The firm must pay fines and beef up pricing and disclosure procedures.
Back in August 2015, PIMCO announced that it had received a Wells notice from the SEC. (We wrote about it here.) The question was whether PIMCO had mispriced certain nonagency mortgage-backed securities during the early months following the February 2012 launch of its PIMCO Total Return Active ETF BOND. In particular, the SEC took issue with the firm’s pricing of a subset of the fund’s nonagency holdings bought in increments smaller than $1 million, referred to as “odd lots.” Pricing vendors quote daily prices based on “round lot” sizes of $1 million or more, which is generally the size at which transactions between institutions occur. The SEC was concerned that PIMCO was overstating the value of the securities by buying odd lots at a discount and then marking them at the higher price quoted by the pricing vendor. The SEC also raised issues about how the firm explained the fund’s performance to investors, as well its compliance policies and procedures.
On Thursday, Dec. 1, the SEC released an administrative order detailing a settlement with PIMCO on the matter. PIMCO also put out a piece responding to and explaining the settlement. For more context on the overall pricing issues, in particular, we’d recommend having a look at the aforementioned piece that we wrote after the Wells notice was issued. Here are some key takeaways from the agreement itself.
What Are the SEC’s Findings?
The order provides several pages of narrative around discussions and actions on the part of PIMCO and its employees, but its allegation of specific violations are summarized as follows:
What Are the Consequences for PIMCO?
PIMCO notes that it has already implemented a process to review all sales of securities originally purchased in odd lots. The goal is to make sure that those sales were executed at prices consistent with round-lot pricing in the market at the time they were sold. If the firm sees evidence that it hasn’t been able to sell odd lots in line with round-lot market prices, PIMCO will use that as a signal to apply appropriate pricing discounts going forward. Thus far, the firm says the procedure has confirmed that its funds have been able to sell its odd lots at prices that aren’t materially different from round-lot prices.
What Does the Settlement Mean for Investors?
Although the SEC order talks a lot about mispricing and negligence in the way that PIMCO described the fund’s performance to the public and the fund’s board, the regulator has not required PIMCO to restate prior NAVs or pay any money directly to the fund or shareholders.
And while the hiring of a consultant and the implementation of more-explicit monitoring of pricing decisions aren’t likely to hurt, neither does it seem likely that they will produce any noticeable effect in the experience of shareholders owning this or any other PIMCO fund.
Does the Settlement Have an Impact on Our View of PIMCO or Our Morningstar Analyst Ratings on PIMCO’s Funds?
At this point, there’s nothing in the SEC document, nor any information we’ve gathered from PIMCO, that changes our overall opinion of the firm or has an impact on the funds' Morningstar Analyst Ratings or our PIMCO Parent Pillar rating.
The entire situation holds a lot more nuance than might appear at first look. Even when the Wells notice was first released, its very premise was confusing. That’s because the notion of performing a fair value analysis on odd-lot purchases was not, to our knowledge, on the radar of investors or asset managers prior to the issuance of PIMCO’s Wells notice in 2015. In fact, the practice of purchasing odd lots at cheap levels--knowing that they would likely be marked up to vendor prices for round lots--has historically been a common tool for unearthing and exploiting the inefficiency inherent in over-the-counter bond trading.
The settlement also raises questions of how firms should price positions of the same bond held in multiple client accounts. We’re not aware of any precedent for vendors pricing bonds differently based on their position sizing, and certainly not for firms holding the same bonds in different accounts under one roof. Moreover, while PIMCO has implemented procedures to continuously make sure that it can substantiate decisions to price newly acquired odd lots at vendor-supplied marks, there’s no indication that the SEC is asking any firms to perform fair value pricing on new odd-lot purchases.
It is safe to assume that these questions will be fodder for discussion among industry professionals, accountants, and lawyers. We plan to continue monitoring these issues and making any necessary changes to our opinion of PIMCO or other firms as a result.