SEC probe adds to Pimco’s troubles

A Pimco trustee recently questioned the $200-million salary of co-founder Bill Gross, above.

A federal investigation of Pacific Investment Management Co. is the latest crack in the armor of the $2-trillion Newport Beach fund giant, where a trustee recently questioned the $200-million salary, “bullying” behavior and “mediocre” recent performance of co-founder Bill Gross.

Word of the Securities and Exchange Commission inquiry follows a series of setbacks for Pimco, including the abrupt departure of Gross’ heir apparent, Mohamed El-Erian, reports of clashes between the two and an outflow of more than $65 billion in investors’ money from Gross’ signature Total Return Fund.

Pimco said it is cooperating with the SEC, which is examining whether Pimco improperly inflated the price of bond holdings in an exchange traded fund. That could have increased the publicly reported value of the fund, which Gross personally managed.

The ETF, as such funds are known, was set up to mirror the investment style of Gross’ Total Return Fund, which serves giant institutional investors. The Total Return Fund, which has $221 billion in assets, is the world’s largest bond mutual fund and a staple of 401(k) and other retirement plans across the nation. The $3.6-billion Total Return Fund ETF reported investment gains of 8.7% from March through August 2012, its first six months of existence. That compared with a gain of 5.2% for the Total Return Fund it emulated, which at the time was growing rapidly and exceeded $270 billion in assets.


The Newport Beach company, which Gross co-founded in 1971, denied any wrongdoing.

“We take our regulatory obligations and responsibilities to our clients very seriously,” the firm said in a statement. “We believe our pricing procedures are entirely appropriate and in keeping with industry best practices.”

Pimco declined to comment further on the SEC investigation. A spokesman for the SEC in Washington declined to comment.

A person close to the investigation, speaking on condition of anonymity because the investigation is confidential, told The Times that investigators from several SEC offices around the country have been working on the case.


The investigation was first reported by the Wall Street Journal, which quoted unidentified sources as saying the SEC has been looking at the case for at least a year. Investigators have recently interviewed Pimco executives, and spent more than a day questioning the 70-year-old Gross.

The disclosure of the investigation follows other turmoil at Pimco. In a March interview with The Times, a longtime independent trustee on the board that oversees Pimco, William J. Popejoy, publicly criticized Gross — specifically his high pay, amid the fund’s declining performance.

That followed high-profile clashes between Gross and El-Erian, including allegations that Gross had monitored El-Erian’s phone calls.

A midsummer Pimco regulatory filing said Popejoy had resigned from the board. Popejoy’s attorney said that was inaccurate but declined to elaborate on Popejoy’s version of events.


Independent bond fund trustees such as Popejoy don’t work for money management firms like Pimco; their job is to oversee the funds, monitoring performance on behalf of investors and negotiating the fees paid to the fund managers.

They generally work far from public scrutiny, and a bond fund trustee criticizing an asset manager, as Popejoy did, is “extremely rare,” said Eric Jacobson, director of fixed-income research at fund tracker Morningstar Inc. “I cannot remember seeing anything like this in the last 10 to 15 years.”

Popejoy has since declined to speak publicly about Gross and the proceedings of the board of trustees, citing the advice of attorneys. In a recent interview, he did say he had differences with the board chairman, Brent R. Harris, a Pimco managing director who is one of two insiders on the seven-man board.

One disagreement centered on the lack of diversity on the board, which is made up entirely of white men, Popejoy said.


He said that when the independent trustee Vern O. Curtis, 80, decided to step down, Harris wanted the replacement to be Peter B. McCarthy, a former banker and U.S. Treasury official. McCarthy already sits on the board that oversees Pimco’s small collection of stock mutual funds.

Popejoy said he instead lobbied to add a female or minority member to the board.

Harris did not immediately respond to requests for comment. The Pimco Funds have yet to replace Popejoy or Curtis.

The SEC probe focused on whether Gross’ ETF fund misled investors through such actions as buying bonds at a discount, then putting a higher value on them when reporting fund results, the Journal reported. Doing so would increase the reported net asset value of the funds.


The SEC has conducted a series of investigations of such pricing issues at mutual funds, and in some cases has brought civil charges. In 2012, UBS Global Asset Management paid $300,000 to settle accusations that it improperly priced securities in three mutual funds.

Such cases, however, can be complicated to sort out. Investigations often find no violations, said Michael Herbst, a Morningstar director of manager research.

Exchange-traded funds often do better, at least at first, than the large funds they emulate. The smaller ETFs are “nimble” and can negotiate discounts and turn quick profits on deals too small for the large funds to pursue, he said.

A powerful bond ETF like the one headed by Gross, for example, might often be able to find small, thinly traded holdings of certain corporate bonds or exotic mortgage securities that could be purchased at a sharp discount.


If an independent valuation firm, such as Interactive Data or Thompson Reuters, was unable to find a recent sale of identical securities, as often occurs, it would then estimate the value for the holdings based on recent sales of similar bonds, Herbst said. That could yield a higher value.

If the mutual fund accurately reported the purchase price, along with the independent valuation, the SEC would probably find no violation, Herbst said. Any violations of securities laws would stem from the mutual fund lying about the purchase price or the independently estimated value.

Twitter: @ScottReckard