The CRIMINAL CASE against BEAR STEARNS         

   

 

                                                                                              begins 10/13/2009

 

Wall Street on Trial: A Case That Could Falter

October 12, 2009, 11:30 am

Dan Slater, a former litigator, is following the government’s criminal case 

against two former Bear Stearns hedge fund managers for DealBook. 

Here is his analysis of the coming trial.

 

 

For the blood-thirsty, there’s the specter of retribution for an act that some believe tipped the first domino in the global financial crisis. For those who think a bailout-happy Washington has taken it too easy on the financial sector, the prosecution of two hedge fund managers, ­ the era’s shadowy and iconic Wall Street players, ­ represents the first instance of government pushing back. And then there’s the legal community, eager to see whether an indictment so rich in seemingly damning e-mail messages will in fact yield guilty verdicts.

But several former prosecutors say that the coming criminal trial of Ralph Cioffi and Matthew Tannin, the former Bear Stearns hedge fund managers brought up on fraud charges in connection with the implosion of two funds, is far from a slam dunk. And they say that any attempt by the government to build a case based on anti-Wall Street sentiment could backfire.

The trial is scheduled to start on Tuesday in Federal District Court in Brooklyn.

At the time of indictment, in June 2008, government lawyers appeared to have uncovered what prosecutors called “badges of fraud” — ­ indicators that people were up to no good. For instance, just a few days before a conference call in which Mr. Tannin told investors that “we’re very comfortable with exactly where we are,” he sent an e-mail message from his personal account telling Mr. Cioffi that the subprime mortgage market ­– the market to which the funds were tied ­ — “looked pretty damn ugly,” and that, if a recent report was correct, “then the entire subprime market is toast.”

The indictment is rife with similarly quotable remarks that appear to be at odds with the defendants’ public pronouncements regarding the health of the funds. But prosecutors must show that these isolated comments represent a pattern of thinking over time — ­a scheme to defraud — rather than merely a thought of the day.

“A case based on internal e-mails, bereft of context, can teeter precariously when witnesses appear at trial and provide an unanticipated framework,” said John Hueston, who prosecuted Enron’s former top executives, Jeffrey K. Skilling and Kenneth L. Lay. “That’s the lesson we learned in Enron. Be careful with what appears, on its face, to be a smoking gun.”

A case heavy on e-mail traffic could, in fact, benefit the defense. Bradley Simon, a former federal prosecutor in the Eastern District of New York, the same office that is handling this prosecution, explained: “As a defense lawyer, I like this situation because everything is subject to interpretation. It’s harder to cross-examine live witnesses, to shake them from their positions. But e-mails aren’t human. You can attribute many meanings. It’s an opportunity for creative lawyering.”

As the first major prosecution for behavior that has been linked to the financial crisis, the enormous portent in this case could also, paradoxically, play to the defendants’ advantage. Many fraud cases brought by the Justice Department in recent memory have involved defendants who are accused of causing the particular collapse in question.

Take Enron. There, it could be argued that Mr. Lay and Mr. Skilling, given the strategies they used, brought down the company.

But the case of Mr. Cioffi and Mr. Tannin, lawyers say, hews to a different narrative. After all, much has changed in the world since the implosion of the Bear Stearns funds in 2007 and the fire sale of Bear to JPMorgan Chase the following year. Lehman Brothers, for instance, would collapse in spectacular fashion and the financial crisis would continue to flower.

Therefore, Mr. Hueston said, “it’d be a mistake for the prosecution to try to inflame the passions of the jury by portraying this case as somehow connected to the meltdown. That argument is too easy to attack.”

Indeed, expect defense lawyers to toss “scapegoat” around liberally in an effort to get jurors, despite any enmity they may have toward bank employees, to see Mr. Cioffi and Mr. Tannin as objects of irrational hostility.

Prosecutors, perhaps aware of this pitfall, wrangled with the defense over whether “lifestyle” evidence would be admissible. The government hoped that presenting the jury with Mr. Cioffi’s assets, including cars, golf memberships and real estate holdings, would help explain why a man who supposedly made more than $30 million in 2005 and 2006, and who had not led a criminal lifestyle, suddenly decided to lie.

(Notably, material aspiration is what gave birth to the case against the prominent New York lawyer Marc Dreier, one of the chief Madoff-era Ponzi schemers. According to a recent profile in Vanity Fair, Mr. Dreier was lamenting his lack of beachfront property when he decided to embark on one of the more brazen frauds in Wall Street history. In July, Mr. Dreier was sentenced to 20 years in prison for defrauding clients and investors out of about $400 million.)

Motive, as the aphorism goes, is never an element but always relevant. Because people don’t just lie, they lie for a reason­ like, say, in the hopes of continuing to live high on the hog. So while motive is not technically part of fraud, it will be argued by both sides to establish whether the defendants had the requisite “intent” — ­ here, a knowing fraud ­ — for the crime charged.

But lifestyle evidence also has a more sinister purpose. It exacerbates class division between defendant and juror, not unlike the $6,000 shower curtain that became the pièce de résistance of the case against L. Dennis Kozlowski, the former chief executive of Tyco International, who in 2005 was convicted of crimes related to looting the company.

As such, the judge, Frederic Block, said at a pretrial hearing in the Cioffi-Tannin case that he did not think “people should be subject to being convicted for crimes based upon the fact they have a big or small lifestyle.” Ultimately, he instructed the government not to mention lifestyle evidence in its opening statement. Although prosecutors are permitted to tell the jury that as the funds’ prospects were looking bleak, Mr. Cioffi redeemed $2 million of his $6 million investment in one of the funds.

Meanwhile, on the other side of the courtroom, defense lawyers will paint their clients as loyal employees whose aggressive salesmanship was fostered by Bear’s notoriously cutthroat and self-interested culture. They will argue that Mr. Cioffi and Mr. Tannin were effective for more than three years before they became early victims of a worldwide financial crisis.

Legal experts say that Mr. Tannin, in particular, might take advantage of a “wrong place, wrong time” argument. His lawyers could theorize, for instance, that his ambivalence over whether he and Mr. Cioffi should approach a lawyer, or even close the funds altogether, reflects a sense of panic and desperation rather than intent to defraud and that he was simply paralyzed by circumstances spiraling out of control.

“There’s a lot of animosity right now toward people on Wall Street,” said Eric Sussman, who led the successful fraud prosecution of the media magnate Conrad M. Black in 2007. “That public sentiment is manifest in all the cases, civil and criminal, coming up. It’s a tough hurdle, but not insurmountable.”

Dan Slater, a former litigator, is a freelance journalist in New York and a former writer for The Wall Street Journal’s Law Blog.

http://dealbook.blogs.nytimes.com/2009/10/12/wall-st-on-trial-a-case-that-could-falter/ 

 

Department of Justice Press Release 

DOJ Seal

 

 

United States Attorney's Office 
Eastern District of New York

Robert Nardoza
Public Affairs Officer

(718) 254-6323 
Robert.Nardoza@usdoj.gov



FOR IMMEDIATE RELEASE                                      June 19, 2008

   
PRESS RELEASE

 TWO SENIOR MANAGERS OF FAILED BEAR STEARNS HEDGE FUNDS INDICTED ON CONSPIRACY AND FRAUD CHARGES

Investor Losses Total More Than $1 Billion

             An indictment was unsealed this morning in federal court in Brooklyn, NY, charging RALPH CIOFFI, the founder and senior portfolio manager of two Bear Stearns hedge funds, and MATTHEW TANNIN, a portfolio manager of the funds, with conspiracy, securities fraud, and wire fraud. CIOFFI was also charged with insider trading. Footnote The defendants are scheduled to be arraigned later today before United States Magistrate Judge Steven M. Gold, at the U.S. Courthouse, 225 Cadman Plaza East, Brooklyn, NY. The case has been assigned to United States District Judge Frederic Block.

            The charges were announced by Benton J. Campbell, United States Attorney for the Eastern District of New York, and Mark J. Mershon, Assistant Director-in-Charge of the Federal Bureau of Investigation, New York Field Division.

According to the indictment, CIOFFI created the Bear Stearns High Grade Structured Credit Strategies Fund in 2003 and the Bear Stearns High Grade Structured Credit Strategies Enhanced Fund in 2006 (collectively referred to hereafter as the Funds). The indictment alleges that the defendants marketed the Funds as a low risk strategy that invested primarily in high grade debt securities, such as AAA and AA rated tranches, or pieces, of collateralized debt obligations (CDOs). CDOs are securities backed by a pool of debt securities, such as mortgages. Both funds utilized leverage, by borrowing capital from Wall Street lenders with the hope of earning a higher rate of return on their investments than the costs of the loans. By the late summer of 2006, the Funds held approximately $1.4 billion of investor funds under management.

The indictment alleges that by March 2007, the defendants believed that the Funds were in grave condition and at risk of collapse. However, rather than alerting the Funds’ investors and creditors to the bleak prospects of the Funds and facilitating an orderly wind-down, the defendants made misrepresentations to stave off withdrawal of investor funds and increased margin calls from creditors in the ultimately futile hope that the Funds’ prospects would improve and that the defendants’ incomes and reputations would remain intact. The subsequent collapse of the Funds during the summer of 2007 resulted in losses to investors totaling more than $1 billion.

The Funds’ Declining Financial Prospects

            Throughout the spring of 2007, the defendants and other Fund employees privately acknowledged the Funds’ declining financial prospects. According to the indictment, CIOFFI told another Fund employee that he feared the current state of the CDO markets and saw a long term meltdown on the horizon.

Similarly, in an April communication to CIOFFI, TANNIN stated,

 

“[T]he subprime market looks pretty damn ugly . . .. If we believe [our internal modeling] is ANYWHERE CLOSE to accurate I think we should close the funds now. The reason for this is that if [our internal modeling] is correct then the entire subprime market is toast . . .. If AAA bonds are systematically downgraded then there is simply no way for us to make money - ever.” (Emphasis in original)

 

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.

The Defendants’ Own Investments in the Funds

           As alleged in the indictment, in the hedge fund industry, the fact that fund managers had their personal money in the funds they managed was critically important to investors. Personal investment, or “skin in the game,” established a manager’s faith in his fund and aligned the interests of managers with investors. However, the indictment charges that the defendants misled investors about the true nature of their investments in the Funds. Specifically:

● Throughout March 2007, TANNIN repeatedly told investors and Bear Stearns brokers responsible for selling the Funds that he believed that the market presented a buying opportunity and that he was adding to his investment in the Funds. In one instance, TANNIN told an investor, “[w]e are seeing opportunities now . . . I am adding capital to the Fund. If you guys are in a position to do the same I think . . . this is a good opportunity.” In fact, TANNIN never invested more of his own money in the Funds.

 

● At the same time, while he was touting the prospects of the Funds, CIOFFI transferred $2 million of his approximately $6 million investment in the Enhanced Fund to another Bear Stearns hedge fund for which he had supervisory responsibilities. This latter fund had recently experienced returns far superior to either the High Grade or Enhanced Funds. CIOFFI never told investors he made this transfer and continued falsely to represent to investors that he held approximately $6 million in the Enhanced Fund.

 

The indictment charges CIOFFI with one count of insider trading based on this $2 million redemption.

Misrepresentations Regarding Investor Redemptions

           The amount of investor redemptions, or requests to withdraw funds, is significant to other investors in a hedge fund. A relatively large amount of pending redemptions may indicate a loss of investor confidence in the fund. A fund facing large redemption requests runs the risk of reducing liquidity and of being forced to sell assets at unfavorable prices to raise cash, thus diminishing the value of the remaining investors’ stake in the fund.

During an April 2007 conference call with investors – following his acknowledgment of the importance of investors knowing the status of redemptions – CIOFFI falsely represented that the Funds “only have a couple million of redemptions for the June 30 date,” when he knew of approximately $47 million in total redemption requests for that date. CIOFFI also omitted any reference to $67 million in redemption requests scheduled for April 30, 2007 and May 31, 2007. According to the indictment, TANNIN also made misrepresentations concerning redemptions to a creditor of the Funds.

The Missing Notes

            The indictment alleges that TANNIN’s tablet computer, on which he took notes during 2007, and CIOFFI’s notebook, in which he had made handwritten notes during the spring of 2007, both went missing after the United States Securities & Exchange Commission requested the production of documents and materials as part of its investigation of the collapse of the funds in the summer of 2007.

“Hedge fund investors, like all investors in our national markets, are entitled to rely on those to whom they entrust their investment dollars,” stated United States Attorney Campbell. “Honesty and fair dealing are at the foundation of this relationship of trust and confidence. These defendants chose to breach that trust, and they will now be held to account.” Mr. Campbell expressed his grateful appreciation to the Federal Bureau of Investigation and the United States Securities & Exchange for their assistance. Mr. Cambpell added that the investigation is continuing.

FBI Assistant Director-in-Charge Mershon stated, “Investing in hedge funds entails certain market risks, but investors don’t assume the risk that fund managers will misrepresent facts. A fund can perform poorly and lose investor capital as a result of bad management, but losing investors’ money isn’t the crime. The crime is in misrepresenting the vitality of the fund, as these defendants surely did.”

If convicted of securities fraud, CIOFFI and TANNIN face maximum sentences of 20 years of imprisonment. If convicted of conspiracy, they each face a maximum sentence of five years.

The United States Attorney for the Eastern District of New York is a member of the Corporate Fraud Task Force, a multi-agency group formed by President Bush in July 2002 to restore public and investor confidence in America’s corporations following a number of major corporate scandals. In the past five years, the task force has yielded more than 1,200 corporate fraud convictions.

The United States Securities & Exchange Commission announced today that it has filed civil charges against both CIOFFI and TANNIN.

The government’s criminal case is being prosecuted by Assistant United States Attorneys Sean Patrick Casey, John A. Nathanson, James Gatta, and Patrick Sean Sinclair.

The Defendants:

 

Name: RALPH CIOFFI
Age: 52

 

Name: MATTHEW TANNIN
Age: 46

Prosecution's Motion

U.S. Department of Justice

United States Attorney

Eastern District of New York

271 Cadman Plaza East

Brooklyn, New York 11201

F.#2007R01328 

September 25, 2009

VIA ECF

The Honorable Frederic Block

United States District Judge

United States District Court

Eastern District of New York

225 Cadman Plaza East

Brooklyn, New York 11201

 

Re: United States v. Ralph Cioffi and Matthew Tannin

Criminal Docket No. 08-415 (FB)

Dear Judge Block:

On August 18, 2009, the government moved in limine

to admit certain evidence pursuant to Federal Rule of

Evidence 404(b). Cioffi opposed this motion on September 1,

2009, and the government now replies. Based on the complete

evidence now obtained and set forth below, the government

asserts that the proffered evidence is direct proof of the

charged crimes. This proof will demonstrate that Cioffi and

Tannin used Cioffi’s investment in the High Grade Structured

Credit Strategies Enhanced Leverage Master Fund Ltd. (the

“Enhanced Fund” or “the Fund”) to lie to Busey Bank to

secure a $4,250,000 line of credit, which Cioffi needed to

complete a construction project in Longboat Key, Florida.

 

The defendants fraudulently pledged Cioffi’s interests in

the Enhanced Fund and bound Bear Stearns Asset Management

(“BSAM”) to the terms of a “Consent and Agreement” (“pledge

agreement”) knowing that BSAM refused to consent to Cioffi

pledging his Enhanced Fund investment. Of course, this is

the very same investment that Cioffi is charged with

illegally redeeming in Count Four of the indictment, and

which Cioffi and Tannin are charged with lying about in

Counts One and Three of the indictment.

 

As discussed below, the concealment of this fraud

is direct evidence of Cioffi’s motive to commit insider

trading and both defendants’ motives to commit the remaining

crimes charged in the indictment. This evidence is

alternatively admissible pursuant to Rule 404(b) of the

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 1 of 15

1 By no means does the government intend to offer all of

these facts at trial. The government provides the Court with a

fullsome recitation of the facts here, however, to refute

Cioffi’s claim that the government has somehow “misrepresented”

the facts surrounding the pledge agreement. (See, e.g.,

Supplemental Memorandum Regarding The Government’s Motion To

Admit Evidence Pursuant To Federal Rule Of Evidence 404(b), dated

September 22, 2009). In Section III-E herein, the government

outlines the proof it intends to offer during trial on these

issues.

 

2

Federal Rules of Evidence as it is directly relevant to

issues of the defendants’ motive, intent, knowledge and

absence of mistake.

 

I. The Facts1

In no uncertain terms, BSAM refused to consent to

Cioffi’s request to pledge his investment in the Enhanced

Fund as collateral for a $4,250,000 line of credit from

Busey Bank. With Tannin’s assistance, Cioffi executed the

pledge anyway, thereby compelling them to hide the truth

from BSAM management and their investors.

 

• Cioffi invested in a multi-million dollar building

project (“La Firenza”) in Florida that was on the verge

of foreclosure in November 2006 (email from Cioffi to

bank officials acknowledging, “[y]our latest threat was

that you would foreclose on 11/13th.” BS-SEC4220963-

65).

• Cioffi negotiated the use of his Fund investment as

collateral to secure a loan (the “pledge”)(11/3/06

email from Cioffi to bank official indicating, “I’m

prepared to secure you with my shares in my Bear

Stearns Hedge Fund . . . As of 10/31/06 the market

value is $5.7M.” BS-SEC4214205).

 

• Cioffi knew that BSAM management had to consent to the

pledge (11/6/06 email BS-SEC4214846; 11/8/06 email

stating, “I’m waiting on Bear Stearns to sign and

return to me the assignment agreement on one of my BSC

accounts that has $5.7M market value in.” BSSEC4218189).

 

• On or within days before November 6, 2006, Tannin

contacted an attorney in BSAM’s legal department (the

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 2 of 15

3

“Attorney”) to obtain the necessary documents for the

pledge. The Attorney neither approved the pledge nor

had the authority to do so. Rather, as set forth

below, he provided ministerial editing services on

certain documents.

 

• On November 6, 2006, the Attorney notified BSAM’s

Global Head of Hedge Funds (the “Global Head”), the

Chairman of BSAM’s Hedge Fund business, BSAM’s General

Counsel, and the Director of BSAM’s Third Party Seeded

Hedge Funds about the pledge. He informed the senior

managers that he had discussed the pledge with outside

counsel, who did not think the pledge was a disclosable

event “because Ralph was maintaining a beneficial

ownership in the interests,” but asked if the managers

had any questions. (BS-USAO 0055990)(Exhibit #1).

 

Cioffi was not a party to this discussion.

 

• Minutes later, the Chairman of the Hedge Funds replied

to all who were on the email questioning whether

Cioffi’s outside interest in this real estate concern

posed a potential conflict of interest for Cioffi.

(BS-USAO 0055991)(Exhibit #2).

 

• About 30 minutes later, Tannin emailed the General

Counsel and explained that La Firenza was a real estate

partnership, in which Cioffi was 40% investor. (BSUSAO

005592)(Exhibit #3).

 

• A few minutes later, Tannin asked the General Counsel

“Are we ok?” (BS-USAO 0055993). The General Counsel

responded, “not yet.” Without addressing whether BSAM

would consent to the pledge, he told Tannin that Cioffi

would have to complete the “Outside Business Interest”

(“OBI”) process at BSAM. The General Counsel directed

Tannin to inform Cioffi that “[a]nything else he hasn’t

disclosed also should be on the table.” The General

Counsel advised Tannin that “[s]ometimes, in times of

difficulty, we prohibit managers from removing their

investment in favor of clients going first. This

[pledge] arrangement has the potential to interfere

with that if there was a problem and the bank seized

the assets at an inopportune time.” (BS-USAO

0056001)(Exhibit #4).

 

• Minutes after sending the last email to Tannin, the

General Counsel forwarded the email exchange to the

Global Head, stating, “FYI.” The Global Head was

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 3 of 15

4

Cioffi and Tannin’s direct supervisor. (BS-USAO

0056001)(Exhibit #5).

 

• On November 7, 2006, the General Counsel exchanged

emails with Cioffi and the compliance department

regarding Cioffi’s involvement in the OBI process. The

General Counsel told a compliance officer, who was

about to go speak with Cioffi, that after Cioffi’s OBI

is approved, “the next question is whether we agree

with him pledging the assets he owns in the fund. We

have the right to restrict a withdrawal by any manager

at anytime if we feel that investor withdrawals have

priority. His arrangement could interfere with that.”

(BS-USAO 0056004)(emphasis supplied)(Exhibit #6).

 

• In the meantime, the Global Head consulted with a

variety of senior managers of BSAM about the propriety

of Cioffi’s pledge, including the Chief Executive

Officer (“CEO”) of BSAM, who delegated the decision on

the pledge to the Global Head. As set forth below, the

Global Head denied the pledge.

 

• For his part, Tannin advocated in favor of Cioffi’s

pledge to the Global Head. (11/13/06 email from Tannin

stating “[t]his is more than you want to know ... but .

. . Ralph’s pledge of the hedge fund shares is to cover

the $3mm lein [sic].” (BS-SEC0354455)(Exhibit #7).

 

• Viewing the decision whether to permit Cioffi to enter

into the pledge agreement as a business, rather than a

legal decision, the Global Head decided not to grant

BSAM’s consent to Cioffi’s pledge of his investment in

the Enhanced Fund. (See 3500 GQ-4 and GQ-5; BSSEC0247403).

 

• On November 14, 2006, the Global Head sent Cioffi an

email telling him that he came by Cioffi’s office to

see him, but that Cioffi was in a meeting. He asked

Cioffi to call him “re the pledge.” (BS-USAO

0056042)(Exhibit #8).

 

• That same day, the OBI Group informed Cioffi that it

had approved his continued interest in La Firenza as an

OBI. (BS-USAO 0056041). The OBI group never

considered or approved the pledge.

 

• On either November 14 or 15, 2006, the Global Head

visited Cioffi’s office again. He informed Cioffi, in

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 4 of 15

 

2 In his position, the Middle Office Manager supported

the portfolio managers, provided estimates to clients on returns

by sector and portfolio, and oversight for administrators. (See

3500-GC-3 at 1).

5

no uncertain or ambiguous terms, that BSAM did not

consent to Cioffi’s pledge. The Global Head gave

Cioffi his reasons for the denial of consent, including

his concern that such a pledge would have to be

disclosed to Fund investors. Cioffi became enraged,

resorting to expletives, and blamed the decision on

BSAM’s General Counsel. (3500 GQ-4 and GQ-5; BSSEC0247403

or BS-USAO 0056042)(Exhibit #9).

 

• On November 29, 2006, Tannin emailed the Attorney and

asked him if him if he was “cool with” a draft pledge

agreement Tannin attached to the email. (BS-USAO

0056071-76). Neither Tannin nor Cioffi advised the

Attorney that BSAM had expressly denied the pledge on

or about November 14, 2006.

 

• Later that day, the Attorney responded to Tannin,

providing some minor typographical edits to the draft

pledge agreement. (BS-USAO 0056081). The Attorney did

not and could not have approved the pledge.

 

• On a later date after November 29, 2006, (see BS-USAO

0056071-75)(Exhibit #10), Tannin brought the pledge

agreement to BSAM’s Hedge Fund Middle Office Manager

(“Middle Office Manager”).2 The Middle Office Manager

signed the agreement at Tannin’s request. Neither

Tannin nor Cioffi advised the Middle Office Manager

that BSAM had expressly prohibited the pledge on or

about November 14, 2006.

 

• On or about December 20, 2006, a Busey Bank Senior

Vice-President, executed the pledge agreement on behalf

of Busey Bank thereby finalizing the pledge of Cioffi’s

Enhanced Fund investment as collateral for the

$4,250,000 line of credit to Cioffi. (BUSEY 00000004-

42).

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 5 of 15

 

3 Inexplicably, the form is in the name of the Bear

Stearns High-Grade Structured Credit Strategies, L.P. (“High

Grade Fund”), despite the fact that, as of December 20, 2006,

Cioffi had no investments in the High Grade Fund. Other

documents, such as the State of Florida Uniform Commercial Code

Financing Statement Form, clarify that the pledge was secured by

Cioffi’s investment in the Enhanced Fund. (BUSEY 00000027).

 

6

• The pledge agreement has four signatories: (1) Matthew

Tannin on behalf of the Enhanced Fund3 and as a

representative of BSAM; (2) the Middle Office Manager

on behalf of BSAM, (3) Ralph Cioffi as the Customer

(Borrower) and (4) Busey Bank’s Senior Vice-President,

on behalf of Busey Bank. Id.

 

• The pledge agreement states that:

1. BSAM consented to Cioffi’s pledge;

 

2. BSAM consented to the assignment of Cioffi’s

security interest in the Enhanced Fund to Busey

Bank;

 

3. BSAM acknowledged that it had been directed by

Cioffi to register Busey Bank’s partnership

interest in the Enhanced Fund as “[Busey Bank] as

pledgee of [Ralph Cioffi];”

 

4. BSAM agreed not to change that registration

without Busey Bank’s written consent;

 

5. BSAM represented that Cioffi’s Enhanced Fund

investment was not otherwise encumbered;

 

6. BSAM agreed not to consider or act upon any

request by Cioffi to withdraw all or some of his

interest in the Enhanced Fund;

 

7. BSAM agreed to consider only withdrawal requests

made by Busey Bank;

 

8. BSAM agreed neither to consider nor act upon any

request by Cioffi to sell, assign or otherwise

dispose of his interest in the Enhanced Fund; and

 

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 6 of 15

7

9. BSAM agreed that the agreement would remain in

effect until it received written notice from Busey

Bank.

 

• By the agreement, Tannin, as the Fund’s agent,

represented that, “as of the date of” the agreement,

the interests of Busey Bank were registered on the

books of the Enhanced Fund as “[Busey Bank] as pledgee

of [Ralph Cioffi].” Tannin also agreed to pay the

proceeds of any distributions or withdrawals incurred

by Cioffi directly to Busey Bank’s account.

 

• Contrary to Tannin’s representations, the security

interests of Busey Bank were never registered on the

books of the Enhanced Fund on December 20, 2006, or on

any date thereafter. (See Fund Shareholder Register,

as of May 31, 2007)(BS-USAO 0057446-51)(Exhibit # 9).

 

• Along with the pledge, Cioffi executed a four-page

revolving promissory note for the $4,250,000 line of

credit, which contained an acceleration clause that

provided that if Cioffi defaulted “in the performance

of or compliance with the Security Agreements or any of

the other loan documents” securing the note, he would

be liable for the entire principal of the loan plus

interest on 10 days notice. (BUSEY 00000006-9)

 

• As of April 1, 2007, Cioffi redeemed $2 million (or

one-third) of his investment in the Enhanced Fund,

which was still, albeit unregistered, subject to the

restrictions of the pledge with Busey Bank. Similar to

the manner in which he approached the pledge, Cioffi

did not personally notify BSAM senior management of his

intent to redeem.

 

• On July 23, 2007, after inquires by Busey Bank, Cioffi

advised the bank that its security interest in the

Enhanced Fund was worthless. (BS-SEC4352711).

 

II. Witness Accounts

 

To verify the above facts, the government

interviewed the CEO, the Global Head, the Middle Office

Manager, the Attorney and Busey Bank personnel. These

interviews have provided the following information.

The Global Head stated that he was the highest

ranking manager in the hedge fund division of BSAM; he was

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 7 of 15

8

Cioffi’s and Tannin’s direct supervisor; and he reported

directly to BSAM’s CEO. The decision to deny the pledge was

his to make, and he communicated his decision to Cioffi

directly and unequivocally. As his subordinate, the Middle

Office Manager, had no authority to overrule the Global

Head’s decision. As the denial was a business decision,

rather than a legal decision, the Attorney had no input in,

much less the authority to overrule, the Global Head’s

denial of consent. Other than the CEO, no other person at

BSAM had the authority to overrule the denial, and the CEO

did not do so. In fact, the Global Head assumed that Cioffi

abided by the denial until only a few days ago.

 

The Attorney stated that he learned about Cioffi’s

pledge from Tannin. The Attorney alerted BSAM senior

management to the pledge because he thought it was unusual

and something they should know about. (See BS-USAO 0055990

(“Matt was being a bit cagey about the purpose of the

loan”)). The Attorney merely provided the pledge documents

to Tannin. He had no contact with Cioffi about the pledge.

 

He did not approve the pledge, nor did he have the authority

to do so. Had he been informed by Cioffi, Tannin or anyone

else that the Global Head forbade Cioffi’s pledge, he would

not have assisted Cioffi and Tannin in any way.

 

The Middle Office Manager stated that Tannin

brought him the pledge agreement, and he signed it. While

he had previously signed investor pledge documents, this was

the first and only time he had seen a portfolio manager

pledging his or her investment in their own fund. He

recalled that he was hesitant to sign the document because

Busey Bank had not yet signed the agreement. He recalled

offering some “push-back” to Tannin over signing the pledge.

 

He was confident, nonetheless, that he would have asked

Tannin whether Cioffi had obtained the proper approvals for

the pledge. Had he been told by Tannin or anyone else, that

the Global Head, his superior at BSAM, had denied Cioffi’s

request to pledge the investment, he is absolutely sure he

would have never signed the pledge.

 

For his part, the CEO stated that the Global Head

had the authority to deny BSAM’s consent to Cioffi’s pledge.

He stated that neither the Attorney nor the Middle Office

Manager had the authority to override the Global Head’s

decision. He, as the CEO, was the only person at BSAM who

was authorized to reverse the Global Head’s decision not to

permit Cioffi to pledge his investment in the Enhanced Fund,

and he did not do so.

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 8 of 15

4 Documents show that Tannin was familiar with the pledge

registration process, having been involved in another investor’s

redemption of his pledged assets in the High Grade Fund to

effectuate a subscription of the same assets into the the

Enhanced Fund only months before. (BS-USAO 0059137)(Exhibit

#10). Not surprisingly, the existence of that investor’s pledge

agreement is clearly reflected in the books and records of the

Enhanced Fund. (See Exhibit #9, BS-USAO 0057448).

9

III. Argument

A. Cioffi Did Not Have BSAM’s Permission To

Pledge His Investment In the Enhanced Fund

 

As a threshold matter, the government can now put

to rest the question of whether Cioffi had BSAM’s consent to

pledge his investment in the Enhanced Fund as collateral for

a loan: Cioffi did not. Cioffi’s recent attempts to skew

the facts by stringing together emails from the Global

Head’s subordinates are meritless. See Supplemental

Memorandum Regarding The Government’s Motion To Admit

Evidence Pursuant To Federal Rule Of Evidence 404(b), dated

September 22, 2009.

 

The evidence is also clear that Tannin was in

lock-step with Cioffi in his scheme to circumvent BSAM’s

decision to deny the pledge and, in doing so, bind BSAM to

the terms of a pledge agreement of which it did not approve.

Tannin was involved in the pre-denial negotiations with the

Global Head: he directly advocated that Cioffi be permitted

to enter into the pledge. Tannin did all of the legwork to

make it appear to Busey Bank that BSAM approved the pledge:

(1) he managed all of the contacts with the Attorney to

obtain the forms needed to effectuate the pledge; (2) he

brought the pledge to the Middle Office Manager for his

signature, without informing him that the Global Head

forbade the pledge; and (3) by signing the pledge, he

represented to Busey Bank that the bank’s interests in

Cioffi’s investment were recorded on the books of the

Enhanced Fund. They never were.4

 

Moreover, Tannin never raised an objection to

Cioffi’s redemption of $2 million from the Enhanced Fund

when he learned of it in April 2007, even though he knew the

proceeds of the redemption were subject to the terms of the

pledge agreement that he signed. Tannin also did not

deposit the proceeds of the redemption in Busey Bank’s

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 9 of 15

5 It should be noted that the Busey Bank loan was

subsequently re-paid in full months after the bank’s collateral

in the Enhance Fund was reduced to zero.

 

10

account as required by the pledge agreement. Tannin, an

attorney, did neither of these things because he, like

Cioffi, knew that BSAM did not consent to the pledge.

 

In sum, the facts will show that Cioffi and Tannin

conspired to circumvent BSAM’s denial of consent for

Cioffi’s pledge. Together, the defendants duped the Middle

Office Manager into signing the pledge and later lied to

Busey Bank in representing, inter alia, that BSAM consented

to the pledge when they knew that was false. As a result of

their efforts, Busey Bank was defrauded into granting Cioffi

a $4,250,000 line of credit based, in part, on collateral in

which the bank did not have a registered interest and was

later rendered worthless.5

 

B. The Pledge Is Direct Evidence Of The

Defendants’ Motive To Commit Securities Fraud

 

Evidence of Cioffi and Tannin’s scheme to

circumvent BSAM’s denial of Cioffi’s pledge coupled with

evidence of the fraud they perpetrated on Busey Bank

provides probative, direct proof of the defendants’ motives

to commit each and every crime charged in the indictment.

This pledge occurred immediately prior to the charged

conspiracy and colored every decision and motive of the

defendants throughout the spring of 2007 and the securities

fraud conspiracy.

 

The defendants had to keep the existence of the

pledge a secret from BSAM and the existence of Cioffi’s

blatant violation of the pledge (i.e., the $2 million

redemption of Busey Bank’s collateral in the Enhanced Fund)

a secret from Busey Bank. Together with their obvious

motives to increase their wealth and maintain their

lifestyles, their motive to conceal pledge-related frauds

drove them to commit additional acts of securities fraud

against the investors in the Funds.

 

To be sure, when Cioffi, aware of negative

material, non-public information about the prospects of the

Funds, redeemed $2 million from the Enhanced Fund in April

2007, he also did so out of concern for the future value of

the collateral he had fraudulently pledged to Busey Bank.

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 10 of 15

11

Having been threatened once with foreclosure by Busey Bank,

Cioffi was aware of Busey Bank’s willingness to initiate

foreclosure proceedings in the event of a default. A

foreclosure would have required Cioffi to pay the entire

balance of the loan on 10 days notice, which would have been

a demand Cioffi was ill-equipped to meet due to the numerous

other financial burdens he carried during the same time

period (see Govt’s September 21, 2009 Letter, p. 10-11).

 

Avoiding foreclosure proved to be a strong motive for Cioffi

to tell lie after lie to his investors to keep the Enhanced

and High Grade Funds in business. That motive was further

augmented by Cioffi’s reasonable expectation that BSAM would

take adverse action against him if it discovered that he

pledged his investment against BSAM’s explicit orders.

 

As an attorney, Tannin was fully cognizant that if

his lies to Busey Bank came to light, he would face

potential criminal liability. Indeed, Tannin’s

misrepresentations to Busey Bank amounted to black-and-white

violations of the law (e.g., falsely binding BSAM to the

pledge when he knew he did not have the authority to do so

and falsely representing that he had registered the

securities in the name of Busey Bank when he had not). Like

Cioffi, Tannin had a strong motive, therefore, to lie to

investors in the hope of propping up the Enhanced Fund and

not drawing Busey Bank’s or BSAM’s attention to the status

of Cioffi’s investment in the Fund.

 

Greed coupled with fear of exposure motivated

Cioffi and Tannin to lie to the Funds’ investors in their

futile attempt to keep the hedge funds alive and, hopefully,

keep their fraudulent pledge deal a secret. Without

question, had the defendants told investors about Cioffi’s

$2 million redemption or the collective state of redemptions

in the Funds in April and May 2007, these disclosures would

have jeopardized the Funds’ stability, thereby increasing

the likelihood of further redemptions and the discovery of

the fraudulent pledge. These were eventualities the

defendants were loathe to let happen.

 

C. The Pledge Is Inextricably Intertwined Direct

Evidence Of The Crimes Charged

 

The government submits that the pledge evidence is

not a remote uncharged act committed by the defendants, but

part of a continuing offense that contributed to their

motives of greed and personal enhancement to commit the

crimes on trial. The pledged securities are the same

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 11 of 15

12

securities that the defendants are charged with lying about

in the indictment. For that reason, the Court should

consider evidence of the pledge as “inextricably

intertwined” direct evidence of the crimes charged, making a

Rule 404(b) analysis unnecessary.

Among other things, evidence of the pledge is

inextricably intertwined proof that directly:

 

• Proves that the defendants had motives, beyond greed

and personal enrichment, for committing securities

fraud and insider trading;

 

• Belies Cioffi’s assertion that he moved $2 million into

the Structured Risk Partners Fund (“SRP”) to put his

“skin in the game” in the SRP Fund, something he had

intended to do since December 2006;

 

• Demonstrates that the defendants never intended, under

any circumstances, to reveal Cioffi’s $2 million

redemption to BSAM or investors in the Funds; and

 

• Establishes that the defendants conspired to conceal

the fact of Cioffi’s redemption after April 2007.

The Second Circuit has made clear that

“evidence of uncharged criminal activity

is not considered other crimes evidence

under Fed. R. Evid. 404(b) if it arose

out of the same transaction or series of

transactions as the charged offense, if

it is inextricably intertwined with the

evidence regarding the charged offense,

or if it is necessary to complete the

story of the crime on trial.”

 

See United States v. Carboni, 204 F.3d 39, 44 (2d Cir. 2000)

(quoting United States v. Gonzalez, 110 F.3d 936, 942 (2d

Cir. 1997)(emphasis supplied); see also United States v.

Baez, 349 F.3d 90, 94 (2d Cir. 2003); United States

v. Avendano, 2004 WL 2734435, at *2 (S.D.N.Y. Nov. 30, 2004)

(finding defendant’s agreement to act as a cocaine courier

for a cooperating witness to be “inextricably intertwined

with the evidence regarding the charged heroin conspiracy

and necessary to complete the story of that alleged

offense,” “highly probative intrinsic evidence of

Defendant’s involvement in the conspiracy charged,” and not

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 12 of 15

13

other crime evidence within the meaning of Rule 404(b));

accord United States v. Leavitt, 878 F.2d 1329, 1338-39

(11th Cir. 1989) ("Evidence of criminal activity other than

the offense charged is not extrinsic evidence under Rule

404(b) if it is inextricably intertwined with the evidence

of the charged offense or is necessary to complete the story

of the charged offense”).

 

The government will offer evidence of the pledge

not to show the defendants’ propensity to commit fraud, but

rather as relevant background evidence to complete the story

of the crimes charges and the relationship, including the

relationship of trust, that developed between the

defendants. See United States v. Langford, 990 F.2d 65, 70

(2d Cir. 1993)(“It is within the court’s discretion to admit

evidence of acts committed prior to the time charged in the

indictment to prove the existence of the alleged conspiracy

as well as to show its background and history”). This

evidence fills out for the jury the manner in which the

defendants conducted their affairs at BSAM. Evidence of the

uncharged acts completes the story of the crimes charged and

helps explain to the jury how the illegal relationship

between the participants in the crime developed. See United

States v. William, 205 F.3d 23, 33-34 (2d Cir. 2000).

 

D. The Pledge Is Admissible Under Rule 404(b)

 

In the alternative, the government submits that

evidence of the pledge is not only admissible for the

reasons set forth above, but is also admissible pursuant to

Fed. R. Evid. 404(b) to show motive, intent, knowledge and

absence of mistake. See e.g., United States v. Smith, 727

F.2d 214, 219-20 (2d Cir. 1984) (affirming admission of

similar acts of securities fraud to show defendant’s

knowledge of, and intent to engage in, “free-riding”

securities scheme”); United States v. Lauersen, No. S2 98

Cr. 1134 (WHP), 2000 WL 1677931 at *3 (S.D.N.Y. November 8,

2000) (evidence of false diagnoses attributed by defendant

to patients not undergoing fertility treatments admitted to

show intent and lack of mistake when making identical false

representations attributable to patients undergoing

fertility treatments).

 

The Second Circuit has “adopted the inclusionary

or positive approach to the Rule.” United States v. Levy,

731 F.2d 997, 1002 (2d Cir. 1984); see also United States v.

DeVillio, 983 F.2d 1185, 1194 (2d Cir. 1993). Consistent

with this approach, "evidence of other crimes, wrongs, or

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 13 of 15

14

acts is admissible for any purpose other than to show a

defendant's criminal propensity." United States v. Brennan,

798 F.2d 581, 589 (2d Cir. 1986) (emphasis added); see also

United States v. Pipola, 83 F.3d 556, 565 (2d Cir. 1996)

(Second Circuit’s “inclusionary interpretation of the rule

allows evidence of other wrongs to be admitted so long as it

is relevant and is not offered to prove criminal

propensity”).

 

As the government set forth in its first letter on

this topic, see Govt’s August 18, 2009 Letter, evidence of

Cioffi’s involvement in the pledge is relevant to his

knowledge of BSAM’s dim view of portfolio managers altering

their investments in their funds, and his intent to avoid

BSAM’s scrutiny. The government otherwise relies on its

prior arguments as they relate to the pledge’s relevance to

Cioffi’s knowledge and disregard of the compliance

procedures at BSAM.

 

E. The Quantity Of Proof Of The Pledge

 

The government has no intention to create a trial

within a trial or to offer any proof that will distract the

jury’s attention away from the crimes charged in the

indictment. To prove the existence of the pledge and its

relationship to the crimes charged, the government expects

to add a limited amount of proof to the trial record. The

Global Head is already a noticed trial witness for the

government. The government plans to ask him a limited

amount of questions about how the pledge came to light and

about the day he explicitly denied BSAM’s consent for

Cioffi’s pledge. The government also intends to call the

Middle Officer Manager to testify to that the pledge is

authentic, that his position at BSAM was subordinate to the

Global Head, that he signed the pledge without having been

advised that BSAM objected to the pledge, and that, to his

knowledge, the pledge was never filed on the books of the

Enhanced Fund.

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 14 of 15

15

IV. Conclusion

For the foregoing reasons, the government respectfully requests that evidence of the pledge agreement be admitted as direct proof of the crimes charged in the

indictment or, in the alternative, be admitted as Rule404(b) evidence.

 

Respectfully submitted,

BENTON J. CAMPBELL

UNITED STATES ATTORNEY

 

                                          By:___________________

James G. McGovern

Ilene Jaroslaw

Patrick Sean Sinclair

Brian Sano

Assistant U.S. Attorneys

 

Case 1:08-cr-00415-FB Document 188 Filed 09/25/09 Page 15 of 15