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Randy Wesson is a research analyst for a large brokerage company following the chemical industry. Wesson receives a phone call from his nephew who works part-time in an airport hospitality center for an airline while going to business school. Many meetings take place at the center on any given day. The nephew tells Wesson that while bringing some faxes into a conference room, he overheard executives of Hunt Chemical talking about the likely divestiture of one of their subsidiaries. His nephew wants to know whether that will be good for Hunt. Wesson should:

A) write a research report describing the possibility of a divestiture, but not mention how he learned about it.

B) not use the information.

C) manufacture a reason to upgrade the stock to a "buy" recommendation to protect his nephew's confidentiality.

D) write a research report describing that he learned about the likely divestiture from his nephew who works at the hospitality center.

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Answer and Explanation

The information is material and nonpublic; therefore, Wesson cannot trade or cause others to trade on the information. Any action concerning the information would violate the Standard on material nonpublic information.

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Scott Marsh is a research analyst for a brokerage firm following the computer industry. Joe Perry is Marsh's former college roommate and is the head of technology for Mercury, a large software company. Perry informs Marsh on Tuesday that in two days the company will be making an official announcement that its release of its newest version of its software will be moved up one month, from October 1 to September 1. The announcement will be surprising to the industry and will likely be met with skepticism because the company has had trouble meeting release dates in the past. Perry assures Marsh that he is certain that they will meet the September 1 date. Marsh considers Perry to be very honest and highly competent. Marsh should:

A) immediately put out a report recommending the stock, but waiting until the official announcement to state his reasons.

B) wait until the public announcement is made, then release a report explaining that he believes the company will make the release date, disclosing that one of the reasons for his opinion is Perry is a friend of his.

C) wait until the public announcement is made, then release a report stating that he is sure that the company will make his release date, but not disclose the relationship with Perry.

D) produce his research report in two days based solely on the official announcement, not taking into consideration the information from Perry.

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Answer and Explanation

The research report cannot be released until the official announcement is made, otherwise he will be violating the Standard on prohibition against the use of material nonpublic information. Once it is made public, Marsh can disclose the nature of the conversation without violating that Standard because the information will now be public. However, he should disclose the relationship with Perry or he will be violating the Standard on communications with clients and prospective clients.

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Lynne Jennings is a research analyst for a large brokerage company following the chemical industry. While flying through Chicago, Jennings visited her sister who works in the airport hospitality center for an airline. Many meetings take place at the center on any given day. At the center Jennings saw several senior officers who she knows are from the largest and fourth largest chemical companies walk into a conference room. She concluded that negotiations for an acquisition might be taking place. She told her sister this, and her sister asked her not to disclose how she got the information. Jennings should:

A) not write a research report disclosing the meeting.

B) write a research report describing that she witnessed the senior officers together in the hospitality center, and must mention in the report that her sister is an employee of the center.

C) write a research report mentioning the meeting but not disclose how she knew that the meeting occurred.

D) write a research report describing that she witnessed the senior officers together in the hospitality center, but need not mention in the report that her sister is an employee of the center.

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Answer and Explanation

The information is material and nonpublic, therefore, Jennings cannot trade or cause others to trade.

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Victor Logan is a portfolio manager for McCoy Advisors, and Jack Brisco is the Director of Research for McCoy. Brisco has developed a proprietary model that has been thoroughly researched and is known throughout the industry as the McCoy model. The model is purely quantitative and screens stocks into buy, hold, and sell categories. The basic philosophy of the model is thoroughly explained to clients. Brisco frequently alters the model based on rigorous researchan aspect that is well explained to clients, although the specific alterations are not continually disclosed. Portfolio managers then make specific sector and security holding decisions, purchasing only securities that are indicated as "buys" by the model. Logan has conducted very thorough research on his own, using the same process that Brisco uses to validate his findings. Logan feels the model is missing some key elements that would further reduce the list of acceptable securities to purchase, however, Brisco has refused to look at Logan's research. Frustrated by this, Logan applies his own version of the model, with the justification that he is still only purchasing securities on the buy list. Because of the conflict with Brisco, he does not disclose the use of the model to anyone at McCoy or to clients. Which of the following statements regarding Logan and Brisco is TRUE? Logan is:

A) violating the Standards by applying his version of the model and by not disclosing it to clients. Brisco is not violating the Standards.

B) violating the Standards by applying his version of the model, but not by failing to disclose it to clients. Brisco is not violating the Standards.

C) violating the Standards by applying his version of the model and by not disclosing it to clients. Brisco is violating the Standards by failing to consider Logan's research.

D) not violating the Standards by applying his version of the model, but is violating the Standards by not disclosing it to clients. Brisco is not violating the Standards.

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Answer and Explanation

Because the research is thoroughly conducted, and Logan has authority to make individual security selection decisions, Logan is not violating the Standards by applying his model. However, Logan is violating the Standard on communication with clients and prospective clients by excluding relevant factors of the investment process. The use of his model is an important aspect of the investment process and should be disclosed to clients. Brisco is not violating the Standards by not considering Logans research.

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Jim Kent is an individual investment advisor in San Francisco with 300 clients. Kent uses open-ended mutual funds to implement his investment policy. For most of his clients, Kent has used the Baker fund, a small company growth fund based in Boston, for a portion of their portfolio. As a result he has become very friendly with Keith Dunston, the manager of the fund, whom Kent feels is mainly responsible for Baker's performance. One day Dunston calls Kent and tells him that he will be leaving the fund in four weeks and moving to San Francisco to work for a different money management company. Dunston is seeking suggestions on housing in the area. Baker has not yet announced Dunston's departure. Kent immediately finds a fund that is a suitable replacement for the Baker fund, and over the next two days he calls his 30 clients with the largest dollar investments in the funds and tells them he feels they should switch their holdings. Baker feels the remaining clients' positions are small enough to wait for their annual review to switch funds. Kent has:

A) violated the Standards by not dealing fairly with clients but has not violated the Standards regarding material nonpublic information.

B) violated the Standards by not dealing fairly with clients and regarding material nonpublic information.

C) violated the Standards regarding nonpublic information but has not violated the Standards in failing to deal fairly with clients.

D) not violated the Standards.

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Answer and Explanation

Kent must treat all clients fairly in acting on the information, regardless of the size of the investment. The information concerning the fund managers departure is not material nonpublic information because its release would have no effect on individual security prices.

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Paul Drake is employed by a company to provide investment advice to participants in the firm's 401(k) plan. Company stock is one of the investment options in the plan. Drake feels that the stock is too risky for employees to own in their 401(k) plan and starts advising them to pull out of the stock. The Treasurer of the company calls Drake and tells him that he will be fired if he continues making such advice because he is violating his fiduciary duty to the company. Drake should:

A) cease making sell recommendations because of the harm that can come to himself.

B) make sell recommendations but point out that the company Treasurer has a differing and valid point of view.

C) continue to advise employees to sell their stock.

D) tell employees that he cannot provide advice on company stock because of a conflict of interest.

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Answer and Explanation

Although Drake is paid by the company, his fiduciary duty is to the plan participants. His advice cannot be compromised by business considerations, otherwise he will be violating the Standard on loyalty, prudence, and care.

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Chuck Thomas is the trustee of a trust of which Jill Wyatt is the main beneficiary. Wyatt's husband is the president of a company. In emptying the recycling bin at home, Wyatt finds some papers that lead her to believe that her husbands company will make a tender offer to acquire another firm. Wyatt takes the information to Thomas, who uses it to purchase shares of the company for the trust, but does not further disclose the information. Thomas has:

A) violated the Standards concerning material nonpublic information.

B) violated the Standards concerning loyalty, prudence, and care.

C) violated the Standards concerning preservation of confidentiality.

D) not violated any Standards.

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Answer and Explanation

Thomas cannot act or cause others to act on material nonpublic information.

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Kim Lee is a research analyst at Superior Investments and is researching a biotech firm specializing in the analysis of "mad cow" disease. While touring company facilities and meeting with management, she learns that they believe they may have found a way to reverse the disease. Moreover, one manager conjectured, "Suppose that we reversed the disease in someone who didn't even have it? We might then be able to boost that individual's IQ into the stratosphere!" After returning to her office, Lee issues a research report describing the compound as an "IQ booster with huge potential." This statement:

A) is reasonable given the information she was provided by the company.

B) lacks a reasonable and adequate basis in fact.

C) is allowable but only if quoted verbatim from her conversations with management.

D) violates the Standard concerning plagiarism.

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Answer and Explanation

Standard V(A) requires that a member have a "reasonable and adequate basis" before making an investment recommendation. Extrapolating on the basis of the conjecture of one member of the management team, without independent corroboration, is clearly in violation of this Standard. She is also in violation of Standard V(B) concerning the use of reasonable judgment regarding what is included or excluded in a communication with a client or prospective client.

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Lee Roth, who is an investment advisor, is riding in a taxi and finds a file of information labeled "Genco Valuation." The folder contains a great deal of financial data, projections and nonpublic information concerning the food products industry that lead Roth to believe that Genco will be worth 50 percent more than its current stock value. Roth also finds some correspondence that leads him to believe that the file belonged to Tom Hagan. Roth tries to find out where Hagan works so he can return the file. Roth can recommend Genco to his clients unless Hagan works for:

A) Roth cannot recommend Genco to his clients at this time.

B) the corporate finance department for Genco.

C) the equity research department for a brokerage firm.

D) an investment advisor that competes with Roth.

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Answer and Explanation

The information is material and nonpublic; therefore, Roth cannot act or cause others to act at this time.

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Janine Walker is an individual investment advisor with 200 individual clients. When she first obtains a client, Walker solicits personal data that helps her formulate an investment recommendation, including tax status, income, expenditure needs, and risk tolerance. The Standards:

A) require Walker to update the data regularly.

B) only require to update a client's data when a material change is being made to the clients' portfolio.

C) require Walker to update the data at least once every three years.

D) require updating a client's data only when a material change occurs to the personal data.

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Answer and Explanation

According to Standard III(C), Suitability, Members and Candidates must reassess client information and update regularly.