Bear Stearns case: Not so simple

At the start of the criminal trial of two hedge-fund managers, a defense lawyer argues that the alleged lies told to investors are not clear-cut.

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By Roger Parloff, senior editor

Ralph Cioffi (left) and Matthew Tannin, the two former Bear Stearns hedge fund managers now on trial
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NEW YORK (Fortune) -- In yesterday's opening statements in the criminal case against two Bear Stearns hedge-fund managers, Brooklyn federal prosecutors followed all the pundits' advice and did what the Enron prosecutors had done so successfully before them: They kept it simple.

Yet simplifying what is intrinsically complex has its perils. At some point, the quest to reduce claims to their clearest, pithiest, and snappiest can lead one to say things that are not literally true. If a prosecutor succumbs to that temptation, a skilled defense lawyer will shove the discrepancy in the prosecutor's ear.

From the looks of yesterday's proceedings, lead defendant Ralph Cioffi has, in Dane Butswinkas of Williams & Connolly, just such an attorney. As a consequence, a fascinating, difficult-to-predict trial appears to be in the offing. (Counsel for co-defendant Matthew Tannin, Susan Brune of Brune & Richard, delivers her opening statement this morning.)

In his admirably succinct, 40-minute preview of the government's case, assistant U.S. attorney Patrick Sinclair said the case was about lies -- lies that Cioffi and Tannin told investors in the three months leading up to the June 2007 collapse of what had been, until then, Bear Stearns' two most illustrious and lucrative hedge funds. (Investors eventually lost about $1.6 billion.)

In an effort to buy time, Sinclair said, in hopes that plunging residential mortgage markets might stabilize, the two executives had repeatedly lied about how much of their own money they had sunk into the funds and about how many other investors had asked to pull their money out of them. (Each defendant is charged with conspiracy, securities fraud, and wire fraud. In addition, Cioffi is charged with insider trading, stemming from his March 2007 withdrawal of $2 million of his own money from one of the doomed funds.)

The opening statement for defendant Cioffi was, in contrast, at first puzzling, plodding, and diffuse. During the first half of a nearly two-hour presentation, Butswinkas told jurors that the trial would become "tedious" and then promptly made good on the prediction.

Temporarily ignoring all the prosecutors' blistering accusations concerning his client, the lawyer launched instead into a dry tutorial on collateralized debt obligations and how hedge funds leverage their investors' assets to increase profits. (I couldn't follow the portion of the lecture concerning leverage, but it had something to do with peach baskets.)

Nevertheless, if the jurors were still listening attentively after the bathroom break, they were rewarded for their patience. For it was then that Butswinkas unexpectedly began inflicting some damage on the prosecution's case.

Like what? Well, prosecutor Sinclair had stressed in his opening that one important, obvious lie made by Cioffi occurred during an April 25, 2007, conference call when he assured investors that he had, to that point, received demands to redeem only about $2 million worth of investments at an upcoming opportunity to do so. In reality, said Sinclair, a major investor had only days earlier informed Cioffi that he would be redeeming his entire $57 million.

Butswinkas contends, however, that the evidence will tell a different story. The investor had actually told Cioffi that he hadn't yet decided whether to pull out his money, and that he was providing formal notice of redemption only to keep his options open.

While that contention might sound dubious, Butswinkas then went on to assert that the investor in question participated in the April 25 conference call. It was taped, so the jury will be able to hear him asking questions on it, Butswinkas continued. Would Cioffi really have lied about that investor's redemptions with the investor on the line? And wouldn't the investor have protested if he thought Cioffi had done so?

The other key category of lie the prosecution promised to prove were the misrepresentations about how much of the defendants' own personal money was in the funds. Prosecutor Sinclair said investors care deeply about that issue, since they wanted to be assured that portfolio managers had "skin in the game."

In response, Cioffi's counsel said that when Cioffi moved $2 million from one of the doomed funds to a third (safer) fund he managed, he was satisfying the desire of superiors at Bear Stearns Asset Management that at least one manager of that third fund have skin in the game, which none yet did. Under the terms of the hedge funds' offering memorandum, which Butswinkas read aloud, there was no obligation for portfolio managers to disclose such personal transfers to investors.

In addition, the $4 million Cioffi kept in the doomed fund still qualified him as one of the top ten individual investors in that fund, Butswinkas said, and one of the top five most personally invested fund managers at Bear Stearns.

Finally, Butswinkas's most titillating promise concerned what he says the evidence will show happened during three crucial days in April 2007. From the moment the indictment became public in June 2008, its single most damaging revelation was the stark and suspicious contrast between the panic Tannin expressed privately about the funds' prospects in an email to Cioffi on April 22, and the confidence he professed to have in the funds in comments to investors just three days later at a conference call.

In the email, Tannin had written, "If we believe the [Bear Stearns internal report is] ANYWHERE CLOSE to accurate, I think we should close the funds now. ... If [the report] is correct, then the subprime market is toast." At the conference call he had said, "So from a structural point of view, from an asset point of view, from a surveillance point of view, we're very comfortable with exactly where we are."

According to Butswinkas, however, something rather important actually had happened between Tannin's two statements. On April 24, a meeting took place involving Cioffi, Tannin, and all the top officers at Bear Stearns Asset Management, including the unit's CEO, Rich Marin. There, the defense claims, the executives thrashed out whether the circumstances were really as dire as Tannin had thought, concluded they weren't, and ended by agreeing that BSAM should invest another $25 million in the funds.

To paraphrase Tannin, if Butswinkas's account is "anywhere close to accurate," the prosecutors may have some serious challenges ahead. To top of page

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