Opinion

Alison Frankel

Judge in SEC case against Bear hedgies plays to the bleachers

By Alison Frankel
June 20, 2012

We now know exactly who caused the financial crisis.

Or, at least, whom U.S. District Judge Frederic Block of Brooklyn holds accountable. According to a 19-page opinion Block issued Monday in the Securities and Exchange Commission case against former Bear Stearns hedge fund executives Ralph Cioffi and Matthew Tannin, “many in the financial world” believe the economic catastrophe was triggered by the collapse of two funds Cioffi and Tannin ran. That’s a pretty heavy burden the judge has laid on the former Bears, who, after all, were acquitted in a 2009 criminal trial of lying to investors about the health of their funds.

Block, who had previously informed the SEC that he would not be a mere rubber stamp for what he called a “chump change” settlement, ended up approving a deal between the agency and the former Bear Stearns execs. (Neither of them admitted or denied the SEC’s allegations, but Cioffi agreed to cough up $800,000 in penalties and disgorgement; Tannin’s total is $250,000.) But the judge took the opportunity of a settlement in this widely followed case to write an opinion that seems directed at the peanut gallery, and not at the SEC, Cioffi, Tannin or their lawyers. His conclusion: “Wall Street predators” caused the economy to buckle, and Congress should think hard about empowering the SEC to recoup investor losses.

According to Block’s discussion of the SEC’s historical enforcement abilities, Congress has twice acted to expand the agency’s mandate. The SEC at first had only the ability to enjoin violations of securities laws. A 1971 ruling by the 2nd Circuit Court of Appeals, followed by similar rulings in other federal circuits, codified the agency’s power also to seek disgorgement of ill-gotten profits as a remedy. Then, in a pair of laws in 1984 and 1990, Congress gave the SEC the right to demand monetary penalties of up to $500,000, depending on the defendant and the alleged violation.

But as the Cioffi and Tannin case shows, disgorgement and penalties still leave a big gap between what investors have lost and what the SEC can recover, Block wrote. “The proposed settlement is based on the theory that Cioffi gained by avoiding losses of approximately $2 million by selling part of his stake in the funds prior to their collapse, while Tannin gained $750,000 he received as a retention bonus in 2007,” the opinion said. “Even assuming that a verdict against them would result in disgorgement of the full $2.75 million, plus an equal amount in penalties, the total amount the SEC could recover would amount to less than half a percent of the $1.6 billion in investor losses the defendants allegedly precipitated.”

Block, whose book about his experiences as a federal judge is coming out next month, said Congress has left it to the private bar to make investors whole but has nevertheless erected barriers that make it difficult for plaintiffs’ lawyers to bring securities class actions. In this case, he said, investors may ultimately recover 30 percent of their losses, but that depends on appeals. “Given this sorry state of affairs,” the judge wrote, “Congress may wish to consider broadening the SEC’s power to recover amounts more reflective of investor losses, and to require any moneys recovered to be paid into Fair Funds for investors’ benefit.” Until then, he wrote, “the court must accept the SEC’s enforcement authority as it currently stands. Regrettably, that authority leaves investors out in the cold.”

Cioffi counsel Edward Little of Hughes Hubbard & Reed said his client is relieved finally to have the case resolved, adding: “I am sure when the judge spoke broadly about the financial crisis and the predators who caused it, he was not speaking specifically about our clients.” Susan Brune of Brune & Richard, who represented Tannin in both the criminal case and the SEC proceeding, declined to comment.

An SEC spokesman said in an email: “The judge’s ruling underscores the statutory limitations on the Commission’s financial penalty authority.” SEC Chairman Mary Schapiro, he said, has also recommended that Congress act to increase the agency’s mandate.

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