often after the fact.
“The Walkers directors approved more than 165 related-party transactions whose applications were incomplete or were submitted after the transactions were completed,” according to the state.
Massachusetts enforcement attorney Michael Regan says in the complaint that the directors “do not appear to have been entirely independent.” They didn’t comply with a civil subpoena, contending the state lacked jurisdiction in the Cayman Islands, Regan says.
“The independent directors properly reviewed every trade that was presented to them,” said spokesman Michael Robinson, a senor vice president at Levick Strategic Communications LLC in Washington, in an e-mail. The directors offered to meet with Massachusetts officials and remain available, he said.
The Barclays lawsuit outlines why the alleged conflicts might be important. It alleges that Cioffi’s employer, Bear Stearns, used the Enhanced Fund “to dump” hundreds of millions of dollars of its riskiest assets, sometimes with no independent third party to value them.
According to the federal complaint, Cioffi e-mailed an unidentified colleague on March 15.
“I’m fearful of these markets,” Cioffi said in the e-mail. “Matt said it’s either a meltdown or the greatest buying opportunity ever. I’m learning towards the former.”
Publicly, he was more upbeat.
“We have an awesome opportunity,” Cioffi told a Bear Stearns co-worker on March 7, according to the criminal complaint. The colleague allegedly had more than 40 clients invested in Cioffi’s two subprime mortgage-dominated hedge funds.
Then, on March 23, Cioffi began transferring a third of his $6 million personal investment to another Bear Stearns vehicle, federal prosecutors say.
Rather than disclose the funds’ growing losses and shut them down, Cioffi and Tannin misled investors into June, according to the federal criminal complaint.
By June 9, 2007, Cioffi may have resigned himself to an unpleasant end. The federal complaint says Cioffi told a confidante then that if he couldn’t turn around the funds, “I’ve effectively washed a 30-year career down the drain.”