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Monday, June 16, 2008

Subprime debut?

Kate Kelly reports in today’s Wall Street Journal that indictments appear to be near in the year-long investigation of former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin. It was the collapse of their funds in July 2007 that marked the beginning of the current credit crisis.

The probe by the Brooklyn U.S. Attorney’s office focuses on the management of two high-profile bond portfolios. The issue is whether Cioffi and Tannin misled investors in these portfolios by misrepresenting the status and safety of the investments, which were tied to the mortgage and credit markets. Around the same time that Cioffi told investors he was “cautiously optimistic” about the safety of the instruments, he was moving $2 million of his own money out of one of the troubled funds. Then these markets plummeted, igniting broad problems within the economy.

This case is being closely watched on Wall Street. If these indictments are obtained, they would represent the first charges against executives in connection with the subprime mortgage market meltdown. This might signal a willingness on the part of prosecutors to aggressively pursue more cases against individual executives in connection with the broad failures in mortgage-related securities.

A few months ago, Cioffi was said to be planning an aggressive defense. One potential avenue will certainly be the unexpected and massive nature of the subprime credit failure. How could anyone have predicted its breadth and power? Moreover, simply because a manager decides to move his own money, this does not make him a liar. Why can’t he be both “guardedly optimistic” as a matter of professional opinion and extraordinarily cautious with his own dough?

For more on the potential for individual prosecutions in the wake of the subprime mortgage crisis and the available defenses, there is an article in this month’s Corporate Counselor newsletter with my byline on it. I don’t claim to have a crystal ball, and I promise not to say I told you so if there is an indictment. CR

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