Opinion ID: 806559
Heading Depth: 3
Heading Rank: 2

Heading: Merrill’s Conduct

Text: Defendant Merrill Lynch, Pierce, Fenner & Smith Incorporated (“Merrill Lynch”)2 underwrote numerous ARS offerings, including two offerings of ARS issued by Ambac—the “Dutch Harbor” and “Anchorage Finance” offerings. Plaintiff The Anschutz Corporation (“Anschutz”) made the following purchases through its broker, Credit Suisse: (1) on July 21, 2006, Anschutz purchased $7.95 million of Dutch Harbor Finance Sub-Trust # II ARS; and (2) on January 25, 2007, Anschutz purchased $5 million of Dutch Harbor Finance Sub-Trust # III ARS and $6 million of Anchorage Finance Sub-Trust #2 ARS. As the sole broker-dealer for those offerings, Merrill Lynch selected and hired the auction agent; received and transmitted all buy, hold, and sell orders; participated in drafting ARS offering statements; and entered into re-marketing agreements with “downstream” brokers who would buy ARS and then re-sell them to their own customers. Merrill Lynch allegedly earned $90 million in profits from its ARS underwriting and broker-dealer services in the years 2006 and 2007. Merrill Lynch also participated as a buyer and seller in the ARS auctions for its own account in order to prevent auction failures. By placing so-called “support bids” in 100 percent of the Dutch Harbor and Anchorage Finance auctions, Merrill Lynch ensured that the auction would “clear” without regard to the volume of buy, sell, or hold orders received from others. The extent of this practice was 2 We refer to Merrill Lynch, together with its parent corporation, Merrill Lynch & Co., Inc., as the “Merrill Defendants.” 4 not fully disclosed to investors. Merrill Lynch allegedly knew that, in the absence of its support bids, the demand for ARS was insufficient to feed the auctions. Merrill Lynch’s practice of placing support bids had two primary effects. First, the support bids, which established the clearing rate in “a significant percentage” of the Dutch Harbor and Anchorage Finance auctions, caused the clearing rates to be lower “than they otherwise would have been.” As a result, Anschutz earned less interest on its ARS that it otherwise would have earned. Second, the undisclosed support bids “injected false information into the marketplace” about the liquidity of the ARS. Anschutz alleges that it relied on the appearance of ARS liquidity manufactured by Merrill Lynch, and on its previous success in buying and selling similar ARS, in deciding to make its purchases. In May 2006, the Securities and Exchange Commission (“SEC”) reached a settlement with 15 investment banks, including Merrill Lynch, that had participated in the ARS market. The SEC issued a cease-and-desist order (the “SEC Order” or the “Order”) on May 31, 2006, ordering the banks to cease various forms of intervention in the ARS market in the absence of adequate disclosures. The SEC Order concluded that the banks had violated § 17(a)(2) of the Securities Act of 1933, 15 U.S.C. § 77q(a)(2), which prohibits material misstatements and omissions in any offer or sale of securities, by “interven[ing] in auctions by bidding for their proprietary accounts or asking customers to make or change orders without adequate disclosures.”3 Although the SEC Order enumerated several violative practices, including bidding to prevent auction failures or to affect clearing rates, the Order did not specify which banks engaged in which practices. The banks were divided into two tiers for civil penalty purposes. Merrill Lynch, along with each of the other banks in “Tier One,” was ordered to pay a penalty of $1.5 million in light of its “relatively large share of the auction rate securities market” and the fact that it “engaged in more types 5 of violative practices than the firms in Tier Two.” In addition, the SEC Order required each bank, among other things, to (1) provide, at or before the completion of each transaction, a written description of the bank’s ARS practices to all first-time purchasers and broker-dealer purchasers, and (2) post a description of the bank’s ARS practices on its website. In August 2006, Merrill Lynch posted a document disclosing its ARS practices on its website (the “Website Disclosure”). See Wilson, 671 F.3d at 125–26 (discussing the same disclosure). The Website Disclosure, which is quoted in the FAC and incorporated therein by reference, included the following statements:  “Auction procedures generally permit auction dealers like Merrill Lynch to buy and sell, in their sole discretion, auction rate securities for their own account between auctions at any time.”  “Merrill Lynch is permitted, but not obligated, to submit orders in auctions for its own account either as a bidder or a seller, or both, and routinely does so in its sole discretion.”  “Merrill Lynch 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 Lynch believes does not reflect the market for the securities.”  “Bids by Merrill Lynch or by those it may encourage to place bids are likely to affect the clearing rate, including preventing the clearing rate from being set at the maximum rate or otherwise causing bidders to receive a higher or lower rate than they might have received had Merrill Lynch not bid or not encouraged others to bid.”  “Because of these practices, the fact that an auction clears successfully does not mean that an investment in the securities involves no significant liquidity or credit risk. Merrill Lynch is not obligated to continue to place such bids . . . in any particular auction to prevent an auction from failing or clearing at a rate Merrill Lynch believes does not reflect the market for the securities. Investors should not assume that Merrill Lynch will do so or that auction failures will not occur.”  “If Merrill Lynch submits an order for its own account, it would likely have an advantage over other bidders because Merrill Lynch would have knowledge of some or all of the other orders placed through Merrill Lynch in that auction . . . . Merrill Lynch’s interests in conducting an auction may differ from those of holders and prospective holders who participate in auctions.” 3 The SEC Order did not, however, prohibit broker-dealers from placing support bids when properly disclosed. 6  “Merrill Lynch may submit a bid in an auction to keep it from failing, but it is not obligated to do so. There may not always be enough bidders to prevent an auction from failing in the absence of Merrill Lynch bidding in the auction for its own account or encouraging others to bid. Therefore, auction failures are possible, especially if the issuer’s credit were to deteriorate, if a market disruption were to occur or if, for any reason, Merrill Lynch were unable or unwilling to bid.” Anschutz alleges that these disclosures were false and misleading, and that they “amount to little more” than the disclosures found to be inadequate in the SEC Order.4 In August 2007, Merrill Lynch discontinued its practice of placing support bids, and the auctions for the Dutch Harbor and Anchorage Finance ARS failed. The market for these ARS “completely evaporated” and has not recovered. Anschutz has been unable to sell its ARS, so that it now holds $18.95 million of “illiquid and severely impaired securities.”