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August 7, 2008 1:24 PM

Citigroup In Landmark Auction-Rate Securities Settlement

Posted by Julie Triedman

Citigroup, Inc., has agreed to buy back more than $7 billion in frozen auction-rate securities from its customers and to pay some $100 million in civil penalties to settle state and federal regulators' claims that it misled clients about the risks of the financial products, New York State attorney general Andrew Cuomo announced this morning. Some 40,000 customers nationwide bought the securities, which have largely been untradable since mid-February; the bank has until November 5 of this year to buy back the securities from its retail and midsize customers.

Citi's lead counsel in the auction-rate securities matter, as Andrew Longstreth reported in Monday's Am Law Litigation Daily, is Brad Karp, newly elected chair of Paul, Weiss, Rifkind, Wharton & Garrison (he steps into the job in January). Citi has also looked to Harry Weiss, cochair of Wilmer's securities enforcement and securities litigation practice groups. Neither was available for immediate comment, though we suspect Citi looked to Weiss, a former associate director of the Securities and Exchange Commission's division of enforcement, for leadership in SEC negotiations.

Of the penalties, some $50 million will go to New York. Assistant attorneys general Vicki Andreadis, Peter Dean, and Armen Morian conducted the Citigroup investigation along with Kitty Kay Chan, economist for the Division of Economic Justice, all under the supervision of David Markowitz, chief of the Investor Protection Bureau, and Eric Corngold, executive deputy attorney general for economic justice. A separate $50 million penalty will be divided among 11 other states, according to the North American Securities Administrators Association (NASAA).

Texas's State Securities Board also reportedly played a leading a role in the agreement on behalf of 11 other states. Among the lawyers leading the charge for Texas are Benette Zivley, director of the State Securities Board's inspection and compliance division; and Denise Voigt Crawford, the longtime commissioner. For the NASAA, Bryan Lantagne, director of the Massachusetts Securities Division, chaired a task force on the matter.

Some $330 billion of the securities have been frozen since the market collapsed in February. Now UBS AG, the largest Swiss bank and a major player in the market, is in talks with three states, including New York, Texas, and Massachusetts, as well as with the SEC, according to a Bloomberg report. Merrill Lynch also faces civil fraud charges lodged by several states. "What we're seeing here is just the tip of the iceberg,'' Jill Fisch, a law professor at the University of Pennsylvania, told Bloomberg. "From Citigroup's perspective, it's good to try to get this resolved instead of it being drawn out through litigation.''

The collapse occurred when the large financial houses such as Citigroup decided not to step in as buyers of last resort. The securities were typically sold to institutions and municipalities as safe short-term investments or as "cash equivalents," but are underlaid by long-term debt. The securities' interest rates are reset via periodic bidding.

In addition to the buyback and penalties, Citi also has consented to a special public arbitration process to resolve claims related to the stalled market, and to undertake to negotiate a settlement with its larger institutional investors, who are not part of this buyback. Retail investors included in the buyback include those who bought up to $10 million worth of the securities and all charities, regardless of the size of their holdings.

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