Reading 2-III: Standards of Professional Conduct & Guidan 2011, investment, generated, accounts, purchase

1215

Session 1: Ethical and Professional Standards
Reading 2-III: Standards of Professional Conduct & Guidance: Duties to Clients

LOS A.: Loyalty, Prudence, and Care.

 

 

Heidi Krueger, CFA, an investment advisor, applies soft dollars generated from client accounts to purchase a report on the economic impact of world events, and to purchase a new conference table for the office she uses to meet with clients and prospects. Do these purchases violate Standard III(A) Loyalty, Prudence, and Care?

A) Both of these purchases violate the Standard.

B) Neither of these purchases violates the Standard.

C) Only one of these purchases violates the Standard.

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Using soft dollars for the purchase of office furniture does not benefit clients and is a violation. Purchasing research reports with soft dollars is not a violation, but the advisor should ensure that research purchased with client brokerage will benefit her clients.

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1215

Jason Reynolds meets Jack Parker, CFA, at a social engagement and asks for some "hot stock tips." Parker declines, but sets up an appointment to review Reynolds’ risk and return objectives and financial constraints. At the conclusion of their appointment, Parker recommends three securities he has thoroughly researched: ACK, D-Wing, and Ophus-Littbinger. Parker is least likely:

A) in violation of Standard III(A) "Loyalty, Prudence, and Care" for failing to consider the three securities in the context of the whole portfolio.

B) in violation of Standard III(A) "Loyalty, Prudence, and Care" for failing to make a reasonable inquiry into the client’s investment experience.

C) not in violation because he has thoroughly researched the three securities and he has reviewed Reynolds’ risk and return objectives, and financial constraints.

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Standard III(A) "Loyalty, Prudence, and Care" requires Parker to make a reasonable inquiry into the client’s investment experience, risk and return objectives, and financial constraints. Investment decisions must be made based on a total portfolio approach, rather than the quality of an individual investment in isolation.

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An analyst with his own money management firm trades on behalf of several large pension funds. The analyst now performs all trades through a particular brokerage firm because the brokerage provides his firm with a no-interest line of credit if paid within 60 days. The line of credit is available to all brokerage clients. The brokerage provides the analyst with personal account privileges that he would not otherwise be eligible for. The brokerage also provides the analyst with free research reports on many companies. Which of these benefits are violations of Standard III(A), Loyalty, Prudence, and Care?

A) Neither of these.

B) The research reports.

C) The personal account privileges.

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The personal account privileges are clearly a violation. The no-interest line of credit could be a violation if the analyst does not factor in the benefits when determining the fees of the clients, but it is not a per se violation. Research reports are least likely to be a violation.

1215

An independent analyst has only one client. One of the client’s largest holdings is a brokerage firm. Because of the large holding by his client, the brokerage firm recently began allowing the analyst to tap into the firm’s computer network to use the firm’s research facilities. This is allowable as long as the analyst:

A) uses the resources to help manage the client's account.

B) discloses the relationship to the client.

C) does both of the actions listed here.

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According to Standard III(A), Loyalty, Prudence, and Care, the analyst must put the client first and inform the client of any possible conflicts of interest. The analyst must channel any benefits derived from his service to the client, back to the client, and inform the client of the benefits.

1215

Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. Calaveccio places a trade with Quantco Brokerage. While Calaveccio's part of the transaction was conveyed correctly to Quantco, there was a trading error made in Calaveccio's account due to a slip up within Quantco. Calaveccio realizes that the error has taken place, and informs his contact at Quantco. Calaveccio allows Quantco to cover the error, with no cost to TrustCo. This is:

A) a violation of Calaveccio's duty to his employer.

B) a violation of Calaveccio's fiduciary duties.

C) permissible under CFA Institute Standards since some trading errors are a fact of life in the securities industry.

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The issue is similar to an allocation of soft dollars. Clearly, if the broker absorbs the loss, they expect to make up the difference in some way. However, since the error was on the part of Quantco Brokerage, Calaveccio is under no obligation to cover the cost of the trading error. Moreover, no reasonable observer expects that there exists any implied future allocation of trades to Quantco in return for correcting their own mistake. There is no violation of Standard III(A), Loyalty, Prudence, and Care.

1215

While trading on behalf of a pension account, an analyst receives special research reports from the brokerage firm with whom she is doing the trades. Such an activity is:

A) a violation of only The Code of Ethics.

B) a violation of both Standard III(A), Loyalty, Prudence, and Care, and the Code of Ethics.

C) not in itself a violation of Standard III(A), Loyalty, Prudence, and Care, nor the Code of Ethics.

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An analyst can receive research from a brokerage firm with whom she is trading on behalf of a client. The analyst should inform the client of the arrangement. The client is more likely to violate Standard III(A) by obtaining non-research services or, worse yet, personal benefits from the brokerage firm.

1215

Alan Cramer, CFA, practices in a country that does not regulate the investment of company retirement plans. He was retained by Bingham Companies to manage their corporate pension plan. Bingham’s management has approached Cramer and requested that Cramer invest the entire plan in Bingham stock.

Cramer may:

A) not invest any of Bingham Company's retirement plan in its own stock regardless of the stock's prospects and in spite of management's request.

B) invest all of the retirement plan assets in Bingham Company stock according to management's request only if Cramer can document that the investment is more prudent than any other investment opportunity he finds.

C) invest a portion of the retirement plan in Bingham Company stock if the investment is prudent and if he keeps the overall portfolio properly diversified.

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Standard III(A), Loyalty, Prudence, and Care, requires members to comply with their fiduciary duty. Retirement plan managers owe their duty to the plan participants, not to the management of the company sponsoring the plan. The fiduciary duty includes the obligation to diversify the plan’s investments, regardless of the quality of the sponsoring company’s stock. Investing in the company’s stock is not prohibited.