Bloomberg Names Regions Morgan Keegan As Worst Performing Bond Fund

On December 28, 2007 Bloomberg news reported:

"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.  It's managed by Jim Kelsoe at Morgan Asset Management Inc. in Memphis, Tennessee.

The Morgan Keegan bond mutual funds are "worst in class" at a time when the phrases "subprime crises" and subprime lending" have become household words and moved from the financial news to mainstream news.  In 2007, the funds lost 50 percent or more of their value, while other funds in their peer group either had positive returns or losses of 8 percent or less.

Of 439 other intermediate bond funds and 253 other high-income bond funds, none suffered losses of this magnitude.

 

Regulators Scrutinize Bear Hedge Fund Redemption

Federal regulators are investigation whether Bear Stearns hedge fund managers withdrew money from the now bankrupt funds shortly before the funds froze investor redemptions.

The Securities and Exchange Commission and United States Attorney are investigating reports that Ralph Cioffi, the Bear Stearns hedge fund manager, withdrew $2 million of his $6 million investment and invested it another Bear Stearns hedge fund.

In February 2007, investors began looking for the exits in an attempt to cut losses. They were blocked from doing so for months by Bear's asset management team, which continued to underplay the turmoil in the mortgage market, according to reports. At one time, the funds, including leverage, held approximately $35 billion in toxic debt.

Investors Suffer Losses in Morgan Keegan Bond Funds

Investors in various Morgan Keegan Bond Funds have suffered huge losses over recent months. Many of these Morgan Keegan Bond Funds have experienced losses in their net asset values of more than 50% since the beginning of 2007, most of these losses coming in the past five months.

Specifically, the following Morgan Keegan Bond Funds have been adversely impacted:

Regions Morgan Keegan Select High Income-A, (Sym: MKHIX), Year to Date Return a/o (12/14/07) –56.66 percent

Regions Morgan Keegan Select High Income-C, (Sym: RHICX), Year to Date Return a/o (12/14/07) –56.76 percent

Regions Morgan Keegan Select High Income-I, (Sym: RHIIX), Year to Date Return a/o (12/14/07) –56.56 percent

RMK High Income Fund, (NYSE: RMH), Year to Date Return a/o (12/14/07) –62.91 percent

RMK Strategic Income Fund, (NYSE: RSF), Year to Date Return a/o (12/14/07) –64.08 percent

Regions Morgan Keegan Select Intermediate Bond Fund-A, (Sym: MKIBX), Year to Date Return a/o (12/14/07) –47.84 percent

Regions Morgan Keegan Select Intermediate Bond Fund-C, (Sym: RIBCX), Year to Date Return a/o (12/14/07) –48.07 percent

Regions Morgan Keegan Select Intermediate Bond Fund-I, (Sym: RIBIX), Year to Date Return a/o (12/14/07) –47.72 percent

All of these funds are managed by Morgan Keegan Asset Management Inc. and James C. Kelsoe. The abysmal performance of these funds is largely attributable to management's decision to concentrate the funds' investments in high risk mortgage- backed securities and CDOs. Recent Bloomberg reports on these funds establish that mortgage-backed securities and CDOs constituted more than 50% of each funds portfolio. This investment strategy appears to have been highly imprudent in light of the many concerns about the mortgage-backed securities and CDO markets that existed in 2005 and 2006.

Indiana Charity Files Arbitration Claims Against Bond Fund Advisor Over Sub-Prime Losses

Last week, an Indiana charity that "makes wishes come true" for children with life threatening illnesses filed arbitration claims over sub-prime related losses it allegedly suffered in a bond fund managed by Regions Morgan Keegan.  The Indiana Children's Wish Find claimed that it lost $48,000 or 22% of its $220,000 investment in the Regions Morgan Keegan Select Intermediated Bond Fund.

The Wish Fund claims that it was misled by Morgan Keegan concerning the level of risk it assumed by investing in the fund.  According to the Wish Fund Regions Bank, an affiliate of Morgan Keegan suggested that the Wish Fund move money from it's money market account into the bond fund.  Regions Bank allegedly represented that the bond fund was an appropriate low risk alternative to a CD.  The Wish Fund alleged that the bond fund was heavily invested in risky-low rated mortgage debt.  

A $34 Billion Cash Fund to Close Up

Investors running for the exits have caused the closure of one of the largest U.S. short-term funds catering to institutional clients.

Columbia Management is shutting its Columbia Strategic Cash Portfolio, it told clients late last week, after facing major withdrawal requests from large investors. The fund, which held $34 billion at the end of November, has been split in two. Of the total, $21 billion has been put into accounts for the large investors who are seeking to cash out. An additional $12 billion remains in the fund, which will be wound down.

Columbia is a unit of Bank of America Corp., and Strategic Cash Portfolio was among its biggest products catering to institutional clients.

The fund's closure spotlights spreading uncertainty among investors as they yank money out of "enhanced" cash funds like Strategic Cash Portfolio. Funds like these are designed to carry slightly more risk than money-market funds, which are traditionally among the safest investments around.

Though Columbia isn't the only fund company struggling to navigate the credit-market turmoil, shutting such a sizable fund represents a black eye for the firm and for Bank of America.
Only some investors will be able to get their cash out. Several of the fund's biggest investors are being redeemed "in kind" -- that is, they have been given their share of the underlying securities, rather than a cash payment. Smaller shareholders can cash out at the fund's share price, which is currently 99.4 cents on the dollar. The fund required a minimum investment of $25 million.

It is the latest crisis not only at enhanced cash funds, but also traditional money-market funds. Two weeks ago, Florida state officials temporarily shuttered an enhanced cash fund after investors pulled out billions of dollars amid concerns about the quality of its investments.
Last month, GEAM Trust Enhanced Cash Fund, managed by GE Asset Management, lost value partly because of its investments in some asset-backed securities. That $5.6 billion fund let investors redeem their money at 96 cents for every dollar invested.

All of this reflects the pressure placed on fund managers by the turmoil in the credit markets.

"Originally, investors hoped they would be treated like money-fund investors and the [fund] advisers would back them" in case the portfolios suffer losses, says Peter Crane, of Crane Data, a research firm specializing in money funds and other short-term investments.

"But GE created the precedent, he says. "And the management company has every right to pass the losses through."

Chris Linehan, a GE spokesman, said "the investors in [GE Enhanced Cash Fund] understood that there could be volatility," he said.

A report yesterday by Standard & Poor's found that about 30 U.S.-oriented enhanced cash funds rated by S&P had lost a total of $20 billion, or 25%, of their assets, in the third quarter. In one of the more dramatic instances, one fund (which S&P declined to identify) saw its assets under management shrink by 98%, or $2.5 billion.

Even traditional money-market funds have felt pressure. In the past few months, at least a half-dozen financial institutions, including Bank of America, have taken steps such as buying the funds' troubled securities to protect their money funds. These include FAF Advisors Inc., a unit of U.S. Bancorp, Credit Suisse Group's Credit Suisse Asset Management and Wachovia Corp.'s Evergreen Investments.

Money-market funds are required to maintain an unchanging $1-per-share net asset value; if they waver from that they are said to "break the buck." Enhanced cash funds don't have the same requirement. Nevertheless, investors generally expect them not to lose principal value.

Enhanced cash funds have grown in popularity as investors sought slightly higher yields amid historically low interest rates. They achieved added returns partly by investing in complex securities backed in part by mortgages and other assets. However, many of these, even those with high credit ratings, have collapsed in price. Spooked by these problems, investors have been fleeing enhanced cash funds.

"This exodus put more downward selling pressure on securities and some [enhanced] funds were forced to sell, causing further stress," Standard & Poor's credit analyst Jaime Gitler said in a report yesterday.

Officials at Columbia declined to identify specific holdings in the Strategic Cash Portfolio. A spokesman said the fund had exposure to troubled investments known as structured investment vehicles in line with other enhanced cash funds.

Losses on some of the fund's investments led Bank of America to try to shore up the fund's portfolio before it was decided to close it down, according to a person familiar with the matter.

The decision by officials at Columbia Management to close Columbia Strategic Cash Portfolio came last week. The fund had suffered $1 billion in withdrawals since the start of the month and several large investors in the pool were seeking to redeem investments. In the past, investors were able to buy and sell shares of the fund at $1 per share. But by last week the value of the portfolio had sunk below $1 per share, so it was no longer possible to cash investors out at that price without inflicting losses on remaining shareholders.

This means, says Mr. Crane, that Columbia is telling the large investors that "if you want to sell something and take a loss, that's up to you."

The spokesman said approximately 90% of the fund's portfolio is investments carrying a rating of triple-A or double-A, the two highest-rating levels.

Bank analyst Jeff Harte of Sandler O'Neill & Partners described closing the fund as "not that big of a deal," since it was an enhanced fund marketed to sophisticated institutional investors. "If you're getting a premium yield, you're taking a premium risk," said Mr. Harte, who rates Bank of America a "hold."

Bank of America had been holding up Columbia Management as a bright spot in its growing wealth-management division. But troubles have been building within the group.

Last month, Bank of America disclosed that it would provide support of up to $300 million for an institutional cash fund, and a similar amount to a separate group of money-market funds that own troubled securities. While Bank of America didn't identify the affected fund at the time, people familiar with the matter now say it was Strategic Cash Portfolio. A Columbia spokesman said that in the firm's continuing dialogue with individual investors and advisers, it explains that the money-market funds aren't affected by what happened to the Strategic Cash product.

Continuing Subprime Woes: Issues With Short Term Money Market Funds

Columbia Management, a unit of Bank of America Corp., has closed its Strategic Cash Portfolio amid losses on asset-backed securities. According to the Wall Street Journal, the fund is currently valued at $12 billion, down from $40 billion just months ago. Bank of America closed this fund just weeks after announcing that it had set aside $600,000,000 to cover potential losses on its money market funds and an institutional cash management fund.

The Strategic Cash Portfolio, considered an enhanced money fund, was offered exclusively to high net worth individuals and institutional investors with at least $25 million or more. The enhanced fund was sold as an alternative to money-market funds, considered among the safest of all investments.

Investors, largely concerned with the crumbling subprime market, began pulling money out of the fund beginning in August 2007. Withdrawal requests continued until the fund was no longer able to sustain itself. Upon its closing, the fund’s share price was reported to be 99.4 cents on the dollar.

According to Bank of America, investors are left with two options. The largest investors will be redeemed “in kind”-given their share of the underlying securities in lieu of a cash payment. Smaller investors will be able to cash out at the 99.4 cents on the dollar current share price.

The Strategic Cash Portfolio is not the only enhanced money fund experiencing pressure from the continuing subprime crisis. Another enhanced money fund, the GEAM Trust Enhanced Cash Fund, managed by GE Asset Management, saw similar losses just a month ago due to investor concerns over the investments held by the fund. Investors in the GEAM fund were able redeem their position at 96 cents on the dollar.

Similarly, SEI, Wachovia/Evergreen Investments, Credit Suisse Asset Management, U.S. Bancorp/FAF Advisors, and Legg Mason separately announced that each had set aside funds or purchased losing investments from their funds to support their money market funds. Most have reported that such actions were necessitated by poor performing investments in special investment vehicles (“SIVs”).

If you are an investor in the Columbia Management Strategic Cash Portfolio, GEAM Trust Enhanced Cash Fund or a similar enhanced money fund, and have experienced significant investment losses, you may have legal claims to recoup your losses.

Bear Stearns hedge fund losses lead to arbitration claims

Arbitration claims were filed this week with Financial Industry Regulatory Authority (FINRA) by Aidikoff, Uhl & Bakhtiari, of Beverly Hills, California.

The Bear Stearns hedge fund at issue in the FINRA claims is the Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage (Overseas) Fund.

Three weeks ago, Massachusetts Secretary of State William Galvin charged Bear Stearns with improper trading in the failed hedge fund as well as the Bear Stearns High-Grade Structured Credit Strategies hedge fund. In late July, both funds filed for bankruptcy protection in theSouthern District of New York, wiping out nearly all investor capital.

According to Ryan Bakhtiari, of Aidikoff, Uhl & Bakhtiari, “Given Bear Stearns’ dominance in the mortgage backed securities underwriting market, they knew or should have known how much subprime exposure both of these hedge funds faced. We’re finding, in our investigation of these funds, that many investors in these funds simply were unaware of what was being held in their portfolios because it was not adequately disclosed.”

Massachusetts Charges Bear Stearns With Improper Trading with Two Failed Hedge Funds

On November 14, 2007, Secretary Galvin charged Bear Stearns with engaging in improper trading activities at two collapsed hedge funds.

Filed on behalf of Massachusetts investors in the funds, the suit charges Bear Stearns Asset Management traded mortgage-backed securities, collateralized debt obligations and other securities from its own account with hedge funds it advised without notifying the client funds independent directors as required, Galvin's office said in a press release.

The rules were designed to control conflicts of interest, but Bear Stearns Asset Management failed to train or oversee people who were supposed to obtain approvals from fund directors, Galvin claimed, violating state securities rules.

Losses at the two mortgage-related funds, the Bear Stearns High-Grade Structured Credit Strategies Fund and High-Grade Structured Enhanced Leverage Fund, cost investors $1.6 billion.

Bear Stearns Fund Seeks to Dissolve

A Bear Stearns investment fund hurt by the decline in the subprime mortgage market and facing creditors' complaints about its management asked a Delaware judge to allow it to dissolve and liquidate its assets.

Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund LP was linked to a Cayman Islands-based fund shutting down because of the collapse in value of investments tied to subprime mortgages, the investment firm's lawyers said Nov. 13 in a filing in Delaware Chancery Court in Wilmington. New York-based Bear Stearns is the fifth-largest U.S. securities firm by market value.

More than three months ago, Bear Stearns placed several hedge funds decimated by subprime mortgage losses in bankruptcy in the Cayman Islands. The company cited volatility in the subprime- lending market and subsequent margin calls for the July filings.

The world's largest financial institutions have written down more than $21 billion of mortgages, securities and corporate loans whose value fell during the third quarter. A surge in defaults of poor-quality home loans has prompted more than 110 mortgage companies to close, seek bankruptcy protection or put themselves up for sale since the start of 2006.

Top-Producing Independent Broker under Investigation

Frank Bluestein, one of the nation's top-producing independent brokers, is under investigation by Michigan securities regulators for allegedly placing clients in partnerships that stopped paying dividends.

Industry sources place Bluestein’s annual fees and commissions at close to $7 million. In the summer of 2007, he was ranked the fourth-largest independent-contractor registered representative, with $1 billion in client assets, by Registered Rep.

According to an attorney familiar with the investigation, 1,500 people invested in a series of private partnerships that paid monthly dividends that stopped about six months ago. Many of them invested through Bluestein over a period of three to ten years with investments ranging from $10,000 to $1 million. The partnerships have been described as investments in real estate and telephone and Internet leases to hotels.

Bluestein’s attorney said his client denies culpability and that the partnerships were offered by a colleague, Ed May. May has no comment. The attorney also claims Bluestein lost “substantial amounts” of his own money through bad investments.

Bluestein’s own practice, Maximum Financial Group, is based in Michigan and over the last decade, he has been affiliated with Gunn- Allen Financial Inc. in Florida, Questar Capital Corp. of Minnesota, and AXA Advisors LLC of New York. Last month, Bluestein resigned from GunnAllen and GunnAllen clarifies that they “did not authorize, endorse, sponsor, approve, sanction, participate or benefit in any way from this activity” and believes the activity was hidden from them. Meanwhile, Questar Capital said they have not received any from Michigan regulators and AXA Advisors has declined to comment on the investigation.

The Michigan Office of Financial and Insurance Services is investigating Bluestein but has not reveals further details or charged Mr. Bluestein in any lawsuits or complaints.

Federal Prosecutors Launch Probe of Bear Stearns Funds

Federal prosecutors have launched a criminal investigation into two Bear Stearns Cos. mortgage-related hedge funds that collapsed during the summer, according to people familiar with the matter.

The U.S. attorney in Brooklyn has made a request to Bear Stearns for information related to the hedge funds, whose failure cost investors $1.6 billion, said these people. The probe is in the early stages, the people added, and has not generated subpoenas.

The specter of a criminal investigation is clearly bad news for the embattled Wall Street firm, which is already under the microscope by the U.S. Securities and Exchange Commission. Thursday, two weeks after reporting an abysmal third quarter marred by broad declines in their asset-management and fixed-income operations, Bear officials tried to put a positive spin on the firm's future during an investor gathering at its New York City headquarters.

"Most of our businesses are beginning to rebound," said Bear Chief Executive James Cayne. Late in New York Stock Exchange trading Thursday, Bear shares closed 0.52% lower, at $127.61.
Bear's two funds, the High-Grade Structured Credit Strategies fund and a riskier sister vehicle known as the High-Grade Structured Credit Strategies Enhanced Leverage Fund, were launched in 2003 and 2006 respectively and managed by Ralph Cioffi, a former Bear mortgage salesman.

Until this past spring, the funds had enjoyed a series of up quarters. But when the market for subprime home loans, which catered to weak borrowers, turned south, so did many of the funds' holdings.

After protracted performance declines and margin calls from Wall Street lenders that could not be met, the funds were shuttered in July. It was around that time that federal prosecutors in Brooklyn took an interest in the matter, said one of the people familiar with the matter.

FINRA Board Approves Rule to Limit Motions to Dismiss in Arbitrations

The Financial Industry Regulatory Authority (FINRA) announced today that its Board of Governors approved rule amendments designed to limit significantly the number of dispositive motions - more commonly known as motions to dismiss -- filed in its arbitration forum and to impose strict sanctions against parties who engage in abusive motions practices.

"In many instances dispositive motions were being used to needlessly delay arbitration hearings, which resulted in investors not getting cases heard on a timely basis and incurring extra costs," said Linda Fienberg, President of FINRA Dispute Resolution. "We believe the proposed revisions will curb any abuses and ensure that investors maintain the right to have their arbitration claims heard."

Under FINRA's proposal, if a party (typically a respondent firm) files a dispositive motion before a claimant finishes presenting its case, the arbitration panel would be limited to three grounds on which to grant the motion: if the parties settled their dispute in writing; "factual impossibility," meaning the party could not have been associated with the conduct at issue; or the existing 6-year time limit on the submission of arbitration claims. The rule proposal also would require that arbitrators hold a hearing on such motions and that any decision to grant a motion to dismiss be unanimous, and be accompanied by a written explanation.

The proposed amendments also would require the panel to assess against the filing party all forum fees associated with hearings on dispositive motions if the panel denies the motion, and would require the panel to award costs and attorneys' fees to the party that opposed a dispositive motion deemed frivolous by the panel. Under the rule proposal, when a respondent files a dispositive motion after the conclusion of the claimant's case, the provisions above would not apply. However, the rule would not preclude the arbitrators from issuing an explanation or awarding costs or fees.

The rule amendments now go to the Securities and Exchange Commission for review and approval.

FINRA Dispute Resolution is the largest securities dispute resolution forum in the world. FINRA facilitates the efficient resolution of monetary, business and employment disputes between investors, securities firms and employees of securities firms by offering both arbitration and mediation services through a network of hearing locations across the United States. FINRA has a total of 73 hearing locations in all 50 states, Puerto Rico and London. For a complete list, see the FINRA Dispute Resolution map of regional offices and mediation hearing locations. To initiate a mediation or arbitration online or to find out more about FINRA Dispute Resolution forum, visit FINRA's Web Site www.finra.org.

FINRA, the Financial Industry Regulatory Authority, is the largest non-governmental regulator for all securities firms doing business in the United States. Created in 2007 through the consolidation of NASD and NYSE Member Regulation, FINRA is dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. FINRA touches virtually every aspect of the securities business-from registering and educating all industry participants to examining securities firms; writing and enforcing rules and the federal securities laws; informing and educating the investing public; providing trade reporting and other industry utilities; and administering the largest dispute resolution forum for investors and registered firms. For more information, please visit our Web site at www.finra.org.

Morgan Keegan still can't price bonds, delays filing

Three fixed-income funds offered by Morgan Keegan & Co., whose assets have been difficult to price because of the subprime mortgage crisis, still cannot file annual reports, a spokeswoman said on Monday.

Morgan Keegan, a unit of Regions Financial Corp., said on Aug. 30 it was seeking a 15-day extension to file the annual reports with the Securities and Exchange Commission.

The challenge of pricing assets in volatile markets has led to further delays, said Kathy Ridley, a spokeswoman for Morgan Keegan. The funds held mortgage- and asset-backed securities.
"While this valuation process has taken longer than expected, significant work has been done and everyone involved is continuing to work diligently to complete the filings as soon as possible," Ridley said in an e-mail.

The funds involved are the RMK Select High Fund Income (MKHIX.O: Quote, Profile, Research), the RMK Select Intermediate Bond Fund (MKIBX.O: Quote, Profile, Research) and the RMK Select Short Term Bond Fund (MSBIX.O: Quote, Profile, Research).

The three funds had net assets of about $2.3 billion as of March 31. But the Select High Income Fund has experienced significant redemptions, Morgan Keegan said in a supplement filing to the fund's prospectus on Aug. 13.

As of Thursday, Sept. 13, the Select High Income Fund, which had $1.2 billion in assets in March, was down almost 32 percent in the third quarter and almost 34 percent year to date, according to Lipper Inc., a unit of Reuters Group Plc.

The lack of liquidity in the fund's securities could result in the fund incurring greater losses on the sale of some its securities than under more stable market conditions, Morgan Keegan said in the supplement filing.

Once Morgan Keegan has finished its valuation process, the brokerage said it would move quickly to communicate directly with shareholders as well as through the RMK Funds Web site.

Hedge Fund Suitability

The hedge fund industry is estimated to be a $875 billion business and growing at about 20% per year, with more than 8,000 active hedge funds. Most hedge funds are highly specialized, relying on the specific expertise of the manager or management team. A hedge fund manager might employ investment strategies, some of which use leverage and derivatives while others are more conservative and employ little or no leverage. In general, hedge funds are not regulated nor are they subject to regulatory oversight.

The recent bankruptcies of two Bear Stearns hedge funds, the High Grade Structured Credit Strategies Master Fund and the High Grade Structured Credit Strategies Enhanced Leverage Master Fund, demonstrates how dangerous hedge funds can be. It has been estimated that Wall Street took in at least $27 billion in revenues from selling and trading risky Mortgage Backed Securities (MBS) during the housing boom. Hedge fund managers purchased questionable securities like Collaterialized Mortgage Obligations (CMOs) and Collateralized Debt Obligations (CDOs) that contained large concentrations in subprime and Alt-A mortgages. Many of the CMOs were represented as investment grade, when in fact they were highly speculative investments that were designed to drive the Wall Street money machine.

The combination of risky strategies, large investments and lack of regulation have lead to catastrophic hedge fund disasters. The most visible was the failure of Long-Term Capital Management, a hedge fund whose founders included two Nobel laureates. Long-Term Capital Management turned a $4.8 billion into $125 billion prior to its failure in the summer of 1998. Long-Term Capital Management investors were virtually wiped out having lost 92% of their assets.

Many, but not all, hedge fund strategies tend to hedge against downturns in the markets being traded. Hedge funds are flexible in their investment options and may use short selling, leverage, derivatives such as call options, put options, index options or futures to mitigate risk.

Not all hedge funds are the same. Investment returns, volatility and risk vary among the different hedge funds strategies. Some strategies, which are not correlated to equity markets, are able to deliver consistent returns with extremely low risk of loss, while others may be as or more volatile than mutual funds. These defensive strategies mean that hedge funds may out perform benchmark indexes during down years.

A result of the lack of regulatory oversight means that hedge funds are approved and monitored almost exclusively by the brokerage firms or banks that sell them. As a result, hedge funds are particularly prone to sales practice abuse or fraudulent sales practices. The pre-sale due diligence done by the brokerage firm is critical. The firm has a responsibility to ask the right questions and review pertinent documents to ensure that selling representations to the customer are consistent with the funds track record, management and investment philosophy.

Brokerage firms also have a continuing duty to monitor hedge funds they recommend. Pre-sale and subsequent due diligence are conducted by the brokerage firm’s due diligence department personnel.

Hedge funds are sometimes sold with restrictions on an investor’s ability to liquidate their accounts. As a result of manager strategies some funds may impose lock up periods of one year.

Hedge funds charge costly incentive fees of approximately 20 percent. Incentive fees are split by the hedge fund manager and the brokerage firm selling the fund. A key reason for the high failure rate of hedge funds is the high-water-mark fee arrangement. If a fund loses investor money, it cannot collect its incentive fee until it regains the assets lost in the previous year and surpasses its previous high point. This can lead to an exodus of talented mangers and staff who leave for other funds not subject to the high-water-mark problem. This can lead fund managers who are in the red at midyear to take extraordinary risks to get back above water. Given that brokerage firms solicit hedge funds as a investment vehicle to reduce or mitigate market risk, this type of situation is problematic.

Bear Stearns Judge Rejects Ban on Hedge Fund Suits

A federal judge refused to grant protection from U.S. lawsuits for Bear Stearns Cos.' two bankrupt hedge funds, finding the Cayman Islands was not the proper jurisdiction for them to liquidate assets.

U.S. Bankruptcy Judge Burton Lifland today said the funds' filings in the Caymans didn't make them eligible for the protection under a provision of the federal bankruptcy law designed to assist foreign companies liquidating overseas. He continued a temporary ban on such suits, telling the funds they could liquidate or reorganize in the U.S., winning an automatic ban on such suits.

"The only adhesive connection with the Cayman Islands that the funds have is the fact that they are registered there,'' Lifland wrote in a ruling in New York, noting that most fund assets were in the U.S.

Bear Stearns' funds had requested protection from U.S. suits under Chapter 15 of the bankruptcy code, arguing in part that their Cayman Islands liquidation could meet the law's standard as a ``foreign main proceeding.''

Lifland rejected that idea and also denied a request by the funds to impose a suit ban by considering the Caymans as a ``non- main'' site of their planned liquidation. He found the funds failed satisfy the legal requirement that they had a ``place of operations where the debtor carries out nontransitory economic activity.''
``There are no employees or managers in the Cayman Islands, the investment manager for the funds is located in New York, the administrator that runs the back-office operations of the funds is in the United States along with the funds' books and records, and prior to the commencement of the foreign proceeding, all of the funds' liquid assets were located in the United States,'' Lifland wrote.
Hedge funds that are technically incorporated outside the U.S. but have their true operations or assets inside the country may be ineligible for Chapter 15, said Kurt Mayr, a lawyer in the financial-restructuring group at Bracewell & Giuliani in Hartford, Connecticut. Funds unable to pay debts may have to reorganize under Chapter 11 of the U.S. bankruptcy law or liquidate under Chapter 7, he said.
Fred Hodara, a lawyer for New York-based Bear Stearns, the fifth largest U.S. investment firm by market value, didn't immediately return a call for comment.
The cases are Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd., 07-12383, and Bear Stearns High- Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd., 07-12384, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Hedge Funds In Trouble

Problems in the credit markets coupled with a sharp drop in equity markets have affected many hedge fund returns. As many managers in the loosely regulated $1.75 trillion industry suffer more losses in August, speculation mounts that more funds could be on the brink of shutting down.

Following is a list of firms whose hedge funds have recently posted losses or have been shut down entirely, their location, and a description of their troubles:

-- Basis Capital (Australia) - The firm's Basis Yield Alpha Fund files for bankruptcy protection in the United States on Aug. 29 amid mounting losses from U.S. subprime mortgage assets. Earlier the group suspended redemptions on two of its funds and appointed U.S.-based Blackstone Group to help prevent a fire sale of assets. In mid-August the group said that one of its portfolios had lost more than 80 percent.

-- Bear Stearns Cos (United States) - Two Bear Stearns funds which invest in collateralized debt obligations -- bonds comprising repackaged mortgages -- by mid-June are trying to sell about $4 billion in bonds to raise cash for redemptions. Major investment banks seize assets or unwind positions. Bear eventually bails out one of the funds and lets the other one fail. In late July, Bear Stearns halts redemptions at a third hedge fund.

-- Absolute Capital (Australia) - Half-owned by Dutch bank ABN AMRO. Temporarily closes two funds in late July with a combined A$200 million in assets amid problems with collateralized debt obligations.

-- Macquarie Bank (Australia) - The bank warns in early August that retail investors in two of its debt funds face losses of up to 25 percent.

-- Oddo Asset Management (France) - The French financial services company in late July closes its Oddo Cash Titrisation, Oddo Cash Arbitrages and Oddo Court Terme Dynamique funds, which manage total assets of around 1 billion euros.

-- Sowood Capital Management (United States) - The hedge fund which managed money for Harvard University tells investors on July 30 that it will wind down after suffering losses of more than 50 percent which wiped out roughly $1.5 billion in capital.

-- SAC Capital (United States) - Hedge fund which manages $14 billion loses 1 percent net of fees in July. It is still up 14 percent net of fees since January.

-- Caxton Associates (United States) - The fund managed by industry veteran Bruce Kovner takes the unusual step of sending a letter to clients to assure them that market rumors about out-sized losses were false. The flagship Caxton Global fund is down about 3 percent in July but remains in the black for the year.

Wall Street's Mortgage Troubles

For the mortgage industry, Wall Street's big investment banks might seem like one of those friends who disappear when the going gets tough.

It wasn't that long ago that the investment houses, looking for ways to cash in on the then-booming housing industry, were buying mortgage lenders at a frenetic pace.

The story now is quite different. This past week, 1,200 people lost their jobs after Lehman Brothers Holdings Inc. closed subprime-lending unit BNC Mortgage LLC, a company it fully acquired in 2004. Similar steps are expected as investment banks try to erase any connection with loans to borrowers with weak credit.

"The mortgage industry has always viewed Wall Street as fair-weather friends, active when things are good and abandoned when times are bad," said Guy Cecala, publisher of trade publication Inside Mortgage Finance. "We're just at the beginning of them pulling away from mortgage operations, and the ones that are not closed down will be cut back severely."

Cecala, whose subscriber base is dwindling as mortgage bankers are laid off, said the investment banks are mostly looking after their image on the Street -- shedding these mortgage units is an easy way to bolster investor confidence. Many of the takeovers were completed at bargain prices, and unwinding them will have little impact on earnings.

Investment banks' stocks have been hurt by the defaults and delinquencies on subprime loans, which sent the overall stock market falling but in particular pummeled financial companies. For the most part, it hasn't threatened the health of the companies, although Bear Stearns Cos. took a harder hit after disclosing that two hedge funds it managed collapsed because of investments in mortgage-backed securities. Its stock, which has since recovered somewhat, fell about 33 percent and wiped about $5 billion in market value.

Those mortgage-backed securities are one of the reasons investment banks wanted to buy subprime mortgage lenders. The banks originate the loans, then bundle them together and sell them as securities to institutional investors.

More than 50 lenders have already gone bust since June and trading in the once-lucrative secondary mortgage market has dried up.

Lehman Brothers said it will take a $52 million charge for closing BNC when it reports third-quarter earnings next month -- hardly anything when compared to the investment bank's record profit of $4 billion last year. The company said it would continue to offer loans through its Aurora Loan Services, which it full acquired in 2003.

"The closure of this has greater implications than simply shuttering a business during a cyclical downturn," said Richard X. Bove, an analyst with Punk Ziegel & Co. "The nature of the mortgage banking business is to boom and then go bust and then boom one more time."
Analysts believe Lehman got out of the subprime business fairly cheaply, especially since it has held a stake in BNC for a number of years before buying it. Others might not be so lucky.

Merrill Lynch, the nation's largest brokerage, acquired First Franklin Financial Corp. from Cleveland-based National City Corp. for $1.3 billion in 2006. Merrill Lynch declined to comment about First Franklin Financial, but Chief Financial Officer Jeff Edwards told analysts during the second quarter that it has taken steps to curb losses in its subprime loan portfolio through risk management.

Bear Stearns operates subprime lender Encore Credit, which it acquired in the past year for about $26 million. It also owns Bear Stearns Residential and EMC Mortgage Corp. The nation's fifth-biggest investment bank laid off about 240 workers earlier this month from its mortgage businesses.

Morgan Stanley bought Saxon Capital in 2006 for about $706 million, Credit Suisse acquired subprime lender Lime Financial Services in April, and Barclays PLC bought EquiFirst Corp. for $225 million that same month. Deutsche Bank bought MortgageIT in 2006 for about $429 million last year.

Barclays and Deutsche Bank did not return telephone calls seeking comment, and the other banks declined to comment.

Hedge-fund redemption shock

Investors are expected to hit hedge funds with a flood of redemption requests this fall, but those who try to withdraw their money may be in for an unpleasant surprise.

Most hedge funds have "lock-ups," a minimum period of time during which investors agree to tie up their money and not make any withdrawals.

Once that period ends, investors generally can redeem their stakes as long as they give advance notice, usually 45 to 90 days before the quarter end. Although that cut-off has passed for many funds for the current quarter, investors can still put in requests to get their money out by year-end.

But hedge funds also can slow withdrawals, or suspend them altogether. While they're usually loath to do this, since it can signal that a fund is on the verge of collapse, current conditions may result in more funds not letting investors take their money out - at least not immediately.

Hedge funds have been hard hit by the recent turmoil in the market. Two Bear Stearns hedge funds heavily invested in securities backed by subprime mortgages blew up in June. Ensuing volatility claimed funds at Sowood Capital Management and led to big losses at so-called quantitative funds, including some run by Goldman Sachs and others.

The losses sparked panic in the market, as well as worries that more problems will surface at other funds. That's raised expectations that hedge-fund investors, which include institutions like university endowments and pension funds, will try to rush to get their money out before losing more. That, in turn, can unleash a vicious cycle: As hedge funds lose cash, they're left with less money to invest, which can make it difficult for the funds to recover and hasten a downward spiral.

To avoid that scenario, hedge funds can make it tougher for nervous investors to bail out. For example, they can slow redemptions by imposing a "gate," which allows them to cap the amount investors withdraw during a given period - usually at 20 percent of the fund's net asset value, according to David Nissenbaum of law firm Schulte Roth & Zabel, whose hedge-fund practice dominates the industry.

They can also block withdrawals completely, for instance when they can't accurately value the fund's assets or don't have the money to meet requests, legal experts say. Bear Stearns froze withdrawals on a third fund this month, although the reason for the suspension was unclear.

How Rating Firms' Calls Fueled Subprime Mess

In 2000, Standard & Poor's made a decision about an arcane corner of the mortgage market. It said a type of mortgage that involves a "piggyback," where borrowers simultaneously take out a second loan for the down payment, was no more likely to default than a standard mortgage.

While its pronouncement went unnoticed outside the mortgage world, piggybacks soon were part of a movement that transformed America's home-loan industry: a boom in "subprime" mortgages taken out by buyers with weak credit.

Six years later, S&P reversed its view of loans with piggybacks. It said they actually were far more likely to default. By then, however, they and other newfangled loans were key parts of a massive $1.1 trillion subprime-mortgage market.

Today that market is a mess. As defaults have increased, investors who bought bonds and other securities based on the mortgages have found their securities losing value, or in some cases difficult to value at all. Some hedge funds that feasted on the securities imploded, and investors as far away as Germany and Australia have suffered. Central banks have felt obliged to jump in to calm turmoil in the credit markets.

It was lenders that made the lenient loans, it was home buyers who sought out easy mortgages, and it was Wall Street underwriters that turned them into securities. But credit-rating firms also played a role in the subprime-mortgage boom that is now troubling financial markets. S&P, Moody's Investors Service and Fitch Ratings gave top ratings to many securities built on the questionable loans, making the securities seem as safe as a Treasury bond.

Also helping spur the boom was a less-recognized role of the rating companies: their collaboration, behind the scenes, with the underwriters that were putting those securities together. Underwriters don't just assemble a security out of home loans and ship it off to the credit raters to see what grade it gets. Instead, they work with rating companies while designing a mortgage bond or other security, making sure it gets high-enough ratings to be marketable.

The result of the rating firms' collaboration and generally benign ratings of securities based on subprime mortgages was that more got marketed. And that meant additional leeway for lenient lenders making these loans to offer more of them.

The credit-rating firms are used to being whipping boys when things go badly in the markets. They were criticized for being late to alert investors to problems at Enron Corp. and other companies where major accounting misdeeds took place. Yet they also sometimes get chastised when they downgrade a company's credit.

Valuations In Spotlight As Funds Halt Redemptions

Fund managers and banks are under scrutiny for their methods in valuing illiquid securities, after some funds admitted they're having trouble putting a price on complex debt instruments backed by residential mortgages and corporate loans.

Units of French bank BNP Paribas SA (BNPQY) and insurer AXA SA (AXA) have suspended redemptions on some of their funds because they said they couldn't value them accurately, while the U.S. Securities and Exchange Commission is reportedly checking the books of U.S. brokerage firms and banks to make sure they aren't hiding losses by misvaluing assets linked to subprime mortgages.

On Tuesday, Sentinel Management Group, a firm managing short-term cash for commodity trading firms and hedge funds, also halted client redemptions because it said it couldn't meet them "without selling securities at deep discounts to their fair value." The firm invests in government and corporate securities.

The lack of confidence in how funds and banks are valuing their subprime exposure - and fear that future risks haven't been accounted for - has already led to a wave of fund redemptions by investors and a sell-off in some banks' shares.

The securities in question are known as collateralized debt obligations, or CDOs, and are widely held by banks, insurers, pension funds and investment funds. Backed by large pools of mortgages, loans or other interest-bearing assets, these securities played an instrumental role in fueling cheap credit to home buyers, companies and other borrowers over the past several years.

The breakdown in valuing them is just one effect of the wider credit crisis that started with a sharp and unexpected rise in the number of U.S. homeowners defaulting on their mortgages.

The losses hit CDO portfolios stuffed with risky mortgages, and some funds holding CDO securities became forced sellers to meet margin calls. Investors lost their confidence in the vehicles' underlying assumptions about default rates, and the trading value of CDOs has tumbled across the board, whether they are exposed to defaulting mortgages or not.

Mortgage delinquencies spreading: AIG

Residential mortgage delinquencies and defaults are becoming more common among borrowers in the category just above subprime, American International Group (NYSE: AIG) said on Thursday.

In a presentation on its subprime exposure, AIG, the world's largest insurer and one of the biggest mortgage lenders, said total delinquencies in its $25.9 billion real estate portfolio were 2.5 percent. It said 10.8 percent of its subprime mortgages were 60 days overdue, compared with 4.6 percent in the category with credit scores just above subprime, indicating that the threat to the mortgage market may be spreading.

Bear Stearns Caymans Filing May Hurt Funds' Creditors

Bear Stearns Cos.' decision to liquidate two bankrupt hedge funds in the Cayman Islands instead of New York may limit creditors' and investors' ability to get their money back.

While most of their assets are in New York, the funds filed for bankruptcy protection July 31 in a court in the Caymans, where they are incorporated. The bank also used a 2005 bankruptcy law to ask a U.S. judge in Manhattan to block all lawsuits against the funds and protect their U.S. assets during the Caymans proceedings.

The Bear Stearns cases may establish a precedent that would let other failed hedge funds liquidate in the Caymans, where judges have a track record of favoring management. The local monetary authority estimates that three out of four hedge funds globally are incorporated in the islands.

Bear Stearns overhauls top management after hedge fund woes

Wall Street investment bank and brokerage Bear Stearns overhauled its top management ranks at the weekend, but its shares continued to fall Monday amid concerns about its exposure to mortgage-related securities.

The bank's president and co-chief operating office Warren Spector announced his resignation from Bear Stearns on Sunday as the bank said it had appointed company veteran Alan Schwartz as its sole president.

Samuel Molinaro, Bear Stearns chief financial officer, will take over the chief operating officer's role while another executive, Jeffrey Mayer, will take Spector's seat on the firm's executive committee.

Bear Stearns, which traces its history to 1923, has endured a couple of difficult months.

The firm told investors in June that "challenging market conditions" roiling the US housing market had contributed to a hefty 21 percent drop in its fixed income revenues during the second quarter to 962 million dollars.
The problems forced it to wind down two hedge funds it had managed which had been heavily invested in complex mortgage-related securities.

Bear Stearns Blocks Withdrawals From Third Hedge Fund

Bear Stearns Cos., the manager of two hedge funds that collapsed last month, blocked investors from pulling money out of a third fund as losses in the credit markets expand beyond securities related to subprime mortgages.

The Bear Stearns Asset-Backed Securities Fund had less than 0.5 percent of its $900 million of assets in securities linked to subprime loans, spokesman Russell Sherman said in an interview yesterday. Even so, investors concerned about losses sought to withdraw their money, he said.

Shares of New York-based Bear Stearns fell as much as 6 percent, pushing some brokerage stocks lower on concern about shrinking profits from debt underwriting and trading. Bear Stearns triggered a decline in credit markets in June, when funds it managed faltered after defaults on home-loans to people with poor credit rose to a 10-year high.

Bear Stearns Seizes Most of Fund

Putting another nail in the coffin of the troubled High-Grade Structured Credit Strategies hedge fund, lenders at Bear Stearns Cos. have seized most of the fund's collateral following its failure to meet a recent margin call.

Bear's move, which according to someone close to the situation came after more than a week of waiting for additional cash or collateral to repay Bear's $1.6 billion line of credit, leaves the High-Grade fund with little or no remaining capital and few assets of any value. Both the High-Grade fund and a more-leveraged sister fund have seen the value of their holdings decline precipitously in recent weeks, as the market for risky subprime mortgages, on which the funds bet heavily, has weakened.

Bear is now saddled with some of the same troubled securities that hobbled the hedge fund. Bear is in the process of unwinding the more leveraged fund, known as the High-Grade Structured Credit Strategies Enhanced Leverage Fund, and plans to do the same with the less-leveraged fund in light of yesterday's news.

The assets it seized consist mostly of the High-Grade fund's remaining collateralized debt obligations, securities backed by pools of subprime mortgages. Subprime-linked CDOs have seen their values slashed recently as the U.S. housing market has declined. But Bear may be able to preserve the securities' value by holding on to them until market conditions improve, says the person close to the situation.

Trader Pleads Guilty In Inside-Information Case

A former hedge-fund trader pleaded guilty to criminal charges involving a scheme to trade on inside information about analysts' ratings changes at UBS AG's securities unit before the changes became public knowledge.

Mark E. Lenowitz, who formerly traded equity securities on behalf of Chelsey Capital in New York and was a partner at Q Capital Investment Partners LP in New Jersey, entered his plea to one count of conspiracy and one count of securities fraud at a hearing in U.S. District Court in Manhattan.

He said he agreed to forfeit more than $337,000 in profits. He faces as many as 25 years in prison, with sentencing scheduled Jan. 18. He was charged in March with conspiracy and five counts of securities fraud.

Six others have also pleaded guilty in two separate schemes.

Mr. Lenowitz is one of 13 people charged in two separate schemes to use inside information to make improper trades ahead of the public announcements of upgrades or downgrades by UBS analysts and ahead of news of pending mergers and acquisitions in which Morgan Stanley was an adviser.

Morgan Keegan's Kelsoe Falls From Top Ranking on Subprime Rout

Jim Kelsoe, a top-ranked junk-bond fund manager since 2000, dropped to last place this year because of losses tied to mortgages for people with poor credit.

Kelsoe's $1.1 billion Regions Morgan Keegan Select High Income Fund fell 4.2 percent from the beginning of 2007 as defaults on subprime home loans reached a five-year high. The mutual fund had 15 percent of assets in the subprime market and at least the same amount in other mortgage debt in May.

The High Income fund got a boost from the holdings for seven years and now ``it's very easy to be critical'' of the investment decision, Kelsoe said in an interview from his office at Morgan Asset Management Inc. in Memphis, Tennessee. The fund had as much as 25 percent of assets in subprime-related securities in 2005.

Kelsoe's fund ranks last of 93 high-yield rivals and it's the eighth-worst performer this year of more than 550 U.S.-based bond funds tracked by Bloomberg. Losses accelerated in June after the collapse of two hedge funds run by Bear Stearns Cos. partly because of bad bets on bonds linked to subprime mortgages.

The $1 billion Regions Morgan Keegan Select Intermediate Bond Fund, which Kelsoe manages, also is the worst in its class, down 2.1 percent this year including reinvested dividends.

"A lot of mutual funds didn't own much of this stuff,'' said Lawrence Jones, an industry analyst at Chicago-based research firm Morningstar Inc., referring to the subprime market. The Morgan Keegan fund ``is the one real big exception.''

The 44-year-old Kelsoe said that, like fund managers drawn in by Internet stocks at the start of the decade, an ``intoxication'' with high-yield subprime investments kept him from pulling out completely. Subprime mortgage bonds rated BBB, or investment grade, yielded 2.05 percentage points more than benchmarks in February, compared with 1.53 percentage points for BB-rated, or junk, corporate bonds, according to JPMorgan Chase & Co. in New York.

Morningstar cut its rating on Kelsoe's High Income fund this month to three stars from four stars, citing above-average risk and underperformance. The highest grade is five. The fund has a one-year Sharpe ratio of minus 0.9, compared with 1.86 for its peers. A higher ratio means better risk-adjusted returns.

The average high-yield fund has gained 2.9 percent this year, according to Morningstar. The top-performing $4.1 billion Pioneer High Yield Fund, run by Andrew Feltus at Boston-based Pioneer Investment Management Inc., has gained 9 percent.

Kelsoe, who has worked at Morgan Keegan for the past 16 years, favors bonds backed by assets such as aircraft leases, and mortgage loans, as well as collateralized debt obligations, or CDOs, instead of corporate bonds, which made up only 21 percent of the fund in March. The $9.5 billion Vanguard High- Yield Corporate Fund, by contrast, has 92 percent of its assets in corporate bonds last month.

The strategy helped Kelsoe avoid getting pummeled by companies dragged down by concerns about accounting scandals at energy trader Enron Corp. in 2001 and phone company WorldCom Inc. the next year. A large part of his outperformance in recent years came from purchases of beaten-down aircraft-lease bonds after the Sept. 11, 2001, terrorist attacks, Morningstar's Jones said.

Kelsoe, who graduated from the University of Alabama in Tuscaloosa, started managing the High Income fund in 1999. Morgan Asset Management is a unit of Birmingham, Alabama-based Regions Financial Corp.

Kelsoe's fund rose 17 percent in 2000, 18 percent the next year and 11 percent in 2002, outperforming 99 percent of its competitors. Since the start of the decade, the fund climbed at an average annual rate of 12 percent, compared with 2.2 percent for the Standard & Poor's 500 Index of U.S. stocks.

The fund is declining this year amid surging delinquencies on mortgages that may cause bond investors to lose about $100 billion in principal, according to estimates from analysts at New York-based Citigroup Inc.

Kelsoe had $4 million at the end of last year in a security backed by second mortgages that Goldman Sachs Group Inc. created in January 2006. The bond was downgraded twice this year by Moody's Investors Service to the lowest rating.

Another holding was an unrated piece of a CDO overseen by Deerfield Capital Management LLC that was sold a year ago by Royal Bank of Scotland Group Plc. The $4.8 million security, which a semi-annual report listed with a 15 percent coupon, is mostly backed by subprime and ``mid-prime'' mortgage securities.

Bear Stearns Tells Fund Investors "No Value Left"

Bear Stearns Cos. told investors in its two failed hedge funds that they'll get little if any money back after "unprecedented declines" in the value of the securities used to bet on subprime mortgages.

"This is a watershed,'' said Sean Egan, managing director of Egan-Jones Ratings Co. in Haverford, Pennsylvania. ``A leading player, which has honed a reputation as a sage investor in mortgage securities, has faltered. It begs the question of how other market participants have fared.''

Estimates show there is ``effectively no value left'' in the High-Grade Structured Credit Strategies Enhanced Leverage Fund and ``very little value left'' in the High-Grade Structured Credit Strategies Fund, Bear Stearns said in a two-page letter. The second fund still has "sufficient assets'' to cover the $1.4 billion it owes Bear Stearns, which as a creditor gets paid back first, according to the letter, obtained yesterday by Bloomberg News from a person involved in the matter.

Bear Stearns, the fifth-largest U.S. securities firm, provided the second fund with $1.6 billion of emergency financing last month in the biggest hedge fund bailout since the collapse of Long-Term Capital Management LP in 1998. The losses its clients now face underscore the severity of the shakeout in the market for collateralized debt obligations, or CDOs, investment vehicles that repackage bonds, loans, derivatives and other CDOs into new securities.

NASD Charges Former Securities America Broker

In the first case of its kind, NASD announced today that it has fined Securities America, Inc. of Omaha, NE, $375,000 for improperly sharing directed brokerage commissions from a mutual fund company with Michael Bullock, a former Securities America broker in the Los Angeles, CA area. NASD also found that Securities America failed to adequately supervise Bullock's communications with his union-sponsored retirement plan clients to ensure that Bullock disclosed his additional compensation to those clients.

In a separate complaint, NASD charged Bullock with improperly receiving directed brokerage commissions and other compensation of more than $280,000. Bullock was also charged with misrepresenting and failing to disclose this compensation to his union retirement plan clients - at the same time he was advising those clients to maintain or include the fund company's mutual funds in the retirement plans they offered to working and retired union members.

SEC Files Action Regarding Amerifirst Funding and Amerifirst Acceptance Corporation

On July 2, 2007, the Securities and Exchange Commission filed an emergency action in Dallas federal court to halt what the Commission contends is a fraudulent offering of securities, known as Secured Debt Obligations ("SDOs"), by Amerifirst Funding, Inc. and Amerifirst Acceptance Corporation (together, "Amerifirst"). The SDOs are notes purportedly secured by automobile financing receivables created or purchased by the defendants. The district court entered, under seal, a temporary restraining order suspending the offering, as well as orders freezing the defendants' assets and requiring an accounting and repatriation of assets. The court also appointed a receiver to secure assets for investors, and ordered defendants to preserve documents and submit to expedited discovery. On July 3, 2007, the court unsealed all of the orders.

The defendants named in the Commission's Complaint are:

Jeffrey C. Bruteyn, age 37, of Dallas, Texas, Managing Director of Amerifirst Funding, Inc. and Amerifirst Acceptance Corporation and the Director and sole owner of Hess Financial Corporation;

Dennis W. Bowden, age 55, of Dallas, Texas, the president of Amerifirst Funding, Inc., a director and chief operating officer of Amerifirst Acceptance Corporation and president and COO of American Eagle Acceptance Corporation;

Amerifirst Funding, Inc., a Texas corporation operated and controlled by Bruteyn and Bowden; and

Amerifirst Acceptance Corporation, a Texas corporation operated and controlled by Bruteyn and Bowden.
The Commission's Complaint also names two relief defendants, seeking return of investor funds they unjustly received:

American Eagle Acceptance Corporation, a Texas corporation controlled by Bowden and held out to be a subsidiary of Amerifirst Funding; and

Hess Financial Corporation, a Texas corporation controlled by Bruteyn.

NASD has told Brookstreet Securities to close customer accounts

Losses on mortgage-backed securities have forced an Irvine brokerage firm to begin shutting down its operations, people close to the company said Thursday.

At least some of the losses were said to be incurred by clients of the brokerage, Brookstreet Securities.

Because of the losses, brokerage regulator NASD told Brookstreet this week to limit its activities to liquidating customer accounts, said Scott Brooks, an executive vice president at the firm. NASD officials declined to comment.

"Unfortunately, we are on 'SELL ONLY,' " Stanley C. Brooks, Scott's father and the firm's founder, said in an e-mail sent Wednesday through the company's nationwide network of 600 brokers, many of whom work from their homes. In the e-mail, Brooks said the 17-year-old firm's net worth had fallen from $11 million at the end of May to a negative $2.1 million.

Scott Brooks referred requests for additional comment to his sister, Julie Mains, an attorney at Brookstreet, who he said was trying to work out a deal to save the firm. Repeated efforts to reach Mains were unsuccessful.

The Brookstreet case is another illustration of how weakness in the housing market, which has led to a wave of defaults on loans to high-risk sub-prime borrowers, is spreading financial pain beyond sub-prime lenders and distressed homeowners.Several major investment operations, including two hedge funds managed by Bear Stearns Cos., have been struggling to avoid being forced to shut down in the wake of losses on mortgage-backed investments.

Brookstreet closes down, 100 laid off

Brookstreet Securities Corp., an Irvine broker-dealer, has shut its doors, laid off 100 local employees and liquidated its assets because it is unable to meet margin calls on complex securities called collateralized mortgage obligations, the company's spokeswoman Julie Mains told Register reporter John Gittelsohn today.

An email sent to employees summed up the situation as a "Disaster."

"It's heartbreaking," Mains said.

She said the company went from $16 million in capital Friday to being $3 million underwater Wednesday because its clearing firm, National Financial Services, sold the securities, which had lost value as Wall Street confidence in Bear Stearns & Co's hedge funds of mortgage-backed securities collapsed .

A spokesman for National Financial Services said it's not his company's fault that Brookstreet ran out of capital.

Mains said some of Brookstreet's customers lost their entire investment and that the National Association of Securities Dealers ordered the company to liquidate its remaining accounts. She said Brookstreet clients should try to find another broker-dealer to take over their accounts.

Here's an email Brookstreet sent to its employees Wednesday:

"To Our Valued Brookstreet Members, Disaster, the firm may be forced to close...
Today, the pricing system used by National Financial has reduced values in all Collateralized Mortgage Obligations. Many of those accounts were on margin and have suffered horrendous markdowns and unrealized as well as realized losses.

National Financial and the regulators expect Brookstreet to pay for realized liquidated losses and take a capital charge for unrealized mark to market losses.

This firm has done a valiant if not Herculean job of managing the liquidations and capital charges to the firm's net worth and net capital. We had reduced the margin balance significantly; we had liquidated and reduced exposure by 80%.

That still left a $70,000,000 margin balance against around 85,000,000 of value. Unfortunately the pricing service used by NF revalued many CMO positions downward last night. We went from a positive net capital of 2.4 million, down from 11 million at the end of May, a negative net capital of 2.1 million. It would take a capital infusion of at least $5,000,000 to keep the company in compliance with no guarantee that additional markdowns will not be forth coming.

I cannot in good conscience request that anyone put money in the firm, I think $10,000,000 would be a minimum without consideration of the horrific customer complaints to follow.

I have told many of you that you are always in danger of not being paid on your last check when working for any broker dealer, which is why I have always paid twice per week and maintained huge net cash positions, generally in the realm of 15,000,000 on average. I will try to get enough money from our account at NFS to complete our upcoming payrolls.

Since I have been writing this letter I have received three hurried inquiries about re capitalizing the company. I will negotiate an arrangement that guarantees that everyone gets paid, to the best of my abilities. Please stay at Brookstreet at least until Friday so I may do my best for each of you. Unfortunately we are on "SELL ONLY."

I believe I will be able to reconstitute another opportunity for everyone that will result is a minimum of change and disruption. There will be disruption.

Please give a day or so for us to come up with the best strategy. This has happened to us in one day, amazing. All of our family net worth is in the firm, please give me time to present a new plan."

First the Losses, Now Bond-Fund Lawsuits

Today, the Wall Street Journal reported that the credit crunch is starting to hit some bond mutual-fund investors in unexpected ways, some are now taking legal recourse for losses in their investments.

In the most recent instance, an Indiana charity filed an arbitration complaint against Memphis, Tenn., broker-dealer Morgan Keegan & Co. unit of Regions Financial Corp., for an alleged misrepresentation in selling a bond mutual fund. The fund has lost nearly half of its value this year.

The complaint comes on the heels of a lawsuit filed in a federal court in Manhattan in October over an institutional bond fund of State Street Corp., which alleged that the fund invested in "high risk" investments. A State Street spokeswoman has denied that the firm incorrectly communicated the investment objective of the fund.

In its arbitration complaint, the Indiana Children's Wish Fund says that it invested around $220,000 in the Regions Morgan Keegan Select Intermediate Bond Fund, on the understanding that it was a relatively safe investment. The complaint was filed with the Financial Industry Regulatory Authority last month.

A Morgan Keegan spokeswoman said via email: "We will respond to the Wish Fund's complaint in due course through the established arbitration process. ... We are confident the arbitration process will result in an appropriate outcome."

The Wish Fund, which grants the wishes of children who are diagnosed with life-threatening illnesses, made the investment based on the recommendation of an agent of Regions Bank who met the Wish Fund's executive director, Terry Ceaser-Hudson, in June this year. According to the complaint, the agent suggested that moving the Wish Fund's money "from a money market account and certificate of deposit investments into his recommended investment was completely safe and a smart business decision."

The Intermediate Bond Fund was hit hard amid the turmoil in the credit markets since this summer, as many of fund's investments in mortgage-backed and other asset-backed securities couldn't find buyers. The fund also had redemptions from investors, which forced the managers to sell in a down market and reduced the value of the portfolio.

The fund is currently down around 45% since the start of the year, the worst performer in the intermediate-term bond-fund category of funds, according to research firm Morningstar Inc. The average fund in this category is up 5% since the start of the year. In late September, the Wish Fund's investment in the Morgan Keegan fund was liquidated at a loss of approximately $48,000 or about 22% of the invested money, says the complaint. "The presentation to the Wish Fund was that this was an appropriate CD alternative, and nothing could be further from the truth," says Thomas Hargett, a partner with Maddox Hargett & Caruso PC in Indianapolis who represents the charity.

The Intermediate Bond fund's Web site says that it may invest in mortgage and other asset-backed securities, and that it may invest up to 35% of its assets in securities that are below investment-grade. As of Sept. 30, the fund invested 11% of its portfolio in securities rated BB+ or lower. In a letter to shareholders late last month, fund manager Jim Kelsoe said that "we will do our best to navigate the portfolios through these difficult times."

Another fund managed by Mr. Kelsoe, the RMK Select High Income fund, has been the worst performer in the category of high-yield or "junk" bond funds. The fund is down 55% since the start of the year, as opposed to a 1.15% return of the average high-yield bond fund, according to Morningstar.

Meanwhile, in the State Street case, one company sued the firm over the State Street's Intermediate Bond Fund, an institutional fund. The complainant, New York publishing firm Unisystems Inc., said that the fund's managers invested in "high risk" instruments and mortgage-backed securities, while representing the fund as a conservative investment option.
The lawsuit alleges that between July 1 and Sept. 1, the fund declined by 25% in value while the index it "purported to track actually increased."

Seniors Beware: What You Should Know About Life Settlements

Lately, more and more seniors are hearing about opportunities to sell their existing life insurance for cash in transactions known as life settlements. A life settlement, or senior settlement, as they are sometimes called, involves selling an existing life insurance policy to a third party—a person or an entity other than the company that issued the policy—for more than the policy's cash surrender value, but less than the net death benefit.

Life settlements can be a valuable source of liquidity for people who would otherwise surrender their policies or allow them to lapse—or for people whose life insurance needs have changed. But they are not for everyone. Life settlements can have high transaction costs and unintended consequences. And even if you decide a life settlement is generally right for you, it can be hard to tell whether you are getting a fair price.

If you are considering selling your life insurance policy to a third party, you can help protect yourself by familiarizing yourself with your existing policy so that you fully understand your options, becoming fully informed about life settlements, shopping around for the best offer, and dealing only with licensed buyers and brokers.

NASAA: Reform arbitration or add court option

The securities arbitraiton system should be refored or else investors should be given the option of taking their disputes to court, according to a group that represents state securities regulators.

“We think it needs to be reformed,” said Joseph Borg, director of the Alabama Securities Commission in Montgomery and president of the North American Securities Administrators Association Inc. “Absent that we may have to consider making it optional.”

As part of its 2007 legislative agenda, Washington-based NASAA is calling for the new Democratic Congress to review the arbitration system.

But it isn’t clear whether the congressional committees that oversee financial services will take up arbitration soon.

“Financial services is a big world,” and House Financial Services Committee Chairman Barney Frank, D-Mass., hasn’t added the subject to his agenda so far, said committee spokesman Steve Adamske.

Among issues that need to be reviewed, Mr. Borg said:
• How arbitration panels are selected.
• Whether arbitrators are properly trained.
• Whether explanations of awards are sufficient.
• Whether the system is cost efficient.