The Securities and Exchange Commission, state regulators, and the Financial Industry Regulatory Authority (FINRA) announced today that Morgan Keegan & Company and Morgan Asset Management have agreed to pay USD200 million to settle fraud charges related to subprime mortgage-backed securities. Two Morgan Keegan employees also agreed to pay penalties for their alleged misconduct, including one who is now barred from the securities industry.
The Memphis-based firms, former portfolio manager James C Kelsoe Jr, and comptroller Joseph Thompson Weller were accused in an administrative proceeding last year of causing the false valuation of subprime mortgage-backed securities in five funds managed by Morgan Asset Management from January 2007 to July 2007. The SEC’s order issued today in settling the charges also finds that Morgan Keegan failed to employ reasonable pricing procedures and consequently did not calculate accurate “net asset values” for the funds. Morgan Keegan nevertheless published the inaccurate daily NAVs and sold shares to investors based on the inflated prices.
The SEC brought its enforcement action in coordination with FINRA and a task force of state regulators from Alabama, Kentucky, Mississippi, Tennessee and South Carolina.
“The falsification of fund values misrepresented critical information exactly when investors needed it most – when the subprime mortgage meltdown was impacting the funds,” says Robert Khuzami, Director of the SEC’s Division of Enforcement. “Such misconduct does grievous harm to investors.”
William Hicks, Associate Director for the SEC’s Atlanta Regional Office, adds: “This enforcement action makes clear that the SEC will deal firmly with those who abuse their responsibility to assign accurate values to securities or other assets held by funds.”
The SEC’s order finds that Kelsoe instructed Morgan Keegan’s fund accounting department to make arbitrary “price adjustments” to the fair values of certain portfolio securities. The price adjustments ignored lower values for those same securities provided by outside broker-dealers as part of the pricing process, and often lacked a reasonable basis. In some instances, when price information was received that was substantially lower than current portfolio values, fund accounting personnel acted at the direction of Kelsoe and lowered values of bonds over a period of days in a series of pre-planned reductions to values at or closer to the price confirmations. As a result, during the interim days, the Morgan Keegan did not price those bonds at their current fair value.
The SEC’s order further finds that Kelsoe screened and influenced the price confirmations obtained from at least one broker-dealer. Among other things, the broker-dealer was induced to provide interim price confirmations that were lower than the values at which the funds were valuing certain bonds, but higher than the initial confirmations that the broker-dealer had intended to provide. The interim price confirmations enabled the funds to avoid marking down the value of securities to reflect current fair value. In some instances, Kelsoe induced the broker-dealer to withhold price confirmations, where those price confirmations would have been significantly lower than the funds’ current valuations of the relevant bonds.
According to the SEC’s order, through his actions Kelsoe fraudulently prevented a reduction in the NAVs of the funds that should otherwise have occurred as a result of the deterioration in the subprime securities market in 2007. His misconduct occurred in the context of a nearly complete failure by Morgan Keegan to employ the fair valuation policies and procedures adopted by the funds’ boards of directors to fair value the funds’ portfolio securities.
Under the settlement, Morgan Keegan is required to pay USD25 million in disgorgement and interest and a USD75 million penalty to the SEC to be placed into a Fair Fund for the benefit of investors harmed by the violations. Morgan Keegan will pay USD100 million into a state fund that also will be distributed to investors. The firms are additionally required to abstain from involvement in valuing fair valued securities on behalf of investment companies for three years. Kelsoe agreed to pay USD500,000 in penalties and be barred from the securities industry by the SEC, and Weller agreed to pay a penalty of USD50,000.
The SEC’s case originated from an SEC examination by Barbara Martin, Glen Richards and Christopher Ray. The matter was investigated by Stephen Donahue, Jack Westrick, and Edward Saunders. The case was litigated by Graham Loomis, Robert Gordon, John O’Halloran, Shawn Murnahan, Jerome Dewitt, Deborah Moore, and Eunita Holton with the assistance of valuation specialist Rick Mayfield. The case was brought under the supervision of Atlanta Regional Director Rhea Dignam and Associate Regional Director William Hicks.