Analysis: Obstacles High for More Mortgage Prosecutions

(Reuters) -- Despite the determination of President Barack Obama to take Wall Street to court for the financial crisis, prosecutors face an uphill struggle to win more convictions like the two they scored on Wednesday against former Credit Suisse Group AG mortgage traders.

David Higgs, 42, and Salmaan Siddiqui, 36, pled guilty in U.S. District Court in New York to a criminal charge of conspiracy to falsify books and records and commit wire fraud in a way that bolstered their bonuses.

The convictions marked the first successful criminal prosecutions against individuals at investment banks involved in the meltdown, and took four years to win, even without a trial.

In building the case, prosecutors enjoyed advantages that are rarely available -- and likely make this kind of success hard to replicate.

Prosecutors drew on a trove of emails and taped telephone recordings from the traders that helped establish criminal intent. They also had price history on their side. The Credit Suisse traders placed unusually high values, or "marks," on their portfolio of bonds months after Citigroup and Merrill Lynch each reported multi-billion-dollar losses on their portfolios of similar mortgage securities.

Credit Suisse in February of 2008 took a $2.85 billion write-down to adjust the value of these securities, known as collateralized debt obligations, on its books.

Prosecutors "got two people to plead guilty, so that suggests this is the lower-hanging fruit" of potential cases, said Robert Anello, a partner at Morvillo Abramowitz, a prominent white-collar defense firm in New York.

John Hueston, a lead prosecutor in the Enron trials who is now a white-collar defense lawyer, said that alleged improprieties in other financial-crisis cases will be much more difficult to dissect and prove.

"This kind of case is going to be the exception," said Hueston, a partner at Irell & Manella in Los Angeles, who represented Angelo Mozilo, former CEO of subprime lender Countrywide Financial Corp, in a criminal investigation that was dropped.

In pleading guilty, Higgs, who is cooperating with investigators, admitted in court that he had "manipulated and inflated" values he reported for a battered portfolio of mortgage bonds. He said he acted at the instruction of his former boss to hide losses and meet profit targets. Meeting the targets was essential to the team's bonuses.

Prosecutors have been less successful with Higgs' former boss, Kareem Serageldin, 38, an American living in London. Serageldin was indicted on the same conspiracy charge, plus other charges. His lawyer, James McGuire, said Wednesday that Serageldin believes he did nothing wrong. He said his client had given several interviews to investigators.

The Securities and Exchange Commission accused those men, along with a fourth Credit Suisse trader, Faisal Siddiqui, of violating civil laws. Asked why the fourth man had not also been charged criminally, U.S. Attorney Preet Bharara said that prosecutors must prove their cases beyond a reasonable doubt, which is a tougher standard than the SEC faces. Faisal Siddiqui, who is not related to Salmaan and was not charged with any criminal wrongdoing, could not be reached for comment.

"These cases are not easy to make," Bharara said. "Often such a criminal case can be made only with the help of cooperating witnesses on the inside of the financial institution, or incriminating recordings of misconduct."

In the only other high-profile criminal case to go to court, involving two former Bear Stearns hedge fund managers, a Brooklyn, N.Y., jury acquitted the men of charges of lying to their investors about the financial stability of funds that invested mainly in subprime securities. In another situation, prosecutors dropped a criminal investigation of the man who ran a division of American International Group Inc that suffered losses on mortgage instruments that led to a government bailout.

The pressure to bring more cases is intense. Obama, in his recent State of the Union Address, said he would direct prosecutors to expand investigations into the dealings that led to the housing crisis.

"The government is trying hard to bring cases," said Jacob Frenkel, a former prosecutor, with Shulman Rogers in Potomac, Maryland.

Yet while these convictions may appear to follow rapidly on the president's speech, the case began before Obama took office.

And mispricing began even earlier. Keeping inflated marks on subprime securities was common once house prices started to slip in 2005, said Janet Tavakoli, a structured finance expert, said in an interview.

Prosecutors in the Credit Suisse case alleged that Higgs lamented in one phone conversation that values on securities in his portfolio in late 2006 had been too high.

The situation across Wall Street got worse at the start of 2007 when the market collapsed, Tavakoli said. "People just did not want to mark down their books."

But proving in criminal court that people at other firms inflated prices for mortgage securities would likely be more difficult than winning the two Credit Suisse convictions. Mortgage securities can be complicated and idiosyncratic, leaving room for people to disagree on how much they are worth.

"It is very hard to value them and very hard to show the criminal state of mind that is needed to bring a criminal case," said defense lawyer Anello.

Higgs, starting as early as August 2007, went to exceptional lengths to hide his losses at Credit Suisse, prosecutors said in a document filed with his guilty plea.

He built spreadsheets to justify his high marks on the roughly $3.5 billion portfolio as prices fell on widely followed market indexes for subprime securities, they alleged.

Dissatisfied with valuations provided by large banks, one of Higgs staff called a friend at a small investment bank to get endorsements for the inflated values, which were essential for traders' bonuses, prosecutors said.

By the time Credit Suisse uncovered and disclosed the inflated marks in February 2008, Higgs portfolio had lost $540 million.

Compared with valuations elsewhere on Wall Street, said Robert Khuzami, enforcement director at the SEC, the marks on the Credit Suisse portfolio "were outliers and artificially high."

(Reporting by David Henry and Lauren Tara LaCapra in New York, and Philip Shishkin in Washington.; Editing by Alwyn Scott)