Legal News

Subprime Legal: The Auction-Rate Securities Mess Goes Criminal

By Dan Slater

A couple weeks ago, in a baldfaced attempt to glamorize the fall-out in the auction-rate securities markets, we wrote that Massachusetts state regulators had “gotten the party started” by charging units of UBS with fraud and dishonest conduct in ARS sales.

Now the Feds want to make their own party out of the ARS mess. Today, the WSJ’s reports that prosecutors in Brooklyn are investigating whether two former Credit Suisse brokers lied to investors about how they placed their money into short-term securities. The investigation is the first known criminal matter stemming from the $330 billion ARS market. (Click here for a recent story on the EDNY’s revived prominence in the world of white-collar prosecutions.)

Auction-rate securities, writes the Journal, allow issuers such as municipalities and student loan companies, closed-end mutual funds or financial institutions to borrow money for the long term but at short-term, or lower, interest rates. Weekly or monthly auctions conducted by Wall Street firms reset those rates.

However, the market for those rates seized up last February. When the auctions failed, investors were left without the ability to sell such securities. The market rout raises questions about whether firms adequately disclosed the risks in such auctions.

The two Credit Suisse brokers, Eric Butler and Julian Tzolov, resigned from Credit Suisse on Sept. 7, 2007, amid accusations by clients that they were misled about the nature of the auction-rate securities they bought. Clients said they were told the securities they purchased were backed by student loans when in fact they were backed by CDO’s that were tied in part to subprime mortgages. (CS is not a target of the investigation.)

A lawyer for Butler declined to comment. But Kenneth Breen, a lawyer for Tzolov, echoed arguments put forth in defense of the indicted Bear Stearns fund managers, saying that his Tzolov shouldn’t be blamed for an unforeseeable market failure and that his clients were sophisticated investors who understood the risks. “Julian Tzolov deceived no one, and he had his clients’ interests at heart at all times. We are confident that the U.S. attorney’s office will make the correct decision and choose not to bring charges.”

Both brokers joined Morgan Stanley a few days after leaving Credit Suisse; a Morgan Stanley spokeswoman said they were terminated on Monday and declined to elaborate.

Full post as published by Law Blog - WSJ.com on July 09, 2008 (boomark / email).