In the first decision of its kind stemming from class action litigation over the collapse of the auction-rate securities (ARS) market, a federal appeals court panel in New York ruled Monday that Merrill Lynch had adequately disclosed to customers that it was preventing auctions from failing.
The U.S. Court of Appeals for the Second Circuit rejected a bid to reinstate a securities fraud class-action suit filed by investors against Merrill Lynch, now Bank of America Merrill Lynch. A lower court dismissed the case last year after deciding Merrill’s disclosures were sufficient.
The appeals court’s affirmation of the lower court’s ruling is a blow to the Securities and Exchange Commission (SEC), which had urged the suit be reinstated. The case had pitted the SEC against the Securities Industry and Financial Markets Association (SIFMA) in friend-of-the-court briefs.
But in its 33-page decision in Colin Wilson v. Merrill Lynch, the three-judge panel concluded “the conduct alleged to be manipulative was sufficiently disclosed to market participants so as to preclude plaintiff’s claim.”
Notably, the court, after asking the SEC for its views on the case, declined to defer to the commission’s assessment, in its brief, that Merrill’s disclosures were inadequate.
“We readily acknowledge that at least some deference to the agency’s position is appropriate given the SEC’s expertise and accountability,” the court said. “Here, however, we are unable to agree with the SEC’s application of the legal principles governing Merrill’s disclosures even under the generous standard of deference that [the plaintiff] urges.”
Typically, the panel noted, federal courts defer to an agency’s interpretation of its regulation, even in a legal brief, unless the interpretation is plainly erroneous or inconsistent with the regulation or there is any other reason to suspect that the interpretation does not reflect the agency’s fair and considered judgment on the matter in question.
While the court declined to “fix the 'exact molecular weight’” of deference it owed to the SEC’s position, and conceded “at least some deference to the agency’s position is appropriate given the SEC’s expertise and accountability,” it said it was unable to agree with the SEC’s “application of legal principles governing Merrill’s disclosures.”
Wilson, the plaintiff, bought his securities on July 17, 2007, on E*Trade.
In the complaint, the plaintiffs alleged that Merrill had manipulated the ARS market by placing bids for its own account, known as “support bidding,” to prevent auctions from failing. They also claim Merrill failed to disclose its intervention to investors.
Last year, Chief Judge Loretta Preska of the U.S. District Court for the Southern District of New York tossed out the case for failing to state a securities fraud claim. In her ruling, she said Merrill had revealed its market participation to the public, including support bids, “with a degree of credibility and intensity necessary to counterbalance any misinterpretations resulting from the alleged manipulation.”
Earlier this year, the second circuit asked the SEC to submit an amicus brief addressing five questions about the adequacy of Merrill’s disclosures and the effect of such disclosures on the plaintiff’s market manipulation claims.
In its brief, filed in June, the commission said Merrill’s disclosures were insufficient as a matter of law to bar investors from claiming market manipulation.
Specifically, the SEC noted, Merrill’s 1997 offering documents for the securities purchased by the investors said in certain circumstances holders “may be unable to sell their shares” and may not have liquidity. In addition, the commission said, beginning in 2006, Merrill’s Web site contained disclosures saying there “may not always” be enough bidders to prevent auction failure and such failure was “possible” if Merrill did not bid.
But SIFMA said in its amicus brief two weeks later that the plaintiffs could not successfully plead market manipulation because widespread disclosures — in offering documents, newsletters, and national news articles — informed investors that broker-dealers’ ARS-market participation “affected the natural interplay between supply and demand.”
Those briefs were the latest episode in a string of efforts by regulators and private litigants alike to police the ARS market and seek compensation for investors harmed by the market’s collapse in 2008.
In May 2006, the SEC settled a securities fraud case against 15 broker-dealers, including Merrill, for conduct including the failure to disclose adequately to investors their efforts to intervene, between January 2003 and June 2004, in the then-$200 billion ARS market. The firms, which did not admit or deny liability, paid more than $13 million in penalties, including $1.5 million each from Merrill and seven other firms.
In August 2008, six months after the ARS market collapsed, the SEC announced a preliminary settlement with Merrill that would enable retail investors who purchased ARS through the firm to receive up to $7 billion to restore their losses and liquidity. Merrill agreed to buy back at par ARS from retail investors who bought securities from the firm before the market tanked.
Meanwhile, plaintiffs’ class-action lawyers filed a series of securities fraud lawsuits in federal courts across the country, stemming from the market’s collapse. Nine investor suits against Merrill were consolidated before Preska.
In interviews, Merrill and SIFMA welcomed the second circuit’s opinion.
“We’re pleased with the court’s decision,” said Bill Haldin, a spokesman for Bank of America Merrill Lynch.
Leslie Norwood, managing director and co-head of SIFMA’s muni division, said the ruling was “a significant win for the industry.”
SEC spokesman John Nester said: “While the court disagreed with our reading of the facts alleged by the plaintiff, we are pleased that the court noted that it agreed with commission’s views on the applicable law.”
An attorney for the investors, Jonathan Levine at Girard Gibbs in San Francisco, said they are evaluating their options. “We’re disappointed that the court of appeals disagreed with the SEC’s conclusion that investors should have been allowed to proceed with their claims,” Levine said.