Ethics: additional compensation / conflict of interest investment, additional, interest, conflict, previously

Makavelim3

Schweser practice test #1, December 2008, Question 10:
Chris Kim, CFA, is a research analyst for Batts Bros, an investment banking firm. Kim follows the energy industry and has frequent contact with industry executives. A CEO of a large oil and gas corp that has previously employed Batts Bros to underwite a stock issue hasinvited Kim to his office to discuss a secondary offering of the company’s stock. The CEO wnats Batts Bros to underwite the stock issue. As an incentive to place the issue quickly with institutional investors, the CEO offers Kim the opportunity to fly on his private jet to his ranch in Texas for an exotic game hunting expedition if Kim’s firm can complete the underwriting within one month. Acording to CFA Institute Standards of Conduct, Kim:
a. must not accept such lavish benefits in order to maintain his objectivity
b. must obtain written consent from Batts Bros before accepting the invitation
c. may accept the invitation without consent if he submits a statement disclosing the value of the trip to Batts Bros when he returns
d. may accept the invitation without consent only if he discloses the trip to Batts Bros before accepting.
Apparently, the answer is b. Why is the answer not a? Standard IV(B) appears to say that analysts may not accept gifts that might reasonably be expected to compromise their objectivity unless they give prior written notice to their employer. But Standard I(B) says members must not accept any gift that reasonably could be expectedto ocmpromise their own objectivity. So is this saying that as long you let your employer know in advance, you are fine, no matter what the extent of the gift? Or is there any conceivable scenario where the gift from the client is so egregious that the member must reject it out of hand, whether or not he notifies his employer?

Darien

We discussed this previously. The key sentence here is “The CEO wnats Batts Bros to underwite the stock issue”, which means you need to know what Kim’s job is before you can answer the question which makes it a pretty crappy question. Kim is doing due diligence for his Batts Bros to see if Batts Bros should take a large position in a new equity issue to sell it to the general public. The conflict of interest here is that Kim would get do poor due diligence because of all the good stuff he is getting from the oil and gas company and then screw his own company. If his own company has disclosure and thinks that the stuff that he is getting does not constitute a risk, then he has no ethical problem.
Personally, I think one of the Batts Bros needs to squash this.

Flok

Thanks to d11j0d and Joey. Joey, helpful commentary as always. Joey, you raise an interesting point in focusing on Kim’s specific role. As I think about it, the quesiton describes him as a Research Analyst, which suggests to me that he is an equity research analyst issuing reports for the investor community (is this too specific an interpretation of “Research Analyst”?), and that the issuer is approaching him simply because he may be their only point of contact into Batts Bros. This would mean that he would simply be acting as an intermediary or a point of introduction to the Corporate Finance department. Of course, that would suggest that once he knows Batts is advising on an offering for the issuer, that presumably brings him “over the Chinese wall” and thus immediately makes him unable to write further reports until postissuance.
Anyway, I suppose the bottom line is that it does not quite put him in so obviously conflicted a position that even his prior written disclosure to his employer is insufficient.
Two broader questions:
1. Is there any conceivable scenario where prior written disclosure to the employer is insufficient protection for the individual, i.e. where the conflict is so egregious and blatant that prior written disclosure to the employer is insufficient?
2. Does the prior disclosure in fact have to be written?