Posted on 01 Feb 2012
Federal prosecutors are preparing to file criminal charges against former Wall Street traders alleging they misstated the value of mortgage bonds, an issue central to the 2008 financial crisis, according to people familiar with the matter.
The Manhattan U.S. Attorney's office is planning to allege in a criminal complaint that several former traders at Credit Suisse Group AG, a major global investment bank, misled the bank's investors by booking inflated prices of mortgage bonds to boost their bonuses, despite knowing the values of those securities had dropped, according to the people familiar with the matter.
Credit Suisse itself won't be charged in the case, these people say. The names of the traders couldn't be determined. Charges could be filed as early as Wednesday, these people say.
Spokespeople for Credit Suisse, the U.S. Attorney's office and the Securities and Exchange Commission, which also is expected to file similar civil charges, declined to comment.
Wall Street valuations of mortgage securities were a major factor in the market turmoil of 2008. For years, financial firms had packaged hundreds of billions of dollars of subprime mortgages into securities. When those mortgages soured, investment banks resisted taking losses, fearing that their own investors and clients would panic.
They ultimately took big write-downs on their mortgage portfolios, throwing markets into turmoil and triggering losses that toppled financial giants Bear Stearns Cos. and Lehman Brothers Inc.
In recent months, federal prosecutors and regulators have stepped up their scrutiny of the area and are preparing additional cases, people familiar with that effort say.
The planned Credit Suisse charges involve alleged activity in February 2008, a month before Bear Stearns collapsed. That is when Credit Suisse suspended four traders in connection with a $2.85 billion overvaluation of asset-backed securities. The dismissal of the traders came as the Swiss-based bank said it would take write-downs of $2.85 billion, shaving $1 billion from its first-quarter earnings that year.
The charges, if they are filed, could raise the stakes for Wall Street amid multiple probes examining whether financial firms deliberately misvalued, or "mismarked," holdings of mortgage securities. They would follow three years of investigations by criminal and civil authorities.
Whether the nation's financial institutions properly acknowledged losses on their investments remains a central question in the wake of the financial crisis. President Barack Obama cited a lack of Wall Street accountability in last week's State of the Union address.
Reliable valuations and transparency have long been regarded as cornerstones of American markets. But as the financial markets came unraveled in 2007 and 2008, some investors began to lose confidence about that issue.
After more than a decade of rapid growth in mortgage-backed securities and other complex investments traded off exchanges, there is little clarity in pricing. Analysts say less than half of all securities trade on exchanges with readily available price information.
Federal prosecutors have been criticized by politicians and investors for not holding individuals on Wall Street criminally accountable for questionable actions during the crisis. The only other major criminal case involving a Wall Street firm was brought by Brooklyn-based federal prosecutors against two Bear Stearns traders. That case ended in acquittals in 2009.
Over the past several years, federal securities regulators have opened several dozen investigations involving the market for subprime mortgages, many of which were extended to borrowers with poor credit histories. The SEC has examined whether Wall Street firms placed higher values on securities they owned than those they placed in customer holdings.
Federal prosecutors have begun to get more active in the area of asset valuations.
In December, the Manhattan U.S. attorney's office criminally charged a London asset manager with overstating the value of sovereign debt held by his hedge fund during the financial crisis. A complaint filed by the SEC at the same time accused Michael Balboa, a former managing director at London's Millennium Global Investments Ltd., of overstating the value of securities issued by the Nigerian government, boosting his bonus by millions of dollars.
A lawyer for Mr. Balboa declined to comment.
The SEC has filed several cases in the past 18 months, and more are in the pipeline, according to people familiar with the matter.
In September, the SEC filed civil charges alleging that hedge-fund manager Corey Ribotsky misled investors about the value of the fund's investments in certain non-exchange-traded securities. A lawyer for Mr. Ribotsky, manager of Long Island-based NIR Group, declined to comment.
In October 2010, the SEC charged two hedge-fund portfolio managers and their investment advisory firms with defrauding investors in the Palisades Master Fund LP by overvaluing illiquid fund assets they placed in a "side pocket." The fund managers have denied wrongdoing and are fighting the charges.
The SEC filed civil fraud charges in June 2010 against a New York-based investment adviser ICP Asset Management LLC, and its president, Thomas Priore. The agency alleged that ICP had intentionally inflated the value of trades to collect millions of dollars in advisory fees. ICP and Mr. Priore have denied wrongdoing and are fighting the charges.
There is plenty of incentive to inflate the values of portfolios because employees' bonuses are tied to the value of their holdings. A Lipper & Co. hedge-fund manager, Edward Strafaci, earned bonuses of $3.9 million between 1998 and 2001 based on improperly marked convertible bonds, according to an earlier case brought by the SEC. Mr. Strafaci pleaded guilty to criminal securities fraud.