U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 20625 / June 19, 2008
SEC v. Ralph R. Cioffi and Matthew M. Tannin, Civil Action No. 08 2457 (FB) (E.D.N.Y. June 19, 2008)
SEC Charges Two Former Bear Stearns Hedge Fund Portfolio Managers with Securities Fraud
The Securities and Exchange Commission today charged two former Bear Stearns Asset Management (BSAM) portfolio managers for fraudulently misleading investors about the financial state of the firm's two largest hedge funds and their exposure to subprime mortgage-backed securities before the collapse of the funds in June 2007.
The SEC's complaint alleges that when the hedge funds took increasing hits to the value of their portfolios during the first five months of 2007 and faced escalating redemptions and margin calls, then-BSAM senior managing directors Ralph R. Cioffi and Matthew M. Tannin deceived their own investors and certain institutional counterparties about the funds' growing troubles until they collapsed and caused investor losses of approximately $1.8 billion.
In a related criminal action today, the U.S. Attorney's Office for the Eastern District of New York announced the indictment of Cioffi and Tannin on conspiracy and fraud charges.
According to the SEC's complaint, filed in the U.S. District Court for the Eastern District of New York, the Bear Stearns High-Grade Structured Credit Strategies Fund and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund collapsed after taking highly leveraged positions in structured securities based largely on subprime mortgage-backed securities. According to the complaint, Cioffi acted as senior portfolio manager and Tannin acted as portfolio manager and chief operating officer for the funds, and they misrepresented the funds' deteriorating condition and the level of investor redemption requests in order to bring in new money and keep existing investors and institutional counterparties from withdrawing money. The complaint alleges that, for example, Cioffi misrepresented the funds' April 2007 monthly performance by releasing insufficiently qualified estimates — based only on a subset of the funds' portfolios — that projected essentially flat returns. The complaint alleges that final returns released several weeks later revealed actual April losses of 5.09 percent for the High-Grade Structured Credit Strategies Fund and 18.97 percent for the High-Grade Structured Credit Strategies Enhanced Leverage Fund.
The SEC's complaint alleges that Cioffi and Tannin also misrepresented their funds' investment in subprime mortgage-backed securities. According to the complaint, monthly written performance summaries highlighted direct subprime exposure as typically about 6 to 8 percent of each fund's portfolio. As alleged in the complaint, however, after the funds had collapsed, the BSAM sales force was ultimately told that total subprime exposure — direct and indirect — was approximately 60 percent.
The SEC further alleges that Cioffi and Tannin continually exaggerated their own investments in the funds while using their personal stake as a selling point to investors. The complaint alleges that Tannin repeatedly told investors, directly and through the Bear Stearns sales force, that he was adding to his own stake in the funds in order to take advantage of the buying "opportunity" presented by the funds' losses. As alleged in the complaint, Tannin never actually added to his investment and he mocked as "silly" at least one investor who sought to redeem instead of following Tannin's supposed example. Meanwhile, as the complaint alleges, Cioffi redeemed $2 million, which was more than one-third of his personal investment in the funds at the end of March 2007. According to the complaint, Cioffi transferred it to another BSAM fund that he described as "short sub prime," which he knew was profitable at the time.
The Commission alleges in its complaint that Cioffi and Tannin violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. In its complaint, the Commission seeks permanent injunctive relief, disgorgement of all illegal profits plus prejudgment interest, and the imposition of civil monetary penalties.
The Commission appreciates the cooperation of the U.S. Attorney's Office for the Eastern District of New York and the Federal Bureau of Investigation, which conducted a separate, parallel investigation.
The SEC's action was conducted through its Enforcement Division's subprime working group, which is aggressively investigating possible fraud, market manipulation, and breaches of fiduciary duty that may have contributed to the recent turmoil in the credit markets. The Commission's investigation is continuing.