Arkansas Business Journal, June 15, 2009 (Jamie Walden)
Arkansas investors who lost more than $2.5 million after investing in Regions Morgan Keegan high-yield bond funds are fighting, with varying degrees of success, to recover their losses.
At least seven Arkansans have already dragged Morgan Keegan into arbitration over investments in several Morgan Keegan funds, according to documents made public by the Financial Industry Regulatory Authority. FINRA, based in Washington, D.C., is an independent regulatory organization created in 2007 through the consolidation of the National Association of Securities Dealers and the regulation, enforcement and arbitration functions of the New York Stock Exchange.
One particular group of Arkansas investors in the RMK funds was, as of last week, ironing out the details of its impending arbitration. The group will claim a collective $1.5 million in losses from the funds.
The group includes the Ouachita Area Council Boy Scouts of America of Hot Springs, Westminster Presbyterian Church of Hot Springs and a Hot Springs engineering firm that declined to reveal its identity before arbitration. The group also included a family trust, some retirement accounts and a few other Arkansans who didn’t want to be named before the arbitration request was filed.
Several state residents have already won awards, some are still in arbitration limbo, and some have walked away empty-handed:
Little Rock gastroenterologist Dr. Louis Velez of St. Vincent Family Clinic went to bat against Morgan Keegan, claiming losses of $533,900. FINRA awarded him $75,000. His case was resolved last month.
Hot Springs Village resident Walter Drissel filed his claim in September, claiming more than $300,000 in compensatory damages. Drissel’s case has yet to be resolved.
Walter Morris, 87, of West Helena – a U.S. Navy veteran who fought in the 1945 Battle of Okinawa during World War II – has also filed a claim for about $70,000 that he lost from his mother’s trust in a Morgan Keegan fund. Morris’ case is still pending.
Harold and Georgia Sweet, two Maumelle retirees, claimed losses of $135,000 from the RMK funds. The Sweets received an $85,000 award, and their case was resolved in November.
Gertrude and Robert McLean, whose suit stretches back to October 2007, claimed a little over $25,000 in compensatory damages. When their case was resolved in October, the McLeans received no award.
Andrew Stoltmann, attorney for Harold and Georgia Sweet and head of Stoltmann Law Offices PC of Chicago, said these RMK cases are so complex that some attorneys require a learning curve. After two to four cases, he said, they begin winning arbitrations. Unfortunately, arbitration appeals are incredibly rare, he added.
Some attorneys representing investors say they don’t blame their clients’ individual Morgan Keegan brokers, who may well have been in the dark about the risks associated with the funds.
“We’ve got about 120 cases. And we’ve not sued a single broker,” said Dale Ledbetter, head of Ledbetter & Associates PA of Fort Lauderdale, Fla, and attorney for Morris, Drissel and the group case. “We think the brokers were victims of the higher-ups at Morgan Keegan.”
Ledbetter said his firm is even representing a few brokers in suits against Morgan Keegan, because they too had money in the funds.
Knowing that his own broker, Ryan Ehrhart, had invested in the funds helped persuade Drissel, of Hot Springs Village, to buy.
“The broker that I dealt with told me, ‘I’m keeping my money in it.’ He volunteered and said, ‘I’m keeping my family’s money in it,'” Drissel said. Marketing Nightmare
Funds that have been the subject of arbitration are the Regions Morgan Keegan High Income Fund, the RMK Advantage Income Fund, the RMK Multi-Sector High Income Fund and the RMK Strategic Income Fund. While the funds and the investment sizes vary, the issues are standard: Were the contents and risks of the funds misrepresented to clients and were the funds suitable for the clients to whom they were sold?
“These [funds] were derivative-laced, hedge fund-like investments that were portrayed to thousands of investors across the country as conservative, stable net-asset value bond funds,” Stoltmann said.
“Basically, the true risks of these funds were not made clear to investors. And these funds took a huge sector bet with highly illiquid investments. And, more egregiously, they were portrayed as conservative bond funds. And they were anything but,” Stoltmann said.
Ledbetter also claimed the portfolios contained derivatives. “A derivative is something that derives its cash flow from the performance of another instrument. And that’s what all of these were,” Ledbetter said.
Morgan Keegan, however, denies that the funds contained derivatives and that the funds were represented as conservative.
“There were a variety of different kinds of investments within these funds, but there were no pure derivatives,” said Kathy Ridley, corporate communications director at Morgan Keegan.
Ridley referred to the 2003 prospectus of the RMK High Income Fund that, among other warnings, says clients could lose some or all of their money in the fund, which exhibits “greater price volatility” and is “less liquid.”
Plaintiffs’ attorneys argue, however, that prospectus warnings don’t nullify marketing misrepresentation.
“The marketing pieces … say the fund is appropriate for clients with an investment objective of capital preservation,” Stoltmann said. “And there are representations made about the conservative credit nature of the holdings. And in reality, nothing could have been further from the truth.
“There were really risky speculative derivatives in these funds. And the true risks weren’t made known.”
Morgan Keegan can’t have it both ways, Stoltmann said.
“You don’t get a rely-on-the-prospectus defense when you have advertising and marketing materials portraying these things as safe and secure. It really was a classic bait-and-switch,” he said.
Stoltmann further argued that the prospectus only provides “general, boilerplate disclosures” that don’t detail the risk specific to those funds, which he said is required for the prospectus to be a legal defense.
“Obviously we disagree,” Ridley said. “And we believe the prospectus did clearly disclose this information.”
Stoltmann said the RMK funds were far more exposed to asset-backed and mortgage-backed securities than competing high-income funds. About 40 percent of the Morgan Keegan funds were invested in asset-backed securities – instruments backed by auto, home equity or student loans and the like – while another 30 percent was invested in mortgage-backed securities, Stoltmann said.
Meanwhile, peer funds generally had only about 3 percent in mortgage-backed and asset-backed securities combined.
“The way [these funds] were structured, quite frankly, it was almost inevitable in any sort of a liquidity or credit adjustment that they would go belly up,” Ledbetter said. “And they did.”
Attorneys say the marketing materials given to investors weren’t the only place the nature of the funds was misrepresented.
“For example, in a September 30, 2006 Annual Report, Morgan Keegan stated that ‘Bond funds tend to experience smaller fluctuations in value than stock funds,'” Sonn & Erez PLC, a Fort Lauderdale, Fla., law firm, said in a press release regarding the FINRA claim it filed on behalf of Dr. Louis Velez. “However, by September 20, 2007, Morgan Keegan revised its statements to read, ‘Investors in any bond fund should anticipate fluctuations in price,’ and removed its prior statement that stated that bond funds experience smaller fluctuations than stock funds. Morgan Keegan by its very own actions admits that its pre-September 2007 disclosures were inaccurate and misled investors and its own stockbrokers.”
(Exactly when each of the disgruntled investors bought into the RMK funds is not a matter of public record, but it was presumably before the summer of 2007, by which time the values had plummeted.)
Ridley, of Morgan Keegan, responded: “That change in disclosure was simply reflecting the change in the market circumstances, changes that were occurring in the market. Historically, bond funds have been less volatile than stock funds.”
Stoltmann said that Morgan Keegan reclassified some securities after the funds sustained major losses.
“We can now establish without any question, without any doubt, that Morgan Keegan was misclassifying securities as either preferred stocks or corporate bonds when in fact they were below-investment-grade derivatives,” Stoltmann said.
“After the funds had lost 75 percent of their value in March of ’08, Morgan Keegan goes back and reclassifies 10 to 15 percent of the same securities that last year they were saying were preferred stocks or corporate bonds. And after a 75 percent drop, they reclassify them as below investment-grade derivatives with huge losses in these securities,” Stoltmannadded.
Ridley responded: “There’s no universally accepted classifications, so, yes, there could have been some changes in the way they were classified.”
Ridley said she was not aware of any securities in the RMK funds being reclassified as derivatives.
Morgan Keegan has yet to relent on any case and doesn’t intend to do so, according to a statement in a press release.
“Overall results [of arbitrations] support our belief that there were no improprieties in the management of these Funds. We plan to continue a vigorous defense of all claims,” Niel Prosser, deputy general counsel for Morgan Keegan, said in a news release.
So far, Stoltmann said, between 300 and 400 cases have been filed in connection with the funds. However, he expects another 100 to 150 to be filed. And more are likely to come from Arkansans.
“Other than Alabama and Tennessee, I would say the third most populous state in terms of people financially devastated by these funds is Arkansas,” Stoltmann said.
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