Published January 24, 2013
Two Wall Street brokerages must arbitrate a healthcare organization's claim stemming from $234 million in auction rate securities in a dispute over who is considered a "customer" for purposes of securities arbitration, a federal appeals court panel has ruled.
Brokerage units of UBS AG and Citigroup Inc failed to convince the U.S. 4th Circuit Court of Appeals that Carilion Clinic, based in Roanoke, Virginia, was not a "customer" to either firm under the Financial Industry Regulatory Authority's (FINRA) securities arbitration rules, according to an opinion on Wednesday.
The court ruled that Carilion bought "commodities or services" from a FINRA member that were regulated by industry rules.
The case stems from Carilion's decision to issue more than $234 million in auction rate securities in 2005 - a move based on advice from UBS and Citi, according to the opinion. The two firms also performed other roles for Carilion related to the securities, including purchasing them and reselling them to investors. Carilion, which operates a network of hospitals, blamed the firms for millions of dollars in losses when the auction rate securities market failed in 2008.
UBS and Citi spokespeople declined to comment.
The court's decision turned on a controversial argument: Citi and UBS argued that Carilion was not their customer because Carilion's claims did not "relate to a brokerage account or investment relationship" at either firm - a phrase that appeared in 2001 federal court interpretation of the term "customer."
While securities industry rules require brokerages to arbitrate claims with "customers," FINRA's definition of that word is vague. Brokerages often argue that the term does not apply to their circumstances and ask courts to hear the complaint instead.
A court case can drag on much longer and cost more than resolving the dispute in arbitration, which could pressure some customers to abandon their claims.
FINRA's only guidance on the term is a rule that says a "customer shall not include a broker or a dealer." The Wall Street industry-funded watchdog runs the forum where brokerages must typically resolve many types of legal disputes.
Auction rate securities were sold as highly liquid short-term instruments similar to money market funds, but with slightly higher returns. When the $330 billion auction rate market failed during the economic crisis, as large investment banks that ran the auctions experienced cash crunches, thousands of investors were left with securities that could not be sold.
The crisis also led to "skyrocketing" interest payments for Carilion, among other expenses, it wrote in a statement of claim filed with FINRA's arbitration unit last year. Higher interest rates - sometimes as high as 20 percent - are a way to compensate auction rate investors who can no longer sell their positions.
The appeals panel also disagreed with the brokerages' view that even if Carilion was a "customer," the parties previously agreed in their contracts with one another to litigate disputes in a New York federal court.
That agreement "did not displace UBS and Citi's arbitration obligation," the court ruled.
A Carilion spokesman was not immediately able to comment.
(Editing by Andrea Ricci)