On June 13, 2013, the SEC settled enforcement proceedings against eight former directors, including six independent directors, of five registered investment companies advised by Morgan Asset Management, Inc. (Morgan Keegan). The SEC’s order instituting enforcement proceedings (Original Order), brought on December 10, 2012, alleged that the directors failed to satisfy their statutory obligations with respect to the fair valuation of mortgage-backed securities held by the funds. The June 13 settled order (Settled Order) found that the directors delegated their asset-pricing responsibilities to Morgan Keegan without giving adequate guidance on how fair valuations should be made or ascertaining how fair values were determined. The SEC’s settlement with the directors follows a related $200 million settlement by Morgan Keegan with the SEC, state regulators and FINRA in 2011.

The Original Order stated that between January 2007 and August 2007, a significant portion (in some cases up to 60%) of the funds’ portfolios contained below-investment grade debt securities, including a large number of securitized products backed by subprime mortgages, for which market quotations were not readily available. The Original Order noted that, pursuant to Section 2(a)(41)(B) of the 1940 Act, such securities were required to be valued at a fair value as determined in good faith by the directors. The SEC alleged that the process employed in making fair valuation determinations for the funds’ securities was deficient in many respects. The Original Order alleged that the directors did not know and did not inquire as to the manner in which Morgan Keegan was making fair value determinations for particular types of securities and did not receive information that would allow the directors to understand the methodology that was being used to fair value securities. The Original Order alleged that these failures were “particularly egregious” given that fair valued securities made up the majority of the funds’ net asset values.

The findings of the Settled Order generally followed the allegations of the Original Order; however, the SEC made several findings in the Settled Order that were not alleged in the Original Order. The Settled Order found that the valuation procedures did not require the directors to ratify any fair value determinations made by Morgan Keegan, and the directors did not ratify any such determinations. The Settled Order alleged that Morgan Keegan repeatedly accepted price adjustments from the portfolio manager, but the directors never provided any guidance as to how Morgan Keegan should evaluate the reasonableness of such adjustments. The Settled Order also discussed the directors’ statutory responsibilities with respect to determining the fair value of securities and reviewed SEC guidance with respect to securities valuation. The Settled Order stated that SEC guidance indicated that “the ultimate responsibility for determining fair value lies with a fund’s directors, and that this responsibility cannot be delegated away.”

The Original Order alleged that the directors caused the funds to violate the following rules under the 1940 Act: (1) for the open-end funds, Rule 22c-1 by redeeming and repurchasing securities at a price other than the current net asset value; (2) Rule 30a-3(a) by failing to maintain internal control over financial reporting; and (3) Rule 38a-1 by failing to adopt and implement meaningful fair-valuation methodologies and related procedures. The Original Order also alleged that, as a result of their conduct, the directors caused certain of the funds’ registration statements to contain statements that were false or misleading with respect to material facts or to omit material facts which were required to be stated in the registration statements. The Settled Order found only that the directors caused the funds to violate Rule 38a-1. The directors were ordered to cease and desist from committing or causing any violations and any future violations of that rule. The directors consented to the entry of the Settled Order without admitting or denying any of the findings.