Goldman Fights Arbitration Over Municipal Bonds Debacle
SAN FRANCISCO — Multimillion-dollar disputes over the 2008 collapse of the auction rate securities market have split the federal courts.
The Fourth Circuit and a Minnesota judge have ruled for municipalities who want to arbitrate claims that investment banks rigged the market, while two New York district judges have sided with investment banks.
On Monday it appeared that split might run right through the Ninth Circuit as well, with Judge Jay Bybee sounding inclined to agree with Goldman Sachs & Co. that a forum selection clause requires the city of Reno's claims be heard in federal court — where they will likely be barred by the statute of limitations.
Judge Mary Schroeder, on the other hand, called Goldman's argument "rather astonishing," suggesting that FINRA arbitration is appropriate.
Sullivan & Cromwell partner Matthew Schwartz urged the court to quickly enjoin an arbitration over ill-fated auction rate securities. "We have an expedited appeal because FINRA arbitration is going on right now," said Schwartz, who represents Goldman.
But the likely outcome was cloudy. The third judge on the panel — U.S. District Judge Anthony Battaglia, visiting from San Diego — did not tip his hand, asking no questions.
The city of Reno issued $210 million in auction rate securities at Goldman Sachs' recommendation in 2005 and 2006. An auction rate security is a bond or other debt instrument with an interest rate that is regularly reset via auction.
Goldman Sachs structured Reno's securities — technically, fixed-rate synthetic debt issued as variable-rate refunding bonds with interest rate swaps. Reno alleges it paid Goldman 25 basis points — or more than $500,000 a year — to manage the auctions. But Goldman did not tell Reno that Goldman and other banks sometimes made support bids to prevent auctions from failing, Reno alleges. As the financial crisis gained momentum in 2008, Goldman stopped making support bids, causing the interest rate to skyrocket from 3.5 percent to 15 percent, Reno alleges. That forced Reno to refinance its bonds at extremely undesirable rates — and to pay Goldman Sachs about $8 million to "unwind" one of its interest rate swaps.
Reno filed an arbitration claim with the Financial Industry Regulatory Authority in 2012. Goldman sued to enjoin it, pointing to the forum selection clause in the parties' contract. It requires "all actions and proceedings" to be brought in Nevada federal court. U.S. District Judge Robert Jones denied the injunction.
"'All actions and proceedings' is all-inclusive," Sullivan & Cromwell's Schwartz argued Monday. "It includes arbitrations."
Judge Bybee appeared to agree, suggesting Reno had waived the right to arbitrate by agreeing to the forum selection clause. He said a Fourth Circuit opinion holding the opposite made no sense to him.
But Schroeder said the forum selection clause might merely have meant that any traditional litigation — or, perhaps, a motion to compel arbitration — would have to be in Nevada, rather than New York.
Representing Reno, James Swanson of New Orleans' Fishman Haygood Phelps Walmsley Willis & Swanson argued that FINRA rules require that members like Goldman Sachs arbitrate disputes with its customers. "If you're going to waive arbitration, the waiver has to be explicit," he argued.
In fact, Swanson said, FINRA rules prohibit members from seeking arbitration waivers. That seemed to stop Bybee in his tracks, who asked Swanson to repeat the argument twice.
On rebuttal, Schwartz accused Swanson of a sneak attack. "The reason I think that argument drew some blank stares from your honors is that argument is not before the court in this appeal," he said.
In any event, Reno was a sophisticated party with able counsel who should be held to the terms of the contract, he argued. "This is not an example of a small town not knowing what it's doing," said Schwartz, of S&C's New York office, adding that by "not small" he meant "relative to the rest of America."