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Mellon Fined for Market Manipulation

DALLAS (CN) - BNY Mellon Capital Markets will pay $1.3 million to Texas, New York and Florida for manipulating auction-rate securities to reduce borrowing costs for Citizens Property Insurance Corp. of Florida.

BNY Mellon Capital Markets is a unit of Bank of New York Mellon.

According to a consent order entered by Texas Securities Commissioner John Morgan, BNY Mellon Financial Markets helped Citizens Insurance manipulate the interest rate on its own auction rate securities in 2008. The lower interest rates on its debt saved Citizens money but cost investors $6.7 million more in interest than they would have paid 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 7 or 28 days. The yield is determined by bidding at the auction; the auction gives investors a chance to get their money without waiting for the debt to mature.

The auction-rate market allowed entities such as Citizens to get long-term financing at interest rates typically associated with shorter-term investments.

The Texas State Securities Board said the consent order came about from an unrelated investigation when the board discovered that in January 2008 Citizens asked Mellon Financial Markets to help it bid on its own auction rate securities and conceal it.

It says a Mellon Financial Markets broker described the trading scenario as "unique" and took the issue to his supervisor, who did not seek legal advice or discuss the issue with Mellon's compliance department. Mellon Financial Markets then began to accept and place bids on behalf of Citizens.

As the interest rates for auction rate securities began to increase, Citizens instructed Mellon to place bids for its debt at interest rates generally below then-current rates for similar ARS issues.

A month later, a global freeze in the credit markets caused a large number of ARS auctions to fail, throwing the auction rate market into turmoil. After suspecting that Mellon was bidding on behalf of Citizens, a broker-dealer told Mellon that no orders would be accepted on behalf of a company bidding on its own auction rate securities.

According to the order, however, Mellon traders continued to select lower interest rates for Citizens for several more days before BNY's legal and compliance departments stopped it.

Mellon traders "understood that holders of Citizens ARS would earn more without Citizens' bidding activity," according to the order. One trader stated that Mellon's participation in the bidding scheme allowed Citizens to "gouge people."

The board found that BNY Mellon Capital Markets' actions constituted "inequitable practices in connection with the sale of securities" and that Mellon failed to "establish, maintain and enforce reasonably designed supervisory procedures," in violation of regulations.

Texas' $500,000 share of the settlement will go to the state's general revenue fund.

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