Corporate & Securities Law

Federal prosecutors, ramping up criminal probes stemming from the credit crunch, are investigating whether two former Credit Suisse Group brokers lied to investors about how they placed their money into short-term securities.  At issue is the $330 billion market for auction-rate securities. 

The investigation, by the Justice Department's U.S. attorney's office for New York's Eastern District, represents the first known criminal matter stemming from the crumbling auction-rate securities market.  The rout in this market has punished thousands of U.S. investors, who are now stuck paying high penalty rates, and it has raised questions about whether Wall Street firms adequately disclosed the risks in such auctions.

Until now, the fallout largely has been a civil-litigation headache for Wall Street firms and others, who have been hit with lawsuits seeking class-action status and more than 80 individual arbitration claims.  The probe surfaces just weeks after prosecutors charged two former Bear Stearns hedge fund managers with securities fraud, the first criminal prosecutions in the year-long credit crunch.  The Bear Stearns managers are contesting the charges.

In the auction-rate securities matter, the two New York-based brokers are Eric Butler and Julian Tzolov.  They have resigned from Credit Suisse amid accusations by clients that they were misled about the nature of the auction-rate securities they had bought.  Clients said they were told the securities they purchased were backed by student loans, according to a regulatory filing by the firm.  In fact, the securities were backed by risky collateralized debt obligations, or pools of bonds tied in part to subprime mortgages, according to people familiar with the matter.  Such CDOs have plunged in value as the housing market deteriorated.

Both brokers joined Morgan Stanley a few days after leaving Credit Suisse in 2007.  A Morgan Stanley spokeswoman said they were fired this last Monday and had declined to elaborate.

Some of the claims say brokers wrongly described auction-rate securities as being money market funds, or other so-called cash equivalents.  Just recently, Massachusetts securities regulators filed a civil fraud lawsuit against investment bank UBS, one of the biggest players in the auction-rate market, alleging that UBS brokers told investors that securities were safe, liquid cash equivalents when, in fact, UBS knew they were not.  UBS has denied wrongdoing.

Importantly, at Credit Suisse and most other Wall Street firms, commissions received by brokers for selling auction-rate securities were three to four times as large for other short-term fixed-income securities, such as corporate-issued commercial paper or short-term Treasury bills.  Credit Suisse brokers typically got a portion of the 0.1% to 0.25% for auction-rate purchases, but received no commission for putting clients into money market funds, says a person familiar with the firm.

SNSFE continues to investigate auction-rate claims and other claims associated with failing investments.  Those with information should feel free to contact SNSFE.

Source:  The Wall Street Journal