Securities Law Blog

The Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and numerous state regulators filed complaints against Morgan Keegan & Company and Morgan Asset Management on April 7, 2010.

Regulators claim that Morgan Keegan and its asset management division misrepresented the bond funds to investors and brokers, manipulated the funds’ net asset value (NAV), and failed to supervise the sale of the funds and due-diligence efforts.

According to the FINRA complaint, from January 2006 through December 2007, Morgan Keegan sold over $2 billion of the bond funds, in particular the Regions Morgan Keegan Select Intermediate Bond Fund. These funds were invested heavily in risky asset- and mortgage-backed securities, including sub-prime products. The funds began experiencing significant financial difficulties in 2007 following the collapse of the subprime securities market.

Specifically, FINRA’s complaint alleges that:

*In its research, investment advice and performance updates to its brokers regarding the Intermediate Fund, Morgan Keegan failed to disclose the material characteristics and risks of investing in the fund, misstated the appropriate use of the fund and otherwise portrayed the fund as a safer investment than it was, even though the firm was aware of material, special risks that made the fund unsuitable for many retail investors.

*Morgan Keegan failed to ensure the accuracy of the advertising materials prepared by the fund manager and distributed by the firm, and failed to ensure that those materials disclosed all material risks, were not misleading and did not contain exaggerated claims.

*Morgan Keegan failed to train its brokers regarding the features, risks and suitability of the fund and, in its communications with its brokers, the firm failed to adequately describe the nature of holdings and material risks of the Intermediate Fund.

*When Morgan Keegan became aware, beginning in early 2007, of the adverse market effects on the bond funds, the firm failed to timely warn its brokers or revise its advertising materials to reflect the disproportionately adverse effect the market was having on the performance of the securities that compromised the bond funds – which Morgan Keegan brokers continued to sell widely. At this time, the firm reassured, rather than warned, its sales force about the riskiness of the bond funds. As a result, some of the firm’s brokers were unaware of the then-turbulent market’s effects on the funds and failed to disclose the negative effects caused by market forces.

According to FINRA, in a May 2007 email from the Director of Investments for the Morgan Keegan Wealth Management Services division, Gary Stringer wrote, “What worries me about this [Regions Morgan Keegan Select Intermediate] bond fund is the tracking error and the potential risks associated with all that asset-backed exposure. Mr. & Mrs. Jones don’t expect that kind of risk from their bond funds. The bond exposure is not supposed to be where you take risks. I’d bet that most of the people who hold that fund have no idea what it’s actually invested in. I’m just as sure that most of our FAs have no idea what’s in that fund either.”

The complaint filed by the SEC points a finger more directly at two “architects” behind the alleged scheme. The SEC alleges that James C. Kelsoe Jr., the portfolio manager of the funds and employee of Morgan Asset Management and Morgan Keegan, instructed the firm’s Fund Accounting department to make “price adjustments” that increased the fair values of certain portfolio securities. The price adjustments allegedly issued by Mr. Kelsoe were routinely entered into a spreadsheet to calculate the NAVs of the funds, without any supporting documents. Mr. Kelsoe also allegedly told the Fund Accounting department to ignore month end quotes from other broker-dealers, which are intended to be used to validate the prices the firm has assigned to the funds’ securities.

According to the SEC, in an October 2009 deposition, Carter Anthony, president of Morgan Asset Management from 2001 to 2006, testified, “Time and time again I was told by Mr. Morgan and Mr. Edwards to leave Mr. Kelsoe alone, he’s doing what we want him to do, he’s also a little bit strange, he gets mad easy, leave him alone.”

The second party named, Joseph Thompson Weller, CPA and head of the Fund Accounting Department and member of the Valuation Committee, allegedly did nothing to remedy the deficiencies in Morgan Keegan’s valuation procedures, nor did he make sure that fair-valued securities were being accurately priced and NAVs were being accurately calculated, according to the SEC’s Division of Enforcement.

FINRA is seeking a fine, disgorgement of all ill-gotten profits and full restitution for affected investors. The SEC will be holding a hearing before an administrative law judge to examine the allegations and determine what sanctions or penalties, if any, should be imposed.