Marking what some say is the start of the criminalization of the credit crisis, federal prosecutors indicted two Bear Stearns hedge fund managers yesterday and announced that more than 400 real estate lawyers, appraisers, and brokers have been arrested in recent months.

The U.S. Attorney’s Office for the Eastern District of New York indicted the founder of two Bear Stearns hedge funds that collapsed last year, Ralph Cioffi, and a portfolio manager at the funds, Matthew Tannin, on charges of conspiracy, securities fraud, and wire fraud. Mr. Cioffi was also charged with insider trading. Meanwhile, the Department of Justice and the Federal Bureau of Investigation announced that 406 defendants have been charged with mortgage fraud since March 1 under Operation Malicious Mortgage.

“There is no doubt that these indictments have opened up the door to the criminalization stage of the subprime fallout,” a securities lawyer and adjunct professor at Northwestern University School of Law, Andrew Stoltmann, said. “I don’t think there is any question that we are going to see more indictments coming.”

The case against Messrs. Cioffi and Tannin revolves around the allegation that the two knowingly misrepresented the health of the hedge funds to investors in an attempt to keep them afloat. Among the allegations: In March of last year, the hedge fund managers told investors the market provided ideal “buying opportunities,” suggesting they put more into the funds. Meanwhile, they directed their Bear Stearns colleagues to forgo making any investments, and instead to use the influx of new funds to shore up liquidity.

Later in March, Mr. Cioffi transferred $2 million of the $6 million he had invested in one of the troubled hedge funds into a third Bear Stearns fund he also managed, leading prosecutors to charge him with insider trading. According to the indictment, Mr. Cioffi told Bear Stearns officials that he moved the money into the third fund so he would have a personal stake in it.

In April, using a personal account, Mr. Tannin sent an e-mail to Mr. Cioffi saying, “The subprime market looks pretty damn ugly. … I think we should close the funds now.” Three days later, Mr. Tannin told investors on a conference call, “The structure of the fund has performed exactly the way it was designed to perform.”

In May, as the funds’ performances tumbled and the subprime market weakened further, investors began clamoring to withdraw their investments and lenders began asking for more collateral. To prevent the funds from collapsing, the managers allegedly lied. In one instance, Mr. Tannin allegedly told a lender that he was not anticipating that any investors would redeem their funds even though, in the two days prior, 13 investors, including two of the largest, had requested redemptions.

The funds collapsed in June, with losses for investors totaling $1.4 billion.

“The subprime crisis took everyone by surprise, including the Fed and Treasury, and dozens of the largest financial institutions have lost over $300 billion to date on the same investments. Ralph Cioffi’s funds lost money in exactly the same way. Because his funds were the first to lose might make him an easy target but doesn’t mean he did anything wrong,” an attorney for Mr. Cioffi, Edward Little, said in a statement. A lawyer for Mr. Tannin, Susan Brune, said her client “is being made a scapegoat for a widespread market crisis.”

Prosecutors had a different perspective: “They lied about the funds in a futile hope that they’d turn around and their incomes and reputations would remain intact,” the U.S. attorney for the Eastern District, Benton Campbell, told reporters yesterday. “Honesty and integrity are important to this business. The defendants chose to breach this trust.”

Lawyers and hedge fund experts say that more indictments surrounding Bear Stearns are possible.

“It is unlikely that only two people were involved with concealing this information,” said a hedge fund professional who, because of the ongoing legal case, requested anonymity. “I wouldn’t be surprised if this is just the beginning of a bigger story for Bear Stearns.”

A professor of law at New York University’s School of Law, Harry First, pointed out that a former Bear Stearns CEO, James Cayne, told investors the bank had no liquidity issues just days before it went bankrupt. “He could be in deep trouble,” he said.

“This was a clear shot over the bow at Bear Stearns’s senior management,” Mr. Stoltmann said. “There are some real, real nervous senior executives at Bear Stearns right now.”

Others watching the case say the prosecutors’ case appears weak. “The defendants told investors that the market offered great ‘buying opportunities’; well, at the time it was true, irregardless of whether these hedge funds were very good vehicles to actually make those purchases,” a professor of law at Columbia Law School, Merritt Fox, said. “There is a doctrine called puffing, where those selling securities put things in a good light, which is perfectly legal unless they say something dishonest.”

The managing director of Institutional Risk Analytics, Christopher Whalen, also dismissed the notion that the failure by the fund managers to tell the investors that they had removed some of their funds or failed to invest additional funds was fraudulent. “If the strongest thing they have got is that the defendants misrepresented themselves as having skin in the game, I’m not particularly impressed. The investors are sophisticated, or supposed to be, and at the end of the game, it is incumbent on them to determine the risk,” he said.

Much of the case comes down to what some in the industry say is a fine line between the salesmanship that is common among brokers and traders on Wall Street, and fraud. “Marketing, advertising, salesmanship is part of the Wall Street, the American, DNA,” the founder of Ritholz Research & Analytics, Barry Ritholz, said. “I think this will wake up a lot of people in the industry that it is one thing to spin it positive, and another to tell something to investors that defrauds them, and you end up going to jail.”