The FBI showed up on the doorstep of Bear Stearns executive Matthew Tannin on a Friday night early last fall. Agents wanted to talk to him about possibly providing some evidence against his boss at Bear Stearns, hedge fund manager Ralph Cioffi. Tannin's response was brief, "Talk to my lawyer."
By that time, the Securities and Exchange Commission already had been combing through Bear Stearns' e-mails and financial records for months in connection with an investigation the agency launched soon after two high-profile funds run by Cioffi collapsed in June 2007. The funds had a lot of exposure to bonds backed by subprime mortgages, and when that market crashed so did the funds. Bear Stearns, in the words of two officials involved in the case, was in "super-cooperative mode" with law enforcement officials.
For those months, the big question was whether the SEC would refer what seemed like a regulatory case to the U.S. Attorney's Office in New York for criminal proceedings. Eventually it did, leading to the most high-profile arrests linked to the subprime mortgage crisis to date.
Following the E-Mail Trail
Prosecutors used a trail of e-mails to accuse Cioffi and Tannin of conspiracy, wire and mail fraud. They said Cioffi and Tannin wrote a raft of e-mails to each other worrying about the possible collapse of the subprime mortgage market while assuring investors all was well. In the end, investors lost $1.6 billion.
"As a defense attorney, I would look at these e-mails and try to persuade a jury they don't show intent to defraud," said former assistant U.S. attorney and Justice Department lawyer Brad Simon. He is now a defense attorney. "They might show other things ... panic, hand-wringing. What do we do now? Rather than let's go out and deceive investors."
Half a dozen hedge fund managers contacted by NPR said the e-mails excerpted in the indictment were far from unusual. Internal e-mails are often emotional. One day a hedge fund manager might think he is doomed — in one e-mail Tannin said that if the figures on subprime mortgages were accurate the funds were "toast," — only to be buoyed by some unexpected opportunity the next day. It is possible that Cioffi and Tannin actually thought they could ride out the crisis, they said.
People close to the case tell NPR that when the full e-mails come out, they will present a very different picture than the one currently painted in the indictment. They say the e-mails are taken out of context and excerpted in such a way as to put both men in the worst possible light. And in the end, if that is true, that could be a problem for the government's case, lawyers said.
"If the government is cherry-picking selected e-mail, that's a powerful argument for the defense," said defense attorney Simon. "If they can say, 'What about these e-mails, how come they aren't in the indictment?' That could be a very different situation."
Former prosecutor Michael Bachner is now a white-collar defense attorney. He says that from what he has gleaned in talking to Cioffi's and Tannin's lawyers, there is much in the e-mails that could exonerate the two men.
"Conversations I have had with defense counsel leads me to believe the case is not nearly as strong as the government would lead everyone to believe," he said.
Looking at the Numbers
From early September until just last week, prosecutors interviewed a host of people including some of the high net-worth individuals who had invested in the fund and saw their money evaporate when the funds went belly up. They also interviewed former Bear Stearns employees. Sources said they were doing so right up until the indictments were handed down last week.
Investigators had spent a good amount of time trying to find inconsistencies in the financials of the two funds Cioffi and Tannin ran. They were hoping to find misstatements there to prove fraud beyond a reasonable doubt. There seemed to be a suggestion of that in May 2007, when Cioffi asked Bear Stearns' pricing committee, which oversees the calculation of the funds' net asset value, to use higher values for some assets held by the funds in calculating its April 2007 losses.
If the committee had supported Cioffi's version of events, the Enhanced Fund would have had a negative 6.5 percent return. The way the pricing committee saw the assets, the return on investment for the fund was down nearly 19 percent. According to people close to the case, Cioffi ended up citing the negative 19 percent number to investors.
If Cioffi and Tannin actually reported the smaller loss, then that would be much more important than the roster of e-mails prosecutors cited. The conflict with the pricing committee was mentioned in the indictment, but what isn't said was that these kinds of arguments between the compliance committee and managers happen all the time.
Is It Politics?
People close to the case said that in the last month or so government lawyers were working literally around the clock to make the indictment happen on a date certain. They wanted the arrests to coincide with another high-profile announcement in Washington — the arrest of 406 lower-level players in the subprime mortgage debacle.
It was clear, one person said, that the Justice Department wanted to announce originator fraud and big Wall Street fraud the same day.
In mid-June it became obvious to defense attorneys that the indictments were imminent. They began to negotiate terms of arrest. They argued that the two men clearly weren't flight risks given that the investigation had been going on for more than six months and both Cioffi and Tannin had spoken to officials, tried to explain their version of events and even provided presentations to explain what was going on with the two funds.
Government attorneys had even said they didn't think Cioffi and Tannin were flight risks. But trying to get them to agree to allowing the two men to surrender in court was a non-starter. Government officials were keen to arrest the two men out of the blue, when they least expected it. Ultimately, their lawyers were able to negotiate that they would be arrested just outside their homes in the morning.
After their arrests, the men were driven to FBI headquarters in downtown Manhattan and went into the federal building through a private garage entrance. They would not leave that way. Lawyers wrote numerous letters to convince officials from both the U.S. Attorney's Office and the FBI not to subject Cioffi and Tannin to a perp walk. That, too, was nonnegotiable. FBI officials said the New York office is fond of perp walks and this was nothing unusual.
The media was alerted first thing last Thursday morning that the two men would be leaving at around 9:30 a.m. from the Duane Street exit of the downtown federal building. Officials close to the case said there was foot-dragging inside headquarters so the two men wouldn't leave before the appointed time. A police officer whistled just seconds before the men emerged so cameras and tape recorders could start rolling. The two men were paraded out in handcuffs and put into waiting cars.
Why Bear Stearns?
The FBI has said it is investigating at least 19 major firms involved in the subprime mortgage crisis. Observers watching the case say it is no surprise that Bear Stearns ended up as the first in the cross hairs because prosecutors were very worried about having indictments further roil the markets. Bear Stearns, because it no longer exists, didn't present that kind of problem.
"Bear Stearns was a safe bet," said Bachner. "Prosecutors knew there wouldn't be a huge ripple effect on the market because it didn't exist anymore. In that respect it was a fairly safe target. They could send a message without hurting the markets or costing people jobs."
NPR has learned from two sources close to the case that the fact that Bear Stearns no longer existed — it was purchased at firesale prices by JPMorgan Chase & Co. — was a part of the prosecutors' decision to indict Cioffi and Tannin first. While it wasn't the only reason and prosecutors felt they had a solid case, the fact that it would have little or no market impact did play into prosecutors' calculations, officials close to the case said. The U.S. Attorney's Office and the FBI declined to discuss the case.
The investigation of the e-mails and witnesses is trying to get to the bottom of one thing: Did Cioffi and Tannin intend to mislead investors in the spring of 2007? Stanley Arkin, a prominent Wall Street lawyer, said there is a human case to be made.
"The fundamental issue here is how do you punish bad judgment when it is not malignant intent? Maybe they didn't mean to hurt their investors. They were dealing with a new kind of credit instrument that was tough to analyze," he said. "I am assuming what happened in some respects, humanly, is that his judgment failed him. His fear of failure came over him, and probably greed as well. So do you send someone to jail for 20 years for that?"
There is also the question of why a case that just a couple of years ago would likely have stayed with the SEC and a civil proceeding would be elevated to a criminal offense. That, said Simon, is all about the current environment. "Just as ... after Enron we saw a slew of indictments coming down, there was WorldCom and a host of others, so a lot of this is politically driven," he said.
"This should have been pursued by a civil or regulatory matter by the Securities and Exchange Commission and not turned into a criminal case," Bachner said. "They did this after Bear Stearns went out of business, they didn't indict any of the higher-ups in Bear Stearns, and certainly Cioffi and Tannin are going to have a very strong argument that everything they did was OK'd by supervisors and they are being made scapegoats."
Some observers said the intense pressure came from Washington because it wanted a high-profile Wall Street case to send the message that the Justice Department is serious about cracking down on mortgage fraud. It is unclear whether Bear Stearns is actually the strongest case the FBI has of the 19 major corporations it is investigating — or simply a convenient target.
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