Ashland Inc., AshThree LLC v. Morgan Stanley & Co.

1
10-1549-cv
Ashland Inc., AshThree LLC v. Morgan Stanley & Co.
UNITED STATES COURT OF APPEALS 1
FOR THE SECOND CIRCUIT 2
August Term, 2010 3
4
(Argued: March 9, 2011 Decided: July 28, 2011) 5
Docket No. 10-1549-cv 6
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ASHLAND INC., ASHTHREE LLC, 8
9 Plaintiffs-Appellants, 10
11 v. 12
13 MORGAN STANLEY & CO., INC., 14
15 Defendant-Appellee. 16
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19 B e f o r e: WINTER, POOLER, and HALL, Circuit Judges. 20
Appeal from an order of the United States District Court for 21
the Southern District of New York (Robert P. Patterson, Jr., 22
Judge) dismissing plaintiffs’ complaint for failure to state a 23
claim under Rule 12(b)(6). Appellants assert claims under 24
Section 10(b) of the Securities Exchange Act of 1934 and New York 25
common law arising from their purchase and retention of auction 26
rate securities. We affirm the dismissal for failure to plead 27
reasonable reliance on appellee’s alleged misrepresentations. 28

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2
CHRISTOPHER P. JOHNSON (Laurin B. 1 Grollman, on the brief), Kasowitz, 2
Benson, Torres & Friedman LLP, New 3 York, New York, for Plaintiffs- 4 Appellants. 5
6 JOHN K. CARROLL (Scott D. Musoff, 7 on the brief), Skadden, Arps, 8 Slate, Meagher & Flom LLP, New 9 York, New York, for Defendant- 10 Appellee. 11
12 WINTER, Circuit Judge: 13
Ashland Inc. and AshThree LLC (together, “Ashland” or 14
“appellants”) appeal from Judge Patterson’s dismissal of their 15
first amended complaint (“FAC”), which asserted claims against 16
Morgan Stanley under Section 10(b) of the Securities Exchange Act 17
of 1934 (the “Exchange Act”) and New York common law. Appellants 18
contend that Morgan Stanley, in oral and email communications 19
with Ashland’s Assistant Treasurer, materially misrepresented the 20
liquidity of certain auction rate securities (“ARS”) and thereby 21
fraudulently induced Ashland to purchase and hold these 22
securities at a time when Morgan Stanley knew that the market for 23
ARS was collapsing. We affirm the district court’s dismissal on 24
the ground that sophisticated investors like appellants cannot 25
plead reasonable reliance on Morgan Stanley’s alleged 26
misrepresentations in light of Morgan Stanley’s publicly-filed 27
statement explicitly disclosing the very liquidity risks about 28
which appellants claim to have been misled. 29
30
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3
BACKGROUND 1
Ashland Inc. is a Kentucky-based global chemical company. 2
It is the sole owner and operator of the special purpose entity 3
AshThree LLC, a Delaware limited liability company. AshThree 4
holds the securities at issue in this case. Appellee Morgan 5
Stanley is a Delaware corporation with its principal place of 6
business in New York. 7
Ashland's relationship with Morgan Stanley began in May 8
2007, when Ashland's long-time financial advisor, Thomas Byrne, 9
moved to Morgan Stanley. Around that time, Byrne called 10
Ashland's Assistant Treasurer, Joseph Broce, to discuss moving 11
Ashland's investments to Morgan Stanley. Byrne recommended 12
investing in Morgan Stanley-brokered ARS. ARS are long-term 13
bonds and stocks whose interest rates or dividend yields are 14
periodically reset through auction. At each auction, holders and 15
buyers of the securities specify the minimum interest rate at 16
which they want to hold or buy. If buy/hold orders meet or 17
exceed sell orders, the auction succeeds. If supply exceeds 18
demand, however, the auction fails and the issuer is forced to 19
pay a higher rate of interest in order to penalize it and to 20
increase investor demand. For a more thorough explanation of the 21
mechanics of ARS, see In the matter of Bear Stearns & Co., et 22
al., SEC Release No. 8684, 88 SEC Docket 259 (May 31, 2006). 23
The ARS at issue in this matter were backed by student loan 24
obligations ("SLARS"). Byrne is alleged to have told Broce that 25

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1 A “hold” order, which is the default for current
investors, means that the investor will continue to hold the
securities regardless of the clearing rate. By contrast, a
“hold-at-rate” order means that the investor will retain the
4
the ARS were "safe, liquid instruments that were suitable to 1
[appellants'] conservative investment policies." Byrne further 2
represented that the SLARS would remain liquid because Morgan 3
Stanley had never conducted a failed auction and “in the event of 4
any instability or weakness in the market for SLARS . . . which 5
Morgan Stanley represented to be a very ‘rare’ occurrence -- 6
Morgan Stanley's brokers and other brokers would step in and 7
place sufficient proprietary bids to prevent auction failure and 8
ensure the liquidity of Ashland's SLARS." Because bid 9
information about ARS auctions was not publicly available, 10
however, appellants could not know how often Morgan Stanley had 11
intervened to ensure a successful auction. Ashland also alleges 12
that, in fact, Morgan Stanley knew as early as August 2007 that 13
the ARS market was collapsing, in part because Morgan Stanley was 14
often required to intervene to prevent auction failure. 15
Ashland purchased SLARS through Morgan Stanley on three 16
separate occasions in 2007 -- September 25, October 2, and 17
November 29. On the days leading up to each purchase, Byrne 18
assured Broce “that SLARS continued to be a safe, liquid 19
investment.” Accordingly, throughout this period, Ashland placed 20
only “hold” or “hold-at-rate” orders at auctions, rather than 21
"sell" orders. 1 In December 2007, Ashland learned that Goldman 22

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securities only if the clearing rate is at, or above, a rate
specified by the investor.
5
Sachs, acting as underwriter in an unrelated ARS auction, had 1
allowed that auction to fail. Byrne reassured Broce that this 2
failure had no bearing on the safety of its SLARS, which were 3
based on student loans backed by a federal guarantee, unlike 4
those in the failed auction. In January 2008, Ashland learned of 5
other auction failures, but Morgan Stanley continued to assert 6
that ARS were a safe, liquid investment. When Ashland began 7
placing “sell” orders around February 2008, however, it found 8
that the market was illiquid because Morgan Stanley was no longer 9
stepping in to ensure auction success. 10
Appellants filed a complaint in the Southern District of New 11
York in June 2009, which they amended in September 2009, 12
asserting claims for violation of Section 10(b) of the Exchange 13
Act, common law fraud, promissory estoppel, breach of fiduciary 14
duty, negligence, negligent misrepresentation, and unjust 15
enrichment. In addition to alleging that Morgan Stanley 16
misrepresented the safety and liquidity of the SLARS, the FAC 17
also alleges the following pertinent omissions. Morgan Stanley 18
failed to disclose: (i) how often demand failed to meet supply 19
in SLARS auctions, and consequently, how often it had to step in 20
to purchase the SLARS; (ii) that the government guarantee and 21
non-dischargeability in bankruptcy of the underlying student debt 22
obligations were unrelated to the SLARS' liquidity; (iii) the 23

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6
relationship between fail rates, AAA ratings, and liquidity; and 1
(iv) that it was not fully committed to ensuring liquidity of the 2
SLARS. 3
The district court dismissed the FAC in its entirety. 4
Ashland Inc. v. Morgan Stanley & Co., 700 F. Supp. 2d 453, 473 5
(S.D.N.Y. 2010). It relied in part on the fact that in May 2006 6
Morgan Stanley "placed a statement of its ARS policies and 7
practices online, ‘as a result of an Order entered into between 8
the [Securities and Exchange Commission (“SEC”)] and certain 9
active broker-dealers in the auction rate securities market.'" 10
Id. at 461. The SEC-ordered statement included several relevant 11
disclosures. It stated that "Morgan Stanley is permitted, but 12
not obligated, to submit orders in auctions for its own account 13
either as a bidder or a seller and routinely does so [in] its own 14
discretion." Id. It further explained that 15
Morgan Stanley routinely places one or more 16 bids in an auction for its own account to 17 acquire ARS for its inventory, to prevent a 18 failed auction or to prevent an auction from 19 clearing at a rate that Morgan Stanley 20 believes is higher than the market for 21 similar securities at the time it makes its 22 bid. . . . [However,] Morgan Stanley is not 23 obligated to bid in any auction to prevent an 24 auction from failing or clearing at an off- 25 market rate. Investors should not assume 26 that Morgan Stanley will do so. 27
28 Id. It also stated that ARS holders "may be disadvantaged if 29
there is a failed auction because they are not able to exit their 30
position through the auction" and explained that "the fact that 31

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7
an auction clears successfully does not mean that an investment 1
in the ARS involves no significant liquidity or credit risk." 2
Id. 3
The district court concluded that the Section 10(b) 4
securities fraud claim failed because: (i) “hold” and “hold-at- 5
rate” orders did not constitute a purchase or sale of securities 6
under Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975); 7
(ii) the FAC did not allege facts to support a strong inference 8
of scienter as to any misrepresentations or omissions; and (iii) 9
the FAC did not allege facts to show that appellants were 10
reasonable in their reliance on any alleged misrepresentations. 11
Ashland, 700 F. Supp. 2d at 467-71. It also dismissed the common 12
law fraud and promissory estoppel claims due to lack of 13
reasonable reliance. Id. at 471-72. Finally, it held that the 14
remaining state law claims were preempted by New York’s Martin 15
Act. Id. at 472. This appeal followed. 16
DISCUSSION 17
We review a district court’s grant of a motion to dismiss 18
under Rule 12(b)(6) de novo, accepting as true all facts alleged 19
in the complaint and drawing all reasonable inferences in favor 20
of the non-moving party. Chase Grp. Alliance LLC v. City of N.Y. 21
Dep’t. of Fin., 620 F.3d 146, 150 (2d Cir. 2010). “To survive a 22
motion to dismiss, a complaint must contain sufficient factual 23
matter, accepted as true, to ‘state a claim to relief that is 24
plausible on its face.’” Ashcroft v. Iqbal, 129 S.Ct. 1937, 1949 25

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2 As a threshold matter, appellants contend that the
district court erred in dismissing a number of their claims
relating to their “holding” of SLARS in reliance upon the alleged
misrepresentations and omissions by Morgan Stanley. Typically, a
“holder” of securities lacks standing to prosecute a claim under
the federal securities laws. See Blue Chip Stamps v. Manor Drug
Stores, 421 U.S. 723, 747-49 (1975) (establishing a purchaser-
seller limit on standing); accord Merrill Lynch, Pierce, Fenner &
Smith Inc. v. Dabit, 547 U.S. 71, 88 n.13 (2006); accord Amorosa
v. AOL Time Warner Inc., 409 F. App’x 412, 417 (2d Cir. 2001)
(summary order) (“[T]here is no ‘holder’ claim under federal
securities law.”). Appellants argue that ARS differ from
traditional securities because ARS are subject to periodic
auctions, which require an ARS owner to make an active decision
to hold the security before the auction. They believe this
eliminates the concerns about “holder” standing raised in Blue
Chip Stamps, including concerns about the lack of competent
evidence that a holder, in fact, made an active decision to hold.
Blue Chip Stamps, 421 U.S. at 743 (elimination of the purchaser-
seller requirement “would throw open to the trier of fact many
rather hazy issues of historical fact the proof of which depended
almost entirely on oral testimony”). We need not reach the
question of whether ARS are sufficiently distinguishable from
other types of securities to confer standing on a holder of ARS
to bring a claim under the securities laws, because we find that
appellants have failed to establish that they reasonably relied
on the alleged misrepresentations by Morgan Stanley.
8
(2009) (quoting Bell Atl. Corp. v. Twombley, 550 U.S. 544, 570 1
(2007)). 2
a) Section 10(b) Claim 3
To sustain a private claim for securities fraud under 4
Section 10(b), “a plaintiff must prove (1) a material 5
misrepresentation or omission by the defendant; (2) scienter; (3) 6
a connection between the misrepresentation or omission and the 7
purchase or sale of a security; (4) reliance upon the 8
misrepresentation or omission; (5) economic loss; and (6) loss 9
causation.” 2 Stoneridge Inv. Partners, LLC v. Scientific- 10

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9
Atlanta, Inc., 552 U.S. 148, 157 (2008). Moreover, a plaintiff’s 1
reliance on the defendant’s misrepresentation must have been 2
reasonable in order for the claim to proceed. See Harsco Corp. 3
v. Segui, 91 F.3d 337, 342 (2d Cir. 1996) (collecting cases from 4
various circuits). "An investor may not justifiably rely on a 5
misrepresentation if, through minimal diligence, the investor 6
should have discovered the truth." Brown v. E.F. Hutton Grp., 7
Inc., 991 F.2d 1020, 1032 (2d Cir. 1993). Factors relevant to 8
this analysis include: 9
(1) [t]he sophistication and expertise of the 10 plaintiff in financial and securities 11 matters; (2) the existence of longstanding 12 business or personal relationships; (3) 13 access to the relevant information; (4) the 14 existence of a fiduciary relationship; (5) 15 concealment of the fraud; (6) the opportunity 16 to detect the fraud; (7) whether the 17 plaintiff initiated the stock transaction or 18 sought to expedite the transaction; and (8) 19 the generality or specificity of the 20 misrepresentations. 21
22 Id. (collecting cases). 23
24 Appellants argue that their reliance on Broce’s 25
misrepresentations was reasonable in light of their longstanding 26
relationship with him, their repeated inquiries as to the 27
liquidity of SLARS, and the fact that auction information was not 28
publicly available. However, the SEC-mandated statement 29
explicitly disclosed the very liquidity risks about which 30

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3 Appellants bring our attention to a letter amicus filed by
the SEC in Wilson v. Merrill Lynch & Co., No. 10-1528 (2d Cir.
argued Feb. 25, 2011). Appellants describe this letter as
adopting their arguments with regard to whether the disclosures
at issue in the present matter adequately described the risks of
ARS. However, the allegations in Wilson were that Merrill Lynch
followed a “‘uniform policy’ of placing support bids ‘if needed’
in ‘every’ auction for which it was the sole or lead auction
dealer.” Amicus Letter Brief for SEC at 4, Wilson, No. 10-1528
(2d Cir. June 24, 2011). The complaint alleged that this conduct
was manipulation designed to create an appearance of an active
market that was in fact illusory. Id. The allegations in the
present case are that Morgan Stanley described the SLARS sold to
appellants as safe and liquid and that in the event of
“instability or weakness in the market for SLARS,” Morgan Stanley
would step in and place sufficient proprietary bids to prevent
auction. Far from alleging that they were misled by Morgan
Stanley’s purchasing of ARS, appellants’ complaint is in large
part about Morgan Stanley’s failure to step in and stabilize the
market for SLARS.
4 Appellants admitted, in their written submissions and oral
argument before the district court, that they had received these
written disclosures after their first purchase of SLARS but
before subsequent auctions at which they placed “hold” and “hold-
at-rate” orders. Regardless of precisely when they received the
statement in writing, the statement was also available online,
and appellants could have easily discovered it through minimal
diligence.
10
appellants claim to have been misled. 3 Specifically, the 1
statement revealed that Morgan Stanley routinely placed bids in 2
its own auctions, in part to prevent auctions from failing. 3
Moreover, the statement was clear that Morgan Stanley did so at 4
its discretion and “[wa]s not obligated to bid in any auction to 5
prevent an auction from failing.” In the face of this SEC- 6
mandated disclosure, 4 Ashland, which admits to being “a 7
sophisticated investor,” was not justified in relying on Byrne’s 8
statements that SLARS “had no liquidity issues,” or that “in the 9

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11
event of ‘instability or weakness,’ Morgan Stanley would ‘come in 1
and make a market,’ as it had always done in the past.” 2
Nor does the alleged misrepresentation that the liquidity of 3
SLARS was assured because of a federal government guarantee of 4
the underlying student loans save appellants’ claim. The value 5
of ARS is of course affected by the riskiness of the underlying 6
collateral. Because the SLARS were backed by pools of guaranteed 7
student loans, they were less risky than ARS backed by non- 8
guaranteed loans, which have a higher risk of default. However, 9
the appeal of ARS or SLARS is that they, in good times, provide a 10
degree of liquidity not associated with the collateral. While 11
the reduced risk of the collateral’s default may affect the 12
liquidity of ARS, a government guarantee of the collateral does 13
not eliminate the risk of SLARS becoming illiquid. A reasonable 14
sophisticated investor knows this because the reason for buying 15
SLARS instead of the student loans themselves is to obtain 16
greater liquidity. Indeed, the FAC alleges that appellants 17
bought SLARS to obtain such liquidity and that Broce conceded the 18
possibility of illiquidity by promising that Morgan Stanley would 19
step in to prevent it. 20
Therefore, even accepting as true all of the facts alleged 21
in the FAC, appellants’ Section 10(b) claim fails due to their 22
inability to plead reasonable reliance on the alleged 23
misrepresentations. 24
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b) Common Law Claims 1
Ashland also appeals from the dismissal of its common law 2
claims. Unlike the district court, we do not address whether 3
Martin Act preemption applies but instead affirm on appellants’ 4
lack of reasonable reliance. See Primetime 24 Joint Venture v. 5
Nat’l Broad., Co., 219 F.3d 92, 103 (2d Cir. 2000) (“Because we 6
review the district court's decision to dismiss under Rule 7
12(b)(6) de novo, we are free to affirm the decision below on 8
dispositive but different grounds.”). 9
Reasonable reliance is a required element of common law 10
fraud, promissory estoppel, breach of fiduciary duty, and 11
negligent misrepresentation under New York law. See Crigger v. 12
Fahnestock & Co., 443 F.3d 230, 234 (2d Cir. 2006) (common law 13
fraud); Kaye v. Grossman, 202 F.3d 611, 615 (2d Cir. 2000) 14
(promissory estoppel); King v. Crossland Sav. Bank, 111 F.3d 251, 15
257-58 (2d Cir. 1997) (negligent misrepresentation); Carr v. 16
Neilson, 909 N.Y.S.2d 387, 387 (N.Y. App. Div. 2010) (breach of 17
fiduciary duty). We therefore affirm the dismissal of these 18
claims for the reasons stated above. Because appellants’ 19
negligence claim is virtually identical to their negligent 20
misrepresentation claim, we also affirm that dismissal. 21
Finally, appellants’ unjust enrichment claim simply does not 22
fit the facts of this case. Under New York law, an unjust 23
enrichment claim requires a plaintiff to prove that “(1) 24
defendant was enriched, (2) at plaintiff's expense, and (3) 25

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13
equity and good conscience militate against permitting defendant 1
to retain what plaintiff is seeking to recover.” Diesel Props 2
S.R.L. v. Greystone Bus. Credit II LLC, 631 F.3d 42, 55 (2d Cir. 3
2011) (internal quotation omitted). The FAC states that 4
“[e]quity and good conscience require disgorgement of fees earned 5
by Morgan Stanley from Ashland’s purchases of Morgan Stanley- 6
brokered SLARS,” because Ashland thought it was purchasing liquid 7
investments. However, the facts alleged are that Ashland, a 8
sophisticated investor, failed to apprise itself of the publicly 9
disclosed riskiness of ARS as liquid investments. There is 10
little in equity and good conscience that weighs in favor of the 11
return of the fees it paid in connection with those transactions. 12
We have considered appellants’ remaining contentions and 13
conclude that they are without merit. 14
CONCLUSION 15
For the foregoing reasons, we affirm the district court’s 16
dismissal of appellants’ complaint. 17
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