Outlook Series | Citigroup Makes Auction Rate Securities Settlement

Citigroup Makes Auction Rate Securities Settlement

Aug. 7, 2008

The Securities and Exchange Commission's Division of Enforcement has reached a preliminary settlement in principle with Citigroup Global Markets including proposed charges and a plan that would give individual investors, small businesses, and charities all $7.5 billion of their money back from auction rate securities (ARS) they purchased from the firm. The agreement also would require Citi to use its best efforts to liquidate by the end of 2009 all of the approximately $12 billion worth of ARS the firm sold to retirement plans and other institutional investors.

The ARS market collapsed in mid-February 2008, leaving tens of thousands of Citi customers holding nearly $20 billion of these illiquid securities for an indefinite period of time. The conduct underlying the proposed charges stems from Citi's marketing of ARS to many of its customers as highly liquid investments, including as money market investments. The liquidity of these securities, however, was premised on Citi providing support bids for auctions it managed when there was not enough customer demand. When Citi stopped supporting auctions in February 2008, there were widespread auction failures. As a result, thousands of Citi customers were left holding illiquid securities.

Linda Chatman Thomsen, Director of the SEC's Division of Enforcement, said, "Today's agreement in principle provides real relief to investors. In a short period of time, about 38,000 individual, small business, and charitable organization investor accounts will receive nearly $7.5 billion in liquidity, and Citi will begin the process of restoring liquidity to over 2,600 institutional investors who hold approximately $12 billion in auction rate securities. This settlement in principle is an outstanding example of federal and state regulatory cooperation for the benefit of investors and markets."

The terms of the agreement in principle, which are subject to finalization, review and approval by the Commission:

Citi will be permanently enjoined from violating the provisions of Section 15(c) of the Exchange Act, and Rule 15c1-2 thereunder, which prohibit the use of manipulative or deceptive devices by broker-dealers.
Citi will liquidate at par all ARS from its retail customers, which include all natural persons, charities, and small businesses, no later than three months from today.
Citi will make whole any losses sustained by customers who purchased ARS before Feb. 12, 2008, and sold such securities after that date at a loss.
Citi will use its best efforts to liquidate ARS from its institutional customers by the end of 2009.
Until Citi actually provides for the liquidation of the securities on the schedule set forth above, Citi will provide no-cost loans to customers that will remain outstanding until the ARS are repurchased, and will reimburse customers for any interest costs incurred under any prior loan programs the firm provided to its ARS customers.
Citi will not liquidate its own inventory of a particular ARS before it liquidates its customers' holding in that security.
To the extent that a customer has incurred consequential damages beyond the loss of liquidity in the customer's holdings of ARS (which should be restored pursuant to the settlement terms above), Citi will participate in a special arbitration process that the customer may elect, and that will be overseen by FINRA, whereby Citi will not contest liability for its misrepresentations and omissions concerning the ARS, but may challenge the existence or amount of any consequential damages; the arbitration claim will be heard by a single, non-industry arbitrator.
This arbitration process will be voluntary on the part of the customer and if a customer elects not to take advantage of these special procedures, a customer may pursue all other arbitration or legal or equitable remedies available through any other administrative or judicial process available to the customer.
Citi will provide notice to all customers of the settlement terms.
Citi will establish a telephone assistance line, with appropriate staffing, to respond to questions from customers concerning the terms of the settlement.
Citi faces the prospect of a financial penalty to the SEC after it has completed its obligations under the settlement agreement. Determinations as to the amount of the penalty, if any, will take into account, among other things, an assessment of whether Citi has satisfactorily completed its obligations under the settlement, and the costs incurred by Citi in meeting those obligations, including penalties incurred and the cost of remediation.

The Commission notes the substantial assistance and cooperation from the New York Attorney General, the Financial Industry Regulatory Authority (FINRA), the North American Securities Administrators Association (NASAA), and Texas securities authorities.

Attorney General Cuomo hailed the agreement as a turning point for investors nationwide seeking relief from the collapse of the auction rate securities market.

“Today’s settlement sends a resounding message to the entire auction rate securities industry: This type of deceptive behavior will not be tolerated and we will actively seek justice on behalf of investors in auction rate securities,” said Attorney General Cuomo. “Our goal is simple: to get investors back their money, and that’s exactly what this deal does.”

Under Cuomo’s settlement, Citigroup has agreed to buy back, no later than November 5, 2008, all illiquid auction rate securities from all Citigroup retail customers, charities, and small to mid-sized businesses. These customers, who number approximately 40,000 nationwide, have been unable to sell their securities since February 12, 2008. Their securities are worth more than $7 billion.

Citigroup will also:

fully reimburse all retail investors who sold their auction rate securities at a discount after the market failed;
consent to a special, public arbitration process to resolve claims of consequential damages suffered by retail investors as a result of not being able to access their funds;
undertake to expeditiously provide liquidity solutions to all other institutional investors; and
reimburse all refinancing fees to any New York State municipal issuer who issued auction rate securities through Citigroup since August 1, 2007.

In addition, Citigroup will pay to the State of New York a civil penalty in the amount of $50 million. The penalty embraces both Citigroup’s substantive conduct and its failure to properly comply with its obligations under the Attorney General’s Martin Act subpoena.

Citigroup will pay a separate civil penalty of $50 million to the North American Securities Administrators Association (“NASAA”), whose ARS Task Force has been conducting its own series of investigations into the marketing and sale of auction rate securities by broker-dealer firms. The ARS Task Force’s investigation of Citigroup was led by the Texas State Securities Board.