Thursday, June 19, 2008
The SEC 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.
According to the SEC's complaint, 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 and Tannin 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. In its complaint, the Commission seeks permanent injunctive relief, disgorgement of all illegal profits plus prejudgment interest, and the imposition of civil monetary penalties.