Monday, August 1, 2011
As we have reported in previous postings, purchasers of auction rate securities (ARS) have fared poorly in their Rule 10b-5 litigation against the investment banks that recommended the securities to them. Ashland Inc. recently had the dismissals of their complaints against two different investment firms affirmed by two Circuits (2d and 6th). The opinions provide good examples of the legal grounds successfully used by defendants to defeat these claims: lack of reasonable reliance on the part of the investor and failure to plead scienter with the requisite particularity required by PSLRA.
The Second Circuit, in particular, has frequently invoked the duty of sophisticated investors to conduct due diligence to bar Rule 10b-5 fraud claims, and Ashland Inc. v. Morgan Stanley & Co., Inc. (10-1549-cv, July 28, 2011) gives the court another opportunity to apply that doctrine. Ashland contended that Morgan Stanley, in both oral and email communications, repeatedly misrepresented the the liquidity of certain ARS, thus inducing them to purchase and hold these securities at a time when Morgan Stanley knew the market for ARS was collapsing. The Second Circuit, however, affirmed the district court's dismissal of the complaint because Ashland, concededly a sophisticated investor, could not plead reasonable reliance on the alleged misrepresentations because Morgan Stanley had,pursuant to an SEC order, previously posted on its website statements that explicitly disclosed the liquidity risks. The Second Circuit also affirmed the district court's dismissal of the claims under New York common law, also because of plaintiffs' lack of reasonable reliance, thus ducking the Martin Act preemption issue that has been the subject of conflicting rulings by the state and federal courts and is currently before the New York Court of Appeals.
The Sixth Circuit based its affirmance of Ashland's dismissal on that other common ground for dismissal -- failure to plead scienter with the requisite particularity. In Ashland Inc. v. Oppenheimer & Co., Inc. (No. 10-5305, July 28, 2011), the court, following the "entirely collective assessment" of Tellabs and Matrixx, concluded that Ashland's factual allegations, when considered together, did not give rise to a strong inference that Oppenheimer acted with scienter. "Simply put, apart from conclusory allegations, Ashland fails to provide any facts explaining why or how Oppenheimer possessed advance, non-public knowledge that underwriters would jointly exit the ARS market and cause its collapse..." The court also affirmed dismissal of the state law claims for failure to plead scienter or (in the case of the non-fraud claims) lack of justifiable reliance.