The SEC and the NY AG have been successful in settling a series of market crisis cases centered on the collapse of the auction rate securities market in March 2008. In litigation both regulators have experienced more difficulty however. Earlier this year the court ruled against the SEC and in favor of Morgan Keegan & Co. in an ARS case, granting the firm’s motion for summary judgment (here). There the court concluded despite false claims that the securities were “liquid” and “the same as cash” the risks of a market collapse had been adequately disclosed in a series of firm marketing materials to preclude liability. SEC v. Morgan Keegan & Co., Civil Action No. 1:09-cv-1965 (N.D. Ga. Opinion and Order dated June 28, 2011).

The New York AG’s Martin Act complaint against Charles Schwab & Co., Inc. alleging false representations in connection with the sale of ARS suffered the same fate as the SEC’s case – it was dismissed. The People of the State of New York v. Charles Schwab & Co., Index No. 453388/2009 (N.Y. Sup. Ct.). The action against Schwabis similar but not identical to the one brought against Moran Keegan. In its complaint the AG alleged that the broker sold action rate securities to its customers based on false representations that the securities were liquid, similar to money market funds and essentially the same as cash. The complaint cited passages from audio tapes of Schwab representatives making the sale pitch using these and similar descriptions to customers.

The complaint also alleged that the sales force was inadequately trained regarding the risks of ARS. The sales staff was not told that in fact the liquidity of the market depended on the supporting bids of the sponsoring underwriter the AG claimed. This allegation was backed by statements obtained from firm sales personnel.

Finally, investors were not told what Schwab learned in the fall of 2007. It was during that period that the firm saw the market begin to experience difficulties.

The court dismissed the complaint, concluding that it failed to allege the statements were false. Under the Martin Act the AG is required to demonstrate only that the challenged act or practice was misleading in a material way. The court however concluded that the statements made to investors at the time were not false. At the time the representations were made the market had been in operation for 20 years. Thus the representations were not false.

In motion papers the AG re-characterized his claim as a failure to explain the risks of future illiquidity. While the court noted that the paragraphs of the complaint cited by the AG referenced a failure to adequately warn the customers, it concluded that “this is not a failure to disclose case.” Rather, the focus is on the representations at the time they were made. At the time they were made the representations were made they were not false. Accordingly, the case was dismissed.

Program: The ABA National Institute On Securities Fraud is being held on November 3-4, 2011 in New Orleans. This is one of the premier securities law programs each year. For more information please click here.

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