Citigroup (NYSE: C) is in talks with federal and New York State authorities to settle charges that it misrepresented the liquidity of the auction-rate securities that it sold to clients. The financial instruments were presented as being nearly as liquid as cash, but when the market in the paper locked up a year ago, owners of the securities could not sell them.

According toThe Wall Street Journal, Citi conversations with regulators "to resolve allegations of wrongdoing in the auction-rate-securities market could result in its buying back several billion dollars of the illiquid securities from investors and paying a sizable fine."

Leaving Citi aside, banks and brokerage houses could face another substantial series of write-offs if the industry decides to come clean on the auction rate mess. The market totaled about $360 billion. While the paper is not worthless, it may bring only 60% of its face value. The leaves a hole of nearly $100 billion.

Financial companies may not have a choice beyond settling. It appears that both personal investors and corporations were told that they could get the money out of auction rate securities with ease. When banks decided to no longer take on the risk of trading the paper, most of the bonds could not be sold at all.

Investors at banks and brokerage houses should get ready for a new round of write-offs large enough to take their shares back to their recent lows.

Douglas A. McIntyre is an editor at 247wallst.com.