The U.S. regulatory probe into Bill Gross’s Pimco Total Return ETF is separate from a broader scrutiny of disclosure in the exchange-traded fund industry, according to a person familiar with the matter.

The U.S. Securities and Exchange Commission is investigating whether Pacific Investment Management Co. bought smaller lots of bonds at discounts, then marked them up, according to the person, who asked not to be identified because the probe isn’t public. While the SEC is probing disclosure issues surrounding ETFs industrywide, the Pimco case is different from that investigation, the person said.

The Pimco Total Return ETF produced more than twice the return of Gross’s similarly managed mutual fund in the first three months after it was started in March 2012, helping it attract assets faster than any other actively managed ETF. The probe is the latest hurdle faced this year by Pimco, which is dealing with record redemptions at its main mutual fund and negative publicity stemming from the abrupt departure of its former chief executive officer, which was followed by the biggest management overhaul in its history.

“The inquiry comes at a time of mixed performance for Pimco’s franchise product, which has seen significant outflows for 16 consecutive months,” Citigroup Inc. analyst William Katz wrote in a note to clients. “We believe the probe highlights the increased regulatory environment while offers an opportunity for asset managers to take share from Pimco.”

Fastest Growth

ETFs, the fastest-growing product in the asset-management industry, have attracted regulatory scrutiny as assets surged more than tenfold over the past decade to $1.7 trillion in the U.S. as of the end of 2013, according to the Investment Company Institute. Pimco started its Total Return ETF to attract what the firm described at the time as “mom-and-pop investors” and has since gathered $3.6 billion in assets.

Since March 1, 2012, the Pimco Total Return ETF had returned 16 percent through Sept. 23, compared with the 9.1 increase for the mutual fund and 5.6 percent return in the Barclays U.S. Aggregate Index for bonds, according to data compiled by Bloomberg. This year, Pimco Total Return ETF has advanced 5 percent, compared with 3.6 percent for the mutual fund and 4.1 percent for the index.

SEC Probe

The issues being probed by the SEC include whether the exchange-traded fund bought investments at discounted prices while relying on higher valuations for the assets when the fund calculated the value of its holdings, according to the person familiar with the matter. The SEC’s probe into pricing issues at Pimco has been going on for months and the agency’s investigators have interviewed Gross, the person said.

“Pimco has been cooperating with the SEC in this non- public matter, and we take our regulatory obligations and responsibilities to our clients very seriously,” Mark Porterfield, a spokesman for Newport Beach, California-based Pimco, said in an e-mailed statement. “We believe our pricing procedures are entirely appropriate and in keeping with industry best-practices.”

Judith Burns, an SEC spokeswoman, declined to comment.

Pimco’s parent company Allianz SE “has been kept regularly informed by Pimco about the SEC investigation,” spokeswoman Petra Brandes said by telephone.

“What they’re being accused of is in fact the industry standard accounting process,” Dave Nadig, the chief investment officer at, a San Francisco-based ETF research and analysis firm, said in a telephone interview.

‘800-Pound Gorilla’

By law, fund managers have to come up with a price, either by asking dealers for quotes or by extrapolating from data points such as credit rating, size, structure, and comparable securities, Nadig said.

“Because Pimco is an 800-pound gorilla, they negotiate a really good price,” he said. “If the SEC wants to change how bonds are priced, then they can do that, but that’s going to change everybody.”

The ETF attributed some of its outperformance against its benchmark to “an allocation to non-Agency mortgages which benefited from limited supply and a recovery in the housing sector,” according to the latest quarterly report on its website.

While securitized debt represented 47 percent of the ETF’s holdings as of March 2, 2012, more than three quarters of those securities were the most easily valued type of government-backed Fannie Mae and Freddie Mac bonds, which don’t trade at discounts in smaller sizes, according to data compiled by Bloomberg. The same was true at the start of the next month.

The fund is now 25 percent invested in securitized debt, mainly less liquid securities without government backing, the data show.

Using Derivatives

ETFs trade on an exchange and can be bought and sold like stocks. While the majority of them mimic broad market indexes, some like Gross’s Total Return ETF employ an active strategy in which the manager selects securities.

The SEC approved the use of derivatives in the Pimco ETF in August, allowing it to invest in options, futures, or swap agreements. That narrowed one of the biggest differences between it and its mutual fund version.

Gross, 70, is co-founder and chief investment officer of Pimco, which manages about $1.97 trillion in assets. Gross’s Total Return mutual fund has experienced 16 straight months of redemptions as returns trailed rivals and investors sought alternatives to traditional bond strategies in anticipation of rising interest rates. Investors pulled a record $41.1 billion from his Pimco Total Return mutual fund in 2013, and an additional $24.8 billion this year through August, according to estimates by Morningstar Inc. in Chicago.

Pimco bolstered its leadership team in January, in the biggest shakeup in its history, after former CEO Mohamed El- Erian unexpectedly announced his decision to leave the firm. The fund named six deputy chief investment officers and in May brought back Paul McCulley in the newly created position of chief economist, all reporting to Gross.