Hedge fund arrests send chill through industry

By Svea Herbst-Bayliss - Analysis

BOSTON (Reuters) - Pictures of hedge fund managers in handcuffs being led away to face fraud charges on Thursday have sent a chilling message to the $2 trillion industry.

The warning was clear: mind what you say in your e-mails if you are a manager and do a lot of due diligence if you are an investor.

While this is not the first time hedge fund managers have been arrested -- police are searching for a convicted manager who recently faked his suicide to avoid prison -- the two former Bear Stearns managers who were surrounded by a swarm of federal agents on Thursday were in a different league.

Ralph Cioffi and Matthew Tannin were called savvy managers who understood the complicated credit markets and worked for a bulge bracket investment bank that promised investors strong risk controls. Bear Stearns also had deep pockets in case something went wrong, analysts thought.

Much of the case against the two was based on e-mail traffic between Tannin and Cioffi, including one that included the prophetic line: "... the entire subprime market is toast."

The two men stand accused of having known their portfolios were in trouble, but lying to investors about it.

"You can't say one thing to investors and another thing to your colleagues and think that is OK. It is not," said Dick Del Bello, a senior partner at Conifer Securities, who used to run the U.S. prime brokerage business for UBS.

The men's arrests are the first criminal charges related to the sub-prime mortgage crisis that has impacted the loosely regulated hedge fund industry through heavy losses and a wave of redemptions.