(Corrects losses in the third paragraph.)

Nov. 28 (Bloomberg) -- Securities firms and banks sold ``too many lottery tickets'' tied to U.S. mortgages and failed to look closely enough at their growing risks, the head of the Securities and Exchange Commission's market regulation division said today.

Financial companies had ``a significant risk management failure'' on so-called super senior classes of collateralized debt obligations made up of asset-backed bonds, Erik R. Sirri said at a conference in New York, according to the text of his remarks published on the agency's Web site.

Merrill Lynch & Co., Citigroup Inc. and other banks that underwrote CDOs have announced mortgage-related losses for the third and fourth quarters of at least $47.2 billion, a tally that includes non-CDO holdings, according to data from JPMorgan Chase & Co. Losses on CDOs may reach $77 billion for the banks and about $260 billion marketwide, JPMorgan analysts said.

The CDO classes were ``a perfect structure to lull even sophisticated traders and risk managers into a state approaching complacency,'' Sirri said.

CDOs repackage pools of assets including subprime-mortgage bonds or buyout loans into new securities with varying degrees of risk. Super-senior classes of mortgage-bond CDOs -- the largest pieces and least likely to experience defaults on underlying securities -- probably will lose 20 to 80 percent, JPMorgan said. They were all originally rated AAA.

Taken by Surprise

Financial companies didn't realize how quickly the value of super-senior CDOs could tumble, and so took on positions of ``eye- popping'' sizes, Sirri said. He spoke at a conference today hosted by the American Institute of Certified Public Accountants and the Securities Industry Association Financial Management Division.

The way that super-senior CDO value can fall quickly can be mimicked by other assets, such as options to sell securities at prices above current ones, he said.

``There is a spectrum of lottery tickets that can be written,'' offering little upside for the seller and potentially large, sudden losses in a worst-case scenario, Sirri said.

Banks also often relied on prices from ``other market participants'' instead of internal assessments to gauge the worth of super-senior CDOs, leaving them ``flying blind,'' he said.

Banks' risk managers helped create large exposure to the safest pieces of CDOs by installing limits on how much of the pieces of mortgage-related securities that are most exposed to defaults they could hold, Sirri said.

``Governance mechanisms intended to limit one type of risk effectively led to others risks being assumed that were more complex and difficult to analyze,'' he said.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net.

Last Updated: November 28, 2007 17:28 EST