Fourth Circuit Decides FINRA Rules to Govern Dispute Over Auction Rate Securities

A federal appeals court has ruled that two Wall Street brokerages must arbitrate a $234 million auction rate securities claim in a dispute with a healthcare organization over what exactly constitutes a customer. In January, a panel of the United States 4th Circuit Court of Appeals held that Carilion Clinic was a customer of UBS AG and Citigroup, Inc. pursuant to the Financial Industry Regulatory Authority‘s (FINRA) securities arbitration rules.

In UBS Financial Services, Inc. v. Carolion Clinic No. 12-2066 (4th Cir. Jan. 23, 2013), Carilion reportedly issued at least $234 million in auction rate securities on the advice of the two brokerage firms in 2005. The firms also purportedly purchased and resold the securities to other customers. Auction rate securities are liquid short-term investments that generally enjoyed a higher rate of return until the recent economic crisis. In 2008, Carilion allegedly lost millions when the $330 billion auction rate securities market failed. The healthcare organization was also reportedly on the hook for the high interest rates normally paid to investors who purchase such securities.

Because FINRA requires that member brokerage firms arbitrate any claims made by customers, UBS AG and Citigroup Inc. argued Carilion was not a customer and instead sought judicial review of the case. The two brokerage firms relied on a 2001 case in which the term “customer” was interpreted by a federal court to include a “brokerage account or investment relationship.” Although FINRA’s definition of customer is vague, the organization only states that a customer may “not include a broker or dealer.” The 4th Circuit disagreed with UBS AG and Citigroup Inc. and held that Carilion was in fact a customer of the two brokerages.

Finally, the appellate court dismissed the brokerage firms’ argument that the parties agreed to forego arbitration and litigate any disputes in a New York court by stating a contract between them was not specific enough to lead a reader to believe the right to FINRA arbitration was waived. Consequently, the forum selection clause “did not displace UBS and Citi’s arbitration obligation.” The appeals court then affirmed the district court’s judgment.