More Settlements In The Auction Rate Securities Investigations

The New York Attorney General and the SEC continue to reach settlements in the auction rate securities market, rolling out three new accords this week. Two agreements involve Bank of America Securities and RBC Capital Markets, while a third related to the former general counsel of UBS AG.

First, the New York Attorney General and the Securities and Exchange Commission reached agreements in principle with Bank of America Securities LLC and Banc of America Investment Services, Inc. (collectively “Bank of America”). The structure of the agreement is similar to that reached in other ARS settlements, as discussed here. Its focus is on individual investors, small businesses and small charities (“retail customers”) recovering their investment.

Under the terms of the agreements, Bank of America will purchase up to $4.7 billion in auction rate securities from retail customers. For larger business and institutional investors, Bank of America is obligated to use its best efforts to provide up to $5 billion in liquidity. The precise meaning of the provision, as in other settlements, is unclear.

Under the terms of the agreements with the SEC and the New York Attorney General Bank of America will begin offering to liquidate all ARS from retail customers with account values up to $15 million for individuals and small business investors and up to $25 million for charities. The Bank will also make whole any losses for these investors. Any consequential damage claims will be resolved at the option of the investor either through traditional means or in a special arbitration process overseen by FINRA. For larger customers, the settlement stipulates only that Bank of America will use its best efforts to provide liquidity.

As part of the agreement with the SEC, charges will be filed alleging that Bank of America made material misrepresentations about the auction rate securities market and its liquidity to its customers. The SEC may also obtain a financial penalty. The release regarding this settlement is available here. In the settlement with the New York Attorney General, the Bank also agreed to pay a $50 million civil penalty.

The settlement involving the SEC, the New York Attorney General and RBC Capital Markets Corporation, an affiliate of Royal Bank of Canada, is similar. Under the terms of the settlement, RBC will purchase at par ARS from individual and small business investors with accounts of $10 million or less and from nonprofit, charitable and religious organizations with accounts of $25 million or less. All losses suffered by these customers will be made whole. Consequential damages will be handled in the same manner as under the Bank of America settlement.

For all other customers, RBS will use its best efforts to provide liquidity by the end of 2009. RBS also agreed to be permanently enjoined from violating the provisions of Section 15(c) of the Securities Exchange Act. The SEC may also impose a civil fine at a later date. The terms of its settlement are available here. In its settlement with the New York Attorney General, RBS also agreed to pay a civil penalty of $9.8 million.

The New York Attorney General also entered into a settlement with David Aufhauser, former General Counsel of UBS AG and General Counsel of the Investment Bank at UBS AG. The case is based on claims that he traded on insider trading in the auction rate securities market. Specifically, the New York Attorney General alleged that on Friday, December 14, 2007, Mr. Aufhauser opened an e-mail from the chief risk officer at UBS detailing significant problems in UBS’s auction rate securities market. After sending an e-mail to two others in the legal department setting up a meeting about the difficulty in the ARS market, Mr. Aufhauser e-mailed his financial advisor, directing the liquidation of his $250,000 portfolio in ARS. On Monday Mr. Aufhauser called the financial advisor and confirmed the sell instruction.

To settle the matter, Mr. Aufhauser agreed to pay $6.5 million to New York State, which includes his incentive compensation for 2008 of $6 million and a $500,000 civil penalty. In addition, Mr. Aufhauser agreed not to be associated with any participant in the securities industry, serve as an officer or director of a public company or practice law in the State of New York for two years.

The Second Circuit Rules On The Application Of The Basic Presumption

The Second Circuit Court of Appeals rejected claims in In Re: Salomon Analyst Metromedia Litig., Case No. 06-3225 (2nd Cir. Sept. 30, 2008) asserting that a plaintiff relying on the fraud-on-the-market presumption of Basic, Inc. v. Levinson, 485 U.S. 224 (1988) must establish that the claimed representations actually affected the price of the securities traded in the open market and that it can only be used as to issuers. The court remanded the case to the district court with instructions.

Plaintiffs claimed that Citicorp USA, Inc., Salomon Smith Barney, Inc., their ultimate parent, Citigroup, Inc., and SSB research analyst Jack Grubman engaged in a scheme to defraud investors in Metromedia. The complaint alleged that defendants issued and disseminated research reports that contained false and misleading statements and material omissions. While the district court dismissed portions of the complaint, certain claims were permitted to move forward. The court certified the class as to those claims relying in part on the Basic presumption.

On appeal, defendants argued that the Basic presumption should not be applied to statements of someone other than the issuer – such as those of the research analyst here – and that plaintiff had to demonstrate that the statements impacted price. The Second Circuit rejected these claims as inconsistent with Basic.

First, the court concluded that there is no case which limits the Basic presumption to statements or omissions made by issuers. This is because the presumption is premised on the theory that in an efficient market share price reflects all publicly available information, including any misrepresentation. This conclusion is consistent with the Supreme Court’s recent decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, 128 S.Ct. 761 (2008), which applied the Basic test to statements of non-issuers.

Second, actual price impact need not be established because, under Basic, “if plaintiffs can show that the alleged misrepresentation was material and publicly transmitted into a well-developed market, then reliance will be presumed, for if a reasonable investor would think that the information would have ‘significantly altered the ‘total mix’ of information … then it may be presumed that, in an efficient market, investors would have taken the omitted information into account, thereby affecting market price ….'” (Citations omitted) This holding is based on principles of common sense, fairness and congressional policy, not economics, the court noted.

The Circuit Court remanded the case to afford defendants an opportunity to rebut the Basic presumption prior to certification, reversing the district court’s ruling on this point. In this regard, the Court stated that “we hold that plaintiffs must show that the statement is material (a prima facie showing will not suffice). However, once that is done, the burden shifts to the defense to show that the allegedly false or misleading material statements did not measurably impact the market price of the security.” (Emphasis original).