Continuing from our last post looking at recent SEC enforcement actions, the US regulator has recently fined ICE Data Pricing & Reference Pricing ("PRD", which was formerly Interactive Data) $8 million. Per the SEC, for 46,000 fixed income securities in the ICE database, the firm did not deliver a pricing feed based on "evaluated prices" (which consider factors such as benchmark yields, reported trades, bids, offers and two-way markets) - but rather gave users single broker quotes. Single broker quotes are, of course, precisely what investors want to avoid through use of a pricing feed.
In this case, the SEC makes a number of points:
- From at least 2015 through June 2019, PRD provided single broker-quoted prices for various types of securities, including, but not limited to, certain synthetic convertible notes, structured notes, index-linked notes, church bonds, asset-backed securities, collateralized mortgage obligations, and commercial mortgage-backed securities.
- In its provision of broker quotes, PRD did not adopt any policies or procedures to assess the reliability of the quotes it received from market participants. PRD did not consider other market information, when available, such as trades or quotes from other sources, as a check on whether the quotes being received reasonably reflected a security’s value.
- From at least 2015 through June 2019, PRD did not always receive daily quotes from market participants for single broker-quoted securities, sometimes only receiving quotes once a month. It was difficult and at times not possible for PRD clients to determine the age of a single broker-quoted price. This meant that clients could have unknowingly relied upon prices for, among other things, trade decisions and account statement values that may have been up to a month old and not taken into account recent market events.
- For the “unchanged value” control, PRD’s automated system notified the evaluator assigned to a security when a quote provider had failed to provide a quote for more than 20 business days. However, there was no policy in place requiring an evaluator to take any action in response to an “unchanged value” notification. In practice, since at least October 2017, the evaluator responsible for index-linked notes waited until 30 business days after the last quote was received before beginning the process for discontinuing the provision of the price, which included first giving the quote provider notice and an opportunity to submit an updated quote.
- From at least 2015 through April 2019, PRD’s unchanged value control did not detect the submission of unchanged quotes from quote providers, i.e. the same quotes being submitted for days, weeks, or months. In April 2019, PRD enhanced its controls to include an unchanged broker quote control. This new control flagged unchanged prices after 20 business days. Even so, the evaluator responsible for index-linked notes was trained to wait until 40 business days before beginning the process for discontinuing the delivery of a price based on an unchanged broker quote. At that point, he would contact the quote provider to confirm that the quote was meant to remain unchanged. Once the quote was confirmed by the provider, it would be accepted without additional scrutiny.
- PRD’s “daily tolerance” control flagged submissions of broker quotes whenever a quote moved up or down by 5% from PRD’s previously provided price. This control was deficient in design and implementation. For example, the evaluator responsible for index-linked notes was trained to apply this control only on broker quotes that moved by at least 10% or at times even 20% or more from the previous quote. Even then, the evaluator had discretion to accept a price based on the new quote. In the instances when the evaluator contacted the quote provider about a change in value, the evaluator only asked whether the quote was what the provider intended to submit. If the quote provider confirmed the quote, it would be delivered through PRD’s price delivery products without additional scrutiny.
- PRD did not consider other market information for broker-quoted securities even when clients presented PRD with trades or other market information that suggested the broker quoted price may not be a reasonable reflection of a security’s value. PRD offered clients the ability to challenge evaluated and broker-quoted prices through a “Security Pricing Evaluation Request” (“SPER”) portal. PRD could either modify or affirm a price in response to a challenge. For most challenges to single broker-quoted prices, the SPER portal generated an automatic response identifying the challenged price as single broker quoted and rejecting the challenge without the challenge being reviewed by an evaluator. In the cases where an evaluator did review market information submitted by a client in support of a challenge to a price of a single broker quoted security, the evaluator contacted the quote provider to confirm that the quote received was what the provider intended to submit to PRD. The evaluator did nothing more to analyze the market information provided by the client through the SPER portal to consider whether the broker quote may not have been a reasonable reflection of the security’s value.
In fairness, the 46,000 securities which were single broker quoted were a small minority of the more than 2 million lines in Interactive Data's overall pricing database. But, nonetheless, single broker quotes would suggest that these names were securities with thin markets and hence elevated pricing risk - which should, we assume, have been subject to higher degrees of care and attention. The SEC's order provides a revealing look behind the curtain as to whether checks and controls are always effective in the pricing industry.
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