An Interesting Twist Where Broker-Dealer Seeks To Enjoin Customer From Arbitration In FINRA And Is Denied By The Second Circuit

An interesting case that securities arbitration attorneys should find ironic. In the case of UBS Financial Services, Inc. v. West Virginia University Hospitals, Inc., decided on September 22, 2011, the Second Circuit upheld the decision of the district court to dismiss a motion to enjoin arbitration in FINRA filed by a FINRA member, UBS, against its customer.

Although the more typical case involves a customer filing a securities fraud action in court, and having the defendant move to enforce an arbitration agreement, and remove the case to FINRA, in this recent case the tables were turned. Instead, it was the customer, West Virginia University Hospitals (WVUH) who wanted to bring an action against UBS in FINRA arbitration, and UBS fought tooth and nail to try to get it thrown out of arbitration and into court.

The case deals with auction rate securities (ARS), which UBS persuaded WVUH to use as the vehicle for a large financing project, where UBS would serve as both the underwriter and the broker-dealer in the auction services. Unknown to WVUH, UBS, as the broker-dealer, would place additional bids on all its auctions to make sure they did not fail, which concealed the true risks of liquidity of this made-up market which collapsed in February 2008 during the financial crisis. This collapse caused WVUH to have to pay much higher interests rates on the debt until it could refinance several months later.

Therefore, WVUH filed an arbitration Statement of Claim against UBS, alleging that UBS had violated the Securities Exchange Act of 1934 and the Uniform Securities Act by advising WVUH to issue ARS while withholding critical information about the ARS market and UBS’s role. Further, WVUH alleged that UBS fraudulently induced it to purchase auction services, while UBS withheld critical information about the ARS market and UBS’s role. Interestingly, in all the agreements between the parties there were no documents which contained an arbitration clause, and none referred to any provisions of the FINRA code.

UBS is a member of FINRA, and as such when it joined it agreed to comply with FINRA’s rules. One of those is Rule 12200 of the FINRA Code, which obligates UBS to arbitrate a dispute with a “customer” at the customer’s demand, if the dispute arises “in connection with” the business activities of the member. This is the rule WVUH used to initiate arbitration. UBS argued this rule did not apply because WVUH was not a “customer,” but the Second Circuit determined, as a matter of law, that WVUH was a customer of UBS when it served as a broker-dealer for the ARS auctions. The court further determined that a “customer” is a non-broker or non-dealer who purchases, or undertakes to purchase, a good or service from a FINRA member.

This case is interesting for all securities arbitration attorneys to note, because it turns the tables on the normal considerations in FINRA arbitration cases. Normally FINRA arbitration is seen as a shield for the broker-dealers, who invoke their arbitration clauses to stay away from the court. However, as this case demonstrates in certain instances customers who wish to can use this FINRA rule as a sword to compel a FINRA member into arbitration even without an arbitration agreement in place, if they so desire.