This month, we discuss Wilson v. Merrill Lynch & Co.,1 in which the U.S. Court of Appeals for the Second Circuit affirmed the district court’s dismissal of a complaint alleging auction rate securities (ARS) market manipulation for failure to state a claim. The court’s opinion, written by Judge Robert Katzmann and joined by Judge Amalya Kearse and Judge Robert Sack, considered whether a claim for market manipulation could be stated under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, where a broker-dealer made certain disclosures regarding its involvement in the auction rate securities market.

Background

Until recently, Merrill Lynch was actively engaged in the marketing and auctioning of ARS. ARS are debt or equity instruments that have long-term maturities, and their interest rates are set by periodic Dutch auctions. At a typical auction, participants submit orders to buy or sell ARS at particular quantities and rates. When buy orders exceed sell orders, the auction succeeds, and the “clearing rate” is set at whatever level allows the sale of all ARS being offered for sale. When sell orders exceed buy orders, the auction fails, and the interest rate reverts to a pre-set “maximum rate.” Depending on buyer interest in ARS at the maximum rate, ARS may or may not be illiquid following a failed auction. From the 1980s until recently, nearly all auctions succeeded; beginning in February 2008, most auctions failed, leaving investors with billions of dollars in illiquid securities.

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