U.S. Charges Brokers in Auction-Rate Probe - TheStreet

U.S. Charges Brokers in Auction-Rate Probe

The two ex-Credit Suisse employees allegedly snookered customers into buying risky auction-rate securities.
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Updated from 12:44 p.m. EDT

Two former

Credit Suisse

(CS) - Get Report

brokers were indicted on securities fraud Wednesday, after allegedly tricking customers into purchasing more than $1 billion in risky auction-rate securities.

The U.S. Attorney's office in Brooklyn also charged Julian Tzolov and Eric Butler with conspiracy and wire fraud charges. The securities fraud count and two counts of wire fraud each carry a sentence of up to 20 years in prison and a $5 million fine. The conspiracy count carries a sentence of up to five years imprisonment and a $250,000 fine.

Butler is scheduled to be arraigned Wednesday afternoon. Separately, the

Securities and Exchange Commission

also charged the pair with fraud. Tzolov, 35, and Butler, 36, resigned from Credit Suisse about a year ago as clients began accusing the brokers of misleading them about their investments.

Tzolov and Butler are accused of falsely telling clients they were purchasing ARS backed by federally guaranteed student loans. They allegedly promoted the investments as low-risk, highly liquid alternatives to products like money-market funds and commercial paper. But instead, Tzolov and Butler allegedly bought $1 billion worth of securities backed by subprime mortgages, collateralized debt obligations, mobile-home contracts and other types of non-guaranteed, non-student-loan assets, according to the Justice Department and SEC.

As part of the scheme, Tzolov and Butler purportedly sent email messages to clients, or asked assistants to send such messages, in which references to "CDO" or "mortgage" were removed, and terms like "student loan" or "education" were falsely inserted, according to the SEC.

In one example cited by the SEC, Butler purchased $15 million worth of preferred shares in the Calamos Strategic Total Return Fund and $10 million worth of Glacier Funding CDO notes. In an e-mail to the client whose money he used to purchase those assets in February 2005, Butler allegedly characterized the purchases as $15 million in "Calamos Student Loan Authority" securities and $10 million in "Glacier Education Loan" securities.

When the credit markets seized up and ARS auctions began to fail, clients were left holding at least $817 million worth of illiquid assets, whose value has since plummeted, according to the SEC.

For its part, Credit Suisse says it has been cooperating with authorities.

"In September 2007, these former employees resigned after we detected their prohibited activity and promptly suspended them," the firm said in a statement. "Credit Suisse immediately informed our regulators and we have continued to assist the authorities."

"The defendants' fraudulent misrepresentations and 'bait-and-switch' tactics saddled investors with unknown risks they did not bargain for," U.S. Attorney Benton Campbell said in a statement.

The SEC is seeking to permanently bar Tzolov and Butler from working in the securities industry, to pay undefined civil penalties and to "disgorge their ill-gotten gains, if any," along with interest.

State and federal authorities have cracked down on major Wall Street banks since the auction-rate market collapsed in February, accusing firms of overstating the safety of the investments relative to cash. Firms including

Citigroup

(C) - Get Report

,

JPMorgan Chase

(JPM) - Get Report

,

Merrill Lynch

(MER)

,

Goldman Sachs

(GS) - Get Report

and others agreed to buy back securities from investors and pay penalties.