* Lawsuit says defendants knew ARS market was fragile

* Suit covers transactions from 2005 to early 2008 (Adds Merrill on reviewing suit, paragraph 3)

NEW YORK, Nov 20 (Reuters) - Dow Corning Corp [DOWCR.UL] sued Merrill Lynch & Co on Friday over the loss of $166 million in auction rate securities, accusing Merrill of misleading investors about the safety and liquidity of the risky debt market that collapsed early in 2008.

The lawsuit in Manhattan federal court by Midland, Michigan based Dow Corning said the transactions took place from 2005 until Feb. 13, 2008 when the ARS market failed. They predate Merrill's takeover by Bank of America Corp (BAC.N: Quote, Profile, Research) on Jan. 1 this year.

A Merrill spokesman declined comment on the lawsuit because the firm had not yet fully reviewed it.

The suit echoed similar litigation against Merrill and other Wall Street firms following the failure of the $330 billion market.

Several investigations have led to settlements in which banks and firms paid back investors for mortgage-backed ARS, debt reset at periodic auctions by Wall Street firms that had been touted as a safe, cash equivalent.

Dow Corning subsidiary Hemlock Semiconductor Corp and insurance company Devonshire Underwriters Ltd, which Dow uses to fund risks, were also named as plaintiffs.

"At least by the fall of 2007, defendants knew that the ARS markets were being artificially supported and were likely to collapse," the lawsuit said. It also alleged that "as late as Feb. 8, 2008, defendants were still marketing the benefits of the ARS markets"

In August, Teva Pharmaceutical Industries Ltd (TEVA.TA: Quote, Profile, Research), the world's biggest maker of generic drugs, sued Merrill over the purchase of $273 million in ARS. [ID: nN06353032]

The case is Dow Corning Corporation et al v Merrill Lynch & Co, U.S. District Court for the Southern District of New York, No. 09-9697. (Reporting by Grant McCool; Editing by Tim Dobbyn)