Bear pair

The fraud charges against Ralph Cioffi and Matthew Tannin -- portfolio managers of the two Bear Stearns Cos. hedge funds that collapsed a little over a year ago -- just do not make sense.

Or at least that's what one would believe based on media commentary in the immediate aftermath of the mid-June indictment.

After all, as the story went, the failure of securities salesmen to be forthright to investors is "standard operating procedure" on Wall Street. What was different about these two portfolio managers?

Others thought they had the answer to that question: Given the markets' struggle to weather the credit crisis,
homeowners' struggle to make mortgage payments and consumers' struggle to fill up gas tanks, someone, in the words of one columnist, "had to do the perp walk." That "someone," the argument went, needed to take the hit so those more directly responsible for policies that contributed to the country's economic woes could avoid answering to those injured by credit difficulties. And finding that "someone" was all the more urgent against a backdrop of Main Street sentiment that the Federal Reserve's mid-March rescue of Bear Stearns showed who -- Wall Street, not Main Street -- had the government's sympathies.

Cioffi and Tannin, who allegedly painted a rosy picture of the doomed hedge funds' prospects to investors while fretting privately about signs the funds' collateralized debt obligations, or CDOs, were withering in value, were good candidates, given the magnitude of, and the publicity surrounding, the funds' catastrophic losses.

In a sense, it's difficult to care about the motivations of prosecutors in bringing the indictment, and I won't speculate about them. If Cioffi and Tannin engaged in activities that constituted fraud under the laws and regulations, then by all means they should be appropriately punished -- keeping in mind that an indictment is only a preliminary step in reaching any legal conclusion. And if the indictment highlights that the government's policing of anti-fraud statutes and regulations was inadequate -- or at least inappropriately focused on this most public of market catastrophes -- so be it. Those outcomes present little to quibble about.

What's more questionable, however, is the claim that prosecutors targeted the two portfolio managers to relieve some of the scrutiny, ever more sharp, on other players in the credit crisis. If the government's motivation behind the indictment was to make a scapegoat out of someone on "Wall Street," presumably it would have gone after someone actually on Wall Street.

To be sure, Cioffi and Tannin worked for Bear Stearns Asset Management Inc., which was, in turn, a subsidiary of Bear Stearns Cos., a major financial services firm whose prime brokerage, investment banking and broker-dealer activities permeated day-to-day Wall Street transactions. But hedge funds (and the investment managers that run them), though dependent in many respects on brokerage firms and other Wall Street institutions, are really separate from what we normally think of as "Wall Street."

Fundamentally, hedge funds are investors, pursuing an array of transactions and strategies that many other types of investors pursue. As investors, they arguably are different more in degree than in kind from Main Street investors. It may be, of course, that the involvement of hedge funds in the capital markets helped shape the investment products and services the markets offered.

For example, the success of CDOs and other asset-backed securities in recent years is due in part to the willingness of hedge funds to buy the bottom-tier tranches of those securities, which carry the potential for the highest yields but, of course, the greatest risk as well.

As a result, to the extent hedge funds have been participants in markets for risky credit-related instruments, they have been a component of the credit crisis. But lenders and other creditors (not hedge funds) were the real masterminds behind the push to securitize mortgages and other assets, and credit ratings agencies (not hedge funds) were sources of the too-optimistic credit ratings for those securities. In other words, hedge funds and their managers are participants in the market enabled by Wall Street's infrastructure. But they are hardly emblematic of it. 

Anita K. Krug is a director with the business department at Howard Rice Nemerovski Canady Falk & Rabkin PC and is a member of the firm's investment management group.