Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, January 24, 2013

Securities Firms' Attempt to Avoid Arbitration Fails -- Again

The securities industry fought hard for the power to require brokerage customers to arbitrate all disputes with their firms.  But some firms appear to think that arbitration is only a good dispute resolution mechanism when they want it and are challenging arbitration proceedings brought by dissatisfied users of their services.  UBS Financial Services, Inc. v. Carilion Clinic (4th Cir. No. 12-2066, Jan. 23, 2013) is a recent example.(Download UBSFinancial.012313[1])

Carilion, a not-for-profit organization that operates hospitals and clinics in Virginia, decided in 2005 to issue municipal bonds and retained UBS and Citigroup Global Markets to advise it on the structure of the bond issues and to assist it in implementing the financing plan.  UBS and Citigroup recommended the issuance of auction-rate bonds and acted as underwriters and lead broker-dealers in the $234 million offering.  Unfortunately, in early 2008 the auction-rate bond market collapsed for the bonds, when UBS and Citigroup stopped submitting support bids.  Carilion was forced to refinance and lost millions of dollars.  Carilion filed an arbitration claim with FINRA, claiming that the firms misled it and asserting claims under both state and federal securities laws.  UBS and Citigroup filed a declaratory judgment action and sought a preliminary injunction against the arbitration, asserting that Carilion was not a "customer" entitled to bring an arbitration under FINRA's rules.  They further argued that Carilion had waived arbitration through the forum selection clause contained in one of the contracts among the parties.  The district court rejected both arguments, and the Fourth Circuit affirmed.

FINRA Rule 12200 requires member firms to arbitrate disputes with customers when the customer requests arbitration and the dispute "arises in connection with the business activities of the member."  UBS and Citigroup asserted that Carilion was not their "customer" because that term, as used in the FINRA rule, is limited to "investors."  Carilion, in contrast, asserted that customer means anyone "who purchases some commodity or service."  The Fourth Circuit agreed with Carilion, finding the broader interpretation is consistent with the purposes of FINRA arbitration and consistent with generally accepted meaning of customer.  Thus, it held that "when FINRA uses 'customer' in Rule 12200, it refers to one, not a broker or dealer, who purchases commodities or services from a FINRA member in the course of the member's business activities insofar as those activities are covered by FINRA's regulation, namely the activities of investment banking and the securities business."

The Fourth Circuit also rejected the firms' argument that the forum selection clause, which provides that "all actions and proceedings arising out of this Agreement ... shall be brought in the United States District Court of the County of New York."  This was "a straightforward issue of contract interpretation," said the Court.  It found that the natural reading of the clause was to require any litigation to be brought in the designated court; "it would never cross a reader's mind that the clause provides that the right to FINRA arbitration was being superseded or waived," especially since the clause did not even use the word arbitration.

The Fourth Circuit relied on a previous opinion from the Second Circuit, UBS Financial Services, Inc. v. West Virginia Hospitals, 660 F.3d 643 (2d Cir. 2011), involving substantially similar facts.

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