• Portfolio
  • Positions
  • Portfolio Summary
  • Account Summary
  • Activity Summary
  • Activity Detail
  • Gain/Loss
  • Account Download
  • Statements
  • Confirms
  • Watch List
• Research
  • Quotes/News/Research
  • Equity Research
  • Fixed Income Research
  • Market Commentaries
  • Investment Ideas
  • Special Reports
  • Marketwatch
  • Global Research
• Trading
  • Equities
  • Options
  • Mutual Funds
  • Fixed Income
  • Order Status
  • Trading Tour
• Payments & Transfers
  • FMA Bill Pay
  • FMA Automatic Funds Transfer
  • FMA Automatic Funds Transfer Status
• Tools
  • Equity Search
  • Fixed Income Search
  • Mutual Fund Search
  • Interactive Charting
  • Financial Planning Center (Calculators)
• Products
  • Equities & Options
  • Fixed Income
  • Mutual Funds
  • Managed Money
  • Annuities
  • Other Investments
  • Account Types
• Services
  • Planning
  • FMA Account
  • ThankYou Network
  • Credit Cards
  • Lending
  • Wealth Management
  • Private Business
  • Philanthropy
  • Investor Education
• My Access
  • My Accounts
  • User Settings
  • Wireless
  • E-Delivery
  • Alerts
  • Bookmarks
  • Account Management

Auction Rate Securities

Practices And Procedures Of Citigroup Global Markets Inc.

This document sets forth Citigroup Global Markets Inc. ("Citigroup")'s material practices and procedures in conducting auctions of auction rate securities ("ARS"). To help the reader put these practices and procedures in context, the document begins with a generic description of the ARS market and features. The reader familiar with ARS may go directly to section B for a description of Citigroup's role in auctions.

A. Overview of the Auction Rate Securities Market

General

ARS are municipal bonds, corporate bonds, and preferred stocks with interest rates or dividend yields that are periodically re-set through auctions, typically every 7, 14, 28, or 35 days. ARS are usually issued with stated intermediate to long-term maturities or in perpetuity; however, due to ARS's interest rate or dividend yield re-set feature, they are priced and traded as short-term instruments. ARS securities are typically of high-grade credit quality. Generally, ARS trade and are callable at par on the auction date and/or any interest payment date at the option of the issuer. Interest is paid in the current period based on the interest rate determined in the prior auction period. From an issuer's perspective, ARS are an alternative to other variable rate financing vehicles. ARS were first developed in 1984, and the ARS market has grown to well over $200 billion. Institutions and individuals participate in the ARS market. Typically, the minimum investment in ARS is $25,000.

ARS are auctioned at par and the return on the investment to the investor and the cost of financing to the issuer between auction dates is determined by the interest rate or dividend yield set through the auctions. The interest rate or dividend yield is set through an auction (commonly referred to as a "Dutch" auction) in which bids with successively higher rates are accepted until all of the securities in the auction are sold. The final rate at which all of the securities are sold is the "clearing rate" that applies to all of the securities in the auction until the next auction. The clearing rate is the lowest rate bid sufficient to cover all of the securities for sale in the auction.

Issuer's Role in Auction Process

The issuer of each ARS selects an auction agent, typically a commercial bank, (the "Auction Agent") to perform certain functions as discussed below.

The issuer of each ARS also selects one or more broker-dealers, to underwrite the offering and/or manage the auction process.

Broker-Dealer's Role in Auction Process

Broker-dealers for ARS securities manage the auction process. Investors can only submit orders to buy, hold or sell ARS through the broker-dealers selected by the issuer of a specific ARS. Such broker-dealers, in turn, submit all orders to the auction agent by the time specified in the auction procedures.

Types of Orders

The types of orders an investor can submit in an auction vary depending on whether the investor has already invested in that particular ARS (an "existing holder") or would like to make an investment in a new ARS (a "potential holder").

Existing Holders
Existing holders may submit to a broker-dealer hold orders, hold order at a rate, bid orders or sell orders.

If an existing holder fails to place an order, the holder will be deemed to have elected to continue to hold its ARS regardless of the clearing rate.

Potential Holders
In contrast, potential holders may submit only a bid to buy securities at a specified rate. If the clearing rate is above the specified rate, a potential holder will receive securities. If the clearing rate is below the specified rate, a potential holder will not receive any securities. Finally, if the clearing rate is at the specified rate, a potential holder may receive all, some or none of the securities.

Orders must be submitted to the broker-dealer by specified times. See "Deadlines" below.

Auction Agent's Role in Auction Process

The Auction Agent's functions include collecting orders from all participating broker-dealers by the auction deadline, determining the amount of securities available for sale (the auction size less hold orders), and organizing the bids in ascending rate orders to determine the winning bid. If there are any orders placed into the auction at a specified rate, the Auction Agent accepts bids with the lowest rate above any applicable minimum rate and then successively higher rates up to the maximum applicable rate, until all sell orders and orders that are treated as sell orders are filled. Bids below any applicable minimum rate or above the applicable maximum rate are rejected.

After determining the clearing rate, the Auction Agent allocates the ARS available for sale to the participating broker-dealers based on the orders they submitted, as such orders are defined below, typically, in the following order of priorities:

If there are multiple bids at the clearing rate, the Auction Agent will allocate securities among the bidders at such rate on a pro-rata basis. Existing holders are likely to receive preference over new bidders at the same rate. All accepted bids receive the same interest rate or dividend yields - the clearing rate.

Notification of Clearing Rate

Once the clearing rate has been determined, the Auction Agent notifies the issuer's paying agent and the participating broker-dealer(s) of the clearing rate, which will be effective the business day following the auction or, in the case of daily auctions, the same day. If the issuer of the ARS had selected more than one firm to act as broker-dealer for the securities in the auction, the Auction Agent also notifies the participating broker-dealers whether each was a net seller or a net buyer of securities. The settlement of such purchase and sale transactions occurs on the business day following the auction unless the auction is occurring daily in which case the settlement is the same day.

All Hold Auctions

If all existing holders determine to hold their ARS without specifying a minimum rate, the auction is called an "All Hold" auction and the new rate will be equal to the so-called "All Hold Rate" specified in the relevant offering documents. The All Hold Rate typically is based on a percentage of a reference rate, usually the London Interbank Offered Rate ("LIBOR"), the Bond Market Association ("TBMA") index, or an index of Treasury securities, which percentage usually produces a rate that is materially below a market rate.

Failed Auctions

In the event the Auction Agent does not receive sufficient orders to purchase all the ARS being sold in the auction, the auction is said to have failed and the rate on the ARS is set at the maximum rate applicable to the specific securities being auctioned (the "Maximum Rate"). The Maximum Rate is often (a) determined by the application of a specified multiple to a reference rate, such as LIBOR, the TBMA index or an index of Treasury securities, or (b) a specified fixed percentage rate. Holders may be disadvantaged if there is a failed auction because they are not able to exit their positions through the auction and the higher rate is designed to generally compensate the holders for the loss of liquidity and encourage the issuer to consider redeeming or restructuring the securities if future auctions also fail.

Bidding By Issuers/Conduit Borrowers in ARS Auctions

Certain Municipal Issuers or Conduit Borrowers have determined to participate in the auction of their own auction rate securities pursuant to recent guidance from the U.S. Securities & Exchange Commission. These Issuers/Conduit Borrowers are required to provide a notice of their intent to participate in the auction and the interest rate and amounts that they will bid for and certain other detailed bidding information. This information will be available to you at www.dacbond.com.

Partial Redemptions of ARS

When an ARS is subject to a partial call or redemption by the issuer, the issuer notifies the depository that carries broker dealer "street name" positions (generally the Depository Trust Company, or "DTC") of the number of units of the specific security the issuer will redeem. Depositories and brokerage firms are required by regulation to allocate partial redemptions through a fair and impartial process. Upon receipt of the issuer's notification, DTC determines the total units held by each firm and conducts an impartial, random number-based lottery to allocate the partial redemption among firms. Upon completion, DTC notifies all firms, including Smith Barney, of the number of units allocated to them for redemption. It is important to understand that this lottery process is NOT designed to result in a pro rata allocation — it is a random allocation of the redemption across all the outstanding securities. In a partial redemption, it is possible that Smith Barney will not receive any allocation for redemption in the depository's allocation process.

Upon receipt of its allocation from the depository, Smith Barney then uses an automated, impartial, random number-based lottery approach as DTC to determine which accounts, and the number of units in each account, will be redeemed. A particular account could be allocated a full, partial, or no redemption. Consistent with recent regulatory guidance, Smith Barney has implemented a requirement that partial redemptions of ARS be fully allocated to client positions before any employee or firm inventory holdings may be redeemed. View a detailed description and illustration of the random number-based lottery methodology used to allocate partial redemptions of ARS.

Clients have the right to withdraw uncalled fully paid securities from their accounts at any time prior to a partial call, subject to any applicable margin, lending or lending-related agreements.

B. Citigroup's Role in Auctions

Bidding by Citigroup

Citigroup is permitted, but not obligated, to submit orders in auctions for its own account either as a bidder or a seller and routinely does so in the auction rate securities market in its sole discretion. If Citigroup submits an order for its own account, it would have an advantage over other bidders because Citigroup would have knowledge of some or all of the other orders placed through Citigroup in that auction and, thus, could determine the rate and size of its order so as to ensure that its order is likely to be accepted in the auction and that the auction is likely to clear at a particular rate. For this reason, and because Citigroup is appointed and paid by the relevant issuer to serve as a broker-dealer in the auction, Citigroup's interests in conducting an auction may differ from those of existing holders and potential holders who participate in auctions. See "Auction Dealer Fees." Citigroup would not have knowledge of orders submitted to the Auction Agent by any other firm that is, or may in the future be, appointed to accept orders pursuant to a broker-dealer agreement.

Where Citigroup is the only broker-dealer selected by the issuer in an auction, Citigroup would be the only broker-dealer that submits orders to the auction agent in that auction. As a result, in such circumstances, Citigroup could discern the clearing rate before the orders are submitted to the auction agent and set the clearing rate with its order.

Bidding with Knowledge
Citigroup may routinely place one or more bids in an auction for its own account to acquire ARS for its inventory, to prevent a failed auction (i.e., an event where there are insufficient clearing bids which would result in the auction rate being set at the Maximum Rate) or an auction from clearing at a rate that Citigroup believes does not reflect the market for the particular ARS being auctioned. Citigroup may place such bids even after obtaining knowledge of some or all of the other orders submitted through it. When bidding for its own account, Citigroup may also bid outside or inside the range of rates that it posts in its Price Talk. See "Price Talk."

Bidding to Prevent Failed Auctions or to Prevent ARS from Clearing at Rate Different than Market Rate
Citigroup also may routinely encourage bidding by others in auctions, including to prevent a failed auction or to prevent an auction from clearing at a rate that Citigroup believes does not reflect the market for the particular ARS being auctioned. Citigroup may routinely encourage such bids even after obtaining knowledge of some or all of the other orders submitted through it.

Consequences of Bidding by Citigroup

Bids by Citigroup or by those it may encourage to place bids are likely to affect (i) the auction rate — including preventing the auction rate from being set at the Maximum Rate or otherwise causing bidders to receive a higher or lower rate than they might have received had Citigroup not bid or not encouraged others to bid and (ii) the allocation of ARS being auctioned — including displacing some bidders who may have their bids rejected or receive fewer ARS than they would have received if Citigroup had not bid or encouraged others to bid. Because of these practices, the fact that an auction clears successfully does not mean that an investment in the ARS involves no significant liquidity or credit risk. Citigroup is not obligated to continue to place such bids or encourage other bidders to do so in any particular auction to prevent an auction from failing or clearing at a rate Citigroup believes does not reflect the market for the securities. Investors should not assume that Citigroup will do so or that failed auctions and unfavorable auction rates will not occur. Investors should also be aware that bids by Citigroup or by those it may encourage to place bids may cause lower auction rates to occur.

Information on the Likelihood of an All-Hold Auction

In any particular auction, if all outstanding ARS are the subject of submitted hold orders, the auction rate for the next succeeding auction period will be the so-called "All Hold Rate", as set forth in the document for the ARS in question (such a situation is called an "All Hold Auction"). When an All Hold Auction is likely, Citigroup may, but is not obligated to, advise its customers who are existing holders of that fact, which might facilitate the submission of bids by existing holders that would avoid the occurrence of an All Hold Auction. If Citigroup decides to inform its customers who are existing holders of the likelihood of an All Hold Auction, it will make that information available to all such holders at the same time.

ARS Held by Citigroup

If Citigroup holds any ARS for its own account on an auction date, Citigroup will submit a sell order into the auction with respect to such ARS, which would prevent that auction from being an All Hold Auction. Citigroup may, but is not obligated to, submit bids for its own account in that same auction, as set forth above.

Auction Dealer Fees

For many auction rate securities, Citigroup has been appointed by the issuer of the securities to serve as a dealer in the auction and is paid by the issuer for its services. Citigroup is typically appointed to serve as a dealer in the auctions pursuant to an agreement between the issuer and Citigroup. That agreement provides that Citigroup will receive from the issuer auction dealer fees based on the principal amount of the securities placed through Citigroup. As a result, Citigroup's interests in conducting auctions may differ from those of investors who participate in auctions.

Citigroup may share a portion of the auction dealer fees it receives from the issuer with other broker-dealers that submit orders through Citigroup, for those orders that Citigroup successfully places in the auctions. Similarly, with respect to auctions for other auction rate securities for which Citigroup does not serve as a dealer, the other broker-dealers who serve as dealers in those auctions may share auction dealer fees with Citigroup for orders that Citigroup submits through those broker-dealers that those broker-dealers successfully place in those auctions.

"Price Talk"

Before the start of an auction, Citigroup may, in its discretion, make available to its customers who are existing holders and potential holders Citigroup's good faith judgment of the range of likely clearing rates for the auction based on market and other information. This is known as "Price Talk." Price Talk is not a guaranty, and existing holders and potential holders are free to use it or ignore it. Citigroup may occasionally update and change the Price Talk based on changes in issuer credit quality or macroeconomic factors that are likely to result in a change in interest rate levels, such as an announcement by the Federal Reserve Board of a change in the Federal Funds rate or an announcement by the Bureau of Labor Statistics of unemployment numbers. Citigroup will make such changes available to its customers who are existing holders and potential holders that were given the original Price Talk.

"All-or Nothing" Bids and Market Orders

Citigroup does not accept "all-or-nothing" bids (i.e., bids whereby the bidder proposes to reject an allocation smaller than the entire quantity bid) or any other type of bid that allows the bidder to avoid auction procedures that require the pro rata allocation of securities where there are not sufficient sell orders to fill all bids at the clearing rate. Citigroup also does not accept market order bids. Potential holders may submit buy orders at specified rates only.

No Assurances Regarding Auction Outcomes

Citigroup provides no assurance as to the outcome of any auction, nor does Citigroup provide any assurance that any bid will be sucessful, in whole or in part, or that the auction will clear at a rate that a bidder considers acceptable. Bids may be rejected or may be only partially filled, or not filled at all, and the rate on any ARS purchased or retained in the auction may be lower than market rates for similar investments.

Citigroup will not agree before an auction to buy ARS from or sell ARS to a customer after the auction.

Deadlines

Each particular auction has a formal time deadline by which all bids must be submitted by Citigroup to the Auction Agent, typically 12:30 p.m. or 1:00 p.m., New York time, on a regular trading day and 11:30 a.m., New York time, on any day in which TBMA has recommended an early market close. This deadline is called the "Submission Deadline." To provide sufficient time to process and submit customer bids to the Auction Agent before the Submission Deadline, Citigroup imposes an earlier deadline for all ARS — called the "Internal Submission Deadline" — by which bidders must submit bids to Citigroup, currently 12:00 p.m., New York time, on a regular trading day and 10:30 a.m., New York time, on any day in which TBMA has recommended an early market close. The Internal Submission Deadline is subject to change by Citigroup. Citigroup may allow for correction of clerical errors after the Internal Submission Deadline and prior to the Submission Deadline. Citigroup may submit bids for its own account at any time until the Auction Submission Deadline. Some auction agents allow for the correction of clerical errors for a specified period of time after the Auction Submission Deadline.

Existing Holder's Ability to Resell Auction Rate Securities May Be Limited

Existing holders will be able to sell the ARS in an auction only if there are bidders willing to purchase all the ARS offered for sale in the auction. If sufficient clearing bids have not been made, existing holders that have submitted sell orders will not be able to sell in the auction all, and may not be able to sell any, of the ARS subject to such submitted sell orders. As discussed above (see "Bidding By Citigroup"), Citigroup may submit a bid in an auction to keep it from failing, but it is not obligated to do so. There may not always be enough bidders to prevent an auction from failing in the absence of Citigroup bidding in the auction for its own account. Therefore, failed auctions are possible, especially if the issuer's credit were to deteriorate, if a market disruption were to occur or if, for any reason, Citigroup were unable or unwilling to bid.

Between auctions, there can be no assurance that a secondary market for the ARS will develop or, if it does develop, that it will provide existing holders the ability to resell the ARS in the secondary market on the terms or at the times desired by an existing holder. Citigroup may, in its own discretion, decide to buy or sell the ARS in the secondary market for its own account at any time and at any price, including at prices equivalent to, below, or above the par value of the ARS. However, Citigroup is not obligated to make a market in the ARS, and may discontinue trading in the ARS without notice for any reason at any time. Existing holders who resell between auctions may receive less than par value, depending on market conditions.

The ability to resell any ARS will depend on various factors affecting the market for the ARS, including news relating to the specific issuer of the ARS, the attractiveness of alternative investments, the perceived risk of owning the specific ARS (whether related to credit, liquidity or any other risk), the tax or accounting treatment accorded ARS generally (including recent clarification of U.S. generally accepted accounting principles as they apply to the accounting treatment of ARS), reactions of market participants to regulatory actions or press reports, financial reporting cycles and market conditions generally. Demand for the ARS may change without warning, and declines in demand may be short-lived or continue for longer periods.

Resignation of the Auction Agent Under the Auction Agent Agreement or Citigroup Under the Broker-Dealer Agreement Could Impact the Ability to Hold Auctions

The Auction Agent agreement typically provides that the Auction Agent may resign from its duties as Auction Agent by giving at least 45 days notice to the issuer and others and does not require, as a condition to the effectiveness of such resignation, that a replacement Auction Agent be in place if its fee has not been paid. The broker-dealer agreement typically provides that Citigroup and any other broker-dealer thereunder may resign upon 30 days notice or immediately, in certain circumstances, and does not require, as a condition to the effectiveness of such resignation, that a replacement broker-dealer be in place. For any auction period during which there is no duly appointed Auction Agent, or during which there is no duly appointed broker-dealer, it will not be possible to hold auctions, with the result that the interest rate on the ARS will be determined as described in the relevant documents.

For more information, please contact your Smith Barney Financial Advisor.

♦ About Us ♦ Institutional Services