For Wall Street, it’s the most important trial of the year.
Next month, ex-Bear Stearns employees Ralph Cioffi and Matthew Tannin will be in federal court, facing up to 20 years in prison for fraud and conspiracy. Cioffi could see another 20 for insider trading.
The only major criminal prosecution stemming from the financial crisis so far, it’s technically about failed hedge funds that were an early harbinger of the storied firm’s collapse and the broader economic downturn.
But more generally, the fine line between salesmanship and fraud will be on trial.
Crain’s: Their trial promises to be a landmark event, since these were the first investment bankers indicted for alleged crimes contributing to the Wall Street cataclysm. Convictions would give the government a boost as it pursues similar cases against former officials of Lehman Brothers and American International Group.
“This case will be looked to by the defence bar and the Wall Street community as a measure of whether the government can prove allegations of fraud in the context of the financial meltdown,” says William Johnson, a former federal prosecutor in Manhattan and now a partner at Fried Frank Harris Shriver & Jacobson.
The trial has Wall Street’s attention for another reason: The optimism that Messrs. Cioffi and Tannin displayed as their funds collapsed is in the DNA of every salesman.
The prosecution will point out inconsistancies between optimistic public pronouncements on the funds’ performance and pessimistic internal emails. For example:
On Feb. 27, Mr. Tannin persuaded Barclays to invest $100 million by telling its bankers that the Enhanced Leverage Fund actually gained 4.3% that month, which he called the fund’s “best month ever,” according to court documents. A week later, Mr. Cioffi assembled his staff and announced that the month’s decline in performance meant “we have an awesome opportunity.”
Behind the scenes, however, the talk was grim.
“Matt said it’s either a meltdown or the greatest buying opportunity ever,” Mr. Cioffi e-mailed a colleague on March 15. “I’m leaning more towards the former.”
The defence will counter that the messages are taken out of context or that they don’t reflect Cioffi or Tannin’s true thoughts or intentions (we’ve written about that possible exaggeration).
It seems a stretch for prosecutors to pin criminal charges on ambiguous emails. And the precedent could be dangerous. We want fund managers to have open and free exchanges in which they debate market outcomes, which are always and everywhere uncertain. Punishing managers for having doubts about strategies threatens to stymie discussion or drive it off any recordable medium.
One question that occurs to us: if Cioffi and Tannin really believed they were lying or defauding their investors, would they have emailed their doubts? This seems absurd given that emails have routinely been used to mount prosecutions and investigations since the dotcom bubble burst. In our eyes, the fact that these emails exist in some ways suggests that Cioffi and Tannin were true believers rather than cheats.
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