Auction-rate securities are preferred shares or debt instruments with rates that reset regularly, usually every week, in auctions overseen by the brokerage firms that originally sold them. But the $300-billion market for these instruments collapsed in February, trapping investors who had been told that they were safe and the instruments were easy to liquidate.

In a letter Friday, Cuomo's office indicated it intended to sue Citigroup Global Markets Inc. and Smith Barney under the state's Martin Act for fraudulent marketing of the securities and for destruction of documents under subpoena.

Cuomo's office said a five-month probe found that Citigroup "repeatedly and persistently" made material misrepresentations and omissions in its underwriting, distribution and sale of auction rate securities.

"Citigroup represented that auction-rate securities were safe, liquid, and cash-equivalent securities," wrote David A Markowitz, chief of Cuomo's investor protection unit. "These representations were false, and had a severe detrimental impact on tens of thousands of Citigroup customers."

He also said Citigroup destroyed audiotapes of phone calls on auction-rate debt that were subject to a 14 April subpoena. The bank learned in mid-June about the destruction, but failed to tell Cuomo's office until 30 June, the letter said.

Citigroup said in an e-mailed statement that recycling tapes is generally its practice. It inadvertently recycled a tape subject to the subpoena, but as soon as it learned it had, it stopped recycling tapes. "We reported this oversight to the regulators, and we have fully cooperated with them in all aspects of this investigation," the statement said.

Citigroup would become the third major Wall Street firm to face legal action over its sales of auction-rate securities in recent weeks. Cuomo sued UBS on 24 July over auction-rate securities, accusing the Swiss bank of a "multi-billion dollar fraud" in steering customers into the debt. (See: New York attorney general charges UBS with securities fraud)

Massachusetts regulators filed charges against UBS in June. On Thursday, they filed a civil-fraud complaint against Merrill Lynch & Co. for allegedly misrepresenting the nature of the securities to investors and for co-opting its "supposedly independent" research analysts to help them reduce its own inventory of the securities.

Cuomo's office did leave the door open for a settlement with Citigroup, saying in the letter the company must buy back retail investors' securities at par; reimburse retail investors for damages they have incurred; undertake immediately to make institutional investors and corporations whole; and pay a significant penalty for its alleged misconduct during the investigation.

The New York attorney general's office has now subpoenaed 30 entities and 100 individuals, seeking information about the sales of auction-rate securities. Among those subpoenaed are Merrill Lynch & Co., JPMorgan Chase & Co. and Goldman Sachs, and high-ranking executives at various companies as well as heads of municipal-bond desks, risk managers, financial advisors and others.