BNY Mellon Capital Markets LLC will pay $1.3 million to Texas and two other states for its role in a scheme to lower borrowing costs for Citizens Property Insurance Corp. of Florida.
Texas' $500,000 share of the settlement goes to the state's general revenue fund.
According to a Dec. 21 Consent Order entered by Texas Securities Commissioner John Morgan, in 2008 Mellon Financial Markets (MFM)1, now a unit of BNY Mellon, helped Citizens manipulate the interest rate on its own auction rate securities (ARS). The lower interest rates on its debt saved Citizens money and cost investors who held the insurer's ARS. Investors earned $6.7 million less in interest than they would have if Citizens had not bid in its own auctions.
An auction rate security is a long-term debt issue whose interest rate is reset at auctions that typically take place every seven or 28 days. The ARS yield is determined by bidding at the auction, and the auction process gives investors a chance to access their funds without waiting for the debt to mature.
The auction-rate market allowed entities such as Citizens to obtain long-term financing at interest rates typically associated with shorter-term investments.The auction-rate market allowed entities such as Citizens to obtain long-term financing at interest rates typically associated with shorter-term investments.
The Consent Order stemmed from an unrelated investigation conducted by the Texas State Securities Board. State Securities Board staff discovered that in January 2008, Citizens asked MFM to help it bid on its own auction rate securities and conceal the fact it was doing so.
A broker for MFM described the trading scenario as "unique"and took the issue to his supervisor. The broker's supervisor did not seek legal advice or discuss the issue with MFM's compliance department, according to the Order. In January 2008, MFM began to accept and place bids on behalf of Citizens.
As the interest rates for auction rate securities began to increase, Citizens instructed MFM to place bids for its debt at interest rates generally below then-current rates for similar ARS issues.
In February 2008, a global freeze in the credit markets caused a large number of ARS auctions to fail, throwing the auction rate market into turmoil. After developing a suspicion that MFM was bidding on behalf of Citizens, a broker-dealer told MFM that no orders would be accepted on behalf of a company bidding on its own auction rate securities.
According to the Order, however, MFM traders continued to select lower interest rates for Citizens for several more days before BNY's legal and compliance departments stopped the process.
MFM traders "understood that holders of Citizens ARS would earn more without Citizens' bidding activity,"according to the Order. One trader stated that MFM's participation in the bidding scheme had allowed Citizens to "gouge people."'The Consent Order finds that BNY Mellon Capital Markets' actions constituted "inequitable practices in connection with the sale of securities"and that the company failed to "establish, maintain and enforce reasonably designed supervisory procedures"in violation of Texas State Securities Board rules and regulations.
The State Securities Board thanks the Office of the New York Attorney General and the Florida Office of Financial Regulation for their cooperation and assistance.
# # #
1 At the time, Mellon Financial Markets was a separate entity. It is now part of the Bank of New York Mellon Corp., the company created by the merger of the Bank of New York and Mellon Financial Corp.