The U.S. Securities and Exchange Commission says BMO has agreed to pay US$40 million to settle charges related to the bank's alleged supervision failure in bond selling. The Bank of Montreal building is pictured in Ottawa on Monday, June 3, 2024.Sean Kilpatrick/The Canadian Press
Bank of Montreal BMO-T will pay the U.S. Securities and Exchange Commission US$40.7-million to settle charges related to misleading investors about key details of the bank’s bonds.
The SEC said Monday that BMO Capital Markets “failed to reasonably supervise” its employees involved in the sale of Agency CMO Bonds. BMO has agreed to pay a US$19-million fine as well as US$21.7-million in disgorgement and interest, which the SEC said represented the bank’s “net profits from its violations, and will be distributed to harmed investors to the extent feasible.”
CMO stands for collateralized mortgage obligations, and Agency CMO bonds are created by pooling residential mortgages into trusts and issuing bonds that pay a rate of return to investors based on the repayment of those mortgages. The CMOs are generally considered lower-risk investments than others because they are backed by full-faith guarantees from U.S. government-sponsored agencies such as Fannie Mae, Freddie Mac and Ginnie Mae.
BMO sold more than US$3-billion worth of Agency CMO bonds from December, 2020, to May, 2023, the SEC said. During that time, according to the SEC’s investigation, a senior member of the BMO team responsible for structuring new-issue CMOs “discovered that when millions of dollars of mortgages from lower-interest mortgage pools were combined with a tiny sliver – usually just US$1,000 – of mortgages from higher-interest rate mortgage pools” the bond would appear to be backed by a much higher proportion of high-interest mortgages than was really the case.
In one example from November, 2021, cited by the regulator, BMO structured a bond backed by two sets of mortgages. The first set of US$77.5-million accounted for virtually all – 99.99 per cent – of the collateral backing the bond and had a gross-weighted average interest coupon rate of 2.47 per cent.
The second set had a much higher gross-weighted average coupon rate, ranging from 3.9 per cent to 5.4 per cent, because the set was pooled from mortgages with much higher interest rates. However, even though the second set only accounted for US$6,000, or 0.01 per cent, of the bond’s total collateral, the bond was marketed as having an overall gross-weighted average coupon rate of 3.96 per cent, which the SEC said was higher than “the overwhelming majority of the underlying collateral.”
BMO sold more than 400 bonds “that were marketed using collateral information that was altered or inflated,” the SEC said. In one instant message viewed by the regulator, a member of BMO’s bond desk told a BMO trader: “I can use 1k of some pools to [change] cosmetics and can move all these [bonds].”
In June, 2022, another member of BMO’s bond desk received a complaint from another market participant that collateral information “needs to be disclosed better” and accused the lender of “not selling what is advertised.” The complaint was never escalated to BMO’s compliance department or to more senior management.
“There were investors who may not have purchased” the bonds, “or would have attempted to negotiate a lower price... had they received accurate information about the underlying collateral at the time of purchase,” the SEC said.
BMO spokesperson Jeff Roman declined to say whether anyone was disciplined as a result of those activities, though he provided a statement saying the lender holds itself “to the highest standards of fair and ethical conduct, and [we] continuously review and enhance our controls and supervisory framework.”
“We’re pleased to have this matter behind us,” Mr. Roman said.
BMO has since added more supervisory policies and procedures concerning the offering and sale of Agency CMO bonds, which the SEC said was part of the “remedial acts promptly undertaken” that influenced the regulator’s decision to settle. While the bank did not admit or deny any wrongdoing, BMO did accept a formal censure from the SEC as part of the settlement agreement.
Jean-Paul Bureaud, executive director of investor advocacy group FAIR Canada, said the case highlights the importance of accurate disclosure, particularly for complex products such as mortgage-backed securities.
“This is a reminder for investors to stay informed and ask questions and highlights why strong regulatory oversight is essential to protecting people’s investments,” Mr. Bureaud said.