Nov 14 (Reuters) - A federal appeals court refused to allow investors to sue Merrill Lynch & Co over allegations the bank manipulated the $330 billion auction-rate securities market.

Monday's decision by the 2nd U.S. Circuit Court of Appeals upheld a lower court ruling absolving Merrill of claims that its prospectuses and website failed to adequately disclose liquidity risks, including how the bank might refuse to use its capital to prevent the failures of auctions it led.

The lawsuit sought class-action status and was brought on behalf of investors who bought auction-rate debt that Merrill helped sell between March 25, 2003 and Feb. 13, 2008. Bank of America Corp bought Merrill on Jan. 1, 2009.

Merrill and other banks and brokerages for many years marketed auction-rate securities as a safe, liquid alternative to cash, with slightly higher returns.

But the market froze in February 2008 when dealers stopped supporting the auctions. This left many investors unable to sell their securities, or able to do so only at a significant loss.

Writing for the 2nd Circuit, Judge Robert Katzmann said Merrill sufficiently disclosed that liquidity depended on its own intervention in auctions, rather than "the natural interplay of supply and demand."

The U.S. Securities and Exchange Commission had filed a brief in support of the investors. The regulator reached its own settlement on the issue with Merrill in August 2008.

Merrill also reached a settlement that month with then-Attorney General Andrew Cuomo to buy back up to $12 billion of auction-rate debt and pay a $125 million fine.

MORGAN STANLEY, SCHWAB ALSO WON DISMISSALS

Monday's decision upheld a March 2010 ruling by U.S. District Judge Loretta Preska in Manhattan.

"We're obviously disappointed in the opinion and we thought the SEC got it right," Jonathan Levine, a lawyer for the investors, said in an interview.

He said he is reviewing the decision. It is unclear whether there will be an appeal.

Bank of America spokesman Bill Halldin said the Charlotte, North Carolina-based lender is pleased with the decision.

Merrill is among more than one dozen financial institutions to repurchase more than $61 billion of auction-rate securities under settlements with state and federal regulators.

Courts in New York have thrown out other litigation against banks over auction-rate securities.

In July, the 2nd Circuit dismissed a case against Morgan Stanley by chemicals company Ashland Inc.

Then last month, a state judge threw out New York's lawsuit against Charles Schwab Corp over its alleged failure to disclose that securities it sold as an agent, rather than as a sponsor, of the auctions could freeze.

The case is Wilson et al v. Merrill Lynch & Co et al, 2nd U.S. Circuit Court of Appeals, No. 10-1528.

For Wilson: Jonathan Levine of Girard Gibbs.

For Merrill Lynch: Jay Kasner, Scott Musoff and Paul Lockwood of Skadden, Arps, Slate, Meagher & Flom.

(Reporting by Jonathan Stempel)

Follow us on Twitter: @ReutersLegal