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January 24, 2013

UBS, Citigroup Must Arbitrate Bond Row with Nonprofit Customer

By Mark S. Nelson, J.D.

UBS Financial Services, Inc. and Citigroup Global Markets, Inc. must arbitrate an ill-fated bond deal with their nonprofit healthcare customer Carilion Clinic, according to the U.S. Court of Appeals for the Fourth Circuit (UBS Financial Services, Incorporated. v. Carilion Clinic, January 23, 2013, Niemeyer, P.). Carilion had alleged that it was UBS's and Citigroup's customer when they misrepresented a bond deal and breached fiduciary duties owed to Carilion. The Fourth Circuit held that Carilion was a "customer" entitled to arbitration under FINRA Rule 12200 and that a forum selection clause in the parties' broker-dealer contracts did not waive this right.

The bond deal. Carilion, UBS, and Citigroup entered into broker-dealer and underwriting agreements for the issuance of $308 million in bonds to finance Carilion's expanded healthcare facilities. The issue included $234 million in auction-rate bonds for which UBS and Citigroup acted as underwriters, lead broker-dealers, and agents for Carilion in talks with credit rating agencies and bond issuers. UBS and Citigroup also sold Carilion interest-rate swaps to hedge the auction rate bonds' risk. But Carilion's auction rate bonds cratered in February 2008 because UBS and Citigroup ended their support bids. Carilion's swaps hedge also failed and the firm had to refinance to avoid higher interest payments.

Carilion tried to arbitrate the disputed bond deal with UBS and Citigroup under FINRA Rule 12200. The district court denied a request by UBS and Citigroup to halt arbitration because Carilion either was not a "customer" or had agreed to a forum selection clause in the broker-dealer agreement that waived arbitration rights. All parties agreed that arbitration is required, absent a waiver, if Carilion is a "customer."

"Customer" broadly defined. The Fourth Circuit held that Carilion was a customer. FINRA Rule 12200 mandates arbitration if a customer requests arbitration and the FINRA members' business activities are disputed. The Fourth Circuit said that "customer" means a non-broker-dealer who buys commodities or services from a FINRA member in the course of that member's FINRA-regulated business activities that include investment banking and securities business. Carilion had urged a broad definition of "customer," while UBS and Citigroup pushed a limited view.

The court said FINRA's rules imply that "customer" has broad meaning. Specifically, FINRA Rule 12100(r) states that "person associated with a member" includes a person who conducts investment banking or securities business and who controls or is controlled by a FINRA member. The court also said FINRA's mission statement adds "context" to the meaning of "customer." FINRA states that it promotes investment banking and securities business, fosters compliance with state and federal securities regulations, and handles disputes between the public and FINRA members. FINRA has not defined "customer" except to omit broker-dealers.

The court also said the dictionary definition of "customer" buoys an expansive view. Citing Merriam-Webster's Collegiate Dictionary (11th ed. 2007 at 308), the court said "customer" means "one that purchases a commodity or service." According to the Fourth Circuit, other federal courts agree that "customer" goes beyond investment and brokerage service clients. But the court refused to limit "customer" under the Eighth Circuit's Fleet Boston decision, as urged by UBS and Citigroup, because that case suggested "customer" may include persons who receive services more closely allied with investment banking and securities businesses than were the services at issue in that case.

The court also rejected a claim by UBS and Citigroup that Carilion should not be a "customer" under FINRA rules because this finding would conflict with Carilion's MSRB status. Likewise, the court said the definition of "customer" in Carilion's brokerage agreements with UBS and Citigroup did not limit the term to those who bought Carilion's bonds. Holding that Carilion was a "customer," said the court, also would not offend FINRA's investor protection goals.

Forum selection not waiver. The Fourth Circuit held that Carilion's agreement to a forum selection clause in brokerage contracts with UBS and Citigroup did not waive its arbitration rights. The court said that although FINRA Rule 12200 rights can be waived, Carilion's brokerage contracts waived only the right to jury trial in any "litigation," which must be pursued in the New York City federal court. No language in these contracts hinted that Carilion's FINRA arbitration rights were superseded.

The case is No. 12-2066.

Attorneys: Edward Everett Bagnell, Jr. (Spotts Fain, P.C.), Jay Cohen (Paul, Weiss, Rifkind, Wharton & Garrision L.L.C.) and Jonathan K. Youngwood, Esq. (Simpson Thacher & Bartlett, L.L.P.) for UBS Financial Services, Inc. and Citigroup Global Markets Inc. Jason Burge (Fishman Haygood Phelps Walmsley & Swanson L.L.P.) and Patrick Thomas Fennell (Crandall & Katt) for Carilion Clinic.

Companies: USB Financial Services, Inc.; Citigroup Global Markets Inc.; Carilion Clinic

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