In a ruling with potential significance for the other remaining auction rate securities lawsuits, on September 17, 2009, Southern District of New York Judge Lewis A. Kaplan granted the defendants’ motion to dismiss, with leave to amend, in the auction rate securities lawsuit pending against Raymond James Financial and certain of its subsidiaries. A copy of Judge Kaplan’s opinion can be found here.


There have been prior dismissals granted in the many pending auction rate securities lawsuits. For example, dismissal motions have been granted in the auction rate securities lawsuits filed against UBS (refer here) and against Northern Trust (refer here), as well as in the auction rate securities lawsuit involving Citigroup (refer here, scroll down).


The Citigroup case had been based on a market manipulation theory rather than on a misrepresentation theory, and is noteworthy in that respect, but the dismissal of the Citigroup case based on the plaintiffs’ failure to adequately plead market manipulation is less relevant to the many other auction rate securities cases – including the one filed against Raymond James—that are based on misrepresentation theories.


Judge Kaplan’s September 17, 2009 dismissal in the Raymond James auction rate securities case is noteworthy in its own right and by contrast to the prior dismissals in the UBS and Northern Trust cases, because in the Raymond James, by contrast to UBS and Northern Trust, had not entered into regulatory settlements involving its investors. Indeed, Raymond James has been the target of certain high profile media criticism (refer here) as a "holdout" for its resistance to entry into a regulatory settlement.


Because Raymond James has not entered a regulatory settlement, the defendants in the Raymond James auction rate securities case were unable to seek dismissal on the same "absence of recoverable damages" theory as did the defendants in the Northern Trust and UBS cases. Thus, by contrast to the dismissals in those other two cases that turned on the existence of the regulatory settlements, the dismissal in the Raymond James case actually related to the sufficiency of plaintiffs’ allegations on the merits, and therefore may be of greater potential significance for other auction rate securities cases, particularly those relating to other defendant companies that have not entered regulatory settlements.


In granting the dismissal motions, Judge Kaplan very carefully distinguished the allegations that had been made against the various corporate defendants, and he carefully assessed the adequacy of the allegations as to each.


Judge Kaplan determined that many of the alleged misrepresentations were made by or on behalf of Raymond James Financial Services (RJFS), the parent company’s retail sales subsidiary that actually sold to investors the auction rate securities that other corporate subsidiaries had underwritten or managed the related auction processes. Judge Kaplan found that there were insufficient allegations concerning the alleged misrepresentations supposedly made to the plaintiff or as part of the overall scheme to be able to attribute misrepresentations as to defendants other than RJFS. He stated that the complaint "fails to allege how the remaining two defendant entities are responsible for the omissions."


Although this failure to attribute the alleged misrepresentations to the defendants other than RJFS alone would have been sufficient to dismiss the defendants other than RJFS, Judge Kaplan further considered the plaintiffs’ scienter allegations and concluded that the insufficiency of the scienter allegations provided an independent basis on which to dismiss the defendants other than RJFS, as well as for dismissing the complaint as a whole.

For reasons similar to those he expressed with respect to his ruling on the misrepresentation issue, Judge Kaplan concluded that the lack of particularized allegations of scienter were "fatal" to the claims against the defendants other than RJFS.


Judge Kaplan further found that plaintiffs’ scienter allegations in general were insufficient. First, he concluded that the plaintiff had not adequately pled "motive and opportunity." He first found that plaintiff’s allegations based on motivations to profit were insufficient. He allowed that plaintiff "comes closer" with her allegation that "defendants’ motive was to unload their excess and soon to be illiquid ARS inventory on unsuspecting customers."


Even these allegations, about the defendants’ supposed motive to unload excess inventory, were found to be insufficient because, Judge Kaplan held, they presumed that "there was a shared knowledge of the entire scheme" among all the defendants – yet the complaint failed, for example, to show that RJFS has knowledge of the issues surrounding the auctions or the securities inventory at the other subsidiaries.


Judge Kaplan noted that in effect the plaintiff sought to "aggregate the knowledge of two or more separate corporate entities on the basis that they share the same corporate parent and nothing more" – which Judge Kaplan found insufficient.


Finally, Judge Kaplan concluded that the plaintiff had not sufficiently alleged "conscious misbehavior or recklessness." Among other things, he found that:


The Court cannot infer that RJFS was aware it was marketing ARS to potential investors fraudulently because there is no showing that RJFS or insiders had access to the underwriters’ "unique" knowledge of the ARS market. Indeed, the complaint itself states that RJFS’s agents, the financial advisors who allegedly made the misrepresentations to investors, "lacked a rudimentary understanding about the auction rate securities and how the auction rate securities market functioned."


The September 17 dismissal is without prejudice. The plaintiff has until October 16, 2009, to submit an amended complaint. Whether or not the plaintiff in this case is successful in curing the pleading defects Judge Kaplan noted remains to be seen. But even if the plaintiff is able to overcome the pleading hurdle, Judge Kaplan’s analysis suggests that other auction rate securities plaintiffs may face significant challenges, even with respect to the defendant companies that have not entered regulatory settlements.


Many if not most of the auction rate securities lawsuits, like the one against Raymond James, involve multiple corporate subsidiaries as defendants, each of which touched a separate part of the auction rate securities process. Unless the plaintiffs in those cases are able to allege that the different subsidiaries had knowledge of the activities and operations of the other subsidiaries, the plaintiffs may, like the plaintiff in the Raymond James case, have difficulty establishing pleading sufficiency for their complaint’s allegations of misrepresentations and scienter against some or all corporate defendants.


To be sure, there may well be cases where plaintiffs can show – or at least allege—that, for example, the sales subsidiary was aware of the difficulties in the auction rate process or with excess inventory. But to the extent the plaintiffs failed to make or establish these connections in their complaint, their complaint may well be dismissed on the same grounds as in the Raymond James case.