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Two former brokers indicted

They sold subprime securities disguised as debt backed by student loans, authorities say.

September 04, 2008|Walter Hamilton | Times Staff Writer

NEW YORK — Two former Wall Street brokers fraudulently sold more than $1 billion of mortgage-backed securities in recent years by hiding their subprime connection, federal authorities said Wednesday.

The former brokers, Julian T. Tzolov and Eric S. Butler, both of New York, were indicted by a federal grand jury Wednesday in Brooklyn on charges of conspiracy, securities fraud and wire fraud.

The men's former employer, brokerage Credit Suisse, had been hired by large companies to invest their cash reserves in so-called auction-rate debt backed by federally insured student loans, according to the indictment.

But the brokers instead often placed clients in auction-rate issues backed by subprime home loans and other mortgage-related securities known as collateralized debt obligations because those issues paid them significantly higher commissions, the government said.

The brokers disguised their actions by falsifying e-mail confirmation statements sent to clients, replacing any mention of the words "mortgage" or "CDO" with "student loan" or "education," according to the indictment and an accompanying Securities and Exchange Commission civil suit.

The allegations of a bait-and-switch scam are a new black mark for the auction-rate debt market, which already had become one of Wall Street's biggest scandals in years.

Auction-rate securities are long-term debt instruments that were designed to trade like short-term securities. The market seized up this year as investors shunned complicated debt issues, leaving thousands of individual and corporate investors unable to cash out of the auction-rate paper.

Major investment banks have reached agreements with regulators recently to repurchase at face value tens of billions of dollars in auction-rate debt that was sold to individuals. But many corporate investors remain stuck in the debt.

Attorneys for Tzolov, 35, and Butler, 36, did not return phone calls seeking comment.

Butler pleaded not guilty and was released on $2.5-million bond. Tzolov was out of the country but expected to return to New York and surrender to authorities.

If convicted, they each could face as long as 20 years in prison and a $5-million fine.

Credit Suisse said the brokers resigned a year ago "after we detected their prohibited activity and promptly suspended them."

Their clients, most of whom are based overseas, are stuck holding at least $817 million in securities that can't be sold, the SEC said.

Worse, the average drop in market value on mortgage-backed auction-rate securities has been significantly steeper than the average loss on student-loan-backed issues.

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walter.hamilton@latimes.com

The Associated Press was used in compiling this report.

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