Bear Stearns Shakes the CDO Honey Pot

All of Wall Street may come to rue the day Bear Stearns(BSC Quote) sold $16 million in collateralized debt obligations to Hudson United Bank(HU Quote).

The sale prompted a complaint to New York Attorney General Eliot Spitzer from Hudson United, which believes Bear Stearns gave it bad prices on the sophisticated bonds. Now Spitzer's office is contemplating taking a broader look at the market for these fast-growing derivative investments.

Bear Stearns disclosed in a regulatory filing last month that Spitzer's office sent it a subpoena seeking information about the transaction. The firm didn't provide any details or identify the customer that bought the CDOs.

A June 23 memorandum from Bear Stearns' legal department, which was obtained by TheStreet.com, indicates Spitzer's office is looking into the marketing of three CDOs sold to Hudson United and the valuations provided to the bank on those transactions. The deals in question involve a series of high-yielding bonds backed by revenue streams from a potpourri of commercial, residential and mobile-home mortgages.

Hudson United complained to Spitzer after trying to sell the CDOs and allegedly finding they were worth much less than Bear Stearns claimed, people familiar with the investigation say.

Hudson United and Bear Stearns both declined to comment on the investigation. A spokesman for Spitzer also had no comment.

The inquiry by Spitzer's office is in its infancy and, for the moment, limited to just Bear Stearns. But if history is any guide, once Spitzer's staff begins probing a Wall Street practice it doesn't like, an investigation rarely remains a small and isolated event.

If Spitzer needed any further prodding, Bear Stearns also disclosed last month that the Securities and Exchange Commission's Miami office is much further long in a separate investigation involving a similar dispute over the pricing of $64 million in CDOs. In the SEC investigation, which began more than a year ago, regulators have notified Bear Stearns they are contemplating filing civil charges against the firm.