Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Tuesday, November 15, 2011

Second Circuit Holds that Merrill's Website Disclosures Defeat ARS Manipulation Claim

In Wilson v. Merrill Lynch & Co. (No. 10-1528-cv, 2d Cir., Nov. 14, 2011)( Download WilsonvML), the Second Circuit  held that an ARS purchaser could not maintain his class action alleging that Merrill, acting as a dealer,  manipulated the ARS market because Merrill adequately disclosed its auction practices on its website.  The appellate court accordingly affirmed the district court’s dismissal of the action.

Central to the plaintiff’s manipulation was Merrill’s practice of “support bidding,” or using its own capital to place bids in order to prevent the failure of auctions for which it served as lead dealer.  Plaintiff alleged that the support bids masked the liquidity risks and created the false impression that the lack of auction failures reflected investor demand.  In resisting the manipulation claim, Merrill relied principally on its public disclosures of its ARS auction practices on its website, mandated by an 2006 SEC Order.

The court acknowledged that its precedents “contain little discussion of when disclosures are sufficient to negate a claim that a certain market practice is manipulative.“   Looking at analogous contexts, the court stated that although half-truths will support claims for securities fraud, there are limits on what securities markets participants are required to disclose.  The court found that Merrill’s 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.”  Moreover, because the plaintiff’s complaint did not adequately allege that at the time of his purchase Merrill intended to place a bid “in every single auction, knew that each auction would fail if it did not place these bids and signaled to its ARS investors that these securities were genuinely liquid,” the court did not have to address whether a “hypothetical complaint” containing those allegations would state a market manipulation claim. 

In reaching its conclusion, the Second Circuit acknowledged that the SEC had filed a brief in support of the plaintiff.  Yet, “although we accept that brief’s articulation of the legal principles that govern the sufficiency of disclosures for purposes of a market manipulation claim, we cannot defer to the SEC’s conclusion that Merrill’s disclosures were inadequate.”

The Second Circuit's conclusion is consistent with its recent decision in Ashland Inc. v. Morgan Stanley & Co., 652 F.3d 333 (2d Cir. 2011).  In that decision claims by a SLARS purchaser that Morgan Stanley materially misrepresented the liquidity of that investment  failed because of website disclosures similar to Merrill’s.

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