Citi & UBS Must Submit|to FINRA Arbitration

(CN) - CitiGroup and UBS failed to persuade a federal judge to block arbitration of a Virginia hospital's claim that the banks propped up the auction rate securities market for years before the 2008 financial crisis.

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Carilion Clinic, a nonprofit healthcare organization with eight hospitals in western Virginia, sought financial advice in 2005 on how to raise fund to renovate and expand its hospitals.

On the recommendation of UBS Financial Services and CitiGroup Global Markets, Carilion issued $74.2 million in bonds and $234.2 million in auction rate securities.

Auction rate securities are bonds for which the interest rate is determined through a periodic auction. At auction, bond holders may hold or sell their shares to investors who indicate the minimum interest rate they will accept. The minimum interest rate at which all shares can be sold becomes the new interest rate. But if not all shares are sold, the auction fails, and the interest rate reverts to a predetermined maximum rate.

Carilion said UBS and Citi propped up the auction rate securities market by bidding in the auctions themselves to prevent auctions from failing. Fewer failed auctions would allegedly encourage security issuers to issue auction-rate securities and increase the banks' broker fees.

Carilion paid the banks more than $500,000 a year to administer the auctions.

However, the auction rate securities market collapsed in 2008 when UBS and Citi stopped bidding on auctions due to the global financial crisis. The clinic's interest rates on those securities increased substantially and it allegedly lost millions of dollars refinancing the debt.

The hospital claimed it was unaware that the banks had been propping up the auction rate securities market and would not have issued those securities had it known.

It filed an arbitration complaint in 2012 with the Financial Industry Regulatory Authority (FINRA), an independent regulatory agency for brokers, against UBS and Citi, which are members of the organization.

The banks sought an order blocking the case from being arbitrated by FINRA. U.S. District Judge John Gibney Jr. in Richmond, Va., denied their request, finding that Carilion was a customer and not just an issuer of securities, as the banks claimed.

"The specific question for this court is whether, given the various functions performed by UBS and Citi, Carilion is a customer under FINRA's rules. The plain meaning of the term 'customer' is generally understood to be 'one that purchases some commodity or service.' In this case, Carilion clearly paid UBS and Citi for a variety of financial services," Gibney wrote.

The banks also failed to convince him that they would be harmed by the FINRA arbitration.

"[T]he plaintiffs argue that they will incur unnecessary expense if they are forced to arbitrate Carilion's action before FINRA. ... Yet, UBS and Citi agreed to arbitrate disputes with their customers by virtue of their membership in FINRA. Having concluded that Carilion has a right to bring its claim in FINRA, any harm suffered by the plaintiffs is a result of their obligations under FINRA rules," Gibney wrote.

"Because arbitration is a 'highly favored mechanism for dispute resolution,' equity favors permitting Carilion's arbitration to proceed. In sum, the plaintiffs have failed to show that the balance of the equities decidedly tips in their favor," he concluded.

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