Citigroup Threatened with Auction Rate Securities LawsuitAug 5, 2008 | Parker Waichman LLP
Citigroup's auction rate securities business will likely be the next target of New York State Attorney General Andrew Cuomo. Cuomo has already sued investment bank UBS for its handling of auction rate securities, and last week threatened to take the same action against Citigroup.
Auction rate securities are long-term corporate bonds, municipal bonds and preferred stock on which the interest rates are reset periodically based on bids submitted through securities firms. Generally, rates are reset every seven, 14, 28 or 35 days. Because they can be sold during weekly or monthly auctions, banks and brokerages often touted auction rate securities as short-term investments or cash equivalents.
Unfortunately, because of the crisis in the credit markets, auctions of these securities haven’t been successful because of worries that bond insurers guaranteeing many of the $330 billion in outstanding auction bonds would be downgraded. Bloomberg.com has also reported that brokers such as Goldman Sachs Group Inc. and Citigroup Inc. also purposely permitted the auctions for preferred securities, which aren’t insured, to fail by not committing their own capital to sales when there weren’t enough bidders. As a result, the market for auction rate bonds has pretty much vanished, leaving a lot of investors holding auction rate securities they once thought were safe vehicles with no way to sell them.
According to The Wall Street Journal, Cuomo's office threatened to go after Citigroup for alleged fraud in the marketing and sales of auction-rate securities and for destroying evidence after being subpoenaed by his office. A lawsuit could be filed within weeks if the two sides don't reach a settlement.
In a letter written to Michael Sharp, general counsel of Citigroup's wealth-management arm by David Markowitz, the head of the investor-protection bureau in Cuomo's office, said its five-month probe showed the bank "committed fraud by making material misrepresentations and omissions" in its underwriting, distribution and sale of the securities. The letter accused the bank of wrongly telling customers the securities were safe, liquid and cash-equivalent. It added that the bank failed to tell investors that, from last August until earlier this year, the market was kept afloat only because the bank placed bids in auctions for the securities. Finally, it accuses Citigroup of violating state law by destroying "recordings of telephone conversations concerning the marketing, sale, distribution or auction" of the securities. According to The Wall Street Journal, the recordings requested by Cuomo's office in an April subpoena.
The letter demanded that Citigroup buy back the auction rate securities it sold, and compensate some investors for damages they have incurred. The letter also said that the Attorney General's office wants the firm to pay an unspecified penalty.
Meanwhile, David Aufhauser has resigned from UBS, the first executive of the investment bank to do so since Cuomo filed suit against it last Thursday. Aufhauser was General Counsel at UBS. According to sources interviewed by The Wall Street Journal, Auhauser was the "Executive A" referred to in Cuomo's lawsuit. According to that complaint, "Executive A" and others at UBS allegedly sold personal holdings of auction rate securities several months ago when they knew the market was falling apart, but did not warn UBS clients that the market was on the verge of collapse.