Weak regulation, poor oversight led to Morgan Keegan investors’ heavy losses [The Commercial Appeal, Memphis, Tenn.]
By Ted Evanoff, The Commercial Appeal, Memphis, Tenn. | |
McClatchy-Tribune Information Services |
Inside the Downtown tower worked dozens of groomed men and women in starched white shirts and trim dark skirts taking home
It was Chardonnay money.
Kelsoe pulled down buy-the-whole-vineyard pay --
He was the genius.
Then an estimated
Investors felt stunned, robbed and puzzled. How could a
This is the story of what went wrong. It mirrors the country's financial mess.
Kelsoe reigned amid feeble regulation outside the company and loose oversight inside, according to interviews with plaintiffs' lawyers, investors, brokers, former regulators and a reading of hundreds of pages of court and legal documents.
"Jim, for lack of a better word, was sort of an island out there," Anthony later told
Two sides
In 2007,
Much of what went on since has been widely reported: Two separate class-action lawsuits by investors are pending in
What happened before June is less well known.
"The board of directors, the regulators -- nobody did their job. If they had done it like they were supposed to do it,
So who is the culprit?
There's truth in both views.
'Leave him alone'
Let's say
Well, say
Would you buy them?
That's the difference.
He had a mathematical mind, a prickly style and he delivered profits.
A decade ago,
"Time and time again," Anthony told regulators, "I was told by Morgan and Edwards, ' leave Kelsoe alone, he's doing what we want him to do, he's also a little bit strange, he gets mad easy, leave him alone,' and I left him alone. I did what I was told to do."
Anthony was Kelsoe's boss, on paper.
The island
The mutual funds were lodged in a small business named
Anthony had hired on the year before. He'd taken charge of Regions' office servicing wealthy people.
In 2001, Regions put the Morgan Asset subsidiary in Carter's department. The new entity dropped the Regions name and kept the name
Anthony stayed in
"He was on my organization chart. He was on there merely as a formality. I didn't put him there," Anthony later said, noting
Kelsoe funds
Rock star, yes, but household name in the city? Not unless you frequented the exclusive
Plenty of
In 1992, not long after
Giovannetti later said he had spotted a rare talent. His start-up
For the asset rich, the big concern is preserving wealth. Hand him
Kelsoe did that for a long time.
Between 2000 and 2005, noted the
Nearly 8,000 mutual funds had opened in America, yet throughout
"I trusted
Not only country-club patrons sought out the Kelsoe funds. So did middle-class savers.
"It's amazing what we were told," said
Nabors' late mother,
"This was a retirement fund for an 80-year-old woman," Nabors said. "We were not high-risk people looking for high-income returns."
In 2008, Nabors recalls, he was shocked.
"We didn't see it as being completely drained until it was too late," Nabors said.
By then, of course, the rock star, son of a small-town
Tangled roots
It's not well remembered today, but investment pros flew high in the 1990s.
America's longest economic expansion ever was rolling along. Old ways toppled.
Set in motion were four currents that would collide and crater
-- Banks -- In
Weeks after the
In
Within days, former Goldman Sachs co-chairman
Within two years, Regions bought
-- Mutual funds -- Many corporate executives wanted to be rid of costly pension burdens. Financial firms ginned up mutual funds to take the tide of new cash. Steered to an alternative savings plan, called 401(k) after a financial law, Americans riding the economic boom doubled their mutual fund holdings to nearly
In
"We saw an opportunity in the market,"
-- U.S. courts -- Aiming at frivolous class-action lawsuits,
This tended to work against the interests of ordinary families. Criminal and civil charges in securities cases are generally considered tougher to prove under federal law.
Investment firms would become bolder.
--
Getting rich
Wholesalers like
Devaney's income, well, the
"Kelsoe was a huge customer of Devaney's," said
What was Kelsoe buying?
He was buying asset-backed bonds -- CDOs and CMOs.
Yes, it sounds like rocket science. It's not. A bond is like an IOU.
Take a bike shop in need of cash to fix the roof. Hat in hand, the owner goes to her brother-in-law. The relative hands over cash and gets back an IOU. The IOU says he gets her delivery truck if she fails to repay the money.
The shop has issued bonds backed by an asset -- the truck.
Of course, Kelsoe was buying more complex asset-backs cooked up on
Say the in-law sold the IOU to a bank. The bank puts the IOU in a box holding 1,000 other IOUs -- Harley motorcycle leases,
With a few legal strokes, the bank turns the box into a new bond called a CDO. Then the bank sells investors the right to collect cash flowing off the IOUs in the box.
That's what Kelsoe was buying. Clients would hand their money to
"This just got away from them," said a
Placing a bet
It's undoubtedly true that most people at
And it's likely, as investors and plaintiff's lawyers say,
Nor did many investors or sales people know the bulk of the assets in the mutual funds were identical CDOs and CMOs.
Yet, Kelsoe never hid what he was doing.
In 2004, investors handed over more than
For example,
Webster CDO 1 contained subprime mortgage loans that banks had made to borrowers with very low credit scores, according to financial analyst
Also stashed in
In 2006,
Major credit rating agencies such as
What could go wrong?
Bursting bubble
"We felt that housing was in a bubble; housing prices had appreciated too much and were likely to come down,"
Paulson spoke to the magazine in 2009, referring to 2005, when he was an obscure investor in
Back then, he had seen other investors avid for the high yields paid on CMOs and CDOs. Yet, home woes were stirring.
In 2005, the Federal Reserve cranked up interest rates. Millions of home loans carried flexible rates. People's mortgage rates would rise coast to coast.
Between
The
Paulson placed a bet. He bought insurance, the credit default swaps, on risky mortgage bonds.
A credit swap is like a bet in roulette. Two years later, the bet paid off. Paulson pocketed
U.S. Treasury Secretary
In
Once worth
Chagrined investors railed at
Yet, the Webster CDO and the
Even so, the Webster CDO melted in 2007. Indeed, most bond funds in the country were hard hit. What hit them was
The prominent
After mortgage loans defaulted in rising numbers in 2006, worried lenders' margin calls caught the hedge funds unprepared.
Unable to come up with cash for the huge margin calls,
The credit markets choked. Banks hoarded cash. Loans dried up. By 2008, big corporations like
The Webster CDO was backed by real assets -- houses, motorcycle leases, business loans and the like.
But no one could borrow enough cash to buy the bond. Its value plummeted through 2007 and 2008.
Inferior tranches
As the credit markets seized in 2007,
Jilted investors and their lawyers would later use her words in court to argue
Escue handled due diligence for
Just before
"Inferior tranches," she noted, infested the bonds.
Like the Webster CDO, the bonds were filled with IOUs.
Cash flow off these lowly IOUs might reward the bond owner with an 11 percent return, while a safe government bond delivered 6 percent.
That's why Kelsoe bought them. Low tranches spiced the returns in the mutual funds. But when times were bad, low-priority tranches dried up first while owners of the superior tranches kept drawing income.
Escue's report, in succinct banker jargon, had pointed that out.
'Uphill battle'
Early in 2007, Wealth Management dropped the Intermediate fund from its list of core investments recommended to clients. The Intermediate fund was relisted as a riskier "alternative" investment.
"Mr. & Mrs.
FAs were financial advisers. The sales force of FAs and brokers was spread out in cities in 20 states.
Wealth Management was only a small unit in
Small or not,
"I really think you have a big sell job on your hands, an uphill battle!" Hennek told Stringer.
Stringer's and Hennek's concerns were never disclosed to the sales force, Borg says in a court document, even after Stringer made a dramatic move in summer 2007.
No longer would Wealth Management recommend any Kelsoe fund for traditional clients or provide the usual reviews -- the due diligence performed by analysts like Escue.
The move puzzled some
"We can not go out and sell the models and state that we are providing all the due diligence on the funds in the models if we are actually not living by that statement?"
"You're making too much out of it," Stringer replied.
'Kelsoe assures'
Across the nation in mid-2007, investors could see prices falling daily.
"The funds will come back and when they do they won't let you back in,"
"Kelsoe assures the funds are safe," a client said her broker told her, according to another court document.
The sales force was getting worried, though.
"Where is the bottom of this pricing?"
"Jim thinks we are close to the end of repricing," Hines replied, adding, "I think this is a buying opportunity."
Prices dropped anyway. That fall,
"I think Jim's done about all he can do through this period," Edwards said, "and, you know, he's done it in a way that really exemplifies, you know, our commitment to doing the right thing for our customers."
Figuring prices
Despite the assurances, Kelsoe was scrambling.
One day he got
"What's more palatable?" replied Derby.
Derby was a managing director of
They were apparently talking about a bond's price.
No one was buying bonds. Credit markets were choked.
The bond was like a house in a town where no houses had changed hands. There was no good way of setting the fair value.
"What's an intermediate number that would make your life somewhat easier?" Derby asked.
The end
Within three years, the
The
Nothing was ever proved in court.
According to lawyers in the city,
The SEC settled the charges, accepting a
Among the individuals in the firm, Stringer faces fraud charges brought by
So does
No Regions executives were ever reprimanded.
"I am upset, but no, I am not angry," said
Like hundreds of other families and small investors in arbitration, Nabors is trying to claw back for the family in arbitration some of his mother's loss in that 2000s' craze -- asset backs.
Lastly, there's the genius of
--
___
(c)2011 The Commercial Appeal (Memphis, Tenn.)
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