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Ashland Inc., Ashthree LLC v. Morgan Stanley & Co.

July 28, 2011

ASHLAND INC., ASHTHREE LLC, PLAINTIFFS-APPELLANTS,
v.
MORGAN STANLEY & CO., INC., DEFENDANT-APPELLEE.



Appeal from an order of the United States District Court for the Southern District of New York (Robert P. Patterson, Jr., Judge) dismissing plaintiffs' complaint for failure to state a claim under Rule 12(b)(6).

The opinion of the court was delivered by: Winter, Circuit Judge:

10-1549-cv

Ashland Inc., AshThree LLC v. Morgan Stanley & Co.

Argued: March 9, 2011

Before: WINTER, POOLER, and HALL, Circuit Judges.

Appellants assert claims under 25 Section 10(b) of the Securities Exchange Act of 1934 and New York 26 common law arising from their purchase and retention of auction 27 rate securities. We affirm the dismissal for failure to plead 28 reasonable reliance on appellee's alleged misrepresentations.

14 Ashland Inc. and AshThree LLC (together, "Ashland" or 15 "appellants") appeal from Judge Patterson's dismissal of their 16 first amended complaint ("FAC"), which asserted claims against 17 Morgan Stanley under Section 10(b) of the Securities Exchange Act 18 of 1934 (the "Exchange Act") and New York common law. Appellants 19 contend that Morgan Stanley, in oral and email communications 20 with Ashland's Assistant Treasurer, materially misrepresented the 21 liquidity of certain auction rate securities ("ARS") and thereby 22 fraudulently induced Ashland to purchase and hold these 23 securities at a time when Morgan Stanley knew that the market for 24 ARS was collapsing. We affirm the district court's dismissal on 25 the ground that sophisticated investors like appellants cannot 26 plead reasonable reliance on Morgan Stanley's alleged 27 misrepresentations in light of Morgan Stanley's publicly-filed 28 statement explicitly disclosing the very liquidity risks about 29 which appellants claim to have been misled.

1 BACKGROUND

Ashland Inc. is a Kentucky-based global chemical company. 3 It is the sole owner and operator of the special purpose entity 4 AshThree LLC, a Delaware limited liability company. AshThree 5 holds the securities at issue in this case. Appellee Morgan 6 Stanley is a Delaware corporation with its principal place of 7 business in New York.

8 Ashland's relationship with Morgan Stanley began in May 9 2007, when Ashland's long-time financial advisor, Thomas Byrne, 10 moved to Morgan Stanley. Around that time, Byrne called 11 Ashland's Assistant Treasurer, Joseph Broce, to discuss moving 12 Ashland's investments to Morgan Stanley. Byrne recommended 13 investing in Morgan Stanley-brokered ARS. ARS are long-term 14 bonds and stocks whose interest rates or dividend yields are 15 periodically reset through auction. At each auction, holders and 16 buyers of the securities specify the minimum interest rate at 17 which they want to hold or buy. If buy/hold orders meet or 18 exceed sell orders, the auction succeeds. If supply exceeds 19 demand, however, the auction fails and the issuer is forced to 20 pay a higher rate of interest in order to penalize it and to 21 increase investor demand. For a more thorough explanation of the 22 mechanics of ARS, see In the matter of Bear Stearns & Co., et 23 al., SEC Release No. 8684, 88 SEC Docket 259 (May 31, 2006). 24 The ARS at issue in this matter were backed by student loan 25 obligations ("SLARS"). Byrne is alleged to have told Broce that 3 1 the ARS were "safe, liquid instruments that were suitable to 2 [appellants'] conservative investment policies." Byrne further 3 represented that the SLARS would remain liquid because Morgan 4 Stanley had never conducted a failed auction and "in the event of 5 any instability or weakness in the market for SLARS . . . which 6 Morgan Stanley represented to be a very 'rare' occurrence -- 7 Morgan Stanley's brokers and other brokers would step in and 8 place sufficient proprietary bids to prevent auction failure and 9 ensure the liquidity of Ashland's SLARS." Because bid 10 information about ARS auctions was not publicly available, 11 however, appellants could not know how often Morgan Stanley had 12 intervened to ensure a successful auction. Ashland also alleges 13 that, in fact, Morgan Stanley knew as early as August 2007 that 14 the ARS market was collapsing, in part because Morgan Stanley was 15 often required to intervene to prevent auction failure. 16 Ashland purchased SLARS through Morgan Stanley on three 17 separate occasions in 2007 -- September 25, October 2, and 18 November 29. On the days leading up to each purchase, Byrne 19 assured Broce "that SLARS continued to be a safe, liquid 20 investment." Accordingly, throughout this period, Ashland placed 21 only "hold" or "hold-at-rate" orders at auctions, rather than 22 "sell" orders.*fn1 In December 2007, Ashland learned that Goldman 4 1 Sachs, acting as underwriter in an unrelated ARS auction, had 2 allowed that auction to fail. Byrne reassured Broce that this 3 failure had no bearing on the safety of its SLARS, which were 4 based on student loans backed by a federal guarantee, unlike 5 those in the failed auction. In January 2008, Ashland learned of 6 other auction failures, but Morgan Stanley continued to assert 7 that ARS were a safe, liquid investment. When Ashland began 8 placing "sell" orders around February 2008, however, it found 9 that the market was illiquid because Morgan Stanley was no longer 10 stepping in to ensure auction success.

11 Appellants filed a complaint in the Southern District of New 12 York in June 2009, which they amended in September 2009, 13 asserting claims for violation of Section 10(b) of the Exchange 14 Act, common law fraud, promissory estoppel, breach of fiduciary 15 duty, negligence, negligent misrepresentation, and unjust 16 enrichment. In addition to alleging that Morgan Stanley 17 misrepresented the safety and liquidity of the SLARS, the FAC 18 also alleges the following pertinent omissions. Morgan Stanley 19 failed to disclose: (i) how often demand failed to meet supply 20 in SLARS auctions, and consequently, how often it had to step in 21 to purchase the SLARS; (ii) that the government guarantee and 22 non-dischargeability in bankruptcy of the underlying student debt relationship between fail rates, AAA ratings, and liquidity; and 2 (iv) that it was not fully committed to ensuring liquidity of the 3 SLARS.

4 The district court dismissed the FAC in its entirety. 5 Ashland Inc. v. Morgan Stanley & Co., 700 F. Supp. 2d 453, 473 6 (S.D.N.Y. 2010). It relied in part on the fact that in May 2006 7 Morgan Stanley "placed a statement of its ARS policies and 8 practices online, 'as a result of an Order entered into between 9 the [Securities and Exchange Commission ("SEC")] and certain 10 active broker-dealers in the auction rate securities market.'" 11 Id. at 461. The SEC-ordered statement included several relevant 12 disclosures. It stated that "Morgan Stanley is permitted, but 13 not obligated, to submit orders in auctions for its own account 14 either as a bidder or a seller and routinely does so [in] its own 15 discretion." Id. It further explained that 16 Morgan Stanley routinely places one or more 17 bids in an auction for its own account to 18 acquire ARS for its inventory, to prevent a 19 failed auction or to prevent an auction from 20 clearing at a rate that Morgan Stanley 21 believes is higher than the market for 22 similar securities at the time it makes its 23 bid. . . . [However,] Morgan Stanley is not 24 obligated to bid in any auction to prevent an 25 auction from failing or clearing at an off- 26 market rate. Investors should not assume 27 that Morgan Stanley will do so. 28 29 Id. It also stated that ARS holders "may be disadvantaged if 30 there is a failed auction because they are not able to exit their 31 position through the auction" and explained that "the fact that 6 1 an auction clears successfully does not mean that an investment 2 in the ARS involves no significant liquidity or credit risk."

3 Id.

The district court concluded that the Section 10(b) 5 securities fraud claim failed because: (i) "hold" and "hold-at- 6 rate" orders did not constitute a purchase or sale of securities 7 under Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975); 8 (ii) the FAC did not allege facts to support a strong inference 9 of scienter as to any misrepresentations or omissions; and (iii) 10 the FAC did not allege facts to show that appellants were 11 reasonable in their reliance on any alleged misrepresentations. 12 Ashland, 700 F. Supp. 2d at 467-71. It also dismissed the common 13 law fraud and promissory estoppel claims due to lack of 14 ...


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