Morgan Keegan got hit Wednesday with enforcement actions from both FINRA and the Securities and Exchange Commission over several bond funds that have cost the firm millions of dollars in investor arbitration complaints.
The FINRA complaint alleges that during January 1, 2006 through Dec. 31, 2007, Memphis-based Morgan Keegan used “false and misleading sales materials” when it marketed and sold the seven bond funds to retail investors. The complaint also states that “all of the funds invested heavily in structured products which caused them serious difficulties beginning in early 2007 and led to their collapse later that year, costing investors well over a billion dollars.” The complaint continued, saying: “The sales materials, combined with the firm’s misleading internal guidance and inadequate training, misled its own financial advisors.”
Jeffrey Erez, a lawyer from Sonn & Erez, who has filed several investor arbitration cases and recently scored a victory against the firm, believes these regulatory actions add credibility to complaints filed by customers.
The seven bond funds were the Regions Morgan Keegan Select Intermediate Bond Fund (the Intermediate fund), the Regions Morgan Keegan Select High Income Fund, the Regions Morgan Keegan Select Short Term Bond Fund, the RMK High Income Fund, the RMK Strategic Income Fund, the RMK Advantage Income Fund, and the RMK Multi-Sector High Income Fund.
FINRA’s complaint singled out Morgan Keegan’s intermediate bond fund in particular, calling it “a risky, contrarian fund.”
Investors weren’t made aware of the risks that the fund faced, FINRA said. “Morgan Keegan failed to take reasonable steps to ensure that its sales force was aware of and disclosed material risks of the intermediate fund to investors,” the complaint stated. But, “all the bond funds invested heavily in structured products, particularly inferior (subordinated) tranches of structured securities (including subprime products), to achieve greater returns.” But when the subprime crisis hit and hurt these bond funds “Morgan Keegan failed, in any 2007 sales materials related to any of the bond funds, to disclose these difficulties to customers or that a substantial portion of the bond funds’ portfolios were acutely affected by then-current economic conditions.”
FINRA even pointed to a May 15, 2007 email from Morgan Keegan’s director of investments to a firm broker. In the email the director “acknowledged the firm’s failure” about inadequate disclosure concerning the intermediate fund. The email allegedly stated: “‘What worries me about this bond fund is the tracking error and the potential risks associated with all that asset-based exposure. Mr. and Mrs. Jones don’t expect that kind of risk from their bond funds. The bond exposure is not supposed to be where you take risks. I’d bet that most of the people who hold that fund have no idea what’s [sic] it’s actually invested in. I’m just as sure that most of our FAs have no idea what’s in that fund either. If people are using [the intermediate fund] as their core, or only bond fund, I think it’s only a matter of time before we have some very unhappy investors.’”
The FINRA complaint said Morgan Keegan sold that intermediate fund to investors as their only bond fund and when it collapsed it led “hundreds of investors to file arbitrations against the firm.”
FINRA is seeking “disgorgement of all ill-gotten gains and full restitution for affected investors” in addition to unspecified fines.
Meanwhile, in a separate but related action, the SEC charged Morgan Keegan and Morgan Asset Management (its investment advisor arm) and two employees with fraud. James Kelsoe, 46, the portfolio manager of the funds, was named as in the SEC case as was Joseph Thompson Weller, 44, who served as the firm’s controller and head of its Fund Accounting Department.
The firm and employees allegedly overstated the value of securities backed by subprime mortgages, according the federal agency. The FINRA complaint focuses on the point of sale of investments, while the SEC action focuses on the valuations.
The SEC's division of enforcement said that Morgan Keegan failed to use “reasonable procedures to internally price the portfolio securities in five funds managed by Morgan Asset, and consequently did not calculate accurate ‘net asset values’ for the funds,” according to a press release.
Moreover, the company “recklessly published these inaccurate daily NAVs, and sold shares to investors based on the inflated prices,” according to the SEC.
Morgan Keegan responded to these allegations in an email to On Wall Street: “We have always held our obligations to our clients and to regulatory law with the utmost seriousness. In that context, we have cooperated fully with the investigations of the SEC, FINRA and the states for nearly three years. We are disappointed at the decision by these agencies and the states to bring charges, which we believe, are meritless and based upon erroneous hindsight analysis. We will vigorously refute these charges.”
In a previous response to an earlier story by On Wall Street, the firm said: “As of March 1, 2010, 81 cases have been heard by arbitration panels with 39 resulting in an outright dismissal of the claims. Overall in the 81 cases tried, claimants have sought approximately $49 million in compensatory damages and have received only $10.3 million in awards. Additionally, 118 cases seeking more than $25 million in damages have been abandoned by claimants.” The bond fund manager still works at Morgan Keegan but no longer manages the funds. The funds, themselves were sold to another firm and three open-end funds were shut down while four others have been renamed.
Recently, Morgan Keegan lost big in two arbitration cases. In one case, an arbitration panel awarded $2.5 million to one investor, Andrew M. Stein. The panel found Morgan Keegan liable for unsuitability, negligence and failure to supervise.
In another defeat, an 89-year-old, highly decorated World War II veteran won an arbitration award of $1.1 million. In that case, the FINRA panel found that Morgan Keegan misrepresented and failed to disclose the true nature of the RMK funds to companies owned by General Henry Cobb Jr.
Erez is Cobb’s lawyer and his firm has tried seven arbitration disputes, winning four, losing one and settling two cases, Erez says. The firm has another two-dozen arbitrations pending and picks up one or two more complaints a week, Erez said.
Morgan Keegan is a unit of Birmingham, Ala.-based Regions Financial Corp.
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