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SEC Seeks Pound of Flesh from Morgan Keegan for Blatant Bond Fund Fraud
It appears that FINRA and the SEC have woken the hell up. And while change
probably isn't coming to Wall Street, Broad and Water are certainly
taking notice. At the very least, Main Street will be happy to hear
that someone is being investigated, that someone is
being held accountable and, yes, that someone will be perp
walked with film at 11.
' 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. ' - SEC release
FINRA and the SEC brought down a sledgehammer upon Morgan
Keegan today, citing one of the most egregious cases of blatant
fraud in recent memory. The short of it is that two employees
explicitly manipulated bond fund NAVs to hide horrible investment
performances. The two in question, "actively screened and manipulated
dealer quotes" ... "fraudulently published NAVs" ... made "price
adjustments" that "were arbitrary and did not reflect fair value" ...
"did not request" and "did not supply, supporting documentation" for
these price adjustments ... "Fund Accounting did not record which dealer
quotes had been overridden at Kelsoe's instruction." The list keeps
going.
"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," - Robert Khuzami, Director of the SEC's Division
of Enforcement
The long of it is that
there was horrifically lax internal oversight, secondary accountants /
auditors proved shameful at best and although Morgan Keegan itself was
allegedly unaware of this rampant fraud, they knew that the holdings
within these bond funds were complete and utter crap. If only that were the end of it.
"This misconduct masked from investors the true impact of
the
subprime mortgage meltdown on these funds." - William Hicks, Associate
Director in the SEC's Atlanta Regional Office
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 the 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 comprised 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.
The bark: Mary
Shapiro's opening statement at today's SEC Open Meeting.
" Today, we are considering a recommendation that the Commission
approve for public comment proposed rules that would fundamentally
revise the regulatory regime for asset-backed securities.
The proposed rules are intended to better protect investors in the
securitization market by giving them more detailed information about
pooled assets, more time to make their investment decisions, and the
benefits of better alignment of the interests of issuers and investors
through a retention or "skin in the game" requirement. Finally, the
rules would bring greater transparency to the private market as well.
As we know all too well, securitization — that is, the buying and
bundling of assets such as housing, student or commercial loans into
securities that are then sold to investors — played a central role in
the financial crisis. Like most investment products, securitization has
both its positive and negative attributes.
At one time, the securitization market provided trillions of dollars
of liquidity to virtually every sector of the economy. This enabled
lenders to make loans and credit available to a wide range of borrowers
and companies seeking financing.
But, securitization has also fostered poor lending practices by
encouraging lenders to shift their risk of loss to investors. In the
area of mortgage-backed securities, sound underwriting practices
sometimes took a back seat to immediate profits. When poorly
underwritten mortgages began to default, the securities backed by the
mortgages lost their value. Investors suffered significant losses, and
have consequently largely withdrawn from the market.
During the past year, we have worked hard to better understand the
practices that contributed to the financial crisis, and to identify ways
to prevent reoccurrence in the future. We — along with other financial
regulators — have looked closely at ABS oversight both in the public
and private markets for these instruments, and have concluded that we
can and must do a better job of protecting investors.
The release that the Commission is considering today is the result of
our comprehensive reevaluation of existing rules, and our conclusion
that three fundamental things need to change in order to better protect
investors and promote more efficient asset-backed securities markets.
First, investors must have better information about the pooled assets
that "back" these securities. This information must be both granular
and current enough to provide investors the data they need to accurately
assess risk and value. It also must be provided in a manner, and
within a timeframe, so that investors can access and use the
information effectively.
Second, the interests of organizations that issue and sponsor these
securities must be better aligned with the interests of investors.
And third, we must consider the impact that more rigorous rules for
the public ABS market will have on the private ABS market, and make sure
that we are not simply moving tomorrow's problems into a less
regulated area.
There are likely many avenues to address these macro objectives. As
staff will explain in more detail in a moment, the release proposes to
address these issues in a number of specific ways.
First, to provide investors with better, more timely and usable
information, the proposal would require ABS issuers to file with the
Commission standardized information about the specific loans in the
pool, allowing investors to better understand their investment. This
"loan level information" would be required at the time that the asset is
securitized and on an ongoing basis.
Additionally, these issuers would be required to file on the SEC Web
site a computer program of the contractual cash flow provisions, or
"waterfall." The waterfall is essentially the rules that dictate how the
borrowers' loan payments are distributed to investors in the ABS, how
losses or lack of payment on those loans is divided among the
investors, and when administrative expenses (such as servicing fees),
are paid to service providers.
This computer program could be used to analyze the loan level
information and would give investors and the markets better tools to
analyze asset-backed securities.
And lastly in this area, the proposal would for the first time give
investors a minimum period of time — specifically five business days —
to consider transaction-specific information, including the loan level
data, before an ABS investment decision needs to be made.
Second, to better align interests — as well as improve the quality of
securities that are offered through the shelf registration process —
the proposal would remove references to the ABS' credit rating as an
eligibility requirement for shelf registration, replacing this instead
with four new eligibility criteria:
The chief executive officer of the ABS depositor would need to
certify that the assets have characteristics that provide a reasonable
basis to believe that they will produce cash flows as described in the
prospectus.The ABS sponsor would be required to retain five percent of the
securitization, net of the sponsor's hedging, to ensure that the
sponsor — like investors — has "skin in the game."The ABS issuer also would be required to provide a mechanism
whereby the investors could confirm that the assets comply with the
issuer's representations and warranties, such as representations and
warranties that the loans in the ABS pool were underwritten in a manner
consistent with the lenders' underwriting standards.The ABS issuer would have to agree to file Exchange Act reports
with the Commission on an ongoing basis (rather than discontinuing
reporting with the Commission in the first year, which the Exchange Act
currently permits many ABS issuers to do).And lastly, we need to re-examine the assumption, in light of the
financial crisis, that sophisticated investors do not need the types of
protections that come with registration under the Securities Act.
Further, as we make improvements to the disclosure provisions which
apply in the public markets, we also must address the potential that
these changes will further drive ABS transactions to the private
structured products markets where some types of asset-backed securities
(such as collateralized debt obligations) are sold.
As a result, we are proposing that when an SEC safe harbor is relied
upon for the unregistered sale of securities (for example, under Rule
144A or Regulation D), the issuers would have to provide investors, upon
request, the same information that would be required if the offering
were in the public markets. This information would need to be provided
at the time of the offering and on an ongoing basis.
The proposal also would require that an ABS issuer file a public
notice of the initial placement of securities to be sold under
Securities Act Rule 144A. This notice would require information tailored
to ABS offerings and be publicly filed with the SEC in its EDGAR
database. Form D, the notice of an offering made in reliance on
Regulation D, also would be revised to collect information on structured
finance products.
This release represents a fundamental revision to the way in which
the ABS market would be regulated. I think changes are both necessary
and critical components of restoring investor confidence. The 90-day
comment period will provide an important opportunity for market
participants to weigh in on the judgment calls that we have
preliminarily made.
During this time, I have also asked our staff to continue to work
with other financial regulators — the FDIC, the Fed, Treasury and the
President's Working Group — to ensure that our work in this area is
fully informed by the activities of our regulatory colleagues. "
The bite: FINRA slapping
Morgan Keegan silly and seeking "the disgorgement of all ill-gotten
profits and full restitution for affected investors."
The juicy details: from today's SEC filing.
C. THE FRAUDULENT SCHEME
Overview
11. During various periods between at least January 2007 and July 2007,
the daily net asset value3 (“NAV”) of each of the Funds was materially
inflated as a result of the fraudulent conduct of Respondents. Kelsoe,
an employee of Morgan Asset and Morgan Keegan, was the portfolio manager
for the Funds. Weller was an officer and treasurer of the Funds and
signed and certified their periodic reports to the Commission.
13. The Funds’ valuation policies and procedures required that
dealer quotes be obtained for certain securities. Unbeknownst to Fund
Accounting and the Funds’ independent auditor (“Independent Auditor”),
Kelsoe actively screened and manipulated the dealer quotes that Fund
Accounting and the Independent Auditor obtained from at least one
broker-dealer. Kelsoe also failed to advise Fund Accounting or the
Funds’ Boards of Directors when he received information indicating that
the Funds’ prices for certain securities should be reduced.
14. Each Fund held securities backed by subprime mortgages, and the
market for such securities deteriorated in the first half of 2007.
Kelsoe’s actions fraudulently forestalled declines in the NAVs of the
Funds that would have occurred as a result of the deteriorating market,
absent his intervention. Morgan Keegan fraudulently published NAVs for
the Funds without following procedures reasonably designed to determine
that the NAVs were accurate.
19. Between at least January 2007 and July 2007, Kelsoe had his
assistant send approximately 262 “price adjustments” to Fund Accounting.
These adjustments were contained in approximately 40 emails sent by the
assistant to a staff accountant in Fund Accounting who calculated the
Funds’ NAVs. The adjustments were communications by Kelsoe to Fund
Accounting concerning the price of specific portfolio securities. In
many instances, these adjustments were arbitrary and did not reflect
fair value.
21. Kelsoe knew his prices were being used to compute the Funds’
NAVs. Among other things, he received bi-weekly reports on the Funds’
holdings and their prices which, by comparison with previous reports,
indicated that his price adjustments were being used and were directly
affecting the NAVs.
22. Fund Accounting did not request, and Kelsoe did not supply,
supporting documentation for his price adjustments. Fund Accounting and
the Funds did not record which securities had been assigned prices by
Kelsoe.
24. When month-end dealer quotes were received by Fund Accounting,
an employee of Fund Accounting performed a cursory review to estimate
whether they contained any securities prices that varied from current
portfolio prices by more than five percent. If so, then Kelsoe
determined whether the current price should be maintained or a new
price—which may or may not have been the price given by the
broker-dealer—should be assigned to the security. Thus, Fund Accounting
routinely allowed Kelsoe to determine whether dealer quotes were used or
ignored.
25. Fund Accounting did not record which dealer quotes had been
overridden at Kelsoe’s instruction.
26. Weller was the head of Fund Accounting and a member of the
Valuation Committee. He knew, or was highly reckless in not knowing, of
the deficiencies in the implementation of valuation procedures set forth
above, and did nothing to remedy them or otherwise to make sure
fair-valued securities were accurately priced and the Funds’ NAVs were
accurately calculated. Among other things, Weller knew that: (i) the
Valuation Committee did not supervise Fund Accounting’s application of
the valuation factors; (ii) Kelsoe was supplying fair value price
adjustments for specific securities to Fund Accounting; (iii) the
members of the Valuation Committee did not know which securities Kelsoe
supplied fair values for or what those fair values were, and did not
receive supporting documentation for those values; and (iv) the only
pricing test regularly applied by the Valuation Committee was the “look
back” test, which compared the sales price of any security sold by a
Fund to the valuation of that security used in the NAV calculation for
the five business days preceding the sale. The test only covered
securities after they were sold; thus, at any given time, the Valuation
Committee never knew how many securities’ prices could ultimately be
validated by it. Weller nevertheless signed the Funds’ annual and
semi-annual financial reports on Forms N-CSR, filed with the Commission,
including certifications pursuant to Sections 302 and 906 of the
Sarbanes-Oxley Act of 2002.
27. Morgan Keegan, acting through Weller and Fund Accounting, failed
to employ reasonable procedures to price the Funds’ portfolio
securities and, as a result of that failure, did not calculate accurate
NAVs for the Funds. Despite these failures, Morgan Keegan recklessly
published daily NAVs of the Funds which it could not know were accurate
and, as distributor of the Funds’ shares, sold shares to investors based
on those NAVs.
Kelsoe's Fraudulent
Manipulation of the Funds' Securities Prices
28. Between at least January 2007 and July 2007, Kelsoe manipulated
the dealer quotes obtained from at least one broker-dealer (“the
Submitting Firm”). At about the time Fund Accounting or the Independent
Auditor sent requests for dealer quotes to the Submitting Firm, Kelsoe
would confer by e-mail or phone with his contact there (the “Salesman”)
regarding the quotes. Among other times, Kelsoe had such conversations
concerning the month-end quotes for December 31, 2006, February 28,
2007, and March 31, 2007.
29. In some instances, even after causing the Submitting Firm to
increase its quotes, Kelsoe subsequently provided price adjustments to
Fund Accounting that were higher than even the Submitting Firm’s
increased quotes. These adjustments were not consistent with the Funds’
procedures. Kelsoe and the Salesman also discussed, and the Submitting
Firm frequently provided, interim quotes that were lower than the prices
at which the Funds were valuing certain bonds, but higher than the
initial quotes that the Submitting Firm had intended to provide. The
interim quotes were accommodations to Kelsoe to enable him to avoid
marking down the securities to the fair value in one adjustment. Kelsoe
knew that the interim quotes did not reflect fair value, that the
Submitting Firm would provide lower quotes in response to future pricing
validation requests, and that he would be required to mark down the
securities over time, but he did not disclose that information to Fund
Accounting, the Funds’ Boards of Directors or the Independent Auditor.
30. For example, on April 25, 2007, the Salesman and Kelsoe spoke by
phone about dealer quotes that would be submitted in connection with
the March 31, 2007 audit by the Independent Auditor. The Salesman then
told Kelsoe that the Submitting Firm’s trading desk had priced down many
of the bonds in the Funds. Kelsoe asked the Salesman not to provide low
dealer quotes that reflected actual bid prices.
31. As a result of the conversation, on April 30, 2007, the
Submitting Firm provided quotes to the Independent Auditor reflecting
interim prices for certain bonds, which were higher than the quotes the
Submitting Firm originally intended to supply, but lower than the Funds’
then current values. For example, the Submitting Firm priced down one
bond (“the Long Beach bond”) from the previous confirmation price of $81
to $65 as an “interim” step. This interim reduction to $65 was
approximately half of the mark-down to $50 that the Submitting Firm’s
trading desk initially had told the Salesman to communicate to the
Independent Auditor for the Long Beach bond. On April 26, 2007, Kelsoe
sent a price adjustment to Fund Accounting marking down the price of the
Long Beach bond from $78, the price at which the Funds’ were valuing
the bond at that time, to $72. Fund Accounting promptly entered the $72
price, which was substantially higher than fair value, into the
spreadsheet used to calculate the Funds’ NAV.
32. The Submitting Firm also refrained from submitting certain
quotes to Fund Accounting, where the quotes would have been lower than
the current valuations being used by the Funds, as the result of
conversations between Kelsoe and the Salesman.
33. Kelsoe did not disclose to Fund Accounting or the Funds’ Boards
that he had received quotes from the Submitting Firm which were lower
than the current valuations recorded by the Funds, and that the
Submitting Firm had refrained from submitting quotes to Fund Accounting
or had submitted quotes at higher prices than it had originally planned.
Kelsoe also did not disclose that he caused the Submitting Firm to
alter or withhold quotes.
Misrepresentations to
Investors and the Funds’ Boards of Directors
40. Kelsoe also made fraudulent misrepresentations and omissions of
material fact directly to the Funds’ investors concerning the Funds’
performance. Specifically, in each of the Funds annual and semi-annual
reports filed with the Commission on Forms N-CSR during the relevant
period (including, among others, the Annual Report for the Morgan Keegan
Select Fund, Inc. for the year-ended June 30, 2007 filed with the
Commission on October 4, 2007), Kelsoe included a signed letter to
investors reporting on the Funds’ performance “based on net asset
value.” Given his actions to manipulate the Funds’ NAVs, Kelsoe knew the
performance he reported was materially misstated. Kelsoe and, through
him, Morgan Asset made untrue statements of material fact concerning the
Funds’ performance in the Funds’ annual and semiannual reports filed
with the Commission on Forms N-CSR. Morgan Asset, through Kelsoe, also
defrauded the Funds by providing a quarterly valuation packet reflecting
inflated prices for certain securities to the Funds’ Boards, failing to
disclose to the Funds’ Boards information indicating that the Funds’
NAVs were inflated, and that Kelsoe was actively screening and
manipulating dealer quotes and providing Fund Accounting with
unsubstantiated price adjustments. In addition, the prospectuses
described Morgan Asset as responsible for fair valuation of the Funds’
portfolios.
»
- advertisements -
Somebody wasn't getting their proper cut...
"13. The Funds’ valuation policies and procedures required that dealer quotes be obtained for certain securities. Unbeknownst to Fund Accounting and the Funds’ independent auditor (“Independent Auditor”), Kelsoe actively screened and manipulated the dealer quotes that Fund Accounting and the Independent Auditor obtained from at least one broker-dealer. Kelsoe also failed to advise Fund Accounting or the Funds’ Boards of Directors when he received information indicating that the Funds’ prices for certain securities should be reduced."
Anyone see any similarities to action in Treasury notes and bonds immediately pre- and post-auction? It may seem a stretch at first blush, but maybe not on second.
"40. Kelsoe also made fraudulent misrepresentations and omissions of material fact directly to the Funds’ investors concerning the Funds’ performance. Specifically, in each of the Funds annual and semi-annual reports filed with the Commission on Forms N-CSR during the relevant period (including, among others, the Annual Report for the Morgan Keegan Select Fund, Inc. for the year-ended June 30, 2007 filed with the Commission on October 4, 2007), Kelsoe included a signed letter to investors reporting on the Funds’ performance “based on net asset value.” Given his actions to manipulate the Funds’ NAVs, Kelsoe knew the performance he reported was materially misstated."
No similarities at all to FASB's "extend and pretend" revisions....
Or while we are at it, could OMB's (and Congress') failure to date to bring now unlimited Freddie and Fannie backstops officially onto the Federal balance sheet, as well as future unfunded obligations, be considered "fraudulent misrepresentations and omissions of material fact...". They may not be breaking any laws on the books, but the action is absolutely criminal to the long-term well-being of this country.
Memphis has got to be one of the most corrupt cities in the country at every level of business and politics (as well as where they conjoin).
What a shiteshow it's gonna be soon enough there.
...geez, that means a Platinum Medal might be due to Memphis with all the AAA competition they face.
I suspect corruption is defined by local tastes and sensibilities. Like porno.
The two perps obviously bet their careers on a quick rebound. Too bad. The Emperor had no clothes.
So this means buy, buy, buy Regions Financial, right?
These Morgan Keegan guys were just sloppy street mutts. A professional con like Madoff kept a similar game going for decades.
A D- for lack of creativity and an F for leaving the extensive paper trail.
nice.
Wondered why that bozo from Morgan Keegan was on CNBS some days(weeks) ago.