In Mayor and City Council of Baltimore v. Citigroup, Inc., No. 10-0722-cv(L) and 10-0867-cv(CON), 2013 WL 791397 (2d Cir. Mar. 5, 2013), the United States Court of Appeals for the Second Circuit upheld the dismissal of two related class action complaints brought on behalf of purchasers of auction rate securities (“ARS”) and ARS issuers, respectively, against a number of large financial institutions. The complaints alleged that the financial institutions violated Section 1 of the Sherman Act, 15 U.S.C. § 1, by conspiring to stop purchasing ARS, thereby rendering ARS almost valueless and triggering the collapse of the ARS market. The Second Circuit based its holding upon a principle first announced by the United States Supreme Court in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) [see blog article here] — that antitrust complaints must allege sufficient factual matter to allow a fact-finder to plausibly infer that the plaintiffs’ alleged injuries were the result of an unlawful conspiracy, rather than independent parallel business conduct.

ARS are long-term bonds with interest rates that fluctuate depending on the outcome of periodic auctions. Since its conception, the ARS market has been concentrated among a group of elite financial institutions that underwrote the issuance of ARS. Auctions would occur at times dictated by a given ARS issuance’s offering documents (typically every 7, 28 or 35 days). If ARS up for auction sold out (demonstrating high demand), the interest rates on the ARS would reset at a lower rate — specifically, the auction would “clear,” such that all of the ARS subject to that auction would reset to the rate at which the last order in the auction was filled.

Because no secondary market for ARS developed, ARS were difficult to liquidate and could not be sold for par value outside of the required auctions. Further, if an auction did not sell out (indicating that there were more people looking to sell than to buy), the auction would “fail” and no ARS could be exchanged — putative sellers would be stuck with their ARS — and the interest rates would default to the maximum rate set out in the offering documents. Because of the dire consequences of a failed auction, the defendant financial institutions would sometimes intervene in the auctions by using proprietary trading accounts to place “support bids” which would result in clearing the auctions despite insufficient external demand.

As the financial market deteriorated throughout 2007 and early 2008, these support bids became increasingly critical to clearing auctions. There were a few isolated failures in 2007, but the ARS market began its implosion on February 12, 2008, when many of the auctions scheduled for that date failed. On February 13, 2008, eighty-seven percent of the auctions failed, and by the next day, the ARS market had essentially shut down. Plaintiffs filed their class action complaints in September of 2008, claiming that defendants had conspired to restrain trade by refusing to issue support bids to protect the auctions they managed.

The United States District Court for the Southern District of New Yorkdismissed the complaint, relying upon the Supreme Court’s decision inCredit Suisse Securities (USA) LLC v. Billing, 551 U.S. 264 (2007) [see blog article here]. The Second Circuit affirmed the dismissal, but did so based on a Twombly analysis, and therefore did not reach the question of whether the Southern District’s Billing analysis was correct.

The Second Circuit explained that the facts pleaded in a complaint must raise a reasonable expectation that discovery will reveal evidence of illegal conduct and that mere legal conclusions couched as factual allegations will get no consideration at all. To state a claim under Section 1 of the Sherman Act, the complaint must allege sufficient facts — as opposed to mere labels or legal conclusions — making the inference that the plaintiff’s injuries were the result of an unlawful conspiracy more plausible than competing inferences, such as that the injuries result from independent, legitimate business decisions by similarly situated actors. The required factual allegations — referred to by Twombly and its progeny as “plus factors” — can include allegations that parallel acts were against defendants’ individual economic self-interests, or that competitors frequently communicated with each other.

In this case, the plaintiffs failed to adequately plead the requisiteTwombly plus factors. For example, although plaintiffs pled two interfirm communications, the vast majority of alleged communications wereintrafirm. The Court found these predominantly internal communications were insufficient to demonstrate more than a high level of interfirm awareness, which is not in itself unlawful.

Plaintiffs also failed to connect any plus factors to the alleged conspiracy. The Court observed that “the [ARS] market as a whole was essentially holding its breath and waiting for the inevitable death spiral of ARS auctions,” which made “abandoning bad investments [] not just a rational decision, but the only rational business decision.” In other words, the most plausible explanation for defendants’ simultaneous withdrawal of support for ARS auctions was not an antitrust conspiracy, but independent (and widespread) assessments that the ARS market was dying and ARS were a bad investment.

The Second Circuit underscored its unease with permitting large antitrust class actions to proceed absent a well-documented inference of conspiracy, noting: “[i]f we permit antitrust plaintiffs to overcome a motion to dismiss simply by alleging parallel conduct, we risk propelling defendants into expensive antitrust discovery on the basis of acts that could just as easily turn out to have been rational business behavior as they could a proscribed antitrust conspiracy.”