Citigroup Inc.’s (C) officers and directors (including Chief Executive Officer Vikram Pandit) won the dismissal of a lawsuit claiming they breached their duty to the bank by manipulating the market for auction-rate securities (ARS).

On Sep 10, U.S. District Judge Laura Taylor Swain in New York dismissed the derivative lawsuit on procedural grounds because the plaintiffs failed to ask the bank to bring the case itself. She gave the plaintiffs an opportunity to file a new complaint.

In a derivative lawsuit, shareholders seek to recover damages from the company instead of being paid to individual shareholders. Damages would be sought from executives or board members. The judge’s written ruling said the pension fund could file an amended complaint by Oct 1, but failure to do so would result in a judgment dismissing the complaint.

Plaintiffs led by the Louisiana Municipal Police Employees Retirement System claimed that Citigroup was exposed to billions of dollars in settlements, fines and lost business after the defendants rigged the market in ARS to hide the lack of liquidity. The defendants included board members Michael Armstrong and former Chairman Win Bischoff.

ARS are debt instruments whose rates are reset in periodic auctions. The credit crisis of 2007 put increasing pressure on the ARS market and by February 2008 the $330 billion market collapsed after brokerages stopped supporting the auctions.

A number of brokerage firms including Citigroup, UBS AG (UBS), Credit Suisse Group AG (CS), Goldman Sachs Group Inc. (GS) have already agreed to buy back tens of billions of dollars in securities from investors after investigators found they didn’t properly inform clients about the risks, or that the market was crumbling, increasing their losses.

In Aug 2008, Citigroup was the first firm that agreed to buy $7.3 billion of the debt from individual investors and pay $100 million in fines. The bank also pledged to help 2,600 institutional customers unload $12 billion of securities. In Oct 2008, Bank of America Corporation (BAC) settled with regulators and agreed to buy back $4.5 billion in securities from its clients.

Citigroup will release its third quarter 2009 earnings on Oct 15, 2009 with a conference call scheduled later in the day to discuss its results. Ahead of its results, we maintain our Neutral recommendation on the stock.
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