The Law Office Of Russell L. Forkey — SEC Charges Morgan Keegan And Two Employees With Fraud Related To Subprime Mortgages
In the first quarter of 2010 — The Securities and Exchange Commission announced administrative proceedings against Memphis, Tennessee-based firms Morgan Keegan & Company and Morgan Asset Management and two employees accused of fraudulently overstating the value of securities backed by subprime mortgages.
The SEC’s Division of Enforcement alleges that Morgan Keegan failed to employ reasonable procedures to internally price the portfolio securities in five funds managed by Morgan Asset, and consequently did not calculate accurate “net asset values” (NAVs) for the funds. Morgan Keegan recklessly published these inaccurate daily NAVs, and sold shares to investors based on the inflated prices.
“This 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,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.
William Hicks, Associate Director in the SEC’s Atlanta Regional Office, said, “This misconduct masked from investors the true impact of the subprime mortgage meltdown on these funds.”
According to the Commission’s order instituting administrative proceedings, the SEC’s Enforcement Division alleges that James C. Kelsoe, Jr., the portfolio manager of the 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 Enforcement Division further alleges that Kelsoe actively screened and manipulated the pricing quotes obtained from at least one broker-dealer. With many of the funds’ securities backed by subprime 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 subprime 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 initiating proceedings, Morgan Keegan priced each portfolio’s securities and calculated its daily NAV through its Fund Accounting Department. The NAV of an investment company is its total assets minus its total liabilities. An investment company calculates the NAV of a single share by dividing its NAV by the number of shares that are outstanding.
According to the SEC’s order, each fund held various amounts of securities backed by subprime mortgages and lacked readily available market quotations. Therefore, the securities were internally priced using fair value methods to determine the amount that the funds would reasonably expect to receive on a current sale of the security. In SEC filings, the funds stated that the fair value of securities would be determined by a valuation committee using procedures adopted by the 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.
The SEC’s Division of Enforcement alleges that from at least January 2007 to July 2007, Kelsoe had his assistant send approximately 262 “price adjustments” to Fund Accounting. In many instances, these adjustments were arbitrary and did not reflect fair value. Despite the lack of any supporting documentation, Kelsoe’s price adjustments were routinely entered into a spreadsheet used to calculate the NAVs of the 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.
A hearing will be scheduled before an administrative law judge to determine whether the respondents committed the alleged violations and provide them an opportunity to defend the allegations. The hearing also will determine what sanctions, if any, are appropriate in the public interest, and whether financial penalties should be imposed.
In order to provide the reader with additional information relative to the status of various Morgan Keegan matters, the Trustee Ad Litem for the Regions Morgan Keegan Trust and Custodial Accounts has issued the following report, which should be read in conjunction with the most recent updates on the Trustee’s website:
Which funds are involved?
The Funds involved in pending lawsuits and their ticker or trading symbols are:
- Regions Morgan Keegan Select High Income Fund (MKHIX, RHICX, RHIIX)
- Regions Morgan Keegan Select Intermediate Bond Fund (MKIBX, RIBCX, RIBIX)
- Regions Morgan Keegan Select Short-Term Bond Fund (MSBIX, RSTCX, MSTBX)
- RMK Advantage Income Fund, Inc. (RMA)
- RMK High Income Fund, Inc. (RMH)
- RMK Multi-Sector High Income Fund, Inc. (RHY)
- RMK Strategic Income Fund, Inc. (RSF)
The Open-End Funds were acquired by Hyperion Brookfield Asset Management, Inc. (doing business as “Helios”) in July of 2008 and the trading symbols were changed as follows:
- Helios Select High Income Fund (HIFAX)
- Helios Select Intermediate Bond Fund (HSIBX)
- Helios Select Short Term Bond Fund (MSBIX)
In 2009, the Open-End Funds were liquidated.
The Closed-End Funds were also acquired by Helios and the trading symbols were changed as follows:
- Helios Advantage Income Fund (HAV)
- Helios Multi-Sector High Income Fund (HMH)
- Helios Strategic Income Fund (HSA)
- Helios High Income Fund (HIH)
What lawsuits involving investments in the funds for affected accounts are pending?
Federal Court Lawsuits
The United States Judicial Panel On Multidistrict Litigation has transferred or assigned almost all federal court lawsuits involving the Funds to the United States District Court for the Western District of Tennessee for coordinated or consolidated pretrial proceedings under the master designation: In Re Regions Morgan Keegan Securities, Derivative and ERISA Litigation, 2:09-md-2009-SHM.
Lawsuits under this master designation include, but are not limited to, the lawsuits described below as Securities Class Actions, the Breach of Contract/Negligence Class Action, and Derivative Actions.
Securities Class Actions
Class action lawsuits alleging federal securities law violations in connection with the Open-End Funds are now consolidated as:
In re Morgan Keegan Open-End Mutual Fund Litigation, CA 2:07-2784-SHM-dkv (W. D. Tenn.)
Class action lawsuits alleging federal securities law violations in connection with the Closed-End Funds are now consolidated as:
In re Morgan Keegan Closed-End Mutual Fund Litigation, CA 2:07-cv-02830-SHM-dkv (W. D. Tenn.)
All of these consolidated class actions are referred to on this website as the “Securities Class Actions.” The status of the Securities Class Actions as of April 14, 2010, is summarized in the most recent Update Report under the heading “Reports and Notices” on the Trustee’s website.
Breach of Contract/Negligence Class Action
Regions (as trustee of Affected Accounts) entered into Investment Advisory Services Agreements (“MAM Agreements”) with Morgan Asset Management, Inc. (“MAM”). MAM is a registered investment advisor owned by MK Holdings, Inc., which like Morgan Keegan & Company, Inc. (“Morgan Keegan”) and Regions, is a subsidiary of Regions Financial Corporation. Under the MAM Agreements, MAM undertook to provide investment and asset management services to Regions as trustee for the Affected Accounts. MAM also provided investment services to the Funds at the same time. The Trustee ad Litem concluded that grounds exist for a claim that, by November of 2006, MAM should have caused the Affected Accounts to divest and discontinue investments in the Funds before substantial losses were incurred. He also concluded that grounds exist for a claim that Morgan Keegan, Regions Financial Corporation, and certain individuals participated in the failure to cause the Affected Accounts to divest and discontinue investments in the Funds before substantial losses were incurred and are also liable for the losses.
Accordingly, the Trustee ad Litem filed a class action lawsuit for Affected Accounts that had investments in the Funds on or after November 9, 2006. This lawsuit (the “Breach of Contract/Negligence Class Action”) asserts claims for damages against MAM, Morgan Keegan, Regions Financial Corporation, and certain individuals based upon breach of contract and negligence. It is now pending before the United States District Court for Western Tennessee as C. Fred Daniels, as Trustee ad Litem, et al. v. Morgan Asset Management, Inc., et al., Case No. 2:09-cv-02800-SHM-cgc.
Several additional lawsuits, referred to as “Derivative Actions,” have been filed with respect to the Funds by persons other than the Trustee ad Litem. These lawsuits are essentially brought on behalf of the Funds themselves against persons and entities who are alleged to have caused the Funds to suffer losses by breaching their duties and obligations to the Funds and by other wrongdoing.
One derivative action, Landers, et al. v. Morgan Asset Management, Inc., et al., CV-02260-SHM-dkv (W.D. Tenn.) is a pending derivative action on behalf of the Open-End Funds. Godfrey, et al. v. Sullivan, et al., 2:10-cv-02192-SHM-dkv (W.D. Tenn.), Cannaday, et al. v. Sullivan, et al., 2:10-cv-02188-SHM-tmp (W.D. Tenn.), Godfrey, et al. v. Sullivan, et al., 2:10-cv-02192-SHM-dkv (W.D. Tenn.), and Cannaday, et al. v. Sullivan, et al., 2:10-cv-02190-SHM-dkv (W.D. Tenn.) are pending derivative actions on behalf of the Closed-End Funds.
Other Litigation Relating To The Funds
On April 7, 2010, the U.S. Securities and Exchange Commission (“SEC”), the Financial Industry Regulatory Authority (“FINRA”), and the Alabama Securities Commission, the Kentucky Department of Financial Institutions, the Mississippi Secretary of State’s Office and the South Carolina Office of the Attorney General (the “Multi-State Actions”) announced the filing of actions relating to the Funds. The case names and other information regarding these actions are:
In the Matter of Morgan Asset Management, Inc., et al., Administrative Proceeding File No. 3-13847
Department of Enforcement v. Morgan Keegan & Company, Inc., Disciplinary Proceeding No. 2007011164501
In the matter of Morgan Asset Management Inc., et al., Joint Administrative Proceeding File Nos.: Alabama: SC-2010-0016, Kentucky: 2010-AH-021, Mississippi: S-08-0050, and South Carolina: 0801:
Individual investors (other than the Trustee ad Litem on behalf of the Affected Accounts) have also filed various lawsuits in state and federal courts, as well as arbitration demands with FINRA. These lawsuits and arbitration proceedings were not initiated by the Trustee ad Litem. The state court lawsuits and arbitrations are still proceeding independently.
Some Affected Accounts (“ERISA Trusts”) were established for, or may constitute, employee benefit plans within the meaning of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), 29 U.S.C. § 1001, et seq. Under the MAM Agreements referenced above, MAM undertook to provide investment and asset management services to Regions as trustee, directed trustee, custodian, or agent for the ERISA Trusts. The Trustee ad Litem concluded that grounds exist for claims that: (1) MAM became a “fiduciary” for the ERISA Trusts within the meaning of the ERISA statutes; (2) MAM should have avoided investments in the Funds by the ERISA Trusts and before the beginning of 2007, should have caused the ERISA Trusts to divest and discontinue investments in the Funds before substantial losses were incurred; (3) by failing to do so, MAM breached its duties as an ERISA fiduciary; and (4) because of their relationships with and control over MAM, Morgan Keegan and Regions Financial Corporation were likewise ERISA fiduciaries and likewise breached their duties as ERISA fiduciaries. The Trustee ad Litem also concluded that grounds exist for alternative claims against MAM, Morgan Keegan, Regions Financial Corporation, certain individuals, and the Funds themselves for participating in breaches of ERISA fiduciary duties as “non-fiduciary parties in interest” within the meaning of the ERISA statutes.
Accordingly, the Trustee ad Litem filed a class action lawsuit for ERISA Trusts that had investments in the Funds on or after November 9, 2006. This lawsuit (the “ERISA Class Action”) seeks to recover losses of ERISA trust assets from MAM, Morgan Keegan, Regions Financial Corporation, certain individuals, and the Funds themselves. The ERISA Class Action is now pending before the United States District Court for Western Tennessee as C. Fred Daniels, as Trustee ad Litem, et al. v. Morgan Asset Management, Inc., et al., Case No. 2:10-cv-02514-SHM-dkv.
What is the current status of lawsuits involving affected accounts?
Please see the most recent Update Report under the heading “Reports and Notices” on this website.
Are all purchases of funds for or by affected accounts covered by the lawsuits?
Due to the time limits for filing lawsuits ( i.e., the statutes of limitations), the claims in the Securities Class Actions only address Funds purchased after certain dates. The particular purchase dates vary depending upon the specific Funds purchased and the particular causes of action asserted in the Securities Class Actions. None of the Securities Class Actions cover Fund purchases made before December 6, 2004. Losses with respect to purchases earlier than the dates specified in the lawsuits are not covered by the Securities Class Actions. The Breach of Contract/Negligence Class Action only covers investments in the Funds that Affected Accounts held or made on or after November 6, 2006. The Derivative Actions, if successful, might recover some losses not recoverable in the Securities Class Actions or the Breach of Contract/Negligence Class Action, but this is by no means certain and many Affected Accounts may not be eligible to participate in any recovery obtained in the Derivative Actions. Finally, the Regulatory Actions discussed above might result in restitution for investors in the Funds.
What is the possibility that there will be a settlement without a trial?
It is not possible to form any estimation about the possibility of settlement. The Trustee ad Litem will be vigilant in this regard if and when an appropriate opportunity is presented.
Will Regions restore all of my account’s losses with respect to the funds?
That has to be determined by the litigation and other proceedings. A substantial risk exists that all Affected Account losses will not be restored by settlements or judgments in the Securities Class Actions, the Derivative Actions, the Breach of Contract/Negligence Class Action, or the Regulatory Actions. As noted above and elsewhere, beneficiaries and others may have individual claims directly against Regions and others that are not being pursued by the Trustee ad Litem.
Are there limitations on the trustee ad Litem’s authority?
The authority of the Trustee ad Litem is limited to claims that would, in the absence of Regions’ conflicts of interest, have to be asserted by Regions as trustee on behalf of the Affected Accounts based on investments in the Funds. The Probate Court has not authorized the Trustee ad Litem to address claims that can be made directly by beneficiaries, settlors, or principals against Regions or others, including, but not limited to, claims for breach of fiduciary duties.
Can the persons interested in the affected Accounts file separate lawsuits?
The Securities Class Actions only assert claims arising under federal securities laws and the Breach of Contract/Negligence Class Action only concerns breach of contract and negligence claims that otherwise would have to be asserted by Regions for the Affected Accounts in the absence of Regions’ conflicts of interest. The beneficiaries, settlors, and principals of the Affected Accounts may have additional rights to bring separate suits or actions directly against Regions, its trust department, or others for, among other potential claims, breaches of fiduciary duties. The Trustee ad Litem is not authorized to bring such suits or actions or to offer advice as to whether (i) suits by beneficiaries, settlors, or principals against Regions or its trust department or others for breach of any obligations or duties can or should be brought or (ii) if there has been a breach of fiduciary duty. The Trustee ad Litem is not discouraging you from bringing such a suit, nor is the Trustee ad Litem encouraging you to bring such a suit. Neither the appointment of the Trustee ad Litem nor any action he may take or not take in that capacity has any bearing on whether you can or should bring such a suit or action. There are attorneys, however, who have actively sought beneficiaries, settlors and principals to engage those attorneys to bring such suits. You may have already been contacted by such attorneys, or you may be contacted by such attorneys in the future. If so, you must evaluate their advice independent of the Trustee ad Litem, because his authority is limited to claims that a trustee for the Affected Accounts (as opposed to the beneficiaries, settlors and principals) must make, not what beneficiaries, settlors and principals should do independently with respect to their trustees or agents ( e.g., Regions). You are encouraged to consult with counsel of your choice.
Please be aware that there are time limits (referred to as “statutes of limitations”) to file lawsuits, and prompt action may be required to avoid this bar if you decide you should file a separate lawsuit. Advice regarding these time limits is a matter that you should discuss with your own counsel.
Conclusions to be drawn from the above discussion – You need to retain your own counsel to make sure that your rights are being protected and because of potential statute of limitation issues, you should act immediately.
With extensive courtroom, arbitration and mediation experience and an in-depth understanding of securities law, our firm provides all of our clients with the personal service they deserve. Handling cases worth $25,000 or more, we represent clients throughout Florida and across the United States, as well as for foreign individuals that invested in U.S. banks or brokerage firms. Contact us to arrange your free initial consultation.