From PEOPLE Magazine Click to enlarge
Dining at the upscale Nello Summertimes in Southampton, N.Y., in May, Anne Hathaway and her boyfriend Raffaello Follieri were the very picture of a glamorous young couple in love. "They seemed really happy," an observer says of the pair, who were joined by Follieri's parents, Pasquale Follieri and Anna Cordella. "She seemed very comfortable," says the source. "His parents really seemed to like her. They were having a great time and laughing. It was a nice family get-together."

Those good times were about to come to an explosive end. Within a month, the four-year romance between Hathaway, 25, and Follieri, 30, was in ruins—and within a week the dashing Italian businessman had been arrested on charges of wire-fraud conspiracy and money laundering. (Legal experts say that if he's convicted he would likely face up to 10 years in prison.) Appearing in a Manhattan court on June 24, Follieri was branded a "con man" by federal prosecutors, who accuse him of bilking investors of millions—largely by making false claims that he had close ties to the Vatican—and then using the money to fund a dolce vita that included yachts, the opulent apartment he shared with Hathaway on Fifth Avenue and hobnobbing with former President Bill Clinton. Said Assistant U.S. Attorney Reed Brodsky: "He was able to deceive everyone."

But of the dozens of victims he allegedly duped, friends say Hathaway fell the hardest. The brunette beauty—who shot to fame at 18 as a squeaky-clean Disney heroine in The Princess Diaries—thought she had found her prince in Follieri, telling PEOPLE in '06 that he was a keeper: "You can say what you want about it, but we just love each other."

That fairy-tale romance had a devastatingly unhappy ending. Even as some friends say they warned Hathaway about Follieri, she stuck by him for months as allegations of his wrongdoing swirled. But in June, when she learned that Follieri's charitable foundation was under investigation by the New York State attorney general for tax irregularities, the actress—who served on its board and was also a donor—broke it off. Says a pal: "That was the last straw."

Days later Follieri was arrested in his boxer shorts by FBI agents at his mother's Trump Tower apartment in Manhattan; meanwhile Hathaway kept a game face as she traveled the world promoting her movie Get Smart. Now held in a 7 1/2-ft.-by-8-ft. concrete-block cell at the Metropolitan Correctional Center in Manhattan, he spent his 30th birthday on June 28 behind bars. Labeled a flight risk by prosecutors (officers found him with a suitcase containing $15,000), he is scrambling to make $21 million bail. "My client is a formidable and resilient young man who is vigorously addressing the strident terms of the bail," says his rep Melanie A. Bonvicino. "He looks forward to overcoming the current allegations."

As for Hathaway, a source close to the star says her busy work schedule—last month she finished shooting the romantic comedy Bride Wars with Kate Hudson—has been a welcome distraction. "Anne didn't mention [the breakup], and people around her didn't ask," says the source. "She was completely blinded on this one. She loved him and so she didn't see much else until now."

Others wonder how she couldn't see. Among the charges in the papers filed by the U.S. Attorney's office: that Follieri kept priestly robes in his office and once asked a monsignor to change into the vestments of a more senior clergyman in order to appear better connected to the Vatican. Investigators say he swindled funds for his $37,000-a-month apartment rent, private jets and medical bills for himself and his "girlfriend"—Hathaway is not named in the complaint—as well as orthodontist bills for his father. (A source says Hathaway was interviewed by the FBI for the investigation; the agency had no comment.) A former employee says that Follieri often bragged that his duplex residence was once used by Aristotle Onassis. "When you walk in the downstairs, it makes a big Godfather impression," says the source. "Everything was white on white on white. In the office there was this giant picture of Anne. It was like, 'This is me, and this is my movie-star girlfriend.'"

Hathaway was equally smitten. "I think she felt she had a major catch who was a powerful, wealthy European businessman," says the former employee. "Everything was 'Don't worry, I'm the man.' Essentially, the knight in shining armor. Unfortunately, the armor was some crap metal that tarnishes."

Multiple sources say they are convinced that Hathaway knew nothing of Follieri's alleged schemes. "She's a sweet girl, and he seemed like the right kind of guy," says a friend of Hathaway's. "At the end of the day, could she tell you that he was a dirty dealer? No way." Adds another: "She's not guilty of anything except being a young woman who hasn't been worked through the wringer by a con artist before."

A guy who wore his confidence like one of his custom suits, Follieri was introduced to Hathaway four years ago by a mutual friend. "She told us the story one night," says a source who knew the couple. "She [said she] was put off initially by his arrogance and attitude [and that] he pursued her and within two weeks they were madly in love."

Raised in suburban Millburn, N.J., Hathaway—who sealed her status on the A-list with 2006's The Devil Wears Prada—fell head-over-designer-heels. "In Sardinia she would just cling to his arms," says Lee Mellis, a close Follieri pal who vacationed with the pair. Adds another friend: "She doesn't need a rich guy. She needs a guy who takes care of her."

At Manhattan's Balthazar restaurant, where the couple were frequent guests, Follieri would often order for "Annie," as he called her. "It was a very chivalrous relationship," says an observer. Whether walking their chocolate Labrador Esmeralda—now being cared for by Follieri's mother—or cooking pasta together at home, "they seemed to have a nice, cozy, happy life together," says a friend.

Still, "they had a turbulent relationship," says the former Follieri employee. "She lacks a tremendous amount of confidence. He was a security blanket for her." During one yachting trip with the couple, says the source, a female employee felt she was being treated poorly by Follieri. "Annie said to the girl, 'Don't go. This is an opportunity of a lifetime to be on a yacht. When are you going to get a chance like this again?'" recalls the source. "It was clear she was taken by the whole powerful-man thing."

That continued even as Follieri became increasingly dogged by legal woes that included bouncing a $215,000 check to a New Jersey businessman. (Follieri paid the debt, and the case was dismissed.) Raised in a small town in Italy, he moved to New York in 2003. There, say prosecutors, he told investors he was raising money to buy and redevelop properties being sold by the Roman Catholic Church—even calling himself the Vatican's chief financial officer. That sales pitch attracted high rollers such as billionaire Ron Burkle, a pal of Bill Clinton's whose business later sued Follieri for $1.3 million for misusing funds. (The suit has been settled.) With Hathaway on his arm, Follieri also pledged millions to worthy causes. The pair partied with the Clintons in the Dominican Republic and became regulars on the social circuit.

Investigators say Follieri exaggerated actual ties to the Vatican to gain the confidence of investors. "Raffaello had an official [looking] document from Pope John Paul empowering him to dispense of church properties," says a Clinton associate. Adds another: "He had a lot of highly reputable people vouching for him, all of whom he had duped."

There were those who had suspicions, however. Bill McCall, chairman of the Boston archdiocese's real estate advisory committee, met with Follieri regarding the purchase of church property in '04. "He kept saying, 'I want to buy,'" recalls McCall, noting that there are strict rules governing the ways Church properties can be converted for commercial use. "To me, there was a naïveté there—I'm not sure he ever would have achieved the rezoning that he needed."

But even after so many alleged deceptions, insiders say his romance with Hathaway was no con. "There was great affection between the two of them, and a great love," says a pal. "I feel so badly for her." Friends are certain that Hathaway's happily ever after is still to be written. "She's got such a real positive outlook on life—inspirational," says her college friend Pamela Cuce, who attended Vassar with the star. "There are few people so sincere and accepting as Annie. She's a very strong woman."

  • Contributors:
  • K.C. Baker/New York City,
  • Sharon Cotliar/New York City,
  • Mary Green/New York City,
  • Hitha Prabhakar/New York City,
  • Callie Schweitzer/New York City,
  • Alyssa Shelasky/New York City,
  • Jennifer Wren/New York City,
  • Wendy Grossman/Washington,
  • D.C.,
  • Maureen Harringt.