SEC backs investors' claim Merrill rigged ARS market, lawyer says

Auction-rate securities holders seeking to win back part of the $330 billion they've invested, may get help from a U.S. Securities and Exchange Commission legal brief supporting claims that Merrill Lynch & Co. rigged the moribund market, a lawyer involved in the case said. Merrill Lynch, now part of Bank of America Corp., failed to adequately inform investors of its alleged role in “propping up” auctions, the SEC said in the brief, filed in the U.S. Court of Appeals for the Second Circuit in New York. “We think the SEC has come down on the side of investors,” Jonathan Levine, a lawyer with Girard Gibbs in San Francisco, said in a telephone interview. His firm represents investors in the appeal. SEC Chairman Mary Schapiro moved to reinvigorate the enforcement unit after President Barack Obama appointed her in January 2009. Investigations surged by 32 percent and the agency went to court seeking emergency orders four times as often as it did a year earlier, Enforcement Director Robert Khuzami said at a congressional hearing in May 2009. If the court agrees with the SEC's argument, it may lead to the reversal of other dismissed auction-rate cases alleging brokers and dealers rigged the market, Levine said. “Now it depends on whether the court accepts the view of the SEC.” $152.9 Billion Outstanding Lawsuits by the agency and state regulators led to the return of at least $60 billion to individual investors. Other holders of the securities had their lawsuits dismissed. About $152.9 billion in municipal, student-loan, preferred and other auction-rate securities remain outstanding, according to data compiled by Bloomberg. Municipal debt comprises $56.1 billion of the total, the data show. After sanctioning Wall Street's biggest dealers for manipulating the markets by using inside knowledge of bids to influence yields when they ran auctions in 2006, the agency let the practice continue as long as it was disclosed to investors. Auction-rate securities are long-term debt with yields that are reset weekly or monthly through auctions. In February 2008, dealers, which had routinely bid to prevent auction failures, withdrew their capital and stopped bidding, leading to a market collapse that left investors with bonds they couldn't sell and sticking some borrowers with high penalty rates, sometimes as much as 20 percent. $7 Billion Settlement Merrill and the SEC reached a preliminary settlement in April 2008 that called for the firm to buy back $7 billion of the securities. The agency said at the time that the dealer had misrepresented them as “safe, highly liquid investments equivalent to money-market instruments and cash,” and that it didn't make adequate disclosures to investors. The SEC's friend-of-the-court brief filed last month may affect the appeals panel, where the agency has “generally been fairly persuasive and deferred to,” said James Cox, a Duke University law professor in Durham, North Carolina. The agency's argument may be persuasive if it provides sufficient analysis of the market and what should have been disclosed to investors so they'd understand how dependent it was on dealer participation. After the market collapsed, investors who said they didn't know about the risk of auction failures soon began to seek redress in the courts. Claimants in some cases said the securities had been sold as similar to money-market funds. “This is uncharted territory before the most respected federal appeals court on securities law issues,” said Jacob S. Frenkel, a lawyer with Shulman, Rogers, Gandal, Pordy & Ecker PA in Potomac, Maryland, who focuses on securities law and white- collar crime. “Because the opinion potentially could impact SEC cases, logic dictated that the court gave the SEC an opportunity to weigh in.” ‘No Game-Changer' “The request for an amicus brief by no means indicates that it will follow the SEC,” Frenkel said by e-mail. “No game-changer here; rather, it's just bringing a very interested stakeholder to the table to express its views.” Judgments have sometimes gone against investors, including some whose claims against Merrill have been consolidated in the case before the appeals court. Citigroup Inc. in March won the dismissal of five consolidated lawsuits brought by investors who claimed the New York-based bank manipulated prices. The SEC brief examines the adequacy of disclosure at the request of the court, said Kevin Callahan, an agency spokesman, in a prepared statement. “We made clear our view that it is not sufficient to disclose the risk that an event may happen when according to the plaintiff's allegations it is known for a certainty that the event has happened or will happen,” Callahan said. Changing Tack Under Schapiro's predecessor, Christopher Cox, the agency instituted policies that slowed enforcement cases and led prosecuting lawyers to conclude their commissioners opposed fining companies, the Government Accountability Office said in a May 2009 report. The GAO is the investigative arm of Congress. The Securities Industry and Financial Markets Association, a New York-based trade group for securities dealers, called the agency's argument “a flawed and unwarranted expansion of private civil liability,” in a brief it filed in the New York case July 8. The group asked that the court reject the appeal, according to the filing by William Sullivan, a lawyer at Paul, Hastings, Janofsky & Walker LLP in Los Angeles. Broker-dealer participation in auctions “reflected a common industry practice that was widely known to investors,” Sullivan said in the brief. “A market manipulation claim cannot survive if the allegedly manipulative conduct was commonly known to market participants.” Merrill Response In its response to the SEC brief, Merrill told the court July 8 that the agency was trying to turn the case into one of misrepresentation, instead of market manipulation, by focusing on the company's duty to alert investors to negative market conditions in late 2007 and early 2008. “The primary thrust of the SEC letter is that Merrill's disclosure of its auction practices became insufficient in the fall of 2007,” company lawyers said in its response. The company said the SEC's position conflicts with the agency's concession in a different case last month that “essentially identical” disclosures by Morgan Keegan & Co. “adequately described the risks” associated with the securities. Bill Halldin, a Merrill spokesman, declined to comment. Katrina Cavalli, a spokeswoman for the securities trade group, said that its brief “speaks for itself.” --Bloomberg News--