Bear Stearns RIP

Cioffi/Tannin Discovery to Proceed: U.S. Attorney Rebuffed

Two former hedge fund managers, Ralph Cioffi and Matthew Tannin, have won a round in their resistance to enforcement actions both civil and criminal. The U.S. District Court for the eastern district of New York has denied a motion by prosecutors to stay discovery in the civil proceeding pending the completion of the criminal case.

Messrs Cioffi and Tannin managed the Bear Stearns High Grade Structured Credit Strategies Fund from October 2003 until July 2007 -- Mr. Cioffi was the senior portfolio manager, Mr. Tannin as portfolio manager reported to Cioffi. They created a related fund near the end of that period, calling it the Bear Stearns High Grade Structured Credit Strategies Enhanced Fund.

The U.S. Attorney, Benton Campbell, filed indictments against both men on June 18, 2008, alleging securities fraud, conspiracy, and wire fraud. The central charge is that they made fraudulent statements regarding the prospects of these entities. The Securities and Exchange Commission filed a civil action the following day on the same theory.

Mr. Cioffi (but not Mr. Tannin) is also accused of insider trading, because late in March 2007, according to the indictment, he transferred approximately $2 million of the money he had personally invested in one of these funds to another hedge fund.

The arguments over a discovery stay

The U.S. Attorney moved to intervene in the civil action in August, and asked for a stay in the SEC’s action -- and so in the defendants’ ability to conduct discovery in that context -- pending resolution of the criminal charges. His filings claim that this will protect the secrecy of grand jury proceedings and in general “prevent the broad civil discovery available in the Civil Case from circumventing the more limited discovery that will be available to the defendants who have been indicted in the Criminal Case.” The SEC has taken no position on this motion.

Each defendant has retained his own counsel. Mr. Cioffi is represented by Edward J.M. Little of the New York law firm Hughes Hubbard & Reed; Mr. Tannin by Susan Brune of Brune & Richard, also of New York. Both have vigorously opposed the motion for a stay.

Defense counsel argue that such a stay is extraordinary, and that under the applicable precedents the government is required to make a specific showing of how the public’s interests will be prejudiced by the continuance of civil discovery. Mr. Little describes the discussion of prejudice in the government’s memo as consisting only of “a few weak assertions [that] simply parrot the usual, generic, and worn claims of prejudice,” e.g. that the defendants would obtain material in the civil case to which, in the criminal context, they are not entitled.

Further, as Little's brief points out, it was the decision of the United States to bring nearly-simultaneous proceedings in the first case that led to the difficulty under which the government now claims to labor. “The government milked all the advantages of initiating simultaneous proceedings -- holding joint press conferences to laud their dual enforcement efforts -- yet now seeks to evade any of the obligations that come with that choice.”

Ms Brune makes much the same point. “If any party has had an unfair advantage it is the government, which has already obtained extensive discovery, including from Mr. Tannin, for use in the civil and criminal cases. At the crux of the [motion for a stay] is the government’s effort to preclude Mr. Tannin entirely from investigating the facts and from defending himself.”

In a reply brief October 8, Mr. Campbell tried to make the argument that he isn’t obliged to provide a specific accounting of possible harms from civil discovery, because “there is no precedent to deny a stay where the government agrees to provide broad discovery in the criminal case.”

There’s such a precedent now

The court’s decision, filed by Senior Judge Frederic Block October 23, sides firmly with the defendants.

Judge Blank denied the USAO's motion. At the very least, he indicates, it is premature. “Neither defendant has answered the civil complaint and no discovery requests have been proposed. In this context -- or, more accurately, absence of context -- the Court cannot engage in any meaningful balancing of the competing interests at stake.”

He also echoed the arguments of the defense counsel about the deliberate choice of tactic on the government’s part. “Courts are justifiably skeptical of blanket claims of prejudice by the government where -- as here -- the government is responsible for the simultaneous proceedings in the first place.”

Discovery will go forward. The decision to deny a stay is without prejudice to the prosecution’s right to object to particular discovery requests.

Investors in the two Bear Stearns funds were among the early victims of the bursting of the subprime bubble, and Messrs Cioffi and Tannin were the first managers accused of crimes as a consequence. But the nature of their allegedly deceptive behavior is less clear-cut than that of a more typical fraud case, such as that which arose out of the collapse of the Bayou funds in 2005. The government isn’t charging that Cioffi and Tannin, like Samuel Israel and Dan Marino in the Bayou affair, pretended to the investors that the returns were positive when they were in fact negative.

The charge, rather, is that the Bear Stearns defendants misrepresented to investors “the financial prospects of the funds [and] their opinions regarding the financial prospects of the funds.” That sounds a bit slippery.

What is especially worrisome is the government’s reliance upon email conversations between the two defendants in an effort to establish that they weren’t always as cheerful as they let on when communication to investors. A pertinent question has come from Tom Kirkendall, a Houston-area lawyer who maintains a much-read blog on business law, “Do we really want a marketplace in which people are afraid of being candid and analyzing the market with associates for fear of criminal liability?”

Given such questions, every step forward in these twinned enforcement proceedings will come under careful scrutiny.