A federal judge has ruled that securities class action plaintiffs who availed themselves of UBS’s auction rate securities regulatory settlement cannot separately maintain claims for damages against UBS. But while this ruling would seem to represent at least the beginning of the end for many similarly placed plaintiffs, we may still be a long way from the end of the auction rate securities litigation, despite the regulatory settlements.
UBS was one of the 21 different companies named as defendants in the wave of auction rate securities lawsuits filed during 2008. The names of all of the auction rate securities lawsuit targets can be accessed here. Background regarding the case against UBS can be found here.
Essentially the plaintiffs alleged that UBS had failed to disclosure the liquidity risks associated with the auction rate securities, and also failed to disclose that UBS and other broker dealers regularly intervened in the market for the securities to maintain trading –and allegedly to manipulate the market as well. When the broker-dealers simultaneously stopped supporting the market on February 13, 2008, the market for the securities collapsed and investors were left with securities for which there was no active market.
On August 8, 2008, UBS announced a nearly $20 billion settlement with regulators regarding the auction rate securities (about which refer here). In the settlement, UBS agreed to buy the securities back from retail investors at par value, or to make up the difference to retail investors who had already sold for less than par.
The plaintiffs in the UBS auction rate securities settlement took advantage of the regulatory settlement and redeemed their securities as par. The defendants moved to dismiss the lawsuit on that basis.
Judge McKenna’s Ruling
In a March 30, 2009 opinion (here), Southern District of New York Judge Lawrence McKenna granted the defendants’ dismissal motion, with leave to amend. Judge McKenna found that
Given that Plaintiffs have availed themselves of the relief provided in the Regulatory Agreement, Plaintiffs cannot now allege out-of-pocket damages. When Plaintiffs elected to have UBS buyback their ARS at par value, they received a full refund of the purchase price. Therefore, Plaintiffs have already been returned to the position they were in before they purchased the ARS and before any fraud ensued….Plaintiffs’ out-of-pocket damages are necessarily zero because after choosing to rescind the ARS purchases, Plaintiffs have effectively paid nothing for their ARS.
Plaintiffs argued that they were entitled damages despite the regulatory settlement because "UBS’s fraudulent acts prevented Plaintiffs from receiving a sufficiently high rate of interest or dividends to compensate them for the risk of illiquidity associated with their ARS investments." Essentially, they were arguing that if they had been appropriately informed about the securities’ liquidity risk, they would demanded and would have been paid higher interest rates or otherwise have enjoyed a higher investment return.
Judge McKenna rejected this argument because plaintiffs in securities actions must choose among prospective remedies, between rescission and out-of-pocket damages. Having elected rescission, the plaintiffs "may not now seek additional interest or dividends as benefits of ARS purchases they have already elected to disavow."
Finally, Judge McKenna found that the class plaintiffs lack constitutional standing to asset claims on behalf of "class members who purchased UBS-underwritten ARS from brokerage firms other than UBS and investors who transferred to another brokerage firm ARS they purchased from UBS before October 2007."
Judge McKenna’s ruling might seem to suggest that the regulatory settlements represent the end of the auction rate securities lawsuits. However, conclusions along those lines could well prove to be premature.
First, Judge McKenna granted the motion with leave to amend. Although there is ample reason to doubt that these plaintiffs can circumvent Judge McKenna’s concerns in an amended pleading, the case itself is not over yet.
Second, other courts may decline to follow Judge McKenna’s conclusions. Indeed, in a March 31, 2009 AmericanLawyer.com article (here) Alison Frankel quotes the plaintiffs’ attorney from the UBS case as saying "we’re not convinced other courts will rule the same way."
Third, there are still the claims of those erstwhile class members who were frozen out of the UBS regulatory settlement, such as those who bought the auction rate securities from a non-UBS broker or who transferred their account away from UBS. As the plaintiffs’ lawyer from the UBS case also is quoted as saying in the American Lawyer article, "the key to the auction rate securities litigation is plaintiffs whose securities were not bought back by the banks."
This category of investors who were shut out of the regulatory settlements also includes the investors who bought their securities from banks or broker dealers who have not yet entered regulatory settlements.
Fourth, in all the regulatory settlements, institutional investors’ interests were treated differently. For example, in the UBS settlement, institutional investors cannot hope to have their investment redeemed until at least 2010. These investors’ liquidity issues continue to give rise to new litigation; for example, I described in recent post (here) the lawsuit that KV Pharmaceuticals filed in late February against Citigroup, in which the company alleged that the illiquidity of its auction rate securities investments was, among other things, forcing the company to lay off workers.
And finally, there is the separate category of litigation that has arisen against auction rate securities investors, rather than against the auction rate securities sellers. These cases involved companies whose balance sheet exposure to auction rate securities has harmed their financial condition, and who face litigation from their own shareholders who claim the companies failed to disclose their exposure. The most recent of these cases, involving Perrigo Company, is discussed here.
In short, while Judge McKenna’s opinion unquestionably represents a significant milestone, it by no means represents the finish line for auction rate securities litigation. Unfortunately, these cases likely will be around for some time to come.
All of that said, Judge McKenna’s opinion does hold out the hope that a large portion of these cases can eventually be cleared out, and the problem at least reduced over time, perhaps to more manageable levels.
I have in any event added the UBS dismissal to my roster of settlements, dismissals and dismissal motion denials in connection with the subprime and credit crisis related lawsuits. The roster can be accessed here.