Two ex-Bear Stearns fund managers have been arrested and indicted on charges related to the collapse of subprime mortgage-related investments, which cost investors more than $1 billion. 

The U.S. Attorney’s Office for the Eastern District in Brooklyn has issued a nine-count indictment against Ralph Cioffi and Matthew Tannin charging them with conspiracy, wire fraud and securities fraud.

Both men have pleaded "not guilty" in front of a Federal judge Thursday afternoon. 

The Federal Bureau of Investigation arrested the two men on Wednesday morning outside their homes without incident.

According to the indictment, Cioffii and Tannin allegedly knew about the problems with their two hedge funds as early as February and attempted to cover up the ever-increasing losses in their portfolio. 

"The worry for me is that the sub prime losses will be far worse than any thing people have modelled," Cioffi wrote in an e-mail on March, 3,  2007, according to the indictment

Cioffi and Tannin ran two Bear Stearns-related hedge funds that collapsed in summer 2007. The day those funds collapsed is often referred to as the “official” beginning of the subprime mortgage mess.

As the hedge fund collapsed, Bear Stearns' investors vainly attempted to pull their money out of Cioffi and Tannin's funds. Investors lost 100% of their collective $1 billion investment. 

The issue at the center of the arrest is if Cioffi and Tannin misled investors in 2007 on the current state of the mortgage market, while privately saying that the investments were in trouble.

As big investors began to worry, Cioffii pulled $2 million of his $6 million own investment from the fund and moved into another Bear Stearns' hedge fund, according to the indictment. Hedge fund managers often invest their own money in a fund along with its investors as a sign of confidence. 

Despite decreasing returns, Tannin and Cioffi continued as to tell investors that "we are seeing opportunities now and we are excited about what is possible. I am adding capital to the fund. If you guys are in a good position to do the same I think you this is a good opportunity."

Tanning told Cioffi a month later "the subprime market looks pretty damn ugly... if [mortgages] are systematically downgraded, there is simply no way for us to make money - ever." 

The e-mail exchanges between Tannin and Cioffi are reminiscent of 2002 and 2003, when then New York Attorney General Elliott Spitzer charged Wall Street industry analysts with misleading investors. Then Merrill Lynch analyst Henry Blodget marketed dot-com related stocks, while internally telling investors they were junk. 

Bear Stearns imploded three months ago and was purchased by JPMorgan Chase (JPM) for a fire sale price of $10 a share. The now defunct investment bank is considered the definitive example of what has happened to the financial world since the housing and credit markets collapsed.