On June 22, 2011, Morgan Keegan was ordered by regulators to pay $200 million to investors to settle claims relating to sales of the Regions Morgan Keegan (“RMK”) Bond Funds. It is estimated that over 35,000 investors lost roughly $1.5 billion in the RMK Bond Funds. The settlement was reached with the Financial Industry Regulatory Authority (“FINRA”), the U.S. Securities and Exchange Commission and five state regulators. RMK Fund Manager James C. Kelsoe also agreed to pay a $500,000 penalty and was barred from the securities industry.
FINRA’s settlement includes findings that Morgan Keegan failed to establish, maintain and enforce an adequate supervisory system, including written supervisory procedures reasonably designed to achieve compliance with NASD rules. Morgan Keegan’s supervisory system and written procedures were not reasonably designed to ensure that its sales literature disclosed certain information as to risk and did not contain exaggerated claims. As a result, Morgan Keegan failed to adequately describe the nature, holdings and certain risks of the Intermediate Fund. In addition, beginning in 2007 when the particular risks associated with the Intermediate Fund’s holdings began to impact negatively the holdings in the fund, Morgan Keegan failed to take steps reasonably designed to revise its advertising materials to inform customers of the specific risks of investing in the fund under the current market conditions.
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.
Our law firm will continue to prosecute cases against Morgan Keegan in the FINRA Arbitration Forum on behalf of aggrieved investors. Investors should consider whether they should file an individual securities arbitration claim as an avenue to recover their losses.
As an investor, it is important to know that you are not to blame for the decline in the value of your Morgan Keegan Bond Funds. While there is some risk to investing in the market in general, there is no room for misrepresentation, omission or fraud. Moreover, when an investor is led to believe that they are making a safe investment in a bond fund, and subsequently loses 55 to 60 percent of their investment, someone needs to be held accountable.
Throughout the year 2007, numerous individuals, businesses and institutions lost a significant amount of money in Morgan Keegan Bond Funds which were managed by Fund Manager James C. Kelsoe. Moreover, many Morgan Keegan financial advisors were misled by the firm into believing that the Bond Funds were “safe” investments. They too feel betrayed by the misrepresentation and omission of Morgan Keegan.
The primary cause of the losses in the Morgan Keegan Bond Funds was not the market. The tremendous losses in the share value of the Funds were caused, in part, by the Funds’ heavy investment in structured or manufactured fixed income securities that had not been tested through market cycles. Specifically, the Funds improperly invested in various “collateralized debt obligations” (“CDOs”) like collateralized bond obligations (“CBOs”), collateralized loan obligations (“CLOs”), and collateralized mortgage obligations (“CMOs”), or “structured financial instruments.” These securities are usually thinly traded, and market quotations for these securities are not readily available. As a result, the value of these securities can only be estimated, which can lead to inflated and overstated valuations. Unfortunately, an overvaluation and inflation of the value of the securities in the Funds contributed to the losses in the Funds.
In addition to the fact that the Funds invested in risky and speculative securities, the Funds’ Manager misallocated the assets in the Funds. Indeed, on July 19, 2007, Bloomberg News quoted James Kelsoe as having an “intoxication” with structured financial instruments. Bloomberg further reported that an analyst at Morningstar, Inc., the mutual fund research firm, noted that “[a] lot of mutual funds didn’t own much of this stuff” and that the High Income Fund was “the one real big exception.”
The failure of the Funds to comply with the procedures relating to the way in which the Funds’ assets were invested directly led to the demise of the Funds. As the subprime and credit related markets collapsed in 2007, the value of the Funds’ securities, which were tied to these sectors, followed. Many of the Funds were restricted to investing only 25% in a single sector. However, in some instances, Morgan Keegan invested over 50% of the Funds’ assets in mortgage related securities. In doing so, not only did Morgan Keegan imprudently invest the Funds’ assets, but, contrary to the representations made in the Funds’ Registration Statements and Prospectuses, the firm subjected the Funds to an extraordinary amount of risk. Moreover, none of the Funds had in place risk management strategies to protect the Funds in the event of a sharp decline. The feared, sharp decline in the value of the securities in the Bond Funds did ultimately take place, and there was no safety net to protect the Funds’ investors.