4/07/2010

SEC Sues Morgan Keegan and Two Employees for Fraud Related to Regions Morgan Keegan Bond Mutual Funds

The United States Securities and Exchange Commission initiated proceedings Morgan Keegan & Company, Morgan Asset Management and two employees accused of fraudulently overstating the value of securities backed by sub-prime mortgages. The SEC's Division of Enforcement alleges that Morgan Keegan failed to use reasonable procedures to price the portfolio securities in five Regions Morgan Keegan bond mutual funds managed by Morgan Asset Management, and consequently did not calculate accurate "net asset values" (NAVs) for the bond funds. The SEC further alleges that Morgan Keegan recklessly published these inaccurate daily NAVs, and sold shares to investors based on the inflated prices. Investors have lost more than $1 billion in the Regions Morgan Keegan bond mutual funds that were subjected to the alleged fraud.

The Director of the SEC's Division of Enforcement has stated that "[t]his scheme had two architects - a portfolio manager responsible for lies to investors about the true value of the assets in his funds, and a head of fund accounting who turned a blind eye to the fund's bogus valuation process." An SEC Associate Director further said that "[t]his misconduct masked from investors the true impact of the sub-prime mortgage meltdown on these funds."

According to the SEC, James C. Kelsoe, Jr., the portfolio manager of the Regions Morgan Keegan bond funds and an employee of Morgan Asset and Morgan Keegan, arbitrarily instructed the firm's Fund Accounting department to make "price adjustments" that increased the fair values of certain portfolio securities. The price adjustments ignored lower values for those same securities quoted by various dealers as part of the pricing validation process. The SEC further alleges that Kelsoe manipulated the pricing quotes obtained from at least one broker-dealer. With many of the funds' securities backed by sub-prime mortgages, Kelsoe's actions fraudulently prevented a reduction in the NAVs of the funds that otherwise should have occurred as a result of the deterioration in the sub-prime securities market.

The SEC's Division of Enforcement additionally alleges that Joseph Thompson Weller, a CPA who was head of the Fund Accounting Department and a member of the Valuation Committee, did nothing to remedy the deficiencies in Morgan Keegan's valuation procedures, nor did he otherwise make sure that fair-valued securities were being accurately priced and NAVs were being accurately calculated.

According to the SEC's order, each Regions Morgan Keegan bond mutual fund held various amounts of securities backed by sub-prime mortgages and lacked readily available market quotations. Therefore, the securities were priced internally using fair-value methods. In SEC filings, the funds stated that the fair value of securities would be determined by a valuation committee using procedures adopted by the mutual funds. In fact, the responsibility was essentially delegated to Morgan Keegan, which along with the valuation committee failed to comply with the funds' procedures in several ways.

Despite the lack of any supporting documentation, Kelsoe routinely adjusted prices for securities held in Regions Morgan Keegan bond funds. Kelsoe also routinely instructed Fund Accounting to ignore month-end quotes from broker-dealers that were supposed to be used to validate the prices the firm had assigned to the funds' securities.

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