Report Says Bear Stearns Fraud Probe Growing

The <"">Bear Stearns fraud probe that has so far yielded indictments against two of the doomed investment bank’s hedge fund managers might soon engulf other banks.  Federal prosecutors reportedly want to know if Ralph Cioffi and Mathew Tannin, the indicted managers, misled banks that lent money to their failed hedge funds.

Cioffi and Tannin ran the High Grade Structured Credit Strategies Fund, and its sister offering, the High Grade Structured Credit Strategies Enhanced Leverage Fund, hedge funds that  invested in securities backed by sub-prime home loans.  Both funds crashed last summer, ushering in the sub-prime mortgage crisis and spelling beginning of the end of Bear Stearns.

According to The New York Times, as early as March 2007, Cioffi and Tannin began receiving worried calls from investors and their lending banks as the subprime mortgage market began to fall apart.  The Times reports that Cioffi, according to transcripts reviewed by prosecutors, told investors on several occasions that he was optimistic about a recovery, culminating with a conference call on April 25 last year.

Earlier this week, both men were indicted on nine counts of conspiracy, securities fraud and wire fraud.  US prosecutors say e-mails allegedly sent by the two suggesting that their funds were headed for trouble, four days before they told investors they were comfortable with their holdings.  Tannin allegedly e-mailed Cioffi saying he was afraid that the market for bond securities they had invested in was “toast,’’ and suggested shutting the funds, the Journal said.  Both men have pled not guilty to the charges.

Now, prosecutors are trying to determine if the former hedge fund managers’ alleged lies extend to rival banks, including Merrill Lynch and Bank of America. According to a report in “Business Week”, prosecutors are particularly interested in a $4 billion collateralized debt obligation that Cioffi and Tannin convinced Bank of America to guarantee and sell in the spring of 2007.  That occurred right before  the market for such risky mortgage-backed securities collapsed.

Bear Stearns, once the fifth-largest U.S. investment bank, faced a run on the bank in March and was forced to sell itself to JPMorgan Chase & Co.  After the hedge funds collapsed last July, Bear’s investors became increasingly reluctant to do business with the company. The buyout of Bear Stearns by JPMorgan Chase – termed a “shotgun marriage” by some – was consummated after the Federal Reserve agreed to provide up to $30 billion in non-recourse financing to JPMorgan, with Bear Stearns’ illiquid mortgage and other securities as collateral.

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