Citigroup Inc. agreed Thursday to buy back about $7.5 billion in auction-rate securities as part of its settlement over regulators' accusations that it marketed the bonds in a misleading manner.
Regulators say that Citigroup, the nation's largest bank by assets, didn't accurately represent the risks of those securities to investors. Similar investigations are under way against other banks, regulators said, though they declined to provide other details.
Still, the settlements could be a harbinger for what to expect if other banks settle with regulators over auction-rate practices. The bonds are a headache for many big banks, including UBS, HSBC and Merrill Lynch – which announced Thursday evening that it would buy back some of the auction-rate securities it issued.
Bank of America Corp. and Wachovia Corp. face lawsuits and inquiries.
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Thursday, Bank of America said in a regulatory filing that it has “received subpoenas and requests for information from various state and federal governmental agencies” over auction-rate securities. It also noted that four class actions – three in California, one in Illinois – have been filed against it since May.
“Bank of America has been fully cooperating with regulators' requests for information about auction rate securities, and we expect to continue to work with the appropriate agencies throughout this process,” said spokeswoman Shirley Norton.
Wachovia said in May that it has received inquiries and subpoenas from the Securities and Exchange Commission and several state regulators over auction-rate securities. Thursday, it emphasized that auction-rate problems affect much of the industry.
“Many securities firms, including Wachovia, continue to respond and cooperate with state regulators about the auction-rate securities market,” spokeswoman Christy Phillips-Brown said.
Auction-rate securities are bonds with interest rates that reset periodically – usually every seven, 28 or 35 days. They can be issued by municipalities, hospitals, student-loan companies and other special entities.
Some financial advisers say they were viewed as safe and stable for years. But that ended abruptly in February, when the country's banks, buffeted by tight credit, stopped submitting the bids that reset those interest rates. Investors were left holding bonds they couldn't sell, which meant they couldn't access their principal.
The problem, regulators say, is that some banks led investors to believe that these bonds were as liquid as cash.
Bank of America and Wachovia have said they're working with customers affected by the freezing of the market. Wachovia's Phillips-Brown said the bank is “examining a number of options designed to return liquidity to our clients as quickly as possible.”
Citigroup did not admit or deny wrongdoing in its Thursday settlements with the SEC, the New York Attorney General's Office, and the North American Securities Administrators Association (NASAA). The settlements carry numerous stipulations for Citigroup, which accounts for about 20 percent of the $300 billion auction-rate market.
Among the terms of the agreement, Citigroup will, within three months, buy back about $7.5 billion in auction-rate securities issued to 38,000 retail investors, which encompasses individuals, small businesses and charities. In addition, it will attempt to restore liquidity to 2,600 institutional investors, who hold $12 billion in auction rates, by the end of 2009.
It will also reimburse retail investors who sold their auction rates at a discount after the market failed, and it cannot liquidate its own auction-rate inventories before it liquidates its customers' holdings. It must notify customers of the settlement and set up a phone line to answer their questions.
If customers have incurred other damages besides a loss of liquidity, they can participate in arbitration overseen by the Financial Industry Regulatory Authority. In those cases, Citi cannot contest its liability.
The bank will pay $50 million to both the New York Attorney General's Office and NASAA. It could face an extra fine from the SEC if it doesn't comply with the settlement.
“‘Highly liquid,' ‘cash equivalent,' ‘money markets' – those are the kinds of phrases that come to mind,” said Linda Thomsen, director of the SEC's division of enforcement, describing what Citigroup investors were purportedly told about the bonds.
Citigroup said it is pleased by the settlement. “Our most important focus continues to be on helping our clients,” the bank said in a statement.
Thomsen, speaking to reporters in Washington, D.C., was asked if the Citigroup settlement would serve as a model for other auction-rate settlements. “The model is to try to do as best as we can to protect investors,” she replied.