Thursday, April 8, 2010

UPDATED: The Morgan Keegan Emails: A Smoking Gun?

Posted By on Thu, Apr 8, 2010 at 2:02 PM

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If there's a smoking gun in the fraud complaints filed this week against Morgan Keegan, it could be an email trail in which a key employee admits to "worries about this bond fund" and "the potential risks associated with all that asset-backed exposure."

The May, 2007 email from Gary Stringer to Roderick Hennek is one of the exhibits in an administrative complaint filed by several states Wednesday against the Memphis-based brokerage firm. Regulators say investors lost approximately $2 billion in Morgan Keegan bond funds that collapsed in 2008.

"Mr. and Mrs. Jones don't expect that kind of risk from their bond funds," wrote Stringer, a director of investments who was responsible for overseeing the due diligence performed on products including Morgan Keegan's "select list" of investment products that passed the company's screening tests. "The bond exposure is not supposed to be where you take risks. I'd bet that most of the people who hold that fund have no idea what it's actually invested in. I'm just as sure that most of our FAs (financial advisers) have no idea what's in that fund either."

What was in the fund were risky subprime mortgages that helped to cause the financial crisis that unfolded in 2008 and continues today.

Hennek responds in part, "I really think you have a big sell job on your hands, an uphill battle! Note I copied no one on this email."

The worried email from Stringer contrasts sharply with upbeat assessments in November, 2007, from Doug Edwards, who was CEO of Morgan Keegan at the time, and expressed full confidence in funds manager James Kelsoe Jr., who the SEC says "lied to investors."

"We all have the funds in our own accounts, and our managed accounts and we have confidence in Jim. If we didn't have confidence in Jim we wouldn't have money in those accounts . . . The company is committed to these funds. We've supported the funds through this period when liquidity has been tough. We have done as good a job as anybody in the business has."

In a prepared statement, Morgan Keegan spokesman Eric Bran said Wednesday, "We have always held our obligations to our clients and to regulatory law with the utmost seriousness. We are disappointed at the decision by these agencies and the states to bring charges which we believe are meritless and based upon erroneous hindsight analysis. We will vigorously refute these charges."

However, emails in the complaints tell another story. Kim Escue, a Morgan Keegan employee in the Wealth Management Services subsidiary, repeatedly tried to meet with Kelsoe in June, 2007, but he dodged her numerous times and refused to let her observe him at work and did not give her the information she sought. Escue recounts her frustrations in a long email included in the state regulators' complaint, which seeks to bar Morgan Keegan from doing business.

Escue produced "cursory" reports on the Kelsoe funds in 2006 which Morgan Keegan used in its marketing materials. But her more detailed 2007 report, including warnings about the funds and information about risky securities known as derivatives, was not released by the firm.

Here is an Escue email from July, 2007, shortly before the Wealth Management division sold 1.3 million shares in a Kelsoe fund without telling the general sales force.

"I assume they finally called me back because they know we have dropped coverage of proprietary products and that we will no longer need the info I have requested or comments from them. They have let me sit for nearly 3 weeks with no comments, feedback, or information that I have requested.
I called her back and she said that she just heard right after she sent the email. They were in no way going to continue providing us with information or allow us to do our due diligence. This was their way of trying to look like they were after the fact. She would not even stay on the phone with me for more than about 3 seconds. I told her that I was going to be calling today to let them know about Wealth Management dropping coverage of all proprietary products and she immediately said "I know, I just heard after I sent the email", I started to talk and she just let me go immediately. I have been stalled and put off since the get go on this and it is definitely in our best interest to drop coverage if we cannot do our regular due diligence."

The SEC charges received prominent national publicity in The New York Times, Wall Street Journal, and other financial publications. The Financial Industry Regulatory Authority (Finra) filed a companion complaint. Finra spokesman Herb Perone told the Memphis Flyer that approximately 1000 arbitration complaints have been filed against Morgan Keegan and that about 700 of them are currently in process. Some complaints that have gone to three-member arbitration panels have been successful, while some have not. Others have been settled or dropped.

Attorneys for investors will now have access to all of the exhibits, including potentially damning emails that might not previously have been turned over in the discovery process, in the Finra, SEC, and state regulators' complaints.

A Memphis attorney familiar with the workings of the SEC and Finra said their actions will make Morgan Keegan's job harder but that criminal action, like the indictments in the Stanford Financial case, are unlikely. Marty Aussenberg worked in the enforcement division of the SEC for five years in Washington. He is also an occasional guest columnist for the Memphis Flyer.

"I don't think you're going to see criminal proceedings," he said.

Finra is seeking unspecified fines, disgorgement of profits, and full restitution to Morgan Keegan investors, but that is far from a guarantee of getting their money back, Aussenberg said.

"It's possible at some point that investors may reap the benefit of these proceedings," he said. "Full restitution means they're going to try to get investors made whole. Could Regions Morgan Keegan survive a billion-dollar hit to their bottom line? I have no idea."

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