U.S. securities regulators have charged several brokers with fraud for selling collateralized mortgage obligations (CMOs) as securities suitable for risk-averse investors.

The U.S. Securities and Exchange Commission filed a complaint in federal district court in West Palm Beach, Fla., alleging that 10 brokers who worked for now-defunct Brookstreet Securities Corp. did not clearly define the risks to customers before investing their money in particularly risky CMOs.

According to the SEC’s complaint, the defendants portrayed particularly risky types of CMOs as secure investments to defraud more than 750 customers, ultimately costing them more than US$36 million in losses. Meanwhile, the 10 brokers received US$18 million in commissions and salaries related to their customers’ investments in CMOs. These allegations have not been proven. In the case, the commission is seeking permanent injunctive relief, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties.

“These brokers disguised the risks of investing in these derivatives of mortgage-backed securities, exposing their customers to substantial losses as the subprime crisis emerged,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “They disregarded their customers’ needs and used deceptive and misleading tactics to enrich themselves at their clients’ expense.”

Additionally, the Financial Industry Regulatory Authority announced charges against six other brokers that were associated with Brookstreet Securities. FINRA’s complaint alleges that from June 2004 through May 2007, the brokers sold CMOs to retail customers when the brokers themselves lacked a basic understanding of these complex and illiquid securities. It alleges that the brokers failed to adequately investigate the CMOs prior to selling the products and misrepresented or failed to disclose important information about the risks associated with an investment in CMOs. These allegations haven’t been proven either.

IE