The Commission prevailed on its appeal to the Eleventh Circuit Court of Appeals in an action against Morgan Keegan & Co. The case centers on claims that the firm defrauded its customers in connection with the purchase and sale of auction rate securities or ARS as the market crisis unfolded. SEC v. Morgan Keegan & Co., No. 11-13992 (11th Cir. May 2, 2012).

In the district court the Commission’s complaint alleged violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c). As the ARS market was collapsing in early 2008, according to the Commission, Morgan Keegan continued selling the securities. Four of its customers stated that they were told things such as ARS are as good as cash and that the securities were completely liquid. Those allegations were bolstered by internal records suggesting that the firm knew the ARS market was unraveling as the sales continued.

The firm argued on a motion for summary judgment that it fully informed investors about the risks of the auction rate securities market in a series of disclosure materials. In support of this claim Morgan Keegan pointed to a twenty-four page ARS Manual, its annual newsletter to customers and a brochure which fully informed customers about the risks of the market. In addition, customer trade confirmations gave buyers the right to rescind any transaction for ten days.

The district court agreed with Morgan Keegan and granted summary judgment in its favor. Characterizing this action as a “’hybrid case where the SEC claims that Morgan Keegan misled the public through the oral statements made to four individuals,’” the court concluded that the SEC must do more to withstand summary judgment than point to a few isolated instances of alleged broker misconduct to obtain the relief it seeks in the face of Morgan Keegan’s disclosure documents.

The Eleventh Circuit reversed. The test for materiality has been well developed in a series of private damage cases, the Court noted, such as Matrixx Initiatives, Inc., v. Siracusano, 131 S.Ct. 1309 (2011) and Basic Inc. v. Levinson, 485 U.S. 224 (1988). The SEC and Morgan Keegan agreed that the test of materiality developed in these cases applies here.

In cases such as Matrixx and Basic the Supreme Court has repeatedly rejected the use of a bright line test for materiality as potentially over or under inclusive. Rather, the High Court has repeatedly opted for a standard utilizing the “total mix” of information important to an objective, reasonable investor test. Under this standard the representations made to the four clients of the firm cannot be disregarded in favor of the written materials relied on by the firm since it deprives them of context, the Court stated. It went on to note that “The problem for Morgan Keegan is the SEC enjoys the authority to seek relief for any violation fo the securities laws, no matter how small or inconsequential . . . The SEC thus may seek a civil penalty against any defendant who has made a single misstatement or omission, if material and made with scienter and in connection with the purchase or sale of securities. . . [thus] a rule excluding all individual broker-investor communications from the materiality inquiry is underinclusive . . .. “ (emphasis original). Since the brokers were acting within the scope of their authority the SEC may establish a violation as to each.

Finally, the Court rejected the conclusion of the district court that the written disclosures of the securities firm were sufficient as a matter of law to warrant summary judgment. Conceding that written disclosures may in some instances be sufficient to render an individual broker’s misrepresentations immaterial, the Court concluded that here the “manner of distribution of its written disclosures . . . was insufficient to warrant summary judgment.” While it is clear that the written disclosures were given to some customers in some years, there is no evidence that in late 2007 and early 2008 the firm directly gave customers written disclosures before purchasing ARS. In fact the only documents they received were the written trade confirmations which say nothing about the liquidity risk of auction rate securities. Accordingly, the Court reversed the grant of summary judgment and remanded the case for trial.

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