Indictment Says Brokers Hid Mortgage Investments From Clients

Two former Credit Suisse Group (CS: 43.76 -4.25%) brokers were indicted by a federal grand jury in Brooklyn on Wednesday, on charges that suggest the two men in question lied to investors over $1 billion in short-term investments. The Wall Street Journal reported Thursday that Julian Tzolov and Eric Butler are alleged to have put investors’ money into mortgage-backed securities within the auction-rate securities market, while telling clients their ARS investments were being placed into relatively less risky federally-backed student loans.

The motive allegedly at play here is one that isn’t all that different from what drove mortgage brokers to push borrowers into subprime loan products: higher commissions. Placing ARS inventment dollars into mortgage-backed investments earned the brokers higher commission, the Journal reported.

Toslov recently left the U.S. and returned to his native Bulgaria; the Journal reported that he will return to the States to face the charges against him.

The auction-rate securities market, which essentially lets issuers borrower long by fund at short-term rates, collapsed earlier this year as bids for the securities at auction dried up amid an expanding credit crisis. Central to the market tie-up was investor fear over some of the securities, which were tied to subprime mortgages.

The indictment suggests in particular that Butler attempted to hide from a client that an auction of their securities had failed, in a bid to get the client to invest further into future ARS issues; the indictment also alleges that both men also deliberately altered the names of issuing entities to remove the words “mortgage” and “CDO” from their titles.

Neither men have commented to the press on the indictment, although a lawyer for Butler told the Journal his client thought he was doing what was in the best interest of his client.

The new charges come as two former fund managers from the former Bear Stearns & Cos. have been charged with misleading investors about the health of two major hedge funds; both funds collapsed as the subprime crisis was first beginning to gather steam. Read full story.

Credit Suisse suspended the brokers last year, and has cooperated with ongoing investigations into trading activity.

Disclosure: The author held no positions in CS when this story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.