Don't lie about debt prices or you could end up in jail. And ifyou've already lied, watch out.

That's the message to traders in the US$375 billion opaquemarket for collateralized loan obligations (CLOs) after MatthewKatke, a former Royal Bank of Scotland Group Plc CLO trader,pleaded guilty Wednesday in the U.S. to committing securitiesfraud. Katke agreed to cooperate with federal prosecutors'investigation into a multimillion-dollar scheme to cheat customerswho bought and sold bonds.

While investigators have been scrutinizing the activities ofseveral mortgage-bond traders since the credit seizure of 2008,their latest action shows they've also been focusing on a marketthat's tried to distance itself from debt backed by home loans thatspurred the crisis. CLOs, which slice pools of speculative-gradecorporate debt into pieces of varying risk and return, have beenissued at an unprecedented clip during the past few years.

“The investigation started on the mortgage side because that wasso obvious—it was in the public eye,” said Erik Gordon, a professorat the University of Michigan's Ross School of Business in AnnArbor. Regulators “are poking around. What they find out is nobodyknows what the value is of the CLOs.”

While subprime mortgage-backed bond issuance hasn't reallyrevived much since the financial crisis, CLO sales have surged.Investors bought a record $123.6 billion of the deals in 2014,surpassing the previous high of $94 billion in 2006, according toJPMorgan Chase & Co. data.

Opaque Market

The U.S. CLO market now includes about $375 billion of debt,according to Wells FargAo & Co. data. That amount is aboutequal to the size of Colombia's annual economic output.

The Financial Industry Regulatory Authority (Finra) disclosesprices on corporate-bond trades within a short period of time toincrease transparency, but doesn't publish those details for CLOs.The debt is largely traded through phone calls. In other words,it's essentially traded in the dark.

Katke's actions show how things can go awry in this opaqueenvironment. He was charged with conspiring to boost RBS's profitsby telling clients the bank bought or sold debt at higher or lowerprices than the firm actually did. He worked at the firm'sStamford, Connecticut, office from 2008 to 2013, when he left tojoin Nomura Holdings Inc., according to records maintained byFinra.

Richard Albert, a lawyer for Katke, declined to comment on theplea.

“RBS has been cooperating and intends to continue to cooperatewith the government with respect to this investigation,” SarahLukashok, a spokeswoman for the Edinburgh-based bank, said in anemail Wednesday.

The case follows the prosecution of Jesse Litvak, a formerJefferies Group LLC mortgage-debt trader who was convicted in March2014 of securities fraud for lying to clients. Litvak has appealedthe conviction.

Katke, meanwhile, is cooperating with authorities. Documentsreleased Wednesday by the U.S. Attorney's office in New Haven,Connecticut, show he agreed to disclose anything he knows about thecharges to which he pleaded guilty as well as unrelated activitiesby others.

–With assistance from Jody Shenn and Kristen Haunss in New York,Christie Smythe in Brooklyn and Tom Schoenberg in Washington.

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