Merrill, Morgan Stanley sued over auction rates

NEW YORK (Reuters) - Merrill Lynch & Co MER.N and Morgan Stanley MS.N were sued on Tuesday by clients accusing them of deceptively marketing auction rate securities.

The Morgan Stanley headquarters is seen in New York January 30, 2008. REUTERS/Shannon Stapleton

The two separate lawsuits, filed in U.S. federal court in Manhattan, are seeking class action status.

Auction rate securities are bonds that banks typically pitched as a safe alternative to cash. They are long-term securities, but the investment banks hold periodic auctions to set the interest rates and give holders the option to sell the securities.

But the securities have become harder to sell in recent months as auctions have failed to attract bidders.

In the suits, the investors claimed the brokers had artificially supported the auction rate securities market, causing their investments to become illiquid. They also claimed that the firms had recklessly misrepresented the risks of such investments.

“Morgan Stanley deceptively marketed (auction rate securities) as cash alternatives to money market funds for investors needing liquidity and utterly failed to disclose material information,” investor Gary Miller said in the lawsuit.

Morgan Stanley denied the allegations in the complaint.

“The challenges of the auction rate markets are industry-wide, and result from broader credit market conditions,” the company said in a statement.

“The auction rate securities market has existed for over 20 years without significant disruption until recent market events,” it added.

The firm said it was working with clients to resolve their individual liquidity needs through various alternatives, including lending.

Merrill Lynch also said the suit against it was without merit.

“Because of the current lack of liquidity in the auction market, auctions for many ARS have ‘failed’ but none has defaulted, and clients are receiving interest or a coupon on the auction security,” Merrill spokesman Mark Herr said in a statement. “When clients purchased ARS from us, we provided them with information about the auction rate security and process.”

Miller is seeking an injunction that would compel Morgan Stanley to rescind millions of dollars it executed in auction rate transactions from March 2003 through February 2008, and compensatory damages for himself and other investors in those securities.

Frederick Burton, who filed the suit against Merrill, alleged the company deceived the investing public and issued misleading information to clients in violation of the Exchange Act. He is also seeking compensatory damages.

Reporting by Emily Chasan; Editing by Lisa Von Ahn, Leslie Gevirtz, Gary Hill