In re Merrill Lynch Auction Rate Sec. Litig..This Document Relates To: 09 Ci v. 5403 (lap).Cmty. Trust Bank Inc.

• Decision Date: 24 January 2011
• Docket Number: No. 09 MD 2030 (LAP).,09 MD 2030 (LAP).
• Citation: 765 F.Supp.2d 375
• Parties: In re MERRILL LYNCH AUCTION RATE SECURITIES LITIGATION.This Document Relates To: 09 Civ. 5403 (LAP).Community Trust Bank, Inc., Plaintiff,v.Merrill Lynch, Pierce, Fenner & Smith Inc., Defendant.
• Court: U.S. District Court — Southern District of New York

765 F.Supp.2d 375

In re MERRILL LYNCH AUCTION RATE SECURITIES LITIGATION.This Document Relates To: 09 Ci

v. 5403 (LAP).Community Trust Bank, Inc., Plaintiff,

v.Merrill Lynch, Pierce, Fenner & Smith Inc., Defendant.

No. 09 MD 2030 (LAP).

United States District Court, S.D. New York.

Jan. 24, 2011.

MEMORANDUM & ORDER

LORETTA A. PRESKA, Chief Judge.

Plaintiff Community Trust Bank (“CT”) filed suit for alleged violations of the federal securities laws and of a variety of Kentucky state laws by Defendant Merrill Lynch, Pierce, Fenner & Smith Inc. (“MLPFS”). All of the claims arise out of CT's purchase of auction rate securities (“ARS”) in a private placement offered by MLPFS. The Defendant's motion to dismiss the Second Amended Complaint (“SAC”) is now before this Court. The motion to dismiss is GRANTED.

I. BACKGROUND

In considering this motion, the Court takes the factual allegations in the complaint as true and draws all reasonable inferences in favor of the plaintiff. See Goldstein v. Pataki, 516 F.3d 50, 56 (2d Cir.2008).

A. The Parties

CT is a Kentucky corporation principally based in Pikeville, Kentucky, with operations throughout eastern Kentucky. (SAC ¶ 1.) Defendant MLPFS is a Delaware corporation with its principal place of business in New York and is registered with the SEC as a broker-dealer. ( Id. ¶ 4.)

B. Auction Rate Securities

ARS are municipal or corporate debt or preferred securities with long-term maturities (or no maturity in the case of preferred stock) but which have variable interest rates set by periodic auctions. ( Id. ¶ 12.) Generally, ARS are traded at “Dutch” auctions held every 7, 28, or 35 days with interest paid at the end of each auction period. ( Id. ¶¶ 16–17.) Following an auction, each bid is ranked by an auction agent from the lowest to the highest interest rate bid. ( See id. ¶ 17.) The bids are filled beginning with the lowest interest rate, followed by orders with progressively higher interest rates, until all instruments available for sale are matched up with purchase orders. ( See id.) The interest rate at which the final ARS available at the auction are sold becomes the “clearing rate.” ( See id. ¶ 18.) Interest rates for the entire ARS issuance up for auction are then set to the clearing rate. ( See id.) If, at a particular auction, there were not enough orders to purchase all of the ARS offered for sale, the auction fails. ( Id.) In the event of an auction failure, ARS holders are unable to sell the securities that they hold, and interest rates on the securities are set to a failure rate. ( Id.) By February 2008, the ARS market had grown to approximately $330 billion in outstanding securities. ( Id. ¶ 13.)

C. The Private Placement

CT purchased $10,050,000 worth of ARS from MLPFS in January 2006. ( Id. ¶ 24.) CT purchased these ARS through a $106 million private placement offered by MLPFS involving noncumulative preferred stock in the Federal National Mortgage Association (“Fannie Mae”). ( Id. ¶¶ 24–25.)

D. Merrill Lynch's Role in the Auctions

In essence, CT makes two distinct but related allegations regarding MLPFS's role in the auctions: (1) that MLPFS did not disclose its bidding practices (namely the placement of support bids ¹ in auctions that would have otherwise failed) and (2) that: as a result of this bidding, the ARS market was not as liquid as MLPFS represented. ( See id. ¶¶ 19–20, 25–27, 31–33, 54–56.) MLPFS's support bids allegedly “hid the true infirmities of the auction rate securities market and the illiquidity of such securities.” ( Id. ¶ 19.) These practices allegedly “enabled [MLPFS] to market its [ARS] securities” to CT. ( Id. ¶ 20.)

E. Collapse of the ARS Market

From January 2006 until February 2008, the auctions functioned as MLPFS had predicted. ( See id. ¶¶ 24–27.) However, on February 13, 2008, following a wave of auction failures, the ARS market collapsed. ( Id. ¶ 27.) On or around this date, MLPFS and other broker-dealers stopped supporting auctions with support bids. ( See id.; see also id. ¶ 19.) As a result of the auction failures, CT has been unable to sell $9.9 million of its ARS. ( See id. ¶¶ 3, 24.)

F. Procedural Background

CT filed this suit in the Eastern District of Kentucky on December 31, 2009. See Cmty. Trust Bank, Inc. v. Merrill Lynch, Pierce, Fenner & Smith Inc., No. 08 Civ. 231 (E.D.Ky. Dec. 31, 2009) (complaint). CT filed its First Amended Complaint on February 23, 2009. On June 10, 2009, 626 F.Supp.2d 1331 (Jud.Pan.Mult.Lit.2009), the Judicial Panel on Multidistrict Litigation transferred this action here for inclusion in coordinated or consolidated pretrial proceedings pursuant to 28 U.S.C. § 1407. CT filed its Second Amended Complaint on October 26, 2009. On November 18, 2009, the Defendant filed this motion to dismiss for failure to state a claim. See Fed.R.Civ.P. 12(b)(6).

II. LEGAL STANDARD

A. Motion to Dismiss

To survive a motion to dismiss for failure to state a claim, “a complaint must contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’ ” Ashcroft v. Iqbal, –––U.S. ––––, ––––, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)). A pleading that offers “labels and conclusions” or “a formulaic recitation of the elements of a cause of action will not do.” Twombly, 550 U.S. at 555, 127 S.Ct. 1955. “Where a complaint pleads facts that are merely consistent with a defendant's liability, it stops short of the line between possibility and plausibility of entitlement to relief.” Iqbal, 129 S.Ct. at 1949. In securities fraud cases like this one, the complaint also must meet heightened pleading requirements under Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act, 15 U.S.C. § 78u–4(b). See ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir.2007).

III. ANALYSIS

Because many of the state law claims contain elements contained within the federal securities law claims, the Court discusses the federal claims first. The Court's federal claims analysis proceeds in three parts: (1) CT's allegations relating to the information received by CT prior to purchasing its ARS; (2) CT's allegations relating to information received after the initial purchase; and (3) CT's pleadings in establishing scienter either prior to or after the initial ARS purchase.

Then, because three state claims include elements mirroring those contained in the federal securities claims, the Court discusses those claims briefly by reference to the federal claims analysis. Next, the Court analyzes CT's breach of fiduciary duty claim. Finally, the Court takes up CT's claim of breach of implied covenant of honesty, good faith, and fair dealing under Kentucky law.

A. Federal Securities Laws (Count One)

To state a misrepresentation claim under Section 10(b) and Rule 10b–5, CT must “allege that the defendant[s] (1) made misstatements or omissions of material fact, (2) with scienter, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff relied, and (5) that the Plaintiffs' reliance was the proximate cause of its injury.” ATSI, 493 F.3d at 105. To make out a market manipulation claim,² the complaint must “allege (1) manipulative acts; (2) damage (3) caused by reliance on an assumption of an efficient market free of manipulation; (4) scienter; (5) in connection with the purchase or sale of securities; (6) furthered by the defendant's use of the mails or any facility of a national securities exchange.” Id. at 101; see 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b–5.

i. Pre–Purchase Allegations

Obviously, a misrepresentation claim must contain an alleged material misrepresentation or omission. CT must point to a material misstatement or some omission that would “significantly alter[ ] the ‘total mix’ of information made available” about its ARS and/or the ARS market. ECA & Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 197 (2d Cir.2009) (citing TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976)). This is a “fact-specific inquiry.” Id. In a case where allegations of market manipulation are rooted in alleged misrepresentations, as here, the need to point to material misrepresentations or omissions to support a manipulation claim is equally pressing. See In re Merrill Lynch ARS Litig., 704 F.Supp.2d 378, 390–91 (S.D.N.Y.2010) (citing Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 477, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977)).

CT's allegations, although they include alleged misstatements, primarily sound in omission. CT alleges that, prior to its purchase of ARS in January 2006, MLPFS did not disclose (1) its bidding practices and the ability of MLPFS to submit support bids or affect the clearing rate, (2) liquidity risks in the ARS market, and (3) various potential conflicts of interest. ( See SAC ¶¶ 19–27, 33, 36.) CT claims that MLPFS manipulated the ARS market by engaging in the allegedly undisclosed practices. ( See id.) Because there is a dispute about whether CT received, by the time of the initial ARS purchase, a Private Placement Memorandum (“PPM”) on which MLPFS relies to rebut CT's claims, infra Part III.A.ii., this section of the Court's opinion considers only the disclosures contained in a pre-investment presentation made to CT and titled “Introduction to Auction Market Securities, 3rd Quarter 2005” (hereinafter “3Q Presentation”).³ (Pl. Mem. Ex. A/B.) This presentation disclosed the basic ARS market features that CT now says were either misrepresented or not disclosed before CT's purchase. It is therefore sufficient to defeat CT's claims under the federal securities laws to the extent that they involve alleged misstatements or omissions occurring prior to CT's purchase. See ECA, 553 F.3d at 197. The Court addresses CT's three separate claims sequentially.

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