How the Scapegoats Escaped

Prosecutors made two big errors in the federal criminal trial of two former Bear Stearns hedge fund managers. Where is the accountability for the biggest financial crash in modern times?

By WILLIAM D. COHAN, NY Times, Published: November 11, 2009

THE quick “not guilty” verdict reached Tuesday afternoon by a Brooklyn jury in the federal criminal trial of two former Bear Stearns hedge fund managers was at once surprising — for its failure to comport with the zeitgeist — but also entirely understandable, based on a close reading of the prosecution’s arguments and the evidence the judge allowed to be introduced. “There was a reasonable doubt on every charge,” one juror told The Times afterward. “We just didn’t feel that the case had been proven.”

In short, the prosecution blew it — on two counts. First, in devising the original indictment for conspiracy and securities fraud against the two defendants, Ralph Cioffi and Matthew Tannin, it relied on damning snippets of lengthy e-mail messages that when viewed in their entirety proved to be highly ambiguous. Second, the prosecution made a reductionist opening argument claiming the men were nothing more than out-and-out liars, needlessly raising the bar in terms of what it had to prove to jurors.

In that opening speech, Patrick Sinclair, the assistant United States attorney for the Eastern District of New York, tried to head off all the confusing Wall Street jargon soon to be unleashed by claiming the defendants had simply been deceitful. He accused them of lying about the size of their personal investments in the funds and in their dealings with nervous investors who were considering getting out when subprime mortgages — in which the funds had invested heavily — began to rapidly lose value in March 2007.

“They did the best thing that they could think of to keep those investors in the fund and with any luck keep their bonuses coming: they lied,” Mr. Sinclair told the jury. “They lied over and over again to lull those investors into a false sense of confidence and make them think that these failing funds continued to be a good investment when the exact opposite was true.”

Unfortunately for the government, the evidence was not nearly as clear-cut as Mr. Sinclair portrayed it to be, and his strategy to make it seem so backfired. Consider the e-mail messages the prosecution placed at the center of its case.

In the indictment, the prosecution quoted from a note Mr. Tannin sent in April 2007 from his personal Gmail account to Mr. Cioffi’s wife. The government made much of the fact that Mr. Tannin chose not to send it to Mr. Cioffi himself or from his Bear Stearns’ e-mail account, suggesting he was trying to hide something. “The subprime market looks pretty damn ugly,” Mr. Tannin wrote, adding that if a recent financial report was correct, “I think we should close the funds now .... The entire subprime market is toast.”

But the jury eventually saw the entire message, in which Mr. Tannin ruminated at length about various courses of action and seemed to be striving to make the soundest financial choice. In other words, it was just what you would hope your fund manager would be worrying about in a precarious time. In the end, he concluded he was feeling “pretty damn good” about what was happening at the funds and that “I’ve done the best possible job that I could have done.” Any wonder the jurors came away with reasonable doubt?

The prosecution’s misjudgments are doubly vexing because there was other evidence around which it might have built a stronger case. The prime example was a “talking points” memo in June 2007, sent by Bear Stearns’s senior management to its brokers for use in discussions with hedge fund investors worried about a meltdown. The episode raised pretty clear doubts about whether Mr. Cioffi and Mr. Tannin had told investors the truth.

According to the memo, one of the questions deemed likely to be asked was: “I thought the fund was diversified, and now it turns out it seems to have had a fair amount of exposure to the subprime mortgage market. What exactly was the exposure?” The answer: “60 percent.” The problem was that in all previous communications to the investors, the two fund managers had suggested that only about six percent of the funds were invested in subprime mortgages.

During the trial, a prominent former Bear Stearns broker, Shelly Bergman, testified about the damning nature of this talking points memo, which was as close to a smoking gun as prosecutors could have hoped for. Yet the prosecution never made much use of his testimony, and it did a poor job of rebutting the defense’s claims that Mr. Bergman had a conflict of interest in testifying against the two fund managers.

So where does the verdict leave us? Word is that three federal grand juries are still investigating what went wrong at Lehman Brothers in 2007, but those prosecutors may be forced to tread lightly in the wake of what happened this week. Even though the facts and circumstances of the Lehman matter are very different from the Cioffi/Tannin episode, Tuesday’s verdict may be the best news in more than a year for Richard Fuld, the former Lehman chief executive.

For now, Mr. Cioffi and Mr. Tannin remain the only bankers indicted for their professional behavior in what became one of the worst financial crises in our history. They became a symbol of greedy carelessness for a public intent on blaming someone — anyone — for Wall Street’s folly. There must be some accountability for the Bear Stearns calamity, to say nothing of the $12 trillion of taxpayer money used to prop up capitalism, right? Not so fast, this Brooklyn jury declared. “The entire market crashed,” one juror explained. “You can’t blame that on two people.”

William D. Cohan, a contributing editor at Fortune and a former Wall Street banker, is the author of “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street.” In January, he will begin a regular column on business at nytimes.com/opinion.