Thursday, August 7, 2008
Citigroup Global Markets, Inc. (Citi) has agreed to a preliminary settlement in principle with the SEC and state regulators, including 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.
The SEC Division of Enforcement set forth the terms of the agreement in principle in its press release. They 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.
In addition, in its press release announcing the settlement, the New York Attorney General stated that Citi 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. Citi will also 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. (Here is NASAA's press release about the settlement.)
In addition, FINRA announced today that it has established a special process for resolving ARS-based claims in its arbitration forum. Qualifying investors will have the option of having their claims heard by a three-person panel of arbitrators, none of whom would be affiliated with a firm that recently sold auction rate securities. The new process comes as a result of the one developed by FINRA for the Securities and Exchange Commission's settlement with Citigroup.
The arbitration panels will continue to consist of two public arbitrators and one non-public arbitrator.
To date, more than 170 cases involving auction rate securities have been filed in FINRA's Dispute Resolution forum. Individuals who since Jan. 1, 2005, have either worked for a firm that sold auction rate securities or themselves sold or supervised someone who sold them will not appear on non-public arbitrator lists given to parties in these and future auction rate securities arbitration cases.