Second Circuit Provides Guidance On The Nature Of Disclosures That Will Avoid Liability For Market Manipulation

Private securities fraud claims brought under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 are most commonly premised on alleged misstatements or omissions in information provided to investors about a publicly-traded company. However, Section 10(b) and Rule 10b-5 encompass a broader range of fraudulent activity, including "manipulative" market conduct.

In Wilson v. Merrill Lynch & Co., Inc., ___ F.3d ___, 2011 WL 5515958 (2d Cir. Nov. 14, 2011), the Second Circuit examined an investor's class action complaint alleging "manipulative" market conduct arising from the widespread disruption of the auction rate securities markets in February 2008. Echoing claims asserted separately against virtually all of the major financial institutions that participated in the auction rate securities markets, the plaintiff claimed that Merrill Lynch & Co., Inc. ("Merrill") manipulated auctions for which it served as a dealer through its practice of placing "support bids" for the securities. In a unanimous opinion, the Second Circuit upheld dismissal of the case on a motion to dismiss, finding that where the conduct alleged to be manipulative is "fairly" disclosed to the market, a plaintiff is precluded from pleading the "manipulative acts" element of a market manipulation claim.

Background of the Case

Auction rate securities ("ARS") are long-term variable rate instruments (bonds or preferred stock) issued by public or private entities, with interest rates or dividends to be set periodically on a shortterm basis through public Dutch auctions of the issued securities.

Auctions for ARS are typically conducted under the auspices of one or more financial institutions, such as Merrill. These financial institutions are permitted to bid in the auctions for their own account and often did so, at least until the credit crisis reached a crescendo in late 2007-early 2008.

Merrill, as had other financial institutions, publicly disclosed that it "may routinely place one or more bids in an auction for its own account to acquire auction rate securities for its inventory, to prevent an auction failure . . . or an auction from clearing at a rate that Merrill believes does not reflect the market for the securities." Merrill also warned that "[i]nvestors should not assume that Merrill Lynch will do so or that auction failures will not occur." After these disclosures were posted on Merrill's website, the plaintiff, Colin Wilson, purchased from E*Trade...