Examples From Book Flashcards
(122 cards)
1
Q
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
to ward off Newton, Miller’s managers persuade Wiley, an investment manager
at First Country Bank, to purchase a significant amount of Miller common stock
in the open market for the employee pension plan. Miller’s officials indicate
that such an action would be favorably received and would probably result in
other accounts being placed with the bank. Although Wiley believes the stock
is overvalued and would not ordinarily buy it, he purchases the stock to support
Miller’s managers, to maintain 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 that Newton retracts its takeover bid.
A
Comment: Standard III(A) requires that a member or candidate, in
evaluating a takeover bid, act prudently and solely in the interests of
plan participants and beneficiaries. To meet this requirement, a member
or candidate must carefully evaluate the long-term prospects of the
company against the short-term prospects presented by the takeover
offer and by the ability to invest elsewhere. In this instance, Wiley, acting
on behalf of his employer, which was the trustee for a pension plan,
clearly violated Standard III(A). He used the pension plan to perpetuate
existing management, perhaps to the detriment of plan participants
and the company’s shareholders, and to benefit himself. Wiley’s
responsibilities to the plan participants and beneficiaries must take
precedence over any ties of his bank to corporate managers and over his
self-interest. Wiley had a duty to examine the takeover offer on its own
merits and to make an independent decision. The guiding principle is the appropriateness of the investment decision to the pension plan, not
whether the decision benefited Wiley or the company that hired him
2
Q
Jackson is CEO of JNI, a successful investment counseling firm that serves as
investment manager for the pension plans of several large regional companies.
JNI’s trading activities generate a significant amount of commission-related
business. Jackson uses the brokerage and research services of many firms, but
most of his company’s trading activity is handled through one large brokerage
company, Thompson, Inc., because the executives of the two firms have a
close friendship. Thompson’s commission structure is high in comparison with
charges for similar brokerage services from other firms. Jackson considers
Thompson’s research services and execution capabilities average. In exchange
for JNI directing its brokerage to Thompson, Thompson absorbs a number of
JNI overhead expenses, including those for rent.
A
Comment: Jackson is breaching his responsibilities by using client
brokerage for services that do not benefit JNI clients and by not
obtaining best price and best execution for JNI clients. Because Jackson
is not upholding his duty of loyalty, he is violating Standard III(A).
3
Q
Everett, a struggling independent investment adviser, serves as investment
manager for the pension plans of several companies. One of her brokers, Scott
Company, is close to finalizing management agreements with prospective new
clients whereby Everett would manage the new client accounts and trade the
accounts exclusively through Scott. One of Everett’s existing clients, Crayton
Corporation, has directed Everett to place security transactions for Crayton’s
account exclusively through Scott. To induce Scott to exert effort to send more
new accounts to her, Everett also directs transactions to Scott from other clients
without their knowledge.
A
Comment: Everett has an obligation at all times to seek best price
and best execution on all trades. Everett may direct new client trades
exclusively through Scott Company as long as Everett receives best
price and execution on the trades or receives a written statement from
new clients that she is not to seek best price and execution and that
they are aware of the consequence for their accounts. Everett may trade
other accounts through Scott as a reward for directing clients to Everett
only if the accounts receive best price and execution and the practice
is disclosed to the accounts. Because Everett does not disclose the
directed trading, Everett violated Standard III(A)
4
Q
(Brokerage Arrangements)
Rome is a trust officer for Paget Trust Company. Rome’s supervisor is
responsible for reviewing Rome’s trust account transactions and her monthly
reports of personal stock transactions. Rome has been using 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
A
Comment: Rome is violating her duty of loyalty to the bank’s trust
accounts by using Gray for brokerage transactions simply because Gray
trades Rome’s personal account on favorable terms. Rome is placing her
own interests before those of her clients.
5
Q
(Client Commission Practices)
Parker, an analyst with Provo Advisors, covers South American equities for
her firm. She likes to travel to the markets for which she is responsible and
decides to go on a trip to Chile, Argentina, and Brazil. The trip is sponsored by
SouthAM, Inc., a research firm with a small broker/dealer affiliate that uses the
clearing facilities of a larger New York brokerage house. SouthAM specializes
in arranging South American briefing trips for analysts, during which they can
meet with central bank officials, government ministers, local economists, and
senior executives of corporations. SouthAM accepts commission dollars at a
ratio of 2 to 1 against the hard dollar costs of the research fee for the trip. Parker
is not sure that SouthAM’s execution is competitive, but without informing her
supervisor, she directs the trading desk at Provo to start giving commission
business to SouthAM so she can take the trip. SouthAM has conveniently timed
the briefing trip to coincide with the beginning of Carnival season, so Parker also
decides to spend five days of vacation in Rio de Janeiro at the end of the trip.
Parker uses commission dollars to pay for the five days of hotel expenses.
A
Comment: Parker is violating Standard III(A) by not exercising her duty
of loyalty to her clients. She must determine whether the commissions
charged by SouthAM are reasonable in relation to the benefit of the
research provided by the trip. She also must determine whether best
execution and prices could be received from SouthAM. In addition, the
five extra days are not part of the research effort, because they do not
assist in the investment decision making. Thus, the hotel expenses for
the five days must not be paid for with client commission dollars.
6
Q
(Excessive Trading)
Knauss manages the portfolios of a number of high-net-worth individuals.
A major part of her investment management fee is based on trading
commissions. Knauss engages in extensive trading for each of her clients to ensure that she attains the minimum commission level set by her firm.
Although the securities purchased and sold for the clients are appropriate and
fall within the acceptable asset classes for the clients, the amount of trading for
each account exceeds what is necessary to accomplish the client’s investment
objectives.
A
Comment: Knauss violated Standard III(A) because she is using the
assets of her clients to benefit her firm and herself.
7
Q
Dill recently joined New Investments Asset Managers. To assist Dill in building
a book of clients, both his father and brother opened new fee-paying accounts.
Dill followed all the firm’s procedures in noting his relationships with these
clients and in developing their investment policy statements. After several
years, the number of Dill’s clients has grown, but he still manages the original
accounts of his family members. An IPO is coming to market that is a suitable
investment for many of his clients, including his brother. Dill does not receive
the amount of stock he requested, so to avoid any appearance of a conflict of
interest, he does not allocate any shares to his brother’s account.
A
Comment: Dill violated Standard III(A) because he did not act for the
benefit of his brother’s account or his other accounts. The brother’s
account is a regular fee-paying account comparable to the accounts of
his other clients. By not allocating the shares proportionately across all
accounts for which he thought the IPO was suitable, Dill disadvantaged
specific clients. Dill would have been correct in not allocating shares to
his brother’s account if that account was being managed outside the
normal fee structure of the firm.
8
Q
(Identifying the Client)
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 concerned that
her work may have negative consequences for the law firm. If the law firm is
Hensley’s client, how does she ensure that her testimony will not violate the
required duty of loyalty, prudence, and care to one’s client?
A
Comment: In this situation, the law firm represents Hensley’s employer
and the aspect of “who is the client” is not well defined. When
acting as an expert witness, Hensley is bound by the standard of
independence and objectivity in the same manner that an independent
research analyst would be bound. Hensley must not let the law firm
influence the testimony she provides in the legal proceedings.
9
Q
(Identifying the Client)
Miller is a mutual fund portfolio manager. The fund is focused on the global
financial services sector. Spears is a private wealth manager in the same city as
Miller and is a friend of Miller. At a CFA Institute local society meeting, Spears
mentions to Miller that her new client is an investor in Miller’s fund. She states
that the two of them now share a responsibility to this client.
A
Comment: Spears’ statement is not entirely accurate. Because she
provides the 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
according to the investment policy statement of the fund. His actions
must not be influenced by the needs of any particular fund investor.
10
Q
(Client Loyalty)
After providing client account investment performance to external-facing
departments but prior to it being finalized for release to clients, 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 previously
placed the firm on “watch” for potential termination owing to underperformance
in prior periods. Nguyen knows this news is unpleasant but informs the
appropriate individuals that the report needs to be updated before releasing it to
the client.
A
Comment: Nguyen’s actions align with the requirements of
Standard III(A). Even though the correction may lead to the firm’s
termination by the client, withholding information on errors is not
in the best interest of the client.
11
Q
(Execution-Only Responsibilities)
Sulejman recently became a candidate in the CFA Program. He is a broker who
executes client-directed trades for several high-net-worth individuals. Sulejman
does not provide any investment advice and only executes the trading decisions
made by clients. He is concerned that the Code and Standards impose a fiduciary
duty on him in his dealing with clients and sends an email to the CFA Institute
Ethics Helpdesk (ethics@cfainstitute.org) to seek guidance on this issue.
A
Comment: In this instance, Sulejman serves in an execution-only
capacity. His duty of loyalty, prudence, and care is centered on the skill
and diligence used when executing trades—namely, by seeking best
execution and making trades within the parameters set by the clients
(instructions on quantity, price, timing, etc.). Acting in the best interests
of the client dictates that trades are executed on the most favorable
terms that can be achieved for the client. Given this job function, the
requirements of the Code and Standards for loyalty, prudence, and care
clearly do not impose a fiduciary duty.
12
Q
Standard III(B)
A
Fair Dealing
Members and Candidates must deal fairly and objectively with all clients when
providing investment analysis, making investment recommendations, taking
investment action, or engaging in other professional activities
13
Q
Example 1 (Selective Disclosure)
Ames, a well-known and respected analyst, follows the computer industry. In
the course of his research, he finds that a small, relatively unknown company
whose shares are traded over the counter has just signed significant contracts
with some of the companies he follows. After a considerable amount of investigation, Ames decides to write a research report on the small company
and recommend purchase of its shares. While the report is being reviewed by the company for factual accuracy, Ames schedules a luncheon with several
of his best clients to discuss the company. At the luncheon, he mentions the
purchase recommendation scheduled to be sent early the following week to all
the firm’s clients.
A
Comment: Ames violated Standard III(B) by disseminating the purchase
recommendation to the clients with whom he had lunch a week before
the recommendation is sent to all clients.
14
Q
Rivers, president of XYZ Corporation, moves his company’s growth-oriented
pension fund to a particular bank primarily because of the excellent
investment performance achieved by the bank’s commingled fund for the prior
five-year period. Later, Rivers compares the results of his pension fund with
those of the bank’s commingled fund. He is startled to learn that, even though
the two accounts have the same investment objectives and similar portfolios,
his company’s pension fund has significantly underperformed the bank’s
commingled fund. Questioning this result at his next meeting with Jackson,
the pension fund’s manager, Rivers is told that, as a matter of policy, when a
new security is placed on the recommended list, Jackson first purchases the
security for the commingled account and then purchases it on a pro rata basis
for all other pension fund accounts. Similarly, when a sale is recommended,
the security is sold first from the commingled account and then sold on a pro
rata basis from all other accounts. Rivers also learns that if the bank cannot get
enough shares (especially of hot issues) to be meaningful to all the accounts, its
policy is to place the new issues only in the commingled account.
Seeing that Rivers is neither satisfied nor pleased by the explanation, Jackson
quickly adds that nondiscretionary pension accounts and personal trust
accounts have an even lower priority on purchase and sale recommendations
than discretionary pension fund accounts. Furthermore, Jackson states that
the company’s pension fund had the opportunity to invest up to 5% in the
commingled fund
A
(Fair Dealing between Funds)
Comment: The bank’s policy does not treat all customers fairly, and
Jackson violated her duty to her clients by giving priority to the growth-
oriented commingled fund over all other funds and to discretionary
accounts over nondiscretionary accounts. Jackson must execute orders
on a systematic basis to be fair to all clients.
15
Q
Morris works for a small regional securities firm. His work consists of corporate
finance activities and investing for institutional clients. PickleDilly, Ltd., is
planning to go public. The partners have secured rights to buy a professional
pickleball franchise and plan to use the funds from the issue to complete the
purchase. Because pickleball is the current rage, Morris believes he has a hot issue on his hands. He has quietly negotiated some options for himself for
helping convince PickleDilly to do the financing through his securities firm.
When he seeks expressions of interest, institutional buyers oversubscribe the
issue. Morris, assuming that the institutions have the financial clout to drive
the stock up, fills all orders (including his own) but decreases the institutional
blocks.
A
(Fair Dealing and IPO Distribution)
Comment: Morris violated Standard III(B) by not treating all customers
fairly. To meet his obligations under the standard, Morris needed
to refrain from taking any shares himself and needed to prorate the
distribution of the shares to clients or use some other distribution
method for treating clients fairly. In addition, he should have avoided
the conflict of interest caused by the options by not seeking those
additional benefits. Because Morris did not avoid the conflict, he must
disclose to his firm and to his clients that he received options as part of
the deal [see Standard VI(A) Disclosure of Conflicts].
16
Q
Preston, the chief investment officer of Porter Williams Investments (PWI),
a medium-size money management firm, has been trying to retain a client,
Colby Company. 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 purchases mortgage-backed securities (MBSs) for several accounts,
including Colby’s. Preston is busy with a number of transactions that day, so
she fails to allocate the trades immediately or write up the trade tickets. A few
days later, when Preston is allocating trades, she notes that some of the MBSs
have significantly increased in price and some have dropped. Preston decides
to allocate the profitable trades to Colby and spread the losing trades among
several other PWI accounts.
A
(Fair Dealing and Transaction Allocation)
Comment: Preston violated Standard III(B) by failing to deal fairly with
her clients in taking these investment actions. Preston should have
allocated the trades prior to executing the orders, or she should have
had a systematic approach to allocating the trades, such as pro rata, as
soon as it was practical after they were executed.
17
Q
(Selective Disclosure)
Saunders Industrial Waste Management (SIWM) publicly indicates to analysts
that it is comfortable with the somewhat disappointing earnings-per-share
projection of US$1.16 for the quarter. Roberts, an analyst at Coffey Investments,
is confident that SIWM management understated the forecasted earnings
so that the real announcement would cause an “upside surprise” and boost
the price of SIWM stock. The “whisper number” (rumored) estimate based on extensive research 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
clients but informally tells his large clients that he expects the earnings per
share to be higher, making SIWM a good buy.
A
Comment: By not sharing his opinion regarding the potential for a
significant upside earnings surprise with all clients, Roberts did not
treat all clients fairly and violated Standard III(B
18
Q
Weng uses email to issue a new recommendation to all his clients. He then calls
his three largest institutional clients to discuss the recommendation in detail,
and they compensate him for the personal outreach.
A
Comment: Weng did not violate Standard III(B). He widely disseminated
the recommendation and information to all his clients prior to discussing
it with a select few. Weng’s largest clients received additional personal
service because they pay higher fees. If Weng had discussed the report
with a select group of clients prior to distributing it to all his clients, he
would have violated Standard III(B) (Additional Services for Select Clients)
19
Q
Hampton is a well-respected private wealth manager in her community with a
diversified client base. She determines that a new 10-year bond being offered
by Healthy Pharmaceuticals is appropriate for five of her clients. Three clients
request 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
oversubscribed at the time of placement. Her firm’s policy is that odd-lot
allocations, especially those below the minimum, should be avoided because
they may affect the liquidity of the security at the time of sale.
Hampton is informed she will receive only US$55,000 of the offering for
all accounts. Hampton distributes the bond investments as follows: The three
accounts that requested US$10,000 are allocated US$5,000 each, and the
two accounts that requested US$50,000 are allocated US$20,000 each.
A
(Minimum Lot Allocations) Comment: Hampton did not violate Standard III(B), even though the
distribution is not on a completely pro-rata basis, because of the
required minimum lot size. With the total allocation being significantly
below the amount requested, Hampton ensured that each client
received at least the minimum lot size of the issue and that the filled
allocations were close in percentage to the requested allocations.
This approach allowed the clients to efficiently sell the bond later, if
necessary.
20
Q
Chan manages the accounts for many pension plans, including the plan of his
father’s employer. Chan developed similar but not identical investment policies
for each client, so the investment portfolios are rarely the same. To minimize
the cost to his father’s pension plan, he intentionally trades more frequently in
the accounts of other clients to ensure the required brokerage commissions are
incurred to continue receiving free research that benefits all the pension plans.
A
Comment: Chan is violating Standard III(B) because his trading actions
are disadvantaging his clients to enhance a relationship with a preferred
client. All clients are benefiting from the research being provided and
should 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. (Excessive Trading)
21
Q
Burdette was recently hired by Fundamental Investment Management (FIM)
as a junior auto industry analyst. Burdette is expected to expand the social
media presence of the firm, including on Facebook, LinkedIn, and X (formerly
known as Twitter). Burdette’s supervisor, Graf, encourages Burdette to explore
opportunities to increase FIM’s online presence and ability to share content,
communicate, and broadcast information to clients.
As part of her auto industry research for FIM, Burdette is completing a report on
the financial impact of Sun Drive Auto Ltd.’s new solar technology for compact
automobiles. This research report will be her first for FIM, and she believes Sun
Drive’s technology could revolutionize the auto industry. In her excitement,
Burdette posts a brief message to FIM LinkedIn followers summarizing her “buy”
recommendation for Sun Drive Auto stock.
A
Comment: Burdette violated Standard III(B) by sending an investment
recommendation to a select group of contacts prior to distributing it to
all clients.
(Limited Social Media Disclosures)
22
Q
Rove, a performance analyst for Alpha-Beta Investment Management, is
describing to the firm’s chief investment officer (CIO) two new reports he would
like 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
client accounts and the percentage of the portfolio each security represents.
The second report would compare the monthly performance of portfolios with
similar strategies. The outliers in each report would be submitted to the CIO
for review.
A
(Performance Analysis)Comment: As a performance analyst, Rove likely has little direct contact
with clients and thus has limited opportunity to treat clients differently.
The recommended reports comply with Standard III(B) while helping the
firm conduct after-the-fact reviews of how effectively the firm’s advisers
are dealing with their clients’ portfolios. Reports that monitor the fair
treatment of clients are an important oversight tool to ensure that
clients are treated fairly.
23
Q
Smith, an investment adviser, has two clients: Robertson, who is 60 years
old, and Lanai, who is 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 and low income needs. Robertson is willing to invest part of his assets
very aggressively; Lanai wants only to achieve a steady rate of return with
low volatility to pay for his children’s education. Smith recommends investing
20% of both portfolios in zero-yield, small-cap, high-technology equity issues
A
Comment: In Robertson’s case, the investment may be appropriate
because of his financial circumstances and aggressive investment
position, but this investment is not suitable for Lanai. Smith violated
Standard III(C) by applying Robertson’s investment strategy to Lanai
because the two clients’ financial circumstances and objectives differ.
(Investment Suitability—Risk Profile)
24
Q
McDowell, an investment adviser, suggests to Crosby, a risk-averse client, that
covered call options be used in his equity portfolio. The purpose would be to
enhance Crosby’s income and partially offset any untimely depreciation in the
portfolio’s value should the stock market or other circumstances affect his
holdings unfavorably. McDowell educates Crosby about all possible outcomes,
including the risk of incurring an added tax liability if a stock rises in price and
is called away and, conversely, the risk of his holdings losing protection on the
downside if prices drop sharply.
A
(Investment Suitability—Entire Portfolio)
Comment: When determining suitability of an investment, the primary
focus should be the characteristics of the client’s entire portfolio, not the
characteristics of single securities on an issue-by-issue basis. The basic
characteristics of the entire portfolio will largely determine whether
investment recommendations are taking client factors into account. In
this case, McDowell properly considers the investment in the context of
the entire portfolio and thoroughly explains the investment to the client.
25
Evans, a portfolio manager at Blue Chip Investment Advisers, learns that some
significant changes have recently taken place in Jones’s life. A wealthy relative
left Jones an inheritance that increased his net worth fourfold, to US$1 million
Comment: The inheritance may have significantly increased Jones’s
ability (and possibly his willingness) to assume risk and perhaps has
diminished the average yield required to meet his current income
needs. Jones’s financial circumstances have changed considerably, so Evans must review and potentially update Jones’s IPS to reflect how
his investment objectives have changed. (IPS Updating)
26
)
Perkowski manages a high-income mutual fund. He purchases zero-dividend
stock in a financial services company because he believes the stock is
undervalued and is in a potential growth industry, which makes it an attractive
investment.
(Following an Investment Mandate)
Comment: A zero-dividend stock does not seem to fit the mandate of
the fund that Perkowski manages. Unless Perkowski’s investment fits
within the mandate or is in the realm of allowable investments the fund
has made clear in its disclosures, Perkowski violated Standard III(C).
27
(IPS Requirements and Limitations)
Gubler, chief investment officer of a property/casualty insurance subsidiary
of a large financial conglomerate, wants to improve the diversification of the
subsidiary’s investment portfolio and increase its returns. The subsidiary’s IPS
provides for liquid investments, such as large-cap equities and government,
supranational, and corporate bonds with a minimum credit rating of AA and
maturity of no more than five years. In a recent presentation, a venture capital
group offered very attractive prospective returns on some of its private equity
funds that provide seed capital to ventures. Investors would have to observe a
minimum three-year lockup period and a subsequent laddered exit option for
a maximum of one-third of their shares per year. Gubler does not want to miss
this opportunity. In an effort to optimize the return on the equity assets in the
subsidiary’s current portfolio and after extensive analysis, he invests 4% in this
seed fund, leaving the portfolio’s total equity exposure still well below its upper
limit.
Comment: Gubler violated Standard III(C). His new investment locks
up part of the subsidiary’s assets for at least three years and up to as
many as five years or more. The IPS requires investments in highly
liquid investments and describes accepted asset classes; private equity
investments with a lockup period would not fall within the mandate.
Even without a lockup period, an asset class with only an occasional and
thus implicitly illiquid market may not be suitable for the portfolio
28
Snead, a portfolio manager for Thomas Investment Counsel, Inc., specializes 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,
in an attempt to motivate and retain key investment professionals, introduced
a bonus compensation system that rewards portfolio managers on the basis
of quarterly performance relative to their peers and to certain benchmark indexes. In an attempt to improve the short-term performance of her accounts,
Snead changes her investment strategy for the retirement funds she manages
and purchases several high-beta stocks for client portfolios. These purchases
are seemingly contrary to the clients’ IPSs. Following their purchase, an
officer of Griffin Corporation, one of Snead’s pension fund clients, asks why
Griffin Corporation’s portfolio seems to be dominated by high-beta stocks of
companies that often appear among the most actively traded issues. No change
in objective or strategy has been recommended by Snead during the year.
Investment Suitability—Risk Profile)
Comment: Snead violated Standard III(C) by investing the clients’ assets
in high-beta stocks. These high-risk investments are contrary to the
long-term risk profile established in the clients’ IPSs. Snead has changed
the investment strategy of the clients in an attempt to reap short-term
rewards offered by her firm’s new compensation arrangement, not in
response to changes in clients’ IPSs.
29
DeVries is trustee of the MPG pension fund. Recently, the fund conducted
a survey on the preferences of the beneficiaries. The survey asked several
questions about the return impact and risks associated with the incorporation
of ESG issues into the investment selection process. The results of the survey
showed that the beneficiaries like high pension payouts, but the investment
returns should be achieved while considering ESG issues.
DeVries introduces an amendment to the IPS to incorporate an ESG framework
into the investment decision-making process. Among the specific factors in
the ESG framework is a restriction on investing in producers of products that
negatively affect the health of consumers. The changes to the IPS are approved
by the MPG pension board and communicated to all external managers.
After receiving communications on the update to the IPS, Van Cleef, an external
manager for the MPG pension fund, purchases stock in a tobacco firm. He
reasons that tobacco, although not healthy, exhibits an attractive risk–return
profile and will contribute to the high pension payouts that the beneficiaries
so desire. Van Cleef believes that investment return is his first priority as a
manager.
Comment: Van Cleef violated Standard III(C) because he failed to
consider the constraints and unique circumstances of the beneficiaries
of the pension fund. In this case, a preference for incorporating ESG
issues into the investment process is clearly mandated.
The trustees have a duty to ensure that the fund’s assets are invested
in accordance with the IPS. Any trustee who is required to abide by the
Code and Standards, such as DeVries, would need to ensure that Van
Cleef sells the inappropriate tobacco securities. (Constraints)
30
Kim is the portfolio manager of a family office. The family office’s IPS objectives
include long-term capital preservation and mitigation of downside risk. Kim is
considering two investments in the chemical industry: Park Inc. and Dong Inc.
Solely on the basis of financial statement analysis, the Park Inc. investment is
the most attractive. Upon further analysis, Kim finds that Dong Inc. scores much
higher than Park Inc. on other factors, including ESG criteria.
Kim believes that companies scoring high on ESG factors typically have higher-
quality management and reduced environmental risks, such as risks that might
lead to costly accidents or regulatory fines. Such factors ultimately benefit the
expected return and risk profile of the investment. On that basis, Kim invests in
Dong Inc. for the family office.
(Suitability Factors)
Comment: Kim has a responsibility to select investments that are
suitable for the IPS objectives. He is permitted to incorporate criteria
beyond financial metrics, including but not limited to ESG issues, into
the investment decision-making process. Kim’s actions are not in conflict
with his obligation to make effective suitability determinations.
31
Taylor of Taylor Trust Company distributes a brochure to potential clients stating
that the firm consistently achieves “25% annual growth” of assets. Taylor Trust’s
common trust fund did increase 25% for the previous year, which mirrored the
increase of the overall market. The fund never had an annual growth rate of 25%
prior to last year, and the average rate of growth of all of Taylor Trust accounts
for five years is 5% per year.
Comment: Taylor’s brochure is in violation of Standard III(D). Taylor
must disclose that the 25% growth occurred only in one year and only
for the firm’s common trust fund. A general claim of firm performance
must take into account the performance of all categories of accounts.
By stating that clients can expect a steady 25% annual compound
growth rate, Taylor is misrepresenting one portfolio’s single-year actual
performance as expected performance
(Performance Calculation and Length of Time)
32
Taylor of Taylor Trust Company distributes a brochure to potential clients stating that the firm consistently achieves “25% annual growth” of assets. Taylor Trust’s common trust fund did increase 25% for the previous year, which mirrored the increase of the overall market. The fund never had an annual growth rate of 25% prior to last year, and the average rate of growth of all of Taylor Trust accounts for five years is 5% per year.
Comment: Taylor’s brochure is in violation of Standard III(D). Taylor must disclose that the 25% growth occurred only in one year and only for the firm’s common trust fund. A general claim of firm performance must take into account the performance of all categories of accounts. By stating that clients can expect a steady 25% annual compound growth rate, Taylor is misrepresenting one portfolio’s single-year actual performance as expected performance.
Performance Calculation and Length of Time)
33
Judd, a senior partner at Alexander Capital Management, circulates a performance report for the capital appreciation accounts for the years 2008 through 2022. The firm claims compliance with the GIPS standards. Returns are not calculated in accordance with the requirements of the GIPS standards, however, because the composite returns are not calculated by asset weighting portfolio returns.
Comment: Judd violated Standard III(D). When claiming compliance with the GIPS standards, firms must meet all the requirements, make mandatory disclosures, and meet any other requirements that apply to that firm’s specific situation. The GIPS standards require firms to asset weight portfolio returns to calculate composite returns. Judd’s violation is not from any misuse of the data but from publishing a performance report with her firm’s false claim of GIPS compliance.
Performance Calculation and Asset Weighting)
34
McCoy is vice president and managing partner of the equity investment group of Mastermind Financial Advisers, a new business. Mastermind recruited McCoy because he had a proven six-year track record with G&P Financial. In developing Mastermind’s advertising and marketing campaign, McCoy prepares an advertisement that includes the equity investment performance he achieved at G&P Financial. The advertisement for Mastermind does not identify the equity performance as being earned while at G&P. The advertisement is distributed to existing clients and prospective clients of Mastermind.
Performance Presentation and Prior Fund/Employer)
Comment: McCoy violated Standard III(D) by distributing an advertisement that contains material misrepresentations about the historical performance of Mastermind. Standard III(D) requires that members and candidates make reasonable efforts to ensure that performance information is a fair, accurate, and complete representation of an individual’s or firm’s performance. As a general matter, this standard does not prohibit showing past performance of accounts managed at a prior firm as part of a performance track record as long as showing that record is accompanied by appropriate disclosures about where the performance took place and the person’s specific role in achieving that performance. If McCoy chooses to use his past performance from G&P in Mastermind’s advertising, he must make full disclosure of the source of the historical performance.
35
Davis developed a mutual fund selection product based on historical information from 2000 to 2015. Davis tests his methodology by applying it retroactively to data from the 2016–22 period, thus producing simulated performance results for those years. In January 2023, Davis’s employer decides to offer the product and Davis begins promoting it through trade journal advertisements and direct dissemination to clients. The advertisements include the performance results for the 2016–22 period but do not indicate that the results were simulated.
Comment: Davis violated Standard III(D) by failing to clearly identify 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 and candidates to make every reasonable effort to ensure that performance information presented to clients is fair, accurate, and complete. Davis’s use of simulated results must be accompanied by full disclosure as to the source of the performance data, including the fact that the results from 2016 through 2022 are the result of applying the model retroactively to that time period.
Performance Presentation and Simulated Results)
36
37
In a presentation prepared for prospective clients, Kilmer shows the rates of return realized over a five-year period by a “composite” of his firm’s discretionary accounts that have a “balanced” objective. This composite, however, consists of only a few of the accounts that met the balanced criterion set by the f irm, excludes accounts under a certain asset level without disclosing the fact of their exclusion, and includes accounts that do not have the balanced mandate, because those accounts help increase the investment results. In addition, to achieve better results, Kilmer manipulates the narrow range of accounts included in the composite by changing the accounts that make up the composite over time.
Comment: Kilmer violated Standard III(D) by misrepresenting the facts in the promotional material sent to prospective clients, distorting his firm’s performance record, and failing to include disclosures that would have clarified the presentation.
Performance Calculation and Selected Accounts Only)
38
Purell is reviewing the quarterly performance attribution reports for distribution 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 compares each stock’s return with its sector return. The attribution report indicates that the value added this quarter came from asset allocation and that stock selection contributed negatively to the calculated return. After trying several different approaches, Purell discovers that calculating attribution by comparing each stock with its industry and then rolling the effect to the sector level improves the appearance of the manager’s stock selection activities. Because the firm defines the attribution terms and the results better reflect the stated strategy, Purell recommends that the client reports should use the revised methodology.
Comment: Modifying the attribution methodology without proper disclosure fails to meet the requirements of Standard III(D). Purell’s recommendation is being done solely for the interest of the firm to improve its perceived ability to meet the stated investment strategy. Such changes obscure the facts regarding the firm’s abilities.
Performance Attribution Changes)
39
While developing a new reporting package for existing clients, Singh, a performance analyst, discovers that her company’s new system automatically calculates both time-weighted and money-weighted returns. She asks the head of client services and retention which return type is preferred given that the f irm has various investment strategies that include bonds, equities, securities without leverage, and alternatives. Singh is told not to label the returns so that the firm may show whichever performance calculation provides the highest return for the period.
Performance Calculation Methodology Disclosure)
Comment: Following these instructions would lead to Singh violating Standard III(D). In reporting inconsistent return types, Singh would not be providing complete information to the firm’s clients. Complete information is provided when clients have sufficient information to judge the performance generated by the firm.
40
Connor, a financial analyst employed by Johnson Investment Counselors, Inc., provides investment advice to the trustees of City Medical Center. The trustees have given her a number of internal reports concerning City Medical’s needs for physical plant renovation and expansion. They have asked Connor to recommend investments that would generate capital appreciation in endowment funds to meet projected capital expenditures. Connor is approached by a local businessman, Kasey, who is considering a substantial contribution either to City Medical Center or to another local hospital. Kasey wants to find out the building plans of both institutions before making a decision, but he does not want to speak to the trustees.
Comment: The trustees gave Connor the internal reports so she could advise them on how to manage their endowment funds. Because the information in the reports is clearly both confidential and within the scope of the confidential relationship, Standard III(E) prohibits Connor from divulging the information to Kasey.
Possessing Confidential Information)
41
Moody is an investment officer at the Lester Trust Company. She has an advisory client who has talked to her about giving approximately US$50,000 to charity to reduce her income taxes. Moody is also treasurer of the Home for Indigent Widows (HIW), which is planning its annual giving campaign. HIW hopes to expand its list of donors, particularly those capable of substantial gifts. Moody recommends that HIW’s vice president for corporate gifts call on her client and ask for a donation in the US$50,000 range.
Disclosing Confidential Information)
Comment: Even though the attempt to help the Home for Indigent Widows was well intended, Moody violated Standard III(E) by revealing confidential information about her client.
42
Samuel, the portfolio manager for Garcia Company’s pension plan, has learned from one of Garcia’s corporate officers that potentially excessive and improper charges were being made to the pension plan by the CEO of Garcia. They tell her that Garcia’s corporate tax returns are being audited and the pension fund is being reviewed. Samuel consults her employer’s general counsel and is advised that Garcia likely violated tax and fiduciary regulations and laws. Two days later, government officials contact Samuel with a request to examine pension fund records.
Disclosing Possible Illegal Activity)
Comment: Samuel and her employer should seek the advice of legal counsel to determine the appropriate steps to take to protect the interests of the participants and beneficiaries of the pension plan and comply with applicable law for responding to government regulators. Samuel may well have a duty to provide the pension fund records her f irm possesses to the government.
43
Bradford manages money for a family-owned real estate development corporation. He also manages the individual portfolios of several of the family members and officers of the corporation, including the chief financial officer (CFO). Based on the financial records of the corporation and some questionable practices of the CFO that Bradford has observed, Bradford believes that the CFO is embezzling money from the corporation and putting it into his personal investment account.
Comment: Bradford should check with his firm’s compliance department or appropriate legal counsel to determine whether applicable securities regulations require reporting the CFO’s financial records to authorities.
Disclosing Possible Illegal Activity
44
Moody is an investment officer at the Lester Trust Company (LTC). She has stewardship of a significant number of individually managed taxable accounts. In addition to receiving quarterly written reports, about a dozen high-net-worth individuals have indicated to Moody a willingness to receive communications about overall economic and financial market outlooks directly from her through social media. Under the direction of her firm’s technology and compliance departments, she establishes a new group page on an existing LTC social media platform specifically for her clients. In the instructions provided to clients, Moody asks them to “join” the group so they may be granted access to the posted content. The instructions also advise clients that the platform is not an appropriate method for communicating personal or confidential information. Six months later, in early January, Moody posts LTC’s year-end “Market Outlook.” The report outlines a new asset allocation strategy that the firm is adding to its recommendations in the new year. In the report, Moody indicates that she will be discussing the changes with clients individually in their upcoming meetings. One of Moody’s clients responds directly on the group page that his family recently experienced a major change in their financial profile. The client describes highly personal and confidential details of the event. Unfortunately, all clients that were part of the group are also able to read the detailed posting until Moody has the comment removed.
Comment: Moody has taken reasonable steps to protect the confidentiality of client information while using the social media platform. She provided instructions clarifying that all information posted on the site would be publicly viewable to all group members and warned against using this method for communicating confidential information. The accidental disclosure of confidential information by a client is not under Moody’s control. Her actions to remove the information promptly once she became aware further align with Standard III(E).
Accidental Disclosure of Confidential Information)
45
Gonzales, a financial adviser, provides investment advice to a number of private wealth clients. At the beginning of all client arrangements, as a part of the onboarding process, Gonzales requires the client to designate a secondary contact who Gonzales can communicate with should she become concerned about the client’s ability to make judicious financial decisions. Gonzales meets with a longtime client, Brennan, a widow, on a regular basis to discuss her portfolio. Brennan has named her son as the person to contact in the event of her mental decline. Gonzales has growing concerns about Brennan’s mental capacity over the past several months because Brennan has forgotten the last three meetings and has had to reschedule follow-up meetings. At those meetings, Brennan not only seems confused by routine matters that Gonzales knows she easily grasped in the past but also seems unclear about her longestablished investment objectives. When Gonzales tries to make light of these lapses, Brennan grows uncharacteristically irritable with her. Gonzales details these meetings and interactions in her files. At the next meeting, Brennan directs Gonzales to liquidate 50% of her portfolio. Brennan informs Gonzales that she wishes to invest that money in a highly speculative private health club venture being opened by her physical therapist. Gonzales has been working with Brennan over many years, and she has always favored a widely diversified portfolio. Prior to acting on Brennan’s directive, Gonzales contacts her client’s son to discuss this situation with him. She documents in Brennan’s file the conversation with both Brennan and her son and her reasons for disclosing confidential information.
Comment: Gonzales has taken the appropriate steps to protect Brennan’s interests by disclosing her concerns about the vulnerability of her client. Brennan previously indicated that in the event of concerns about her mental capacity, Gonzales should contact her son. Gonzales’s observation of Brennan’s mental decline and concern over the dependent relationship with her physical therapist are valid reasons to question the sudden instruction to liquidate a large portion of her investments. Gonzales is thus not in violation of the Standard III(E) Preservation of Confidentiality.
Vulnerable Investor)
46
Smith-Pelley, a financial planner, receives a call from longtime client, Carlson, who shares the news that, after a recent divorce from her husband of 37 years, she met and married a man 25 years her junior while on a holiday in another country. The man is a citizen of that country but will be moving home with Carlson. Carlson asks Smith-Pelley to liquidate half of her investment account so she can move out of her flat and into an expensive country estate with her new husband. Carlson also directs Smith-Pelley to add her new husband’s name to all her investment account documents. Carlson does as directed. Over the next six months, more funds are withdrawn from the account, mostly by Carlson’s new husband. Carlson’s children from her first marriage, also clients of Smith-Pelley, contact him to demand that their mother’s accounts be frozen, claiming she has diminished mental capacity and is being taken advantage of by the new man in her life. Smith-Pelley does nothing and refuses to discuss Carlson’s accounts with her children.
Confidential Information to Family Members)
Comment: Smith-Pelley is not in violation of his ethical duties by failing to act on Carlson’s children’s directions or discussing her account with them. Although Carlson’s recent decisions may raise red flags because the changes were sudden and unexpected, they do not indicate a loss of Carlson’s decision-making ability. As such, he is right to act for the benefit of his client, follow her direction, and keep her investment information confidential.
47
Allen works for a brokerage firm and is responsible for an underwriting of securities. A senior manager for an issuing company 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.
Comment: Although it is recommended that members and candidates seek the advice of legal counsel, the reliance on such advice does not absolve a member or candidate from the requirement to comply with the law or regulation. Allen should report this situation to his supervisor, seek an independent legal opinion, and determine whether the regulator should be notified of the error.
Notification of Known Violations)
48
Brown’s employer, an investment banking firm, is the principal underwriter for an issue of convertible debentures by the Courtney Company. Brown discovers that the Courtney Company concealed severe third-quarter losses in its foreign operations. The preliminary prospectus was already distributed.
(Dissociating from a Violation)
Comment: Knowing that the preliminary prospectus is misleading, Brown should report his findings to the appropriate supervisory persons in his firm. If the matter is not remedied and Brown’s employer does not dissociate from the underwriting, Brown must sever all his connections with the underwriting. Brown should also seek legal advice to determine whether additional reporting or other action should be taken.
49
Washington’s firm advertises its past performance record by showing the 10-year return of a composite of its client accounts. Washington discovers, however, that the composite omits the performance of accounts that left the firm during the 10-year period, whereas the description of the composite indicates the inclusion of all firm accounts. This omission led to an inflated performance figure. Washington is asked to use promotional material that includes the erroneous performance number when soliciting business for the firm.
Comment: Misrepresenting performance is a violation of the Code and Standards. Although she did not calculate the performance herself, Washington will assist in violating Standard I(A) if she were to use the inflated performance number when soliciting clients. She must dissociate herself from the activity. If discussing the misleading number with the person responsible is not an option for correcting the problem, she must bring the situation to the attention of her supervisor or the compliance department at her firm. If her firm is unwilling to recalculate performance, she must refrain from using the misleading promotional material and should notify the firm of her reasons. If the firm insists that she use the material, she should consider whether her obligation to dissociate from the activity requires her to seek other employment
Dissociating from a Violation)
50
Collins is an investment analyst for a major Wall Street brokerage firm. He works in a developing country with a rapidly modernizing economy and a growing capital market. Local securities laws are minimal—in form and content—and include no punitive prohibitions against insider trading.
Comment: Collins must abide by the requirements of the Code and Standards, which are stricter than the rules of the developing country. In handling material nonpublic information that comes into his possession, he must follow Standard II(A) Material Nonpublic Information.
Following the Highest Requirements)
51
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). Jameson, believing that, as a US citizen working for a US-based company, she should comply only with US law, 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.
Comment: Jameson is in violation of Standard I(A). As a registered investment adviser in Karramba, Jameson is prevented by Karrambian securities law from participating in IPOs regardless of the law of her home country. In addition, because the law of the country where she works is stricter than the Code and Standards, she must follow the stricter requirements of the local law rather than the requirements of the Code and Standards.
Following the Highest Requirements)
52
White communicates with clients and potential clients through social media. She posts investment information, including performance reports and investment opinions and recommendations, along with brief announcements and opinions (e.g., “Prospects for future growth of XYZ company look good! #makingmoney4U”). Prior to White’s use of social media, the local regulator issued new requirements and guidance governing online electronic communication. White’s communications conflict with the recent regulatory announcements.
Comment: White is in violation of Standard I(A) because her communications do not comply with the existing applicable regulation governing use of social media. White must be aware of the evolving legal requirements pertaining to areas of the financial services industry that apply to her. She should seek guidance from appropriate, knowledgeable, and reliable sources, such as her firm’s compliance department, external service providers, or outside counsel, unless she diligently follows legal and regulatory trends affecting her professional responsibilities. Having appropriate knowledge of the laws directly applicable to her professional activities is also required by Standard I(E) Competence.
Failure to Maintain Knowledge of the Law)
53
Scherzer is a portfolio manager for National Investment Advisors (NIA). He, along with many other NIA personnel, assists in preparing for the firm’s annual audit of financial reports required by local regulations. While gathering and preparing material to assist Strasberg, the firm’s chief financial officer (CFO), and her audit team in fulfilling the firm’s annual regulatory reporting requirements, Scherzer neglects to properly collect and disclose certain information required by the regulations.
Knowledge of Applicable Law)
Comment: Although Scherzer occasionally assists with the firm’s f inancial audit, his primary professional responsibilities relate to portfolio management of client accounts. As such, Standard I(A) does not require Scherzer to have detailed knowledge of the financial audit regulations applicable to his firm. Strasberg, as the CFO and the person responsible for the internal audit team, would be required by Standard I(A) to understand and comply with the audit regulations. Scherzer can rely on Strasberg to understand what information is required by the regulations and give him advice on how to properly gather and disclose that information.
54
Taylor, a mining analyst with Bronson Brokers, is invited by Precision Metals to 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 modest accommodations 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 other analysts, with one exception—Adams, an employee of a large trust company who insists on following his company’s policy and paying for his hotel room himself
Comment: The policy of the company where Adams works complies closely with Standard I(B) by avoiding even the appearance of a conflict of interest, but Taylor and the other analysts did not necessarily violate Standard I(B). In general, when allowing companies to pay for travel and/or accommodations in these circumstances, members and candidates must use their judgment. They must be on guard that such arrangements do not impinge on a member’s or candidate’s independence and objectivity. In this example, the trip was strictly for business and Taylor was not accepting irrelevant or lavish hospitality. The itinerary required chartered flights, for which analysts were not expected to pay. The accommodations were modest. In the final analysis, members and candidates must consider both whether they can remain objective and whether their integrity might be perceived by their clients to have been compromised.
Travel Expenses
55
Dillon, an analyst in the corporate finance department of an investment services firm, is making a presentation to a potential new business client that includes the promise that her firm will provide full research coverage of the potential client.
Comment: Dillon may agree to provide research coverage, but she must not commit her firm’s research department to providing a favorable recommendation. The firm’s recommendation (favorable, neutral, or unfavorable) must be based on an independent and objective investigation and analysis of the company and its securities.
Research Independence)
56
Fritz is an equity analyst at Hilton Brokerage who covers the mining industry. He has concluded that the stock of Metals & Mining is overpriced at its current level, but he is concerned that a negative research report will hurt the good relationship between Metals & Mining and the investment banking division of his firm. In fact, a senior manager of Hilton Brokerage just sent him a copy of a proposal his firm made to Metals & Mining to underwrite a debt offering. Fritz needs to produce a report right away and is concerned about issuing a less-than-favorable rating.
Research Independence and Intrafirm Pressure)
Comment: Fritz’s analysis of Metals & Mining must be objective and based solely on consideration of company fundamentals. Any pressure from other divisions of his firm is inappropriate. This conflict could have been eliminated if, in anticipation of the offering, Hilton Brokerage had placed Metals & Mining on a restricted list.
57
Fritz is an equity analyst at Hilton Brokerage who covers the mining industry. Fritz has concluded that Metals & Mining stock is overvalued at its current level, but he is concerned that a negative research report might jeopardize a close rapport that he has nurtured over the years with Metals & Mining’s CEO, chief financial officer, and investment relations officer. Fritz is concerned that a negative report might also result in management retaliation—for instance, cutting him off from participating in conference calls when a quarterly earnings release is made, denying him the ability to ask questions on such calls, and/or denying him access to top management for arranging group meetings between Hilton Brokerage clients and top Metals & Mining managers.
Comment: Fritz’s analysis must be objective and based solely on consideration of company fundamentals. Any pressure from Metals & Mining is inappropriate. To support the integrity of his conclusions, Fritz should fully document his work, including how his investment recommendation is based on relative valuation. Research Independence and Issuer Relationship Pressure)
58
Mandel is a senior portfolio manager for ZZYY Capital Management who oversees a team of investment professionals who manage labor union pension funds. A few years ago, ZZYY sought to win a competitive asset manager search to manage a significant allocation of the pension fund of the United Doughnut and Pretzel Bakers Union (UDPBU). UDPBU’s investment board is chaired by Gomez, a recognized key decision maker and long-time leader of the union. To improve ZZYY’s chances of winning the competition, Mandel made significant monetary contributions to Gomez’s union reelection campaign fund. Even after ZZYY was hired as a primary manager of the pension fund, Mandel believed that his firm’s position was not secure. Mandel continued to contribute to Gomez’s reelection campaign fund and lavishly entertained the union leader and his family at top restaurants on a regular basis. All of Mandel’s outlays were routinely handled as marketing expenses reimbursed by ZZYY’s expense accounts and were disclosed to his senior management as being instrumental in maintaining a strong close relationship with an important client.
Comment: Mandel not only offered but actually gave monetary gifts, benefits, and other considerations that reasonably could be expected to compromise Gomez’s objectivity. Therefore, Mandel was in violation of Standard I(B).
Example 11 (Influencing Manager Selection Decisions)
59
Jorund, a securities analyst following airline stocks, is a rising star at her firm. Her boss has been carrying a “buy” recommendation on International Airlines and asks Jorund to take over coverage of the airline. He tells Jorund that under no circumstances should the prevailing buy recommendation be changed.
Research Independence and Prior Coverage)
Comment: Jorund must be independent and objective in her analysis of International Airlines. If she believes that her boss’s instructions have compromised her, she has two options: She can tell her boss that she cannot cover the company under these constraints, or she can take over coverage of the company, reach her own independent conclusions, and if they conflict with her boss’s opinion, share the conclusions with her boss or other supervisors in the firm so that they can make appropriate recommendations. Jorund must issue only recommendations that reflect her independent and objective opinion.
60
Grant directs a large amount of his commission business to a New York–based brokerage house. In appreciation for all the business, the brokerage house gives Grant two tickets to the World Cup in South Africa, two nights at a nearby resort, several meals, and transportation via limousine to the game.
Gifts and Entertainment from Related Parties)
Comment: Grant violated Standard I(B) because accepting these substantial gifts may impede his independence and objectivity. Members and candidates must not solicit or accept gifts, contributions, or other compensation that affects their independence and objectivity or that reasonably could be expected to influence their decisionmaking process. Best practice is to avoid situations that might cause or be perceived to cause a loss of independence or objectivity in recommending investments or taking investment action. By accepting the trip, Grant created a conflict of interest and opened himself up to the accusation that he may give the broker favored treatment in return. At a minimum, Grant must disclose this conflict to his employer and clients.
61
Green manages the portfolio of Knowlden, a client of Tisbury Investments. Green achieves an annual return for Knowlden that is consistently better than that of the benchmark she and the client previously agreed to. As a reward, Knowlden offers Green two tickets to Wimbledon and the use of Knowlden’s flat in London for a week. Green discloses this gift to her supervisor at Tisbury.
Example 8 (Gifts and Entertainment from Clients)
Comment: Green is in compliance with Standard I(B) because she disclosed the gift from one of her clients. Members and candidates may accept bonuses or gifts from clients as long as they disclose them to their employer because gifts in a client relationship are deemed less likely to affect a member’s or candidate’s objectivity and independence than gifts in other situations. Disclosure is required, however, so that supervisors can monitor such situations to guard against employees favoring a gift-giving client to the detriment of other fee-paying clients (such as by allocating a greater proportion of IPO stock to the gift-giving client’s portfolio).
62
63
Wayne is the investment manager of the Franklin City Employee Pension Plan. He recently completed a successful search for a firm to manage the foreign equity allocation of the plan’s diversified portfolio. He followed the plan’s standard procedure of seeking presentations from a number of qualified f irms and recommended that his board select Penguin Advisers because of its experience, well-defined investment strategy, and performance record. The f irm claims compliance with the Global Investment Performance Standards (GIPS®) and has been verified. Following the selection of Penguin, a reporter from the Franklin City Record calls to ask whether there was any connection between this action and the fact that Penguin Advisers 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 by the Pension Investment Academy, which had arranged the itinerary of meetings with economic, government, and corporate officials in major cities in several Asian countries. The Pension Investment Academy obtains support for the cost of these trips from a number of investment managers, including Penguin Advisers; the Academy then pays the travel expenses of the various pension plan managers on the trip and provides all meals and accommodations. The president of Penguin Advisers was also one of the travelers on the trip.
Travel Expenses from External Managers)
Comment: Although Wayne can probably put to good use the knowledge he gained from the trip when selecting external portfolio managers and in other areas of managing the pension plan, his recommendation of Penguin Advisers may be tainted by the possible conflict incurred when he participated in the international trip partly paid for by Penguin Advisers and when he was in the daily company of the president of Penguin Advisers. To avoid violating Standard I(B), Wayne’s basic expenses for travel and accommodations should have been paid by his employer or the pension plan; contact with the president of Penguin Advisers should have been limited to informational or educational events only; and the trip, the organizer, and the sponsor should have been made a matter of public record.
64
Research Independence and Compensation Arrangements)
Herrero recently left his job as a research analyst for a large investment adviser. While looking for a new position, he was hired as a contractor by an investor relations firm to write a research report on one of its clients, a small educational software company. The investor relations firm hopes to generate investor interest in the technology company. The firm will pay Herrero a flat fee plus a bonus if any new investors buy stock in the company as a result of Herrero’s report.
Comment: If Herrero accepts this payment arrangement, he will be in violation of Standard I(B) because the compensation arrangement can reasonably be expected to compromise his independence and objectivity. Herrero will receive a bonus for attracting investors, which provides an incentive to draft a positive report regardless of the facts and to ignore or play down any negative information about the company. Herrero should accept only a flat fee that is not tied to the conclusions or recommendations of the report. Issuer-paid research that is objective and unbiased is acceptable under certain circumstances as long as the analyst takes steps to maintain his or her objectivity and includes in the report proper disclosures regarding potential conflicts of interest.
65
Mandel is a senior portfolio manager for ZZYY Capital Management who oversees a team of investment professionals who manage labor union pension funds. A few years ago, ZZYY sought to win a competitive asset manager search to manage a significant allocation of the pension fund of the United Doughnut and Pretzel Bakers Union (UDPBU). UDPBU’s investment board is chaired by Gomez, a recognized key decision maker and long-time leader of the union. To improve ZZYY’s chances of winning the competition, Mandel made significant monetary contributions to Gomez’s union reelection campaign fund. Even after ZZYY was hired as a primary manager of the pension fund, Mandel believed that his firm’s position was not secure. Mandel continued to contribute to Gomez’s reelection campaign fund and lavishly entertained the union leader and his family at top restaurants on a regular basis. All of Mandel’s outlays were routinely handled as marketing expenses reimbursed by ZZYY’s expense accounts and were disclosed to his senior management as being instrumental in maintaining a strong close relationship with an important client
Influencing Manager Selection Decisions)
Comment: Mandel not only offered but actually gave monetary gifts,
benefits, and other considerations that reasonably could be expected to
compromise Gomez’s objectivity. Therefore, Mandel was in violation of
Standard I(B).
66
Scott is a performance analyst who is responsible for analyzing the performance of external managers for her firm. While completing her quarterly analysis, Scott notices a change in one manager’s reported composite construction. The change concealed the bad performance of a particularly large account by placing that account into a new residual composite. This change allowed the manager to remain at the top of the list of manager performance. Scott knows her firm has a large allocation to this manager, and the fund’s manager is a close personal friend of the CEO. She needs to deliver her final report but is concerned about pointing out the composite change.
Fund Manager Relationships)
Comment: Scott would be in violation of Standard I(B) if she did not disclose the change in her final report. The analysis of managers’ performance must not be influenced by personal relationships or the size of the allocation to the outside managers. By not including the change, Scott would not be providing an independent analysis of the performance metrics for her firm.
67
Stein is head of performance measurement for her firm. During the last quarter, many members of the organization’s research department were removed because of the poor quality of their recommendations. The subpar research caused one larger account holder to experience significant underperformance, which resulted in the client withdrawing his money after the end of the quarter. The head of sales requests that Stein remove this account from the firm’s performance composite because the performance decline can be attributed to the departed research team and not the client’s adviser
Comment: Pressure from other internal departments can create situations that cause a member or candidate to violate the Code and Standards. Stein must maintain her independence and objectivity and refuse to exclude specific accounts from the firm’s performance composites to which they belong. As long as the client invested under a strategy similar to that of the defined composite, it cannot be excluded because of the poor stock selections that led to the underperformance and asset withdrawal.
Intrafirm Pressure
68
Rogers is a partner at Rogers and Black, a small firm offering investment advisory services. She assures a prospective client who inherited a portfolio worth US$1 million that “we can perform all the financial and investment services you need.” Rogers and Black is well equipped to provide investment advice but, in fact, cannot provide a full array of financial and investment services, such as tax planning.
Representing the Firm’s Abilities)
Comment: Rogers violated Standard I(C) by orally misrepresenting the services her firm can perform for the prospective client. Using vague, imprecise, and general language such as “all the financial and investment services you need” oversells and misrepresents the services she and her firm can provide. She must limit herself to describing the range of investment advisory services Rogers and Black can provide and offer to help the client obtain elsewhere the financial and investment services that her firm cannot provide.
69
Disclosure of Issuer-Paid Research)
McGuire is an issuer-paid analyst hired by publicly traded companies to electronically promote their stocks. McGuire creates a website that promotes his research efforts as a seemingly independent analyst. McGuire posts a profile and a strong buy recommendation for each company on the website, indicating that the stock is expected to increase in value. He does not disclose the contractual relationships with the companies he covers on his website, in the research reports he issues, or in the statements he makes about the companies in internet chatrooms.
Comment: McGuire violated Standard I(C) because the internet site is misleading to potential investors. Even if the recommendations are valid and supported with thorough research, his omissions regarding the true relationship between himself and the companies he covers constitute a misrepresentation. McGuire also violated Standard VI(A) Avoid or Disclose Conflicts, by not disclosing the existence of an arrangement with the companies from which he receives compensation in exchange for his services.
70
Yao is responsible for the creation and distribution of the marketing materials for his firm, which claims compliance with the GIPS standards. Yao creates and distributes a presentation of performance for the firm’s Asian Equity Composite that states the composite has ¥350 billion in assets. In fact, the composite has only ¥35 billion in assets, and the higher figure on the presentation is a result of a typographical error. Nevertheless, the erroneous material is distributed to a number of clients before Yao catches the mistake.
Comment: Once the error is discovered, Yao must take steps to cease distribution of the incorrect material and correct the error by informing those who have received the erroneous information. Because Yao did not knowingly make the misrepresentation, however, he did not violate Standard I(C). Since his firm claims compliance with the GIPS standards, he must also comply with the GIPS standards requirements addressing the treatment of material errors.
Correction of Unintentional Errors)
71
Muhammad is the president of an investment management firm. The promotional material for the firm, created by the firm’s marketing department, incorrectly claims that Muhammad has an advanced degree in finance from a prestigious business school in addition to the CFA designation. Although Muhammad attended the school for a short period of time, he did not receive a degree. Over the years, Muhammad and others in the firm have distributed this material to numerous prospective clients and consultants.
Comment: Even though Muhammad may not have been directly responsible for the misrepresentation of his credentials in the firm’s promotional material, he should have known of the misrepresentation because he used this material numerous times over an extended period, and therefore, he violated Standard I(C). Once Muhammad became aware of the errors in the promotional material, he should have corrected the information. Best practice would be for Muhammad to provide correct information to any recipients of the erroneous material.
Not Correcting Known Errors)
72
Grant, a research analyst for a Canadian brokerage firm, has specialized in the Canadian mining industry for the past 10 years. She recently read an extensive research report on Jefferson Mining, Ltd., by Barton, an analyst at a different f irm. Barton provided extensive statistics on the mineral reserves, production capacity, selling rates, and marketing factors affecting Jefferson’s operations. He also noted that initial drilling results on a new ore body, which had not been made public, might show the existence of mineral zones that could increase the life of Jefferson’s main mines, but Barton cited no specific data as to the initial drilling results. Grant called an officer of Jefferson, who gave her the initial drilling results over the telephone. The data indicated that the expected life of the main mines would be tripled. Grant added these statistics to Barton’s report and circulated it as her own report within her firm.
Comment: Grant plagiarized Barton’s report by reproducing large parts of it in her own report without acknowledgment and, therefore, violated Standard I(C).
Plagiarism
73
When Marks sells mortgage-backed derivatives called “interest-only strips” (IOs) to public pension plan clients, she describes them as “guaranteed by the US government.” Purchasers of the IOs are entitled only to the interest stream generated by the mortgages, however, not the notional principal itself. One particular municipality’s investment policies and local law require that securities purchased by its public pension plans be guaranteed by the US government. Although the underlying mortgages are guaranteed, neither the investor’s investment nor the interest stream on the IOs is guaranteed. When interest rates decline, causing an increase in prepayment of mortgages, interest payments to the IOs’ investors decline, and these investors lose a portion of their investment.
Misrepresentation of Information)
Comment: Marks violated Standard I(C) by misrepresenting the terms and character of the investment.
74
Potential Information Misrepresentation)
Abdrabbo manages the investments of several high-net-worth individuals in the United States who are approaching retirement. Abdrabbo advises these individuals that a portion of their investments should be moved from equity to bank-sponsored certificates of deposit and money market accounts so that the principal will be “guaranteed” up to a certain amount. The interest is not guaranteed.
Comment: Although there is risk that the institution offering the certificates of deposit and money market accounts could go bankrupt, in the United States, these accounts are insured by the US government through the Federal Deposit Insurance Corporation. Therefore, using the term “guaranteed” in this context is appropriate if the amount is within the government-insured limit. Abdrabbo must explain these facts to the clients.
75
Swanson is a senior analyst in the investment research department of Ballard and Company. Apex Corporation has asked Ballard to assist in acquiring the majority ownership of stock in the Campbell Company, a financial consulting f irm, and to prepare a report recommending that stockholders of Campbell agree to the acquisition. Another investment firm, Davis and Company, had already prepared a report for Apex analyzing both Apex and Campbell and recommending an exchange ratio. Apex has given the Davis report to Ballard officers, who have passed it on to Swanson. Swanson reviews the Davis report and other available material on Apex and Campbell. From his analysis, he concludes that the common 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 a Campbell stockholder would need to know to make a decision. Swanson reports his 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.”
Comment: 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 if he identifies Davis as the source; he could then add his own analysis and conclusions to the report before signing and distributing it.
Plagiarism
76
Browning, a quantitative analyst for Double Alpha, Inc., is excited after returning from a seminar. In that seminar, Jorrely, a well-publicized quantitative analyst at a national brokerage firm, discussed one of his new models in great detail, and Browning is intrigued by the new concepts. He proceeds to test the model, making some minor changes but retaining the concepts, until he produces some very positive results. Browning quickly announces to his supervisors at Double Alpha that he has discovered a new model and that clients and prospective clients should be informed of this positive finding as ongoing proof of Double Alpha’s continuing innovation and ability to add value.
Comment: Although Browning tested Jorrely’s model on his own and even slightly modified it, he must still acknowledge the original source of the idea. Browning can certainly take credit for the final, practical results; he can also support his conclusions with his own test. The credit for the innovative thinking, however, must be given to Jorrely.
Plagiarism
77
78
Zubia would like to include in his firm’s marketing materials some “plainlanguage” 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 descriptions come from other sources, but Zubia wishes to use them without reference to the original authors.
Plagiarism
Comment: Copying verbatim any material without acknowledgment, including plain-language descriptions of the P/E multiple and standard deviation, violates Standard I(C). Even though these concepts are general, best practice would be for Zubia to describe them in his own words or cite the sources from which the descriptions are quoted. Members and candidates would be violating Standard I(C) if they either were responsible for creating marketing materials without attribution or knowingly used plagiarized materials.
79
80
Through a mainstream media outlet, Schneider learns about a study that she would like to cite in her research. She questions whether she should cite both the mainstream intermediary source and the author of the study itself when using that information.
Plagiarism
Comment: In all instances, a member or candidate must cite the actual source of the information. Best practice for Schneider would be to obtain the information directly from the author and review it before citing it in a report. In that case, Schneider would not need to report how she found out about the information. For example, suppose Schneider read in the Financial Times about a study issued by CFA Institute; best practice for Schneider 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 interpretation of the report from the Financial Times and the newspaper does not add value to the report itself, the newspaper is merely a conduit to the original information and does not need to be cited. If she does not obtain the report and review the information, Schneider runs the risk of relying on second-hand information that may misstate facts. If, for example, the Financial Times erroneously reported some information from the original CFA Institute study and Schneider copied that erroneous information, she would be including misinformation in her research. To avoid a potential violation of Standard I(C), Schneider must obtain the complete study from its original author and cite only that author or use the information provided by the intermediary and cite both sources
81
Ostrowski runs a two-person investment management firm. His firm subscribes to a service from a large investment research firm that provides research reports that can be repackaged by smaller firms for those firms’ clients. Ostrowski’s firm distributes these reports to clients as its own work.
Misrepresentation of Information)
Comment: Ostrowski may rely on third-party research that has a reasonable and adequate basis, but he must not imply that he is the author of such research. If he does, Ostrowski is misrepresenting the extent of his work in a way that misleads the firm’s clients or prospective clients.
82
Stafford is part of a team at Appleton Investment Management responsible for managing a pool of assets for Open Air Bank, which distributes structured securities to offshore clients. He becomes aware that Open Air is promoting the structured securities as a much less risky investment than the investment management policy followed by himself and the team to manage the original pool of assets. Also, Open Air has procured an independent rating for the pool that significantly overstates the quality of the investments. Stafford communicates his concerns to his supervisor, who responds that Open Air owns the product and is responsible for all marketing and distribution. Stafford’s supervisor goes on to say that the product is outside the US regulatory regime that Appleton follows and that all risks of the product are disclosed at the bottom of page 184 of the prospectus.
Misrepresentation of Information)
Comment: As a member of the investment team, Stafford is qualified to recognize the degree of accuracy of the materials that characterize the portfolio, and he is correct to be concerned about Appleton’s responsibility for a misrepresentation of the risks. Stafford must continue to pursue the issue of Open Air’s inaccurate promotion with Appleton’s compliance personnel and management. Stafford cannot be part of promoting, recommending, or distributing information about securities that he considers misleading without potentially violating Standard I(C).
83
Palmer is head of performance for an investment manager. When asked to provide performance numbers to databases, he avoids disclosing that the firm excludes from composites accounts that have underperformed their benchmark. The composite returns reported to the databases, although accurate for the accounts that have not underperformed their benchmark, do not present a true representation of the investment manager’s track record.
Misrepresenting Composite Construction)
Comment: “Cherry-picking” accounts to include in either published reports or information provided to databases or other external parties conflicts with Standard I(C). Selecting only the best-performing accounts to include in a track record materially misrepresents the firm’s composite results. Palmer should work with his firm to strengthen its reporting practices concerning composite construction to avoid misrepresenting the firm’s track record or the quality of the information being provided.
84
Finch is a sales director at a commercial bank, where he directs the bank’s client advisers in the sale of third-party mutual funds. Each quarter, he holds a divisionwide training session where he provides fact sheets on investment funds the bank is allowed to offer to clients. These fact sheets, which can be redistributed to clients, are created by the mutual fund firms and contain information about the funds, including investment strategy and target distribution rates. Finch knows that some of the fact sheets are out of date; for example, one longonly fund approved the use of significant leverage last quarter as a method to enhance returns. He continues to provide the sheets to the sales team without updates because the bank has no control over the marketing material released by the mutual fund firms.
Presenting Out-of-Date Information
Comment: Finch is violating Standard I(C) by providing information that misrepresents aspects of the funds. By not providing the sales team and, ultimately, the clients with the updated information, he is misrepresenting the potential risks associated with the funds with outdated fact sheets. Finch must instruct the sales team to clarify the deficiencies in the fact sheets with clients and ensure they have the most recent fund documents before accepting orders for investing in any fund.
85
Lowery manages the Majesty Fund, which was established in 2018 and has become one of the leading Asian environmental, social, and governance (ESG) funds. The fund’s mandate is to seek sustainable wealth creation. Lowery uses ESG scores provided by third-party rating organizations to assess potential investments for the fund. The fund declares in promotional material and client agreements that it engages in proactive engagement and proxy voting for companies owned by the fund to create sustainable growth. However, Lowery has done neither of these activities. As a result, the fund has never published its detailed engagement reports that include its engagement strategy and its outcomes. Moreover, there has been no clear communication by the fund regarding its proxy voting and its consequences.
(Overstating ESG Claims)
Comment: A firm that describes one of its funds as considering ESG factors must clearly describe what that means and not overstate the sustainability, social impact, or governance credentials of the fund. By stating that the fund would conduct proactive engagement with management and proxy voting for companies owned by the fund in order to create sustainable growth and failing to do so, Lowery misrepresented the fund and failed to meet Standard I(C).
86
For many years, Stafford was a partner at Lionsgate LLP, a large, full-service accounting firm that provides audit and other services, primarily in the area of investment performance. She leaves Lionsgate, with a junior associate, to form her own firm, Angelwood Analytics. Angelwood’s website, social media, and print marketing heavily emphasize Stafford’s expertise and experience and state that Stafford will be personally involved in all client work. Angelwood’s clients are small at first, but eventually Stafford attracts several large clients. To service these larger clients, she transitions to an oversight role and hires new staff to work with her longtime clients. Business becomes so successful that Stafford resorts to hiring third-party contractors that eventually provide support for over 50% of Angelwood’s work. The staff she uses are qualified, industry practice allows use of third-party contractors for the work, and Angelwood’s client agreement states that staffing decisions for each client are discretionary for the firm.
Misleading Description of Services)
Comment: Stafford violated Standard I(C) since her communications were not accurate and complete given the circumstances. Stafford, through her firm, did not accurately describe how her firm was staffed to perform the services that she promoted. While stating that clients could expect her knowledge and expertise, Stafford increasingly relied on junior employees and third-party staffers. While this was acceptable, she did not give a complete picture of how Angelwood will be providing investment services for clients when promoting the firm.
87
For the past two decades, Huggins has managed an investment advisory firm catering to retail clients and high-net-worth individuals. Overall, the investment performance history of the firm for the past five years has been satisfactory, but since the onset of the global pandemic, performance has dropped appreciably. On the firm’s website, Huggins provides the five-year performance history of the fund as a way to convince potential clients to hire his firm for advisory services. He does not update the information on the website to clarify that the performance history since the beginning of the pandemic has been less than stellar, even though that information is available.
Inaccurate, Dated Performance History)
Comment: Huggins violated Standard I(C) by not providing accurate and timely information as part of his marketing to potential clients.
88
Hamilton is a research analyst for a private equity fund focused on impact investing in the ESG space. Hamilton creates several research reports to distribute to potential investors that generally demonstrate and describe the process the fund goes through when choosing ESG investments. The reports for potential investors are not as detailed as the research reports provided to investors once they commit to investing in the fund. After committing US$50 million to the fund, one investor, a charitable foundation, receives the more detailed reports. The chief investment officer of the foundation is unhappy that the private equity fund seems overweighted in developing technology and therefore represents a riskier investment than was indicated by the more general information initially provided by Hamilton
Insufficient, Omitted Information).
Comment: The information provided by members and candidates when meeting their responsibilities under Standard I(C) must be appropriate for the circumstances. In some circumstances, it may be appropriate to limit the information provided to potential investors, who are not yet clients, while providing more detailed disclosures and information about the investment process to those who have already entered into a client relationship. However, limiting information cannot rise to the level of misrepresenting the nature or risks of the investment. In this case, Hamilton appears to have provided only limited information about the extent to which the fund is invested in developing technology and therefore violated Standard I(C) by improperly misrepresenting the true level of risk of the investment.
89
The sovereign wealth fund of a developing country is seeking an investment manager to manage a portion of the fund’s assets. The fund’s directors want to take advantage of the efficiencies, innovation, and increased profitability they believe are available through the use of artificial intelligence (AI) tools in the investment process. As such, they include several questions on the use of artificial intelligence on the request for proposal (RFP) sent out to potential managers. Al-Wazir, CEO of AWZ Investment Advisers, is intent on being competitive in the fund’s manager search, even though his firm is just beginning to explore AI to enhance investment performance. Wanting to provide a seemingly thorough and knowledgeable answer, he uses ChatGPT to complete the portion of the RFP asking for a narrative of how each responding manager incorporates AI in its investment process.
Comment: Al-Wazir violated Standard I(C) by misrepresenting his firm’s capabilities relating to AI in its investment process and using ChatGPT to respond to the RFP to hide his superficial knowledge of the topic and seem more knowledgeable than he is.
Misleading Description of Service, Misrepresenting Knowledge)
90
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 clients have observed him having numerous drinks. Back at work after lunch, he clearly is intoxicated while making investment decisions. His colleagues make a point of handling any business with Sasserman in the morning because they distrust his judgment after lunch.
Comment: Sasserman’s excessive drinking at lunch and subsequent intoxication at work constitute a violation of Standard I(D) because this conduct has raised questions about his professionalism and competence. His behavior reflects poorly on him, his employer, and the investment industry.
Professionalism and Competence
91
Hoffman, a security analyst at ATZ Brothers, Inc., a large brokerage house, submits reimbursement forms over a two-year period to ATZ’s self-funded health insurance program for more than two dozen bills, most of which have been altered to increase the amount due. An investigation by the firm’s director of employee benefits uncovers the inappropriate conduct. ATZ subsequently terminates Hoffman’s employment and notifies CFA Institute.
Comment: Hoffman violated Standard I(D) because he engaged in intentional conduct involving fraud and deceit in the workplace that adversely reflected on his integrity.
Fraud and Deceit)
92
Brink, an analyst covering the automotive industry, is CEO of a very successful boutique investment research firm. Because she is a prominent member of the community and a CFA charterholder with years of experience in the investment industry, several local charities ask Brink to sit on their board, and she does so as a volunteer. The board of one of the charitable institutions for which Brink serves on the board decides to buy five new vans to deliver hot lunches to lowincome elderly people. Brink offers to handle purchasing agreements. To pay a long-standing debt to a friend who operates an automobile dealership—and to compensate herself for her trouble—she agrees to a price 20% higher than normal and splits the surcharge with her friend.
Comment: Brink’s volunteer work for the board of the charitable organization is a professional activity for the purposes of this standard since she serves on the board because of her status as an experienced investment analyst and CFA charterholder. Brink engaged in misconduct involving dishonesty, fraud, and misrepresentation and violated Standard I(D).
Fraud and Deceit)
93
Garcia manages a mutual fund dedicated to socially responsible investing. She is also an environmental activist. As a result of her participation in nonviolent protests, Garcia has been arrested on numerous occasions for trespassing on the property of a large petrochemical plant that is accused of damaging the environment.
Personal Actions and Integrity)
Comment: Generally, Standard I(D) is not meant to cover legal transgressions resulting from acts of civil disobedience in support of personal beliefs, because such conduct does not reflect poorly on the member’s or candidate’s professional reputation, integrity, or competence.
94
O’Hara volunteers at his local society as an instructor at the society’s CFA exam review course for local candidates in the CFA Program. O’Hara engages in inappropriate behavior with several female candidates that includes making suggestive remarks, unwanted touching, and repeatedly asking candidates out on dates despite being rebuffed by them.
Misconduct as a CFA Institute Society Volunteer)
Comment: O’Hara is in violation of Standard I(D) by engaging in sexual harassment that reflects poorly on his professional reputation and integrity. Although the actions do not take place in the workplace, O’Hara’s actions are professional conduct within the meaning of the Code and Standards because the conduct takes place as part of his work with the local society and encompasses the use of his charter and membership in the organization.
95
Nehjer recently retired from a successful career as an economist for an investment adviser to live at her country estate. She maintains active CFA Institute membership with the organization and the local society. A multinational firm has announced its intention to open a large casino within 5 km of her estate. Local officials are balancing the positive economic impact of the casino with the negative effects it will have on the character of the community. Nehjer and her neighbors strenuously object to the casino. She publishes an open letter stating that studies have shown that the positive economic impact of gambling venues is widely overblown. She cites a number of statistics in her letter that she fabricated or altered to help make her point. She signs her name to the letter, indicating that she has a PhD and is a CFA charterholder.
Comment: By engaging in fraud, dishonesty, and deceit in using fabricated and altered statistics in an effort to support her opinion on the casino issue, Nehjer engaged in misconduct and violated Standard I(D). Although she is retired, her actions in this case are professional conduct within the meaning of the standard because she identified herself as a CFA charterholder and explicitly used her charter in an attempt to give her analysis and opinions more credibility.
Identification as a CFA Charterholder)
96
Mewis is an analyst for an investment advisory firm and a candidate for the CFA designation. She has a strong interest in environmental protection and combatting climate change. She starts a blog in which she provides analysis of investment opportunities and makes stock picks for companies based on her evaluation of their environmental, social, and governance (ESG) factors. Her work with her employer is unrelated to ESG analysis, and her employer gives permission for her to create the blog if her ESG-related work is done on her own time and she does not identify herself as an analyst for the firm. In one of her blog posts, Mewis severely criticizes JKL company for causing substantial harm to the environment in its manufacturing process and having incompetent management. She posts on her blog that the company is likely soon to be the subject of regulatory action and private litigation that will greatly affect JKL’s profitability. Mewis has no knowledge that any of this is true but seeks to damage the company because of a personal dispute with her ex-husband, the CEO of the company.
Writing about Investments Outside the Workplace or Academia)
Comment: Mewis violated Standard I(D) by engaging in dishonesty, fraud, and deceit and in conduct that reflects adversely on her professional reputation and integrity. Although her actions are not related to her employment with the investment adviser, her conduct relates to the candidate’s involvement in the investment profession and security markets.
97
Tan is a candidate for the CFA designation and a junior analyst working in the downtown office of his employer, QRS Advisers. Because parking is extremely limited, most QRS employees commute to the company offices using public transportation. Tan wants the convenience of driving his own personal vehicle to work. He submits false documentation to government officials indicating that he has health issues that make him eligible for a disabled person parking permit. The government issues his permit, and he regularly drives to work and parks at one of the “disabled person only” spots near his office.
Comment: While Tan’s actions involve dishonesty, fraud, deceit, and lying to government officials, his actions do not fall within the definition of professional conduct for the purposes of application of the Code and Standards. His conduct is, at most, tangential to his employment and does not implicate his participation in the CFA Program or any other affiliation with CFA Institute. As a result, while his conduct is deplorable, it is not “professional” conduct to which the Code and Standards apply.
(Actions Unrelated to Professional Conduct
98
Mondelo is a well-known security analyst, as well as a devoted follower of a national politician running for high public office. Prior to the election, Mondelo volunteers extensively for this politician. After election day, the opponent of Mondelo’s candidate is declared the winner. The candidate whom Mondelo supports claims that widespread election fraud took place and urges his followers to demonstrate against the election at the nation’s capital on the day his opponent is to be sworn into office. Thousands of followers, including Mondelo, follow the candidate’s direction and join the protest. A large number of demonstrators engage in violence and vandalism of government offices. During their investigation of the criminal activity, law enforcement officials interview Mondelo. He denies engaging in violence or vandalism. However, security cameras and the cell phone videos of other protesters that are posted on social media capture Mondelo fighting with police, setting fire to vehicles, and yelling racial slurs at supporters of the newly elected candidate. Mondelo’s subsequent arrest makes national news because of his prominence in the investment industry, and he is fired from his job.
Actions Unrelated to Professional Conduct
Comment: Mondelo’s violent actions during the protest and lying to government investigators about his actions involve dishonesty and deceit and call into question his integrity and character. However, although he is fired from his job, the activity is not related to his employment or his participation in the investment profession and is unrelated to his charter or any affiliation with CFA Institute. As a result, his activities related to this event do not amount to professional conduct within the meaning of the Code and Standards and are, therefore, not covered by Standard I(D). Should Mondelo be convicted of a crime that is punishable by more than one year in prison for any actions, including those that arise out of his conduct at the election protest, he could be summarily suspended from CFA Institute under the Rules of Procedure for Conduct Related to the Profession (as amended and restated 1 January 2022).
99
Lee runs a geopolitical consulting firm where she analyzes international political, social, and economic issues and developments to produce research reports for her clients, many of which are investment management firms. Lee has been closely monitoring news regarding a new multinational trade deal that has the potential to significantly boost commercial activity among countries in a certain region of the world. As soon as the trade deal was officially ratified and announced, she quickly downloaded a copy of the agreement and read it to understand its terms and impact. She also consulted with experts in the f ield to obtain their opinions on the impacts of the trade deal and confirm her understanding of its terms and implications.
Comment: Lee satisfied the requirement of Standard I(E). Lee was able to write a knowledgeable and informative research report for her clients by keeping abreast of developments in her field through news reports, consulting with experts, and studying the trade deal itself to ensure that her knowledge was up to date.
100
Choe is the director of research at a large sell-side firm. Several of Choe’s clients asked her to incorporate environmental, social, and governance (ESG) ratings into the research reports the firm produces. Until now, the firm’s research reports have been based only on traditional quantitative metrics. Choe hires an experienced ESG analyst for her team, and she requires all research analysts, including herself, to attend ESG-focused seminars and obtain an ESG investment specialist certificate. In due time, Choe and her team begin to incorporate ESG considerations into their research reports.
Comment: Choe extended her competence in her field by educating herself on new considerations relevant to her industry and by hiring someone with ESG expertise to fill a knowledge and skills gap before she and her team incorporated ESG considerations into the firm’s research reports. As such, Choe satisfied the requirement of Standard I(E
(Improving Competence
101
Glusker is a regulatory attorney for a hedge fund who sought to transition to a sales role after impressing senior management with his strong business acumen. There is a licensing requirement involving an examination that an individual must first pass before being qualified to serve in a sales function. Among other things, the examination covers technical rules and regulations designed to ensure fairness when dealing with clients and prospects. Glusker was not familiar with these rules and regulations because he was never asked to provide guidance on them as a regulatory attorney. Glusker did not learn the material or study for the examination and instead relied on his industry knowledge to receive a passing score.
Comment: Glusker failed to satisfy the requirement of Standard I(E). He did receive a passing score on a licensing examination, but passing the examination, by itself, is not adequate to demonstrate competency. Glusker’s failure to learn the applicable rules and regulations relating to fairness when dealing with clients and prospects means that he does not possess the required knowledge to serve in his new role, despite passing the licensing examination.
(Change in Role
102
Evans is one member of a five-person team of analysts at a boutique research f irm providing independent research to buy-side firms. Evans primarily covers the energy and transportation sectors. Evans’s boss leaves the firm to return to academia. Firm management promotes Evans to director of research and hires two junior analysts to replace her. Evans now has supervisory responsibility for four analysts and is responsible for all research produced by the firm. Prior to her promotion date, Evans spends a great deal of time and effort getting up to speed on the research projects of the firm that she was not involved in. Although she has never directly managed others in the past, Evans does not spend any time becoming familiar with effectively managing employees, leading teams, or compliance requirements relating to subordinates
Supervisory Responsibility
Comment: Evans violated Standard I(E). Her new position demands competence in other skills, abilities, and knowledge beyond those needed for her previous position. Evans must ensure she extends her competence to cover all responsibilities of her new role. She also must now obtain the skills and knowledge needed for fulfilling her supervisory responsibility of the other analysts. This could include attending conferences or taking professional development courses on management, earning compliance credentials, and internal training on supervisory responsibility
103
104
Mifune is a financial planner for over 150 retail investors. Based on the investment objectives, financial circumstances, and risk tolerance of 40 of his clients, he suggests they purchase life insurance products from Vouchsafe Insurance Company. Mifune researched Vouchsafe and recommended it because it has a high credit rating, strong financials, and a decade-long history of providing affordable, safe insurance products. Within 18 months, as the result of previously unknown financial impropriety and fraud by the company’s chief financial officer, Vouchsafe goes bankrupt and the insurance contracts for thousands of policyholders become worthless. Mifune’s clients claim that he was incompetent in recommending the Vouchsafe policies.
Choosing Investments)
Comment: Assuming that Mifune’s research of Vouchsafe was thorough and appropriate, his failure to uncover the fraudulent practices of the company he recommended, which had misled the investment industry as a whole, does not, by itself, indicate that Mifune is an incompetent f inancial planner or violated Standard I(E).
105
Halsey is a portfolio manager for a number of high-net-worth individuals. Several of his clients are impressed by the significant gains in a short time frame that they believe can be achieved by investing in cryptocurrency. They urge Halsey to include cryptocurrency products as part of their portfolios. Although Halsey is generally aware of cryptocurrency and has read several articles about the cryptocurrency investment trend in reputable newspapers, Halsey is unfamiliar with the nature of the asset or the difference between the many cryptocurrency products. Not wanting to seem out of touch with current developments in the market, lose clients, or miss out on a hot market trend by delaying an investment decision until he completes research into the asset, Halsey purchases a cryptocurrency product that has been heavily promoted through social media and online advertising for several of his clients.
Understanding New Investment Products)
Comment: Given his limited knowledge, Halsey is not competent to invest in cryptocurrency for his clients. By hastily investing in cryptocurrency products without understanding the nature of the investment or the suitability of the investment for his clients, Halsey violated Standard I(E).
106
Barnes, the president and controlling shareholder of the SmartTown clothing chain, decides to accept a tender offer and sell the family business at a price almost 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 the family company at present), who tells her husband, Staple. Staple, however, tells his stockbroker, Halsey, who immediately buys SmartTown stock for himself.
Comment: The information regarding the pending sale is both material and nonpublic. Staple violated Standard II(A) by communicating the inside information to his broker. Halsey also violated the standard by buying the shares on the basis of material nonpublic information.
Acting on Nonpublic Information)
107
Controlling Nonpublic Information)
Peter, an analyst with Scotland and Pierce Incorporated, is assisting his firm with a secondary offering for Bright Ideas Lamp Company. Peter participates, via video conference call, in a meeting with Scotland and Pierce investment banking employees and Bright Ideas’ CEO. Peter is advised that the company’s earnings projections for the next year have significantly dropped. Throughout the video conference call, several Scotland and Pierce salespeople and portfolio managers walk in and out of Peter’s office, where the call is taking place. As a result, they are aware of the drop in projected earnings for Bright Ideas. Before the call is concluded, firm personnel trade the stock of Bright Ideas Lamp Company on behalf of the firm’s clients and the firm’s proprietary account.
Comment: Peter violated Standard II(A) because he failed to prevent the transfer and misuse of material nonpublic information to others in his f irm. Peter’s firm should have adopted information barriers to prevent the communication of nonpublic information between departments of the firm. Firm personnel who are members or candidates and who traded on the information also violated Standard II(A) by trading on inside information.
108
Levenson is an analyst based in Taipei who covers the Taiwanese market for her firm, which is based in Singapore. She is invited, together with the other 10 largest shareholders of a manufacturing company, to meet the finance director of that company. During the meeting, the finance director states that the company expects its workforce to strike next Friday, which will cripple productivity and distribution. Can Levenson use this information as a basis to change her rating on the company from “buy” to “sell”?
Comment: Levenson must first determine whether the material information is public. According to Standard II(A), if the company has not made this information public (a small group forum does not qualify as a method of public dissemination), she must not use the information.
Selective Disclosure of Material Information)
109
Fechtman is trying to decide whether to hold or sell shares of an oil-and-gas exploration company that she owns in several of the funds she manages. Although the company has underperformed the index for some time already, the trends in the industry 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 a large multinational conglomerate and that it would be a good idea to buy the stock right now. After talking to various investment professionals and checking their opinions on the company, as well as checking industry trends, Fechtman decides the next day to accumulate more stock in the oil-and-gas exploration company
Determining Materiality)
Comment: Although information on an expected takeover bid may be generally material and nonpublic, in this case, the source of information is unreliable, so the information cannot be considered material. Therefore, Fechtman is not prohibited from trading the stock based on this information.
110
Teja is a buy-side analyst covering the furniture industry. Looking for an attractive company to recommend to clients, he analyzes several furniture makers by studying their financial reports and visiting their operations. He also talks to some designers and retailers to find out which furniture styles are trendy and popular. Although none of the companies that he analyzes are clear buy recommendations, he discovers that one of them, Swan Furniture Company (SFC), may be in financial trouble. SFC’s extravagant new designs have been introduced at substantial cost. Even though these designs initially attracted attention, the public is now buying more conservative 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 recommendation, investment managers start reducing the SFC stock in their portfolios.
Applying the Mosaic Theory)
Comment: While company information on quarterly earnings data is material and nonpublic, Teja based his conclusion about the earnings drop on public information and pieces of nonmaterial nonpublic information (such as opinions of designers and retailers). Therefore, trading based on Teja’s correct conclusion is not prohibited by Standard II(A).
111
Clement is a senior financial analyst who specializes in the European automobile sector at Rivoli Capital. Because he has been repeatedly nominated by many leading industry magazines and newsletters as a “best analyst” for the automobile industry, he is widely regarded as an authority on the sector. After speaking with representatives of Turgot Chariots—a European auto manufacturer with sales primarily in the Asia-Pacific (APAC) region—and after conducting interviews with salespeople, labor leaders, his firm’s APAC currency analysts, and banking officials, Clement analyzed Turgot Chariots. He concluded that (1) its newly introduced model will probably not meet sales expectations, (2) its corporate restructuring strategy may face serious opposition from unions, (3) the depreciation of the South Korean won should lead to pressure on margins for the industry in general and Turgot’s market segment in particular, and (4) banks could take a tougher-than-expected stance in the upcoming round of credit renegotiations with the company. For these reasons, he changes his conclusion about the company from “market outperform” to “market underperform.” Clement retains the support material used to reach his conclusion in case questions later arise.
Applying the Mosaic Theory)
Comment: To reach a conclusion about the value of the company, Clement pieced together a number of nonmaterial or public bits of information that affect Turgot Chariots. Therefore, under the mosaic theory, Clement did not violate Standard II(A) in drafting the report.
112
The next day, Clement prepares to be interviewed on a global financial news television program where he will discuss publicly for the first time his changed recommendation on Turgot Chariots. While preparing for the program, he mentions to the show’s producers and Zito, the journalist who will be interviewing him, the information he will discuss. 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.
Comment: When Zito receives advance notice of Clement’s change of opinion, she knows it will have a material impact on the stock price, even if she is not aware of Clement’s underlying reasoning. She is not a client of Clement but obtains early access to the material nonpublic information prior to publication. Her trades are based on material nonpublic information; thus, she violated Standard II(A). Zito further violated the standard by relaying the information to her father. It would not matter if he or any other family member traded; the act of providing the information violated Standard II(A).
Analyst Recommendations as Material Nonpublic Information)
113
Kellogg is a retired investment professional who manages his own portfolio. He owns shares in National Savings, a large local bank. A close friend, Mayfield, is a senior executive at National. National has seen its stock price drop considerably, and the news and outlook for the bank have not been positive in recent months. In a conversation about the economy and the banking industry, Mayfield relays the information that National will surprise the investment community in a few days when it announces excellent earnings for the quarter. Kellogg is pleasantly surprised by this information, and thinking that Mayfield, as a senior executive, knows the law and would not disclose inside information, he doubles his position in the bank. Subsequently, National announces that it had good operating earnings but had to set aside reserves for anticipated significant losses on its loan portfolio. The combined news causes the stock to go down 60%.
Acting on Nonpublic Information)
Comment: Even though Kellogg believes that Mayfield would not break the law by disclosing inside information, Kellogg violated Standard II(A) by purchasing additional shares of National. The fact that he lost money on the purchase does not absolve Kellogg for trading on material nonpublic information. It is the member’s or candidate’s responsibility to make sure, before executing investment actions, that comments about earnings are not material nonpublic information.
114
Nadler, a trader for a mutual fund, gets a text message from another firm’s trader, whom he has known for years. The message indicates that the trader believes a particular software company is 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 purchase several hundred thousand shares of the stock. Nadler is aggressive in placing the portfolio manager’s order and completes the purchases by the following morning, a day ahead of the firm’s planned earnings announcement.
Comment: There are often rumors and whisper numbers before a release of any kind. The text message from the other trader would most likely be considered market noise. Unless Nadler knew that the trader had an ongoing business relationship with the public firm, he had no reason to suspect he was receiving material nonpublic information that would prevent him from completing the trading request of the portfolio manager.
Materiality Determination)
115
McCoy is the senior drug analyst at a mutual fund. Her firm hires a service that connects her to experts in the treatment of cancer. Through various phone conversations, McCoy enhances her understanding of the latest therapies for successful treatment. This information is critical to McCoy for making informed recommendations of the companies producing these drugs.
Using an Expert Network)
Comment: McCoy is appropriately using the expert networks to enhance her evaluation process. She neither asked for nor received information that may be considered material and nonpublic, such as preliminary trial results. McCoy is allowed to seek advice from professionals within the industry that she follows.
116
Watson is a research analyst working for a hedge fund. To stay informed, Watson relies on outside experts for information on such industries as technology and pharmaceuticals, where new advancements occur frequently. The meetings with the industry experts often are arranged through networks or placement agents that have specific policies and procedures in place to deter the exchange of material nonpublic information. Watson arranges a call to discuss future prospects for one of the fund’s existing technology company holdings, a company that was testing a new semiconductor product. The scientist leading the tests indicates his disappointment with the performance of the new semiconductor. Following the call, Watson relays the insights he received to others at the fund. The fund sells its current position in the company and buys many put options because the market is anticipating the success of the new semiconductor and the share price reflects the market’s optimism.
Comment: Watson violated Standard II(A) by passing along material nonpublic information concerning the ongoing product tests, which the fund used to trade in the securities and options of the related company. Watson cannot simply rely on the agreements signed by individuals who participate in expert networks that state that he has not received information that would prohibit his trading activity. He must make his own determination whether information he received through these arrangements reaches a materiality threshold that would influence his trading.
Using an Expert Network)
117
The principal owner of Financial Information Services (FIS) entered into an agreement with two microcap companies to promote the companies’ stock in exchange for stock and cash compensation. The principal owner caused FIS to disseminate emails, design and maintain several websites, and distribute an online investment newsletter—all of which recommended investment in the two companies. The systematic publication of purportedly independent analyses and recommendations containing inaccurate and highly promotional and speculative statements increased public investment in the companies and led to dramatically higher stock prices.
Comment: The principal owner of FIS violated Standard II(B) by using inaccurate reporting and misleading information under the guise of independent analysis to artificially increase the stock price of the companies.
Independent Analysis and Company Promotion)
118
Gray is a private investor in Belgium who bought a large position several years ago in Fame Pharmaceuticals, a German small-cap security with limited average trading volume. He has decided to significantly reduce his holdings owing to the poor performance of the company. Gray is worried that the low trading volume for the stock may cause the price to decline further as he attempts to sell his large position. Gray divides his holdings into multiple accounts in different brokerage firms and private banks in the names of family members, friends, and even a private religious institution. He then creates a rumor campaign on various blogs and social media outlets promoting the company. Gray begins to buy and sell the stock using the accounts in hopes of raising the 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.
Example 2 (Personal Trading Practices and Price)
Comment: Gray violated Standard II(B) by fraudulently creating the appearance that there was greater investor interest in the stock through the online rumors. Additionally, through his trading strategy, he created the appearance that there was greater liquidity in the stock than actually existed. He manipulated the price through both misinformation and trading practices.
119
Murphy is an analyst at Divisadero Securities & Co., which has a significant number of hedge funds among its most important brokerage clients. Some of the hedge funds hold short positions on Wirewolf Semiconductor. Two trading days before the publication of a quarter-end report, Murphy alerts his sales force that he is about 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 consensus.
● Wirewolf’s highly respected chief financial officer may be about to join another company. Knowing that Wirewolf has already entered its declared quarter-end “quiet period” before reporting earnings (and thus would be reluctant to respond to rumors), Murphy times the release of his research report specifically to sensationalize the negative aspects of the message in order to create significant downward pressure on Wirewolf’s stock—to the distinct advantage of Divisadero’s hedge fund clients. The report’s conclusions are based on speculation, not on fact. The next day, the research report is broadcast to all of Divisadero’s clients and to the usual newswire services. Before Wirewolf’s investor relations department can assess the damage on the final trading day of the quarter and refute Murphy’s report, its stock opens trading sharply lower, allowing Divisadero’s clients to cover their short positions at substantial gains.
Creating Artificial Price Volatility)
Comment: Murphy violated Standard II(B) by aiming to create artificial price volatility designed to have a material impact on the price of an issuer’s stock.
120
Sekar manages two funds—an equity fund and a balanced fund—whose equity components are supposed to be managed in accordance with the same model. According to that model, the funds’ holdings in stock of Digital Design Inc. (DD) are excessive. Reduction of the DD holdings would not be easy, however, because the stock has low liquidity. Sekar decides to start trading larger portions of DD stock back and forth between his two funds to slowly increase the price; he believes market participants will see growing volume and increasing price and become interested in the stock. If other investors are willing to buy the DD stock because of such interest, then Sekar will be able to get rid of at least some of his overweight position without inducing price decreases. In this way, the whole transaction will be for the benefit of fund participants, even if additional brokers’ commissions are incurred.
Comment: Sekar’s plan would be beneficial for his funds’ participants but is based on artificial distortion of both trading volume and the price of the DD stock and thus constitutes a violation of Standard II(B).
Personal Trading and Volume)
121
Gordon, an analyst of household products companies, is employed by a research boutique, Picador & Co. Based on information that she has gathered during 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 new product initiatives in South America. After modestly boosting her projections for revenue and for gross profit margin in her worksheet models for Hygene, Gordon estimates that her earnings projection of US$2.00 per diluted share for the current year may be as much as 5% too low. She contacts the chief f inancial officer (CFO) of Hygene to try to gain confirmation of her findings from her trip and to get feedback regarding her revised models. The CFO declines to comment and reiterates 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 telling Picador & Co. clients who follow a momentum investment style that consensus earnings projections for Hygene are much too low; she explains that she is considering raising her published estimate by an ambitious US$0.15–US$2.15 per share. She believes that when word of an unrealistically high earnings projection filters back to Hygene’s investor relations department, the company will feel compelled to update its earnings guidance. Meanwhile, Gordon hopes that she is correct at least with respect to the earnings direction and that she will help clients who act on her insights to profit from a quick gain by trading on her advice.
Creating Artificial Price Volatility)
Comment: By exaggerating her earnings projections in order to try to fuel a quick gain in Hygene’s stock price, Gordon is in violation of Standard II(B). However, it would have been acceptable for Gordon to write a report that
● framed her earnings projection in a range of possible outcomes and
● outlined clearly the assumptions used in her Hygene models that took into consideration the findings from her trip through Latin America.
122
In an effort to pump up the price of his holdings in Moosehead & Belfast Railroad Company, Weinberg logs on to several investor chatrooms to start rumors that the company is about to expand its rail network in anticipation of receiving a large contract for shipping lumber.
Pump and Dump Strategy)
Comment: Weinberg violated Standard II(B) by disseminating false information about Moosehead & Belfast with the intent to mislead market participants.
