A federal appeals court in New York threw out part of the conviction of former Credit Suisse Group AG broker Eric Butler for misleading clients about the safety of auction-rate securities he sold.

The 2nd U.S. Circuit Court of Appeals reversed Butler's August 2009 securities fraud conviction by a Brooklyn, New York, jury for selling debt that caused $1.12 billion of investor losses, saying prosecutors brought the case in the wrong court. It upheld Butler's conviction on two conspiracy charges.

Butler's case is one of the first criminal prosecutions stemming from the credit crisis that began in 2007.

In his appeal, Butler argued that the government should not have brought the case in Brooklyn, which is part of the Eastern District of New York, only because he and co-defendant Julian Tzolov flew from John F. Kennedy International Airport located in the district to meet clients.

A three-judge appeals court panel agreed that this reason could not sustain the securities fraud charge. It noted that Butler worked mainly in Credit Suisse's Madison Avenue offices in Manhattan, which is in a different jurisdiction

.

We have little difficulty concluding that the government failed to offer competent proof that any act or transaction constituting the securities fraud violation occurred in the Eastern District, Judge Barrington Parker wrote.

In contrast, Parker said the conspiracy charges were different because without the overt act of traveling through the airport, Butler could not have had face-to-face meetings with investors, a regular part of his fraudulent scheme.

The panel sent the case back to the district court, where U.S. District Judge Jack Weinstein in January 2010 sentenced Butler to five years in prison and imposed a $5 million fine.

Butler has been free on bail, and could face less prison time when he is resentenced.

We're going to review the 2nd Circuit opinion and consider our options, said Robert Nardoza, a spokesman for U.S. Attorney Loretta Lynch in the Eastern District.

Steven Molo, a lawyer for Butler, did not immediately return requests for comment.

It is unclear how the ruling might affect Lynch's ability to police Wall Street. Her predecessor oversaw the fraud trial of former Bear Stearns Cos hedge fund managers Ralph Cioffi and Matthew Tannin, which ended in acquittals in November 2009.

RISKIER DEBT SOLD

Prosecutors accused Butler and Tzolov of trying to win higher commissions by misleading clients into believing they were buying safe securities backed by federally guaranteed student loans, when in fact they were buying auction-rate securities backed by riskier mortgage and corporate debt.

They said the scheme unraveled when auctions began to fail, causing losses at companies such as drugmakers GlaxoSmithKline Plc and Roche Holding AG , fertilizer maker Potash Corp of Saskatchewan Inc

and semiconductor company STMicroelectronics NV .

The entire $330 billion auction-rate market collapsed in February 2008. On June 2, the Second Circuit upheld most of a roughly $400 million arbitration award for STMicroelectronics against Credit Suisse.

Tzolov testified against Butler after pleading guilty in July 2009 to fraud and conspiracy, and to bail jumping for having fled to Spain.

His lawyer Benjamin Brafman in an interview said Tzolov was sentenced last week to four years in prison, including the nearly two years he has already spent in federal custody.

The case is U.S. v. Butler, 2nd U.S. Circuit Court of Appeals, No. 10-00562.

(Reporting by Jonathan Stempel, editing by Gerald E. McCormick)