Auction Rate Securities (ARS) Investors May Be Helped by SEC Brief

Depending on whether or not the court agrees with the Securities and Exchange Commission (SEC) brief supporting views that Merrill Lynch & Company, now a part of Bank of America, rigged the auction rate securities (ARS) market, investors could get a boost according to a Bloomberg release. In the legal brief filed by the SEC in the U.S. Court of Appeals for the Second Circuit in New York, it argues that Merrill Lynch failed to adequately disclose to investors what its role was in "propping up" auctions and could help with investor claims.

Wall Street's major players were sanctioned for manipulating the markets by using inside knowledge of bids to influence yields back when they ran the auctions in 2006 and then allowed the practice continue as long as they disclosed the process to investors. In February 2008, the biggest dealers which had routinely bid to prevent auction failures withdrew their capital and stopped bidding causing the market to freeze and leaving investors with bonds they couldn't sell in order to access their money. The auction rate securities (ARS) are long term debt instruments with yields that are reset weekly or monthly through the auction process.

In a settlement with the SEC in April 2008, Merrill was to buy back $7 billion worth of the ARS, because it had misrepresented them to be safe, highly liquid investments that were equivalent to CDs, money market funds and cash. James Cox, a law professor at Duke University in Durham, North Carolina said that the SEC's brief might be persuasive if it gives sufficient analysis into the market and what ought to have been done to disclose to investors how dependent the auction process was on dealer participation. However, the court's request for an amicus brief does not mean that it will follow the SEC's argument but rather it is asking for its views on what occurred and what ought to have been done. Therefore, the SEC brief focuses on the adequacy of disclosures made by Merrill to its customers. Kevin Callahan, a SEC spokesman, said that "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."

Merrill's counsel has said that broker-dealer participation in auctions "reflected a common industry practice that was widely known to investors" and therefore a market manipulation claim cannot prevail if the "manipulative conduct was commonly known to market participants."

The case is Colin Wilson v. Merrill Lynch & Company, Inc., et al., No. 10-1528, U.S. Court of Appeals for the Second Circuit, New York, New York.

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