There are a number of elements of the Morgan Keegan mutual fund fiasco that are plain outrageous. Start with making up prices for securities in a number of Morgan Keegan’s mutual funds. Continue with those made up prices often coming from the manager of the funds himself.
Yes, lying to investors is downright criminal and its good to see regulators from FINRA to the Securities and Exchange Commission go after the people involved. But to me, what is more troubling is an allegation put forth by four state regulators who also investigated what was going on with these funds – that the managers of these funds often bought securities that they never bothered to attempt to understand.
At the center of the case is James Kelsoe, who the SEC alleges deliberately inflated the value of subprime securities that were sitting in his fund’s portfolio in an attempt to hide the huge losses his funds were experiencing. These funds invested in the trash of the trash – subprime securities that were repackaged into even more highly leveraged securities. It is alleged in the SEC complaint that Kelsoe persuaded lower level accounting staff to adjust prices of securities in his portfolio at least 262 times.
Because these securities became so illiquid, mutual fund managers like Kelsoe were supposed to go to outside firms and get quotes from trading desks that they could use to place a value on the securities. In one example of the SEC complaint, a bond that was listed on Kelsoe’s books had been valued at $81. The trading desk originally said it was worth $50 but eventually agreed to supply a higher price – $65.
But what struck me was that Morgan Keegan was routinely buying securities without any knowledge of what these securities were (see the state regulators complaint and go to point 125.) Al Landers, a portfolio analyst for the funds, on numerous occasions asked for information about certain holdings “long after” the fund had bought them, according to the complaint.
One email from Landers to a trader in the structured finance group at Seaport Group tells it all:
“June 26, 2007. It looks like we bought Broderick CDO from you guys back in March. Do you have a mktg book for that and/or any of the offering docs. I’m trying to get a handle on how much subprime exposure we have in our CDOs…”
What prompted the email from Landers was questions from investors.
In another email Landers asks if one of the securities Morgan Keegan bought (Centurion VII) was a CLO? The answer was a hybrid CDO/CLO, mostly with U.S. investments but some European.
They not only bought securities in which they had no clue how much subprime (or the quality of it) were in them. They also bought securities not knowing exactly what it was – a collateralized debt obligation, which is repackaged (with leverage) asset-backed securities, or, a collateralized loan obligation, which is repackaged bank loans.
It is deplorable that mutual funds being billed as safe fixed-income securities were being fraudulently and negligently sold to individual investors who were looking for preservation of principal and a steady stream of income.
Whatever money people connected with these funds made (salaries and fund fees), it ought to be returned to the investors who lost billions of dollars.