Securities Fraud Attorney Blog

Below is a profile of Ross Intelisano from the Spring 2010 edition of the Brooklyn Law School Magazine BLSLaw Notes.

BLSLawNotes
The Magazine of Brooklyn Law School | Spring 2010
Alumni Update
Ross Intelisano ’94: Fighting Fraud from Bear Stearns to Bernie Madoff and Beyond

In 2006, Ross Intelisano made a prediction. A seasoned securities arbitration lawyer with a reputation as one of the leading authorities on securities fraud and Ponzi schemes, Intelisano looked into the future and saw a financial crisis of unimaginable proportion. He put his vision on paper and published an article in Bloomberg Law Reports entitled “Hedge Fund Fraud — The Future of Securities Arbitration?” in which he predicted, one year prior to the Bear Stearns High Grade Funds implosion, that broker-dealers would roll out proprietary hedge funds that were bound to unleash havoc on the financial system. Unfortunately for the market, and for the countless number of investors hurt by Bear Stearns, Intelisano was right.

In 2007, as predicted, Bear Stearns’ High Grade hedge funds crashed, with $1.6 billion in losses. Intelisano was there to pick up the pieces, taking on Bear Stearns on behalf of Racetrac, a multi-billion dollar private company that had lost $5 million in Stearns’ High Grade Structured Credit Strategies Hedge Fund. In December 2009, after a 16-day arbitration in Atlanta, Intelisano won a $3.4 million arbitration award on their behalf. The award was groundbreaking for two reasons: It was the first verdict in any forum relating to the High Grade Funds, and it was rendered after portfolio managers Ralph Cioffi and Matthew Tannin were acquitted in a federal criminal trial.

While the Racetrac arbitration was an historic case, it was not the first time Intelisano had been on the pioneering end of an arbitration. He has long been a crusader for defrauded investors.

After graduating from the Law School in 1994, Intelisano joined Pressman & Associates, a one-man shop where he began to practice securities and employment law. Three years later, he was recruited by Eppenstein & Eppenstein, a premier securities arbitration firm, where he served as co-trial counsel on Engel et. al. v. Refco, the legendary commodities fraud case. The 100-day arbitration, on behalf of 13 individuals and family-run businesses, generated a $43 million judgment in 2001. It remains the largest collected arbitration award ever rendered on behalf of retail investors against a brokerage firm.

In 2003, he joined forces with Eppenstein colleague John G. Rich to form Rich & Intelisano where he continued to try landmark cases, most notably working on behalf of investors who lost over $25 million in the $300 million Bayou hedge fund Ponzi scheme run by convicted fraudster Sam Israel. In Bayou, Intelisano once again did the unprecedented, filing a group arbitration case not against Israel, but against the registered investment advisor who had recommended Bayou to investors, for failure to perform adequate due diligence. The case, which was settled in mediation, was the first time in the world of secu¬rities arbitration that anyone had implicated an investment advisor in a Ponzi scheme.

And then came Bernie Madoff and a Ponzi scheme so large that it dwarfed anything the securities world had ever seen ($18 billion is the latest estimate). Intelisano’s phone started ringing. “I spent hours consoling investors, listening to all of these tragic stories of middle class people who had lost every dime they had saved over a lifetime,” he recalled. “I knew they would never get it back. It was the lowest point of my career as a lawyer.”

While he knew he would not be able to help investors sue Madoff (their restitution is being handled by a court-appointed trustee), he brought back the “investment advisor theory” he advanced in Bayou, and is currently representing a group of 12 victims in claims against investment advisors to Madoff feeder funds. The hearings begin in June.

With the Madoff cases ahead of him, and the victories in Racetrac and Bayou behind him, Intelisano has become one of the country’s most well respected experts in the world of hedge fund fraud. He has appeared on The Today Show, Anderson Cooper 360, Dateline NBC, PBS’s Frontline, Closing Bell with Maria Bartiromo, and is regularly quoted in The New York Times and The Wall Street Journal.

Looking into the future, Intelisano believes the horizon remains clouded over with the potential for serious fraud. “Over-the-counter derivatives, credit default swaps, oil futures, all of these products that the government is worried about regulating are very complex and are improperly being sold to retail and institutional investors. Firms aren’t watching the shop. No one is.”

Prediction noted.

62 • BLSLawNotes

Below is a New York Times Piece about Bayou v. Goldman Sachs

Goldman Must Pay Some Bayou Losses
By LOUISE STORY and GRETCHEN MORGENSON
Goldman Sachs has been ordered to pay $20.58 million to creditors of a failed hedge fund to settle claims that the bank helped the fund perpetrate a Ponzi scheme.
The award represents the first time that a bank has been held accountable for a Ponzi scheme because of its role as a middleman.
Goldman cleared trades and lent money to the Bayou Group, a Connecticut hedge fund that collapsed in 2005, when state and federal investigators said the firm defrauded investors of hundreds of millions of dollars.
The Bayou fraud resurfaced in 2008 when its founder, Samuel Israel III, faked his own suicide after being sentenced to 20 years in prison for fraud. He later turned himself in and is now serving 22 years.
Bayou’s creditors filed a complaint against Goldman two years ago, saying the bank either knew or should have known of Bayou’s fraud. Goldman, the complaint said, had access to Bayou’s trading records, which showed losses, as well as its marketing materials, which showed profits.
The award, in a decision by an arbitration panel of the Financial Industry Regulatory Authority issued on Thursday, may put other banks on notice to better scrutinize their hedge fund clients’ activities.
“This case shows that you can’t just stick your head in the sand when a fraud is going on in your shop,” said Ross B. Intelisano, a lawyer at Rich & Intelisano, who brought the arbitration against Goldman. The bank “argued that you could, and the panel disagreed.”
A Goldman spokesman pointed to the bank’s filing in the case, which questioned whether the creditors could use bankruptcy laws to hold Goldman accountable for the $20.58 million of investor money that Bayou transferred among its Goldman accounts. The money was never actually conveyed to Goldman, the bank said, so it should not be considered a fraudulent transfer.
The arbitration panel does not determine whether wrongdoing occurred, but merely decides on compensation.
“We are disappointed with the award and are considering our options,” said Ed Canaday, a spokesman for Goldman.
Goldman has limited grounds for vacating an arbitration award, however.
The award to Bayou’s creditors is yet another legal woe for Goldman. The bank is also the target of a Securities and Exchange Commission investigation of its mortgage operations before and during the financial crisis, and Goldman is fighting an S.E.C. complaint and private lawsuits about mortgage securities it created. Goldman has defended its actions in the mortgage market and said the parties that purchased its mortgage deals should have known what they were dealing with.
Although the Bayou case dates long before the financial crisis and has nothing to do with mortgage bonds, Goldman made similar claims in its reply. The bank, for instance, said the creditors of Bayou were “highly sophisticated investors.” Goldman also said it had no duty to monitor the “honesty and the finances” of its account holders.
Goldman served as Bayou’s main prime broker from 1999 to 2005, meaning that the bank had a wide view of the hedge fund’s activities, according to the creditors’ complaint. In that role, Goldman was the custodian of Bayou’s assets and a lender to the fund. Goldman also prepared Bayou’s account statements, the creditors said.
The award represents the amount of money that was put into the Bayou funds held at Goldman between March 2003 and June 2005. It accounts for just over 8 percent of the $250 million in losses that Bayou investors incurred in the fraud. If this award is included in the total recovered by Bayou investors, it will rise to more than half of their losses.
Bayou began losing money long before it went bust, for more than $88 million in losses during its association with Goldman. At the same time, Bayou told prospective investors that it had positive returns. During those years, Bayou marketed its relationship with Goldman as a mark of legitimacy, the creditors said.
Goldman was aware that Bayou was losing money, the creditors said. In 2004, Goldman’s risk managers created a list of the top 10 money losers among its clients. The No. 1 loser was a Bayou fund, and two other Bayou funds were ranker lower. The list, the complaint said, was circulated among Goldman executives.
A month after that list was circulated, Goldman requested and received a copy of Bayou’s marketing materials, which falsely claimed positive returns. Goldman also was warned about Bayou by an outside firm in 2002, the complaint said.
Goldman’s employees, the complaint said, “have repeatedly claimed that they had no obligation to concern themselves with what had occurred at the Bayou Hedge Fund at anytime.”

Below is the Wall Street Journal piece regarding Bayou v. Goldman Sachs.

JUNE 26, 2010
Goldman Told to Pay Bayou Fund Creditors
By SUSANNE CRAIG
Goldman Sachs Group Inc. was ordered to pay $20.6 million, the largest arbitration award levied against the securities firm, to unsecured creditors of Bayou Group LLC who accused Goldman of ignoring signs of fraud at the hedge-fund firm.
Bayou collapsed in 2005, and the firm's former chief executive, Samuel Israel III, is serving a 20-year prison term for fraud. He pleaded guilty to misrepresenting the value of Bayou's funds and defrauding clients out of more than $400 million.
Goldman cleared trades for the Connecticut hedge-fund firm before it collapsed. In 2008, Bayou's unsecured creditors' committee filed an arbitration claim against two Goldman units.
"Through either gross negligence or a willful choice to ignore the signs of fraud, [Goldman] failed to diligently investigate the red flags it was made aware of, to contact Bayou's auditors to request additional information, or to alert the appropriate authorities of what it had learned," lawyers for the committee alleged in the claim.
A three-person Financial Industry Regulatory Authority arbitration panel didn't provide an explanation for its ruling, issued Thursday. A Goldman spokesman said the panel didn't conclude that the firm committed any wrongdoing or violated any rules.
In its response to the initial arbitration filing, Goldman said the $20.5 million represents money that was fraudulently transferred among Bayou accounts and was never in Goldman's possession. Clearing operations typically maintain client records and send out trade confirmations, often earning big fees in return.
The Goldman spokesman said the New York company is "disappointed with the award and is exploring its options." Unlike court decisions, it is extremely hard to overturn arbitration awards because courts can't review the facts in an arbitration case. Courts are allowed to reverse such awards only for exceptional reasons, such as finding that an arbitrator acted improperly.
"This is a big victory for the victims," said Ross Intelisano, a partner at New York law firm Rich & Intelisano LLP who represented the Bayou creditors.
The largest previous arbitration award against Goldman was $2.8 million in 1994, according to Securities Arbitration Commentator, a Maplewood, N.J., newsletter that tracks arbitration cases. The Bayou ruling also is the sixth-largest arbitration award to any customer of a Wall Street firm, the newsletter said.
Winning damages from clearing firms is especially difficult because firms are required to spell out their duties in advance, often limiting their liability to only those functions. In its response to the arbitration filing, Goldman said the law "does not require clearing firms or prime brokers to monitor the suitability of the transactions they process or to investigate their account holders." Imposing such a standard "would slow commerce, raise costs and imperil financial markets," the firm said.
Separately, the Financial Crisis Inquiry Commission said Goldman President and Chief Operating Officer Gary D. Cohn and Chief Financial Officer David Viniar will testify at a hearing next week to examine the role of derivatives in the financial crisis.

Rich & Intelisano, LLP won a $20.5 million arbitration award against Goldman Sachs related to the Bayou hedge fund Ponzi scheme. The award is 100% of the compensatory damages requested. It is the largest arbitration award ever rendered against Goldman and the sixth largest customer arbitration award against any Wall Street firm. It is also the first win in any court or arbitration forum by investors against a clearing or prime broker related to a hedge fund Ponzi scheme based upon fraudulent transfer theories.

Partner John Rich masterminded the case, and tried it together with partner Ross Intelisano, with significant help from Matt Woodruff, Diane Mall Sammarco and Eric Clem of our office.

The award is on Finra’s website. The Firm represented the Bayou Creditors’ Committee in the 18 day arbitration hearing. The three arbitrator panel held over 13 pre-hearing sessions and 36 hearing sessions in 2008 through 2010.

From 1999 through 2005 Goldman Sachs Execution & Clearing, Goldman’s clearing broker, served as the sole prime and clearing broker for the Bayou funds. During 2002 through 2004, Goldman earned over $5 million in fees from Bayou. The Bayou victims alleged in their complaint that Goldman knew or should have known that Bayou was committing fraud and should have done an investigation into Bayou’s activities at Goldman. Instead, Goldman turned a blind eye to numerous red flags and suspicious activity in order to continue to reap fees.

The investment world is buzzing about the SEC’s fraud allegations against Goldman Sachs for misrepresenting and omitting to disclose Paulson’s role in choosing RMBS securities for the ABACUS CDO and then shorting the same individual RMBS through CDS transactions with Goldman. According to the SEC, “investors in the liabilities of ABACUS are alleged to have lost more than $1 billion.” It is hard to tell whether direct investors in ABACUS lost $1 billion or whether that includes companies which had CDS risk exposure to it. Either way, what are the money losers going to do about it?

According to the SEC complaint, IKB, the German commercial bank, bought $150 million of Class A-1 and Class A-2 Notes which seem to look like the AAA-rated upper tranches of ABACUS. But there is no other disclosure of who else bought ABACUS from Goldman. I presume that IKB was very cooperative with the SEC and allowed its name to be used in the complaint as opposed to being dubbed “Investor #1". IKB has likely been negotiating with Goldman behind the scenes. I expect to see a civil complaint filed by IKB against Goldman in federal court in New York shortly. However, they are probably better off arbitrating the dispute for numerous reasons (privacy, low cost, limited dispositive motion practice, etc.).

The SEC complaint also explains how a division of ACA, the monoline insurance company, served as the “Portfolio Selection Agent” for ABACUS, and another division of ACA (ACA Capital) also sold protection on $909 million of the super senior tranche of ABACUS through credit default swaps as well. ABN AMRO, the European bank, then assumed that same exposure through CDS deals with Goldman and ACA. The complaint alleges Goldman defrauded IKB, ACA and ABN AMRO. ABN AMRO was bought by the Royal Bank of Scotland and after ABACUS went to almost zero, RBS paid Goldman $841 million, most of which was then paid by Goldman to Paulson due to Paulson’s short bets on the underlying tranches. Got that?

So, RBS is holding the potential claims against Goldman (and Paulson?) for $841 million. Very interesting to see if RBS sues either of them.

But what about the rest of the ABACUS investors? According to the Flip Book available on Reuters’ website, ABACUS was a $2 billion synthetic CDO. Who else bought it besides IKB? And what are these investors going to do once they’ve read the SEC complaint? I have a guess or two.

By the way, Goldman netted $15-20 million for structuring and marketing ABACUS. Amazingly, Paulson paid Goldman $15 million to allow it to help pick the RMBS for ABACUS. This is a killer fact for the SEC.

Below is an article from Reuters this week regarding our client’s $3.4 million arbitration victory against Bear Stearns related to the Bear Stearns High Grade Fund. There are many investors who, for one reason or another, had decided not to file arbitrations against Bear Stearns. Investors should be aware that FINRA has a six year eligibility rule. In some jurisdictions, an investor who files a FINRA arbitration more than six years after the purchase of the High Grade Fund may be the subject to a motion to dismiss in the FINRA arbitration. Since the original High Grade Fund launched in about September 2003, early investors who are contemplating taking action should make a final decision sooner rather than later so as to avoid any potential motion. Investors who rolled over from the High Grade Fund to the Enhanced Leverage Fund should have no FINRA eligibility rule issues.

Investor in defunct Bear fund wins $3.4 mln award
3:15pm EST
* Award follows acquittal of fund managers
* JPMorgan Chase is responsible for paying the investor
By Matthew Goldstein
NEW YORK, Feb 9 (Reuters) - A Georgia-based chain of service stations that lost money with a Bear Stearns hedge fund that collapsed in July 2007 has won a $3.4 million arbitration award.
The award by the securities industry arbitration panel is the first ruling in favor of an investor in one of two now defunct Bear hedge funds since a jury acquitted the funds' former managers of criminal charges in November.
The award suggests that investors who lost $1.6 billion in the collapse of the two highly leveraged funds may still be able to recoup some of their money. The award was made on Dec. 23 and was posted recently on a website maintained by the Financial Industry Regulatory Authority.
The three-member arbitration panel, as is customary, did not offer much of a rationale in its written decision for the award of $3.4 million in damages to Racetrac Petroleum Inc, an Atlanta-based chain of more than 525 gas stations and convenience stores across the U.S. Southeast.
The award represents 70 percent of Racetrac's $5 million investment in one of the former Bear funds, according to a copy of the arbitration award posted on the website.
Ross Intelisano, one of Racetrac's attorneys, declined to comment on the award. Carl Bolch, chief executive officer of privately-held Racetrac, did not return a phone call.
The arbitration panel reached its decision after holding 32 hearing sessions last year. Six of those hearings took place in December, after a Brooklyn, N.Y., jury acquitted former Bear managers Ralph Cioffi and Matthew Tannin on Nov. 10.
Federal prosecutors had charged the pair with lying to investors about the health of the funds, which had invested heavily in complex bonds backed by subprime mortgages. The summer 2007 collapse of the funds, which at their peak controlled more than $30 billion in mortgage-related securities, is often seen as the start of the financial crisis.
The arbitrators found that Bear, which is now part of JPMorgan Chase & Co , was negligent and failed to adequately supervise the funds.
The Racetrac ruling shows that even though Cioffi and Tannin were acquitted, "they can still be held responsible in an arbitration forum for their misconduct," said attorney Steven Caruso, who represents Bear fund investors in a number of pending arbitrations.
The ruling is a blow to JPMorgan Chase, which assumed most of Bear's legal liabilities when it acquired the ailing investment bank in March 2008.
A JPMorgan spokesman declined to comment on the award.
When JPMorgan bought Bear for $10 a share in a deal engineered by the federal government, the bank said it was setting aside $6 billion to pay for any litigation arising from the acquisition. But following the acquittal of Cioffi and Tannin, some in the legal world thought investors in the Bear funds might have a tough time prevailing in lawsuits and arbitration.
Indeed, many investor lawsuits and arbitrations had been put on hold pending the outcome of the criminal trial.
But the Racetrac case went forward after a U.S. district judge rejected an attempt by federal prosecutors to stay the arbitration. (Reported by Matthew Goldstein; editing by John Wallace)

Below is a Reuter’s article about the first Bear Stearns High Grade Fund arbitration case won by an investor. John Rich and Ross Intelisano of Rich & Intelisano, LLP were lead trial counsel and Jake Zamansky and Ted Glenn of Zamansky & Associates were co-counsel.

"Investor in Defunct Bear Fund Wins $3.4 Mln Award"

* Award follows acquittal of fund managers

* JPMorgan Chase is responsible for paying the investor

By Matthew Goldstein

NEW YORK, Feb 9 (Reuters) - A Georgia-based chain of service stations that lost money with a Bear Stearns hedge fund that collapsed in July 2007 has won a $3.4 million arbitration award.

The award by the securities industry arbitration panel is the first ruling in favor of an investor in one of two now defunct Bear hedge funds since a jury acquitted the funds' former managers of criminal charges in November.

The award suggests that investors who lost $1.6 billion in the collapse of the two highly leveraged funds may still be able to recoup some of their money. The award was made on Dec. 23 and was posted recently on a website maintained by the Financial Industry Regulatory Authority.

The three-member arbitration panel, as is customary, did not offer much of a rationale in its written decision for the award of $3.4 million in damages to Racetrac Petroleum Inc, an Atlanta-based chain of more than 525 gas stations and convenience stores across the U.S. Southeast.

The award represents 70 percent of Racetrac's $5 million investment in one of the former Bear funds, according to a copy of the arbitration award posted on the website.

Ross Intelisano, one of Racetrac's attorneys, declined to comment on the award. Carl Bolch, chief executive officer of privately-held Racetrac, did not return a phone call.

The arbitration panel reached its decision after holding 32 hearing sessions last year. Six of those hearings took place in December, after a Brooklyn, N.Y., jury acquitted former Bear managers Ralph Cioffi and Matthew Tannin on Nov. 10.

Federal prosecutors had charged the pair with lying to investors about the health of the funds, which had invested heavily in complex bonds backed by subprime mortgages. The summer 2007 collapse of the funds, which at their peak controlled more than $30 billion in mortgage-related securities, is often seen as the start of the financial crisis.

The arbitrators found that Bear, which is now part of JPMorgan Chase & Co , was negligent and failed to adequately supervise the funds.

The Racetrac ruling shows that even though Cioffi and Tannin were acquitted, "they can still be held responsible in an arbitration forum for their misconduct," said attorney Steven Caruso, who represents Bear fund investors in a number of pending arbitrations.

The ruling is a blow to JPMorgan Chase, which assumed most of Bear's legal liabilities when it acquired the ailing investment bank in March 2008.

A JPMorgan spokesman declined to comment on the award.

When JPMorgan bought Bear for $10 a share in a deal engineered by the federal government, the bank said it was setting aside $6 billion to pay for any litigation arising from the acquisition. But following the acquittal of Cioffi and Tannin, some in the legal world thought investors in the Bear funds might have a tough time prevailing in lawsuits and arbitration.

Indeed, many investor lawsuits and arbitrations had been put on hold pending the outcome of the criminal trial.

But the Racetrac case went forward after a U.S. district judge rejected an attempt by federal prosecutors to stay the arbitration. (Reported by Matthew Goldstein; editing by John Wallace)

The SEC announced that it will continue to pursue its civil enforcement case against former Bear Stearns High Grade Fund portfolio managers Ralph Cioffi and Matthew Tannin, after the recent acquittal of criminal charges against Messrs. Cioffi and Tannin. According to recent news reports, Robert Khuzami, head of enforcement at the SEC, told Reuters TV, “We filed a case based on the evidence from our investigation.” Mr. Khuzami added, “we have a different standard of proof.”

The SEC’s complaint (available on its website) is indeed far more broad than the charges lodged by the U.S. Attorneys’ Office in Brooklyn. It also reaches all of the way back to the beginning of the High Grade Fund’s existence as opposed to just the late 2006, early 2007 time period the prosecutors focused on. The prosecutors’ standard of proof of “beyond a reasonable doubt” is much stiffer than the SEC’s and civil litigants’ standard of “by a preponderance of evidence.” In order for Messrs. Cioffi and Tannin to re-enter the securities industry, they will have to defend the SEC action as well.

Katherine Burton and David Glovin wrote a good piece on Galleon on Friday. Here it is.

Galleon Wiretaps Rattle Hedge Funds as Insider Trading Targeted

Oct. 26 (Bloomberg) -- First came the biggest bear market since the 1930s, then Bernard Madoff's $65 billion Ponzi scheme and the threat of increased regulation. Now hedge funds have a new concern: getting caught on tape as the government expands its use of wiretaps to ferret out insider trading.

Prosecutors, using secretly recorded phone conversations for the first time against hedge funds, alleged Oct. 16 that billionaire Raj Rajaratnam and five others made $20 million by swapping material inside information on companies such as Hilton Hotels Corp. and Google Inc. They may charge at least 10 more people soon, people familiar with the matter said last week.

Rajaratnam, founder of New York-based Galleon Group LLC, regularly talked to hundreds of contacts, including other traders, according to people who know him. His arrest rattled hedge-fund managers, who are questioning whether legitimate discussions caught on the tapped lines will draw scrutiny, say lawyers who've fielded such queries. A broader worry: whose phones are being monitored as prosecutors and U.S. Securities and Exchange Commission continue their probes?

"The word wiretap strikes fear in the hearts of everyone, even the innocent," said Brad Balter, who runs Balter Capital Management LLC, a Boston-based firm that allocates clients' money to hedge funds.

Ross Intelisano, an attorney with Rich & Intelisano LLP in New York, said he received a call from an executive at a $1 billion hedge fund who was considering hiring a company to test his firm's phones for listening devices. The client asked what to do if the firm found any. "Do we go to the police?" the executive asked, according to Intelisano.

The executive instructed his colleagues to be extra careful about what they say on the phone, not because they are breaking the law, but because they are fearful that any conversation about stocks could be misconstrued, Intelisano said.

Calls Aren't Safe

"After the Bear Stearns case, e-mails aren't safe, and now phone calls aren't safe," Intelisano said. "From now on, people are going to be meeting for lunch."

Prosecutors used e-mails to build their case against former Bear Stearns Cos. hedge-fund mangers Ralph Cioffi and Matthew Tannin, who are currently on trial in Brooklyn for misleading investors about the health of two funds that collapsed in 2007. It's the biggest trial stemming from a U.S. probe of banks and mortgage firms whose losses in subprime loans and related securities total at least $396 billion.

For hedge-fund managers whose knowledge of wiretaps may have been limited to "The Wire," the HBO drama in which Baltimore police eavesdrop on drug dealers, electronic bugging is a new reality of their industry as U.S. Attorney Preet Bharara's new Complex Frauds Unit targets white-collar crime.

Continue reading "Galleon Wiretaps Rattle Hedge Funds" »

Opening statements in the criminal trial of Ralph Cioffi and Matthew Tannin, the former portfolio managers for the Bear Stearns High Grade Funds, start today in federal court in Brooklyn, NY. The High Grade Funds imploded in 2007 causing $1.4 billion in investor losses. Prosecutors have charged Cioffi and Tannin with securities fraud and Cioffi with insider trading. The media coverage so far has focused almost exclusively on emails sent by Cioffi and Tannin regarding their personal thoughts about the Funds. The government alleges that Cioffi and Tannin thought the Funds were in serious trouble but then told investors on conference calls that everything was fine. While emails are often sexy and this is an important part of the case, the defense will likely argue that the email quotes were taken out of context and that the portfolio managers were simply analyzing the prospects of the Funds and were not intentionally lying to investors.

The press has not focused much on two just as important aspects of the prosecution’s case which should be easier to prove. First, according to the prosecutors, on the investor conference calls, the managers told investors that there was a lesser amount of investor redemptions in the High Grade Funds than there actually were. Here, the government can argue that Cioffi and Tannin clearly knew how much in redemptions were put in by investors yet they told investors a different number so investors wouldn’t run for the exits. The redemption amounts are undisputed facts and much less susceptible to defense spinning.

Second, the prosecutors allege that Cioffi and Tannin used their personal investments in the Funds as part of their pitch to investors, to invest in, and stay invested in the Funds. In early 2007, the government alleges Tannin told investors he was adding to his position. Also, Cioffi redeemed $2 million of his own personal monies in 2007 and did not notify investors. The government can argue that Tannin lied to investors about his own personal investments in order to keep them in the Funds. Also, that Cioffi, because he used his own personal investments in the Funds as a marketing tool, wilfully omitted his $2 million personal redemption in order to induce investors to stay in the Funds. The longer the Funds were alive, the better chance Cioffi and Tannin could continue to reap their multi million dollar annual bonuses.

Both of the these arguments are not as reliant on what Cioffi and Tannin believed when they wrote certain emails. Since it is unlikely that Cioffi and Tannin will testify at the criminal trial, the prosecutors may want to focus more on the redemption issues.

Matthew Tannin, the former Bear Stearns High Grade Fund portfolio manager, kept a personal diary of e-mails to himself in a G-Mail account. The U.S. Attorney's Office received the e-mails after using a search warrant on Google. According to e-mails released by prosecutors yesterday, Tannin wrote in as early as November 2006 that the funds "could blow up”. U.S. District Judge Frederic Block said at a hearing that he will likely allow prosecutors to introduce the newly obtained e-mails as evidence at Tannin’s trial. The U.S. Attorney's Office apparently has not finished reviewing all of the e-mails.

These e-mails could be extremely helpful in the government's case against Tannin. His trial is set for Oct. 13. The prosecutors can use Tannin’s e-mails to show his knowledge and intent that Tannin and a co-defendant Ralph Cioffi misled clients about the funds.

The e-mails may also be helpful for the many investors who have pending securities arbitration cases against Bear Stearns (our firm has multiple, significant arbitrations pending at FINRA). Since the notebook and Tablet PC of Cioffi and Tannin have gone missing, Tannin's newly discovered personal e-mail diary may be investors only chance to look into Tannin's thoughts regarding the funds.

The Bear Stearns High Grade Funds blew up in the early summer of 2007, precipitating the the credit crisis around the world. On October 13, 2009, in federal court in Brooklyn, NY, Ralph Cioffi and Matthew Tannin, the portfolio managers of the High Grade Funds, will be facing criminal trial on fraud and conspiracy charges. Cioffi has also been charged with insider trading. This is the first major criminal trial stemming from the subprime mortgage era. It will be closely watched around the world. The U.S. Attorneys' Office of the Eastern District of New York recently won a huge trial against former Credit Suisse broker Eric Butler who was convicted of fraudulently selling millions of dollars of auction rate securities. The Brooklyn jury convicted Butler of conspiracy to commit securities fraud, securities fraud and conspiracy to commit wire fraud and he faces a maximum sentence of 45 years in prison. A major battle is being fought over whether the prosecutors can introduce evidence that a Tablet PC and a notebook of Cioffi and Tannin disappeared and about Cioffi's lavish lifestyle.

Bear Stearns was ordered to pay at least $125 million by a New York bankruptcy judge for failing to disclose to investors that Manhattan Investment Fund was committing hedge fund fraud and the firm was instead accepting Manhattan’s funds to cover Bear’s margin exposure. This is a huge decision.

For many years, clearing firms and prime brokers have enjoyed significant protection from the courts when one of their clients have committed securities fraud. The firms have always argued: “all we were doing was clearing trades and providing margin.” The firms forgot to add “and minting money.”

Wall Street firms earn up to $10 billion in prime brokerage revenue each year. A big portion of this is from hedge funds. All the while, firms have been primarily shielded from potential liability when a fund blows up due to hedge fund fraud. The Manhattan decision may change that. Now, when a prime broker sees red flags of potential fraud by a hedge fund it does business with, it better start doing some due diligence.

With the U.S. government recently deciding not to regulate hedge funds, it looks like the major battles over who is to blame when hedge funds blow up will take place in courts and arbitration.