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Flynn Walks on Fund Probe Criminal Counts

The ex-CIBC banker was arrested 21 months ago at Eliot Spitzer's direction.

Updated from 10:50 a.m. EST

In a stunning turnaround, New York Attorney General Eliot Spitzer dropped all criminal charges Monday against Paul Flynn, the lone investment banker to be indicted in the mutual fund trading scandal.

Prosecutors with Spitzer's office announced the surprising decision in open court before New York Supreme Court Justice James Yates.

In a two-minute hearing, Yates said he had an order from prosecutors dismissing the case, declining to elaborate. He said the order would be sealed after 48 hours. Neither Flynn nor the prosecutor would comment on the proceeding.

A copy of the order was reviewed by

. In it, prosecutors say that

a recent $125 million settlement by Flynn's former employer, the

Canadian Imperial Bank of Commerce


, "has bolstered defendant Flynn's contention that his conduct in this matter was known and approved by his firm."

The order also notes that other former CIBC employees implicated in the scheme will only be charged civilly, and not criminally. Spitzer contends in the order that a dismissal of the criminal case will not "undermine confidence in the sphere of securities enforcement."

The decision to drop the charges against Flynn comes 21 months after state police, acting at Spitzer's direction,

arrested the former CIBC investment banker outside his Larchmont, N.Y., home. The high-profile arrest came at the height of the mutual fund scandal, which went a long way toward securing Spitzer's public image as Wall Street's toughest cop.

Prosecutors had accused the former banker of providing more than $1 billion in financing to hedge funds involved in abusive mutual trading.

But ever since a New York jury acquitted former

Bank of America

(BAC) - Get Free Report

broker Theodore Sihpol on 29 counts of larceny, falsifying business records and other offenses related to mutual fund trading, Spitzer has been in retreat.

In August, two months after the stinging Sihpol defeat, Spitzer's office agreed to a relatively lenient plea deal with two former executives of Security Trust, a defunct trust bank that processed abusive trades for two big hedge funds. As part of their guilty pleas to felony charges, Spitzer's office agreed that neither man, William Kenyon and Grant Seeger, would have to serve any jail time. Instead, Spitzer recommended probation for both.

Soon after, Spitzer agreed to drop the four remaining criminal charges against Sihpol. The New York prosecutor decided against another trial after Sihpol, in settling with the

Securities and Exchange Commission

, agreed to a $200,000 penalty and accepted a five-year bar from the securities industry.

The Sihpol verdict appears to have shaken the confidence of Spitzer's legal team. In the weeks immediately following the verdict, sources say, Spitzer's prosecutors became reluctant about pursuing additional criminal trials stemming from the mutual fund scandal.

The order dismissing the case makes reference to the Sihpol verdict, noting the jury acquitted the former broker because his "supervisor knew of and profited from his deceptive scheme.

In an attempt to spin the dismissal in the most favorable light, the order notes that the mutual fund investigation has collected nearly $3 billion in fines and restitution and "created new public confidence in the vigor of enforcement in the mutual fund industry.''

Still, after Sihpol, Spitzer would have had a hard time convicting anyone in the mutual fund scandal. Early on, critics had questioned Spitzer's attempt to criminalize conduct that many thought only amounted to civil securities laws violations.

In fact, sources say Spitzer offered a lenient plea deal to Flynn before ultimately deciding to drop the charges. Prosecutors proposed letting Flynn plead guilty to a misdemeanor, instead of a felony, and to recommend probation as a sentence.

But Flynn hung tough, and his refusal to negotiate with Spitzer apparently paid off.

All along, the investment banker had contended that his superiors at CIBC were aware of his actions and the financing decisions were part of an orchestrated effort to profit from abusive mutual fund trading. The civil settlement negotiated this summer with CIBC backed up much of Flynn's defense.

In the settlement, regulators charged that CIBC lent up to $2 billion to hedge fund traders, generating more than $75 million in fees. The settlement, particularly the civil complaint filed by Spitzer, provided great detail about how the Toronto-based financial services firm served as broker, banker and back office trade processor for hedge funds trading shares of mutual funds.

While Flynn's name was mentioned often in the Spitzer complaint, the former CIBC employee who emerged as the biggest potential wrongdoer was former broker Michael Sassano, whose

exploits have been well-documented by


Regulators alleged that Sassano and his 10-employee team engaged in both market-timing -- the frequent trading of mutual fund shares -- and illegal after-hours trading for hedge fund clients. The Sassano team had the only brokers at CIBC permitted to engage in abusive mutual fund trading. For a time, Sassano ranked as one of CIBC's top earners.

Oppenheimer & Co.,

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, the firm that acquired CIBC's brokerage group in early 2004, has indicated that a number of former brokers and their supervisors may face civil charges over their involvement in mutual fund trading.

But to date, no charges, either civil or criminal, have been filed against anyone associated with CIBC other than those leveled against Flynn.