Aug. 6 (Bloomberg) -- The states victimized by the collapse of the auction-rate securities market are negotiating with Citigroup Inc., the biggest underwriter of such debt, to pay as much as $100 million to settle claims it fraudulently sold the bonds to investors, a person familiar with the case said.

Citigroup may also buy back more than $5 billion in auction-rate securities from investors stuck with the debt since the $330 billion market collapsed six months ago, the person said. New York State Attorney General Andrew Cuomo told the bank on Aug. 1 he was preparing to sue over the sale of the bonds. A multi state task force has also been investigating New York-based Citigroup, along with other Wall Street banks.

The settlement would be another blow to Citigroup Chief Executive Officer Vikram Pandit, 51, who recorded a $2.5 billion loss in the second quarter because of $12 billion of writedowns and increased bad-loan reserves. The settlement may establish a precedent for an agreement between regulators and UBS AG, which has also been targeted by regulators in the matter.

Auction-rate securities are typically bonds whose interest rates are reset by periodic bidding. Cuomo said Citigroup failed to tell customers that the auction-rate market survived between August 2007 and February 2008 only because of bidding from the bank. Customer holdings have been frozen since Feb. 13.

The Wall Street Journal reported the settlement talks earlier today.

To contact the reporters on this story: Karen Freifeld in New York State Supreme Court at 1590 or kfreifeld@bloomberg.net; Michael McDonald in Boston at mmcdonald10@bloomberg.net.

Last Updated: August 6, 2008 12:27 EDT