Way back in November 2007, before the financial crisis exploded, the Massachusetts Securities Division did something that got very little attention at the time. Led by director Bryan Lantagne, it filed charges against a unit of Bear, Stearns & Co. following the collapse a few months earlier of two affiliated hedge funds that left investors with $1.6 billion in losses. The Division accused Bear Stearns Asset Management, which managed the funds, of violating federal and state securities laws by engaging in related party trades without getting the necessary approval from the funds’ independent directors.
In the complaint, which you can read here, the state accused BSAM of failing to properly manage conflicts of interests created by a deluge of related-party transactions. The hedge funds, which invested heavily in subprime mortgage-backed securities, bought and sold the securities from Bear Stearns and other related entities. Although these conflicts were disclosed to investors, the investors were also assured that the related-party sales would be overseen and approved by two independent directors of the funds. But that didn’t happen, the complaint maintained, which violated the federal Investment Advisers Act of 1940. Of the transactions that required approval in 2006, the year before the hedge funds cratered, 79 percent failed to get it.
A year after filing the charges, in November 2008, the Massachusetts Securities Division reached a $9.3 million settlement with Bear Stearns Asset Management. By then BSAM was owned by JPMorgan Chase & Co., which had scooped up Bear Stearns for the fire sale price of $2 a share the previous March. Like the filing of the complaint, the resolution of the state’s case hardly caused a ripple in the press. As you’ll recall, there was a lot going on in November 2008, and a $9 million settlement by a state financial regulator probably seemed as newsworthy as a fender bender at a tailgating party.
But lo and behold, that little deal that nobody cared about in 2008 has turned out to be the high-water mark in regulatory enforcement stemming from Bear Stearns’s collapse. Four years later, no government entity has been able to match it.
This sad fact was emphasized on Monday when U.S. Senior District Judge Frederic Block in Brooklyn begrudgingly approved the Securities and Exchange Commission’s settlement with former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin–managers of the very same funds at issue in the Massachusetts case–for a total of $1.05 million. During a hearing last February, Block had called the sum “chump change.” Still, in his 19-page ruling, Block reluctantly conceded that he was compelled to approve the deal, given the constraints of the securities laws. Clearly frustrated, the judge bemoaned this “sorry state of affairs” and called on Congress “to consider whether more should be done by the government to come to the aid of the victims of Wall Street predators.”
Remember, this is a judge who is intimately familiar with the facts of this case. Block presided over the criminal trial of Cioffi and Tannin in 2009, in which they were acquitted by a jury. This isn’t someone spouting off about Wall Street greed who doesn’t understand the facts. Block got a close up look at what happened at Bear Stearns and he’s upset.
The SEC might have been able to get a bigger recovery if it had filed charges against BSAM, as the Massachusetts regulators did. But it never did. I explored this puzzle in an earlier article in The American Lawyer magazine in April. It’s a long story, but basically JPMorgan asked the SEC to agree that it wouldn’t be liable for Bear Stearns’s misdeeds. And while it didn’t get a hard-and-fast promise, the SEC did give some vague assurances in writing. The SEC and JPMorgan declined to comment for that article. We also reached out to the SEC for this article, but didn’t hear back.
Unfortunately, this weak regulatory response isn’t limited to Bear Stearns. The SEC hasn’t brought any charges related to the fall of Lehman Brothers, and I doubt it will. (And while shareholder suits have led to some decent settlements–$275 million for Bear Stearns and $90 million for Lehman Brothers–the top executives at the two companies won’t have to pay a penny out of their pockets. Directors and officers insurance will pick up the tab.)
So between Lehman and Bear Stearns, we have a tad over $1 million collected by the SEC. That makes Massachusetts and its $9.3 million deal look like the Seal Team Six of regulators.
This article originally appeared in The AmLaw Litigation Daily.
