Hold ’em or fold ’em Bear Stearns style

Former Bear Stearns hedge fund managers Ralph Cioffi and Martin Tannin were arrested yesterday at their homes in New Jersey and Manhattan, and charged by the U.S. Attorney’s office in Brooklyn with securities fraud in connection with the allegation that they lied to investors about the health and safety of their funds. The indictment alleges that even though they knew the market for securitized interests in subprime mortgages was in dire trouble, Cioffi and Tannin told investors that the funds were in good shape, excellent buying opportunities existed, and they themselves invested their own money in the funds and added to their positions. Meanwhile, the charges cite emails between the two saying the subprime market was “toast” and the funds were in deep trouble. Ostensibly, the managers failed to disclose to remaining investors that others had withdrawn significant amounts from the funds. Lawyers for both men have denounced the prosecution’s case. One of Cioffi’s lawyers, Edward Little, stated: “Because his funds were the first to lose might make him an easy target, but doesn’t mean he did anything wrong.”

The issue in this case will be the extent to which it is proper for an investment adviser to characterize risk in a positive way and encourage investment while still maintaining personal doubts about the viability of a particular market. This is not a case of premeditated fraud in which phony companies were set up and flat-out lies were told to investors. To what extent can an adviser remain upbeat in the face of a declining financial situation in the hope that things will come around or a downturn will present a real buying opportunity? The massive extent of the subprime failure was beyond anyone’s crystal ball capabilities to predict. Now, in order to give the appearance of punishing those responsible, federal prosecutors are bent on dissecting every move these beleaguered advisers made. As I told the Newark Star Ledger, this effort to clean up Dodge is misguided. CR