Citigroup Global Markets Inc., which merged with Legg Mason Wood Walker Inc., in late 2005, has agreed to pay a civil penalty of $200,000 to settle Securities and Exchange Commission charges that Legg Mason engaged in undisclosed auction-rate securities practices in the municipal market that may have affected investors’ returns.
The settlement, which the SEC announced yesterday, follows by almost one year the commission’s $13 million global settlement with 15 broker-dealer firms over similar charges in the $200 billion-plus municipal, corporate, and preferred stock auction-rate securities markets. Citigroup was one of the firms in the global settlement, agreeing to pay $1.5 million to settle the charges.
SEC officials said yesterday that Citigroup’s civil penalty might have been only $125,000 if Legg Mason had reported its alleged abuses at the same time as the other firms. Instead, the officials said, Legg Mason reported them after the other firms.
The auction-rate securities in the case of Legg Mason were most, if not all, municipal, SEC officials said.
A Citigroup spokesman said yesterday: “This settlement, which closes this issue, involves a legacy [Legg Mason] matter, which Citigroup inherited through its merger in 2005. We are committed to ensuring our auction practices meet the highest industry standards and believe in the appropriateness of the practices on our desk.”
According to the commission, Legg Mason, from at least Jan. 1, 2003, through June 30, 2004, intervened in auctions for the securities by bidding for its own proprietary account without disclosing to issuers or investors that it was doing so. The firm’s goal was to prevent the auctions from failing, in which case the issuer would have had to pay an above-market rate set by a predetermined formula.
But the SEC said that Legg Mason’s actions in some cases affected the clearing rate — the rate that determines the interest rate or yield the issuer must pay to investors until the next auction. The clearing rate is typically the lowest rate bid sufficient to cover all of the securities for sale in the auction. The SEC said Legg Mason’s bidding in some cases lowered the clearing rate and the return that investors received on their investments. Also, because Legg Mason was under no obligation to guarantee against a failed auction, investors may not have been aware of the associated liquidity and credit risks, the SEC said.
In the settlement agreement, the SEC said that the civil penalty imposed on Citigroup was based on the cooperation that Legg Mason afforded the commission staff, and Legg Mason’s “relatively small share of the auction-rate securities markets,” as well as the fact that the firm reported the alleged abuses to the SEC later than other broker-dealers.
Auction-rate securities are municipal bonds, corporate bonds, or preferred stocks with interest rates or dividend yields that are periodically re-set through auctions.
Issuers often use auction-rate securities as an alternative to variable-rate bond financing and investors use them as an alternative to money market funds.
Auction rate securities are auctioned at par so the return on the investment to the investor and the cost of the financing to the issuer between auction dates is determined by the interest rate set through the auctions. One or more broker-dealers underwrite, and manage an auction. The issuer hires an auction agent, typically a bank, to collect the orders and determine the clearing rate for the auction.
In an auction, investors can submit “hold” orders to keep their securities at the rate at which the auction clears; “hold-at-rate” orders to keep the securities at the clearing rate or above a specified rate; “sell” orders to sell the securities regardless of the clearing rate; and “buy” bids to buy the securities at the clearing rate or above a specified rate.”
If all of the holders of the securities choose to hold their positions without bidding a particular rate, then the clearing rate is the all-hold rate, a below-market rate set by a pre-determined formula. If there are not enough bids to cover the securities for sale, then the auction fails.
In its global settlement with the 15 firms, the SEC charged the firms with a number of undisclosed auction-rate securities practices besides intervening in auctions, including: submitting or changing orders after auction deadlines; prioritizing customers’ bids to increase the likelihood that their bids would be filled; and engaging in “price talk” that provided certain customers with information that gave them an advantage over other customers in determining what rate to bid.
