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Sunday, June 23, 2024 | Back issues
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2nd Circuit Kills Antitrust Case Against Banks

(CN) - The 2nd Circuit affirmed dismissal of an antitrust class action against Citigroup and 15 other giant banks, stemming from the collapse of the auction rate securities market.

A federal judge in Manhattan had dismissed the City of Baltimore's complaint, finding that the defendants' conduct "was impliedly immunized from antitrust scrutiny by the securities laws."

A three-judge panel of the 2nd Circuit affirmed, finding that plaintiffs failed to state a claim under the Sherman Act.

The defendants included Citigroup, UBS, Merrill Lynch, Morgan Stanley, Lehman Brothers, Bank of America, Wachovia, Goldman Sachs, JPMorgan Chase, the Royal Bank of Canada and Deutsche Bank.

The plaintiffs included both buyers and issuers of auction rate securities, or ARS. They claimed the banks conspired to stop propping up the ARS market in violation of the Sherman Act. But the 2nd Circuit ruled: "Even construed liberally, plaintiffs' complaints do not successfully allege a violation of Section 1 of the Sherman Act."

Second Circuit Judges Leval, Katzmann and Hall wrote: "For many years, the auction process appeared to work smoothly, rarely resulting in failure. ARS earned a reputation as safe liquid instruments and as an attractive alternative to normally low-risk, low-return money market funds. ...

"ARS, however, had a problem - a strong secondary market for ARS apparently never developed. Without auctions, ARS were relatively illiquid assets which usually could not be sold for par value."

The façade began crumbling in 2006, when the Securities and Exchange Commission sanctioned more than a dozen brokers with cease-and-desist orders after it found "that some of them had, without properly disclosing their activities, intervened in the auction process to prevent auction failures and set clearing rates," the panel wrote.

The market trudged along with a few hiccups after the SEC's administrative proceedings. However, "These support bids appear to have become increasingly important to the auctions' success as financial market conditions deteriorated throughout 2007 and early 2008," the judges wrote. "Some ARS offerings directly financed subprime mortgage lending and many others were insured by entities that were linked to such lending. As the housing market slipped into crisis, investors sought to extricate themselves from related positions. Yet, with the exception of a few isolated failures in late 2007, the auctions continued to clear as normal.

"All of this changed when many of the auctions held on February 12, 2008, failed. The next day, 87 percent of scheduled auctions failed. By Valentine's Day, the ARS market had essentially ceased functioning, and has never recovered."

Plaintiffs filed nearly identical lawsuits in 2008, one on behalf of ARS investors, and the other on behalf of ARS issuers.

They claimed the defendants earned high fees from ARS offerings and had agreed to "manufacture demand by jointly propping up the auctions with support bids, keeping the fees flowing, and avoiding the loss of goodwill that auction failures would inevitably provoke."

The district court dismissed both, finding the Sherman Act claims precluded by securities laws. Plaintiffs appealed.

They narrowed their claims alleging collusion, focusing on the claim that "Defendants violated the antitrust laws only by withdrawing from the ARS market 'in a virtually simultaneous manner' on February 13, 2008."

But the 2nd Circuit disagreed, finding that "Defendants' alleged actions - their en masse flight from a collapsing market in which they had significant downside exposure - made perfect business sense."

The judges wrote: "As the complaints vividly demonstrate, each defendant was well aware of these dynamics - the market as a whole was essentially holding its breath waiting for the inevitable death spiral of ARS auctions. In such an environment it is unsurprising, and expected, that once failures reached a critical mass, defendants would exit the market very quickly. In fact, at that point abandoning bad investments was not just a rational business decision, but the only rational business decision."

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