NEW YORK (Reuters) - Two former Credit Suisse brokers were charged on Wednesday with fraud and conspiracy over deceptive sales of subprime-related auction-rate debt, government officials said, part of an industrywide probe of the securities.
The U.S. Attorney’s office in Brooklyn and the Securities and Exchange Commission accused the former brokers, Eric Butler and Julian Tzolov, of misleading customers into believing that auction-rate securities in their accounts were backed by federally guaranteed student loans and were a safe and liquid alternative to bank deposits or money market funds.
Credit Suisse Group AG CSGN.VX said in a statement that it was cooperating with authorities over the former employees.
“In September 2007, these former employees resigned after we detected their prohibited activity and promptly suspended them,” the statement said. “Credit Suisse immediately informed our regulators, and we have continued to assist the authorities.”
Butler, 36, pleaded not guilty to charges of conspiracy, securities fraud and wire fraud in U.S. District Court in Brooklyn Wednesday afternoon after he was arrested by the FBI at his Manhattan apartment Wednesday morning.
Butler was released on bail by U.S. Magistrate Judge Ramon Reyes after posting a $2.5 million bond backed by his apartment.
His lawyer, Paul Weinstein, said Butler “believed he was doing the best for his clients, and they agreed until the entire auction rate securities market fell, which had nothing to do with him, and he will defend the charges.”
Tzolov, 35, was believed to be out of the country, according to a person with knowledge of the investigation. Assistant U.S. Attorney Greg Andres, speaking after the court hearing, declined to comment on Tzolov’s whereabouts.
Tzolov’s lawyer did not immediately respond to a telephone message requesting comment.
When the mortgage-backed auction-rate securities market failed earlier this year, Credit Suisse clients lost their money, the U.S. Attorney’s office said.
Prosecutors in several states and the SEC have reached settlements with several major investment banks in the past month over their handling of the risky debt.
Starting last week, financial industry regulators have been investigating 40 firms throughout the industry, visiting those with large amounts of auction-rate securities in accounts, sources familiar with the probe said.
They include international and U.S. companies of various sizes, affiliates of banks and insurers, and independent firms.
According to regulators, brokerages misled investors into believing that auction-rate debt, which has rates that reset in periodic auctions, was safe and the equivalent of cash.
Much of the $330 billion market has been frozen since February, when brokerages abandoned their traditional role as buyers of last resort.
According to the federal indictment, Butler and Tzolov came up with a scheme so they could obtain higher commissions.
“They sold their clients a bill of goods,” FBI Assistant Director-in-Charge Mark Mershon said in a statement.
“The FBI remains committed to policing the securities industry to protect investors from all forms of unscrupulous and illegal conduct.”
The securities fraud count and the two counts of wire fraud against Tzolov and Butler each carry a maximum sentence of 20 years’ imprisonment and a $5 million fine.
The conspiracy count carries a maximum sentence of five years’ imprisonment and a $250,000 fine.
In a separate complaint, the SEC said the two men made unauthorized purchases of more than $1 billion in auction-rate securities for corporate customers’ accounts.
It said the customers gave Tzolov and Butler permission to purchase only auction-rate securities backed by federally guaranteed student loans, which the men had promoted as low-risk investments.
Instead, the SEC said, the defendants “purchased for these customers without authorization” auction-rate securities collateralized by subprime mortgages, collateralized debt obligations, mobile home contracts, and other nonfederally guaranteed nonstudent loan collateral.
Reporting by Grant McCool, Martha Graybow and Juan Lagorio; Editing by Lisa Von Ahn/Jeffrey Benkoe