Wells Fargo Investments LLC has agreed to repay about $1.3 billion to clients whose funds were frozen in the auction-rate securities market in a settlement with state securities regulators, an industry association said on Wednesday.

The company, a unit of San Francisco-based Wells Fargo & Co , has agreed to offer to buy back ARS by mid-February 2010, the North American Securities Administrators Association said in a statement.

Wells Fargo will also reimburse clients who sold securities at a discount after the market froze and pay $1.9 million in penalties to states, said the statement.

The settlement stems from a probe by Washington state regulators into allegations that Wells Fargo misled clients by assuring them the ARS securities were a safe, liquid alternative to cash, certificates of deposit or money market funds.

ARS are long-term debt instruments whose interest rates are regularly reset through auctions. The market froze in February 2008, trapping both investors and issuers and prompting complaints from investors around the country who were unable to withdraw money from their accounts.

Wells Fargo clients held an estimated $2.95 billion in ARS at the time, said the statement.

Settlement negotiations were led by state securities regulators in California, Georgia, Missouri, Oregon, Texas, Utah and Washington.

California Attorney General Edmund Brown said earlier he will hold a press conference at 1 p.m. EST (1800 GMT) on Wednesday to unveil a billion-dollar settlement with a major bank, according to an advisory that did not name the bank.

(Reporting by Ciara Linnane, Editing by Chizu Nomiyama)