By Grant McCool
NEW YORK (Reuters) - When two former Bear Stearns hedge fund managers go on trial on Tuesday on charges they misled investors over risky securities, their attorneys may have to fight a perception that Wall Street is in the dock over the financial crisis.
Big money managers Ralph Cioffi and Matthew Tannin are the first Wall Streeters from a listed company that was bailed out by the government in 2008 to be criminally charged. The bailout paved the way for JPMorgan Chase & Co to take over Bear Stearns.
The indictment neither charges the pair of causing the company's demise nor contributing to the financial crisis, but defense lawyers will be keen to weed out potential jurors who may harbor such biases.
"Unfortunately, the defendants wear the scarlet 'IB' (for) investment banker across their chests and this is a problem for them," said James Cox, professor of law at Duke University in Durham, North Carolina. "Juries have not been very friendly to executives who are seen as poster children for an ongoing financial climate."
Emails written by Cioffi, 53, and Tannin, 48, from late November 2006 through mid-2007 as the credit crisis loomed, will be a key battleground in the trial.
Jury selection starts on Tuesday in Brooklyn federal court with opening arguments expected later in the week for a five- to six-week-long trial before U.S. District Court Judge Frederic Block.
Prosecutors contend that at least by March 2007 -- more than 18 months before the full extent of the financial crisis became clear -- Cioffi and Tannin promoted to investors two funds worth $1.4 billion crammed with subprime mortgage-backed securities, while privately expressing, in their emails, fears of a market calamity.
The June 2008 indictment said the pair along with unidentified others "agreed to make misrepresentations in the ultimately futile hope that the funds' bleak prospects would change."
The funds collapsed in June 2007.
Both men deny charges of fraud and conspiracy that could put them in prison for 20 years. Cioffi has denied an additional charge of insider trading. No one else has been criminally charged, but the pair and Raymond McGarrigal, a senior portfolio manager of the funds, face civil lawsuits.
One is a claim by Bank of America Corp, the largest U.S. bank, which was the underwriter on a now toxic $4 billion collateralized debt obligation (CDO), a security backed by a pool of debt such as mortgages. The CDO was put together by the two Bear funds.
A subprime mortgage was one obtained by a borrower with a relatively poor credit history or weaker financial means than a borrower who qualified for a prime mortgage.
In a March 3, 2007, email cited in the indictment, Cioffi told Tannin: "the worry for me is that sub prime losses will be far worse than any thing people have modeled." Four days later, in an email to a colleague, Cioffi wrote: "I'm fearful of these markets. Matt said it's either a melt down or the greatest buying opportunity ever, I'm leaning more toward the former."
An even earlier email, from November 23, 2006, by Tannin in his private gmail account, was cited by prosecutors in court papers on Thursday after they obtained a CD-ROM disk from Google Inc last week.
Tannin, in a diary entry, recounts a meeting with a colleague in which "I had a wave of fear set over me that the fund couldn't be run the way that I was 'hoping'. And that it was going to subject investors to 'blow up risk'."
Lawyers for the men are expected to argue that other inferences could be drawn from the emails, such as they were debating possible outcomes for the market.
"If you are managing your hedge fund, you constantly are assessing your 'what if?' scenarios in your risk profile," said Jack Sylvia, a New York securities litigator and defense lawyer who is not involved in the case. "To single out a couple of hedge fund managers puts the blame on them for the collapse of an entire class of securities and, to me, is unfair."
Cioffi and Tannin, well-known in the world of hedge funds but not to the general public, ran the Bear Stearns High Grade Structured Credit Strategies Master Fund and the High Grade Structured Credit Strategies Enhanced Master Fund.
Less than a year after the funds fell in the toxic environment of subprime mortgages, Bear Stearns collapsed, wiping out billions of dollars in equity for its shareholders. The company was once valued at more than $45 billion.
FINANCIAL WORLD CRISIS
The trial's outcome will be closely watched by law enforcement agencies investigating possible malfeasance in the bailed-out giant insurer American International Group and the bankruptcy of Lehman Brothers Holdings Inc that shook the entire financial world just over a year ago.
The two men, who earned millions of dollars a year, are not accused of a long-running multibillion-dollar fraud such as those of executives of other publicly traded companies WorldCom, Enron or Adelphia Communications a few years ago.
Imprisoned fraudster Bernard Madoff's decades-long investment scheme of as much as $65 billion through his private firm is in a category of its own.
But the spotlight shone on Cioffi and Tannin at a key early moment in the liquidity crisis.
"The question for the jury is going to be whether these defendants actually believed that the market would collapse, which would suggest an intent to deceive, or whether they were merely fearful or suspicious of the market, which may not necessarily be culpable," said Bill Johnson, who until a month ago was a white-collar crime prosecutor in a different district of New York and has returned to private law practice.
Bear Stearns' troubles were an important part of the credit freeze and the shock to the subprime mortgage market that led up to the financial crisis, but it was not the fault of Cioffi and Tannin, their lawyers argue.
"Many in the press unfairly linked Bear Stearns' demise to the failure of two of its prominent hedge funds," counsel for the two men said in court papers in May this year.
In the days before the trial, Cioffi's lead lawyer Dane Butswinkas said only that he was ready to defend the case. Tannin's lead lawyer Susan Brune declined comment. A spokesman for the U.S. attorney in Brooklyn declined comment.
The fund managers were arrested by the FBI on the morning of June 19, 2008, at their homes in New Jersey and New York, three months after the U.S. Department of Justice announced "Operation Malicious Mortgage" in response to the subprime-induced credit crunch.
The case is U.S. v. Cioffi and Tannin 08-415 in U.S. District Court, Eastern District of New York (Brooklyn)
(Reporting by Grant McCool; Editing by Martin Howell and Jan Paschal)