Imagine you are invested in a hedge fund around the time the credit crisis was beginning to rear its head. You get on a call with one of the hedge fund managers and are told that he is "very comfortable with exactly where we are" and "there's no basis for thinking this is one big disaster." When asked about redemptions by other investors, the hedge fund manager reports that there were "just a 'couple of million' dollars of redemptions requested by investors in June." In another conversation, the hedge fund manager assures you that he himself is putting more of his own money in the fund.
It turns out, however, that three days before the conference call the hedge fund manager e-mailed a colleague to say: "The entire subprime market is toast," . . . "[t]here is simply no way for us to make money — ever." He had also written that "if an internal report prepared by a colleague is 'ANYWHERE CLOSE to accurate, I think we should close the funds now.'" Furthermore, it turns out that rather than investors asking for merely a couple of million dollars back, one investor had informed the fund that "it wished to withdraw its entire $57 million investment." The fund manager later admits that "he pulled the couple of million dollars amount 'out of thin air.'" Finally, the manager was taking millions of dollars of his own money out of the fund while claiming to be adding to his investment.
Now let's say that you and the rest of your fellow investors ended up losing $1.5 billion on your investment in this fund. Were you defrauded? Should the hedge fund manager go to jail? Should he go to jail for 20 years?
Well, that's exactly what a jury will get to decide in the criminal trial of former Bear Stearns executives Ralph Cioffi and Matthew Tannin, which began this past Tuesday. (The quoted language above was taken from here and here.) Commentators are framing the case as one of spin versus fraud, but the real issue is going to be intent. Most people would equate "spin" with immaterial puffery. But even as far as courts and judges are willing to go to label optimistic misstatements immaterial puffery in the context of securities litigation, I think that would be a hard sell on these facts. Rather, the difficult task for the prosecution in this case will be to prove that these statements were made with an intent to defraud as opposed to being mere responses to "panic and desperation . . . that he was simply paralyzed by circumstances spiraling out of control." Of course, he apparently wasn't too panicked or paralyzed to pull out his own money or chat up investors.
{ 1 comment… read it below or add one }
It's fraud. The manager made false statements of material fact that he knew to be false (or with reckless disregard to the truth thereof) with the intent to deceive his caller, and upon which the caller did rely. There is probably a factual question of whether the reliance was reasonable, but it should not be too difficult to meet this hurdle.
The manager will claim that his statements were not "factual" but rather opinion or "sales spin". But he had superior information which contradicted any such "spin". Furthermore he lied about his own actions.