City of Pasadena Wins Right to Arbitrate Auction Rate Securities Case Against UBS


A number of cities and local governments that issued auction rate securities at low interest rates are now paying higher interest rates because of widespread auction failures that began occurring in early 2008. Some of them have filed arbitration claims against the Wall Street banks that recommended the issuance of auction rate securities, underwrote them, and acted as broker-dealers in administering the auctions. They allege that the banks misled them by failing to disclose their role in supporting the auctions in the absence of a sufficient number of bidders. Many banks that had established a course of entering supporting bids began allowing auctions to fail in early 2008. When auctions failed, the issuing municipality’s interest rate reset at default rates as high as 20 percent, pursuant to the terms of the bond.

In one such case, the City of Pasadena filed an arbitration claim with the Financial Industry Regulatory Authority (FINRA) against UBS Financial Services. Pasadena alleged that UBS recommended the use of auction rate securities to refinance its debt and raise funds for various projects, but omitted to disclose that UBS typically entered supporting bids in the auctions to keep interest rates low, and that the success of the auctions was dependent upon that support. When UBS withdrew its support, the auctions failed and the interest rates reset at the higher default rate.

Rather than answering Pasadena’s claim in arbitration, UBS went to court and filed a petition asking the court to declare that Pasadena could not arbitrate against UBS on the ground that it was not a customer of UBS ? essentially arguing that FINRA had no jurisdiction. U.S. District Judge R. Gary Klausner denied UBS’s petition, holding that UBS had not made a sufficient showing that Pasadena was not its customer, and was unlikely to prevail on the merits of that claim. See Order Re: Plaintiffs’ Motion for Preliminary Injunction, Document 24, UBS Financial Services Inc. v. City of Pasadena, Case No. 2:12cv-05019-RGK-JC, United States District Court, Central District of California (July 31, 2012).

As this case and others like it proceed through FINRA arbitration, other municipalities that were similarly misled are likely to follow suit and seek recovery of their losses.

In addition, banks sold as much as $500 billion of interest rate swaps to municipal bond issuers as a way to further lower their interest payments. Municipalities paid billions of dollars to buy their way out of these swaps when interest rates turned against them. Their Wall Street counterparties, on the other hand, made out like bandits, receiving hundreds of millions of dollars in fees.

Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.