The Wall Street Journal-20080215-Bear Probe May Center on Investor Call

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Bear Probe May Center on Investor Call

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A developing criminal investigation into the collapse of two internal hedge funds at Wall Street firm Bear Stearns Cos. could hinge on whether the funds' managers misled investors during a conference call last spring about the desperate straits they faced, say people familiar with the matter.

In an investor call held April 25, say these people, Bear Stearns fund manager Ralph Cioffi told participants he was "cautiously optimistic" about Bear's ability to hedge its holdings of securities tied to subprime, or low-end, home loans. The previous month, Mr. Cioffi had moved $2 million of his own money out of one of the two troubled funds into a newer, less risky internal fund, say these people.

At the same time, these people add, Mr. Cioffi was holding continuing discussions in internal emails with colleagues about the worrisome state of the credit markets, and wondering aloud whether the declines in subprime securities would spell trouble for his funds.

Prosecutors in the U.S. Attorney's office for the Eastern District of New York, based in Brooklyn, are examining whether any disparity between the public and private comments of Mr. Cioffi and others could constitute fraud, the people familiar with the matter say. Grand-jury subpoenas, or requests for the two fund managers to give confidential testimony to a jury, have not been issued, these people say.

The criminal probe, which began last summer, could become the highest-profile case to deal with the collateral damage caused to investors by the implosion of the subprime-mortgage market. A year after early cracks in the market -- which have resulted in thousands of borrowers being forced from their homes and mortgage investors losing more than $100 billion -- Wall Street firms face large regulatory and legal fallout.

Federal prosecutors are looking at ways in which Merrill Lynch & Co. and UBS AG valued subprime securities, among other things. Those matters follow probes by the Securities and Exchange Commission into the origination, packaging and valuing of subprime mortgages at a number of firms, including Bear. Related investigations, including one by New York state's attorney general, Andrew Cuomo, are examining how securities firms priced individual home loans for purchase.

Lawyers for Messrs. Cioffi and fund co-manager Matthew Tannin are considering volunteering their clients to prosecutors for informational interviews, a person familiar with the matter says. Other key players in the case, including Richard Marin, the former head of Bear Stearns Asset Management, and Evan Kerr, one of the funds' salesmen, already have met with prosecutors, as have others, the people familiar with the matter say.

Messrs. Cioffi and Tannin plan to mount an aggressive defense, the people familiar with the matter say. Mr. Cioffi is likely to argue that his decision early last March to move the $2 million was approved by internal compliance officers as a way to show confidence in a new fund, these people add. He and Mr. Tannin are likely to portray their discussions about the market turmoil and its potential impact on the funds as standard exchanges about events in the subprime arena that any two money managers holding mortgage securities would likely have had, according to the people familiar with the matter. Some of the discussions were captured in internal email messages, these people add.

Mr. Tannin declined to comment, referring a phone call to his lawyer. Mr. Marin, who has left Bear, and Mr. Kerr, who is still employed there, couldn't be reached to comment.

Bear Stearns has been cooperating with the U.S. Attorney in the case. The firm is unlikely to be indicted, say people familiar with the matter. In a parallel civil investigation by the SEC, Bear hasn't received a "Wells notice," or a warning that charges are imminent, these people add.

Also at issue for prosecutors in the April 25 investor call was Mr. Cioffi's response to a question about the High-Grade fund's exposure to subprime loans, the people familiar with the matter say. When a participant wondered whether packaged mortgage securities in the fund -- called collateralized debt obligations, or CDOs -- were tied to subprime assets, Mr. Cioffi replied that he didn't have time to teach "CDO 101," or answer basic questions about the securities, these people add.

Any indictments in the case could help the cause of the funds' former investors, some of whom now are suing the fund managers and Bear in hopes of recouping losses. Such a move "would substantially bolster the investors' claims against Bear Stearns," says attorney Ross Intelisano, whose clients lost a total of about $70 million when the funds failed.

The Bear Stearns investigations are significant because the collapse of the firm's two internal funds helped trigger the credit crisis, leading other financial firms to eventually reprice their holdings of mortgage securities. Bear Stearns, for its part, recently has written down $1.9 billion in mortgage and related securities.

The failure of the High-Grade fund and a less-risky sister entity, the High-Grade Structured Credit Strategies Fund, has blemished Bear's reputation for savvy risk management and helped send its shares into a tailspin from which they haven't yet recovered.

Last month, longtime Bear Chief Executive James Cayne resigned.

Yesterday, Bear Stearns shares were at $78.47 in 4 p.m. New York Stock Exchange composite trading, down $2.06, or 2.6% for the day. That is less than half the shares' 52-week high of $170.23.