Wilson v. Merrill Lynch & Co.

Decision Date14 November 2011
Docket NumberDocket No. 10–1528–cv.
Citation671 F.3d 120
PartiesColin WILSON, Plaintiff–Appellant,Ronald Levy, Michael Bonde, Plaintiffs, v. MERRILL LYNCH & CO., INC., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Defendants–Appellees.*
CourtU.S. Court of Appeals — Second Circuit

OPINION TEXT STARTS HERE

Daniel C. Girard (Jonathan K. Levine, Aaron M. Sheanin, on the brief), Girard Gibbs LLP, San Francisco, CA, for PlaintiffAppellant.

Jay Kasner (Scott D. Musoff, on the brief), Skadden, Arps, Slate, Meagher & Flom LLP, New York, NY, for DefendantsAppellees.

Jacob H. Stillman, Solicitor (Tracey A. Hardin, Senior Litigation Counsel, of counsel), for amicus curiae Securities and Exchange Commission.David L. Schwarz (Mark C. Hansen, Kevin J. Miller, of counsel), Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C., Washington, D.C., for amicus curiae The Anschutz Corporation.William F. Sullivan, Paul, Hastings, Janofsky & Walker LLP, Los Angeles, CA (Howard M. Privette, D. Scott Carlton, Paul, Hastings, Janofsky & Walker LLP, Los Angeles, CA, Stephen B. Kinnaird, Paul, Hastings, Janofsky & Walker LLP, Washington, D.C., Barry Sher, Paul, Hastings, Janofsky & Walker LLP, New York, NY, Kevin M. Carroll, Associate General Counsel, The Securities Industry and Financial Markets Association, of counsel) for amicus curiae The Securities Industry and Financial Markets Association.

Before: KEARSE, SACK, and KATZMANN, Circuit Judges.

KATZMANN, Circuit Judge:

This case requires us to determine when a broker-dealer's disclosures of its market activities suffice to negate a claim that these activities are “manipulative” within the meaning of the securities laws.

PlaintiffAppellant Colin Wilson appeals from a judgment of the United States District Court for the Southern District of New York (Preska, C.J.) dismissing his complaint with prejudice. Wilson, a purchaser of auction rate securities (“ARS”), brings a purported class action lawsuit against DefendantsAppellees Merrill Lynch & Co., Inc. (Merrill Lynch & Co.) and Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch) (collectively, “Merrill”). He alleges that Merrill engaged in a scheme to manipulate the ARS market in violation of Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act) and Rule 10b–5(a) & (c) promulgated thereunder. Merrill moved to dismiss the complaint, and the district court granted that motion on several grounds, including that Merrill's disclosures of its auction practices preclude Wilson's claim that these practices were manipulative. On appeal, Wilson contends that this dismissal was in error. For the reasons set forth below, we conclude that Wilson's claim cannot proceed in light of Merrill's disclosures. Accordingly, we affirm the judgment of the district court.

BACKGROUND

The following facts are drawn from the allegations in Wilson's First Amended Consolidated Class Action Complaint (the “complaint”), together with those “documents ... incorporated in it by reference” and “matters of which judicial notice may be taken.” Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir.2002) (internal quotation marks omitted).

This case arises from the collapse of the ARS market. ARS are debt or equity interests issued by various public and private entities and traded through periodic auctions. At times relevant to Wilson's claim, ARS were used by issuers as an alternative financing vehicle and were promoted to investors as a safe, liquid alternative to money market funds. The ARS market, which began in the 1980s, was initially dominated by institutional investors. Eventually, however, unsophisticated investors entered the market. By February 2008, the ARS market exceeded $330 billion in value.

The periodic auctions held with respect to ARS would determine both the ownership of the securities as well as their “clearing rate,” i.e., the rate of interest that was paid on the securities until the next auction. At each auction, participants submitted orders to buy, sell, or hold ARS at particular interest rates or in particular quantities. When the number of shares subject to buy orders at a given rate met or exceeded the number of shares offered for sale at that rate, the auction would succeed, and the clearing rate would be set at the lowest interest rate at which all sell orders could be fulfilled. When the number of shares offered for sale exceeded the number of shares bid for purchase, the auction would fail, and the interest rate on the ARS would reset to a predetermined rate known as the “maximum rate.” If the maximum rate were sufficiently high, it would ensure that the ARS remained liquid by attracting new buyers or prompting the issuer to refinance. If, on the other hand, the maximum rate were too low, then new buyers would not be attracted, and the auction failure, absent further intervention, would leave investors with illiquid securities.

Merrill Lynch, a broker-dealer registered with the Securities and Exchange Commission (“SEC”), is a wholly owned subsidiary of Merrill Lynch & Co., which is one of the world's leading financial firms. Merrill participated in the ARS market in various capacities. First, Merrill served as an underwriter for issuers who wished to raise cash though the use of ARS. Second, Merrill was paid by issuers to act as a dealer through which investors submitted auction orders, either directly or through intermediary brokerages designated as “remarketing agents” or “distributing firms,” for that issuer's ARS. Compl. ¶ 36. Merrill underwrote billions of dollars of ARS and served as sole, lead, co-lead, or joint lead auction dealer for over $24 billion of those securities.

On July 17, 2007, Wilson purchased from E*Trade, an online brokerage, $125,000 of ARS for which Merrill served as dealer. He continues to hold most of these securities, which are now illiquid.

A. Merrill's Alleged Market Manipulation

On behalf of himself and all purchasers of ARS for which Merrill served as sole, lead, co-lead or joint lead auction dealer (Merrill ARS) between March 25, 2003 and February 13, 2008, Wilson alleges that Merrill engaged in a scheme to manipulate the ARS market. Central to the alleged scheme is Merrill's practice of “support bid[ding],” or using its own capital to place bids in order to prevent the failure of auctions for which it served as sole or lead dealer. Wilson contends that pursuant to a tacit understanding among Merrill and ARS issuers, Merrill “followed a uniform policy of placing support bids if needed to prevent auction failures in every auction for which it was sole or lead auction dealer.” Id. ¶ 46. Between January 3, 2006 and May 27, 2008, Merrill placed support bids in more than 5,800 auctions. Wilson claims that the support bids “masked the liquidity risks inherent in [Merrill] ARS” and created the false impression that the lack of auction failures reflected investor demand and that Merrill ARS could readily be liquidated if needed. Id. ¶¶ 50–51. Merrill's support bidding also permitted it to set clearing rates for auctions that would have failed absent its interventions. Wilson maintains that Merrill manipulated the clearing rates in order to reduce its own inventory of Merrill ARS, which it obtained through support bidding, and thereby sent a false signal to the market about the price and liquidity of these securities.

According to the complaint, until the credit market deteriorated in the summer of 2007, Merrill invariably prevented ARS auctions from failing. Beginning in August and September 2007, Merrill declined to place support bids in at least 34 ARS issuances, thus allowing those auctions to fail. At that point, Merrill continued to support the ARS market while monitoring the industry for auction failures. On February 13, 2008, Merrill and all other major dealers withdrew their support from the ARS market. As a result, 87% of all ARS auctions failed, and investors like Wilson were left with illiquid securities.

Wilson's complaint sets forth a number of other ways in which Merrill allegedly misled ARS investors during this period:

• Merrill described its ARS as liquid and safe investments similar to money market funds and categorized these securities as “Other Cash” on clients' account statements. Id. ¶ 53.

• Although Merrill's research department was purportedly independent from Merrill's ARS trading desk, the trading desk shared material non-public information about Merrill's inventory of Merrill ARS with its research analysts. These research analysts, in turn, then issued research reports intended to sustain the “façade of liquidity” with respect to the Merrill ARS market and to reduce Merrill's inventory of these securities. Id. ¶ 51. In late August 2007, a managing director of the ARS trading desk demanded that a research report identifying some of the liquidity risks of Merrill ARS be retracted and succeeded in having that report be replaced by one that downplayed these risks. Id. ¶¶ 68–69.

• Through various sales incentives, Merrill encouraged its financial advisors to sell ARS to clients without disclosing Merrill's internal pessimism about the ARS market. See id. ¶¶ 91–98.

B. Merrill's Disclosures

In resisting Wilson's manipulation claim, Merrill relies on several public disclosures of its ARS auction practices. The first such disclosure arose from an SEC investigation resulting in a settlement with several ARS broker-dealers, including Merrill. This investigation, which began in 2004, concluded on May 31, 2006, when the SEC filed an Order Instituting Administrative and Cease–and–Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease–and–Desist Order Pursuant to Section 8A of the Securities Act of 1933 and Section 15(b) of the Securities Exchange Act of 1934 (the 2006 SEC Order”). The 2006 SEC Order stated that certain ARS broker-dealers violated the securities laws by intervening in...

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