Articles Posted in Hedge Fund Fraud

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.
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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.

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.