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Updated from 10:18 a.m. EDT



will pay $2.65 billion to the former owners of WorldCom for its role in the misrepresentations that sent the huge telecommunications company into bankruptcy two years ago.

The New York bank announced a class-action settlement Monday in which it is allowed to deny breaking the law while paying former stock- and bondholders of WorldCom recompense that comes out to about $1.64 billion after tax. The money will go into a pool paid out to purchasers of WorldCom stock and bonds between April 29, 1999, through June 25, 2002.

WorldCom declared bankruptcy on the latter date, wiping out tens of thousands of shareholders, after discovering massive profit misstatements related to the way it expensed the cost of its phone lines. While CEO Bernard Ebbers and CFO Scott Sullivan bore the brunt of Wall Street's wrath, Citigroup's close relationship with the company, embodied in the person of Salomon Smith Barney analyst Jack Grubman, also was a primary focus of investor ire.

Shareholders alleged Citigroup was culpable because Grubman consistently praised the stock even as its fortunes declined, while his parent company collected tens of millions of dollars in investment banking fees. They also alleged Ebbers was given access to sure-thing IPO shares in return for keeping his business with Citi.

Citigroup, which previously agreed to a $400 million penalty under New York Attorney General Eliot Spitzer's campaign against faulty research, will adjust all of its legal reserves in light of Monday's settlement. The bank will record an after-tax charge of $4.95 billion, or 95 cents a share, to reflect the adjustment in the current quarter, bringing the entire litigation reserve after paying the WorldCom settlement to $6.7 billion, pretax.

Grubman previously agreed to pay $15 million and be banned from the securities industry for life. Citigroup dropped the Salomon Smith Barney name last year and renamed its retail brokerage business Smith Barney. The rest of its securities business has no separate brand name.

Citigroup was recently trading down $1.37, or 2.9%, to $45.35. The stock is down about 7% on the year and has consistently suffered from a valuation discount due in part to investor fears about its liability in scandals like WorldCom and


. The company hopes Monday's settlement, which comes out to about half its first-quarter profit, will help allay those concerns.

"Citigroup is a growth company," said CEO Charles Prince, who succeeded Sanford Weill in the post six months ago. "It is important that we put this unfortunate chapter behind us so we can focus on our continuing prospects for growth. Today's settlement is a milestone event in that effort. We are taking a leadership position in bringing to a close this difficult era in the history of our industry and our company."

At $6.7 billion, Citigroup's reserve exceeds the $5.27 billion the bank earned in the first quarter, and the 95-cent charge nearly matches the $1.01 a share Citigroup earned in the first quarter. Of course, Citigroup, which earned $17.85 billion last year, is such a cash machine it can more readily establish a sizeable legal reserve than other banks.

Citigroup and the other banks in the Enron litigation have been in mediation for nearly a year with the plaintiffs lawyers in that case. The parties are said to be far from reaching a settlement.

Meanwhile, Citigroup's Worldcom litigation could have ramifications for nearly a dozen other banks that also were named as defendants, most notably

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. The deal with Citigroup does not end the lawsuit against those banks. In fact, it will probably set a precedent in any negotiations with those lenders.

Citigroup previously agreed to a roughly $126 million penalty to regulators for its role in the bankruptcy of Enron.

WorldCom emerged from bankruptcy in April as



, just one week after federal prosecutors charged Ebbers and Sullivan with three counts each of securities fraud, conspiracy and making false statements. Sullivan pleaded guilty and agreed to cooperate with federal prosecutors. Ebbers pleaded innocent and is free on bail.