Citi to Buy Back $7.3 Billion of Bonds
Settlement Aims to Help Customers Unload Auction-Rate Securities

By Heather Landy
Special to The Washington Post
Friday, August 8, 2008

NEW YORK, Aug. 7 -- Citigroup agreed Thursday to buy back $7.3 billion of bonds from retail and small-business customers who got stuck holding the debt when the market for so-called auction-rate securities melted down in February.

The offer, part of a settlement announced by New York State Attorney General Andrew M. Cuomo, will be extended over the next three months to 40,000 individual, nonprofit and small- and medium-size business customers. The bank also agreed to work with larger customers, including retirement plans and other institutional investors, to help them unload $12 billion of auction-rate debt.

Demand for the bonds, sold as often as once a week at auctions that would determine their interest rates, evaporated earlier this year during the broader credit crunch, leaving investors unable to cash in their holdings. Cuomo last week threatened to sue Citigroup, alleging that the company defrauded investors by marketing auction-rate bonds as safe, cash-like instruments.

"It turns out they were anything but," Cuomo said at a news conference announcing the settlement between Citigroup and regulators from several states, along with the Securities and Exchange Commission.

Under the settlement, Citigroup neither admitted nor denied wrongdoing but agreed to pay $100 million in civil penalties.

Cuomo said regulatory investigations into the role of other Wall Street dealers in the auction-rate securities market would continue. Cuomo's office last month sued the Swiss bank UBS over allegations that it defrauded customers of auction-rate securities.

"We are proceeding" with the investigations, Cuomo said. "Citibank was one of the largest firms in this business but certainly not the only firm."

Citigroup had been the primary dealer on $72 billion of auction-rate securities before the market collapsed. As of June 30, the bank's auction-rate program had shrunk to $48 billion, according to regulatory documents filed last week.

As part of its settlement, Citigroup will consent to a public arbitration process to resolve claims from customers who sold their auction-rate holdings at a discount following the market crisis and refund refinancing costs incurred after the meltdown by municipalities that issued auction-rate bonds through the bank in the past year.

The bank has three months to complete the securities repurchases from retail and small-business customers who cannot sell the bonds at auction. In the meantime, Citigroup will allow those customers to borrow amounts equal to their auction-rate securities holdings should they need the cash.

"Since the beginning of the auction-rate securities crisis, Citi has worked diligently with issuers, investors, and regulatory authorities to obtain liquidity for holders of illiquid auction-rate securities," Citigroup said in a statement about the settlement. "We remain committed to continuing our work on initiatives that will secure the best and fastest route to providing liquidity to our clients."

Citigroup estimated that the $7.3 billion of bonds eligible for repurchase are currently worth about $500 million less than their collective face amounts, implying a market value of about 93 cents on the dollar. The impact of bringing those bonds onto Citigroup's balance sheet "is expected to be de minimis," the company said.

The bank still must help restore liquidity for more than 2,600 institutional customers holding about $12 billion of auction-rate debt. Under the terms of the settlement, Cuomo is giving Citigroup three months to show it has made sufficient headway in that effort. After that, he could pursue additional legal action.

Federal regulators will wait until the end of 2009 before imposing any potential penalties on Citigroup as it works out arrangements with its larger customers.

"We think this provides an incentive for Citigroup to continue to work on the institutional problem," Fredric Firestone, an associate director in the SEC's division of enforcement, said at the news conference here.

Cuomo repeatedly argued Thursday that the breakdown in the auction-rate securities market was just as much a "Main Street" problem as a "Wall Street" problem.

"This is not an abstract financial issue," he said. "These are real people, and the denominations [in which dealers] sold auction-rate securities dropped over time so relatively small investors" could participate in the market.

Separately Thursday, Merrill Lynch offered to buy back auction-rate securities from retail customers for a one-year period beginning in January.

"Our clients have been caught in an unprecedented liquidity crisis," Merrill chief executive John Thain said in a statement. "We are solving it by giving them the option of selling their positions to us."

Merrill was sued last month by the top securities regulator in Massachusetts, who made allegations similar to those that Cuomo pursued against Citigroup.

Merrill's retail clients hold about $12 billion of auction-rate securities. That balance should fall to less than $10 billion by the time the repurchase offers are extended next year, as a result of expected redemptions by issuers, the firm said. The company does not expect the repurchases to have a material impact on its financials.

Robert Heim, a former SEC assistant regional director in New York, said the settlement with Citigroup could put additional pressure on UBS to settle with Cuomo.

"The investment-management business is very competitive, and customers will look to see which [firms] are more friendly toward investors and possibly more compliant with regulators' requests and concerns," said Heim, now a partner in the New York law firm Meyers & Heim.

UBS last month said it was developing a system to buy back as much as $3.5 billion of auction-rate preferred stock -- shares with dividends that are reset weekly or monthly -- from advisory and brokerage clients who have been unable to sell the securities because of the failed auctions.

UBS was sued less than two weeks later by Cuomo, who alleged that as the market showed signs of trouble, the firm continued to tell clients the securities were safe investments even as several UBS officials dumped the securities from their personal accounts.

In a statement after the announcement of the Citigroup settlement, UBS said it was "consistently working with regulators toward a comprehensive solution for all auction-rate securities investors."

A UBS spokesman declined to comment further.

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