The Securities and Exchange Commission (SEC) filed administrative proceedings against Morgan Keegan & Co. and Morgan Asset Management and two employees accused of fraudulently overstating the value of securities backed by subprime mortgages.
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 did not acccurately calculate the funds' net asset values (NAVs). Morgan Keegan recklessly published these inaccurate daily NAVs, and sold shares to investors based on the inflated prices, the SEC said.
"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," said Robert Khuzami, director of the SEC's division of enforcement.
"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, said.
The SEC's enforcement division alleges that James C. Kelsoe, Jr., the portfolio manager of the funds and an employee of Morgan Asset and Morgan Keegan, arbitrarily instructed the firm's fund accounting department to make "price adjustments" that increased the fair values of certain portfolio securities, according to the SEC's order instituting administrative proceedings,
The price adjustments did not take into account the lower values for those same securities quoted by different dealers as part of the pricing validation process. The enforcement division further alleges that Kelsoe actively screened and manipulated the pricing quotes from at least one broker-dealer.
The SEC said that with many of the funds' securities backed by subprime mortgages, Kelsoe's actions fraudulently prevented a reduction in the funds' NAVs that otherwise should have happened as a result of the the subprime securities market deterioration.
The SEC's division of enforcement also alleges that Joseph Thompson Weller, a CPA who was head of the fund accounting department and a member of the valuation committee, did nothing to remedy the deficiencies in Morgan Keegan's valuation procedures, nor did he make sure that fair-valued securities were being accurately priced and NAVs accurately calculated.
The SEC's order initiating proceedings stated that Morgan Keegan priced each portfolio's securities and calculated its daily NAV via its fund accounting department. An investment firm's NAV is its total assets minus its total liabilities. An investment company calculates the NAV of a single share by dividing its NAV by the number of shares that are outstanding.
According to the SEC's order, each fund held different amounts of securities backed by subprime mortgages and lacked readily available market quotations. Thus, the securities were internally priced using fair value methods to determine the amount that the funds would reasonably expect to get on a current sale of the security. In SEC filings, the funds stated that the securities' fair value would be determined by a valuation committee utilizing procedures adopted by the funds. The responsibility was essentially delegated to Morgan Keegan, the SEC said, which, togerther with the valuation committee, did not comply with the funds' procedures in many ways.
The SEC's division of enforcement alleges that from at least January 2007 to July 2007, Kelsoe had his assistant sent around 262 "price adjustments" to fund accounting. In many cases, these adjustments were arbitrary and did not reflect fair value. Inspite of the lack of any supporting documentation, Kelsoe's price adjustments were routinely entered into a spreadsheet used to calculate the funds' NAVs. Kelsoe also routinely instructed fund accounting to ignore month-end quotes from broker-dealers that were supposed to be used to validate the prices the firm had assigned to the funds' securities.
A hearing will be scheduled before an administrative law judge to know whether the respondents committed the alleged violations and to offer them an opportunity to defend the allegations. The hearing also will determine if any sanctions are appropriate in the public interest, and whether financial penalties should be imposed.