Brian N. Smiley

(1) U.S. Attorneys Office for the Eastern District of New York (Brooklyn) – investigating Bear Stearns and UBS;

(2) U.S. Attorneys Office for the Southern District of New York (Manhattan) – newly initiated investigation concerning activities of Merrill Lynch & Co.;

(3) Securities & Exchange Commission – thirty-six investigations involving such biggies as Merrill, UBS, Bear Stearns, Morgan Stanley, and Citigroup;

(4) FBI – investigating 14 companies for accounting fraud and insider trading;

(5) New York Attorney General – has issued subpoenas to Bear Stearns, Deutsch Bank, Morgan Stanley, Merrill Lynch and Lehman;

(6) Massachusetts Secretary of State - has sued Merrill Lynch over mortgage- backed securities sold to a municipality and is now probing Bear Stearns.

And that was just on Page C1! On Page C2, we learn that New York’s Attorney General, Andrew Cuomo, has blasted as mere “window dressing” the proposals of Moody’s and Standard & Poore’s to “improve” the manner in which they rate mortgage related bonds. These rating firms are squirming under heavy scrutiny for having given their highest ratings of creditworthiness to bonds backed largely by loans to uncreditworthy borrowers. And why would they do that? Cynics might suspect it has something to do with the fact that S&P and Moody’s get paid to rate the bonds by the people who issue them. Can you say “conflict of interest”?

Judging by the WSJ, I’d say we are about to enter an era of full employment for white-collar criminal defense lawyers. Times may be tougher for the poor investors who got stuck holding the bag when Wall Street’s tainted investments got sold to Main Street.

Brian N. Smiley

The Associated Press notes that, by posting significant fourth quarter losses, “Merrill Lynch joins rival Wall Street investment houses Morgan Stanley and Bear Stearns Cos. in posting losses in the last three months of fiscal 2007. Citigroup Inc., the nation’s largest bank, reported on Tuesday a quarterly loss of almost $10 billion, the largest in its 196-year history.” The article also noted that Merrill’s stock fell around 50% in 2007.

All of these companies are toying with layoffs, bailouts from foreign investors, and other uplifting alternatives. All of the companies point to the CDO and subprime debt debacle as the cause of their woes.

http://www.nytimes.com/aponline/business/AP-Earns-Merrill-Lynch.html?scp=5&sq=subprime

Read the story by the San Francisco Chronicle:

http://www.sfisonline.com/cgi-bin/article.cgi?f=/c/a/2008/01/03/BU42U86EG.DTL&hw=ultra&sn=010&sc=273

The Lehman Brother’s contingent “disputed the [claimant’s] accusation. ‘These clients had a professional investment consultant with whom we dealt… we believe we have meritorious defenses to this claim.’” In other words, the claimants sought securities over exposed in the subprime market.

As the true extent of the subprime debt crisis plays out, it is safe to expect many more situations where damages have been incurred.

Read the full story:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aMvCcBjj9w9M&refer=home#

The New York Times quotes Bernake in saying that “In the financial markets, the subprime shock ‘has contributed to a considerable increase in investor uncertainty,’ he reported, adding that the Fed is seeing ‘considerable evidence that the banks have become more restrictive in their lending to firms and households.” The extent of the subprime mortgage damage goes beyond investor uncertainty as many investors unknowingly purchased risky securities and suffered as a result.

http://www.nytimes.com/2008/01/11/business/11fed.html

Coleman Stipanovich supervised an investment fund for Florida’s school district until he resigned on December 4, 2007 and after school districts in Florida began panicking and pulling money out of his fund. Apparently, in July and August 2007, Stipanovich bought $842 million of mortgage-backed debt with taxpayer money. The securities defaulted within four months.

David Evans uncovered a consistent scheme of purchasing subprime laden debts. “As the subprime crisis unfolded around the world, Stipanovich and [pool manager] Lombardi increased their holdings of high-risk debt. They steadily reduced holdings of government securities in favor of higher-yielding—and riskier—commercial paper. In February 2007, London-based HSBC Holdings Plc, Europe’s largest bank by market value, reported it had losses of $1.8 billion more than expected on its U.S. subprime lending. In the same month, Lombardi bought the $400 million in Countrywide CDs.”

Florida’s funds suffered not only due to a consistent plan of purchasing high risk subprime securities but also from the predatory self-dealing of its managers.

http://www.bloomberg.com/news/marketsmag/mm_0208_story2.html

However, some funds suffered far more than the average losses, among them the Regions Morgan Keegan family of funds. “The worst-performing bond fund was the $190 million Regions Morgan Keegan Select High income, which plunged 59 percent because of losses tied to subprime mortgages” according to Bloomberg.com.

What can we learn from this? We know that these Morgan Keegan Funds were overexposed to subprime mortgages, and that their managers did not take the proper steps to mitigate the decline. Other bond funds were able to weather the subprime decline; the Regions Morgan Keegan funds were an exceptional case of mismanagement.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ainZkO4sUAtA

Andy Meek of The Daily News said the Indiana charity “was one of the first investors in the group of bloodied RMK funds to file a claim or lawsuit recently saying the funds’ volatility had not been fully disclosed.” Apparently, this is the case for many of the Regions Morgan Keegan Funds, most of which have suffered tremendously from the subprime mortgage fallout. In Memphis, further lawsuits have already been filed against the RMK Select Intermediate Bond Fund and the RMK Multisector Bond Fund.

The Morgan Keegan Funds were heavily laden with risky mortgage backed securities. Individual investors were not warned about the potential volatility of these funds. The RMK funds and their managers overexposed their funds to the subprime mortgage market, and the funds investors are bearing the losses from the mortgage fallout, and the managers should have been more responsible.

Read the full story:
http://www.memphisdailynews.com/Editorial/StoryLead.aspx?id=100438
http://www.memphisdailynews.com/Editorial/StoryLead.aspx?id=100478

The press release highlighted some specifics. “The complaint alleges that parts of the Funds’ portfolios have been invested in collateralized debt obligations (“CDOs”), including CDOs backed by subprime mortgages to higher-risk borrowers… As late of the summer of 2007, as the housing and credit crisis depended, MK Select and the RHY Fund continued to play down and conceal the Funds’ growing exposure to the problems in the subprime market.” It wasn’t until late in 2007 that the Regions Morgan Keegan fund managers fully admitted their risks in the face of the plummeting subprime market.

It is safe to assume that the Regions Morgan Keegan funds are not alone in their exposure to the subprime crisis. Mutual Funds, CDOs, and SIVs across the country bought up subprime debt with the promise of high returns while ignoring the inherent risks. Their casual disregard of the inherent volatility in the subprime mortgage market is sure to lead to further charges.

Read the Story:
http://markets.about.com/about?GUID=4148961&Page=MediaViewer&ChannelID=3191

SIVs are perhaps the most sinister investment vehicles. “SIVs finance themselves by selling asset-backed commercial paper, or short-term loans backed by collateral such as mortgages. When the subprime debt market blew up in August, investors stopped buying SIV commercial paper. As a result, in September and October, SIVs didn’t have the cash to pay debt holders of more than $8 billion of their paper.” These programs do not file with the SEC and do not publicly disclose financial statements. As a result, they can hide any and all risk associated with their investments.

State pension plans bought up SIVs and CDOs riddled with subprime debt and are now facing tremendous losses not only from market declines but from major default rates. As Bloomberg Markets David Evans says: “Until municipal fund managers learn to steer clear of traps like CDOs and SIVs, taxpayers’ money will be at risk—and it’s not likely anyone will tell them.” Taxpayers certainly aren’t the winners in the subprime mess.

http://www.bloomberg.com/news/marketsmag/mm_0108_story3.html

The answer, as most of us now know, is that the credit ratings were not the same, and many funds were overexposed to subprime mortgages with no warnings to their investors. For example, Evans and Tomlinson noted that “Corporate bonds rated Baa, the lowest Moody’s investment rating, had an average 2.2 percent default rate over five-year periods from 1983 to 2005… From 1993 to 2005, CDOs with the same Baa grade suffered five-year default rates of 24 percent.” Were these CDO ratings a mistake? Did the rating services really not know of the subprime risk? Or was something else at stake?

Evans and Tomlinson looked into the rating companies themselves and found that “[i]n the past three years, S&P, Moody’s and Fitch have made more money from evaluating structured finance—which includes CDOs and asset-backed securities—than from rating anything else, including corporate and municipal bonds, according to their financial reports. The companies charge as much as three times more to rate CDOs than to analyze bonds.” Also, the ratings companies are typically paid by the issuers of debt.

The ratings companies are quick to point to their disclaimers, noting that investors should not rely on said ratings. In the end, many investors and brokers did. However, many fund managers who gathered up subprime securities should have known better.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ajD1HS5Dj_Ro
http://www.bloomberg.com/news/marketsmag/ratings.html

To illustrate how extremely out of place subprime debt is in money market funds, David Evans rounded up Bruce Bent, who is said to have created the first money market fund. Bent said, “ ‘[subprime debt] doesn’t have a place in money market funds. When I created the first money market fund, I said you have to have immediate liquidity, safety, and a reasonable rate of return.”’ CDOs backed with subprime mortgages are illiquid, risky, and defaulting.

Most major brokerages contend that they will not allow their money markets to default, and will infuse cash to ensure shares trade at $1 per share. Unfortunately, the appeal of an FDIC insured account is growing compared to any investment with CDOs and subprime debt.

http://www.bloomberg.com/news/marketsmag/mm_1007_story2.html

Bloomberg.com reports that “Morgan Keegan, with more than $7.4 billion in assets under management, said in an Aug. 30 SEC filing that three of its bond funds would delay semi-annual regulatory reports because ‘recent instability’ in fixed income markets required ‘a more extensive process’ to verify the values of certain securities. Of the three, Regions Morgan Keegan Select High Income Fund and Regions Morgan Keegan Select Intermediate Bond Fund have ‘experienced significant net redemptions,’ according to an Aug. 13 notice to investors. Should they need to sell securities to pay departing shareholders, getting a ‘fair’ price ‘may be difficult,’ the notice said.”

That notice can’t be encouraging to shareholders. It is understandable why they want to get out as fast as possible.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=avblNsmdksmY#