In a decision with potentially far-reaching importance for the scope of permissible arbitrations in FINRA’s dispute resolution forum, the Second Circuit held yesterday that an issuer who purchases auction-facilitating services for its auction rate securities from a broker-dealer is a “customer” of that broker-dealer within the meaning of FINRA Rule 12200.  See UBS Financial Services Inc. v. West Virginia University Hospitals Inc., Docket No. 11-235-cv (Sept. 22, 2011).  (The court also decided that FINRA arbitrators should decide the enforceability of a forum selection clause in the parties’ arbitration agreement.)  This was a closely-watched case in the securities arbitration world, as both the Public Investors Arbitration Bar Association and the Securities Industry and Financial Markets Association filed amici briefs. 

WVUH is a not-for-profit health consortium that issues bonds to finance capital improvements and other needs.  In the 2000s, it issued several bond offerings (totaling $329 million) structued as auction-rate securities (ARS), where the bonds’ interest rate is set by periodic Dutch auction.  UBS Financial Services served as both the lead underwriter and the broker-dealer responsible for setting up the auctions.  After the market for ARS collapsed in 2008, WVUH filed a FINRA arbitration claim against UBS alleging fraud in connection with its disclosures about the ARS market.

UBS took the position that WVUH was not its customer under FINRA Rule 12200, and thus it did not have to submit to arbitration on these claims.  It sought an injunction from the district court, which was denied.  On appeal, the Second Circuit affirmed, and construed FINRA’s Rule 12200 broadly, as it held that a “customer” is not limited to an investor utilizing investment or brokerage services of a broker-dealer, but includes any entity that purchases any services from the broker-dealer.

This decision opens the door to other disputants who have business relationships with FINRA member firms that are not necessarily investment or brokerage relationships to pursue claims arising out of their relationship in FINRA arbitration.