The “blame Goldman” defense

August 5, 2009

Sometimes the best defense to a criminal charge is pointing to an even bigger villain. So maybe former Bear Stearns hedge fund manager Ralph Cioffi should look to blame his funds’ spectacular implosion two summers ago on the one Wall Street firm everyone loves to hate: Goldman Sachs.

In two months’ time, Cioffi and his former co-manager, Matthew Tannin, are scheduled to go on trial in federal court on charges they lied to their investors about the financial health of the Bear funds.

The timing couldn’t be worse for Cioffi and Tannin. The media will soon be dominated by stories marking the one-year anniversary of the Lehman Brothers bankruptcy — the event that kicked the financial crisis into overdrive and turned the phrase “bank bailout’ into an obscenity.

It was the collapse of the Bear funds that has been widely seen as the starting point of the crisis. The public’s lust for blood, and desire to have someone pay for all the pain and turmoil the banks have caused since, will be reinvigorated come the fall.

And this is a big problem for Cioffi and Tannin because after all the bailout money that’s been spent to save the banks, the two former hedge fund managers hold the dubious distinction of being the only prominent Wall Street bankers who have been charged with any crime arising from the crisis.

It may not be fair, but there’s a chance that the jury sitting in that courtroom in Brooklyn will hold Cioffi and Tannin to account for all the collective sins of Wall Street.

So what better way to turn things around then by heaping blame on Goldman for the Bear funds’ demise? Right or wrong, Goldman, with its outsized profits and seemingly above-it-all arrogance, is emerging as the new villain on Wall Street.

Did anyone say vampire squid?

With the start of the trial drawing near, the lawyers for Cioffi and Tannin aren’t talking. Yet a “blame Goldman” defense strategy isn’t as far-fetched as it may seem.

Not many know that Goldman sold a $300 million slug of a now-toxic collateralized debt obligation called “Timberwolf 1″ to the Bear funds in March 2007 — a time when the hedge funds were already teetering on the brink.

Timberwolf was a Goldman deal through and through. Goldman was the sole underwriter on the $1 billion CDO, and the underlying mess of subprime-backed mortgage bonds was managed by Greywolf Capital, an investment firm formed by a group of former Goldman bond traders. (Greywolf declined to comment.)

The Bear funds were the single biggest investor in the Timberwolf deal.

There was some internal dissension within the Bear funds about the timing and size of the transaction. Still, people who were close to the Bear funds say Cioffi pushed ahead with the deal despite those internal reservations.

But here’s the interesting thing: within two weeks of selling off pieces of the Timberwolf CDO to the Bear funds, Goldman began marking down the value of some of the securities it had just brought to market.

Goldman’s actions had far-reaching ramifications for the Bear funds because it forced Cioffi’s team to similarly mark down the value of other CDOs that the funds owned. Those mark-downs ultimately fed upon each other and may have hastened the Bear funds’ rapid demise, the people close to the Bear funds say.

In hindsight, the move by Goldman to mark down the value of the Timberwolf CDO deal likely was a reaction to the rapidly deteriorating condition of the U.S. housing market in the spring of 2007.

Even a person who was close to the Bear funds’ operations says that the Goldman mark-down wasn’t beyond the pale. It may have been a bit brutal, but not unethical.

And the Goldman mark-down, of course, came well after prosecutors say Cioffi and Tannin began lying to investors about their funds’ condition. But the point of the “blame Goldman” strategy isn’t to explain everything away; it’s to get a jury to focus on a bigger and more menacing fish.

For Cioffi and Tannin, it may be the best card to play in a weak hand.

3 comments

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Read this and tell me how Goldman Sachs is innocent-

http://www.rollingstone.com/politics/sto ry/29127316/the_great_american_bubble_ma chine

Posted by Steve Hunts | Report as abusive

I think the lesson in the crisis to the public is that White-collar Crime and Fraud are very hard to detect and quite difficult to prosecute and that reliance on regulators is not sufficient protection for an investor, entrepreneur or institution.

With the advanced capabilities of electronics, there is no reason large firms can not police against the activities that got these two individuals in to trouble. It is in deed sad that when the fund was under distress (and its managers with it) that Bear Stearns did not have an internal mechanism to regulate what these managers were telling investors.

I am not privy to the evidence, these individuals conduct prior to the funds crisis or if there were complaints regarding their ethical performance prior to their intentional misleading of investors. However considering the bank of America compensation issue and the fact that these individuals worked for Bear Stearns, that the liability for their actions is in part that of Bear Stearns and they should not receive a Madoff Style sentence.

By nature of their position at a firm, they were not chiefs, but soldiers and the firm should regulate that its solders act in a legal fashion with association to such large pools of capital.

Especially when under duress, as they were.

The duress element should be considered if behavior prior to the implosion was inconsistent with criminal misconduct during the implosion.

I think that they are guilty of poor judgment under duress and that the firm (or its remnants) is to blame.

The firms have been excused from policing their employees and fines like the $33mm are insufficient deterrent for internal ethics in the policing of improper conduct.

The SEC should have much stiffer fines and has not kept up to date but that is beating a dead horse, much like these two individuals who face being scapegoated for an industries abjectly absent internal governance.

I do not know what is presently in place at the major banks which have fund managers and traders who are basically entrepreneurs with no capital investment but there should be an Internal Security Desk.

The Internal Security Desk should operate on mathematical models of Capital Scale, Debt Proportions, Team Experience, Trading Volumes and profit/loss (which should be looked at with equal scrutiny). That the Internal Security Desk should automatically intercept information and distribute to the SEC via Notification when certain mathematical models are violated by any individual component of the firm. These models should be established by the SEC and mandatory to all automated trading and firms with volumes over a certain threshold. The Security Desk should be staffed by personnel trained in Investigations of Securities Violations and should be the firms internal police force. That the internal trading police force, should have powers and obligations beyond the board of directors to the SEC and Treasury by a (“Special Securities Policing License”). Like security guards at a facility, these (“Federally Licensed Securities Trading Monitors”) should upon violation of accepted mathematical models be able to monitor and control all communications and/or remove individuals who represent a threat to Public Financial Safety through Improper Trading Conduct.

I did not have sex with that woman … …

You can not always count on individual accountability, even from the most outstanding individuals. We’re human and we make errors. That is why in the trading world, we need a new regulatory framework for Trading Security Officers who report directly to their firm and the Police (DOJ & SEC).

[...] during tomorrow’s questioning of Tom Montag. Another question: will Tannin and Cioffi appear as surprise witnesses. We have yet to encounter any discussion of how and why Abacus may have been involved in this deal, [...]

[...] during tomorrow’s questioning of Tom Montag. Another question: will Tannin and Cioffi appear as surprise witnesses. We have yet to encounter any discussion of how and why Abacus may have been involved in this deal, [...]