A former Credit Suisse broker testified on Thursday that he and his former business partner lied to corporate clients and sent them incorrect information in emails to cover up investments in risky debt.

In one of the first criminal prosecutions stemming from the credit crunch to go to trial, former broker Julian Tzolov told a jury that he and another broker, Eric Butler, had told clients their securities were backed by government-guaranteed student loans, when in fact they were not.

We were doing it for two reasons: We were receiving higher commissions and couldn't get allocations on student loans, said Tzolov, seated in Brooklyn federal court in a gray suit two weeks after pleading guilty to securities fraud, wire fraud, conspiracy and bail jumping.

Tzolov, 36, was called by the government as a witness in the trial of his onetime friend and business partner Butler, who has pleaded not guilty to an indictment of fraud in $1 billion worth of deals in mortgage-backed auction rate securities from 2004 to 2007.

Butler's trial started on July 23 and Tzolov is detained, awaiting sentencing. Tzolov pleaded guilty after he was arrested in Spain days before the trial.

In May, Tzolov fled house arrest in his New York apartment. A Bulgarian national, he also pleaded guilty last month to fraudulently obtaining a U.S. permanent residence card.

Auctions started to fail in the $330 billion market for mortgage-backed adjustable rate securities (ARS) in August 2007 and then the market collapsed in February 2008. ARS was debt reset at periodic auctions by Wall Street companies that had touted it as a safe, cash equivalent.

Several U.S. investigations have led to settlements in which companies have paid back investors.

We sent incorrect, untrue emails to clients with incorrect terms of securities, Tzolov said in a clear, steady voice in court under questioning by U.S. prosecutor Greg Andres about how he and Butler covered up the fraud to clients.

Tzolov testified that he and Butler inserted words such as education or funding and student loans and took out terms like CDOs, or collateralized debt obligations. He said the difference was significant because a federal guarantee would have added another layer of protection to the collateral.

We didn't want that word to raise a red flag among certain clients, he said.

The securities were in fact backed by residential mortgages, subprime mortgages, credit card receivables and auto loans, he said.

The jury has heard evidence that six companies in Canada, Switzerland, Britain, Bermuda and Panama were clients of the two men at Credit Suisse. Some of the companies were left with illiquid securities totaling nearly $1 billion.

On Thursday, jurors heard a tape of a confrontational telephone conversation between an executive at Geneva-based ST Microelectronics and Tzolov and Butler in Oct 2007 by which time they had left Credit Suisse for Morgan Stanley.

This is a fraud, guys. Be very, very careful, the executive, Guiseppe Notarnicola, told the men in discussing his dismay at finding his company's investments were not backed by student loans as promised.

Credit Suisse has said Tzolov and Butler resigned in 2007 after the company suspended them for prohibited activity. The company said it cooperated with authorities in the matter. They then briefly worked at Morgan Stanley.

As Tzolov testified, pictures were shown in court of Tzolov in a lime-green shirt celebrating with a smiling blue-shirted Butler. In court Butler, 37, wore a gray suit and leaned forward with his arms on a table and stared at Tzolov, who is expected to spend several days testifying.

The trial before U.S. District Judge Jack Weinstein will resume on Monday.

In opening arguments last month, the prosecutor accused Butler of lying to clients about auction rate securities deals, while the defense emphasized the collapse of the market.

The case is USA v Tzolov and Butler 08-370 in U.S. District Court for the Eastern District of New York (Brooklyn)

(Reporting by Grant McCool, editing by Gerald E. McCormick, Bernard Orr)

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