Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
160 Cards in this Set
- Front
- Back
|
PROFESSIONALISM: all Sub-types |
Knowledge of the Law Independence and Objectivity Misrepresentation Misconduct |
|
|
Misconduct |
Members and Candidates must not engage in any professional conductinvolving dishonesty, fraud, or deceit or commit any act that reflectsadversely on their professional reputation, integrity, or competence. |
|
|
Misrepresentation |
Members and Candidates must not knowingly make any misrepresenta-tions relating to investment analysis, recommendations, actions, or otherprofessional activities. |
|
|
Independence and Objectivity |
Members and Candidates must use reasonable care and judgment to achieveand maintain independence and objectivity in their professional activities.Members and Candidates must not offer, solicit, or accept any gift, benefit,compensation, or consideration that reasonably could be expected to com-promise their own or another’s independence and objectivity. |
|
|
Knowledge of the Law |
Members and Candidates must understand and comply with all appli-cable laws, rules, and regulations (including the CFA Institute Code ofEthics and Standards of Professional Conduct) of any government, regu-latory organization, licensing agency, or professional association govern-ing their professional activities. In the event of conflict, Members andCandidates must comply with the more strict law, rule, or regulation.Members and Candidates must not knowingly participate or assist in andmust dissociate from any violation of such laws, rules, or regulations. |
|
|
Ethics |
set of moral principles or rules of conduct that provideguidance for our behavior when it affects others |
|
|
INTEGRITY OF CAPITAL MARKETS: all Sub-types |
Material Nonpublic Information Market Manipulation |
|
|
Material Nonpublic Information |
Members and Candidates who possess material nonpublic informationthat could affect the value of an investment must not act or cause othersto act on the information. |
|
|
Market Manipulation |
Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants. |
|
|
DUTIES TO CLIENTS |
Loyalty, Prudence, and Care Fair Dealing Suitability Performance Presentation Preservation of Confidentiality |
|
|
Application (Standard) (SUBSTANDARD): Michael Allen works for a brokerage firm and is responsible for an underwriting of securities. A company official gives Allen information indicating that the financial statements Allen filed with the regulator overstate the issuer’s earnings. Allen seeks the advice of the brokerage firm’s general counsel, who states that it would be difficult for the regulator to prove that Allen has been involved in any wrongdoing. |
(1)(Notification of Known Violations): Although it is recommended that members and candidatesseek the advice of legal counsel, the reliance on such advice does notabsolve a member or candidate from the requirement to comply with thelaw or regulation. Allen should report this situation to his supervisor,seek an independent legal opinion, and determine whether the regulatorshould be notified of the error. |
|
|
Application (Standard) (SUBSTANDARD):Lawrence Brown’s employer, an investment banking firm, is the principal underwriterfor an issue of convertible debentures by the Courtney Company. Browndiscovers that the Courtney Company has concealed severe third-quarter lossesin its foreign operations. The preliminary prospectus has already been distributed |
(1)(Dissociating from a Violation): Knowing that the preliminary prospectus is misleading,Brown should report his findings to the appropriate supervisory personsin his firm. If the matter is not remedied and Brown’s employer does notdissociate from the underwriting, Brown should sever all his connectionswith the underwriting. Brown should also seek legal advice to determinewhether additional reporting or other action should be taken. |
|
|
Application (Standard) (SUBSTANDARD): Kamisha Washington’s firm advertises its past performance record by showing the10-year return of a composite of its client accounts. Washington discovers, however,that the composite omits the performance of accounts that have left the firm during the 10-year period, whereas the description of the composite indicates theinclusion of all firm accounts. This omission has led to an inflated performancefigure. Washington is asked to use promotional material that includes the erroneousperformance number when soliciting business for the firm. |
(1) (Dissociating from a Violation): Misrepresenting performance is a violation of the Code andStandards. Although she did not calculate the performance herself,Washington would be assisting in violating Standard I(A) if she were touse the inflated performance number when soliciting clients. She mustdissociate herself from the activity. If discussing the misleading numberwith the person responsible is not an option for correcting the problem,she can bring the situation to the attention of her supervisor or the compliancedepartment at her firm. If her firm is unwilling to recalculateperformance, she must refrain from using the misleading promotionalmaterial and should notify the firm of her reasons. If the firm insists thatshe use the material, she should consider whether her obligation |
|
|
Application (Standard) (SUBSTANDARD): James Collins is an investment analyst for a major Wall Street brokerage firm. Heworks in a developing country with a rapidly modernizing economy and a growingcapital market. Local securities laws are minimal—in form and content—andinclude no punitive prohibitions against insider trading. |
(1) (Following the Highest Requirements): Collins must abide by the requirements of the Code andStandards, which might be more strict than the rules of the developingcountry. He should be aware of the risks that a small market and theabsence of a fairly regulated flow of information to the market representto his ability to obtain information and make timely judgments. Heshould include this factor in formulating his advice to clients. In handlingmaterial nonpublic information that accidentally comes into his possession,he must follow Standard II(A)–Material Nonpublic Information. |
|
|
Application (Standard) (SUBSTANDARD): Laura Jameson works for a multinational investment adviser based in the United States. Jameson lives and works as a registered investment adviser in the tiny, but wealthy, island nation of Karramba. Karramba’s securities laws state that no investment adviser registered and working in that country can participate in initial public offerings (IPOs) for the adviser’s personal account. Jameson, believing that, as a US citizen working for a US-based company, she should comply only with US law, has ignored this Karrambian law. In addition, Jameson believes that as a charterholder, as long as she adheres to the Code and Standards requirement that she disclose her participation in any IPO to her employer and clients when such ownership creates a conflict of interest, she is meeting the highest ethical requirements. |
(1) (Following the Highest Requirements): Jameson is in violation of Standard I(A). As a registered investmentadviser in Karramba, Jameson is prevented by Karrambian securitieslaw from participating in IPOs regardless of the law of her homecountry. In addition, because the law of the country where she is workingis stricter than the Code and Standards, she must follow the stricterrequirements of the local law rather than the requirements of the Codeand Standards. |
|
|
Application (Standard) (SUBSTANDARD): Krista Blume is a junior portfolio manager for high-net-worth portfolios at a large global investment manager. She observes a number of new portfolios and relationships coming from a country in Europe where the firm did not have previous business and is told that a broker in that country is responsible for this new business. At a meeting on allocation of research resources to third-party research firms, Blume notes that this broker has been added to the list and is allocated payments for research. However, she knows the portfolios do not invest in securities in the broker’s country, and she has not seen any research come from this broker. Blume asks her supervisor about the name being on the list and is told that someone in marketing is receiving the research and that the name being on the list is OK. She believes that what may be going on is that the broker is being paid for new business through the inappropriate research payments, and she wishes to dissociate from the misconduct. |
(1) (Reporting Potential Unethical Actions): Blume should follow the firm’s policies and procedures forreporting potential unethical activity, which may include discussions with her supervisor or someone in a designated compliance department. Sheshould communicate her concerns appropriately while advocating for disclosurebetween the new broker relationship and the research payments. |
|
|
Application (Standard) (SUBSTANDARD): Colleen White is excited to use new technology to communicate with clients andpotential clients. She recently began posting investment information, includingperformance reports and investment opinions and recommendations, to herFacebook page. In addition, she sends out brief announcements, opinions, andthoughts via her Twitter account (for example, “Prospects for future growth ofXYZ company look good! #makingmoney4U”). Prior to White’s use of these socialmedia platforms, the local regulator had issued new requirements and guidancegoverning online electronic communication. White’s communications appear toconflict with the recent regulatory announcements. |
(1) (Failure to Maintain Knowledge of the Law): White is in violation of Standard I(A) because her communicationsdo not comply with the existing guidance and regulation governinguse of social media. White must be aware of the evolving legalrequirements pertaining to new and dynamic areas of the financial servicesindustry that are applicable to her. She should seek guidance fromappropriate, knowledgeable, and reliable sources, such as her firm’s compliancedepartment, external service providers, or outside counsel, unlessshe diligently follows legal and regulatory trends affecting her professionalresponsibilities. |
|
|
Duties to Employers |
In matters related to their employment, Members and Candidates mustact for the benefit of their employer and not deprive their employer of theadvantage of their skills and abilities, divulge confidential information, orotherwise cause harm to their employer. Employer Responsibilities Independent Practice Leaving an Employer Use of Social Media Whistleblowing Nature of Employment |
|
|
Steven Taylor, a mining analyst with Bronson Brokers, is invited by Precision Metalsto join a group of his peers in a tour of mining facilities in several western US states.The company arranges for chartered group flights from site to site and for accom-modations in Spartan Motels, the only chain with accommodations near the mines,for three nights. Taylor allows Precision Metals to pick up his tab, as do the otheranalysts, with one exception—John Adams, an employee of a large trust companywho insists on following his company’s policy and paying for his hotel room himself. |
The policy of the company where Adams works compliesclosely with Standard I(B) by avoiding even the appearance of a conflict ofinterest, but Taylor and the other analysts were not necessarily violatingStandard I(B). In general, when allowing companies to pay for travel and/or accommodations in these circumstances, members and candidatesmust use their judgment. They must be on guard that such arrangementsnot impinge on a member’s or candidate’s independence and objectivity. In this example, the trip was strictly for business and Taylor was notaccepting irrelevant or lavish hospitality. The itinerary required charteredflights, for which analysts were not expected to pay. The accommodationswere modest. These arrangements are not unusual and did not violateStandard I(B) as long as Taylor’s independence and objectivity were notcompromised. In the final analysis, members and candidates should con-sider both whether they can remain objective and whether their integritymight be perceived by their clients to have been compromised. (1) (Travel Expenses) |
|
|
Susan Dillon, an analyst in the corporate finance department of an investment ser-vices firm, is making a presentation to a potential new business client that includesthe promise that her firm will provide full research coverage of the potential client. |
Dillon may agree to provide research coverage, but she mustnot commit her firm’s research department to providing a favorable rec-ommendation. The firm’s recommendation (favorable, neutral, or unfa-vorable) must be based on an independent and objective investigation andanalysis of the company and its securities. (1) (Research Independence) |
|
|
Walter Fritz is an equity analyst with Hilton Brokerage who covers the mining indus-try. He has concluded that the stock of Metals & Mining is overpriced at its currentlevel, but he is concerned that a negative research report will hurt the good relation-ship between Metals & Mining and the investment banking division of his firm. Infact, a senior manager of Hilton Brokerage has just sent him a copy of a proposal hisfirm has made to Metals & Mining to underwrite a debt offering. Fritz needs to pro-duce a report right away and is concerned about issuing a less-than-favorable rating. |
Fritz’s analysis of Metals & Mining must be objective andbased solely on consideration of company fundamentals. Any pressurefrom other divisions of his firm is inappropriate. This conflict could havebeen eliminated if, in anticipation of the offering, Hilton Brokerage hadplaced Metals & Mining on a restricted list for its sales force. (1) ( Research Independence and Intrafirm Pressure) |
|
|
As in Example 3, Walter Fritz has concluded that Metals & Mining stock is over-valued at its current level, but he is concerned that a negative research reportmight jeopardize a close rapport that he has nurtured over the years with Metals& Mining’s CEO, chief finance officer, and investment relations officer. Fritz isconcerned that a negative report might result also in management retaliation—forinstance, cutting him off from participating in conference calls when a quarterlyearnings release is made, denying him the ability to ask questions on such calls,and/or denying him access to top management for arranging group meetingsbetween Hilton Brokerage clients and top Metals & Mining managers. |
As in Example 3, Fritz’s analysis must be objective and basedsolely on consideration of company fundamentals. Any pressure fromMetals & Mining is inappropriate. Fritz should reinforce the integrity ofhis conclusions by stressing that his investment recommendation is basedon relative valuation, which may include qualitative issues with respect toMetals & Mining’s management. (1) ( Research Independence and Issuer Relationship Pressure) |
|
|
As support for the sales effort of her corporate bond department, Lindsey Warneroffers credit guidance to purchasers of fixed-income securities. Her compensationis closely linked to the performance of the corporate bond department. Near thequarter’s end, Warner’s firm has a large inventory position in the bonds of Milton, Ltd., and has been unable to sell the bonds because of Milton’s recent announce-ment of an operating problem. Salespeople have asked her to contact large clientsto push the bonds. |
Unethical sales practices create significant potential viola-tions of the Code and Standards. Warner’s opinion of the Milton bondsmust not be affected by internal pressure or compensation. In this case,Warner must refuse to push the Milton bonds unless she is able to justifythat the market price has already adjusted for the operating problem. (1) ( Research Independence and Sales Pressure) |
|
|
Jill Jorund is a securities analyst following airline stocks and a rising star at herfirm. Her boss has been carrying a “buy” recommendation on InternationalAirlines and asks Jorund to take over coverage of that airline. He tells Jorund thatunder no circumstances should the prevailing buy recommendation be changed. |
Jorund must be independent and objective in her analysis ofInternational Airlines. If she believes that her boss’s instructions havecompromised her, she has two options: She can tell her boss that shecannot cover the company under these constraints, or she can take overcoverage of the company, reach her own independent conclusions, andif they conflict with her boss’s opinion, share the conclusions with herboss or other supervisors in the firm so that they can make appropriaterecommendations. Jorund must issue only recommendations that reflecther independent and objective opinion. (1) ( Research Independence and Prior Coverage) |
|
|
Edward Grant directs a large amount of his commission business to a New York–based brokerage house. In appreciation for all the business, the brokerage housegives Grant two tickets to the World Cup in South Africa, two nights at a nearbyresort, several meals, and transportation via limousine to the game. Grant fails todisclose receiving this package to his supervisor. |
Grant has violated Standard I(B) because accepting these substantial gifts may impede his independence and objectivity. Every member and candidate should endeavor to avoid situations that might causeor be perceived to cause a loss of independence or objectivity in recommending investments or taking investment action. By accepting the trip,Grant has opened himself up to the accusation that he may give the broker favored treatment in return. (1) (Gifts and Entertainment from Related Party) |
|
|
Theresa Green manages the portfolio of Ian Knowlden, a client of TisburyInvestments. Green achieves an annual return for Knowlden that is consistently better than that of the benchmark she and the client previously agreed to. As areward, Knowlden offers Green two tickets to Wimbledon and the use of Knowlden’sflat in London for a week. Green discloses this gift to her supervisor at Tisbury. |
Green is in compliance with Standard I(B) because she dis-closed the gift from one of her clients in accordance with the firm’s poli-cies. Members and candidates may accept bonuses or gifts from clientsas long as they disclose them to their employer because gifts in a clientrelationship are deemed less likely to affect a member’s or candidate’sobjectivity and independence than gifts in other situations. Disclosureis required, however, so that supervisors can monitor such situations toguard against employees favoring a gift-giving client to the detriment ofother fee-paying clients (such as by allocating a greater proportion of IPOstock to the gift-giving client’s portfolio). Best practices for monitoring include comparing the transaction costs ofthe Knowlden account with the costs of other accounts managed by Greenand other similar accounts within Tisbury. The supervisor could alsocompare the performance returns with the returns of other clients withthe same mandate. This comparison will assist in determining whether apattern of favoritism by Green is disadvantaging other Tisbury clients orthe possibility that this favoritism could affect her future behavior. (1) (Gifts and Entertainment from Client) |
|
|
Tom Wayne is the investment manager of the Franklin City Employees PensionPlan. He recently completed a successful search for a firm to manage the foreignequity allocation of the plan’s diversified portfolio. He followed the plan’s stan-dard procedure of seeking presentations from a number of qualified firms andrecommended that his board select Penguin Advisors because of its experience,well-defined investment strategy, and performance record. The firm claims com-pliance with the Global Investment Performance Standards (GIPS) and has beenverified. Following the selection of Penguin, a reporter from the Franklin CityRecord calls to ask if there was any connection between this action and the factthat Penguin was one of the sponsors of an “investment fact-finding trip to Asia”that Wayne made earlier in the year. The trip was one of several conducted bythe Pension Investment Academy, which had arranged the itinerary of meetingswith economic, government, and corporate officials in major cities in severalAsian countries. The Pension Investment Academy obtains support for the cost ofthese trips from a number of investment managers, including Penguin Advisors;the Academy then pays the travel expenses of the various pension plan managerson the trip and provides all meals and accommodations. The president of PenguinAdvisors was also one of the travelers on the trip. |
Although Wayne can probably put to good use the knowl-edge he gained from the trip in selecting portfolio managers and in other areas of managing the pension plan, his recommendation of PenguinAdvisors may be tainted by the possible conflict incurred when he participated in a trip partly paid for by Penguin Advisors and when he wasin the daily company of the president of Penguin Advisors. To avoidviolating Standard I(B), Wayne’s basic expenses for travel and accom-modations should have been paid by his employer or the pension plan;contact with the president of Penguin Advisors should have been limitedto informational or educational events only; and the trip, the organizer,and the sponsor should have been made a matter of public record. Evenif his actions were not in violation of Standard I(B), Wayne should havebeen sensitive to the public perception of the trip when reported in thenewspaper and the extent to which the subjective elements of his decisionmight have been affected by the familiarity that the daily contact of sucha trip would encourage. This advantage would probably not be shared byfirms competing with Penguin Advisors. (1) (Travel Expenses from External Manager) |
|
|
Javier Herrero recently left his job as a research analyst for a large investmentadviser. While looking for a new position, he was hired by an investor-relationsfirm to write a research report on one of its clients, a small educational softwarecompany. The investor-relations firm hopes to generate investor interest in thetechnology company. The firm will pay Herrero a flat fee plus a bonus if any newinvestors buy stock in the company as a result of Herrero’s report. |
If Herrero accepts this payment arrangement, he will be inviolation of Standard I(B) because the compensation arrangement canreasonably be expected to compromise his independence and objectivity.Herrero will receive a bonus for attracting investors, which provides anincentive to draft a positive report regardless of the facts and to ignore orplay down any negative information about the company. Herrero shouldaccept only a flat fee that is not tied to the conclusions or recommen-dations of the report. Issuer-paid research that is objective and unbiasedcan be done under the right circumstances as long as the analyst takessteps to maintain his or her objectivity and includes in the report properdisclosures regarding potential conflicts of interest. (1) (Research Independence and Compensation) Arrangements) |
|
|
Two years ago, Bob Wade, trust manager for Central Midas Bank, was approachedby Western Funds about promoting its family of funds, with special interest in theservice-fee class of funds. To entice Central to promote this class, Western Fundsoffered to pay the bank a service fee of 0.25%. Without disclosing the fee beingoffered to the bank, Wade asked one of the investment managers to review Western’sfunds to determine whether they were suitable for clients of Central Midas Bank.The manager completed the normal due diligence review and determined that the new funds were fairly valued in the market with fee structures on a par with competitors. Wade decided to accept Western’s offer and instructed the team of portfo-lio managers to exclusively promote these funds and the service-fee class to clientsseeking to invest new funds or transfer from their current investments. Now, two years later, the funds managed by Western begin to underperformtheir peers. Wade is counting on the fees to reach his profitability targets and con-tinues to push these funds as acceptable investments for Central’s clients. |
Wade is violating Standard I(B) because the fee arrangementhas affected the objectivity of his recommendations. Wade is relying onthe fee as a component of the department’s profitability and is unwillingto offer other products that may affect the fees received. See also Standard VI(A)–Disclosure of Conflicts. (1) (Recommendation Objectivity and Service Fees) |
|
|
Bob Thompson has been doing research for the portfolio manager of the fixed-income department. His assignment is to do sensitivity analysis on securitized sub-prime mortgages. He has discussed with the manager possible scenarios to use tocalculate expected returns. A key assumption in such calculations is housing priceappreciation (HPA) because it drives “prepays” (prepayments of mortgages) andlosses. Thompson is concerned with the significant appreciation experienced overthe previous five years as a result of the increased availability of funds from subprimemortgages. Thompson insists that the analysis should include a scenario run with–10% for Year 1, –5% for Year 2, and then (to project a worst-case scenario) 0% forYears 3 through 5. The manager replies that these assumptions are too dire becausethere has never been a time in their available database when HPA was negative. Thompson conducts his research to better understand the risks inherentin these securities and evaluates these securities in the worst-case scenario, anunlikely but possible environment. Based on the results of the enhanced scenarios,Thompson does not recommend the purchase of the securitization. Against thegeneral market trends, the manager follows Thompson’s recommendation and doesnot invest. The following year, the housing market collapses. In avoiding the sub-prime investments, the manager’s portfolio outperforms its peer group that year. |
Thompson’s actions in running the worst-case scenario againstthe protests of the portfolio manager are in alignment with the principlesof Standard I(B). Thompson did not allow his research to be pressuredby the general trends of the market or the manager’s desire to limit theresearch to historical norms. (1) (Recommendation Objectivity)
See also Standard V(A)–Diligence and Reasonable Basis. |
|
|
Adrian Mandel, CFA, is a senior portfolio manager for ZZYY Capital Managementwho oversees a team of investment professionals who manage labor union pensionfunds. A few years ago, ZZYY sought to win a competitive asset manager searchto manage a significant allocation of the pension fund of the United Doughnutand Pretzel Bakers Union (UDPBU). UDPBU’s investment board is chaired by arecognized key decision maker and long-time leader of the union, Ernesto Gomez.To improve ZZYY’s chances of winning the competition, Mandel made significantmonetary contributions to Gomez’s union reelection campaign fund. Even afterZZYY was hired as a primary manager of the pension, Mandel believed that hisfirm’s position was not secure. Mandel continued to contribute to Gomez’s reelec-tion campaign chest as well as to entertain lavishly the union leader and his fam-ily at top restaurants on a regular basis. All of Mandel’s outlays were routinelyhandled as marketing expenses reimbursed by ZZYY’s expense accounts and weredisclosed to his senior management as being instrumental in maintaining a strongclose relationship with an important client. |
Mandel not only offered but actually gave monetary gifts,benefits, and other considerations that reasonably could be expected tocompromise Gomez’s objectivity. Therefore, Mandel was in violation ofStandard I(B). (1) (Influencing Manager Selection Decisions) |
|
|
Adrian Mandel, CFA, had heard about the manager search competition for theUDPBU Pension Fund through a broker/dealer contact. The contact told himthat a well-known retired professional golfer, Bobby “The Bear” Finlay, who hadbecome a licensed broker/dealer serving as a pension consultant, was orchestrat-ing the UDPBU manager search. Finlay had gained celebrity status with severallabor union pension fund boards by entertaining their respective board membersand regaling them with colorful stories of fellow pro golfers’ antics in clubhousesaround the world. Mandel decided to improve ZZYY’s chances of being invitedto participate in the search competition by befriending Finlay to curry his favor.Knowing Finlay’s love of entertainment, Mandel wined and dined Finlay at high-profile bistros where Finlay could glow in the fan recognition lavished on him byall the other patrons. Mandel’s endeavors paid off handsomely when Finlay rec-ommended to the UDPBU board that ZZYY be entered as one of three finalistasset management firms in its search. |
Similar to Example 13, Mandel lavished gifts, benefits, andother considerations in the form of expensive entertainment that couldreasonably be expected to influence the consultant to recommend thehiring of his firm. Therefore, Mandel was in violation of Standard I(B). (1) (Influencing Manager Selection Decisions) |
|
|
Amie Scott is a performance analyst within her firm with responsibilities for ana-lyzing the performance of external managers. While completing her quarterlyanalysis, Scott notices a change in one manager’s reported composite construc-tion. The change concealed the bad performance of a particularly large accountby placing that account into a new residual composite. This change allowed themanager to remain at the top of the list of manager performance. Scott knowsher firm has a large allocation to this manager, and the fund’s manager is a closepersonal friend of the CEO. She needs to deliver her final report but is concernedwith pointing out the composite change. |
Scott would be in violation of Standard I(B) if she did notdisclose the change in her final report. The analysis of managers’ perfor-mance should not be influenced by personal relationships or the size ofthe allocation to the outside managers. By not including the change, Scottwould not be providing an independent analysis of the performance met-rics for her firm. (1) (Fund Manager Relationships) |
|
|
Jill Stein is head of performance measurement for her firm. During the last quarter,many members of the organization’s research department were removed becauseof the poor quality of their recommendations. The subpar research caused onelarger account holder to experience significant underperformance, which resultedin the client withdrawing his money after the end of the quarter. The head of salesrequests that Stein remove this account from the firm’s performance compositebecause the performance decline can be attributed to the departed research teamand not the client’s adviser. |
Pressure from other internal departments can create situationsthat cause a member or candidate to violate the Code and Standards. Steinmust maintain her independence and objectivity and refuse to excludespecific accounts from the firm’s performance composites to which theybelong. As long as the client invested under a strategy similar to that ofthe defined composite, it cannot be excluded because of the poor stockselections that led to the underperformance and asset withdrawal. (1) (Intrafirm Pressure) |
|
|
Standard I(C) Misrepresentation |
Members and Candidates must not knowingly make any misrepresentationsrelating to investment analysis, recommendations, actions, or other profes-sional activities. |
|
|
Anthony McGuire is an issuer-paid analyst hired by publicly traded companies toelectronically promote their stocks. McGuire creates a website that promotes hisresearch efforts as a seemingly independent analyst. McGuire posts a profile and astrong buy recommendation for each company on the website indicating that thestock is expected to increase in value. He does not disclose the contractual rela-tionships with the companies he covers on his website, in the research reports heissues, or in the statements he makes about the companies in internet chat rooms. |
McGuire has violated Standard I(C) because the websiteis misleading to potential investors. Even if the recommendations arevalid and supported with thorough research, his omissions regardingthe true relationship between himself and the companies he coversconstitute a misrepresentation. McGuire has also violated StandardVI(A)–Disclosure of Conflicts by not disclosing the existence of anarrangement with the companies through which he receives compensa-tion in exchange for his services. (1) (Disclosure of Issuer-Paid Research) |
|
|
Hijan Yao is responsible for the creation and distribution of the marketing materi-als for his firm, which claims compliance with the GIPS standards. Yao createsand distributes a presentation of performance by the firm’s Asian equity compos-ite that states the composite has ¥350 billion in assets. In fact, the composite hasonly ¥35 billion in assets, and the higher figure on the presentation is a result of atypographical error. Nevertheless, the erroneous material is distributed to a num-ber of clients before Yao catches the mistake. |
Once the error is discovered, Yao must take steps to ceasedistribution of the incorrect material and correct the error by inform-ing those who have received the erroneous information. Because Yao didnot knowingly make the misrepresentation, however, he did not violateStandard I(C). Because his firm claims compliance with the GIPS stan-dards, it must also comply with the GIPS Guidance Statement on ErrorCorrection in relation to the error. (1) (Correction of Unintentional Errors) |
|
|
Syed Muhammad is the president of an investment management firm. The pro-motional material for the firm, created by the firm’s marketing department,incorrectly claims that Muhammad has an advanced degree in finance froma prestigious business school in addition to the CFA designation. AlthoughMuhammad attended the school for a short period of time, he did not receive adegree. Over the years, Muhammad and others in the firm have distributed thismaterial to numerous prospective clients and consultants. |
Even though Muhammad may not have been directly respon-sible for the misrepresentation of his credentials in the firm’s promotionalmaterial, he used this material numerous times over an extended periodand should have known of the misrepresentation. Thus, Muhammad hasviolated Standard I(C). (1) (Noncorrection of Known Errors) |
|
|
Cindy Grant, a research analyst for a Canadian brokerage firm, has specialized inthe Canadian mining industry for the past 10 years. She recently read an exten-sive research report on Jefferson Mining, Ltd., by Jeremy Barton, another analyst.Barton provided extensive statistics on the mineral reserves, production capac-ity, selling rates, and marketing factors affecting Jefferson’s operations. He alsonoted that initial drilling results on a new ore body, which had not been madepublic, might show the existence of mineral zones that could increase the life ofJefferson’s main mines, but Barton cited no specific data as to the initial drillingresults. Grant called an officer of Jefferson, who gave her the initial drilling resultsover the telephone. The data indicated that the expected life of the main mineswould be tripled. Grant added these statistics to Barton’s report and circulated itwithin her firm as her own report. |
Grant plagiarized Barton’s report by reproducing large partsof it in her own report without acknowledgment. (1) (Plagiarism) |
|
|
When Ricki Marks sells mortgage-backed derivatives called “interest-only strips”(IOs) to public pension plan clients, she describes them as “guaranteed by the USgovernment.” Purchasers of the IOs are entitled only to the interest stream gener-ated by the mortgages, however, not the notional principal itself. One particularmunicipality’s investment policies and local law require that securities purchasedby its public pension plans be guaranteed by the US government. Although theunderlying mortgages are guaranteed, neither the investor’s investment nor theinterest stream on the IOs is guaranteed. When interest rates decline, causingan increase in prepayment of mortgages, interest payments to the IOs’ investorsdecline, and these investors lose a portion of their investment. |
Marks violated Standard I(C) by misrepresenting the terms and character of the investment. (1) (Misrepresentation of Information) |
|
|
Khalouck Abdrabbo manages the investments of several high-net-worth individu-als in the United States who are approaching retirement. Abdrabbo advises theseindividuals that a portion of their investments be moved from equity to bank-sponsored certificates of deposit and money market accounts so that the principalwill be “guaranteed” up to a certain amount. The interest is not guaranteed. |
Although there is risk that the institution offering the certifi-cates of deposits and money market accounts could go bankrupt, in theUnited States, these accounts are insured by the US government throughthe Federal Deposit Insurance Corporation. Therefore, using the term“guaranteed” in this context is not inappropriate as long as the amountis within the government-insured limit. Abdrabbo should explain thesefacts to the clients. (1) (Potential Information Misrepresentation) |
|
|
Steve Swanson is a senior analyst in the investment research department ofBallard and Company. Apex Corporation has asked Ballard to assist in acquiringthe majority ownership of stock in the Campbell Company, a financial consultingfirm, and to prepare a report recommending that stockholders of Campbell agreeto the acquisition. Another investment firm, Davis and Company, had already pre-pared a report for Apex analyzing both Apex and Campbell and recommendingan exchange ratio. Apex has given the Davis report to Ballard officers, who havepassed it on to Swanson. Swanson reviews the Davis report and other availablematerial on Apex and Campbell. From his analysis, he concludes that the com-mon stocks of Campbell and Apex represent good value at their current prices;he believes, however, that the Davis report does not consider all the factors aCampbell stockholder would need to know to make a decision. Swanson reportshis conclusions to the partner in charge, who tells him to “use the Davis report,change a few words, sign your name, and get it out.” |
If Swanson does as requested, he will violate Standard I(C).He could refer to those portions of the Davis report that he agrees with ifhe identifies Davis as the source; he could then add his own analysis andconclusions to the report before signing and distributing it. (1) (Plagiarism) |
|
|
Claude Browning, a quantitative analyst for Double Alpha, Inc., returns from aseminar in great excitement. At that seminar, Jack Jorrely, a well-known quantita-tive analyst at a national brokerage firm, discussed one of his new models in greatdetail, and Browning is intrigued by the new concepts. He proceeds to test the model, making some minor mechanical changes but retaining the concepts, untilhe produces some very positive results. Browning quickly announces to his super-visors at Double Alpha that he has discovered a new model and that clients andprospective clients should be informed of this positive finding as ongoing proof ofDouble Alpha’s continuing innovation and ability to add value. |
Although Browning tested Jorrely’s model on his own andeven slightly modified it, he must still acknowledge the original source ofthe idea. Browning can certainly take credit for the final, practical results;he can also support his conclusions with his own test. The credit for theinnovative thinking, however, must be awarded to Jorrely. (1) (Plagiarism) |
|
|
Fernando Zubia would like to include in his firm’s marketing materials some“plain-language” descriptions of various concepts, such as the price-to-earnings(P/E) multiple and why standard deviation is used as a measure of risk. The descrip-tions come from other sources, but Zubia wishes to use them without reference tothe original authors. Would this use of material be a violation of Standard I(C)? |
Copying verbatim any material without acknowledgement,including plain-language descriptions of the P/E multiple and standarddeviation, violates Standard I(C). Even though these concepts are general,best practice would be for Zubia to describe them in his own words orcite the sources from which the descriptions are quoted. Members andcandidates would be violating Standard I(C) if they either were respon-sible for creating marketing materials without attribution or knowinglyuse plagiarized materials. (1) (Plagiarism) |
|
|
Through a mainstream media outlet, Erika Schneider learns about a study that shewould like to cite in her research. Should she cite both the mainstream intermedi-ary source as well as the author of the study itself when using that information? |
In all instances, a member or candidate must cite the actualsource of the information. Best practice for Schneider would be to obtainthe information directly from the author and review it before citing it ina report. In that case, Schneider would not need to report how she foundout about the information. For example, suppose Schneider read in theFinancial Times about a study issued by CFA Institute; best practice forSchneider would be to obtain a copy of the study from CFA Institute,review it, and then cite it in her report. If she does not use any interpreta-tion of the report from the Financial Times and the newspaper does notadd value to the report itself, the newspaper is merely a conduit of theoriginal information and does not need to be cited. If she does not obtainthe report and review the information, Schneider runs the risk of relying on second-hand information that may misstate facts. If, for example, theFinancial Times erroneously reported some information from the origi-nal CFA Institute study and Schneider copied that erroneous informationwithout acknowledging CFA Institute, she could be the object of com-plaints. Best practice would be either to obtain the complete study fromits original author and cite only that author or to use the information pro-vided by the intermediary and cite both sources. (1) (Plagiarism) |
|
|
Paul Ostrowski runs a two-person investment management firm. Ostrowski’sfirm subscribes to a service from a large investment research firm that providesresearch reports that can be repackaged by smaller firms for those firms’ clients.Ostrowski’s firm distributes these reports to clients as its own work. |
Ostrowski can rely on third-party research that has a reason-able and adequate basis, but he cannot imply that he is the author of suchresearch. If he does, Ostrowski is misrepresenting the extent of his workin a way that misleads the firm’s clients or prospective clients. (1) (Misrepresentation of Information) |
|
|
Tom Stafford is part of a team within Appleton Investment Management respon-sible for managing a pool of assets for Open Air Bank, which distributes structuredsecurities to offshore clients. He becomes aware that Open Air is promoting thestructured securities as a much less risky investment than the investment manage-ment policy followed by him and the team to manage the original pool of assets.Also, Open Air has procured an independent rating for the pool that significantlyoverstates the quality of the investments. Stafford communicates his concerns tohis supervisor, who responds that Open Air owns the product and is responsiblefor all marketing and distribution. Stafford’s supervisor goes on to say that theproduct is outside of the US regulatory regime that Appleton follows and that allrisks of the product are disclosed at the bottom of page 184 of the prospectus. |
As a member of the investment team, Stafford is qualified torecognize the degree of accuracy of the materials that characterize theportfolio, and he is correct to be worried about Appleton’s responsibilityfor a misrepresentation of the risks. Thus, he should continue to pursuethe issue of Open Air’s inaccurate promotion of the portfolio accordingto the firm’s policies and procedures. The Code and Standards stress protecting the reputation of the firm andthe sustainability and integrity of the capital markets. Misrepresentingthe quality and risks associated with the investment pool may lead tonegative consequences for others well beyond the direct investors. (1) (Misrepresentation of Information) |
|
|
Trina Smith is a fixed-income portfolio manager at a pension fund. She hasobserved that the market for highly structured mortgages is the focus of sales-people she meets and that these products represent a significant number of trad-ing opportunities. In discussions about this topic with her team, Smith learns thatcalculating yields on changing cash flows within the deal structure requires veryspecialized vendor software. After more research, they find out that each deal isunique and that deals can have more than a dozen layers and changing cash flowpriorities. Smith comes to the conclusion that, because of the complexity of thesesecurities, the team cannot effectively distinguish between potentially good andbad investment options. To avoid misrepresenting their understanding, the teamdecides that the highly structured mortgage segment of the securitized marketshould not become part of the core of the fund’s portfolio; they will allow some ofthe less complex securities to be part of the core. |
Smith is in compliance with Standard I(C) by not investing insecurities that she and her team cannot effectively understand. Becauseshe is not able to describe the risk and return profile of the securities tothe pension fund beneficiaries and trustees, she appropriately limits thefund’s exposure to this sector. (1) ( Avoiding a Misrepresentation) |
|
|
Robert Palmer is head of performance for a fund manager. When asked to pro-vide performance numbers to fund rating agencies, he avoids mentioning that thefund manager is quite liberal in composite construction. The reason accounts areincluded/excluded is not fully explained. The performance values reported to therating agencies for the composites, although accurate for the accounts shown eachperiod, may not present a true representation of the fund manager’s ability. |
“Cherry picking” accounts to include in either publishedreports or information provided to rating agencies conflicts with StandardI(C). Moving accounts into or out of a composite to influence the overallperformance results materially misrepresents the reported values overtime. Palmer should work with his firm to strengthen its reporting prac-tices concerning composite construction to avoid misrepresenting thefirm’s track record or the quality of the information being provided. (1) (Misrepresenting Composite Construction) |
|
|
David Finch is a sales director at a commercial bank, where he directs the bank’sclient advisers in the sale of third-party mutual funds. Each quarter, he holds adivision-wide training session where he provides fact sheets on investment fundsthe bank is allowed to offer to clients. These fact sheets, which can be redistrib-uted to potential clients, are created by the fund firms and contain informationabout the funds, including investment strategy and target distribution rates. Finch knows that some of the fact sheets are out of date; for example, onelong-only fund approved the use of significant leverage last quarter as a methodto enhance returns. He continues to provide the sheets to the sales team withoutupdates because the bank has no control over the marketing material released bythe mutual fund firms. |
Finch is violating Standard I(C) by providing informationthat misrepresents aspects of the funds. By not providing the sales teamand, ultimately, the clients with the updated information, he is misrepre-senting the potential risks associated with the funds with outdated factsheets. Finch can instruct the sales team to clarify the deficiencies in thefact sheets with clients and ensure they have the most recent fund pro-spectus document before accepting orders for investing in any fund. (1) (Presenting Out-of-Date Information) |
|
|
Bob Anderson is chief compliance officer for Optima Asset Management Company,a firm currently offering eight funds to clients. Seven of the eight had 10-year returnsbelow the median for their respective sectors. Anderson approves a recent adver-tisement, which includes this statement: “Optima Asset Management is achievingexcellent returns for its investors. The Optima Emerging Markets Equity fund, forexample, has 10-year returns that exceed the sector median by more than 10%.” |
From the information provided it is difficult to determinewhether a violation has occurred as long as the sector outperformanceis correct. Anderson may be attempting to mislead potential clients byciting the performance of the sole fund that achieved such results. Pastperformance is often used to demonstrate a firm’s skill and abilities incomparison to funds in the same sectors. However, if all the funds outperformed their respective benchmarks, thenAnderson’s assertion that the company “is achieving excellent returns”may be factual. Funds may exhibit positive returns for investors, exceedbenchmarks, and yet have returns below the median in their sectors. Members and candidates need to ensure that their marketing effortsdo not include statements that misrepresent their skills and abilities toremain compliant with Standard I(C). Unless the returns of a single fundreflect the performance of a firm as a whole, the use of a singular fund forperformance comparisons should be avoided. (1) (Overemphasis of Firm Results) |
|
|
Standard I(D) Misconduct |
Members and Candidates must not engage in any professional conductinvolving dishonesty, fraud, or deceit or commit any act that reflectsadversely on their professional reputation, integrity, or competence. |
|
|
Simon Sasserman is a trust investment officer at a bank in a small affluent town.He enjoys lunching every day with friends at the country club, where his clientshave observed him having numerous drinks. Back at work after lunch, he clearlyis intoxicated while making investment decisions. His colleagues make a point ofhandling any business with Sasserman in the morning because they distrust hisjudgment after lunch. |
Sasserman’s excessive drinking at lunch and subsequentintoxication at work constitute a violation of Standard I(D) because thisconduct has raised questions about his professionalism and competence.His behavior reflects poorly on him, his employer, and the investmentindustry. (1) (Professionalism and Competence) |
|
|
Howard Hoffman, a security analyst at ATZ Brothers, Inc., a large brokeragehouse, submits reimbursement forms over a two-year period to ATZ’s self-fundedhealth insurance program for more than two dozen bills, most of which havebeen altered to increase the amount due. An investigation by the firm’s director ofemployee benefits uncovers the inappropriate conduct. ATZ subsequently termi-nates Hoffman’s employment and notifies CFA Institute. |
Hoffman violated Standard I(D) because he engaged in inten-tional conduct involving fraud and deceit in the workplace that adverselyreflected on his integrity. (1) (Fraud and Deceit) |
|
|
Jody Brink, an analyst covering the automotive industry, volunteers much of herspare time to local charities. The board of one of the charitable institutions decidesto buy five new vans to deliver hot lunches to low-income elderly people. Brinkoffers to donate her time to handle purchasing agreements. To pay a long-standingdebt to a friend who operates an automobile dealership—and to compensate herselffor her trouble—she agrees to a price 20% higher than normal and splits the sur-charge with her friend. The director of the charity ultimately discovers the schemeand tells Brink that her services, donated or otherwise, are no longer required. |
Brink engaged in conduct involving dishonesty, fraud, andmisrepresentation and has violated Standard I(D). (1) (Fraud and Deceit) |
|
|
Carmen Garcia manages a mutual fund dedicated to socially responsible investing.She is also an environmental activist. As the result of her participation in nonvio-lent protests, Garcia has been arrested on numerous occasions for trespassing on theproperty of a large petrochemical plant that is accused of damaging the environment. |
Generally, Standard I(D) is not meant to cover legal trans-gressions resulting from acts of civil disobedience in support of personalbeliefs because such conduct does not reflect poorly on the member’s orcandidate’s professional reputation, integrity, or competence. (1) (Personal Actions and Integrity) |
|
|
Meredith Rasmussen works on a buy-side trading desk of an investment managementfirm and concentrates on in-house trades for a hedge fund subsidiary managed by ateam at the investment management firm. The hedge fund has been very successfuland is marketed globally by the firm. From her experience as the trader for much ofthe activity of the fund, Rasmussen has become quite knowledgeable about the hedgefund’s strategy, tactics, and performance. When a distinct break in the market occursand many of the securities involved in the hedge fund’s strategy decline markedly invalue, Rasmussen observes that the reported performance of the hedge fund does notreflect this decline. In her experience, the lack of effect is a very unlikely occurrence.She approaches the head of trading about her concern and is told that she should notask any questions and that the fund is big and successful and is not her concern. Sheis fairly sure something is not right, so she contacts the compliance officer, who alsotells her to stay away from the issue of the hedge fund’s reporting. |
Rasmussen has clearly come across an error in policies, procedures, and compliance practices within the firm’s operations. Accordingto the firm’s procedures for reporting potentially unethical activity, sheshould pursue the issue by gathering some proof of her reason for doubt.Should all internal communications within the firm not satisfy her concerns, Rasmussen should consider reporting the potential unethicalactivity to the appropriate regulator. (1) (Professional Misconduct) See also Standard IV(A) for guidance on whistleblowing and StandardIV(C) for the duties of a supervisor. |
|
|
Standard II |
Integrity of Capital Markets |
|
|
Standard II(A) Material Nonpublic Information |
Members and Candidates who possess material nonpublic information thatcould affect the value of an investment must not act or cause others to act onthe information. |
|
|
Frank Barnes, the president and controlling shareholder of the SmartTown cloth-ing chain, decides to accept a tender offer and sell the family business at a pricealmost double the market price of its shares. He describes this decision to his sister(SmartTown’s treasurer), who conveys it to her daughter (who owns no stock in thefamily company at present), who tells her husband, Staple. Staple, however, tells hisstockbroker, Alex Halsey, who immediately buys SmartTown stock for himself. |
The information regarding the pending sale is both materialand nonpublic. Staple has violated Standard II(A) by communicating theinside information to his broker. Halsey also has violated the standard bybuying the shares on the basis of material nonpublic information. (2) (Acting on Nonpublic Information) |
|
|
Samuel Peter, an analyst with Scotland and Pierce Incorporated, is assisting hisfirm with a secondary offering for Bright Ideas Lamp Company. Peter participates,via telephone conference call, in a meeting with Scotland and Pierce investmentbanking employees and Bright Ideas’ CEO. Peter is advised that the company’searnings projections for the next year have significantly dropped. Throughoutthe telephone conference call, several Scotland and Pierce salespeople and port-folio managers walk in and out of Peter’s office, where the telephone call is tak-ing place. As a result, they are aware of the drop in projected earnings for BrightIdeas. Before the conference call is concluded, the salespeople trade the stock ofthe company on behalf of the firm’s clients and other firm personnel trade thestock in a firm proprietary account and in employees’ personal accounts. |
Peter has violated Standard II(A) because he failed to preventthe transfer and misuse of material nonpublic information to others in hisfirm. Peter’s firm should have adopted information barriers to prevent thecommunication of nonpublic information between departments of thefirm. The salespeople and portfolio managers who traded on the informa-tion have also violated Standard II(A) by trading on inside information. (2) (Controlling Nonpublic Information) |
|
|
Elizabeth Levenson is based in Taipei and covers the Taiwanese market for herfirm, which is based in Singapore. She is invited, together with the other 10 largest shareholders of a manufacturing company, to meet the finance director ofthat company. During the meeting, the finance director states that the companyexpects its workforce to strike next Friday, which will cripple productivity and dis-tribution. Can Levenson use this information as a basis to change her rating onthe company from “buy” to “sell”? |
Levenson must first determine whether the material infor-mation is public. According to Standard II(A), if the company has notmade this information public (a small group forum does not qualify as amethod of public dissemination), she cannot use the information. (2) (Selective Disclosure of Material Information) |
|
|
Leah Fechtman is trying to decide whether to hold or sell shares of an oil-and-gasexploration company that she owns in several of the funds she manages. Althoughthe company has underperformed the index for some time already, the trends in theindustry sector signal that companies of this type might become takeover targets.While she is considering her decision, her doctor, who casually follows the markets,mentions that she thinks that the company in question will soon be bought out by alarge multinational conglomerate and that it would be a good idea to buy the stockright now. After talking to various investment professionals and checking theiropinions on the company as well as checking industry trends, Fechtman decidesthe next day to accumulate more stock in the oil-and-gas exploration company. |
Although information on an expected takeover bid may be ofthe type that is generally material and nonpublic, in this case, the sourceof information is unreliable, so the information cannot be consideredmaterial. Therefore, Fechtman is not prohibited from trading the stock onthe basis of this information. (2) (Determining Materiality) |
|
|
Jagdish Teja is a buy-side analyst covering the furniture industry. Looking for anattractive company to recommend as a buy, he analyzes several furniture makers bystudying their financial reports and visiting their operations. He also talks to somedesigners and retailers to find out which furniture styles are trendy and popular. Although none of the companies that he analyzes are a clear buy, he discovers thatone of them, Swan Furniture Company (SFC), may be in financial trouble. SFC’sextravagant new designs have been introduced at substantial cost. Even thoughthese designs initially attracted attention, the public is now buying more conserva-tive furniture from other makers. Based on this information and on a profit-and-loss analysis, Teja believes that SFC’s next quarter earnings will drop substantially.He issues a sell recommendation for SFC. Immediately after receiving that recom-mendation, investment managers start reducing the SFC stock in their portfolios. |
Information on quarterly earnings data is material and non-public. Teja arrived at his conclusion about the earnings drop on the basisof public information and on pieces of nonmaterial nonpublic informa-tion (such as opinions of designers and retailers). Therefore, trading basedon Teja’s correct conclusion is not prohibited by Standard II(A). (2) (Applying the Mosaic Theory) |
|
|
Roger Clement is a senior financial analyst who specializes in the European auto-mobile sector at Rivoli Capital. Because he has been repeatedly nominated bymany leading industry magazines and newsletters as a “best analyst” for the auto-mobile industry, he is widely regarded as an authority on the sector. After speak-ing with representatives of Turgot Chariots—a European auto manufacturer withsales primarily in South Korea—and after conducting interviews with salespeople,labor leaders, his firm’s Korean currency analysts, and banking officials, Clementanalyzed Turgot Chariots and concluded that (1) its newly introduced model willprobably not meet sales expectations, (2) its corporate restructuring strategy maywell face serious opposition from unions, (3) the depreciation of the Korean wonshould lead to pressure on margins for the industry in general and Turgot’s marketsegment in particular, and (4) banks could take a tougher-than-expected stancein the upcoming round of credit renegotiations with the company. For these rea-sons, he changes his conclusion about the company from “market outperform” to“market underperform.” Clement retains the support material used to reach hisconclusion in case questions later arise. |
To reach a conclusion about the value of the company, Clementhas pieced together a number of nonmaterial or public bits of informationthat affect Turgot Chariots. Therefore, under the mosaic theory, Clementhas not violated Standard II(A) in drafting the report. (2) (Applying the Mosaic Theory) |
|
|
The next day, Clement is preparing to be interviewed on a global financial newstelevision program where he will discuss his changed recommendation on TurgotChariots for the first time in public. While preparing for the program, he mentionsto the show’s producers and Mary Zito, the journalist who will be interviewing him,the information he will be discussing. Just prior to going on the air, Zito sells her holdings in Turgot Chariots. She also phones her father with the information because she knows that he and other family members have investments in Turgot Chariots. |
When Zito receives advance notice of Clement’s change ofopinion, she knows it will have a material impact on the stock price, evenif she is not totally aware of Clement’s underlying reasoning. She is nota client of Clement but obtains early access to the material nonpublicinformation prior to publication. Her trades are thus based on materialnonpublic information and violate Standard II(A). Zito further violates the Standard by relaying the information to her father.It would not matter if he or any other family member traded; the act ofproviding the information violates Standard II(A). The fact that the infor-mation is provided to a family member does not absolve someone of theprohibition of using or communicating material nonpublic information. (2) (Analyst Recommendations as Material Nonpublic Information) |
|
|
Ashton Kellogg is a retired investment professional who manages his own portfo-lio. He owns shares in National Savings, a large local bank. A close friend and golf-ing buddy, John Mayfield, is a senior executive at National. National has seen itsstock price drop considerably, and the news and outlook are not good. In a conver-sation about the economy and the banking industry on the golf course, Mayfieldrelays the information that National will surprise the investment community ina few days when it announces excellent earnings for the quarter. Kellogg is pleas-antly surprised by this information, and thinking that Mayfield, as a senior exec-utive, knows the law and would not disclose inside information, he doubles hisposition in the bank. Subsequently, National announces that it had good operatingearnings but had to set aside reserves for anticipated significant losses on its loanportfolio. The combined news causes the stock to go down 60%. |
Even though Kellogg believes that Mayfield would not breakthe law by disclosing inside information and money was lost on the pur-chase, Kellogg should not have purchased additional shares of National. Itis the member’s or candidate’s responsibility to make sure, before execut-ing investment actions, that comments about earnings are not materialnonpublic information. Kellogg has violated Standard II(A). (2) (Acting on Nonpublic Information) |
|
|
John Doll is a research analyst for a hedge fund that also sells its research to aselect group of paying client investment firms. Doll’s focus is medical technology companies and products, and he has been in the business long enough andhas been successful enough to build up a very credible network of friends andexperts in the business. Doll has been working on a major research report recom-mending Boyce Health, a medical device manufacturer. He recently ran into anold acquaintance at a wedding who is a senior executive at Boyce, and Doll asked about the business. Doll was drawn to a statement that the executive, who hasresponsibilities in the new products area, made about a product: “I would not gettoo excited about the medium-term prospects; we have a lot of work to do first.”Doll incorporated this and other information about the new Boyce product in hislong-term recommendation of Boyce. |
Doll’s conversation with the senior executive is part of themosaic of information used in recommending Boyce. When holding dis-cussions with a firm executive, Doll would need to guard against solic-iting or obtaining material nonpublic information. Before issuing thereport, the executive’s statement about the continuing development ofthe product would need to be weighed against the other known publicfacts to determine whether it would be considered material. (2) (Mosaic Theory) |
|
|
Larry Nadler, a trader for a mutual fund, gets a text message from another firm’strader, whom he has known for years. The message indicates a software companyis going to report strong earnings when the firm publicly announces in two days.Nadler has a buy order from a portfolio manager within his firm to purchaseseveral hundred thousand shares of the stock. Nadler is aggressive in placing theportfolio manager’s order and completes the purchases by the following morning,a day ahead of the firm’s planned earnings announcement. |
There are often rumors and whisper numbers before a releaseof any kind. The text message from the other trader would most likelybe considered market noise. Unless Nadler knew that the trader had anongoing business relationship with the public firm, he had no reason tosuspect he was receiving material nonpublic information that would pre-vent him from completing the trading request of the portfolio manager. (2) (Materiality Determination) |
|
|
Mary McCoy is the senior drug analyst at a mutual fund. Her firm hires a servicethat connects her to experts in the treatment of cancer. Through various phoneconversations, McCoy enhances her understanding of the latest therapies for suc-cessful treatment. This information is critical to Mary making informed recom-mendations of the companies producing these drugs. |
McCoy is appropriately using the expert networks to enhanceher evaluation process. She has neither asked for nor received informa-tion that may be considered material and nonpublic, such as preliminarytrial results. McCoy is allowed to seek advice from professionals withinthe industry that she follows. (2) (Using an Expert Network) |
|
|
Tom Watson is a research analyst working for a hedge fund. To stay informed,Watson relies on outside experts for information on such industries as technol-ogy and pharmaceuticals, where new advancements occur frequently. The meet-ings with the industry experts often are arranged through networks or placementagents that have specific policies and procedures in place to deter the exchange ofmaterial nonpublic information. Watson arranges a call to discuss future prospects for one of the fund’s exist-ing technology company holdings, a company that was testing a new semicon-ductor product. The scientist leading the tests indicates his disappointment withthe performance of the new semiconductor. Following the call, Watson relays theinsights he received to others at the fund. The fund sells its current position in thecompany and buys put options because the market is anticipating the success ofthe new semiconductor and the share price reflects the market’s optimism. |
Watson has violated Standard II(A) by passing along materialnonpublic information concerning the ongoing product tests, which thefund used to trade in the securities and options of the related company.Watson cannot simply rely on the agreements signed by individuals whoparticipate in expert networks that state that he has not received information that would prohibit his trading activity. He must make his own deter-mination whether information he received through these arrangementsreaches a materiality threshold that would affect his trading abilities. (2) (Using an Expert Network) |
|
|
Standard II(B) Market Manipulation |
Members and Candidates must not engage in practices that distort prices orartificially inflate trading volume with the intent to mislead market participants. |
|
|
The principal owner of Financial Information Services (FIS) entered into an agree-ment with two microcap companies to promote the companies’ stock in exchangefor stock and cash compensation. The principal owner caused FIS to disseminatee-mails, design and maintain several websites, and distribute an online investmentnewsletter—all of which recommended investment in the two companies. The sys-tematic publication of purportedly independent analyses and recommendationscontaining inaccurate and highly promotional and speculative statements increasedpublic investment in the companies and led to dramatically higher stock prices. |
The principal owner of FIS violated Standard II(B) by usinginaccurate reporting and misleading information under the guise of inde-pendent analysis to artificially increase the stock price of the companies.Furthermore, the principal owner violated Standard V(A)–Diligence andReasonable Basis by not having a reasonable and adequate basis for recommending the two companies and violated Standard VI(A)–Disclosureof Conflicts by not disclosing to investors the compensation agreements(which constituted a conflict of interest). (2) (Independent Analysis and Company Promotion) |
|
|
John Gray is a private investor in Belgium who bought a large position several yearsago in Fame Pharmaceuticals, a German small-cap security with limited averagetrading volume. He has now decided to significantly reduce his holdings owing tothe poor price performance. Gray is worried that the low trading volume for thestock may cause the price to decline further as he attempts to sell his large position. Gray devises a plan to divide his holdings into multiple accounts in differentbrokerage firms and private banks in the names of family members, friends, and even a private religious institution. He then creates a rumor campaign on variousblogs and social media outlets promoting the company. Gray begins to buy and sell the stock using the accounts in hopes of raisingthe trading volume and the price. He conducts the trades through multiple brokers,selling slightly larger positions than he bought on a tactical schedule, and over time,he is able to reduce his holding as desired without negatively affecting the sale price. |
John violated Standard II(B) by fraudulently creating theappearance that there was a greater investor interest in the stock throughthe online rumors. Additionally, through his trading strategy, he createdthe appearance that there was greater liquidity in the stock than actuallyexisted. He was able to manipulate the price through both misinforma-tion and trading practices. (2) (Personal Trading Practices and Price) |
|
|
Matthew Murphy is an analyst at Divisadero Securities & Co., which has a signifi-cant number of hedge funds among its most important brokerage clients. Some ofthe hedge funds hold short positions on Wirewolf Semiconductor. Two trading daysbefore the publication of a quarter-end report, Murphy alerts his sales force that he isabout to issue a research report on Wirewolf that will include the following opinions: quarterly revenues are likely to fall short of management’s guidance, earnings will be as much as 5 cents per share (or more than 10%) below con-sensus, and Wirewolf’s highly respected chief financial officer may be about to joinanother company. Knowing that Wirewolf has already entered its declared quarter-end “quietperiod” before reporting earnings (and thus would be reluctant to respond to rumors),Murphy times the release of his research report specifically to sensationalize thenegative aspects of the message in order to create significant downward pressure onWirewolf’s stock—to the distinct advantage of Divisadero’s hedge fund clients. Thereport’s conclusions are based on speculation, not on fact. The next day, the researchreport is broadcast to all of Divisadero’s clients and to the usual newswire services. Before Wirewolf’s investor-relations department can assess the damage onthe final trading day of the quarter and refute Murphy’s report, its stock openstrading sharply lower, allowing Divisadero’s clients to cover their short positionsat substantial gains. |
Murphy violated Standard II(B) by aiming to create artificialprice volatility designed to have a material impact on the price of an issuer’sstock. Moreover, by lacking an adequate basis for the recommendation,Murphy also violated Standard V(A)–Diligence and Reasonable Basis. (2) (Creating Artificial Price Volatility) |
|
|
Rajesh Sekar manages two funds—an equity fund and a balanced fund—whoseequity components are supposed to be managed in accordance with the samemodel. According to that model, the funds’ holdings in stock of Digital DesignInc. (DD) are excessive. Reduction of the DD holdings would not be easy, how-ever, because the stock has low liquidity in the stock market. Sekar decides tostart trading larger portions of DD stock back and forth between his two funds toslowly increase the price; he believes market participants will see growing volumeand increasing price and become interested in the stock. If other investors arewilling to buy the DD stock because of such interest, then Sekar will be able to getrid of at least some of his overweight position without inducing price decreases. Inthis way, the whole transaction will be for the benefit of fund participants, even ifadditional brokers’ commissions are incurred. |
Sekar’s plan would be beneficial for his funds’ participants butis based on artificial distortion of both trading volume and the price ofthe DD stock and thus constitutes a violation of Standard II(B). (2) (Personal Trading and Volume) |
|
|
ACME Futures Exchange is launching a new bond futures contract. To con-vince investors, traders, arbitrageurs, hedgers, and so on, to use its contract, theexchange attempts to demonstrate that it has the best liquidity. To do so, it entersinto agreements with members in which they commit to a substantial minimumtrading volume on the new contract over a specific period in exchange for sub-stantial reductions of their regular commissions. |
The formal liquidity of a market is determined by the obligations set on market makers, but the actual liquidity of a market is betterestimated by the actual trading volume and bid–ask spreads. Attempts tomislead participants about the actual liquidity of the market constitutea violation of Standard II(B). In this example, investors have been inten-tionally misled to believe they chose the most liquid instrument for somespecific purpose, but they could eventually see the actual liquidity of thecontract significantly reduced after the term of the agreement expires. Ifthe ACME Futures Exchange fully discloses its agreement with membersto boost transactions over some initial launch period, it will not violateStandard II(B). ACME’s intent is not to harm investors but, on the con-trary, to give them a better service. For that purpose, it may engage in aliquidity-pumping strategy, but the strategy must be disclosed. (2) (“Pump-Priming” Strategy) |
|
|
Emily Gordon, an analyst of household products companies, is employed by aresearch boutique, Picador & Co. Based on information that she has gathered dur-ing a trip through Latin America, she believes that Hygene, Inc., a major marketer of personal care products, has generated better-than-expected sales from its newproduct initiatives in South America. After modestly boosting her projections forrevenue and for gross profit margin in her worksheet models for Hygene, Gordonestimates that her earnings projection of US$2.00 per diluted share for the currentyear may be as much as 5% too low. She contacts the chief financial officer (CFO)of Hygene to try to gain confirmation of her findings from her trip and to get somefeedback regarding her revised models. The CFO declines to comment and reiter-ates management’s most recent guidance of US$1.95–US$2.05 for the year. Gordon decides to try to force a comment from the company by tellingPicador & Co. clients who follow a momentum investment style that consensusearnings projections for Hygene are much too low; she explains that she is con-sidering raising her published estimate by an ambitious US$0.15 to US$2.15 pershare. She believes that when word of an unrealistically high earnings projectionfilters back to Hygene’s investor-relations department, the company will feel com-pelled to update its earnings guidance. Meanwhile, Gordon hopes that she is atleast correct with respect to the earnings direction and that she will help clientswho act on her insights to profit from a quick gain by trading on her advice. |
By exaggerating her earnings projections in order to try to fuela quick gain in Hygene’s stock price, Gordon is in violation of StandardII(B). Furthermore, by virtue of previewing her intentions of revisingupward her earnings projections to only a select group of clients, she isin violation of Standard III(B)–Fair Dealing. However, it would have beenacceptable for Gordon to write a report that framed her earnings projection in a range of possible outcomes, outlined clearly the assumptions used in her Hygene models thattook into consideration the findings from her trip through LatinAmerica, and was distributed to all Picador & Co. clients in an equitable manner. (2) (Creating Artificial Price Volatility) |
|
|
In an effort to pump up the price of his holdings in Moosehead & Belfast RailroadCompany, Steve Weinberg logs on to several investor chat rooms on the internetto start rumors that the company is about to expand its rail network in anticipa-tion of receiving a large contract for shipping lumber. |
Weinberg has violated Standard II(B) by disseminating falseinformation about Moosehead & Belfast with the intent to mislead mar-ket participants. (2) (Pump and Dump Strategy) |
|
|
Bill Mandeville supervises a structured financing team for Superior InvestmentBank. His responsibilities include packaging new structured investment products and managing Superior’s relationship with relevant rating agencies. To achievethe best rating possible, Mandeville uses mostly positive scenarios as modelinputs—scenarios that reflect minimal downside risk in the assets underlyingthe structured products. The resulting output statistics in the rating request andunderwriting prospectus support the idea that the new structured products haveminimal potential downside risk. Additionally, Mandeville’s compensation fromSuperior is partially based on both the level of the rating assigned and the suc-cessful sale of new structured investment products but does not have a link to thelong-term performance of the instruments. Mandeville is extremely successful and leads Superior as the top originatorof structured investment products for the next two years. In the third year, theeconomy experiences difficulties and the values of the assets underlying struc-tured products significantly decline. The subsequent defaults lead to major tur-moil in the capital markets, the demise of Superior Investment Bank, and the lossof Mandeville’s employment. |
Mandeville manipulates the inputs of a model to minimizeassociated risk to achieve higher ratings. His understanding of structuredproducts allows him to skillfully decide which inputs to include in support of the desired rating and price. This information manipulation forshort-term gain, which is in violation of Standard II(B), ultimately causessignificant damage to many parties and the capital markets as a whole.Mandeville should have realized that promoting a rating and price withinaccurate information could cause not only a loss of price confidence inthe particular structured product but also a loss of investor trust in thesystem. Such loss of confidence affects the ability of the capital marketsto operate efficiently. (2) (Manipulating Model Inputs) |
|
|
Allen King is a performance analyst for Torrey Investment Funds. King believesthat the portfolio manager for the firm’s small- and microcap equity fund dislikeshim because the manager never offers him tickets to the local baseball team’sgames but does offer tickets to other employees. To incite a potential regulatoryreview of the manager, King creates user profiles on several online forums underthe portfolio manager’s name and starts rumors about potential mergers for sev-eral of the smaller companies in the portfolio. As the prices of these companies’stocks increase, the portfolio manager sells the position, which leads to an investi-gation by the regulator as King desired. |
King has violated Standard II(B) even though he did not per-sonally profit from the market’s reaction to the rumor. In posting thefalse information, King misleads others into believing the companieswere likely to be acquired. Although his intent was to create trouble forthe portfolio manager, his actions clearly manipulated the factual infor-mation that was available to the market. (2) (Information Manipulation) |
|
|
Standard III |
Duties to Clients |
|
|
Standard III(A) Loyalty, Prudence, and Care |
Members and Candidates have a duty of loyalty to their clients and mustact with reasonable care and exercise prudent judgment. Members andCandidates must act for the benefit of their clients and place their clients’interests before their employer’s or their own interests. |
|
|
First Country Bank serves as trustee for the Miller Company’s pension plan.Miller is the target of a hostile takeover attempt by Newton, Inc. In attempting toward off Newton, Miller’s managers persuade Julian Wiley, an investment man-ager at First Country Bank, to purchase Miller common stock in the open marketfor the employee pension plan. Miller’s officials indicate that such action wouldbe favorably received and would probably result in other accounts being placedwith the bank. Although Wiley believes the stock is overvalued and would notordinarily buy it, he purchases the stock to support Miller’s managers, to main-tain Miller’s good favor toward the bank, and to realize additional new business.The heavy stock purchases cause Miller’s market price to rise to such a level thatNewton retracts its takeover bid. |
Standard III(A) requires that a member or candidate, in eval-uating a takeover bid, act prudently and solely in the interests of planparticipants and beneficiaries. To meet this requirement, a member orcandidate must carefully evaluate the long-term prospects of the com-pany against the short-term prospects presented by the takeover offer andby the ability to invest elsewhere. In this instance, Wiley, acting on behalfof his employer, which was the trustee for a pension plan, clearly violatedStandard III(A). He used the pension plan to perpetuate existing management, perhaps to the detriment of plan participants and the company’sshareholders, and to benefit himself. Wiley’s responsibilities to the planparticipants and beneficiaries should have taken precedence over any tiesof his bank to corporate managers and over his self-interest. Wiley hada duty to examine the takeover offer on its own merits and to make anindependent decision. The guiding principle is the appropriateness of theinvestment decision to the pension plan, not whether the decision ben-efited Wiley or the company that hired him. (3) (Identifying the Client—Plan Participants) |
|
|
JNI, a successful investment counseling firm, serves as investment manager forthe pension plans of several large regionally based companies. Its trading activi-ties generate a significant amount of commission-related business. JNI uses thebrokerage and research services of many firms, but most of its trading activity ishandled through a large brokerage company, Thompson, Inc., because the execu-tives of the two firms have a close friendship. Thompson’s commission structure ishigh in comparison with charges for similar brokerage services from other firms.JNI considers Thompson’s research services and execution capabilities average. Inexchange for JNI directing its brokerage to Thompson, Thompson absorbs a num-ber of JNI overhead expenses, including those for rent. |
JNI executives are breaching their responsibilities by usingclient brokerage for services that do not benefit JNI clients and by notobtaining best price and best execution for their clients. Because JNIexecutives are not upholding their duty of loyalty, they are violatingStandard III(A). (3) (Client Commission Practices) |
|
|
Charlotte Everett, a struggling independent investment adviser, serves as invest-ment manager for the pension plans of several companies. One of her brokers,Scott Company, is close to consummating management agreements with prospec-tive new clients whereby Everett would manage the new client accounts and tradethe accounts exclusively through Scott. One of Everett’s existing clients, CraytonCorporation, has directed Everett to place securities transactions for Crayton’saccount exclusively through Scott. But to induce Scott to exert efforts to sendmore new accounts to her, Everett also directs transactions to Scott from otherclients without their knowledge. |
Everett has an obligation at all times to seek best price andbest execution on all trades. Everett may direct new client trades exclu-sively through Scott Company as long as Everett receives best price andexecution on the trades or receives a written statement from new clientsthat she is not to seek best price and execution and that they are awareof the consequence for their accounts. Everett may trade other accountsthrough Scott as a reward for directing clients to Everett only if theaccounts receive best price and execution and the practice is disclosedto the accounts. Because Everett does not disclose the directed trading,Everett has violated Standard III(A). (3) (Brokerage Arrangements) |
|
|
Emilie Rome is a trust officer for Paget Trust Company. Rome’s supervisor isresponsible for reviewing Rome’s trust account transactions and her monthlyreports of personal stock transactions. Rome has been using Nathan Gray, a broker,almost exclusively for trust account brokerage transactions. When Gray makes a market in stocks, he has been giving Rome a lower price for personal purchases and a higher price for sales than he gives to Rome’s trust accounts and other investors. |
Rome is violating her duty of loyalty to the bank’s trustaccounts by using Gray for brokerage transactions simply because Graytrades Rome’s personal account on favorable terms. Rome is placing herown interests before those of her clients. (3) (Brokerage Arrangements) |
|
|
Lauren Parker, an analyst with Provo Advisors, covers South American equitiesfor her firm. She likes to travel to the markets for which she is responsible anddecides to go on a trip to Chile, Argentina, and Brazil. The trip is sponsored bySouthAM, Inc., a research firm with a small broker/dealer affiliate that uses theclearing facilities of a larger New York brokerage house. SouthAM specializes inarranging South American trips for analysts during which they can meet withcentral bank officials, government ministers, local economists, and senior execu-tives of corporations. SouthAM accepts commission dollars at a ratio of 2 to 1against the hard-dollar costs of the research fee for the trip. Parker is not sure thatSouthAM’s execution is competitive, but without informing her supervisor, shedirects the trading desk at Provo to start giving commission business to SouthAMso she can take the trip. SouthAM has conveniently timed the briefing trip tocoincide with the beginning of Carnival season, so Parker also decides to spendfive days of vacation in Rio de Janeiro at the end of the trip. Parker uses commis-sion dollars to pay for the five days of hotel expenses. |
Parker is violating Standard III(A) by not exercising her duty ofloyalty to her clients. She should have determined whether the commis-sions charged by SouthAM are reasonable in relation to the benefit of theresearch provided by the trip. She also should have determined whetherbest execution and prices could be received from SouthAM. In addition,the five extra days are not part of the research effort because they do notassist in the investment decision making. Thus, the hotel expenses for thefive days should not be paid for with client assets. (3) (Client Commission Practices) |
|
|
Vida Knauss manages the portfolios of a number of high-net-worth individuals. Amajor part of her investment management fee is based on trading commissions.Knauss engages in extensive trading for each of her clients to ensure that sheattains the minimum commission level set by her firm. Although the securitiespurchased and sold for the clients are appropriate and fall within the acceptableasset classes for the clients, the amount of trading for each account exceeds whatis necessary to accomplish the client’s investment objectives. |
Knauss has violated Standard III(A) because she is using theassets of her clients to benefit her firm and herself. (3) (Excessive Trading) |
|
|
Adam Dill recently joined New Investments Asset Managers. To assist Dill inbuilding a book of clients, both his father and brother opened new fee-payingaccounts. Dill followed all the firm’s procedures in noting his relationships withthese clients and in developing their investment policy statements. After several years, the number of Dill’s clients has grown, but he still man-ages the original accounts of his family members. An IPO is coming to marketthat is a suitable investment for many of his clients, including his brother. Dilldoes not receive the amount of stock he requested, so to avoid any appearance of aconflict of interest, he does not allocate any shares to his brother’s account. |
Dill has violated Standard III(A) because he is not acting forthe benefit of his brother’s account as well as his other accounts. Thebrother’s account is a regular fee-paying account comparable to theaccounts of his other clients. By not allocating the shares proportionatelyacross all accounts for which he thought the IPO was suitable, Dill is disadvantaging specific clients. Dill would have been correct in not allocating shares to his brother’saccount if that account was being managed outside the normal fee struc-ture of the firm. (3) (Managing Family Accounts) |
|
|
Donna Hensley has been hired by a law firm to testify as an expert witness.Although the testimony is intended to represent impartial advice, she is con-cerned that her work may have negative consequences for the law firm. If the lawfirm is Hensley’s client, how does she ensure that her testimony will not violate therequired duty of loyalty, prudence, and care to one’s client? |
In this situation, the law firm represents Hensley’s employerand the aspect of “who is the client” is not well defined. When acting asan expert witness, Hensley is bound by the standard of independence andobjectivity in the same manner as an independent research analyst wouldbe bound. Hensley must not let the law firm influence the testimony sheprovides in the legal proceedings. (3) (Identifying the Client) |
|
|
Jon Miller is a mutual fund portfolio manager. The fund is focused on the globalfinancial services sector. Wanda Spears is a private wealth manager in the samecity as Miller and is a friend of Miller. At a local CFA Institute society meeting,Spears mentions to Miller that her new client is an investor in Miller’s fund. Shestates that the two of them now share a responsibility to this client. |
Spears’ statement is not totally correct. Because she providesthe advisory services to her new client, she alone is bound by the duty of loyalty to this client. Miller’s responsibility is to manage the fund accord-ing to the investment policy statement of the fund. His actions should notbe influenced by the needs of any particular fund investor. (3) (Identifying the Client) |
|
|
After providing client account investment performance to the external-facingdepartments but prior to it being finalized for release to clients, Teresa Nguyen,an investment performance analyst, notices the reporting system missed a trade.Correcting the omission resulted in a large loss for a client that had previouslyplaced the firm on “watch” for potential termination owing to underperformancein prior periods. Nguyen knows this news is unpleasant but informs the appropri-ate individuals that the report needs to be updated before releasing it to the client. |
Nguyen’s actions align with the requirements of StandardIII(A). Even though the correction may to lead to the firm’s terminationby the client, withholding information on errors would not be in the bestinterest of the client. (3) (Client Loyalty) |
|
|
Baftija Sulejman recently became a candidate in the CFA Program. He is a bro-ker who executes client-directed trades for several high-net-worth individuals.Sulejman does not provide any investment advice and only executes the tradingdecisions made by clients. He is concerned that the Code and Standards impose afiduciary duty on him in his dealing with clients and sends an e-mail to the CFAEthics Helpdesk (ethics@cfainstitute.org) to seek guidance on this issue. |
In this instance, Sulejman serves in an execution only capacity and his duty of loyalty, prudence, and care is centered on the skill anddiligence used when executing trades—namely, by seeking best executionand making trades within the parameters set by the clients (instructionson quantity, price, timing, etc.). Acting in the best interests of the clientdictates that trades are executed on the most favorable terms that can beachieved for the client. Given this job function, the requirements of theCode and Standards for loyalty, prudence, and care clearly do not imposea fiduciary duty.(3) (Execution-Only Responsibilities): |
|
|
Standard III(B) Fair Dealing |
Members and Candidates must deal fairly and objectively with all clientswhen providing investment analysis, making investment recommendations,taking investment action, or engaging in other professional activities. |
|
|
Bradley Ames, a well-known and respected analyst, follows the computer industry.In the course of his research, he finds that a small, relatively unknown companywhose shares are traded over the counter has just signed significant contracts withsome of the companies he follows. After a considerable amount of investigation,Ames decides to write a research report on the small company and recommendpurchase of its shares. While the report is being reviewed by the company for fac-tual accuracy, Ames schedules a luncheon with several of his best clients to dis-cuss the company. At the luncheon, he mentions the purchase recommendationscheduled to be sent early the following week to all the firm’s clients. |
Ames has violated Standard III(B) by disseminating the pur-chase recommendation to the clients with whom he has lunch a weekbefore the recommendation is sent to all clients.(3) (Selective Disclosure) |
|
|
Spencer Rivers, president of XYZ Corporation, moves his company’s growth-oriented pension fund to a particular bank primarily because of the excellentinvestment performance achieved by the bank’s commingled fund for the priorfive-year period. Later, Rivers compares the results of his pension fund with thoseof the bank’s commingled fund. He is startled to learn that, even though the twoaccounts have the same investment objectives and similar portfolios, his com-pany’s pension fund has significantly underperformed the bank’s commingledfund. Questioning this result at his next meeting with the pension fund’s man-ager, Rivers is told that, as a matter of policy, when a new security is placed onthe recommended list, Morgan Jackson, the pension fund manager, first purchasesthe security for the commingled account and then purchases it on a pro rata basisfor all other pension fund accounts. Similarly, when a sale is recommended, thesecurity is sold first from the commingled account and then sold on a pro ratabasis from all other accounts. Rivers also learns that if the bank cannot get enoughshares (especially of hot issues) to be meaningful to all the accounts, its policy is toplace the new issues only in the commingled account. Seeing that Rivers is neither satisfied nor pleased by the explanation, Jacksonquickly adds that nondiscretionary pension accounts and personal trust accountshave a lower priority on purchase and sale recommendations than discretionarypension fund accounts. Furthermore, Jackson states, the company’s pension fundhad the opportunity to invest up to 5% in the commingled fund. |
The bank’s policy does not treat all customers fairly, andJackson has violated her duty to her clients by giving priority to thegrowth-oriented commingled fund over all other funds and to discretionary accounts over nondiscretionary accounts. Jackson must executeorders on a systematic basis that is fair to all clients. In addition, tradeallocation procedures should be disclosed to all clients when they becomeclients. Of course, in this case, disclosure of the bank’s policy would notchange the fact that the policy is unfair. (3) (Fair Dealing between Funds) |
|
|
Dominic Morris works for a small regional securities firm. His work consists ofcorporate finance activities and investing for institutional clients. Arena, Ltd., isplanning to go public. The partners have secured rights to buy an arena footballleague franchise and are planning to use the funds from the issue to complete thepurchase. Because arena football is the current rage, Morris believes he has a hotissue on his hands. He has quietly negotiated some options for himself for helpingconvince Arena to do the financing through his securities firm. When he seeksexpressions of interest, the institutional buyers oversubscribe the issue. Morris,assuming that the institutions have the financial clout to drive the stock up, thenfills all orders (including his own) and decreases the institutional blocks. |
Morris has violated Standard III(B) by not treating all custom-ers fairly. He should not have taken any shares himself and should haveprorated the shares offered among all clients. In addition, he should havedisclosed to his firm and to his clients that he received options as part ofthe deal [see Standard VI(A)–Disclosure of Conflicts]. (3) (Fair Dealing and IPO Distribution) |
|
|
Eleanor Preston, the chief investment officer of Porter Williams Investments (PWI),a medium-size money management firm, has been trying to retain a client, ColbyCompany. Management at Colby, which accounts for almost half of PWI’s revenues, recently told Preston that if the performance of its account did not improve,it would find a new money manager. Shortly after this threat, Preston purchasesmortgage-backed securities (MBSs) for several accounts, including Colby’s. Prestonis busy with a number of transactions that day, so she fails to allocate the tradesimmediately or write up the trade tickets. A few days later, when Preston is allocat-ing trades, she notes that some of the MBSs have significantly increased in priceand some have dropped. Preston decides to allocate the profitable trades to Colbyand spread the losing trades among several other PWI accounts. |
Preston has violated Standard III(B) by failing to deal fairlywith her clients in taking these investment actions. Preston should haveallocated the trades prior to executing the orders, or she should have hada systematic approach to allocating the trades, such as pro rata, as soonas practical after they were executed. Among other things, Preston mustdisclose to the client that the adviser may act as broker for, receive com-missions from, and have a potential conflict of interest regarding bothparties in agency cross-transactions. After the disclosure, she shouldobtain from the client consent authorizing such transactions in advance. (3) (Fair Dealing and Transaction Allocation) |
|
|
Saunders Industrial Waste Management (SIWM) publicly indicates to analyststhat it is comfortable with the somewhat disappointing earnings-per-share projection of US$1.16 for the quarter. Bernard Roberts, an analyst at Coffey Investments,is confident that SIWM management has understated the forecasted earnings sothat the real announcement will cause an “upside surprise” and boost the priceof SIWM stock. The “whisper number” (rumored) estimate based on extensiveresearch and discussed among knowledgeable analysts is higher than US$1.16.Roberts repeats the US$1.16 figure in his research report to all Coffey clientsbut informally tells his large clients that he expects the earnings per share to behigher, making SIWM a good buy. |
By not sharing his opinion regarding the potential for a signifi-cant upside earnings surprise with all clients, Roberts is not treating allclients fairly and has violated Standard III(B). (3) (Selective Disclosure) |
|
|
Jenpin Weng uses e-mail to issue a new recommendation to all his clients. He then calls his three largest institutional clients to discuss the recommendation in detail. |
Weng has not violated Standard III(B) because he widely dis-seminated the recommendation and provided the information to all his cli-ents prior to discussing it with a select few. Weng’s largest clients receivedadditional personal service because they presumably pay higher fees orbecause they have a large amount of assets under Weng’s management. IfWeng had discussed the report with a select group of clients prior to dis-tributing it to all his clients, he would have violated Standard III(B). (3) (Additional Services for Select Clients) |
|
|
Lynn Hampton is a well-respected private wealth manager in her community witha diversified client base. She determines that a new 10-year bond being offeredby Healthy Pharmaceuticals is appropriate for five of her clients. Three clientsrequest to purchase US$10,000 each, and the other two request US$50,000 each.The minimum lot size is established at US$5,000, and the issue is oversubscribedat the time of placement. Her firm’s policy is that odd-lot allocations, especiallythose below the minimum, should be avoided because they may affect the liquid-ity of the security at the time of sale. Hampton is informed she will receive only US$55,000 of the offering forall accounts. Hampton distributes the bond investments as follows: The threeaccounts that requested US$10,000 are allocated US$5,000 each, and the twoaccounts that requested US$50,000 are allocated US$20,000 each. |
Hampton has not violated Standard III(B), even though thedistribution is not on a completely pro rata basis because of the requiredminimum lot size. With the total allocation being significantly below theamount requested, Hampton ensured that each client received at least theminimum lot size of the issue. This approach allowed the clients to efficiently sell the bond later if necessary. (3) (Minimum Lot Allocations) |
|
|
Ling Chan manages the accounts for many pension plans, including the plan ofhis father’s employer. Chan developed similar but not identical investment policies for each client, so the investment portfolios are rarely the same. To minimizethe cost to his father’s pension plan, he intentionally trades more frequently in theaccounts of other clients to ensure the required brokerage is incurred to continuereceiving free research for use by all the pensions. |
Chan is violating Standard III(B) because his trading actionsare disadvantaging his clients to enhance a relationship with a preferredclient. All clients are benefiting from the research being provided andshould incur their fair portion of the costs. This does not mean that additional trading should occur if a client has not paid an equal portion of the commission; trading should occur only as required by the strategy. (3) (Excessive Trading) |
|
|
Mary Burdette was recently hired by Fundamental Investment Management(FIM) as a junior auto industry analyst. Burdette is expected to expand the socialmedia presence of the firm because she is active with various networks, includ-ing Facebook, LinkedIn, and Twitter. Although Burdette’s supervisor, Joe Graf,has never used social media, he encourages Burdette to explore opportunities toincrease FIM’s online presence and ability to share content, communicate, andbroadcast information to clients. In response to Graf’s encouragement, Burdetteis working on a proposal detailing the advantages of getting FIM onto Twitter inaddition to launching a company Facebook page. As part of her auto industry research for FIM, Burdette is completing a reporton the financial impact of Sun Drive Auto Ltd.’s new solar technology for com-pact automobiles. This research report will be her first for FIM, and she believesSun Drive’s technology could revolutionize the auto industry. In her excitement,Burdette sends a quick tweet to FIM Twitter followers summarizing her “buy”recommendation for Sun Drive Auto stock. |
Burdette has violated Standard III(B) by sending an investment recommendation to a select group of contacts prior to distributingit to all clients. Burdette must make sure she has received the appropriatetraining about FIM’s policies and procedures, including the appropriatebusiness use of personal social media networks before engaging in suchactivities. (3) (Limited Social Media Disclosures) See Standard IV(C) for guidance related to the duties of the supervisor. |
|
|
Paul Rove, performance analyst for Alpha-Beta Investment Management, isdescribing to the firm’s chief investment officer (CIO) two new reports he wouldlike to develop to assist the firm in meeting its obligations to treat clients fairly.Because many of the firm’s clients have similar investment objectives and portfolios, Rove suggests a report detailing securities owned across several clients andthe percentage of the portfolio the security represents. The second report wouldcompare the monthly performance of portfolios with similar strategies. The outliers within each report would be submitted to the CIO for review. |
As a performance analyst, Rove likely has little direct contactwith clients and thus has limited opportunity to treat clients differently.The recommended reports comply with Standard III(B) while helping thefirm conduct after-the-fact reviews of how effectively the firm’s advisersare dealing with their clients’ portfolios. Reports that monitor the fairtreatment of clients are an important oversight tool to ensure that clientsare treated fairly. (3) (Fair Dealing between Clients) |
|
|
Standard III(C) Suitability |
When Members and Candidates are in an advisory relationship with aclient, they must: Make a reasonable inquiry into a client’s or prospective client’sinvestment experience, risk and return objectives, and financial con-straints prior to making any investment recommendation or takinginvestment action and must reassess and update this informationregularly. Determine that an investment is suitable to the client’s financial situ-ation and consistent with the client’s written objectives, mandates,and constraints before making an investment recommendation ortaking investment action. Judge the suitability of investments in the context of the client’stotal portfolio. When Members and Candidates are responsible for managing a port-folio to a specific mandate, strategy, or style, they must make onlyinvestment recommendations or take only investment actions that areconsistent with the stated objectives and constraints of the portfolio. |
|
|
Caleb Smith, an investment adviser, has two clients: Larry Robertson, 60 yearsold, and Gabriel Lanai, 40 years old. Both clients earn roughly the same salary,but Robertson has a much higher risk tolerance because he has a large asset base.Robertson is willing to invest part of his assets very aggressively; Lanai wants onlyto achieve a steady rate of return with low volatility to pay for his children’s educa-tion. Smith recommends investing 20% of both portfolios in zero-yield, small-cap,high-technology equity issues. |
In Robertson’s case, the investment may be appropriatebecause of his financial circumstances and aggressive investment posi-tion, but this investment is not suitable for Lanai. Smith is violatingStandard III(C) by applying Robertson’s investment strategy to Lanaibecause the two clients’ financial circumstances and objectives differ. (3) (Investment Suitability—Risk Profile) |
|
|
Jessica McDowell, an investment adviser, suggests to Brian Crosby, a risk-averseclient, that covered call options be used in his equity portfolio. The purpose wouldbe to enhance Crosby’s income and partially offset any untimely depreciation inthe portfolio’s value should the stock market or other circumstances affect hisholdings unfavorably. McDowell educates Crosby about all possible outcomes,including the risk of incurring an added tax liability if a stock rises in price andis called away and, conversely, the risk of his holdings losing protection on thedownside if prices drop sharply. |
When determining suitability of an investment, the primaryfocus should be the characteristics of the client’s entire portfolio, not thecharacteristics of single securities on an issue-by-issue basis. The basiccharacteristics of the entire portfolio will largely determine whetherinvestment recommendations are taking client factors into account.Therefore, the most important aspects of a particular investment arethose that will affect the characteristics of the total portfolio. In this case,McDowell properly considers the investment in the context of the entireportfolio and thoroughly explains the investment to the client. (3) (Investment Suitability—Entire Portfolio) |
|
|
In a regular meeting with client Seth Jones, the portfolio managers at Blue ChipInvestment Advisors are careful to allow some time to review his current needs and circumstances. In doing so, they learn that some significant changes haverecently taken place in his life. A wealthy uncle left Jones an inheritance thatincreased his net worth fourfold, to US$1 million. |
The inheritance has significantly increased Jones’s ability (andpossibly his willingness) to assume risk and has diminished the averageyield required to meet his current income needs. Jones’s financial cir-cumstances have definitely changed, so Blue Chip managers must updateJones’s investment policy statement to reflect how his investment objectives have changed. Accordingly, the Blue Chip portfolio managers shouldconsider a somewhat higher equity ratio for his portfolio than was calledfor by the previous circumstances, and the managers’ specific commonstock recommendations might be heavily tilted toward low-yield, growth-oriented issues. (3) (IPS Updating) |
|
|
Louis Perkowski manages a high-income mutual fund. He purchases zero-dividendstock in a financial services company because he believes the stock is undervaluedand is in a potential growth industry, which makes it an attractive investment. |
A zero-dividend stock does not seem to fit the mandate ofthe fund that Perkowski is managing. Unless Perkowski’s investment fitswithin the mandate or is within the realm of allowable investments thefund has made clear in its disclosures, Perkowski has violated StandardIII(C). (3) (Following an Investment Mandate) |
|
|
Max Gubler, chief investment officer of a property/casualty insurance subsidiaryof a large financial conglomerate, wants to improve the diversification of the subsidiary’s investment portfolio and increase its returns. The subsidiary’s investmentpolicy statement provides for highly liquid investments, such as large-cap equi-ties and government, supranational, and corporate bonds with a minimum creditrating of AA and maturity of no more than five years. In a recent presentation, aventure capital group offered very attractive prospective returns on some of itsprivate equity funds that provide seed capital to ventures. An exit strategy wasalready contemplated, but investors would have to observe a minimum three-yearlockup period and a subsequent laddered exit option for a maximum of one-thirdof their shares per year. Gubler does not want to miss this opportunity. Afterextensive analysis, with the intent to optimize the return on the equity assetswithin the subsidiary’s current portfolio, he invests 4% in this seed fund, leavingthe portfolio’s total equity exposure still well below its upper limit. |
Gubler is violating Standard III(A)–Loyalty, Prudence, andCare as well as Standard III(C). His new investment locks up part of thesubsidiary’s assets for at least three years and up to as many as five years and possibly beyond. The IPS requires investments in highly liquid invest-ments and describes accepted asset classes; private equity investmentswith a lockup period certainly do not qualify. Even without a lockupperiod, an asset class with only an occasional, and thus implicitly illiquid,market may not be suitable for the portfolio. Although an IPS typicallydescribes objectives and constraints in great detail, the manager mustalso make every effort to understand the client’s business and circum-stances. Doing so should enable the manager to recognize, understand,and discuss with the client other factors that may be or may becomematerial in the investment management process. (3) (IPS Requirements and Limitations): |
|
|
Paul Ostrowski’s investment management business has grown significantlyover the past couple of years, and some clients want to diversify internationally.Ostrowski decides to find a submanager to handle the expected internationalinvestments. Because this will be his first subadviser, Ostrowski uses the CFAInstitute model “request for proposal” to design a questionnaire for his search. Byhis deadline, he receives seven completed questionnaires from a variety of domes-tic and international firms trying to gain his business. Ostrowski reviews all theapplications in detail and decides to select the firm that charges the lowest feesbecause doing so will have the least impact on his firm’s bottom line. |
When selecting an external manager or subadviser, Ostrowskineeds to ensure that the new manager’s services are appropriate for hisclients. This due diligence includes comparing the risk profile of the clients with the investment strategy of the manager. In basing the decisionon the fee structure alone, Ostrowski may be violating Standard III(C). When clients ask to diversify into international products, it is an appro-priate time to review and update the clients’ IPSs. Ostrowski’s review maydetermine that the risk of international investments modifies the riskprofiles of the clients or does not represent an appropriate investment. See also Standard V(A)–Diligence and Reasonable Basis for further discus-sion of the review process needed in selecting appropriate sub managers. (3) (Submanager and IPS Reviews) |
|
|
Samantha Snead, a portfolio manager for Thomas Investment Counsel, Inc., special-izes in managing public retirement funds and defined benefit pension plan accounts,all of which have long-term investment objectives. A year ago, Snead’s employer, inan attempt to motivate and retain key investment professionals, introduced a bonuscompensation system that rewards portfolio managers on the basis of quarterly per-formance relative to their peers and to certain benchmark indices. In an attempt toimprove the short-term performance of her accounts, Snead changes her investmentstrategy and purchases several high-beta stocks for client portfolios. These purchases are seemingly contrary to the clients’ investment policy statements. Following theirpurchase, an officer of Griffin Corporation, one of Snead’s pension fund clients, askswhy Griffin Corporation’s portfolio seems to be dominated by high-beta stocks ofcompanies that often appear among the most actively traded issues. No change inobjective or strategy has been recommended by Snead during the year. |
Snead violated Standard III(C) by investing the clients’ assetsin high-beta stocks. These high-risk investments are contrary to thelong-term risk profile established in the clients’ IPSs. Snead has changedthe investment strategy of the clients in an attempt to reap short-termrewards offered by her firm’s new compensation arrangement, not inresponse to changes in clients’ investment policy statements. See also Standard VI(A)–Disclosure of Conflicts.(3) (Investment Suitability—Risk Profile) |
|
|
Andre Shrub owns and operates Conduit, an investment advisory firm. Prior toopening Conduit, Shrub was an account manager with Elite Investment, a hedgefund managed by his good friend Adam Reed. To attract clients to a new Conduitfund, Shrub offers lower-than-normal management fees. He can do so because thefund consists of two top-performing funds managed by Reed. Given his personalfriendship with Reed and the prior performance record of these two funds, Shrubbelieves this new fund is a winning combination for all parties. Clients quicklyinvest with Conduit to gain access to the Elite funds. No one is turned awaybecause Conduit is seeking to expand its assets under management. |
Shrub has violated Standard III(C) because the risk profileof the new fund may not be suitable for every client. As an investmentadviser, Shrub needs to establish an investment policy statement for eachclient and recommend only investments that match each client’s risk andreturn profile in the IPS. Shrub is required to act as more than a simplesales agent for Elite. Although Shrub cannot disobey the direct request of a client to purchasea specific security, he should fully discuss the risks of a planned purchaseand provide reasons why it might not be suitable for a client. This require-ment may lead members and candidates to decline new customers ifthose customers’ requested investment decisions are significantly out ofline with their stated requirements. See also Standard V(A)–Diligence and Reasonable Basis. (3) (Investment Suitability) |
|
|
Standard III(D) Performance Presentation |
When communicating investment performance information, Members andCandidates must make reasonable efforts to ensure that it is fair, accurate,and complete. |
|
|
Kyle Taylor of Taylor Trust Company, noting the performance of Taylor’s commontrust fund for the past two years, states in a brochure sent to his potential clients,“You can expect steady 25% annual compound growth of the value of your invest-ments over the year.” Taylor Trust’s common trust fund did increase at the rate of25% per year for the past year, which mirrored the increase of the entire market.The fund has never averaged that growth for more than one year, however, and theaverage rate of growth of all of its trust accounts for five years is 5% per year. |
Taylor’s brochure is in violation of Standard III(D). Taylorshould have disclosed that the 25% growth occurred only in one year.Additionally, Taylor did not include client accounts other than thosein the firm’s common trust fund. A general claim of firm performanceshould take into account the performance of all categories of accounts.Finally, by stating that clients can expect a steady 25% annual compoundgrowth rate, Taylor is also violating Standard I(C)–Misrepresentation,which prohibits assurances or guarantees regarding an investment. (3) (Performance Calculation and Length of Time) |
|
|
Anna Judd, a senior partner of Alexander Capital Management, circulates a per-formance report for the capital appreciation accounts for the years 1988 through2004. The firm claims compliance with the GIPS standards. Returns are not calculated in accordance with the requirements of the GIPS standards, however, because the composites are not asset weighted. |
Judd is in violation of Standard III(D). When claiming compli-ance with the GIPS standards, firms must meet all of the requirements,make mandatory disclosures, and meet any other requirements that applyto that firm’s specific situation. Judd’s violation is not from any misuse ofthe data but from a false claim of GIPS compliance. (3) (Performance Calculation and Asset Weighting) |
|
|
Aaron McCoy is vice president and managing partner of the equity investmentgroup of Mastermind Financial Advisors, a new business. Mastermind recruitedMcCoy because he had a proven six-year track record with G&P Financial. Indeveloping Mastermind’s advertising and marketing campaign, McCoy preparesan advertisement that includes the equity investment performance he achievedat G&P Financial. The advertisement for Mastermind does not identify the equityperformance as being earned while at G&P. The advertisement is distributed toexisting clients and prospective clients of Mastermind. |
McCoy has violated Standard III(D) by distributing an adver-tisement that contains material misrepresentations about the historicalperformance of Mastermind. Standard III(D) requires that membersand candidates make every reasonable effort to ensure that performanceinformation is a fair, accurate, and complete representation of an individual’s or firm’s performance. As a general matter, this standard doesnot prohibit showing past performance of funds managed at a prior firmas part of a performance track record as long as showing that record isaccompanied by appropriate disclosures about where the performancetook place and the person’s specific role in achieving that performance. IfMcCoy chooses to use his past performance from G&P in Mastermind’sadvertising, he should make full disclosure of the source of the historicalperformance. (3) (Performance Presentation and Prior Fund/Employer) |
|
|
Jed Davis has developed a mutual fund selection product based on historical infor-mation from the 1990–95 period. Davis tested his methodology by applying it retroactively to data from the 1996–2003 period, thus producing simulated performanceresults for those years. In January 2004, Davis’s employer decided to offer the prod-uct and Davis began promoting it through trade journal advertisements and directdissemination to clients. The advertisements included the performance results forthe 1996–2003 period but did not indicate that the results were simulated. |
Davis violated Standard III(D) by failing to clearly iden-tify simulated performance results. Standard III(D) prohibits members and candidates from making any statements that misrepresent the performance achieved by them or their firms and requires members andcandidates to make every reasonable effort to ensure that performanceinformation presented to clients is fair, accurate, and complete. Use ofsimulated results should be accompanied by full disclosure as to thesource of the performance data, including the fact that the results from1995 through 2003 were the result of applying the model retroactively tothat time period. (3) (Performance Presentation and Simulated Results) |
|
|
In a presentation prepared for prospective clients, William Kilmer shows the ratesof return realized over a five-year period by a “composite” of his firm’s discretion-ary accounts that have a “balanced” objective. This composite, however, consistedof only a few of the accounts that met the balanced criterion set by the firm,excluded accounts under a certain asset level without disclosing the fact of theirexclusion, and included accounts that did not have the balanced mandate becausethose accounts would boost the investment results. In addition, to achieve betterresults, Kilmer manipulated the narrow range of accounts included in the com-posite by changing the accounts that made up the composite over time. |
Kilmer violated Standard III(D) by misrepresenting the factsin the promotional material sent to prospective clients, distorting hisfirm’s performance record, and failing to include disclosures that wouldhave clarified the presentation. (3) (Performance Calculation and Selected Accounts Only) |
|
|
Art Purell is reviewing the quarterly performance attribution reports for distribu-tion to clients. Purell works for an investment management firm with a bottom-up,fundamentals-driven investment process that seeks to add value through stock selection. The attribution methodology currently compares each stock with its sector. Theattribution report indicates that the value added this quarter came from asset alloca-tion and that stock selection contributed negatively to the calculated return. Through running several different scenarios, Purell discovers that calculat-ing attribution by comparing each stock with its industry and then rolling theeffect to the sector level improves the appearance of the manager’s stock selectionactivities. Because the firm defines the attribution terms and the results betterreflect the stated strategy, Purell recommends that the client reports should usethe revised methodology. |
Modifying the attribution methodology without propernotifications to clients would fail to meet the requirements of StandardIII(D). Purrell’s recommendation is being done solely for the interestof the firm to improve its perceived ability to meet the stated investment strategy. Such changes are unfair to clients and obscure the factsregarding the firm’s abilities. Had Purell believed the new methodology offered improvements to theoriginal model, then he would have needed to report the results of bothcalculations to the client. The report should also include the reasons whythe new methodology is preferred, which would allow the client to makea meaningful comparison to prior results and provide a basis for compar-ing future attributions. (3) (Performance Attribution Changes) |
|
|
While developing a new reporting package for existing clients, Alisha Singh, aperformance analyst, discovers that her company’s new system automaticallycalculates both time-weighted and money-weighted returns. She asks the head ofclient services and retention which value would be preferred given that the firmhas various investment strategies that include bonds, equities, securities withoutleverage, and alternatives. Singh is told not to label the return value so that thefirm may show whichever value is greatest for the period. |
Following these instructions would lead to Singh violatingStandard III(D). In reporting inconsistent return values, Singh would notbe providing complete information to the firm’s clients. Full informationis provided when clients have sufficient information to judge the perfor-mance generated by the firm. (3) (Performance Calculation Methodology Disclosure) |
|
|
Richmond Equity Investors manages a long–short equity fund in which clientscan trade once a week (on Fridays). For transparency reasons, a daily net assetvalue of the fund is calculated by Richmond. The monthly fact sheets of the fundreport month-to-date and year-to-date performance. Richmond publishes theperformance based on the higher of the last trading day of the month (typically,not the last business day) or the last business day of the month as determinedby Richmond. The fact sheet mentions only that the data are as of the end of themonth, without giving the exact date. Maggie Clark, the investment performanceanalyst in charge of the calculations, is concerned about the frequent changes andasks her supervisor whether they are appropriate. |
Clark’s actions in questioning the changing performancemetric comply with Standard III(D). She has shown concern that thesechanges are not presenting an accurate and complete picture of the per-formance generated. (3) (Performance Calculation Methodology Disclosure) |
|
|
Standard III(E) Preservation of Confidentiality |
Members and Candidates must keep information about current, former, andprospective clients confidential unless: The information concerns illegal activities on the part of the client; Disclosure is required by law; or The client or prospective client permits disclosure of the information. |
|
|
Sarah Connor, a financial analyst employed by Johnson Investment Counselors, Inc.,provides investment advice to the trustees of City Medical Center. The trustees havegiven her a number of internal reports concerning City Medical’s needs for physicalplant renovation and expansion. They have asked Connor to recommend investmentsthat would generate capital appreciation in endowment funds to meet projected capi-tal expenditures. Connor is approached by a local businessman, Thomas Kasey, whois considering a substantial contribution either to City Medical Center or to anotherlocal hospital. Kasey wants to find out the building plans of both institutions beforemaking a decision, but he does not want to speak to the trustees. |
The trustees gave Connor the internal reports so she couldadvise them on how to manage their endowment funds. Because theinformation in the reports is clearly both confidential and within thescope of the confidential relationship, Standard III(E) requires thatConnor refuse to divulge information to Kasey. (3) (Possessing Confidential Information) |
|
|
Lynn Moody is an investment officer at the Lester Trust Company. She has anadvisory customer who has talked to her about giving approximately US$50,000to charity to reduce her income taxes. Moody is also treasurer of the Home forIndigent Widows (HIW), which is planning its annual giving campaign. HIWhopes to expand its list of prospects, particularly those capable of substantial gifts.Moody recommends that HIW’s vice president for corporate gifts call on her cus-tomer and ask for a donation in the US$50,000 range. |
Even though the attempt to help the Home for IndigentWidows was well intended, Moody violated Standard III(E) by revealingconfidential information about her client. (3) (Disclosing Confidential Information) |
|
|
Government officials approach Casey Samuel, the portfolio manager for GarciaCompany’s pension plan, to examine pension fund records. They tell her thatGarcia’s corporate tax returns are being audited and the pension fund is beingreviewed. Two days earlier, Samuel had learned in a regular investment review withGarcia officers that potentially excessive and improper charges were being made tothe pension plan by Garcia. Samuel consults her employer’s general counsel and isadvised that Garcia has probably violated tax and fiduciary regulations and laws. |
Samuel should inform her supervisor of these activities, andher employer should take steps, with Garcia, to remedy the violations.If that approach is not successful, Samuel and her employer should seekadvice of legal counsel to determine the appropriate steps to be taken.Samuel may well have a duty to disclose the evidence she has of the con-tinuing legal violations and to resign as asset manager for Garcia. (3) (Disclosing Possible Illegal Activity) |
|
|
David Bradford manages money for a family-owned real estate development corpo-ration. He also manages the individual portfolios of several of the family membersand officers of the corporation, including the chief financial officer (CFO). Basedon the financial records of the corporation and some questionable practices of theCFO that Bradford has observed, Bradford believes that the CFO is embezzlingmoney from the corporation and putting it into his personal investment account. |
Bradford should check with his firm’s compliance departmentor appropriate legal counsel to determine whether applicable securitiesregulations require reporting the CFO’s financial records. (3) (Disclosing Possible Illegal Activity) |
|
|
Lynn Moody is an investment officer at the Lester Trust Company (LTC). She hasstewardship of a significant number of individually managed taxable accounts. In addition to receiving quarterly written reports, about a dozen high-net-worthindividuals have indicated to Moody a willingness to receive communicationsabout overall economic and financial market outlooks directly from her by way ofa social media platform. Under the direction of her firm’s technology and compli-ance departments, she established a new group page on an existing social mediaplatform specifically for her clients. In the instructions provided to clients, Moodyasked them to “join” the group so they may be granted access to the posted con-tent. The instructions also advised clients that all comments posted would beavailable to the public and thus the platform was not an appropriate method forcommunicating personal or confidential information. Six months later, in early January, Moody posted LTC’s year-end “MarketOutlook.” The report outlined a new asset allocation strategy that the firm is add-ing to its recommendations in the new year. Moody introduced the publicationwith a note informing her clients that she would be discussing the changes withthem individually in their upcoming meetings. One of Moody’s clients responded directly on the group page that his familyrecently experienced a major change in their financial profile. The client describedhighly personal and confidential details of the event. Unfortunately, all clients thatwere part of the group were also able to read the detailed posting until Moody wasable to have the comment removed. |
Moody has taken reasonable steps for protecting the confidentiality of client information while using the social media platform. Sheprovided instructions clarifying that all information posted to the sitewould be publically viewable to all group members and warned againstusing this method for communicating confidential information. Theaccidental disclosure of confidential information by a client is not underMoody’s control. Her actions to remove the information promptly onceshe became aware further align with Standard III(E). In understanding the potential sensitivity clients express surroundingthe confidentiality of personal information, this event highlights a needfor further training. Moody might advocate for additional warnings orcontrols for clients when they consider using social media platforms fortwo-way communications. (3) (Accidental Disclosure of Confidential Information) |
|
|
Standard IV |
Duties to Employers |
|
|
Standard IV(A) Loyalty |
In matters related to their employment, Members and Candidates mustact for the benefit of their employer and not deprive their employer of theadvantage of their skills and abilities, divulge confidential information, orotherwise cause harm to their employer. |
|
|
Samuel Magee manages pension accounts for Trust Assets, Inc., but has becomefrustrated with the working environment and has been offered a position withFiduciary Management. Before resigning from Trust Assets, Magee asks four bigaccounts to leave that firm and open accounts with Fiduciary. Magee also persuadesseveral prospective clients to sign agreements with Fiduciary Management. Mageehad previously made presentations to these prospects on behalf of Trust Assets. |
Magee violated the employee–employer principle requiringhim to act solely for his employer’s benefit. Magee’s duty is to Trust Assetsas long as he is employed there. The solicitation of Trust Assets’ currentclients and prospective clients is unethical and violates Standard IV(A). (4) (Soliciting Former Clients) |
|
|
James Hightower has been employed by Jason Investment ManagementCorporation for 15 years. He began as an analyst but assumed increasing respon-sibilities and is now a senior portfolio manager and a member of the firm’s invest-ment policy committee. Hightower has decided to leave Jason Investment andstart his own investment management business. He has been careful not to tellany of Jason’s clients that he is leaving; he does not want to be accused of breach-ing his duty to Jason by soliciting Jason’s clients before his departure. Hightower isplanning to copy and take with him the following documents and information hedeveloped or worked on while at Jason: (1) the client list, with addresses, telephonenumbers, and other pertinent client information; (2) client account statements;(3) sample marketing presentations to prospective clients containing Jason’s per-formance record; (4) Jason’s recommended list of securities; (5) computer models to determine asset allocations for accounts with various objectives; (6) computermodels for stock selection; and (7) personal computer spreadsheets for Hightower’smajor corporate recommendations, which he developed when he was an analyst. |
Except with the consent of their employer, departing members and candidates may not take employer property, which includesbooks, records, reports, and other materials, because taking such materials may interfere with their employer’s business opportunities. Taking anyemployer records, even those the member or candidate prepared, violatesStandard IV(A). Employer records include items stored in hard copy or anyother medium (e.g., home computers, portable storage devices, cell phones). (4) (Former Employer’s Documents and Files) |
|
|
Reuben Winston manages all-equity portfolios at Target Asset Management(TAM), a large, established investment counselor. Ten years previously, Philpott &Company, which manages a family of global bond mutual funds, acquired TAM ina diversification move. After the merger, the combined operations prospered in thefixed-income business but the equity management business at TAM languished.Lately, a few of the equity pension accounts that had been with TAM before themerger have terminated their relationships with TAM. One day, Winston finds onhis voice mail the following message from a concerned client: “Hey! I just heard thatPhilpott is close to announcing the sale of your firm’s equity management busi-ness to Rugged Life. What is going on?” Not being aware of any such deal, Winstonand his associates are stunned. Their internal inquiries are met with denials fromPhilpott management, but the rumors persist. Feeling left in the dark, Winstoncontemplates leading an employee buyout of TAM’s equity management business. |
An employee-led buyout of TAM’s equity asset managementbusiness would be consistent with Standard IV(A) because it would reston the permission of the employer and, ultimately, the clients. In thiscase, however, in which employees suspect the senior managers or princi-pals are not truthful or forthcoming, Winston should consult legal counsel to determine appropriate action.(4) (Addressing Rumors) |
|
|
Laura Clay, who is unemployed, wants part-time consulting work while seeking afull-time analyst position. During an interview at Bradley Associates, a large insti-tutional asset manager, Clay is told that the firm has no immediate research open-ings but would be willing to pay her a flat fee to complete a study of the wirelesscommunications industry within a given period of time. Clay would be allowedunlimited access to Bradley’s research files and would be welcome to come to theoffices and use whatever support facilities are available during normal workinghours. Bradley’s research director does not seek any exclusivity for Clay’s output,and the two agree to the arrangement on a handshake. As Clay nears completion of the study, she is offered an analyst job in the research department of Winston &Company, a brokerage firm, and she is pondering submitting the draft of her wire-less study for publication by Winston. |
Although she is under no written contractual obligation toBradley, Clay has an obligation to let Bradley act on the output of her studybefore Winston & Company or Clay uses the information to their advan-tage. That is, unless Bradley gives permission to Clay and waives its rightsto her wireless report, Clay would be in violation of Standard IV(A) if shewere to immediately recommend to Winston the same transactions rec-ommended in the report to Bradley. Furthermore, Clay must not take fromBradley any research file material or other property that she may have used. (4) (Ownership of Completed Prior Work) |
|
|
Emma Madeline, a recent college graduate and a candidate in the CFA Program,spends her summer as an unpaid intern at Murdoch and Lowell. The senior man-agers at Murdoch are attempting to bring the firm into compliance with the GIPSstandards, and Madeline is assigned to assist in its efforts. Two months into herinternship, Madeline applies for a job at McMillan & Company, which has plansto become GIPS compliant. Madeline accepts the job with McMillan. Before leav-ing Murdoch, she copies the firm’s software that she helped develop because shebelieves this software will assist her in her new position. |
Even though Madeline does not receive monetary compensation for her services at Murdoch, she has used firm resources in creatingthe software and is considered an employee because she receives compensation and benefits in the form of work experience and knowledge.By copying the software, Madeline violated Standard IV(A) because shemisappropriated Murdoch’s property without permission. (4) (Ownership of Completed Prior Work) |
|
|
Dennis Elliot has hired Sam Chisolm, who previously worked for a competingfirm. Chisolm left his former firm after 18 years of employment. When Chisolmbegins working for Elliot, he wants to contact his former clients because he knowsthem well and is certain that many will follow him to his new employer. Is Chisolmin violation of Standard IV(A) if he contacts his former clients? |
Because client records are the property of the firm, contacting former clients for any reason through the use of client lists or otherinformation taken from a former employer without permission would bea violation of Standard IV(A). In addition, the nature and extent of thecontact with former clients may be governed by the terms of any non-compete agreement signed by the employee and the former employer thatcovers contact with former clients after employment. Simple knowledge of the names and existence of former clients is notconfidential information, just as skills or experience that an employeeobtains while employed are not “confidential” or “privileged” information. The Code and Standards do not impose a prohibition on the useof experience or knowledge gained at one employer from being used atanother employer. The Code and Standards also do not prohibit formeremployees from contacting clients of their previous firm, in the absenceof a noncompete agreement. Members and candidates are free to usepublic information about their former firm after departing to contact for-mer clients without violating Standard IV(A). In the absence of a noncompete agreement, as long as Chisolm maintainshis duty of loyalty to his employer before joining Elliot’s firm, does nottake steps to solicit clients until he has left his former firm, and does notuse material from his former employer without its permission after hehas left, he is not in violation of the Code and Standards. (4) (Soliciting Former Clients) |
|
|
Geraldine Allen currently works at a registered investment company as an equityanalyst. Without notice to her employer, she registers with government authoritiesto start an investment company that will compete with her employer, but she doesnot actively seek clients. Does registration of this competing company with theappropriate regulatory authorities constitute a violation of Standard IV(A)? |
Allen’s preparation for the new business by registering with theregulatory authorities does not conflict with the work for her employer ifthe preparations have been done on Allen’s own time outside the officeand if Allen will not be soliciting clients for the business or otherwiseoperating the new company until she has left her current employer. (4) (Starting a New Firm) |
|
|
Several employees are planning to depart their current employer within a fewweeks and have been careful to not engage in any activities that would conflictwith their duty to their current employer. They have just learned that one of theiremployer’s clients has undertaken a request for proposal (RFP) to review and pos-sibly hire a new investment consultant. The RFP has been sent to the employerand all of its competitors. The group believes that the new entity to be formedwould be qualified to respond to the RFP and be eligible for the business. The RFPsubmission period is likely to conclude before the employees’ resignations areeffective. Is it permissible for the group of departing employees to respond to theRFP for their anticipated new firm? |
A group of employees responding to an RFP that theiremployer is also responding to would lead to direct competition betweenthe employees and the employer. Such conduct violates Standard IV(A) unless the group of employees receives permission from their employer as well as the entity sending out the RFP. (4) (Competing with Current Employer) |
|
|
Alfonso Mota is a research analyst with Tyson Investments. He works part time asa mayor for his hometown, a position for which he receives compensation. MustMota seek permission from Tyson to serve as mayor? |
If Mota’s mayoral duties are so extensive and time-consumingthat they might detract from his ability to fulfill his responsibilities atTyson, he should discuss his outside activities with his employer andcome to a mutual agreement regarding how to manage his personal com-mitments with his responsibilities to his employer.(4) (Externally Compensated Assignments) |
|
|
After leaving her employer, Shawna McQuillen establishes her own money man-agement business. While with her former employer, she did not sign a noncompeteagreement that would have prevented her from soliciting former clients. Upon herdeparture, she does not take any of her client lists or contact information and sheclears her personal computer of any employer records, including client contactinformation. She obtains the phone numbers of her former clients through publicrecords and contacts them to solicit their business. |
McQuillen is not in violation of Standard IV(A) because shehas not used information or records from her former employer and is notprevented by an agreement with her former employer from soliciting herformer clients.(4) (Soliciting Former Clients) |
|
|
Meredith Rasmussen works on a buy-side trading desk and concentrates on in-house trades for a hedge fund subsidiary managed by a team at the investmentmanagement firm. The hedge fund has been very successful and is marketedglobally by the firm. From her experience as the trader for much of the activityof the fund, Rasmussen has become quite knowledgeable about the hedge fund’sstrategy, tactics, and performance. When a distinct break in the market occurs,however, and many of the securities involved in the hedge fund’s strategy declinemarkedly in value, Rasmussen observes that the reported performance of thehedge fund does not reflect this decline. In her experience, the lack of any effectis a very unlikely occurrence. She approaches the head of trading about her con-cern and is told that she should not ask any questions and that the fund is big andsuccessful and is not her concern. She is fairly sure something is not right, so shecontacts the compliance officer, who also tells her to stay away from the issue ofthis hedge fund’s reporting. |
Rasmussen has clearly come upon an error in policies, procedures, and compliance practices in the firm’s operations. Havingbeen unsuccessful in finding a resolution with her supervisor and thecompliance officer, Rasmussen should consult the firm’s whistleblowing policy to determine the appropriate next step toward informingmanagement of her concerns. The potentially unethical actions of theinvestment management division are appropriate grounds for further dis-closure, so Rasmussen’s whistleblowing would not represent a violation ofStandard IV(A). (4) (Whistleblowing Actions) See also Standard I(D)–Misconduct and Standard IV(C)–Responsibilitiesof Supervisors. |
|
|
Angel Crome has been a private banker for YBSafe Bank for the past eight years.She has been very successful and built a considerable client portfolio during thattime but is extremely frustrated by the recent loss of reputation by her currentemployer and subsequent client insecurity. A locally renowned headhunter con-tacted Crome a few days ago and offered her an interesting job with a competingprivate bank. This bank offers a substantial signing bonus for advisers with theirown client portfolios. Crome figures that she can solicit at least 70% of her clientsto follow her and gladly enters into the new employment contract. |
Crome may contact former clients upon termination of heremployment with YBSafe Bank, but she is prohibited from using cli-ent records built by and kept with her in her capacity as an employeeof YBSafe Bank. Client lists are proprietary information of her formeremployer and must not be used for her or her new employer’s benefit. Theuse of written, electronic, or any other form of records other than pub-licly available information to contact her former clients at YBSafe Bankwill be a violation of Standard IV(A). (4) (Soliciting Former Clients) |
|
|
Krista Smith is a relatively new assistant trader for the fixed-income desk of a majorinvestment bank. She is on a team responsible for structuring collateralized debtobligations (CDOs) made up of securities in the inventory of the trading desk. At ameeting of the team, senior executives explain the opportunity to eventually sepa-rate the CDO into various risk-rated tranches to be sold to the clients of the firm.After the senior executives leave the meeting, the head trader announces variousresponsibilities of each member of the team and then says, “This is a good time tounload some of the junk we have been stuck with for a while and disguise it withratings and a thick, unreadable prospectus, so don’t be shy in putting this CDOtogether. Just kidding.” Smith is worried by this remark and asks some of her col-leagues what the head trader meant. They all respond that he was just kidding but that there is some truth in the remark because the CDO is seen by management asan opportunity to improve the quality of the securities in the firm’s inventory. Concerned about the ethical environment of the workplace, Smith decides totalk to her supervisor about her concerns and provides the head trader with a copyof the Code and Standards. Smith discusses the principle of placing the clientabove the interest of the firm and the possibility that the development of the newCDO will not adhere to this responsibility. The head trader assures Smith that theappropriate analysis will be conducted when determining the appropriate securi-ties for collateral. Furthermore, the ratings are assigned by an independent firmand the prospectus will include full and factual disclosures. Smith is reassured bythe meeting, but she also reviews the company’s procedures and requirements forreporting potential violations of company policy and securities laws. |
Smith’s review of the company policies and procedures forreporting violations allows her to be prepared to report through theappropriate whistleblower process if she decides that the CDO development process involves unethical actions by others. Smith’s actions complywith the Code and Standards principles of placing the client’s interestsfirst and being loyal to her employer. In providing her supervisor with acopy of the Code and Standards, Smith is highlighting the high level ofethical conduct she is required to adhere to in her professional activities. (4) (Notification of Code and Standards) |
|
|
Laura Webb just left her position as portfolio analyst at Research Systems, Inc.(RSI). Her employment contract included a non-solicitation agreement thatrequires her to wait two years before soliciting RSI clients for any investment-related services. Upon leaving, Webb was informed that RSI would contact clientsimmediately about her departure and introduce her replacement. While working at RSI, Webb connected with clients, other industry associates,and friends through her LinkedIn network. Her business and personal relation-ships were intermingled because she considered many of her clients to be personalfriends. Realizing that her LinkedIn network would be a valuable resource for newemployment opportunities, she updated her profile several days following herdeparture from RSI. LinkedIn automatically sent a notification to Webb’s entirenetwork that her employment status had been changed in her profile. |
Prior to her departure, Webb should have discussed any client information contained in her social media networks. By updatingher LinkedIn profile after RSI notified clients and after her employmentended, she has appropriately placed her employer’s interests ahead ofher own personal interests. In addition, she has not violated the non-solicitation agreement with RSI, unless it prohibited any contact with cli-ents during the two-year period. (4) (Leaving an Employer) |
|
|
Sanjay Gupta is a research analyst at Naram Investment Management (NIM).NIM uses a team-based research process to develop recommendations on invest-ment opportunities covered by the team members. Gupta, like others, providescommentary for NIM’s clients through the company blog, which is posted weeklyon the NIM password-protected website. According to NIM’s policy, every contri-bution to the website must be approved by the company’s compliance departmentbefore posting. Any opinions expressed on the website are disclosed as represent-ing the perspective of NIM. Gupta also writes a personal blog to share his experiences with friends andfamily. As with most blogs, Gupta’s personal blog is widely available to interestedreaders through various internet search engines. Occasionally, when he disagreeswith the team-based research opinions of NIM, Gupta uses his personal blog toexpress his own opinions as a counterpoint to the commentary posted on theNIM website. Gupta believes this provides his readers with a more complete per-spective on these investment opportunities. |
Gupta is in violation of Standard IV(A) for disclosing confiden-tial firm information through his personal blog. The recommendationson the firm’s blog to clients are not freely available across the internet, buthis personal blog post indirectly provides the firm’s recommendations. Additionally, by posting research commentary on his personal blog,Gupta is using firm resources for his personal advantage. To comply withStandard IV(A), members and candidates must receive consent from theiremployer prior to using company resources. (4) (Confidential Firm Information) |
|
|
Standard IV(B) Additional Compensation Arrangements |
Members and Candidates must not accept gifts, benefits, compensation, orconsideration that competes with or might reasonably be expected to createa conflict of interest with their employer’s interest unless they obtain writtenconsent from all parties involved. |
|
|
Geoff Whitman, a portfolio analyst for Adams Trust Company, manages theaccount of Carol Cochran, a client. Whitman is paid a salary by his employer,and Cochran pays the trust company a standard fee based on the market valueof assets in her portfolio. Cochran proposes to Whitman that “any year that myportfolio achieves at least a 15% return before taxes, you and your wife can flyto Monaco at my expense and use my condominium during the third week ofJanuary.” Whitman does not inform his employer of the arrangement and vaca-tions in Monaco the following January as Cochran’s guest. |
Whitman violated Standard IV(B) by failing to inform hisemployer in writing of this supplemental, contingent compensationarrangement. The nature of the arrangement could have resulted in par-tiality to Cochran’s account, which could have detracted from Whitman’sperformance with respect to other accounts he handles for Adams Trust.Whitman must obtain the consent of his employer to accept such a sup-plemental benefit. (4) (Notification of Client Bonus Compensation) |
|
|
Terry Jones sits on the board of directors of Exercise Unlimited, Inc. In returnfor his services on the board, Jones receives unlimited membership privileges forhis family at all Exercise Unlimited facilities. Jones purchases Exercise Unlimitedstock for the client accounts for which it is appropriate. Jones does not disclosethis arrangement to his employer because he does not receive monetary compen-sation for his services to the board. |
Jones has violated Standard IV(B) by failing to disclose to hisemployer benefits received in exchange for his services on the board ofdirectors. The nonmonetary compensation may create a conflict of inter-est in the same manner as being paid to serve as a director. (4) (Notification of Outside Compensation) |
|
|
Jonathan Hollis is an analyst of oil-and-gas companies for Specialty InvestmentManagement. He is currently recommending the purchase of ABC Oil Companyshares and has published a long, well-thought-out research report to substantiatehis recommendation. Several weeks after publishing the report, Hollis receives acall from the investor-relations office of ABC Oil saying that Thomas Andrews,CEO of the company, saw the report and really liked the analyst’s grasp of thebusiness and his company. The investor-relations officer invites Hollis to visit ABCOil to discuss the industry further. ABC Oil offers to send a company plane topick Hollis up and arrange for his accommodations while visiting. Hollis, after gaining the appropriate approvals, accepts the meeting with the CEO but declinesthe offered travel arrangements. Several weeks later, Andrews and Hollis meet to discuss the oil business andHollis’s report. Following the meeting, Hollis joins Andrews and the investmentrelations officer for dinner at an upscale restaurant near ABC Oil’s headquarters. Upon returning to Specialty Investment Management, Hollis provides a fullreview of the meeting to the director of research, including a disclosure of thedinner attended. |
Hollis’s actions did not violate Standard IV(B). Through gain-ing approval before accepting the meeting and declining the offered travelarrangements, Hollis sought to avoid any potential conflicts of interestbetween his company and ABC Oil. Because the location of the dinnerwas not available prior to arrival and Hollis notified his company of thedinner upon his return, accepting the dinner should not impair his objec-tivity. By disclosing the dinner, Hollis has enabled Specialty InvestmentManagement to assess whether it has any impact on future reports andrecommendations by Hollis related to ABC Oil. (4)(Prior Approval for Outside Compensation) |
|
|
Standard IV(C) Responsibilities of Supervisors |
Members and Candidates must make reasonable efforts to ensure that any-one subject to their supervision or authority complies with applicable laws,rules, regulations, and the Code and Standards. |
|
|
Jane Mattock, senior vice president and head of the research department of H&V,Inc., a regional brokerage firm, has decided to change her recommendation forTimber Products from buy to sell. In line with H&V’s procedures, she orallyadvises certain other H&V executives of her proposed actions before the reportis prepared for publication. As a result of Mattock’s conversation with DieterFrampton, one of the H&V executives accountable to Mattock, Frampton imme-diately sells Timber’s stock from his own account and from certain discretionaryclient accounts. In addition, other personnel inform certain institutional custom-ers of the changed recommendation before it is printed and disseminated to allH&V customers who have received previous Timber reports. |
Mattock has violated Standard IV(C) by failing to reasonablyand adequately supervise the actions of those accountable to her. She didnot prevent or establish reasonable procedures designed to prevent dissemination of or trading on the information by those who knew of herchanged recommendation. She must ensure that her firm has proceduresfor reviewing or recording any trading in the stock of a corporation thathas been the subject of an unpublished change in recommendation.Adequate procedures would have informed the subordinates of theirduties and detected sales by Frampton and selected customers. (4) (Supervising Research Activities) |
|
|
Deion Miller is the research director for Jamestown Investment Programs. Theportfolio managers have become critical of Miller and his staff because theJamestown portfolios do not include any stock that has been the subject of amerger or tender offer. Georgia Ginn, a member of Miller’s staff, tells Miller thatshe has been studying a local company, Excelsior, Inc., and recommends its pur-chase. Ginn adds that the company has been widely rumored to be the subjectof a merger study by a well-known conglomerate and discussions between themare under way. At Miller’s request, Ginn prepares a memo recommending the stock. Miller passes along Ginn’s memo to the portfolio managers prior to leavingfor vacation, and he notes that he has not reviewed the memo. As a result of thememo, the portfolio managers buy Excelsior stock immediately. The day Millerreturns to the office, he learns that Ginn’s only sources for the report were herbrother, who is an acquisitions analyst with Acme Industries, the “well-knownconglomerate,” and that the merger discussions were planned but not held. |
Miller violated Standard IV(C) by not exercising reasonablesupervision when he disseminated the memo without checking to ensurethat Ginn had a reasonable and adequate basis for her recommendationsand that Ginn was not relying on material nonpublic information.(4) (Supervising Research Activities) |
|
|
David Edwards, a trainee trader at Wheeler & Company, a major national broker-age firm, assists a customer in paying for the securities of Highland, Inc., by usinganticipated profits from the immediate sale of the same securities. Despite the factthat Highland is not on Wheeler’s recommended list, a large volume of its stockis traded through Wheeler in this manner. Roberta Ann Mason is a Wheeler vicepresident responsible for supervising compliance with the securities laws in thetrading department. Part of her compensation from Wheeler is based on commis-sion revenues from the trading department. Although she notices the increasedtrading activity, she does nothing to investigate or halt it. |
Mason’s failure to adequately review and investigate purchaseorders in Highland stock executed by Edwards and her failure to super-vise the trainee’s activities violate Standard IV(C). Supervisors shouldbe especially sensitive to actual or potential conflicts between their ownself-interests and their supervisory responsibilities. (4) (Supervising Trading Activities) |
|
|
Samantha Tabbing is senior vice president and portfolio manager for Crozet, Inc.,a registered investment advisory and registered broker/dealer firm. She reports toCharles Henry, the president of Crozet. Crozet serves as the investment adviserand principal underwriter for ABC and XYZ public mutual funds. The two funds’prospectuses allow Crozet to trade financial futures for the funds for the limitedpurpose of hedging against market risks. Henry, extremely impressed by Tabbing’sperformance in the past two years, directs Tabbing to act as portfolio managerfor the funds. For the benefit of its employees, Crozet has also organized theCrozet Employee Profit-Sharing Plan (CEPSP), a defined contribution retirementplan. Henry assigns Tabbing to manage 20% of the assets of CEPSP. Tabbing’sinvestment objective for her portion of CEPSP’s assets is aggressive growth.Unbeknownst to Henry, Tabbing frequently places S&P 500 Index purchase andsale orders for the funds and the CEPSP without providing the futures com-mission merchants (FCMs) who take the orders with any prior or simultaneous STANDARD IV(C) | 149 designation of the account for which the trade has been placed. Frequently, neitherTabbing nor anyone else at Crozet completes an internal trade ticket to record thetime an order was placed or the specific account for which the order was intended.FCMs often designate a specific account only after the trade, when Tabbing pro-vides such designation. Crozet has no written operating procedures or compliancemanual concerning its futures trading, and its compliance department does notreview such trading. After observing the market’s movement, Tabbing assigns toCEPSP the S&P 500 positions with more favorable execution prices and assignspositions with less favorable execution prices to the funds. |
Henry violated Standard IV(C) by failing to adequately super-vise Tabbing with respect to her S&P 500 trading. Henry further vio-lated Standard IV(C) by failing to establish record-keeping and reportingprocedures to prevent or detect Tabbing’s violations. Henry must makea reasonable effort to determine that adequate compliance procedurescovering all employee trading activity are established, documented, com-municated, and followed. (4)(Supervising Trading Activities and Record Keeping) |
|
|
Meredith Rasmussen works on a buy-side trading desk and concentrates on in-house trades for a hedge fund subsidiary managed by a team at the investment man-agement firm. The hedge fund has been very successful and is marketed globallyby the firm. From her experience as the trader for much of the activity of the fund,Rasmussen has become quite knowledgeable about the hedge fund’s strategy, tac-tics, and performance. When a distinct break in the market occurs and many of thesecurities involved in the hedge fund’s strategy decline markedly in value, however,Rasmussen observes that the reported performance of the hedge fund does not atall reflect this decline. From her experience, this lack of an effect is a very unlikelyoccurrence. She approaches the head of trading about her concern and is told thatshe should not ask any questions and that the fund is too big and successful and isnot her concern. She is fairly sure something is not right, so she contacts the compli-ance officer and is again told to stay away from the hedge fund reporting issue. |
Rasmussen has clearly come upon an error in policies, procedures, and compliance practices within the firm’s operations. Accordingto Standard IV(C), the supervisor and the compliance officer have theresponsibility to review the concerns brought forth by Rasmussen.Supervisors have the responsibility of establishing and encouraging anethical culture in the firm. The dismissal of Rasmussen’s question violatesStandard IV(C) and undermines the firm’s ethical operations. (4) (Accepting Responsibility) See also Standard I(D)–Misconduct and, for guidance on whistleblowing,Standard IV(A)–Loyalty. |
|
|
Brendan Witt, a former junior sell-side technology analyst, decided to return toschool to earn an MBA. To keep his research skills and industry knowledge sharp,Witt accepted a position with On-line and Informed, an independent internet-based research company. The position requires the publication of a recommenda-tion and report on a different company every month. Initially, Witt is a regularcontributor of new research and a participant in the associated discussion boardsthat generally have positive comments on the technology sector. Over time, hisability to manage his educational requirements and his work requirements beginto conflict with one another. Knowing a recommendation is due the next day forOn-line, Witt creates a report based on a few news articles and what the conven-tional wisdom of the markets has deemed the “hot” security of the day. |
Allowing the report submitted by Witt to be posted highlightsa lack of compliance procedures by the research firm. Witt’s supervisorneeds to work with the management of On-line to develop an appropri-ate review process to ensure that all contracted analysts comply with therequirements. (4) (Inadequate Procedures) See also Standard V(A)–Diligence and Reasonable Basis because it relatesto Witt’s responsibility for substantiating a recommendation. |
|
|
Michael Papis is the chief investment officer of his state’s retirement fund. Thefund has always used outside advisers for the real estate allocation, and this infor-mation is clearly presented in all fund communications. Thomas Nagle, a recog-nized sell-side research analyst and Papis’s business school classmate, recentlyleft the investment bank he worked for to start his own asset management firm,Accessible Real Estate. Nagle is trying to build his assets under management andcontacts Papis about gaining some of the retirement fund’s allocation. In the pre-vious few years, the performance of the retirement fund’s real estate investmentswas in line with the fund’s benchmark but was not extraordinary. Papis decidesto help out his old friend and also to seek better returns by moving the real estateallocation to Accessible. The only notice of the change in adviser appears in thenext annual report in the listing of associated advisers. |
Papis’s actions highlight the need for supervision and review atall levels in an organization. His responsibilities may include the selectionof external advisers, but the decision to change advisers appears arbitrary.Members and candidates should ensure that their firm has appropriatepolicies and procedures in place to detect inappropriate actions, such asthe action taken by Papis. (4) (Inadequate Supervision) See also Standard V(A)–Diligence and Reasonable Basis, Standard V(B)–Communication with Clients and Prospective Clients, and StandardVI(A)–Disclosure of Conflicts. |
|
|
Mary Burdette was recently hired by Fundamental Investment Management(FIM) as a junior auto industry analyst. Burdette is expected to expand the socialmedia presence of the firm because she is active with various networks, includ-ing Facebook, LinkedIn, and Twitter. Although Burdette’s supervisor, Joe Graf,has never used social media, he encourages Burdette to explore opportunities toincrease FIM’s online presence and ability to share content, communicate, andbroadcast information to clients. In response to Graf’s encouragement, Burdetteis working on a proposal detailing the advantages of getting FIM onto Twitter inaddition to launching a company Facebook page. As part of her auto industry research for FIM, Burdette is completing a reporton the financial impact of Sun Drive Auto Ltd.’s new solar technology for com-pact automobiles. This research report will be her first for FIM, and she believesSun Drive’s technology could revolutionize the auto industry. In her excitement,Burdette sends a quick tweet to FIM Twitter followers summarizing her “buy”recommendation for Sun Drive Auto stock. |
Graf has violated Standard IV(C) by failing to reasonablysupervise Burdette with respect to the contents of her tweet. He did notestablish reasonable procedures to prevent the unauthorized dissemination of company research through social media networks. Graf mustmake sure all employees receive regular training about FIM’s policiesand procedures, including the appropriate business use of personal socialmedia networks. (4) (Supervising Research Activities) See Standard III(B) for additional guidance. |
|
|
Chen Wang leads the research department at YYRA Retirement PlanningSpecialists. Chen supervises a team of 10 analysts in a fast-paced and understaffedorganization. He is responsible for coordinating the firm’s approved process toreview all reports before they are provided to the portfolio management team foruse in rebalancing client portfolios. One of Chen’s direct reports, Huang Mei, covers the banking industry. Chenmust submit the latest updates to the portfolio management team tomorrowmorning. Huang has yet to submit her research report on ZYX Bank because sheis uncomfortable providing a “buy” or “sell” opinion of ZYX on the basis of thecompleted analysis. Pressed for time and concerned that Chen will reject a “hold”recommendation, she researches various websites and blogs on the banking sec-tor for whatever she can find on ZYX. One independent blogger provides a new interpretation of the recently reported data Huang has analyzed and concludeswith a strong “sell” recommendation for ZYX. She is impressed by the originalityand resourcefulness of this blogger’s report. Very late in the evening, Huang submits her report and “sell” recommenda-tion to Chen without any reference to the independent blogger’s report. Given thelate time of the submission and the competence of Huang’s prior work, Chen com-piles this report with the recommendations from each of the other analysts andmeets with the portfolio managers to discuss implementation. |
Chen has violated Standard IV(C) by neglecting to reasonablyand adequately follow the firm’s approved review process for Huang’sresearch report. The delayed submission and the quality of prior work donot remove Chen’s requirement to uphold the designated review process.A member or candidate with supervisory responsibility must make rea-sonable efforts to see that appropriate procedures are established, docu-mented, communicated to covered personnel, and followed. (4)(Supervising Research Activities) |
