Criminal Charges Filed by SEC Against Memphis-based Firms Over Mortgage-backed Securities Fraud

Jack Humphrey, Regulatory journalist
June 23, 2011 /

The Securities and Exchange Commission has filed fraud charges against Morgan Keegan & Company and Morgan Asset Management over subprime mortgage-backed securities.

Last year, the SEC accused the Memphis-based firms, former portfolio manager James Kelsoe Jr., and comptroller Joseph Thompson of falsifying the valuation of subprime mortgage-backed securities in five funds managed by Morgan Asset Management from January 2007 to July 2007.

The criminal charges were filed one day after the American multinational banking firm JPMorgan agreed to pay $153.6 million to settle charges of misleading statements to investors in a complex mortgage securities transaction.

According to a settlement issued by the SEC, Morgan Keegan allegedly “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 added.

The enforcement action was taken together with the Financial Industry Regulatory Authority (FINRA) and a task force of state regulators from Alabama, Kentucky, Mississippi, Tennessee and South Carolina.

Robert Khuzami, Director of the SEC’s Division of Enforcement, said: “The falsification of fund values misrepresented critical information exactly when investors needed it most – when the subprime mortgage meltdown was impacting the funds.”

The complaint alleged that Morgan Keegan’s fund accounting department made arbitrary “price adjustments” to the fair values of certain portfolio securities under Kelsoe’s instruction, which ignored lower values for those same securities provided by outside broker-dealers as part of the pricing process.

This often lacked reasonable basis, the SEC added.

For instance, accounting personnel 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 when the price was lower than current portfolio values.

This resulted in Morgan Keegan failing to put price to those bonds at their current fair values during the interim days.

The SEC further found that Kelsoe “screened and influenced the price confirmations obtained from at least one broker-dealer.”

The broker-dealer was allegedly “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.”

Through interim price confirmations, the funds were able to prevent the marking down of 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,” the SEC claimed.

When subprime mortgage-backed securities deteriorated in 2007, Kelsoe fraudulently prevented a reduction in the NAVs of the funds that should otherwise have taken place, thanks to Morgan Keegan’s failure to employ the fair valuation policies and procedures adopted by the funds’ boards of directors to fair value the funds’ portfolio securities.

The settlement ordered Morgan Keegan to pay $25 million in disgorgement and interest and a $75 million penalty to the SEC to be placed into a Fair Fund for the benefit of investors harmed by the violations.

Further, Morgan Keegan will pay $100 million into a state fund that also will be distributed to investors.

The firms can no longer get involved in valuing fair valued securities on behalf of investment companies for three years.

Kelsoe agreed to pay $500,000 in penalties and be barred from the securities industry by the SEC, and Weller agreed to pay a penalty of $50,000.


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