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Morgan Keegan Blamed for Municipal Bond Derivative Debacle in Tennessee

Apr 8, 2009 | Parker Waichman Alonso LLP

Morgan Keegan & Company, an investment bank based in Tennessee, is being scrutinized for its role in touting investments in municipal bond derivatives that have left the finances of many small towns in ruins.  According to The New York Times, Morgan Keegan not only sold the derivatives, but took an active role in "educating" community leaders about the risks and benefits of the investments.

According to the Times report, one town - Lewisburg, Tenn.-  that entered into one of these deals saw its interest payments quadruple to $1 million per year.  The payments have crippled the town's finances.  And the scenario is the same in many other communities that were convinced by Morgan Keegan to take on these risky bonds.

Leaders in many communities advised by Morgan Keegan told the Times they were not made fully aware that interest rates on the bonds could go sky high if the economy took a turn for the worse.  Because the market for municipal bond derivatives in Tennessee was poorly regulated, Morgan Keegan was able to teach many of the state-sponsored seminars that were meant to educate local officials about the risks and benefits of these investments.  

According to the Times, that allowed Morgan Keegan to dominate nearly every facet of the municipal bond derivative business in the state.  It worked out well for the investment bank:  According to the Times, Morgan Keegan sold more than $2 billion of the derivatives to 38 Tennessee communities since 2001.  That business generated millions of dollars in fees for Morgan Keegan.

Morgan Keegan claims that it provided unbiased and complete information about municipal bond derivatives in the seminars it taught.  But according to the Times, one expert who reviewed a textbook provided to attendees of a 2003 seminar said it focused much more on benefits than risks.  Another critic of the municipal bond industry told the Times that the Morgan Keegan seminars were little more than infomercials.  An attendee of one such meeting told the Times that the information presented was "way over my head", but that reps from Morgan Keegan were reassuring, telling her  "Don’t worry if you don’t understand it."

Since the Times began investigating the municipal bond derivative fiasco, officials in Tennessee have ordered a statewide freeze on bond derivatives and a review of the seminar taught by Morgan Keegan and others.  In Washington, federal regulators are now considering ways to restrict the use of municipal bond derivatives, the Times said.