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Archive for September, 2007


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.

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