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发表于 2012-3-22 11:07
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Kendall Kratz is consulting for Westmoreland Financial Services. Kratz was brought in by William J. Westmoreland IV, grandson of the company’s founder, to address concerns about ethics.
Westmoreland Financial does not have a centralized ethics code, but rather a series of rules of conduct, most of which were instituted more than 20 years ago. William Westmoreland is worried that the firm’s policies have not changed with the times, so he has hired Kratz to review all of the rules and bring the firm into compliance with the Asset Manager Code of Professional Conduct.
As soon as he arrives at Westmoreland Financial, Kratz receives a copy of all the rules of conduct for his review. Every client receives a copy of these rules. Kratz settles down in a vacant office to read and writes down the following.- IPO’s are distributed to about 60 percent of client accounts in proportion to account size, but the remaining 40 percent do not receive any allocation.
- All investment policy statements are reviewed on an annual basis.
- Portfolio managers may accept any gift valued up to $200 provided that they notify their supervisors in writing, but must receive written consent from the compliance officer in advance before accepting anything more expensive.
- Most stock research is done in-house. About 30 percent of Westmoreland Financial clients do not own bonds, but substantially all of client brokerage pays for bond research.
- Westmoreland Financial employees must receive preauthorization before buying stocks in the company’s portfolio model, and are not to buy stocks in advance of recommending them for addition to the portfolio model.
In a later discussion with William Westmoreland, he learns that all of the firm’s trades are conducted through Babel Brokerage, a business owned by William Westmoreland’s nephew. Babel provides best pricing and execution.
After making some recommendations regarding rules changes, Kratz is given two files to consider. William Westmoreland believes the firm has not acted correctly, and wants Kratz’s opinion.
The first file relates to the matter of Justin Yeats, a wealthy and flamboyant movie actor with more than $15 million under management at Westmoreland Financial. Veronica Jung, who manages the Yeats account, wrote this account of what happened:
“Yeats called me at 8 a.m. Eastern time, an hour before the market opened. He wanted me to purchase stock in Flimflam Films. He told me that the CEO of Flimflam spoke at a large fund-raiser the night before and provided some enticing sales figures for the firm’s latest movie.
“Yeats, who is a bit of a stock junkie, also told me to purchase shares of Blanton Resorts. He said he recently stayed in a Blanton Resort and found it offered amenities not found elsewhere. He then did some research, talking to the resort manager to assess his qualifications and entrepreurial business approach, and reviewing the company’s mission statement and financials. After all that, he concluded that Blanton was hiring the right people to grow the business.
“After Yeats hung up, I looked up Flimflam and discovered that the shares looked cheap. I then checked news reports, but found only one story about the fund-raiser on the society page. The CEO’s comments were not discussed. I also did some research on Blanton and learned that the stock’s volume was low, and only one analyst covered it. The stock appeared very cheap relative to earnings and book value. I immediately recommended Blanton for addition to the portfolio model and submitted a purchase order for Blanton for all of my accounts before the market opened, knowing it would not be executed until after the stock was approved by the investment director in the afternoon.
“I bought shares of Flimflam for Yeats, and then picked up a few shares for myself, but I did not buy Blanton for Yeats until the larger order was submitted, because I did not want to give Yeats preferential treatment.
“Later that day, Agent Cornelius Fillmore of the Internal Revenue Service (IRS) called to request Yeats’ trading records for a tax audit. In accordance with company policy, I refused, citing privacy concerns. Fillmore did not take the news well and said the agency’s attorneys would be in touch. After the legal threat, I reconsidered and sent him the files.”
The second file contains Westmoreland’s disclosure policy:- All returns disclosure will be presented net of fees.
- All returns will be calculated on a quarterly basis, with monthly results available upon request.
- Any legal action taken against the analyst who manages the client account will be disclosed.
- All clients will receive a summary of our investment strategy and information about the risks of the investments in their portfolios.
- Reports will contain information about our use of soft dollars, referral fees, sales incentives, brokerage arrangements, and a breakdown of our employees’ holdings of stocks’ in the client’s portfolio.
After reading the disclosure policy, Kratz recommends that the company add four items to the disclosure policy: - Allocation procedures.
- Qualifications of account managers.
- Asset-valuation methods.
- Proxy-voting policies.
Which of Kratz’s four suggested additions to the disclosure policy goes beyond the recommendations set down by the Code?
The suggested disclosures include allocation procedures, valuations methods, and proxy policies, but not qualifications of employees. (Study Session 2, LOS 6.c)
With regard to the Flimflam stock, the Code was: A)
| broken when Jung purchased Flimflam shares for herself, but not when she purchased the shares for Yeats or when Yeats tipped her off about Flimflam. |
| | C)
| broken when Jung purchased Flimflam for herself, and when she purchased Flimflam for Yeats, but not when Yeats tipped her off about Flimflam. |
|
A speech at a fund-raiser is most likely a public event. When a reporter is there, the issue of disclosure is moot, regardless of whether the reporter thought to write about the business news. Yeats’ tip is legitimate, and barring any rules about preauthorization, of which we have no knowledge, Jung’s purchase of Flimflam shares for Yeats, then afterward for herself, seems ethically sound. (Study Session 2, LOS 6.b)
With regard to Babel Brokerage, Westmoreland Financial: A)
| is in compliance with the Code. |
| B)
| can comply with the Code only if it receives permission from clients. |
| C)
| can comply with the Code only if it switches a different brokerage. |
|
While the use of Babel Brokerage may not look good, the holy grail of brokerage is best pricing and execution. If clients are receiving the best service possible, the fact that William Westmoreland’s nephew owns the company does not put Westmoreland Financial in violation of the Code. However, the firm would be wise to either switch brokerages or disclose the relationship to clients and receive permission. (Study Session 2, LOS 6.b)
How many items on Westmoreland’s disclosure policy are insufficient to satisfy the Code?
Standard 4.A.14 says that firms must disclose all significant events that would help a prospective client interpret the compliant presentation thus legal disclosure should include information about action taken against the firm not just the investment advisor. Firms are required to present either gross or net of fees as long as it is properly labeled so this is not a violation of the GIPS. It is a recommendatin that returns should be presented gross of fees. The other three statements satisfy the Code. (Study Session 2, LOS 6.b)
With regard to the Yeats account, Jung broke the Code: A)
| when she recommended Blanton shares for purchase, and when she failed to purchase Blanton shares for Yeats in the morning. |
| B)
| only when she sent the trading records to the IRS. |
| C)
| when she failed to purchase Blanton shares for Yeats in the morning, but not when she recommended Blanton shares for purchase. |
|
Jung violated the investment-process rules when she recommended Blanton stock for purchase based on nothing more than a recommendation from a client and a few minutes of analysis. She received a phone call an hour before the market opened, yet managed to talk to her client and research two stocks before the hour was up. She did not meet the standard, “Thoroughly investigate and research different investment options to have a reasonable basis for a recommendation.” As for Yeats’ shares, while she did not have enough information to recommend Blanton, she did have Yeats’ instructions to purchase the stock for himself. There appear to be no insider-trading issues, as the only nonpublic information he cited was an informal conversation with the manager, which is not likely to be material. So Jung should have purchased the shares for Yeats immediately, but not recommended them for anyone else until she had researched the company thoroughly. Based on her reasoning for not buying Flimflam, Jung was apparently allowed to purchase specific stocks at the request of investors without submitting them for approval by the investment director, so no matter what she thought about Blanton, there was no reason to wait on buying shares for Yeats. Regarding the IRS, confidentiality rules do not necessarily apply to official legal investigations. (Study Session 2, LOS 6.b)
Which of the rules Kratz wrote down is most likely in violation of the Code? A)
| Most stock research is done in-house. About 30 percent of Westmoreland Financial clients do not own bonds, but substantially all of client brokerage pays for bond research. |
| B)
| IPO’s are distributed to about 60 percent of client accounts in proportion to account size, but the remaining 40 percent do not receive any allocation. |
| C)
| Portfolio managers may accept any gift valued up to $200 provided that they notify their supervisors in writing, but must receive written consent from the compliance officer in advance before accepting anything more expensive. |
|
The Code prohibits the acceptance of gifts other than of a modest value. There is no dollar amount stipulated in the standards although most likely $200 could be considered excessive. The other requirements in the gift policy appear to conform. The IPO allocation looks bad from the start, but the Code says investments must be fairly distributed among the accounts for which they are suitable. IPO’s are not for everyone, and it is certainly plausible that 40 percent of client accounts are too conservative for such securities. An annual review of investment policy statements is sufficient. Regarding soft dollars, the Code and Standards acknowledges that not every client will benefit from the all research. Such mismatches are unavoidable from a practical standpoint, and as long as brokerage is allocated toward research alone, the firm should be covered. (Study Session 2, LOS 6.b) |
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