Despite all the finger-pointing over who’s to blame for the worst financial crisis since the Great Depression, just two prominent players face criminal charges.
But even though the case against them is compelling, and the government wants to make an example of them, legal experts say it will be hard to nail down anyone else.
Ralph Cioffi and Matthew Tannin, both former hedge fund managers at Bear Stearns, are accused of painting a rosy picture of their portfolios, even though "the defendants believed that the funds were in grave condition and at risk of collapse," according to the prosecution.
Prosecutors blamed Cioffi and Tannin for causing Bear Stearns investors to lose more than $1 billion, alleging that their fraudulent behavior led to the collapse of their hedge funds and, subsequently, Bear Stearns. They have both pleaded not guilty and are out on bail: $4 million for Cioffi and $1.5 million for Tannin.
The trial is scheduled to begin Oct. 13 in U.S. District Court in Brooklyn, New York. Cioffi and Tannin could each face 20 years if convicted of securities fraud.
Cioffi could face an additional 20 years on charges of insider trading for moving $2 million of his own money out of a poorly-performing Bear Stearns fund and into a separate fund "for which he had supervisory responsibilities," according to prosecutors.
A spokesman for Tannin’s legal defense declined to comment. Lawyers for Cioffi did not return messages.
Making an example
"I don’t know whether it’s a test case, but [it] certainly will test the government theory of going after Wall Street defendants who, according to the government, were less than forthright about the future prospects of their fund," said Robert Mintz, a former federal prosecutor who leads white collar defense at the law firm McCarter & English.
Ken Springer, a former FBI agent, certified fraud examiner and president of the consultant firm Corporate Resolutions, was more succinct: "I think this a line in the sand that the government is drawing and I think they’re going to make an example."
Springer described this as a "pivotal case for the government to show that this kind of behavior is not acceptable" and he said the prosecution’s evidence is "compelling."
The two defendants presented their hedge funds, which totaled some $1.4 billion in 2006, as "low risk" investments in AAA-rated pieces of collateralized debt obligations, backed by pools of securities such as mortgages, according to government lawyers.
By the spring of 2007, they allege the two men were having private conversations about the declining prospects of their funds and the impending meltdown. Tannin told Cioffi that the "subprime market looks pretty damn ugly" and he suggested that they "close the funds now," according to prosecutors.
"Notwithstanding their views to the contrary, the defendants led investors and creditors to believe that, despite the challenges presented in the market, the funds would continue to generate an increasing net asset value," wrote prosecutors, in a press release at the time of their June 19, 2008 indictment faxless pay day loans.
And on Sept. 22, prosecutors accused Cioffi, a New Jersey resident, of flying to Florida to try to retrieve documents from the Fort Myers-based Busey Bank, where he had attempted to obtain a $4.25 million line of credit. His lawyers deny that he was trying to snag the documents ahead of a federal subpoena, as the prosecutors allege.
Ken Rubinstein, an asset protection lawyer with the New York firm Rubinstein & Rubinstein, also believes that prosecutors have a strong case against Cioffi and Tannin, but that it’s a unique situation.
"These are the only two that have come out because these are the only two where the facts are clear enough in the government’s favor," he said.
Fraudulent - or just stupid?
Even though Cioffi and Tannin are the only fund managers charged with the fraudulent behavior that fueled the collapse, no one is alleging that they alone brought down Wall Street.
"I think it’s clear that there’s been a lot of fraud in the system," said Dick Bove, banking analyst for Rochdale Securities. "It’s a multi-layered system, and at every layer people chose not to do the proper due diligence, which is criminal. Everywhere along the line there were excesses, and perhaps the biggest excesses [were from] the government itself, because it had an obligation [to prevent fraud.]"
Despite the rampant wrongdoing by white collars leading up to the market meltdown of 2007, Bove said that pinpointing fraudulent acts and perpetrators is complex and difficult.
"There would have to be some intensive investigating to ferret out the people who were doing these things and I don’t know what the risk-reward will be," he said. "It’s going to take a lot of work to figure out who they are."
Even when investigators find a couple of suspects, like Cioffi and Tannin, it can be difficult to prove that they had any intention of deliberately misleading investors, or if they were simply making stupid mistakes.
In this way, hedge fund investors are just as responsible for their demise as the portfolio managers, said David Wyss, chief economist for Standard & Poor’s.
"Nobody held a gun to these people’s heads and told them to buy subprime mortgages," he said. "It’s a combination of stupidity and overconfidence, and unfortunately, both were national epidemics."
But even if most of the pre-crash behavior on Wall Street can be attributed to lack of due diligence rather than deliberate fraud, Bove said that’s hardly an excuse.
"Is it wrong? Goddamn right, it’s wrong," he said. "Is anyone going to do anything about it? I sincerely doubt it."
"I think, in the end, that the defense is going to argue that some of the greatest minds in the economy were unable to predict the recession, so how could these two be held accountable?" said Mintz, the lawyer at McCarter & English.