More Whistleblowers Coming Forward Ahead of SEC Bear Stearns Hedge Fund Case

By Teri Buhl

Former Bear Stearns hedge fund manager Ralph Cioffi was acquitted of misleading investors in his 2009 criminal trial. But in the two years since, a growing number of former Bear Stearns employees have come forward with their own accounts of Cioffi's actions heading into the financial crisis.

In the meantime, the Securities and Exchange Commission has been preparing its own civil lawsuit against Cioffi, which is scheduled to go trial in February.

The SEC's lawsuit, filed in 2008, accuses Cioffi of misleading investors about the health of two Bear Stearns Asset Management hedge funds and the types of mortgage-backed security assets they were buying.

At their height, the Bear Stearns funds held $1.8 billion in assets. Now, they're in bankruptcy. Former employees describe a free flow of information between Bear Stearns' fund management unit and its investment banking division that packaged and sold mortgage-backed securities. The situation raises questions about Cioffi's knowledge that go to the heart of the SEC's case.

...

"Investors were only allowed to get security-level data," Van Leeuwen said in an interview for a documentary film being produced about Bear Stearns. "We'd send out these statement to about 30 to 40 people at Bear Stearns, but then I saw Ralph Cioffi from BSAM was also on the list...He was privy to loan-level detail from when the company bought the loans, which put him head and shoulders ahead any other investors."

...

Van Leeuwen said that Cioffi was given advance knowledge of all of the mortgage-securitization deals that Bear was doing.

"He had the capability to scan all that info and having access to all the loan-level data breaks the transparency issues that is such a barrier for investors right now," said Van Leeuwen, who worked for EMC from 2004 to 2006.

Brett Sherman, a former Morgan Stanley in-house securities attorney, said that if Cioffi traded on loan-level data that wasn't available to the general public, it may have constituted insider trading.

"Under the federal securities laws, it is illegal to buy or sell publicly traded securities based on access to material information that is not available to public investors," said Sherman, who's now in private practice and representing investors who are suing Bear Stearns. "So if the evidence shows that Mr. Cioffi bought or sold mortgage bonds based on access to loan-level data that was never available to the investing public -- or even if he traded on that data before it was public -- then it seems like a classic case of insider trading."

...

The SEC's complaint, filed in the U.S. District Court in Brooklyn, N.Y., claims that Cioffi knew five months before the funds blew up that the securities were suffering deep losses and facing margin calls. In June 2007, investors in the hedge funds were told the funds were shutting down and redemptions were locked.

...

Another EMC whistleblower... says he handled more than $30 billion of collateral packaged into Bear Stearns mortgage securities. "I knew the trouble we were having with the two hedge funds and heard about it before it hit the headlines," the analyst said. "In a February 2007 conference call, the people from Bear were saying that the sunshine is gone and if you find a ray of sunshine, hold onto it. This is the worst we've seen in the mortgage market."

If the SEC can prove that Cioffi knew that the RMBS and collateralized debt obligations his hedge funds bought were performing poorly before their last open redemption date of April 2007, it could bolster the commission's claim that Cioffi misled investors to keep them from redeeming.