New York Top Stories: Bond Manipulation

Defendants’ Alleged Conduct Contributed to More Than $2.6 Billion Dollar Write-Down in Bank’s Reported Net Income; Two Defendants Have Pled Guilty and Are Cooperating with the Government’s Investigation

Preet Bharara, the United States Attorney for the Southern District of New York, and Janice K. Fedarcyk, the Assistant Director in Charge of the New York Office of the Federal Bureau of Investigation (“FBI”), announced today the filing of charges against KAREEM SERAGELDIN, DAVID HIGGS, and SALMAAN SIDDIQUI, respectively, managing director/global head of structured credit, managing director, and vice-president in the Investment Banking Division of Credit Suisse Group (“Credit Suisse”). The defendants are charged with fraudulently inflating the prices of asset-backed bonds which comprised subprime residential mortgage backed securities (“RMBS”) and commercial mortgage backed securities (“CMBS”) in Credit Suisse’s trading book in late 2007 and early 2008. The defendants’ alleged manipulation of these bond prices contributed to Credit Suisse taking a $2.65 billion write-down of its 2007 year-end financial results. SERAGELDIN, HIGGS, and SIDDIQUI were able to secure significant year-end bonuses for themselves since bonus amounts were largely based on trading books’ profitability. SERAGELDIN’s 2007 bonus was over $1.7 million and his Incentive Share Unit Award was more than $5.2 million. The latter was rescinded after Credit Suisse discovered the alleged fraud. HIGGS and SIDDIQUI each pled guilty today, to one count of conspiracy to falsify books and records and commit wire fraud, for their roles in the scheme. They are cooperating with the government’s investigation.

Manhattan U.S. Attorney Preet Bharara said: “While the residential housing market was in free fall, and shock waves were reverberating throughout the economy, these defendants decided they were above the rules of the market and above the law. As alleged, they papered over more than a half billion dollars in subprime mortgage-related losses to secure for themselves a big payday at the same time that many people were losing their homes and their jobs.”

FBI Assistant Director in Charge Janice K. Fedarcyk stated: “The defendants’ overvaluation of mortgage-backed securities benefitted them in the short run, and contributed to Credit Suisse incurring a two billion-dollar-plus write-down when discovered. While the housing market was collapsing, the defendants profited, not by correctly predicting the trend, but by cooking the books.”

The following allegations are based on the Indictment filed against SERAGELDIN and the Informations to which HIGGS and SIDDIQUI pled guilty:

The Defendants’ Roles at Credit Suisse

SERAGELDIN was employed at Credit Suisse as a managing director. He held the position of global head of the Structured Credit Group in the Securities Department of Credit Suisse’s Investment Banking Division, and divided his time between the company’s New York, and London offices. The Structured Credit Group held and traded ABS (“Asset Backed Security”) cash bonds, which included RMBS and CMBS. SERAGELDIN oversaw and managed a number of trading books, including a trading book known as “ABN1.” The ABN1 book was comprised primarily of several thousand individual long and short subprime-related positions, and also included other securities. The long positions consisted of, among other things, various types of cash securities, including AAA-rated and non-AAA-rated cash bonds. Until March 2008, ABN1 had a net asset value of approximately $5.35 billion, approximately $3.71 billion of which consisted of ABS cash bonds, including RMBS and CMBS positions.

HIGGS, who reported directly to SERAGELDIN, was also employed as a managing director at Credit Suisse during the relevant time period, and was based in Credit Suisse’s London office. SIDDIQUI was employed as a trader and Vice President at Credit Suisse and was based in the New York office. Together with an unnamed co-conspirator (“CC-1”), SIDDIQUI was responsible for the day-to-day marking of the value of certain trading books overseen by SERAGELDIN.

Pricing of Mortgage-Backed Securities

Credit Suisse traders were required at all relevant times to price securities they held at their fair value, that is, on a “mark-to-market” basis, determined by reference to the current market price of the asset or liability, or the current price for a similar asset or liability. In the absence of a liquid market, Credit Suisse traders were required to look to other indicia in order to determine the fair value of the assets on their books. During this time, the ABX Index served as a benchmark for certain securities backed by home loans. It was widely understood within Credit Suisse that traders were to consult the corresponding ABX indices when pricing RMBS bonds and related products.

The Defendants’ Bond Pricing Scheme

The deterioration throughout 2007 of the real estate market in the United States, including the subprime housing market, led to significant reductions in valuations of mortgage-backed securities. As mortgage delinquencies increased across the country, the value of the securities backed by these mortgages decreased and the market for them became increasingly illiquid.

By late November 2007, SERAGELDIN was aware that the market for mortgage-backed securities had declined enormously. On November 28, 2007, SERAGELDIN told HIGGS, SIDDIQUI, and CC-1 that “the housing market [was] going down the tubes” and that they had to “find a way to sell these bonds,” i.e., mortgage-backed bonds in ABN1. As SERAGELDIN recognized, “[t]hose bonds are going to start trading worse than the [ABX] Index.” The defendants did not sell the bonds because the market prices for the bonds were substantially below the inflated value at which they marked the bonds.

From August 2007 through February 2008, SERAGELDIN, HIGGS, SIDDIQUI and their co-conspirators artificially increased the price of bonds in order to create the false appearance of profitability in the ABN1 trading book. Specifically, SERAGELDIN directed HIGGS on numerous occasions to reach specific Profit & Loss (“P&L”) targets on a daily and month-end basis. HIGGS, in turn, instructed SIDDIQUI, CC-1, and another unnamed co- conspirator (“CC-2”) to mark the books so as to achieve the particular P&L targets specified by SERAGELDIN, rather than to reflect the fair value of the bonds.

In order to reach specific P&L targets, SERAGELDIN, HIGGS, SIDDIQUI, and their co-conspirators marked up bond prices without regard to fair market value; improperly offset mark-downs with gains realized in other parts of the book to avoid a P&L impact; and engaged in the practice of “reversing out,” which involved freezing marks at a favorable point in time to achieve a desired P&L result. In addition, as part of their scheme, SERAGELDIN, HIGGS, SIDDIQUI, and their co-conspirators concealed their manipulation of bond marks from internal control personnel within Credit Suisse who were charged with independently ensuring the accuracy of bond prices, and they devised other ways to avoid detection of their fraud.

Credit Suisse’s ABN1 Trading Book Was Falsely Inflated as a Result of the Scheme

As a result of the scheme, there was a growing disparity between the values ascribed to the marks in the ABN1 book and the available external benchmarks, such as the ABX Index. From August 2007 through the end of that year, as ABX Index prices fell, bond prices in ABN1 that were supposed to reflect the ABX Index remained effectively stable, thereby giving the false impression to Credit Suisse senior management that the ABN1 book was profitable. On one occasion in January 2008, SERAGELDIN expressed concern to HIGGS that the overpriced bonds were at risk of being discovered: “We should mark these down because someone is going to spot this.”

The 2008 Mark-Down

On March 20, 2008, Credit Suisse issued a press release, which announced completion of its internal review and stated that the fair value reduction, or write-down, of the ABS positions—which includes but is not limited to the ABNl book—was approximately $2.65 billion.

Approximately $540 million of this write-down was attributable to the ABN1 trading book and included ABS cash bonds for the fourth quarter 2007 that SERAGELDIN manipulated and inflated in connection with his scheme.

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SERAGELDIN, 38, a United States citizen who currently resides in the United Kingdom, is charged with conspiracy to falsify books and records and to commit wire fraud, as well as with substantive charges of falsifying books and records and wire fraud. If convicted, SERAGELDIN faces a maximum sentence of five years in prison on the conspiracy count, a maximum sentence of 20 years in prison on each of the books and records and the wire fraud counts, a maximum fine of $5,000,000 on the books and records count, and a maximum fine of the greater of $250,000, or twice the gross gain or loss from the offense on each of the conspiracy and wire fraud counts.

HIGGS, 42, a citizen and resident of the United Kingdom, and SIDDIQUI, 36, a resident of the Washington, D.C. metropolitan area, each pled guilty to one count of conspiracy to falsify books and records and commit wire fraud. HIGGS and SIDDIQUI each face a maximum sentence of five years in prison and a fine of the greater of $250,000, or twice the gross gain or loss from the offense.

Mr. Bharara praised the work of the Federal Bureau of Investigation and thanked the Securities and Exchange Commission for its assistance in the investigation of this case. He said the investigation is continuing.

This case is being handled by the Office’s Securities and Commodities Fraud Task Force. Assistant United States Attorneys Virginia Chavez Romano and Eugene Ingoglia are in charge of the prosecution.

This case was brought in coordination with President Barack Obama’s Financial Fraud Enforcement Task Force, on which Mr. Bharara serves as a Co-Chair of the Securities and Commodities Fraud Working Group. President Obama established the interagency Financial Fraud Enforcement Task Force to wage an aggressive, coordinated, and proactive effort to investigate and prosecute financial crimes. The task force includes representatives from a broad range of federal agencies, regulatory authorities, inspectors general, and state and local law enforcement who, working together, bring to bear a powerful array of criminal and civil enforcement resources. The task force is working to improve efforts across the federal executive branch, and with state and local partners, to investigate and prosecute significant financial crimes, ensure just and effective punishment for those who perpetrate financial crimes, combat discrimination in the lending and financial markets, and recover proceeds for victims of financial crimes.

The charges contained in the Indictment are merely accusations, and SERAGELDIN is presumed innocent unless and until proven guilty.