Finn v. Smith Barney: 10(b) Market Manipulation Suit Dismissed for Lack of Reliance

In Finn v. Smith Barney,  No. 11-1270-cv, 2012 WL 1003656 (2d Cir. Mar. 27, 2012), the Second Circuit affirmed the Southern District of New York’s dismissal of market manipulation claims brought under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The plaintiffs were investors who purchased auction rate securities (“ARS”), securities whose interest rates were reset periodically via a Dutch auction, from the defendants, various Citigroup, Inc. subsidiaries (collectively, “Citigroup”). The investors alleged that Citigroup’s frequent intervention in the ARS market was manipulative, and that the parent company, Citigroup Inc., was a 20(a) controlling person.

Section 10(b) forbids the use of a “manipulative or deceptive device” in contravention of the Security and Exchange Commission’s (“SEC”) rules and regulations. SEC Rule 10b-5 forbids any fraudulent practice in connection with the purchase or sale of securities. Manipulation occurs when a party intentionally or willfully controls or artificially affects security prices for fraudulent or deceptive purposes. Further, “[m]arket manipulation requires a plaintiff to allege (1) manipulative acts; (2) damage (3) caused by reliance on an assumption of an efficient market free of manipulation; (4) scienter; (5) in connection with the purchase or sale of securities; (6) furthered by the defendant’s use of the mails or any facility of a national securities exchange.”

The plaintiffs alleged that they purchased the ARS under the belief that the auction markets were driven solely by investor supply and demand, and that Citigroup’s increasing interventions, by placing bids for its own accounts, distorted that market. However, various documents--including prospectuses, confirmations, website disclosures, and media reports--had disclosed that Citigroup could, to prevent auction failure, “routinely place . . . bids . . . for its own account” that were “likely to affect” auction rates and allocations. In light of these disclosures, the court held that the plaintiffs could not plausibly claim reasonable reliance on the assumption of an efficient free market.

The plaintiffs further argued that the sheer frequency of Citigroup’s market interventions rendered any disclosures misleading. However, the court reasoned that at least one of Citigroup’s disclosures specifically included the word “routinely,” indicating the potential for such a high frequency of intervention.

The plaintiffs also argued that the district court had taken improper judicial notice of the disclosure documents in question. Under Federal Rule of Evidence 201(b)(2), such notice may be taken when a document can be readily and accurately determined “from sources whose accuracy cannot reasonably be questioned.” Because the district court took judicial notice for the sole purpose of establishing the public availability of the disclosure documents, and the documents were in fact publicly available before and during the class period, the judicial notice was not an abuse of discretion.

Because Citigroup’s disclosure negated the reliance element of the alleged 10(b) violations, there was no primary manipulation; without primary manipulation, there could be no 20(a) liability for the parent company, Citigroup, Inc. Therefore, the court affirmed the dismissal of all claims.

The primary materials for this case may be found on the DU Corporate Governance Website.