Ralph Cioffi, 52, and Matthew Tannin, 46, were charged on Thursday with falsely saying the hedge funds were thriving while knowing investments in subprime mortgages could cause their collapse. Prosecutors claimed the men lied about liquidity, redemption requests, and their own investments before the funds shut down a year ago, costing investors $1 billion.

"They've got a lot of evidence to establish a securities fraud against hedge fund managers," said former federal prosecutor William Mateja. While acknowledging he had not heard the defense's side, "it appears that [prosecutors] have a strong case," he said.

The indictment and arrests of Cioffi and Tannin are the first charges relating to last year's mortgage-market breakdown. The government is probing banks and mortgage firms whose losses in subprime loans and related securities total $397 billion.

Cioffi's lawyer criticized Brooklyn U.S. Attorney Benton Campbell for ordering the arrests, saying it was an effort by the government to make an example of innocent men.

"Because his funds were the first to lose might make him an easy target but doesn't mean he did anything wrong," defense lawyer Edward Little said.

Tannin's lawyer, Susan Brune, said her client was innocent and prosecutors have made him a "scapegoat."

The e-mails cited in the indictment "are really absolutely the key," Villanova University Law School Dean Mark Sargent said after reading the document. "They show that they knew the funds were cratering, that the bottom had dropped out of the subprime market, and their leverage was putting enormous pressure on the fund."

One e-mail showed the men fretting after a report showed the funds' securities were worth far less than they hoped, according to the indictment. "If we believe the report is ANYWHERE CLOSE to accurate I think we should close the funds now," Tannin wrote in the e-mail. "The reason for this is that if the . . . report is correct then the entire subprime market is toast."

Prosecutors also cited a series of statements that Cioffi and Tannin made to investors in conference calls and privately to lenders and subordinates. Cioffi failed to tell investors that he redeemed $2 million of his own $6 million investment, moving it to another Bear Stearns hedge fund, prosecutors said.

Tannin repeatedly told investors that he would add his own money to the funds, and didn't, prosecutors said.

"The movement of money is key," said Andrew Hruska, a former federal prosecutor in Washington and Brooklyn. "When you say 'I'm putting in money' when in fact you're taking it out, there's no argument."

Tips for Corporate Targets

What should executives do if facing a federal investigation? Here are reminders from two Philadelphia attorneys*, both former prosecutors. Says Thomas M. Gallagher: "If somebody is shredding documents, the hard case just became easier to prosecute" because authorities get leverage over a suspect.

Compliance: Start a program to detect wrongdoing and implement corrective steps.

Assign responsibilities: Be sure every employee knows his role in compliance oversight.

Know the rules: Understand government policies regarding your business operations.

Get help: Notify corporate counsel as soon as you learn of a government probe.

Stay calm: Don't overreact to an investigation. Understand your legal rights and responsibilities.

Document control: Comply with government policies on what documents must be retained.

Avoid cover-up: Destroying documents and lying during an investigation are crimes, apart from the charge underlying the probe itself.

*Gallagher and Michael A. Schwartz are attorneys at Pepper Hamilton.