Matthew Tannin and Ralph Cioffi, former Bear Stearns’ hedge fund managers, were taken into custody at their homes Thursday morning. They are facing criminal charges due to the collapse of the subprime mortgage market and the resulting implosion of the two hedge funds they managed.  

Both former executives are accused of deceiving investors about the risk of their investments in subprime mortgages. The principal question is what did they really know when they presented the funds as promising investments.  

The prosecutors look to rely heavily on private emails.  According to the Wall Street Journal, the two allegedly sent emails implying the funds they invested in were about to crash four days before they told their investors they were confident in these funds. Tannin supposedly told Cioffi he thought the market they invested in was “toast” and wanted to shut down the funds.  

“The arrests are appropriate given the magnitude and the egregiousness of their alleged misconduct,” said attorney Steven Caruso, who is representing investors in arbitration cases against these funds.  

Their arrests are the first of possible fraud cases by banks and mortgage firms whose investments in the subprime market decreased in value. The market’s losses are now totaling around $396.6 billion. The current indictments may lead to several other criminal cases and civil suits in the future. 

Bear Stearns’ termination should have been predicted when the Federal Reserve intervened early this year to bail out the bank after the hedge funds collapsed. This collapse added fuel to the fire for the recent credit crisis. It was proof that the market could critically impair the companies that bought and resold these loans.  

Tannin and Cioffi were brought up in lawsuits last year by hedge fund investor, Barclays Bank, claiming they were purposely misled. Barclays stated Bear Stearns’ knew for months the assets in its Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund had decreased in cost since their original value.  Barclays reported that the email from Tannin said the fund is “having our best month ever.” But, at the time the fund was actually having “severe liquidity problems, and lost hundreds of millions of dollars.”  The funds failed despite Cioffi and Tannin’s positive evaluations , resulting in over $20 billion in assets to crash.

Former Bear Stearns Cos. managers Ralph Cioffi and Matthew Tannin are on the verge of criminal charges for securities fraud for mismanaging two Bear Stearns Cos. hedge funds, costing investors $1.6 billion in losses.  

Federal prosecutors have suggested that Cioffi and Tannin could face indictment. “At issue is whether the managers intentionally misled investors by presenting a rosy picture of the funds at a time when they were privately communicating with colleagues about their worries over how the investment vehicles would ride out weakness in the mortgage market,” says Wall Street Journal reporter Kate Kelly.  

Bear Stearns’ recent history of financial problems has raised concerns over its management abilities and risk controls. Bear Stearns invested large amounts of borrowed securities into bonds backed by subprime mortgages.

Despite the subsequent meltdown of mortgage-backed securities, Cioffi and Tannin remained optimistic about the subprime market. However, in May 2007, Bear Stearns was unable to repay its investors with cash and meet demands from lenders for additional cash, or margin calls. As a result, Bear Stearns lent $3.2 billion in order to recover its High-Grade fund only to see the funds file for bankruptcy protection a month later. Additional losses to the firm came from the bond market losses and investor panic. 

The potential indictment of managers from Bear Stearns, now part of J.P. Morgan Chase & Co., could mark the beginning of more investigations dealing with the mortgage-market crisis, which began a year ago. More financial firms are taking precautions to provide more precise valuations on their holdings of mortgage securities.

After 18-years, Citigroup veteran Reaz Islam, is leaving the firm.  Mr. Islam most recently was the manager of two Citigroup, Inc. hedge funds that have imploded over the last several months.

The hedge funds, Falcon Strategies and ASTA/MAT, are fixed income funds marketed to individual investors.  The funds were sold as low risk, conservative investments.  Over the last couple of months, both of these funds have been wiped out. 

Falcon Stategies has lost over 75% of its value and ASTA/MAT was at one time down 77%. 

Last month Citigroup set aside $250 million to help some investors recoup a portion of their losses.  Unfortunately, this set aside does not even begin to fully compensate for investors’ losses.  As a result, a number of lawsuits have been filed by aggrevied investors.  

Our firm is interested in meeting with investors of these funds in order to evaluate their investments to see if a case of action exists.