Citigroup Pays Billions In Auction Rate Scandal
The nation’s largest bank, Citigroup, is the first Wall Street firm to plead a deal with federal and state regulators over claims of fraudulently marketing and selling auction rate securities to investors.
Under a settlement with New York State Attorney General Andrew Cuomo and the Securities and Exchange Commission (SEC), Citigroup will buy back approximately $7.3 billion of the illiquid securities from individual investors, charities and businesses with assets of less than $10 million, as well as pay a hefty fine of $100 million. Of that amount, $50 million is civil penalty to New York State, with a separate $50 million civil penalty to the North American Securities Administrators Association (NASAA).
The deal requires Citigroup to purchase the auction rate bonds by the end of February 2009.
Earlier this month, Cuomo and the SEC accused Citigroup of deceiving as many as 40,000 investors by downplaying the risks of auction securities during a time when the auction market was nearing collapse.
Auction rate securities are long-term, interest-bearing bonds issued by municipalities, student loan companies and others. Interest rates on the securities reset at weekly or monthly auctions, where existing investors can sell their auction bonds. In February, however, the $330 billion auction market essentially froze when Wall Street investment banks abandoned their role as a buyer of the securities. As a result, millions of investors were stuck with illiquid securities.
Citigroup is the largest underwriter of auction rate debt.
The decision to buy back the auction securities from investors follows a dismal second quarter for Citigroup, which recorded a $2.5 billion loss because of write downs on subprime mortgages and other risky debt totaling $12 billion. As of last year, the bank has incurred more than $58 billion of write downs and credit losses.
As part of its settlement agreement, Citigroup also must use its “best efforts†to help some 2,600 institutional investors sell roughly $12 billion of the frozen instruments they hold.
For months, state and federal regulators have intensified their probes of Wall Street firms over alleged wrongdoings in the auction rate market. Only hours after the Citigroup settlement was announced, Merrill Lynch - also a target of several investigations - agreed to buy back an estimated $10 billion of auction securities at full value beginning in January. Merrill’s offer is good for one year and, like Citigroup’s agreement, does not apply to institutional clients.
As reported Aug. 8 in the New York Times, the exclusion of institutional investors in the agreements with Citigroup and Merrill Lynch - and potentially other banks to follow - may be a calculated move on the part of regulators in that these investors were sold riskier securities backed by the student loan and mortgage markets and banks may not have the ability to absorb those losses.
On the same day it was announced that Citigroup and Merrill Lynch reached deals to resolve their auction rate charges, Bank of America revealed it had received subpoenas from state and federal regulators regarding its auction-rate securities practices.
Other firms under the glare of scrutiny by state and federal regulators include UBS, Goldman Sachs, Lehman Brothers, JPMorgan Chase, Morgan Stanley and Wachovia Corporation.
Moving forward, if Citigroup follows through and fulfills its commitment to buy back $7.3 billion of auction rate securities from individual investors, it will unprecedented, and one of the largest amounts recovered to date from one company.
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