U.S. securities regulators filed civil charges against eight board members of mutual funds run by Morgan Keegan, including one of the firm's founders, saying they failed to oversee managers who inaccurately priced toxic mortgage-backed assets leading up to the financial crisis.
The charges from the U.S. Securities and Exchange Commission on Monday against the firm's founder Allen Morgan Jr. and seven others marked a rare effort by the agency to hold the board of a mutual fund responsible for wrongdoing by its manager.
Such boards are supposed to represent the interests of the shareholders who own the funds - not those of a manager or sponsor. But the SEC has rarely held board members accountable when funds run into trouble, prompting criticism that the system of oversight is too weak.
The SEC said the eight former board members had violated laws requiring fund directors to help determine the fair value of securities when market quotations are not available. The directors delegated the responsibility to a valuation committee without "providing meaningful substantive guidance on how fair valuation determinations should be made," the SEC said.
Five of Morgan Keegan's bond funds had loaded up on mortgage-backed securities during the real estate bubble. But when prices started to drop in 2007, the funds mispriced the securities to hide large losses, the SEC said. The value of the funds ultimately plunged.
The directors also made no meaningful effort to learn how the fair values were determined, the SEC added.
"Investors rely on board members to establish an accurate process for valuing their mutual fund investments," SEC Enforcement Director Robert Khuzami said. "Otherwise, they are left in the dark about the value of their investments and handicapped in their ability to make informed decisions."
HOLDING DIRECTORS ACCOUNTABLE
Mercer Bullard, a University of Mississippi law professor and an advocate for fund investors, said the case was significant because the SEC has rarely pursued charges against mutual fund directors.
"The mere fact of charging the independent directors would reflect a fundamental shift in the SEC's investment-management enforcement strategy," Bullard said.
The case comes about 1 1/2 years after Morgan Keegan, now a unit of Raymond James Financial Inc, agreed to pay $200 million to settle fraud charges in a related case tied to the subprime mortgage crisis.
A star manager at the firm, James Kelsoe, also agreed to pay $500,000 in penalties and be barred from the securities industry for life.
The 2011 settlements with regulators included details of how Kelsoe used risky mortgage-backed securities to inflate his funds' values.
Neither the brokerage nor Kelsoe admitted or denied the allegations.
The seven other board members charged by the SEC are Kenneth Alderman, W. Randall Pittman and Mary S. Stone of Birmingham, Alabama; Albert C. Johnson of Hoover, Alabama; Jack R. Blair and James Stillman R. McFadden of Germantown, Tennessee, and Archie W. Willis III of Memphis, Tennessee.
Attorneys for Alderman and Morgan, who lives in Memphis, could not be reached immediately. Lawyers f or the other defendants said they intended to fight the charges.
"The SEC has chosen to ignore a host of facts and circumstances which demonstrate that these directors at all times acted diligently and in good faith during the unprecedented market turmoil of 2007," the lawyers said in a statement.
Allen Morgan, Jr. co-founded Morgan Keegan in 1969 and served as its chairman and chief executive from its inception until 2003. In 2002, he was also chairman of the retail brokerage industry's trade group, then called the Securities Industry Association.
The SEC's charges against the board members could add fuel to a wave of litigation against the company, depending on the allegations and ultimate findings, lawyers say.
Morgan Keegan has faced more than 1,000 customer arbitration cases over the bond funds, which invested in risky mortgage-backed securities while being marketed as being safe. The funds later lost as much as 80 percent of their value as the subprime market imploded in 2007 and 2008. Some of those cases are still winding through the Financial Industry Regulatory Authority's arbitration system.
"It's a good development for people who still have cases remaining," said Andrew Stoltmann, a Chicago-based lawyer who has represented investors in arbitrations involving the funds. "It illustrates that the fraud went to the highest level of Morgan Keegan, including the directors and the named person of Morgan Keegan."
In October, Morgan Keegan and thousands of investors in a closed-end fund at issue agreed to a $62 million settlement, subject to court approval. Shares of closed-end funds represent a stake in a portfolio of securities. There are a fixed number of these shares so they don't offer the same liquidity as open-end funds' shares.
Other pending litigation includes a class action suit stemming from the open-ended, or conventional, funds at issue. All board members named in the SEC's action on Monday are also defendants in that case, according to the plaintiff's lawyer.
Regions Financial Corp, the former owner of Morgan Keegan, retained responsibility for the fund litigation.
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