* Brokerage argued that client was not a "customer"
* Court disagrees, says brokerages must arbitrate
By Suzanne Barlyn
Jan 24 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
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
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
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.