Ethical and Professional Standards
Reading 3. Guidance for Standards I-VII
Learning Outcome Statements
a. demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues of professional integrity;
b. distinguish between conduct that conforms to the Code and Standards and conduct that violates the Code and Standards;
c. recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.
CFA Curriculum, 2020, Volume 1
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Subject 18. Standard VI (A) Disclosure of Conflicts
A. Disclosure of Conflicts.
Members and Candidates must make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective clients, and employers. Members and Candidates must ensure that such disclosures are prominent, are delivered in plain language, and communicate the relevant information effectively.
Conflicts can occur between the interest of clients, the interests of employers, and the member's or candidate's own personal interest. In the investment industry, a conflict or the perception of a conflict often cannot be avoided and full disclosure is required.
1. Disclosure to Clients
Members shall disclose to their clients and prospects all matters, including beneficial ownership of securities or other investments, that reasonably could be expected to impair the members' ability to make unbiased and objective recommendations.
A member must disclose to clients/prospects the following conflicts:
- Material ownership in the member's firm's investment account.
- Market-making activities.
- Corporate finance relationships.
The most obvious conflict that arises is when members own stocks in a company that they recommend to their clients.
- Sell-side members must disclose any material beneficial ownership in a security. A sell-side analyst working for a broker or dealer may be enticed, for example, by corporate issuers to write research reports about certain companies.
- Buy-side members should disclose their procedures for reporting requirements for personal transactions. A buy-side analyst will be faced with similar conflicts as banks exercise their underwriting and security-dealing powers. The marketing division may ask an analyst to recommend the stock of a certain company in order to obtain business from that company.
Service as a director of another firm poses three possible conflicts:
- A possible conflict between the director's fiduciary duty to his or her clients and the director's duty to the shareholders of the firm.
- A director may receive options to purchase securities or actual securities in his or her firm as part of a remuneration package. This may entice the director to push up the price of the firm's securities.
- A director is likely to become aware of material nonpublic information, which may place him or her in a position of possible conflict.
Members should also disclose, with approval from their employers, special compensation arrangements with the employer that might conflict with clients' interests, such as bonuses based on short-term performance, commissions, performance fees, incentive fees, and referral fees.
Procedures for compliance
Many firms require employees and their families to report all transactions by employees and their families for purposes of detecting conflicts of interest and trading on material nonpublic information. Whether such requirements exist or not, members should report to employers, clients, and prospective clients any material beneficial interest they may have in securities and any corporate directorships or other special relationships they may have with the companies they are recommending. Members should make the disclosures before they make any recommendations or take any action regarding such investments.
There are two approaches to avoid potential conflicts of interest:
- Avoidance: Personal investment through "blind trust" or "mutual fund," in which you have no influence on investment decisions.
- Disclosures: As soon as the member has made full disclosure of the potential conflict, the client has all the relevant information to allow him or her to make a decision regarding the investment.
Failure to disclose a performance-based bonus plan: A manager gets a bonus from her employer based on the performance of the pension accounts she manages. One of her clients asks her why his pension plan seems to be weighted in favor of high beta stocks. She says nothing about the bonus plan.
You manage the pension fund for the Tremont Corporation. Huntington Biomedical is one of the largest holdings in the fund. You also serve on the board of directors for Huntington. You must disclose this relationship. While it is not unethical to have a responsibility to the fund's beneficiaries and to the shareholders of Huntington, you must make sure that the fund's board is aware of your other appointment.
Consider the same scenario, but instead of being on Huntington's board, you own a significant block of Huntington stock. You must disclose this beneficial ownership too. As long as you do not violate other standards regarding Priority of Transactions or Fair Dealing, disclosure of your holdings will be sufficient to meet this standard.
An analyst recommends a stock. However, he fails to disclose that he is on the company's board or that he has inherited a sizable amount of the stock, or that his wife owns 20% of the company. The standard is violated by the analyst's failure to disclose his beneficiary interest in the recommended company.
Company XYZ is considering hiring John to manage its pension fund. XYZ asks John to vote the XYZ stock proxies held in other accounts he manages in favor of XYZ's management. John will violate the standard if he accepts XYZ's offer. He should vote the proxies in the best interest of his clients.
2. Disclosure of Conflicts to Employers
Members and candidates should:
- Disclose to their employer all matters, such as beneficial interest (ownership of securities), corporate directorships, trusteeships and any special relationships, that reasonably could be expected to interfere with their duties to their employers or abilities to make unbiased and objective recommendations.
- Comply with any prohibitions on activities imposed by their employers if a conflict of interest exists.
- Discuss any action involving conflict of interest with their firm's compliance officer.
Many firms restrict employees' investment activities to avoid conflicts of interest. Members should obey their employers' guidelines. However, you are not required to desist from personal trading and board memberships, if your employer allows them.
Procedures for compliance
- Report to employers any beneficial interest and special relationships (e.g., corporate directorships) that may be considered a conflict of interest.
- Discuss with compliance officers or supervisors before taking any actions that could lead to such conflict.
You come from a wealthy family that made much of its fortune in the automotive industry. You and your family still have a considerable position in several stocks in the industry. You are employed as an industry analyst in the automotive sector. You are obliged to disclose your beneficial ownership to your employer.
Mark makes personal trades without compliance with his firm's prohibition as the firm has no intention of trading these stocks and Mark does not cover that particular industry within the firm. Mark violates the standards for ignoring the firm's trading prohibitions. He should realize that the firm's policy is designed to prevent material conflict of interest and the appearance of conflict.
John acts as a trustee for another company. However, he has NOT disclosed his involvement to his employer. He violates the standard, as it prohibits a member's conflict of interest that might be detrimental to the employer's business. Being a trustee can be time-consuming, and thus detrimental to the firm.
An investment manager with a large firm believes that his firm would not be interested in equity-linked notes, and as such purchases one for himself. One month later he prepares a report for his firm suggesting that they should start investing in equity-linked notes. The manager has violated this standard; his ability to make an unbiased decision is impaired since he already owns the notes himself.
User Contributed Comments 3You need to log in first to add your comment.
disclose you positions/ owenership that may lead to conflict of interests.
or appearance of conflict of int
prevent even the APPEARANCE of conflict