By Katie Benner

Federal prosecutors are investigating whether two former Credit Suisse (CS) brokers lied to investors about how they placed their money into auction rate securities, a type of bond investment that has hurt investors, reports the Wall Street Journal. The $330 billion market for auction rate securities allows issuers such as municipalities and student loan companies, closed-end mutual funds or financial institutions to borrow money in the form of long-term bonds. The market has treated these bonds like safe, short-term investments because investors can sell them at weekly auctions. But the auction market for these bonds dried up when the credit crisis hit, and investors were trapped in these long-dated securities because there were no buyers.

The investigation is being conducted by the U.S. attorney’s office for New York’s Eastern District, according to the Journal. Many individual investors have already filed lawsuits in an attempt to get their money out of these bonds. Some of these claims say brokers misleadingly described auction-rate securities as “money market” funds, or other cash equivalents. Massachusett’s regulators last week filed a civil fraud suit against UBS (UBS) executives, alleging that UBS brokers told investors the securities “were safe, liquid ‘cash alternatives’ when UBS knew they were not.” UBS has denied wrongdoing.

In the Credit Suisse case, New York-based brokers Eric Butler and Julian Tzolov resigned from the firm on Sept. 7, 2007, amid accusations by clients that they were misled about the nature of the auction-rate securities they bought, according to the report. Clients said they were told the securities they purchased were backed by student loans, but they were really backed by risky collateralized debt obligations, or pools of bonds tied in part to subprime mortgages, said the Journal. Credit Suisse has said that it is working with regulators to get to the bottom of the matter, and the report says it is not a target of the investigation.

A spokesman for the U.S. attorney’s office and Paul Weinstein, a lawyer for Mr. Butler, declined to speak with the Journal. But Kenneth Breen, a lawyer for Tzolov, said his client is a well-respected broker who shouldn’t be blamed for an unforeseeable market failure. “Julian Tzolov deceived no one,” he told the newspaper. “He had his clients’ interests at heart at all times. We are confident that the U.S. attorney’s office will make the correct decision and choose not to bring charges.”

Both brokers joined Morgan Stanley a few days after leaving Credit Suisse; but a Morgan Stanley spokeswoman told the Journal that they were fired on Monday and declined to elaborate.

So much for Credit Suisse’s (CS) savvy handling of the mortgage meltdown. The Swiss bank said Tuesday morning it will write down the value of some asset-backed structured credit trading positions by $2.85 billion, due to “significant adverse first quarter 2008 market developments.” Credit Suisse said it expects the writedown to shave $1 billion from its first-quarter earnings, though the bank says it believes it remains profitable for the period. Shares fell 4% in premarket trading in New York.

The announcement comes just a week after Credit Suisse posted a 72 percent decline in fourth quarter earnings that nonetheless made it look substantially sharper than rival UBS (UBS), which took some $14 billion in fourth-quarter writedowns tied to souring mortgage-backed securities. Credit Suisse said Tuesday that it continues to probe the problems in its asset-backed book, adding that the bank “has identified mismarkings and pricing errors by a small number of traders in certain positions in our Structured Credit Trading business.” Credit Suisse spokesman Marc Dosch said a “small number” of traders had been suspended,  Bloomberg reported. Just another case of savvy risk management, no doubt.