The Securities and Exchange Commission yesterday filed securities fraud charges against Memphis-based Morgan Keegan & Co. for misleading thousands of investors about the liquidity risks associated with auction-rate securities, while Alabama regulators took initial steps to ban the firm from doing business in the state.

In a four-count, 27-page complaint filed in federal court in Atlanta, the SEC said Morgan Keegan officials knew of widespread liquidity problems in the market, beginning in late 2007, but failed to disclose them to its customers. The SEC said it is seeking a court order that would require Morgan Keegan to buy back illiquid ARS from its customers.

In conjunction with the suit, the Alabama Securities Commission issued a "show cause" order giving the company 28 days to explain why it should not be banned from doing business in the state.

"The actions filed today by the ASC and SEC demonstrate outstanding efforts of the two agencies to use all the tools available, both at the state and federal levels, to stop investor harm and discipline those who engage in dishonest and unethical practices," ASC director Joseph P. Borg said in a statement.

But Kathy Ridley, a spokeswoman for the firm, said in a statement that it is "both surprised and disappointed" by the SEC's actions, arguing the ARS market collapsed "virtually overnight" and that since then, it has made restoring liquidity for investors holding the securities a high priority. Ridley said the firm will work with the ASC to resolve the matter to everyone's satisfaction.

Morgan Keegan has repurchased $56 million in ARS from more than 485 individual investors, she said, adding that its investment bankers have assisted issuers of ARS in successfully refunding some 62 issues totaling more than $874 million par value. As a result, its clients' exposure to ARS has fallen from $2.2 billion in early 2007 to $365 million today, she said.

The ARS market collapsed on a widespread basis Feb. 12, 2008, when firms that historically supported the auctions, but were under no contractual obligation to do so, stopped propping them up.

But the SEC said that even though Morgan Keegan officials knew of widespread liquidity problems in the market, which were tied to downgrades to bond insurers that backed ARS, the firm's officials downplayed the securities' risks and accelerated sales of them to customers in an attempt to prevent the auctions that it managed from failing.

In late February, the auctions managed by the firm began to fail on a widespread basis after it reached its own inventory limits of the securities. As a result, thousands of the firms' customers were unable to liquidate about $1.2 billion of ARS holdings even though the securities were marketed variously as "zero risk," "fully liquid," "cash alternatives," "just like a money market," "as liquid on a weekly basis as cash," a "liquid and safe investments," or a "totally liquid (7 day) money parking account," the SEC said.

Only on March 20, 2008, some five weeks after the market collapsed, did Morgan Keegan institute an "enhanced disclosure" policy requiring customers who wished to purchase ARS to sign a disclosure letter stating that they understood their securities were currently, or had recently been, failing at auction and that it may be a "considerable period of time" before liquidity returned to the investment.

The SEC said it is filing the suit in the Atlanta court in part because the firm sold ARS to at least 60 customers in the area between Nov. 1, 2007, and March 20, 2008. As of the end of last August, the firm's retail customers in Georgia held about $122 million of ARS, "more than the aggregate retail customer ARS holdings for any other state."

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