updated 9/3/2008 7:00:46 PM ET 2008-09-03T23:00:46

A former Wall Street broker pleaded not guilty Wednesday to charges he and a colleague duped investors into purchasing more than $1 billion in high-risk securities by making it look as though the trades were protected by the federal government.

An indictment unsealed in federal court in Brooklyn said because the securities actually were tied to subprime mortgages, Eric Butler and Julian Tzolov stood to pocket higher commissions. The scheme was exposed when the subprime market collapsed.

“The defendants’ fraudulent misrepresentations and bait-and-switch tactics saddled investors with unknown risks they did not bargain for,” U.S. Attorney Benton Campbell said in announcing the case against the former Credit Suisse Securities brokers.

Butler, 36, was released on $2.5 million bond following his arraignment on securities fraud, wire fraud and conspiracy charges. The Bulgarian-born Tzolov, 35, was out of the country but expected to return and surrender on the same charges.

If convicted, each faces up to 20 years in prison and a $5 million fine.

Defense attorney Paul Weinstein said Butler would fight the charges. He called his client “an excellent broker” who “believed he was doing the best for his clients.”

Tzolov’s attorney, Kenneth Breen, declined comment.

Credit Suisse said the two resigned last September “after we detected their prohibited activity and promptly suspended them.”

The New York investment firm said it immediately informed the Securities and Exchange Commission of their activities and has continued to assist the agency in its investigation.

The indictment and a related SEC civil lawsuit alleged that Butler and Tzolov led corporate customers to believe that auction rate securities being purchased in their accounts were backed by federally guaranteed student loans and were safe like cash.

In reality, the securities were backed by subprime mortgages, collateralized debt obligations and other high-risk investments, the authorities said. Because of their higher risk, they brought a higher yield and much larger commissions for the brokers.

The authorities said Tzolov and Butler deceived foreign corporate customers by sending them e-mail confirmations in which the terms “St. Loan” or “Education” were added to names of other types of securities purchased for the customers.

The two brokers also frequently deleted references in the e-mails to “CDO,” for collateralized debt obligations, or “mortgage” from the names of the securities purchased, the agency said. CDOs are complex financial instruments that combine various slices of debt.

As a result, customers were stuck holding more than $800 million in securities that lost their liquidity and value when the market for auction rate securities began to collapse in August 2007, according to the SEC.

The SEC is seeking unspecified restitution and civil fines against the brokers.

Andrew Calamari, associate director of the SEC’s New York regional office, said the case shows “how the recent turmoil in the subprime market has affected even investors who had no intention of buying subprime securities.”

In recent months at least eight major investment banks, including Merrill Lynch & Co., Goldman Sachs Group Inc., Citigroup Inc. and Morgan Stanley, have signed deals with federal and state regulators to buy back more than $50 billion worth of auction rate securities. The regulators alleged that the banks misled customers into believing that the investments were safe.

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