Nov. 6 (Bloomberg) -- Wall Street firms that sold mortgage- backed securities to a $30 billion pool run by the state of Florida for local governments are under investigation for fraud by the U.S. Securities and Exchange Commission.

Lehman Brothers Holdings Inc., JPMorgan Chase & Co. and Credit Suisse Group AG may have misled officials overseeing Florida’s Local Government Investment Pool in 2007 when they sold the securities without disclosing “the risk and liquidity of investments,” the SEC said in an Oct. 17, 2008, letter to the State Board of Administration that runs the pool.

The SEC sought testimony and documents as part of its so- called formal inquiry, according to a letter and subpoena sent to the State Board. Assets in the pool, now known as Florida Prime, plunged to less than $6 billion in the weeks after it disclosed in November 2007 that it held $2.2 billion of below- investment-grade securities. The mortgage-backed bonds were the same kind that led financial institutions worldwide to take $1.7 trillion in losses and writedowns.

“Everybody’s glad it’s being looked into,” said Jeannie Garner, director of financial services for the 400-member Florida League of Cities in Tallahassee, Florida. “There’s been no resolution.”

Money Fund

The pool was used like a savings account by cities, school districts and county governments to invest money until the cash was needed to pay for government services. Before November 2007, the pool was the largest public money market fund in the U.S., holding cash for about 1,000 local governments.

The St. Petersburg Times reported on the letter today and attached it to its Web site. The paper said it obtained the letter from the State Board of Administration.

The board, which also manages state funds, including $104 billion in pension funds, in May 2008 disclosed that the SEC made inquiries regarding securities sold to the fund. The agency sought documents related to investments in Countrywide Financial Corp., Axon Financial Funding, KKR Atlantic Funding Trust and at least eight other securities owned by the pool, according to a letter dated Feb. 22, 2008.

The SBA board didn’t tell its three trustees, Governor Charlie Crist, Chief Financial Officer Alex Sink and Attorney General Bill McCollum, about the October elevation to a formal probe because the agency had agreed to hold the order confidential, spokesman Dennis MacKee told the newspaper.

Confidentiality Agreement

The board was asked to sign the confidentiality agreement at the request of the SEC, said Ash Williams, executive director of the board, in a phone interview. The board disclosed the investigation when it released the earlier letter and trustees were informed about the investigation, he said.

“This is not news,” Williams said.

Lehman, JPMorgan and Credit Suisse “may have been or may be employing devices, schemes or artifices to defraud, obtaining money or property by means of untrue statements of material fact or omitting to state material facts,” the October 2008 letter said.

A subpoena sent to the board, dated April 2, 2009, sought documents about the pool.

Credit Suisse spokeswoman Victoria Harmon and JPMorgan spokesman Brian Marchiony, both in New York, declined to comment. An SEC spokesman in Washington declined to comment.

Liquidating Trustee

Lehman Brothers filed for bankruptcy in September 2008. The trustee liquidating Lehman’s brokerage “has been cooperating with the SEC’s investigation,” said Sarah Cave, the trustee’s attorney. James Giddens, an attorney with Hughes & Hubbard in New York, is the trustee.

After the run on the fund, the state on Nov. 29, 2007, froze it, stopping all withdrawals. In December, Blackrock Inc., which was hired to advise the pool on its holdings, advised that it be split into two funds, with a new one created to hold assets tainted by the mortgage-backed securities. Their existence was reported by Bloomberg News.

Florida Prime, which now has about $5 billion under management, has eliminated two-thirds of its bad holdings, replaced managers, increased oversight and secured a AAAm rating from Standard & Poor’s, the highest for a money fund.

The pool now allows investors get money when they want it and has subjected itself to an evaluation of its investment practices by an outside firm, Ennis, Knupp & Associates Inc. of Chicago, said Williams, the executive director.

“We have made changes and think we offer a fund that brings value to the marketplace,” Williams said.

Lacking Confidence

Even so, half the 132 respondents to a questionnaire from Federated Investors Inc. last March said they lacked confidence in the fund. Federated was hired as an investment adviser at the time.

“There needs to be more safeguards and oversight by outside professionals,” said Wayne Blanton, executive director of the Florida School Boards Association. “There’s just not a lot of money coming into the fund from our members.”

Few cities have returned to the fund, with many now depositing surplus cash in local banks, Garner said.

“The cities are investing as safely as possible,” Garner said. “They got burned.”

To contact the reporters on this story: Darrell Preston in Dallas at dpreston@bloomberg.net.

Last Updated: November 6, 2009 15:56 EST