Massachusetts Regulators Accuse
Bear Stearns of Fraud

Massachusetts securities regulators filed a complaint accusing Bear Stearns Cos. of fraud for allegedly improperly trading with two in-house hedge funds that collapsed this summer.

Regulators in the office of Secretary of State William F. Galvin say in the administrative complaint that Bear Stearns traded mortgage-backed securities for its own account with the hedge funds without notifying the funds' independent directors in advance.

Advance disclosure of principal trades is required to make sure trades are fair for investors. The failure of the two mortgage-related funds, Bear Stearns High-Grade Structured Credit Strategies Fund and High-Grade Structured Credit Enhanced Leverage Fund, cost investors $1.6 billion. Massachusetts believes it has standing on behalf of state residents invested in the funds.

Regulators say "hundreds" of principal transactions -- including those involving mortgage-backed securities and collateralized debt obligations -- were processed without prior approval from the funds' independent directors. In 2006, 79% of principal transactions lacked prior approval, while 59% were missing prior approval in 2005, and 30% in 2004, the complaint says.

Massachusetts regulators issued subpoenas and tried to arrange interviews with the two independent directors at Walkers Fund Services in Cayman Islands, but the directors never appeared to answer questions "because they claimed that the securities division lacked jurisdiction in the Cayman Islands," the complaint says.

"By consistently choosing unaffiliated directors who were domiciled outside the United States," Bear Stearns "effectively shielded those unaffiliated directors from accountability for the essential duties they were to perform for investors in the fund," the complaint says.

The two independent directors "do not appear to have been entirely independent" from Bear Stearns because Walkers had other business and legal relationships with the investment firm, the complaint says.

Mr. Galvin said in a statement that "the cavalier attitude that this company had about its various conflicts of interest is intolerable." The Complaint calls for Bear Stearns to cease and desist from alleged violations of the securities laws and to pay a fine, to be determined. A spokesman for Bear Stearns was not immediately available.

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