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X In Re Merrill Lynch Auction Rate

December 7, 2010


The opinion of the court was delivered by: X Loretta A. Preska, Chief United States District Judge:

X This document relates to Amended Opinion & Order

In this case, Plaintiffs, Louisiana Stadium and Exposition District ("LSED") and the State of Louisiana (collectively "Plaintiffs"), allege ten causes of action against Defendants Merrill Lynch, Pierce, Fenner & Smith, Inc. ("MLPFS") and Merrill Lynch & Co., Inc., ("Merrill") (collectively "Defendants") related to Plaintiffs' auction rate securities ("ARS") issuance. On February 8, 2010, Defendants filed a motion for judgment on the pleadings against Plaintiffs. The motion is GRANTED in part and DENIED in part.


A. The Parties

LSED is a subdivision of the State of Louisiana, with offices located in New Orleans, Louisiana. (See Third Amended and Supplemental Complaint ¶ 15 ("Compl.").) LSED owns the Louisiana Superdome, and the State is the lessee of the Superdome. (Id. ¶¶ 15-16.) When LSED's expenses exceed its revenues, the State "funds the . . . shortfall." (Id. ¶ 16.)

Defendant MLPFS is a Delaware corporation with its principal place of business in New York. MLPFS is a subsidiary of Merrill and provides, among other things, underwriting and brokerage services. (See id. ¶ 17; see also Memorandum of Law in Support of Defendants Merrill Lynch & Co., Inc. and Merrill Lynch, Pierce Fenner & Smith Incorporated's Motion for Judgment on the Pleadings ("Defs. Mem.") at 16.) Defendant Merrill is also a Delaware corporation with its principal place of business in New York and is the parent company of MLPFS. (See Compl.

¶ 19.) B. Auction Rate Securities

The following facts are recited as alleged in the complaint and are regarded as true in considering this motion for judgment on the pleadings. See Hayden v. Paterson, 594 F.3d 150, 160 (2d Cir. 2010). All reasonable inferences are drawn in favor of the plaintiff. Id.; see Ashcroft v. Iqbal, ___ U.S. ___, ___, 129 S. Ct. 1937, 1949-50 (2009).

ARS are long-term variable-rate debt instruments that are traded at periodic Dutch auctions, which are normally held every seven, fourteen, twenty-eight, or thirty-five days. (Compl. ¶¶ 6-7.) At a Dutch auction, buy orders are entered at interest rates selected by the bidder. (Id. ¶ 5.) Orders to buy or sell ARS at an auction can only be placed through a designated broker-dealer. (Id. ¶ 6.) The broker-dealers collect the orders and forward them to an auction agent who administers the Dutch auction. (Id.)

These auctions dictate the interest rates payable on the ARS. (Id. ¶ 5.) Each bid, or buy order, is ranked by the auction agent from lowest to highest based on the interest rate of the bid. (See id.) The orders are filled beginning with the lowest interest rate, followed by orders with progressively higher interest rates, until all instruments available for sale are matched up with purchase orders. (See id.) The lowest interest rate at which all the ARS available at the auction are sold becomes the "clearing rate." (See id.) Interest rates for the entire ARS issuance up for auction are set to the clearing rate following an auction. (See id.) If, at a particular auction, the buy and sell orders are insufficient to purchase all of the ARS offered for sale, the auction fails. (Id. ¶ 7.) In the event of an auction failure, ARS holders are unable to sell the securities that they hold, and the interest rate on the ARS rises to the maximum rate (or failure rate) of approximately 12% until the next auction. (Id.) By February 2008, the ARS market had grown to approximately $330 billion in outstanding securities. (Id. ¶ 8.)

C. The Solicitation and Agreement

In early 2005, LSED sought to restructure its existing debt. (See id. ¶ 28.) Subsequently, LSED issued a "Solicitation for Offers for Senior Managing Underwriter" (the "Solicitation") seeking investment banking services. (Id. ¶ 29.) After receiving the Solicitation, MLPFS responded by submitting a proposal to LSED on April 19, 2005. (See id. ¶ 30.) In its proposal, MLPFS stated, among other things, that it would "provide a full spectrum of client services . . . in order to create the most innovative and cost effective financing program." (Id.) On May 19, 2005, LSED hired MLPFS to fill the role of senior managing underwriter and charged it with the task of designing and implementing a structure for refinancing LSED's debt associated with the Louisiana Superdome. (See id. ¶ 37; Plaintiffs' Memorandum of Law in Opposition to Merrill Lynch's Motion for Judgment on the Pleadings ("Pls. Mem.") at 1; Defs. Mem. at 3.)

After the parties reviewed various financing options, MLPFS recommended the ARS structure to LSED. (See Compl. ¶ 43.) MLPFS proposed a "synthetic fixed rate structure" for the ARS, which would convert LSED's variable rate payments as set by the auctions into fixed obligations (created by interest rate swap agreements and a credit enhancement in the form of bond insurance). (Id.) According to MLPFS, the ARS structure it recommended would allow LSED to meet its financing objectives with a synthetic fixed interest rate of under 5%. (Id. ¶ 55.) To illustrate how the proposed ARS structure would work, MLPFS supplied LSED with a number of debt service schedules that showed how LSED's payments would unfold over the refinancing period. (See id. ¶¶ 43-56.) LSED claims that it relied on these schedules when determining whether to follow MLPFS's recommendation to issue ARS. (See id. ¶ 59.) Accordingly, on March 23, 2006, based on MPLFS's recommendations, LSED issued three series of ARS bonds: Series 2006A, 2006B, and 2006C.*fn1 (Id. ¶ 62.)

The bonds were issued in "auction mode," meaning that the rate of interest was set by way of the auction procedure outlined above. (Id. ¶ 66.) However, they could be converted to traditional fixed- or variable-rate "modes" until at least January 30, 2008.*fn2 (Id. ¶¶ 66, 113.) Plaintiffs allege that MLPFS undertook a duty to provide LSED with advice about whether to convert the bonds to another "mode" by which the bonds' interest rates were set. (Id. ¶ 140.)

In addition to serving as lead underwriter, MLPFS served as the broker-dealer for the auctions pursuant to another agreement between the parties (the "Broker-Dealer Agreement"). (See id. ¶ 71; Defs. Mem. at 7-8.) Under the Broker-Dealer Agreement, MLPFS earned approximately $644,000 in addition to its other compensation earned between the issuance of the ARS and the auction failures in February 2008. (Compl. ¶ 71.)

D. Merrill Lynch's Role as a Bidder

Plaintiffs allege that MLPFS failed to disclose its bidding practices in the ARS market. LSED's central allegation is that the operation of the recommended ARS structure entirely depended on MLFPS's placing support bids*fn3 at every auction for which it was the sole or lead underwriter/broker-dealer. (See id. ¶¶ 91-92, 108; see Pls. Mem. at 7, 9.) Support bids ensured that all the ARS for sale in any given auction would be purchased and thus the auction would not fail. (Compl. ¶ 91.) Absent support bids, LSED could not have obtained the low interest rates promised by MLPFS because the auctions would have otherwise failed, causing LSED to pay the failure rate of 12%. (See id. ¶ 48; Pls. Mem. at 7-8.)

MLPFS's policy of placing support bids in every auction to prevent auction failures allegedly created a false impression of liquidity in the ARS market. (See Compl. ¶¶ 96-97.) From January 3, 2006, to May 27, 2008, 5,892 auctions throughout the ARS market would have failed but for MLPFS's support bids. (Id. ¶ 96; Pls. Mem. at 7.) Cumulatively, approximately 69% of the auctions for LSED's ARS would have failed but for MLPFS's support bids. (Compl. ¶ 96.) As it relates to LSED's ARS, Plaintiffs allege that MLPFS submitted a bid for 100% of LSED's bonds in 100% of the auctions to ensure no failures, and MLPFS's bids set the clearing rate in nearly every auction. (Id. ¶ 91.) Specifically, Plaintiffs allege that 76 of 98 Series 2006A auctions, 72 of 97 Series 2006B auctions, and 46 of 86 Series 2006C auctions would have failed without support bids. (Id. ¶ 93-95.) Furthermore, MLPFS's support bids set the clearing rate in all but 5, 5, and 16 of those auctions, respectively. LSED claims it did not learn any of this until the auctions failed. (Id. ¶ 91.)

E. The 2006 SEC Order and Merrill Lynch's Website Disclosure

On May 31, 2006, following an investigation into the auction practices and procedures of numerous investment banks, including MLPFS, the Securities and Exchange Commission ("SEC") issued an "Order Instituting Administrative and Cease-and Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order Pursuant to Section 8A of the Securities Act of 1933 and Section 15(b) of the Securities Exchange Act of 1934" (the "SEC Order"). (See id. ¶ 100; see also Defs. Mem. at 10.) The SEC Order stated that various investment banks intervened in auctions for a variety of reasons, such as bidding to prevent auction failures or to affect the auctions' clearing rates, without proper disclosure. (See Compl. ¶ 101.) The SEC Order listed MLPFS as a respondent and noted that each and every respondent engaged in violative activity with respect to ARS practices. (SEC Order at 2-3.) The order created two tiers for penalty purposes, the first of which received larger penalties in part because those respondents "engaged in more types of violative practices." (Id. at 9.) MLPFS was placed in the first tier. (Id.) The SEC determined that without proper disclosure, these types of conduct violated the prohibition on material misstatements and omissions in the offer and sale of securities. (See id. at 3; Compl. ¶ 101.) The order did not prohibit broker-dealers from bidding for their own accounts when properly disclosed. (SEC Order at 6 n.6.) Pursuant to the SEC Order, MLPFS entered into an agreement with the SEC in which MLPFS agreed, among other things, to post on its website a written description of its auction practices and procedures that would be available to all issuers of ARS.*fn4 (See id. at 9-11; Compl. ¶ 103.)

In compliance with the settlement, in August 2006, MLPFS posted a twenty-three page document on its website entitled "Description of Merrill Lynch's Auction Rate Practices and Procedures" (the "August Disclosure"). (See Compl. ¶ 103.) MLPFS's website posting disclosed, among other things, that MLPFS "may routinely place one or more bids in an auction for its own account . . . to prevent an auction failure." (Id.) The posting further stated that MLPFS "may submit a bid in an auction to keep it from failing, but it is not obligated to do so." (August Disclosure at 18.) Finally, the website posting warned of the risk of an auction failure, stating, "[i]f sufficient bids have not been made, auction failure results, and holders that have submitted sell orders will not be able to sell in the auction all, and may not be able to sell any, of the securities subject to such submitted sell orders." (Id.)

Both the August Disclosure and the SEC Order are incorporated by reference in the complaint and therefore may be considered in resolving this motion. Chambers v. Time Warner, Inc., 282 F.3d 147, 152 (2d Cir. 2002).

F. The Collapse of the ARS Market

From March 2006 until February 2008, the auctions functioned as MLPFS had predicted. (See Compl. ¶ 108; see Pls. Mem. at 8.) But on February 13, 2008, a wave of auction failures resulted in the collapse of the ARS market; consequently, LSED's interest rate climbed to the failed auction rate of 12%. (See Compl. ¶ 108.)

G. Procedural Background

LSED filed this suit in the Eastern District of Louisiana on January 22, 2009. See Complaint, La. Stadium & Exposition Dist. v. Fin. Guar. Ins. Co., No. 09 Civ. 235 (E.D. La. Jan. 22, 2009). On June 10, 2009, the United States Panel on Multidistrict Litigation transferred this action here for inclusion in coordinated or consolidated pretrial proceedings pursuant to 28 U.S.C. § 1407. LSED filed a second amended complaint on September 30, 2009. After the Defendants sent LSED letters detailing perceived deficiencies in the second amended complaint, LSED filed a third amended complaint on December 10, 2009. On February 8, 2010, Defendants filed a motion for judgment on the pleadings. See Fed. R. Civ. P. 12(c).

"The standard for addressing a Rule 12(c) motion for judgment on the pleadings is the same as that for a Rule 12(b)(6) motion to dismiss for failure to state a claim."

Cleveland v. Caplaw Enters., 448 F.3d 518, 521 (2d Cir. 2006). The Court so proceeds.

II. STATUTE OF LIMITATIONS ANALYSIS The Court addresses Defendants' federal, then state, statute of ...

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