UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT August Term, 2010
July 28, 2011
ASHLAND INC., ASHTHREE LLC, PLAINTIFFS-APPELLANTS,
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:
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.
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."
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 reasonable reliance. Id. at 471-72. Finally, it held that the 15 remaining state law claims were preempted by New York's Martin 16 Act. Id. at 472. This appeal followed.
We review a district court's grant of a motion to dismiss 19 under Rule 12(b)(6) de novo, accepting as true all facts alleged 20 in the complaint and drawing all reasonable inferences in favor 21 of the non-moving party. Chase Grp. Alliance LLC v. City of N.Y. 22 Dep't. of Fin., 620 F.3d 146, 150 (2d Cir. 2010). "To survive a 23 motion to dismiss, a complaint must contain sufficient factual 24 matter, accepted as true, to 'state a claim to relief that is 25 plausible on its face.'" Ashcroft v. Iqbal, 129 S.Ct. 1937, 1949 7 1 (2009) (quoting Bell Atl. Corp. v. Twombley, 550 U.S. 544, 570 2 (2007)).
a) Section 10(b) Claim
To sustain a private claim for securities fraud under 5 Section 10(b), "a plaintiff must prove (1) a material 6 misrepresentation or omission by the defendant; (2) scienter; (3) 7 a connection between the misrepresentation or omission and the 8 purchase or sale of a security; (4) reliance upon the 9 misrepresentation or omission; (5) economic loss; and (6) loss 10 causation."*fn2 Stoneridge Inv. Partners, LLC v. Scientific- Atlanta, Inc., 552 U.S. 148, 157 (2008). Moreover, a plaintiff's 2 reliance on the defendant's misrepresentation must have been 3 reasonable in order for the claim to proceed. See Harsco Corp. 4 v. Segui, 91 F.3d 337, 342 (2d Cir. 1996) (collecting cases from 5 various circuits). "An investor may not justifiably rely on a 6 misrepresentation if, through minimal diligence, the investor 7 should have discovered the truth." Brown v. E.F. Hutton Grp., 8 Inc., 991 F.2d 1020, 1032 (2d Cir. 1993). Factors relevant to 9 this analysis include: (1) [t]he sophistication and expertise of the 11 plaintiff in financial and securities 12 matters; (2) the existence of longstanding 13 business or personal relationships; (3) 14 access to the relevant information; (4) the 15 existence of a fiduciary relationship; (5) 16 concealment of the fraud; (6) the opportunity 17 to detect the fraud; (7) whether the 18 plaintiff initiated the stock transaction or 19 sought to expedite the transaction; and (8) 20 the generality or specificity of the 21 misrepresentations.
Id. (collecting cases). 24 25 Appellants argue that their reliance on Broce's 26 misrepresentations was reasonable in light of their longstanding 27 relationship with him, their repeated inquiries as to the 28 liquidity of SLARS, and the fact that auction information was not 29 publicly available. However, the SEC-mandated statement 30 explicitly disclosed the very liquidity risks about which 9 1 appellants claim to have been misled.*fn3 Specifically, the 2 statement revealed that Morgan Stanley routinely placed bids in 3 its own auctions, in part to prevent auctions from failing.
Moreover, the statement was clear that Morgan Stanley did so at 5 its discretion and "[wa]s not obligated to bid in any auction to 6 prevent an auction from failing." In the face of this SEC- 7 mandated disclosure,*fn4 Ashland, which admits to being "a 8 sophisticated investor," was not justified in relying on Byrne's 9 statements that SLARS "had no liquidity issues," or that "in the event of 'instability or weakness,' Morgan Stanley would 'come in 2 and make a market,' as it had always done in the past." 3 Nor does the alleged misrepresentation that the liquidity of 4 SLARS was assured because of a federal government guarantee of 5 the underlying student loans save appellants' claim. The value 6 of ARS is of course affected by the riskiness of the underlying 7 collateral. Because the SLARS were backed by pools of guaranteed 8 student loans, they were less risky than ARS backed by non- 9 guaranteed loans, which have a higher risk of default.
However, 10 the appeal of ARS or SLARS is that they, in good times, provide a 11 degree of liquidity not associated with the collateral. While 12 the reduced risk of the collateral's default may affect the 13 liquidity of ARS, a government guarantee of the collateral does 14 not eliminate the risk of SLARS becoming illiquid. A reasonable 15 sophisticated investor knows this because the reason for buying 16 SLARS instead of the student loans themselves is to obtain 17 greater liquidity. Indeed, the FAC alleges that appellants 18 bought SLARS to obtain such liquidity and that Broce conceded the 19 possibility of illiquidity by promising that Morgan Stanley would 20 step in to prevent it.
21 Therefore, even accepting as true all of the facts alleged 22 in the FAC, appellants' Section 10(b) claim fails due to their 23 inability to plead reasonable reliance on the alleged 24 misrepresentations.
b) Common Law Claims
2 Ashland also appeals from the dismissal of its common law 3 claims. Unlike the district court, we do not address whether 4 Martin Act preemption applies but instead affirm on appellants' 5 lack of reasonable reliance. See Primetime 24 Joint Venture v. 6 Nat'l Broad., Co., 219 F.3d 92, 103 (2d Cir. 2000) ("Because we 7 review the district court's decision to dismiss under Rule 8 12(b)(6) de novo, we are free to affirm the decision below on 9 dispositive but different grounds.").
10 Reasonable reliance is a required element of common law 11 fraud, promissory estoppel, breach of fiduciary duty, and 12 negligent misrepresentation under New York law. See Crigger v. 13 Fahnestock & Co., 443 F.3d 230, 234 (2d Cir. 2006) (common law 14 fraud); Kaye v. Grossman, 202 F.3d 611, 615 (2d Cir. 2000) 15 (promissory estoppel); King v. Crossland Sav. Bank, 111 F.3d 251, 16 257-58 (2d Cir. 1997) (negligent misrepresentation); Carr v. 17 Neilson, 909 N.Y.S.2d 387, 387 (N.Y. App. Div. 2010) (breach of 18 fiduciary duty). We therefore affirm the dismissal of these 19 claims for the reasons stated above. Because appellants' 20 negligence claim is virtually identical to their negligent 21 misrepresentation claim, we also affirm that dismissal.
22 Finally, appellants' unjust enrichment claim simply does not 23 fit the facts of this case. Under New York law, an unjust 24 enrichment claim requires a plaintiff to prove that "(1) 25 defendant was enriched, (2) at plaintiff's expense, and (3) 12 1 equity and good conscience militate against permitting defendant 2 to retain what plaintiff is seeking to recover." Diesel Props 3 S.R.L. v. Greystone Bus. Credit II LLC, 631 F.3d 42, 55 (2d Cir. 4 2011) (internal quotation omitted). The FAC states that 5 "[e]quity and good conscience require disgorgement of fees earned 6 by Morgan Stanley from Ashland's purchases of Morgan Stanley- 7 brokered SLARS," because Ashland thought it was purchasing liquid 8 investments. However, the facts alleged are that Ashland, a 9 sophisticated investor, failed to apprise itself of the publicly 10 disclosed riskiness of ARS as liquid investments. There is 11 little in equity and good conscience that weighs in favor of the 12 return of the fees it paid in connection with those transactions.
13 We have considered appellants' remaining contentions and 14 conclude that they are without merit.
For the foregoing reasons, we affirm the district court's 17 dismissal of appellants' complaint.