Subject 1. Case facts
Preston Partners is a medium-sized investment management firm that specializes in managing large-capitalization portfolios of U.S. equities for pension funds and personal accounts. Preston Partners has adopted CFA Institute's Code of Ethics and Standards of Professional Conduct as part of the firm's own policy and procedures manual.
Preston had written the manual himself but, because he had been pressed for time, had stuck to the key elements rather than addressing all policies in detail. He made sure that every employee received a copy of the manual when he or she joined the firm.
During his daily review of all the Preston Partners' trades and the major price changes in the portfolios, Preston found that one of his portfolio managers, Gerald Smithson, CFA, had added to all his clients' portfolios the stock of Utah BioChemical Company, a client of Preston Partners, and of Norgood PLC, a large northern European manufacturer and distributor of drugs and laboratory equipment headquartered in the United Kingdom.
Preston had known of a strong, long-standing relationship between Smithson and the president of Utah BioChemica. Preston Partners manages Utah BioChemica's pension fund, and Smithson manages the personal portfolios of Arne Okapuu, president and CEO of Utah BioChemical.
According to Smithson, while he was on vacation in London, he had seen Okapuu in a restaurant dining with the chairman of Norgood. Smithson called on an old analyst friend in London, Andrew Jones, and asked him for some information on Norgood, the stock of which was trading as American depositary receipts (ADRs) on the New York Stock Exchange. Jones sent Smithson his firm's latest research report, which was recommending a "hold" on the Norgood stock.
Smithson performed a complete analysis of the biochemical industry, and the two companies involved. Based on his analysis, the fact that the two companies were in complementary businesses, and what he saw in the London restaurant, Smithson began to wonder if Okapuu was negotiating a merger with or takeover of Norgood.
Convinced of the positive prospects for Utah BioChemical and Norgood, Smithson put in a block trade for 50,000 shares of each company. The purchase orders were executed during the next two weeks.
Since the firm's policy and procedures manual was not clear on methods for allocating shares from a block trade, Smithson decided to allocate the shares by beginning with his largest client accounts and working down to the small accounts. Smithson's clients ranged from very conservative personal trust accounts to pension funds with aggressive objectives and guidelines.
The two companies made the merger announcement yesterday, and with that news, the share prices of both companies increased more than 40 percent.
Study notes from a previous year's CFA exam:
a. evaluate the practices and policies presented;
b. explain the appropriate action to take in response to conduct that violates the CFA Institute Code of Ethics and Standards of Professional Conduct.