Bank of New York Mellon Settles Auction-Rate Investigation

December 22, 2011, 9:39 PM EST By Chris Dolmetsch

(Updates with company comment in last paragraph.)

Dec. 22 (Bloomberg) -- Bank of New York Mellon Corp. will pay $1.3 million to New York, Texas and Florida to resolve a probe into manipulative trading of auction-rate securities.

The joint investigation by the Texas State Securities Board, the Florida Office of Financial Regulation and New York Attorney General Eric Schneiderman was tied to the actions of Mellon Financial Markets as an intermediary broker on behalf of Citizens Property Insurance Corp. of Florida, according to statements from Schneiderman’s office and the Florida and Texas agencies. The settlement includes penalties, fees and costs.

Auction-rate securities are municipal bonds, corporate bonds and preferred stocks whose rates of return are periodically reset through auctions. The market for the securities collapsed in February 2008 after major dealers withdrew their support for the auctions, causing most to fail.

“The manipulative trading of auction-rate securities in New York will not be tolerated under any circumstances,” Schneiderman said in a statement. “My office will continue to protect the integrity of New York’s global financial markets at all costs.”

Mellon Financial in January and February 2008 enabled Citizens Property to buy large quantities of its own auction- rate securities by placing bids in its own auctions as if it were an independent third-party buyer, Schneiderman’s office said in a statement.

Help From Mellon

Citizens Property knew that broker-dealers who were managing the securities would have rejected the bids and asked for help from Mellon Financial Markets, which agreed to submit the trades to help the Florida insurer avoid detection, Schneiderman’s office said.

Citizens Property’s bids were below market rates and resulted in the auctions’ clearing at rates lower than they would have had the insurer not intervened, Schneiderman’s office said. Investors earned $6.7 million less in interest than they would have if Citizens hadn’t joined the auctions, the Texas State Securities Board said.

Mellon Financial “traders and their managers understood that CPIC’s bidding would set clearing rates lower than they would have been in the absence of such bidding, and that this would be both detrimental and objectionable to other investors bidding on or holding CPIC’s auction rate securities,” Schneiderman’s office said.

Fees Earned

Mellon Financial earned about $300,000 in fees from the conduct, Schneiderman’s office and the Texas board said. Florida will receive $400,000 of the settlement and Texas will receive $500,000, which will go to the state’s general revenue fund.

At least one broker at Mellon Financial described the trading scenario as “unique” and brought the issue to his supervisor, who didn’t seek legal advice or discuss it with the company’s compliance department, the Texas board said.

After the market collapsed, a broker-dealer, suspicious that Mellon Financial was bidding for Citizens, said orders wouldn’t be accepted on behalf of a company bidding on its own securities, the Texas agency said.

Traders continued the practice until Bank of New York Mellon ordered it to stop, authorities said. One trader said the activity allowed Citizens to “gouge people,” the Texas State Securities Board said.

“BNY Mellon Capital Markets is pleased to have resolved this matter, which centered on the isolated conduct of three individuals who are no longer with the company,” Ron Sommer, a Bank of New York Mellon spokesman, said in a statement.

Two Entities

Mellon Financial Markets was a separate financial entity at the time the activity occurred, the Texas agency said.

It would be inappropriate for Citizens Property Insurance to comment on the settlement, Christine Ashburn, director of legislative and external affairs for the Tallahassee-based company, said in an e-mail.

“It is important to recognize that Citizens was vigilant in obtaining guidance from outside legal counsel prior to engaging in these transactions,” Ashburn said. “We continue to believe that our actions were legally permissible, and we remain committed to providing any information regulators may request.”

--With assistance from David Mildenberg in New York. Editors: Mary Romano, Charles Carter

To contact the reporter on this story: Chris Dolmetsch in New York at cdolmetsch@bloomberg.net.

To contact the editor responsible for this story: Michael Hytha at mhytha@bloomberg.net.

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