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John W. Oughtred, Individually and On Behalf of All Others Similarly Situated v. E*Trade Financial Corporation & E*Trade Securities LLC

March 31, 2011


The opinion of the court was delivered by: Sidney H. Stein, U.S. District Judge.


Plaintiffs Roger Bresnahan and Srinivasan Murari*fn1 bring this putative class action pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), 78t-1(a), and Securities and Exchange Rule 10b-5 promulgated under that statute, 17 C.F.R. § 240.10b-5, alleging that defendants E*Trade Financial Corporation and E*Trade Securities LLC defrauded purchasers of auction rate securities by making misrepresentations and omissions of material fact about the risks, value, and liquidity of those securities. Defendants have moved to dismiss the complaint on the grounds that plaintiffs have not adequately pled any of the elements required to succeed on their claims. Because plaintiffs fail to establish the strong inference of scienter required to state a claim for relief pursuant to Section 10(b) and Rule 10b-5, defendants' motion is granted.


The following facts are taken from the Second Amended Complaint ("SAC") and are presumed to be true for purposes of this motion.

A. Parties

Roger Bresnahan and Srinivasan Murari purchased auction rate securities ("ARS") from defendant E*Trade Securities LLC ("E*Trade") during the class period of April 3, 2003 to February 13, 2008 ("Class Period"). (SAC ¶¶ 2, 13-14.) Defendant E*Trade Financial Corporation ("E*Trade Financial") is a financial firm that conducts a brokerage business through its subsidiary, defendant E*Trade. (Id. ¶ 15.)E*Trade Financial and E*Trade are Delaware corporations headquartered in New York. (Id. ¶¶ 15-16.)


ARS are long-term debt or preferred stock that pay variable interest rates set at periodic auctions. (Id. ¶ 28.) Buyers in these auctions specify the number of ARS they want and the lowest interest rate at which they are willing to purchase those securities. The lowest rate at which there are sufficient buyers to purchase all of the ARS sets the clearing rate, which then applies to all of the ARS until the next auction. (Id. ¶¶ 32, 35.)If buyers do not offer enough bids to purchase all the securities offered at an auction, then the auction fails and no securities sell. (Id. ¶ 35.)In the event of an auction failure, ARS holders receive a predetermined rate of return on their investment known as the "maximum rate." (Id. ¶ 36.)However, there is no guarantee that this maximum rate will be high enough to attract new buyers. (Id. ¶¶ 37-38.)

C. Support Bids and the ARS Market Failure

First created in the mid-1980s, the market for ARS grew to over $300 billion in outstanding securities by February 2008. (Id. ¶ 31.) Until August 2007, auction dealers followed "uniform policies" of using their own capital to "plac[e] support bids in auctions as necessary to prevent auction failures." (Id. ¶ 41.) These support bids created an outward appearance of liquidity that, according to plaintiffs, did not in truth exist. (Id. ¶¶ 39-43, 46-47.)

In August 2007 auction dealers began allowing a limited number of auctions to fail. (Id. ¶ 41.) Then, in February 2008, the ARS market abruptly collapsed when auction dealers ceased intervening in the auctions. (Id. ¶¶ 8, 44.) That collapse meant ARS holders were saddled with billions of dollars of securities they could not sell. (Id.)

D. E*Trade's Involvement with ARS

E*Trade did not issue ARS or underwrite ARS or directly bid in ARS auctions. Rather, it acted primarily as a "remarketing agent" who sold hundreds of millions of dollars of ARS to its clients during the Class Period and transmitted its clients' orders to auction dealers.(Id. ¶¶ 34, 56.) E*Trade allegedly "held an inventory of ARS in its proprietary accounts" and sought to "sell these pre-purchased ARS to clients." (Id. ¶ 99.) Moreover, plaintiffs allege that "[f]or certain customers, E*Trade would provide instant liquidity between auctions by purchasing the customer's ARS and moving the ARS into E*Trade's own error account" or by selling these ARS to other customers. (Id. ¶ 114.) E*Trade allegedly led clients to believe that ARS were highly liquid, short-term investments similar to money market funds, when in fact they were not. (Id. ¶¶ 3-4.)

E. Plaintiffs' Purchase of ARS

Bresnahan and Murari purchased ARS through E*Trade based exclusively on the advice of E*Trade brokers. (Id. ¶¶ 13-14, 125-31, 139-45.) Around March 2005, Bresnahan consulted with his E*Trade broker, John Gibson, seeking "a conservative investment with liquidity." (Id. ¶ 128; see also ¶ 127.) Gibson recommended ARS. (Id. ¶ 128-29.) He allegedly assured Bresnahan that ARS "were the equivalent of money market funds" and that Bresnahan's "money would become liquid and available every seven days," the period of time between auctions. (Id.¶ 128.)

Murari received an unsolicited telephone call from E*Trade broker William Welthaus in late 2007, (id. ¶ 141), during which Welthaus told Murari that ARS "were the equivalent of money market funds and 'as good as cash.'" (Id. ¶ 142.) In response to Murari's concerns about liquidity, Welthaus assured him that he could sell his ARS "every week." (Id.)

Neither the brokers, nor any other E*Trade employees, provided plaintiffs with any written materials or otherwise explained the risks of the ARS market. (Id. ¶¶ 132-36, 146-50.) Plaintiffs claim that had they known about the risks of ARS ownership, they would not have bought ARS from E*Trade or done so at the prices they paid. (Id. ¶¶ 138, 152.) Although some of plaintiffs' ARS have been redeemed by the issuers, E*Trade has not repurchased any of the ARS they sold plaintiffs. (Id. ¶¶ 13-14.) Since the ARS markets collapsed in February 2008, plaintiffs have been unable to sell their ARS "at par" and have allegedly been damaged as a result. (Id. ¶¶ 137-38, 151-52.)

F. E*Trade's Other Alleged Misstatements and Omissions

Plaintiffs allege that throughout the Class Period, E*Trade supplied clients with documents that contained misleading statements about ARS. For instance, if a client asked for written information about ARS, E*Trade financial advisors would forward marketing materials created by companies that actually issued ARS, such as Oppenheimer and Nuveen, rather than sending a prospectus or materials written by E*Trade. (Id. ¶¶ 101-04.) These materials described ARS as short-term investments that were a "cash alternative." (Id. ¶ 102.) E*Trade also forwarded weekly spreadsheets from auction dealers with "price talk" about the range of interest rates at which an auction was expected to clear and a "Term" during which an ARS buyer would have to hold the securities between periodic auctions. (Id. ¶¶ 105-06.) Moreover, E*Trade allegedly listed ARS as "cash" on customers' account statements and in the "Portfolio Analyzer" tool on the E*Trade website. (Id. ¶¶ 111-12.) E*Trade did not disclose the role of auction dealers who supported ARS auctions or what would happen if ARS auctions failed. (Id. ¶ 89.)

In the "Summer 2007," E*Trade emailed its existing customers to encourage them to purchase ARS, stating that "[t]he ARS market continues to experience tremendous growth and our electronic trading platform will further fulfill accelerated supply and demand for this currently under-serviced asset class." (Id. ¶ 75.) E*Trade also made unsolicited telephone calls to customers with significant cash holdings, encouraging them "to invest their cash in the money market-like auction rate securities." (Id. ¶ 83.) Then, in a December 21, 2007 press release, E*Trade Financial announced "an aggressive customer win-back campaign." (Id. ¶ 78.) When customers responded to this campaign's television or internet advertisements with inquiries about money market accounts, they were directed to E*Trade's "fixed income specialists" or "bond desk," which encouraged investment in ARS. (Id. ¶¶ 79-81.)

Plaintiffs allege that "once the ARS markets started to fail in August 2007, E*Trade failed to provide their clients with any information regarding the increased risks of failure, accurate information that ARS are not short-term, cash alternative investments and that companies like Nuveen and ...

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