The SEC resolved an action with Morgan Keegan and two of its officers based on the fraudulent pricing of subprime real estate mortgage backed securities. In the Matter of Morgan Asset Management, Inc., Adm. Proc. File No. 3-14847 (June 22, 2011). The action was brought in coordination with FINRA and a task force of state regulators from Alabama, Kentucky, Mississippi, Tennessee and South Carolina.
The proceeding named as Respondents: Morgan Asset Management Inc., a registered investment adviser; Morgan Keegan & Co., Inc., a registered broker dealer; James Kelsoe, the senior portfolio manager for Morgan Asset; and Joseph Weller, Morgan Keegan’s Controller and the head of its Fund Accounting Department reported to him. The order alleged violations of Investment Company Act Section 34(b) and Advisers Act Sections 206(1), 206(2) and 206(4) and related rules.
Morgan Asset, through Mr. Kelsoe as Portfolio Manger, managed several Funds from late 2004 through mid 2008. These Funds held varying amounts of securities backed by subprime mortgages. Many of those securities lacked readily available market quotations. Accordingly the Investment Company Act required that they be priced by the Funds’ Board of Directors using fair value methods.
In filings made with the SEC, the Funds stated that the fair value of the securities would be determined by Morgan Asset’s Valuation Committee using procedures adopted by their board of directors. Those valuation procedures required that the securities be valued in good faith by the Valuation Committee. A series of general and specific factors were to be considered. One factor was broker-dealer price confirmations. The prices in those conformations could only be overridden if there was a reasonable basis to believe they were not accurate. If that step was taken the reasons for the override were required to be documented.
In fact the Funds delegated the responsibility for determining fair value to Morgan Keegan which primarily staffed the Valuation Committee. According to the Order, neither Morgan Keegan nor the Valuation Committee reasonably satisfied their responsibilities under the Funds’ procedures.
Morgan Asset adopted its own procedures to determine fair value to assign to portfolio securities and to validate those values periodically. Those procedures required that each quarter a list of fair value securities be furnished to the board with explanatory notes for their review. Morgan Asset failed to fully implement this provision.
As the subprime market declined in the first half of 2007 Mr. Kelsoe furnished Fund Accounting with price adjustments to various portfolio securities. In some instances in making these price adjustments Mr. Kelso ignored broker dealer price confirmations. The reason for these actions was not documented. With regard to one broker dealer Mr. Kelsoe is alleged to have “screened” the price quotes. Some of his price adjustments were higher than the prices obtained from broker dealers. Ultimately many of his price adjustments were arbitrary and did not reflect fair value according to the Order. As a result of these actions Mr. Kelsoe fraudulently prevented a reduction in the NAVs of the funds according to the Order.
Mr. Weller, as a member of the Valuation Committee, knew, or was reckless in not knowing, that the valuation policies were not being properly implemented. He failed to take steps to correct these deficiencies. Indeed, Morgan Keegan largely failed to implement the Funds’ valuation policies. As a result Morgan Keegan did not calculate current NAV for the Funds. Nevertheless, the firm published daily NAVs of the Funds. Shares were sold and redeemed based on those NAVs despite the fact that Morgan Keegan did not know if they were accurate.
Each of the Respondents settled the action. Under the terms of the settlements:
- Morgan Keegan was censured and a cease and desist order was entered based on Section 34(b) of the Investment Company Act. The firm will jointly and severally, along with Morgan Asset, disgorge $20,500,000 along with prejudgment interest and pay a civil penalty of $75 million to the SEC. The firm agreed to implement a series of undertakings as part of the settlement. In addition, the firm is paying $100 million into a state fund for investors.
- Morgan Assets was also censured and a cease and desist order was entered based on Sections 206(1), (2) and (40 of the Advisers Act and Section 34(b) of the Investment Company Act. The firm also agreed to implement a series of undertakings.
- Respondent Weller was ordered to cease and desist with respect to Rules 22c-1 and 38a-1 of the Investment Company Act. He was also suspended from association in a supervisory capacity in the industry and from participating in any penny stock offering for twelve months. In addition, he is denied the privilege of appearing and practicing before the Commission as an accountant with a right to reapply after two years. Mr. Weller also agreed to pay a civil penalty of $50,000.
- Respondent Kelsoe was ordered to cease and desist with respect to Sections 206(1), (2) and (4) of the Advisers Act and Section 34(b) of the Investment Company Act. He was also barred from the industry and from participating in any penny stock offering. Mr. Kelsoe will pay a civil penalty of $250,000 to the SEC and $500,000 in penalties overall.
The disgorgement, prejudgment interest and penalties paid to the SEC will be paid into a Fair Fund for investors.