UPDATE 2-Morgan Keegan sued by SEC over auction-rate debt

Tue Jul 21, 2009 4:50pm EDT

* Investors stuck with $1.2 bln in debt, SEC says

* Debt marketed as cash equivalent, SEC says

* Morgan Keegan says surprised, been cooperating with SEC (Adds Morgan Keegan comment, Charles Schwab case)

By Jonathan Stempel

NEW YORK, July 21 (Reuters) - Morgan Keegan & Co, a unit of Regions Financial Corp (RF.N), was sued on Tuesday by U.S. regulators for allegedly leaving customers stuck with $1.2 billion of auction-rate securities that became illiquid.

In a lawsuit filed in federal court in Atlanta, the U.S. Securities and Exchange Commission demanded that Morgan Keegan buy back debt sold to customers before March 20, 2008, forfeit $4.3 million of underwriting and distribution fees, and pay a civil fine.

Morgan Keegan spokesman Eric Bran said the brokerage was "surprised and disappointed" by the SEC actions. He said Morgan Keegan has been cooperating with the regulator, and has been repurchasing auction-rate debt from clients since early 2009.

Auction-rate debt has rates that reset in periodic auctions and was often marketed by brokers as a cash substitute. After the $330 billion market froze in February 2008 when dealers stopped taking part in auctions, many investors could not sell the debt, or could sell it only at a loss.

In its lawsuit, the SEC accused Memphis, Tennessee-based Morgan Keegan of failing to disclose the debt's liquidity risks, even after it stopped supporting the market.

"Morgan Keegan brokers told various customers that auction-rate securities carried 'zero risk' or were 'guaranteed' and were 'fully liquid,' 'cash alternatives,' 'just like a money market,' 'as liquid on a weekly basis as cash,' a 'liquid and safe investment,' or a 'totally liquid (7 day) money parking account,'" the complaint said.

As of July 15, 2009, Morgan Keegan customers still held $272 million of illiquid auction-rate debt, the SEC said.

More than 20 firms, including many of the largest U.S. banks, have agreed to buy back in excess of $61 billion of auction-rate debt and pay hundreds of millions of dollars of fines, through settlements with regulators including the SEC and New York Attorney General Andrew Cuomo.

The latest to settle, TD Ameritrade Holding Corp (AMTD.O), agreed on Monday to buy back $456 million of the debt. Charles Schwab Corp SCHW.O on Monday rejected a demand by Cuomo to settle a similar probe or face a possible lawsuit.

Morgan Keegan in March received a "Wells notice" from the SEC indicating that civil charges might be forthcoming. A Wells notice gives a recipient a chance to mount a defense.

Also on Tuesday, Regions posted a $244 million second-quarter net loss applicable to common shareholders, its second quarterly loss in three quarters, hurt by deterioration in the credit quality of commercial and real estate loans.

The case is SEC v. Morgan Keegan & Co, U.S. District Court, Northern District of Georgia (Atlanta), No. 09-1965. (Reporting by Jonathan Stempel, editing by Matthew Lewis and Tim Dobbyn)