CFA Ethics - Standard III (A) Flashcards
Give Standard III (A).
Member and candidates must have a duty of LOYALTY to their clients and must act with reasonable CARE and Exercise PRUDENT judgement
Members and candidates must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests.
What are the key words of Standard III (A)?
Loyalty
Prudence
Care
How must investment actions be carried out?
they must be carried out for the sole benefit of the client and in a manner which, given the known facts and circumstances, to be in the best interest of the client
How should members and candidates treat investment actions?
As if it were their own money; with the same prudence, judgement, and care
What does prudence require?
Caution and discretion in general
Following investment parameters set out by the client and balancing risk and return
How is prudence exercised?
Prudence is exercised with the care, skill and diligence that should be reasonable expected of a person acting in the same capacity as the member or candidate.
What does Standard III (A) set out?
It sets out the minimum requirements for candidates and members in fulfilling responsibilities to clients; it is the benchmark
What is Standard III (A) not a substitute for and why?
It is not a substitute for a member’s or candidate’s legal and/or regulatory obligations.
As stated in Standard I (A) the MOST STRICT requirements imposed on them is what the member or candidate must ultimately abide by (including any legal fiduciary duty)
What must a member/candidate be aware of in the regard of a client’s assets? What can arise?
Whether they have “custody” or effective control of their client’s assets.
A heightened sense of responsibility
When are members/candidates considered to have custody of a client’s assets?
When they have any direct or indirect access to client funds
In what respect must any pool of client’s assets be managed? What kind of determinant is this?
In accordance with the terms of the governing documents (e.g. trust documents and investment management agreements) which are the PRIMARY DETERMINANT of manager’s powers and duties.
Does Standard III (A) place members/candidate under fiduciary duty?
It does not. It requires members/candidates to work in the best interests of their clients.
How does a member/candidate acting as a trade execution professional prudently work in the client’s best interests?
By using their skills and diligence to execute trades in the most favourable terms possible WITHIN the parameters set by the client
Who is the actual client to whom the duty of loyalty is owed in portfolios of pension plans or trusts? Who is it not?
The client is the beneficiaries of the plan/trust and is not the manager who hires the charter
What should member/candidate try to avoid all the time?
Real or potential conflicts of interest.
Due to the disparity of knowledge in the investment area between the investment manager and the client, what should the manager ensure for the client and with the client?
The manager should ensure the client’s objectives and expectations for the performance of the account are realistic and suitable to the circumstances. The manager should ensure that the risks are appropriate.
If the firm and the client’s differing goals create potential conflicts of interest, what should the member/candidate do?
Provide clear and factual disclosures of the circumstances
When is the member/candidate duty satisfied with an individual investment?
When its position in the overall portfolio is thoroughly considered in entirety
Example 1 (Identifying the Client—Plan Participants): 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 Julian Wiley, an investment manager at First Country Bank, to purchase Miller common stock in the open market for the employee pension plan. Miller’s officials indicate that such 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.
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 should have taken 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.
Example 2 (Client Commission Practices): JNI, a successful investment counseling firm, serves as investment manager for the pension plans of several large regionally based companies. Its trading activities generate a significant amount of commission-related business. JNI uses the brokerage and research services of many firms, but most of its trading activity is handled through a 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. JNI 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.
Comment: JNI executives are breaching their responsibilities by using client brokerage for services that do not benefit JNI clients and by not obtaining best price and best execution for their clients. Because JNI executives are not upholding their duty of loyalty, they are violating Standard III(A).
Example 3 (Brokerage Arrangements): Charlotte 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 consummating 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 securities transactions for Crayton’s account exclusively through Scott. But to induce Scott to exert efforts to send more new accounts to her, Everett also directs transactions to Scott from other clients without their knowledge.
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 has violated Standard III(A).
Example 4 (Brokerage Arrangements): Emilie 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 Nathan 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.
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.
Example 5 (Client Commission Practices): Lauren 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 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.
Comment: Parker is violating Standard III(A) by not exercising her duty of loyalty to her clients. She should have determined whether the commissions charged by SouthAM are reasonable in relation to the benefit of the research provided by the trip. She also should have determined 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 should not be paid for with client assets.
Example 6 (Excessive Trading): Vida 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.
Comment: Knauss has violated Standard III(A) because she is using the assets of her clients to benefit her firm and herself.
