Pricing Service? SEC Bends the Law to Sanction Valuer of Fixed Income Securities

Former NYC Mayor Michael “Mike” Bloomberg started it all. After graduating with a B.S. in electrical engineering in 1966, he went on to gain an M.B.A. from Harvard. In 1973, he became a general partner at Salomon Brothers, where he headed equity trading. After Phibro Corporation acquired Salomon Brothers in 1981, Bloomberg was bought out for $10 million. He used this money to further develop the computerized financial systems he had designed at Salomon. Believing that Wall Street would pay for live-time-accurate business information delivered on computer terminals, he started his own company and designed what were initially called Market Master terminals, the first of which was installed in December 1982.

Building on its early success, the company, renamed Bloomberg L.P. in 1986, expanded into all kinds of financial services from pricing securities to radio and television. The hallmarks of Bloomberg service are timely and accurate business information. Bloomberg retired from any management role in the company by 2000. Nonetheless, it is somewhat ironic that a subsidiary of his company, Bloomberg Finance, L.P., should be subject to adverse regulatory action due to failing to give customers complete information about the pricing of securities.

On Monday 23 January 2023 The U.S. Securities and Exchange Commission (“SEC”) announced that it had settled charges against Bloomberg Finance L.P. (“Bloomberg”) for misleading disclosures about Bloomberg’s paid subscription service, BVAL. According to the SEC, BVAL “provides daily price valuations for fixed income securities to financial service entities.” The SEC Order Instituting Cease-and-Desist Proceedings of that date (the ”Order”) found that from at least 2016 until October 2022, Bloomberg failed to disclose that BVAL customers that the valuations for certain fixed-income securities could be based on a single data input, such as a broker quote. This was contrary to Bloomberg’s disclosures about the BVAL methodology, which it claimed were “independent valuations of fixed income securities …derived by using proprietary algorithmic methodologies.” The Order recites that “[t]hrough BVAL, Bloomberg provides daily price valuations for more than 2.5 million securities across all asset classes to more than 1,300 financial institution customers.” Bloomberg has claimed that BVAL is an industry-leading pricing service providing coverage for many thinly traded and hard-to-price securities.

The Order further asserts that BVAL price valuations are used for many purposes, including the following:

1. Evaluating whether to hold or sell securities or purchase different securities;
2. Determining fund share prices and fund valuations;
3. Reporting prices of securities on investor account statements and in corporate books and records;
4. Complying with generally accepted accounting principles;
5. Computing the value of securities and portfolios; and
6. Calculating advisory and asset management fees.

Clearly, BVAL and its accuracy were and are important to market functioning. The failure to tell those 1,300 financial institution customers that one of the two valuation methods used by BVAL, the Evaluator Input Tool, sometimes based price calculations on only “a single data point about the target security, such as a broker quote” was misleading to those customers. That disclosure failure deserves condemnation and regulatory sanction. It would be appropriate for the SEC to regulate pricing services such as BVAL and to take enforcement action against a service that does not fairly disclose its pricing methodology, or worse, provides intentional or negligently obtained false information. BUT, the SEC has no such regulation on the books; nor has one been proposed (although the SEC did issue a request for comment on June 22, 2022, on whether pricing services implicate the Investment Advisers Act of 1940). Instead, the Commission in the Order imposed a $5 million civil penalty on Bloomberg for violating Section 17(a)(2) of the Securities Act of 1933 as amended. Section 17(a)(2) as cited in the Order prohibits:

…any person in the offer or sale of any securities…directly or indirectly…to obtain money or property by means of any untrue statement of a material fact or omission to state a material fact necessary in order to make the statement made, in light of the circumstances under which they were made, not misleading.

Basing the sanction on Section 17(a)(2) when the “misstatements” may have had NO connection with any offer or sale of a security is pure bureaucratic hubris. That is what led 2 of the 5 SEC Commissioners (Peirce and Uyeda) to refuse to support the SEC enforcement action against Bloomberg, saying in a January 24, 2023 Statement:

A one-off enforcement action that rests on a strained reading of Securities Act Section 17(a)(2) is not the right way to make regulatory policy.

When a butcher fails to tell a customer that the scale is “off,” at some point a weights and measures official will call him to task. While Bloomberg deserved similar treatment, it is strangely unfortunate that the SEC should act to invent a regulatory violation because it had not timely adopted an appropriate regulation of pricing service companies.

If you have any questions concerning this post or any related matter, please feel free to contact me at pdhutcheon@norris-law.com.