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Credit Suisse brokers take Auction Rate Securities fraud to new depths

Posted Sep 4th 2008 9:48AM by Peter CohanPeter Cohan RSS Feed
Filed under: Products and services, Law, Scandals, Housing, Recession

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The New York Times reports that two Credit Suisse brokers took Auction Rate Securities (ARS) fraud to a new level. They fabricated an ARS-issuing agency -- a made up student loan securitizer -- as they sold investors their most toxic Collateralized Debt Obligations (CDOs) backed by subprime mortgages and mobile home loans. Their deception is not new in concept -- evidence of ARS fraud has already emerged -- but the scope of the fraud is noteworthy.

Since I first began writing about the $330 billion ARS market -- long-term securities whose rates were reset in weekly auctions until they failed -- 6,162 comments have appeared from people trying to get their money back. And many of the issuers have announced settlements with authorities because investigators have found evidence that many of them were actively trying to dump the ARS from their own books into those of unsuspecting individual investors by telling them the ARS were safe and offered slightly higher-than-money-market yields.

But this Credit Suisse fraud reaches a different level. According to the Times, "Eric Butler, [who] sold customers some of the most toxic investments of the subprime age - [CDOs] - in what federal prosecutors characterize as a $1 billion bait-and-switch -- told those investors that they were getting "securities [that] were as safe as cash." The Times wrote that Butler "claimed, [that] the outfit that issued them, Glacier Education Loan, bought student loans guaranteed by the federal government. The problem: there is no such thing as Glacier Education Loan."

Butler and his partner, Julian Tzolov, covered up their scheme by changing "the descriptions of the securities in e-mail messages with customers, replacing terms like "C.D.O." with words like "student" or "education." They sent customers 50 e-mail messages that falsely described the securities, according to the S.E.C. complaint. Sometimes they instructed sales assistants to omit the terms "C.D.O." or "mortgage," according to the Times.

This fraudulent scheme appears far more creative than the more run-of-the-mill deception uncovered in e-mails from other brokers. For instance, at UBS AG (NYSE: UBS), investigators uncovered evidence that executives knew the ARS auctions were going to fail so they dumped their personal ARS holdings before launching a campaign to convince their private banking clients to buy them so they could get the toxic waste off of their books.

I welcome comments from anyone who can explain why they willingly pay a broker. After all, if an investor wants to buy or sell a security, they can do so online without broker intervention for a lower fee. And such self-service avoids the ample risk of fraud of which the current ARS mess is just the tip of the iceberg.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

Tags: ARS, auction rate securities, AuctionRateSecurities, credit suisse, CreditSuisse, featured, ubs, wall street, WallStreet

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