May 17, 2021

Global Indices Provider Settles SEC Charges for Disclosure Failures

Steven Lofchie Commentary by Steven Lofchie

A global provider of stock market indices settled SEC charges for the dissemination of stale index values due to an undisclosed quality control feature in one of its volatility-related indices.

In its Order, the SEC stated that the index provider employed an undisclosed "Auto Hold" feature that was triggered by a value of an index breaching a certain threshold, at which point the provider would continue to report the index value immediately preceding the breaching value. The SEC alleged that on February 5, 2018, one of the provider's futures indices experienced a 115 percent uptick, triggering the "Auto Hold" feature, which in turn resulted in the provider publishing outdated index values between 4:00 p.m. and 5:08 p.m. The SEC found that the provider did not release the "Auto Hold" during this time period, resulting in the index's indicative value being incorrectly reported in violation of Section 17(a)(3) ("Use of interstate commerce for purpose of fraud or deceit") of the Securities Act. Had the index's true indicative value been published, investors would have been placed on notice that the index crossed a key threshold enabling the issuer of an exchange-traded note using the index to accelerate or call all outstanding notes.

To settle the charges, the provider agreed to (i) cease and desist from further violations and (ii) a $9 million civil money penalty.

In a statement, SEC Commissioner Hester M. Peirce disagreed with the agency's action against the firm, warning that it may lead to the expansion of the application of securities laws to entities "with even more tenuous connections to the offer and sale of securities." While the firm may have violated its contract with the issuer as a result of its nondisclosure, Ms. Peirce asserted that the firm did not engage with investors or offer or sell a security, thus not rendering its disclosure failures a violation of SA Section 17(a)(3). Ms. Peirce expressed openness towards assessing the need for a regulatory framework for index providers, emphasizing that enforcement actions are not an adequate substitute for rule making.


Section 17(a)(3) of the Securities Act provides, in pertinent part, that: "It shall be unlawful for any person in the offer or sale of any securities . . . by the use of any means . . . to engage in any transaction. . . . "

Thus Ms. Peirce raises an important question: to what extent (if at all) should the regulators stretch their interpretation of their authority to reach conduct that may be inappropriate, but is arguably not within the scope of their authority? As the Commissioner observes, this is a question that has import far beyond this case, and in fact to regulators other than the SEC.

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The settlement strikes an interesting balance. The inclusion of negligence-based violations of Section 17(a)(3) - rather than scienter-based violations under Section 10(b)(5) of the Exchange Act - appears to recognize the unique factual circumstances involved here. At the same time, a $9 million penalty for unintentional conduct seems aggressive, and will likely make index providers reevaluate their disclosures and their policies and procedures for ensuring accuracy.

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