2nd Circ. rebuffs SEC in Merrill auction-rate securities ruling

By Alison Frankel
November 14, 2011

One of the most controversial aspects of the U.S. Supreme Court’s June 2011 ruling in Janus v. First Derivative Traders was that the Justices rejected the Securities and Exchange Commission’s interpretation of federal securities laws. The SEC said Janus Capital wasn’t liable for the allegedly misleading statements in a prospectus issued by a Janus mutual fund, even though the SEC argued that it was — and even though federal courts traditionally pay deference when they ask agencies to offer their expertise in interpreting the law.

The SEC took another blow Monday, when a three-judge panel of the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of an auction-rate securities class action against Merrill Lynch, despite an SEC brief arguing the case should proceed. The SEC agreed with a Merrill ARS investor who asserted that the boilerplate disclosure Merrill posted after a 2006 SEC consent decree shouldn’t shield it from claims it manipulated the market for ARS. The Second Circuit panel felt otherwise.

To be sure, Judge Robert Katzmann, writing for a panel that also included Judges Robert Sack and Amalya Kearse, said that the Merrill opinion should be read narrowly. “We see no need to fix the ‘exact molecular weight’ of the deference that we owe to the SEC’s position,” Katzmann wrote. “We readily acknowledge that at least some deference to the agency’s position is appropriate, given the SEC’s expertise and accountability. Here, however, we are unable to agree with the SEC’s application of the legal principles governing Merrill’s disclosures.”

But it’s notable that the appeals court declined to adopt the SEC’s view after expressly asking the agency to weigh in. U.S. District Judge Loretta Preska of Manhattan federal court had dismissed the class action in March 2010, ruling that Merrill’s posted disclosures, which followed an SEC investigation of the ARS market, were an adequate warning that the firm bid on its own securities to prop up prices. The Second Circuit already had considered the post-2006 disclosures all ARS issuers agreed to in a July 2011 ruling, Ashland v. Oppenheimer, but hadn’t asked the SEC about the reach of the disclosures. So after Girard Gibbs appealed Preska’s dismissal of the Merrill class action, the appeals court sought a letter brief from the agency.

The SEC, like the class, asserted that Merrill’s disclosure didn’t go far enough in disclosing its interference in the ARS market. The Second Circuit said that it did. “We find no error in the district court’s conclusion that Merrill’s disclosures of its support bidding practices sufficed to preclude [the class's] claim that these practices were manipulative,” the opinion said. “These disclosures revealed, at the very least, the possibility that Merrill would place support bids in some auctions that it managed and that in the absence of these bids, some of these auctions might fail.”

I asked an SEC spokesman for the agency’s response but didn’t hear back. Class counsel Jonathan Levine of Girard Gibbs said, “We’re disappointed that the Court of Appeals disagreed with the SEC conclusion that investors should have been allowed to proceed with claims.”

Merrill was represented by Jay Kasner, Scott Musoff, and Paul Lockwood of Skadden, Arps, Slate, Meagher & Flom, which also prevailed in the appeals court’s Ashland ruling in July.

Even though the Second Circuit has now upheld the dismissal of two ARS cases, that’s not the end of all ARS litigation, according to George Carpinello and Adam Shaw of Boies, Schiller & Flexner. They represent individual plaintiffs in two ARS cases brought by individual investors, including a case against Merrill that Preska — the judge who dismissed the Merrill case at issue before the Second Circuit — greenlighted. “The court made it clear that this is a limited ruling,” said Carpinello. “It clearly had problems with the way the facts were pled…Our cases are about what was said to our clients at a particular point in time when the broker had knowledge of what was going on.”

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