The Sixth Circuit drew the line between auction rate securities suits which survive a motion to dismiss and those which must fail in Ashland, Inc. v. Oppenheimer & Co., no. 10-5305 (6th Cir. July 28, 2011). This is one of a number of recent rulings in actions brought by the SEC and private plaintiffs concerning these securities (here).

Ashland, a diversified global chemical company based in Kentucky, began purchasing auction rate securities or ARS in May 2007 on the advise of Oppenheimer & Co., Inc. At the time the company sought to invest about $1.3 billion which it had set aside for acquisitions. Oppenheimer recommended ARS, pointing out their strong credit rating while noting that they were “safe and liquid” investments which were “comparable to money market instruments.” Ashland followed the recommendation.

By mid-2007 Ashland became concerned about the sub-prime market and its possible impact on the securities held by the company. Oppenheimer recommended student loan backed ARS which offered the same benefits as the municipal bonds backed ARS the company previously purchased but had the advantage of not being linked to the sub-prime market. Ashland followed the recommendation and began purchasing the securities.

In January 2008 Ashland learned that Goldman Sachs allowed one of its ARS auctions to fail. Oppenheimer assured the company that this was an aberration. Later that month however Lehman Brothers and then Piper Jaffray permitted auctions to fail. Oppenheimer continued marketing ARS to Ashland without informing the company of these events. The company built a portfolio of about $194 million making its last purchases in February 2008.

Four days after Ashland’s last purchase the CEO of Oppenheimer called a meeting of firm executives. The firm concluded that there were problems with the ARS market. The next day the market imploded. Oppenheimer then told Ashland to sell its holdings. By then the securities were illiquid. Its holdings could only be sold at a discount. When Ashland did encounter an acquisition target its fund was not available. Money had to be borrowed to do the deal.

Ashland filed suit. The central claim in the complaint is that the securities firm failed to tell the company that the continued health of the ARS market depended on the intervention of underwriters who had no obligation to continue supporting it. The district court dismissed the complaint. The Circuit Court affirmed.

The key issue, according to the Court, is whether plaintiff adequately pleaded a strong inference of scienter as required by the PSLRA. This means that the facts alleged must be taken collectively to asses if they meet the requirements of the statute under Tellabs, Inc v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007). The Court then reaffirmed its recent decision in Frank v. Dana Corp., 2011 WL 202717, at *5 (6th Cir. May 25, 2011), in which the Circuit Curt abandoned its prior analytical method in favor of a holistic approach (this decision is discussed here). While the facts may support an inference of scienter, it is outweighed by those which are contrary. Ashland has failed to explain “why or how Oppenheimer possessed advance, non-pubic knowledge that underwriters would jointly exit the ARS market and cause its collapse in February 2008 . . . “ While Oppenheimer employees were aware of what might happen if the underwriters chose to exit the market this was a seemingly remote risk in view of past history. Indeed, it is likely that the market collapse “caught Oppenheimer and its employees off guard” the Court concluded.

Surveying other ARS related litigation bolstered the conclusion that the claims here are inadequate the Court concluded. In the few cases which have survived a motion to dismiss the plaintiff has explained “why or how the defendant knew about the ARS market’s impending liquidity . . .” according to the Court (emphasis original). In In re Merrill Lynch Auction Rate Sec. Litig., No. –MD 2030, 2011 WL 1330847, at *2 (S.D.N.Y. Mar. 30, 2011), for example, the plaintiffs claimed that the ARS auction managers had exclusive access to the supply and demand in the market and knew it was “teetering” beginning in early 2007. Similarly, in Dow Corning Corp. v. BB&T Corp., No. 09-5637, 2010 WL 4860354, at * 10 (D.N.J. Nov. 23, 2010) and other cases, plaintiffs claimed that the defendants propped up a languishing ARS market in order to unload inventories. Conversely, cases involving only “vague allegations that market participants knew of, yet failed to disclose, risks surrounding the ARS market . . . “ have not survived a motion to dismiss. The case here falls in the latter group.

Two upcoming programs on the FCPA:

Program: Is FCPA Enforcement To Aggressive? August 5, 2011, ABA Annual Meeting Toronto.
Is FCPA Enforcement Overly Aggressive? The program links are here and here.

Program: Current Trends in FCPA Enforcement, August 17, 2011, Live in Menlo Park, CA, and webcast nationally. The program link is here.