Monday, 06.23.08

Hedged In

Photo by AFP/Getty Images.

On Thursday, two Bear Stearns executives surrendered to federal agents over charges that they had misled investors about the state of Bear Stearns hedge funds.

As night follows day, arrests follow financial scandals. Investors in those funds can't be unhappy about seeing their managers doing the perp walk. And the evidence certainly seems damning. Days before they delivered an upbeat assessment to their investors, the two execs were exchanging worried e-mails about the state of the funds. "I think we should close the funds now," one wrote. Instead, they reassured their worried customers. Only a month later came the now-infamous meltdown that eventually led to the fire sale of their 85-year-old firm.

The two executives, Ralph Cioffi and Matthew Tannin, can expect one of the endless securities trials that seem to have become a permanent feature of public life in the new millennium. But it will probably be harder than it looks to make a good case against them. The public information available so far comes from the prosecution team. Expect the defense to proffer its own explanations, ones that will likely sound far less cut-and-dried. Moments of panic are hardly unknown in financial markets; the crime committed by the defendants may simply have been deciding that no, things weren't so bad after all.

Of course, that may be enough for juries tired of an endless string of financial mishaps and executives shining on the public. Securities cases are notoriously difficult to try: Eliot Spitzer, who made his reputation taking down Wall Street, lost the only major case he took to trial. Some of the questions involved are thorny enough to keep accounting professors wrangling for years. Yet we expect juries composed of a random cross section of Americans, most of whom can't even read a balance sheet, to wade through the numbing details and pluck the truth from a sea of numbers.

A few years ago, a securities lawyer described the central difficulty of these prosecutions (or defenses): Often, she said, the lawyers themselves have a hard time figuring out exactly what happened. Breaking it down so that the jury can understand is fiendishly difficult. And the longer you spend on it, the more the juries resent you for forcing them to endure the tedium of a basic accounting class. Making juries hate you is not the key to litigation success. "So how do juries decide these cases?" I asked her.

She shrugged. "Beats me."

Nonetheless, expect to see more such arrests. With the ongoing uncertainty in the financial markets, the current economic troubles, and everyone watching the equity erode in their homes, prosecutors can hardly avoid the pressure to single out malefactors for us to pin our anger on. And indeed, there are undoubtedly some out there to find. At any given time, it's a certainty that someone, somewhere, is doing something wrong.

— Megan McArdle

Filed Under: Bear Stearns, finance, Wall Street