Auction rate securities cases have spawned a new arbitration procedure that relies on a single public arbitrator to hear cases brought by investors who allege "consequential damage" claims from ARS.
Those are damages caused by not having access to their funds.
In settlements this month with regulators, the brokerage units of Citigroup Inc. of New York and UBS AG of Zurich, Switzerland, agreed to participate in this special arbitration procedure for their ARS investors. Last week, without settling with regulators, Morgan Stanley of New York said that it too would participate.
Significantly, under the special arbitration program, firms have agreed not to contest their liability.
They could, however, argue that investors haven't suffered consequential damages. The firms will also pay all forum fees.
"For example, if an investor had money tied up in ARS and had been trying to purchase a home and their down payment was locked up and they suffered some finan- cial damage as a result, those damages will be addressed" in the special procedure, said Karen Tyler, North Dakota securities commissioner in Bismarck and president of the North American Securities Administrators Association Inc. of Washington.
State regulators have been instrumental in developing and settling the ARS cases.
Observers said that business owners may also have valid consequential-damage claims. Furthermore, some investors haven't been receiving interest on auction rate securities backed by student loans.
Under the settlements, investors at UBS and Citigroup's Smith Barney brokerage unit who have sold auction rate securities at less than par would be made whole. Morgan Stanley made the same offer to its clients.
The special ARS process will be overseen by the Financial Industry Regulatory Authority Inc. of New York and Washington.
More firms could soon be participating in the special hearing process.
Last week, New York Attorney General Andrew Cuomo demanded that JPMorgan Chase & Co. of New York and Wachovia Corp. of Charlotte, N.C., negotiate similar settlements over ARS sales.
He was one of the regulators who settled with Citigroup and UBS.
NO DENIALS
Proving consequential damages can be difficult, but it is "fairly remarkable that [UBS and Citigroup are] not allowed to deny wrongdoing," said Sam Edwards, a partner at Shepherd Smith Edwards & Kantas LLP in Houston, whose firm represents about two dozen ARS claim-ants. As a result, "all we're [going to be doing in a hearing] is fighting over damages," he said.
In another development, Finra said this month that it would set up a unique arbitrator selection process so that the case of any investor with an ARS-related claim could be heard by arbitrators not affiliated with a firm that recently sold such securities.
The arbitration panels will still have the usual makeup — one industry or "non-public" arbitrator and two public arbitrators.
Finra's move addresses a longstanding criticism from the plaintiff's bar that industry arbitrators who work for firms that sell products involved in an investor claim shouldn't hear the case.
In a move unrelated to ARS cases, Finra said last month that it would begin a two-year pilot program in October allowing some investor plaintiffs to use a panel made up of three public arbitrators. The pilot is for investor claimants in general, not just ARS clients.
The firms that are participating in the pilot include Charles Schwab & Co. Inc. of San Francisco, Citigroup, Merrill Lynch & Co. Inc. of New York, Morgan Stanley, UBS and Wachovia Securities LLC of St. Louis.
The plaintiff's bar and state regulators have been pushing for several years to eliminate the use of industry arbitrators.
"We're watching what happens" with the pilot, said Lisa J. Roth, chief executive of Keystone Capital Corp. and chairman of the National Association of Independent Broker/Dealers Inc., both in San Diego. The NAIBD supports the use of industry arbitrators.
"Many of our members are [in-dustry] arbitrators," Ms. Roth said. Industry panelists add expertise to a panel, she said.
"We're more than capable of rendering an objective decision," Ms. Roth said.
If panels have no industry members, why not just go to court in-stead? "It's easier to teach a judge [about the securities industry] than a retired accountant from Kansas," said John Busacca, owner of the Broker Dealer Exchange LLC and one of the founders of the Securities Industry Professional Association, which represents firms and registered representatives. Both entities are based in Orlando, Fla.
The SIPA recently sent out a regulatory alert about the Finra pilot program, and many recipients have expressed concerns, Mr. Busacca said.
Most industry interests, including the Securities Industry and Financial Markets Association of New York and Washington, support arbitration and see Finra's pilot program as a way to head off even more-dramatic changes in the arbitration system.
Bills that would ban mandatory pre-dispute arbitration contracts used with employees and consumers are pending in both the House and Senate.
E-mail Dan Jamieson at [email protected].
