Federal Criminal Defense Blog : Georgia Federal Criminal Defense Lawyer & Attorney : Gillen Withers & Lake Law Firm : White Collar Crime, RICO, Trial : Atlanta, Savannah, GA

The story of the week is the U.S. Securities and Exchange Commission filing a complaint against international investment firm Goldman Sachs ("Goldman") on April 15 in the U.S. District Court for the Southern District of New York, alleging that Goldman and a Goldman employee, Fabrice Tourre, a former Vice President of Goldman in New York and current Executive Director of Goldman Sachs International in London, allegedly made materially false statements to investors regarding a synthetic collateralized debt obligation, or CDO, which Goldman marketed to investors. A CDO is an asset-backed security which derives its value from underlying assets. The CDO in question was called Abacus 2007-CD1 ("Abacus 2007" or "CDO"), was backed by subprime residential home mortgages. Goldman issued a press release following the filing of the complaint stating that "The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation."

The SEC complaint alleges that Goldman used marketing materials for Abacus 2007 which falsely represented that the portfolio of mortgage-backed securities which formed the CDO were selected by ACA Management LLC ("ACA"), a firm with experience in analyzing mortgage-backed securities. However, the complaint contends that Paulson & Co., Inc. ("Paulson"), allegedly participated in the selection of the portfolio in the Spring of 2007 without any mention in Goldman's marketing materials and without the knowledge of Goldman's investors. Paulson also allegedly entered into "credit default swap" ("CDS") agreements with Goldman. Under a CDS agreement, in its basic form, an entity or person purchases "protection" against a potential default or "credit event" involving a credit instrument such as a bond or loan. The purchaser of the protection makes quarterly or premium payments to the seller of the protection. In the event that the instrument goes into default,  the seller pays the purchaser the par value of the bond or other fixed amount. CDS agreements may be used for speculative purposes, such as betting on a default in credit or loan obligations. The SEC alleges that Paulson, in selecting the securities which made up Abacus 2007, had a financial incentive to select securities which would experience credit events.

Paulson allegedly was under the belief since 2006 that certain "Triple B" rated subprime mortgage loans would experience "credit events," a/k/a significant losses. Paulson then allegedly approached Goldman and asked it to create a CDO composed of the mortgage-backed securities it believed would experience credit events. Paulson and Goldman would then allegedly "short" the CDO by entering into a CDS agreement.

The complaint alleges that Tourre designed the Abacus 2007 transaction, prepared the marketing materials and communicated with investors. At the time they were structuring the transaction, Goldman, Paulson and Tourre knew that the market for mortgage-backed CDOs was declining. Tourre allegedly sent an e-mail to a friend in January of 2007 in which he stated ""More and more leverage in the system, The whole building is about to collapse anytime now...Only potential survivor, the fabulous Fab[rice Tourre] ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!" The following month, Tourre allegedly received an e-mail from the head of Goldman's structured product correlation trading desk stating that "the cdo biz is dead we don't have a lot of time left."

The complaint also alleges that Goldman, Paulson and Tourre chose ACA Management as the portfolio selection agent because they knew they could not attract investors if the investors knew that Paulson had selected the CDO in order to short it. Paulson then allegedly identified over 100 Triple B bonds which it expected to experience credit events, including mortgage-backed securities with a high concentration of subprime adjustable rate mortgages and buyers with low FICO scores.

Tourre and representatives of Goldman, Paulson and ACA met in January and February of 2007 to select the portfolio for Abacus 2007. ACA allegedly had no knowledge that Paulson intended to short the CDO and the complaint alleges that Goldman allegedly mislead ACA into believing that Paulson was investing in the equity of the CDO and had a "long position" in the CDO's success, as opposed to taking a short position adverse to the interests of Goldman investors. ACA allegedly only permitted Paulson to participate in the portfolio selection process because it was led to believe that Paulson was a large equity investor. Tourre allegedly sent an email to a co-worker during these meetings stating "I am at this aca paulson meeting. this is surreal."

By the end of January, 2009, 99% the Abacus 2007 portfolio had been downgraded and investors in the CDO had lost $1 billion. Conversely, Paulson allegedly received $1 billion in profit. Investors in Abacus 2007 included IKB, a commercial bank in Germany, which lost almost all of the $150 million which it invested; and ACA's parent company, ACA Capital Holdings, the largest investor which invested some $951 million.

The SEC alleges that Goldman and Tourre violated Section 17(a) of the Securities and Exchange Act of 1933, 15 U.S.C. s 77q(a) and Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. s 78j(b). It seeks civil penalties and fines against the defendants.

Goldman, by all appearances, intends to fight back against the allegations. In a second press release, it contends that the accusations are unfounded in law and fact. Goldman maintains that it would not structure a portfolio that was designed to lose money, that it retained substantial risk in the transaction, and points out that it lost more than $90 million itself. It contends that its large investors were provided with extensive information relating to the underlying mortgage securities and the risks, and provided input on the underlying mortgage securities. Furthermore, Goldman points out that ACA was the largest investor and had every incentive to select securities which would not experience credit events. Goldman also claims that it never represented to ACA that Paulson would be a long investor, and that the industry practice is not to disclose the identities of buyers to sellers.

The complaint against Goldman is the largest action thus far to emerge out of the financial collapse which began in 2007, and which has angered the public and has lawmakers, law enforcement and the SEC itself feeling the heat. Former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin were acquitted on fraud charges last November relating to a failed hedge fund.

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The trial of Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin got underway last week. As reported by attorney Jacob Zamansky in Forbes and the New York Daily News, the parties gave opening statements on Thursday. Assistant U.S. Attorney Patrick Sinclair argued that Bear Stearns financial officer Matthew Tannin allegedly told investors on 11 occasions that he was putting more of his own money into Bear Stearns’ troubled High-Grade Structured Credit Strategies Fund and High-Grade Structured Credit Enhanced Leveraged Fund. Tannin allegedly told investors that it would be “silly” to redeem their investments. Sinclair also told the jury that Cioffi failed to disclose to investors that he had transferred $2 million of his own money to another Bear Stearns fund. The prosecution cited alleged incriminating e-mails between Cioffi and Tannin in which the defendants allegedly acknowledged that the subprime mortgage market was “toast” and that they should “close the fund.” Sinclair argued that Cioffi’s and Tannin’s actions were allegedly to save their bonuses and reputations. He spoke to the jury for about 45 minutes.
 

In contrast, Cioffi’s attorney, Dane Butswinkas, delivered a two hour opening statement using charts and exhibits to show the complexity of Bear Stearns’ management structure, hedge funds and the operation of the collateralized debt obligation (CDO) market. Butswinkas argued that the defendants were the victims of market forces beyond their control and that the defendants did their best to predict the future performance of the market and the funds. Tannin’s counsel, Susan Brune, also spent approximately two hours explaining to the jury about hedge funds, CDOs and market risk. Brune attributed the failure of the funds on a “run on the bank” and argued that the funds’ investors were well aware of the risks. Brune characterized the prosecution’s theory as “I lost my money, therefore there has to be a fraud.” The defense argued that the e-mails were taken out of context, and that worrying about markets is not a crime.
 

Nearly 300 investors kept their investments in the hedge funds, which lost $1.4 billion in July of 2007. The two hedge funds had experienced positive growth until the preceding quarter, however an internal Bear Stearns report showed that securitized subprime mortgages were losing value fast.
 

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The trial of former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin begins today in Brooklyn, as reported by Bloomberg. A jury will be selected today. 

Cioffi and Tannin are charged with allegedly causing losses of $1.4 billion to investors by misleading investors regarding the health of two Bear Stearns hedge funds, the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd. ("Enhanced Fund"). and the Bear Stearns High- Grade Structured Credit Strategies Master Fund Ltd. ("Master Fund"). Cioffi was a hedge fund manager and Tannin was an attorney who served as chief operating officer. They are charged with alleged conspiracy, securities fraud and wire fraud. Cioffi is also charged with alleged insider trading.

Cioffi's and Tannin's attorneys have argued that the collapse of Bear Stearns was actually the result of the failure of two other Bear Stearns hedge funds a year prior to the failure of the Enhanced Fund and the Master Fund.

U.S. Attorney Benton Campbell, a former member of the Justice Department’s Enron Corp. Task Force, and Assistant U.S. Attorney James McGovern, are leading the prosecution of Cioffi and Tannin. The prosecution alleges that Cioffi and Tannin were promoting the funds to investors while knowing that the health of the funds was in serious risk. The government has listed 38 witnesses and 532 exhibits which it intends to present at trial, however, the centerpiece of the government's evidence is expected to be Cioffi's and Tannin's own words in e-mails.Cioffi allegedly sent one e-mail on March 15, 2007, with the subject-line "Fear," stating that he was fearful of what the markets were going to do. In another e-mail, Tannin allegedly stated that if AAA bonds were downgraded, there would be no way for the funds to make money. Google released additional private e-mails to the government last week. Prosecutors allege that e-mails show Cioffi and Tannin allegedly boasting of how they were luring investors to invest more money in the funds at the same time they knew that the funds were in trouble. Witnesses for the government are expected to include Bear Stearns employees and investors in the hedge funds.

Cioffi is defended by attorney Brendan Sullivan, who won reversal of the charges against Alaska Senator Ted Stevens, as well as Margaret Keeley and Dane Butswinkas, all of Williams & Connolly LLP. Tannin is being represented by Susan Brune and Nina Beattie of Brune & Richard LLP. Commentators have observed that the e-mails by Cioffi and Tannin can be read in "many" ways.

A year following the failure of the funds, Bear Stearns itself failed and was purchased by JP Morgan Chase & Co. The failure of Bear Stearns was accompanied by failures of Lehman Brothers Holdings, Inc., and AIG. Losses from U.S. banks and mortgage companies in the financial collapse total at least $396 billion.

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The indictment against Bearn Stearns executives Ralph Cioffi and Matthew Tannin is available here. Cioffi and Tannin are charged in the only major prosecution to date arising out of the collapse of numerous Wall Street firms beginning in 2007.

As related in the indictment, the Bear Stearns High Grade Structured Credit Strategies Fund Ltd. ("High Grade Fund") and the Bear Stearns High Grade Credit Strategies Enhanced Master Fund Ltd. ("Enhanced Fund") were hedge funds registered as a Cayman Island corporation. The High Grade Fund and the Enhanced Fund were brokered by Bear Stearns Securities Corporation (BSSC). Cioffi was the founder and Senior Portfolio Manager of the funds. Tannin was a Portfolio Manager who reported to Cioffi.

The indictment alleges that the High Grade Fund opened in 2003 and was invested in low-risk, high grade debt securities and collateralized debt obligations (CDOs). The fund purchased income earning assets through repurchase agreements. The indictment alleges that Cioffi and Tannin allegedly told investors that they could expect annual returns of 10 to 12 percent and that the fund was only slightly riskier than a money market fund.

By 2006, the performance of the High Grade Fund began to decline due to investors' threats to withdraw their investments. In response to this decline, Cioffi and Tannin allegedly created the Enhanced Fund, which was also invested in CDOs, but had greater leverage than the High Grade Fund and could allegedly provide greater returns than the High Grade Fund with only slightly more risk. Cioffi and Tannin had their own monies invested in the funds. In July, 2006, Cioffi and Tannin allegedly told investors that they were moving their funds from the High Grade Fund to the Enhanced Fund. Many investors allegedly moved their investments to the Enhanced Fund.

The Government acknowledges that the funds had positive monthly returns until January 2007. It alleges that in about March 2007, The indictment also alleges that Cioffi and Tannin owed duties to BSAM, the funds and the funds' investors. Cioffi and Tannin, despite allegedly knowing that the funds had serious problems, allegedly began to make misrepresentations to investors in hopes that the funds' incomes would recover. Cioffi and Tannin allegedly misrepresented material facts in communicationswith investors and lenders including the funds' financial prospects, liquidity and exposure to the subprime mortgage market, as well as Cioffi's and Tannin's personal investments in the funds. Cioffi allegedly had a meeting with the funds' portfolio management team in March of  2007 after which he instructed those attending the meeting not to discusse the funds' difficulties with others. The indictment cites communications between Cioffi, Tannin and others on the portfolio management team, in which they allegedly expressed concern over the condition of the funds.

Despite the condition of the funds, Cioffi and Tannin allegedly continued to make misrepresentations regarding the condition of the funds in hopes of enticing more investors and improving the financial condition of the funds. Furthermore, the indictment alleges that, beginning in March 2007, Cioffi allegedly began to transfer the more than $6 milion which he had invested in the funds to other Bear Stearns hedge funds without disclosing this fact to the funds investors.

 On April 17, 2007, the management team produced a CDO report which stated that the CDOs held by the funds were worth significantly less than had previously been determined. The indictment alleges that Cioffi and Tannin communicated regarding hiding the funds' troubles from other fund employees and allegedly made false statements regarding the financial condition of the funds during a conference call with investors on April 25, 2007. In the meantime, major investors in the funds were redeeming tens of millions from the funds. In June, 2007, investors in the funds were told that the funds had lost 100% of their value, or approximately $1.4 billion.

Cioffi and Tannin are charged in the Eastern District of New York with one count of conspiracy to commit securities fraud and wire fraud, three counts of securities fraud, and four counts of wire fraud, as well as a criminal forfeiture count against their real and personal property. Cioffi's and Tannin's trial is scheduled to begin on September 28.

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As is well known, Bear Stearns, one of the largest investment banks in the world, was sold to JP Morgan Chase and effectively ceased to exist in March of 2008, after two Bear Stearns hedge funds invested in collateralized debt obligations—mainly subprime home loans—and once worth approximately $1.6 billion, lost nearly all of their value. The collapse of Bear Stearns was the harbinger for a succession of massive failures of financial institutions, including Lehman Brothers, Merrill Lynch and AIG, triggering the current global recession.

As reported by New York Magazine, Reuters and the Daily Telegraph, two managers of the hedge funds, Ralph Cioffi and Matthew Tannin were charged in June in the Eastern District of New York with several counts of wire and securities fraud for allegedly misleading investors regarding the status of the funds in the Spring of 2007. Cioffi, a hedge fund manager, and Tannin, the Chief Operating Officer of Bear Stearns Asset Management (BSAM), have pled not guilty. The collapse in value of the funds cost investors approximately $1.4 billion. When traders wanted to sell some of the funds’ subprime mortgages, no one wanted to buy them.

The trial of Cioffi and Tannin is set to begin in October. The evidence against Cioffi and Tannin consists largely of e-mails between them and investors describing the funds as “an awesome opportunity,” despite allegedly knowing that the funds had problems. Bear Stearns investors are expected to testify at the trial. Both men have consistently maintained their innocence. They face a potential 20 years in prison if convicted.

Cioffi is also charged with alleged insider trading for withdrawing $2 million of his own money from the funds. The government alleges that he engaged in hundreds of transactions involving the funds without the necessary approval by the fund’s directors and despite being warned about conflicts of interest. All trades between Bear Stearns, a securities firm, and BSAM, an asset management firm, were supposed to be vetted by an independent committee. In the Fall of 2006, Bear Stearns ordered a moratorium on such internal trades by Cioffi. Prosecutors sought to introduce evidence of Cioffi’s alleged insider trading in order to demonstrate how Cioffi allegedly operated.

British bank Barclays, a shareholder of one of the funds, also filed suit against Cioffi and Tannin for alleged fraud, however, the suit has been withdrawn.

The prosecution of Cioffi and Tannin makes conspicuously noticeable the fact that no senior executives from Bear, Lehman Brothers, AIG, etc., have been charged with any wrongdoing in the fallout from the financial crisis.

 

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