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Subject 2. Case discussion

Analysis of the situation

This case depicts violations or possible violations of CFA Institute's Code and Standards related to a member's duties toward the member's employer.

Standard IV (A) - Duties to Employers: Loyalty

Sherman's solicitation of clients and prospects and his plans to take Pearl property for the benefit of Glenarm are a breach of Standard IV(A).

Standard IV(A) does not preclude members from seeking alternative employment, but it does obligate a member to protect the interests of the employer by refraining from any conduct that could deprive an employer of profit or the benefits of the member's skills and abilities. An employee is free to make arrangements to leave any employer and go into competitive business-so long as the employee's preparations to leave do not breach the employee's duty of loyalty to the current employer.

In this case, Sherman had an obligation to act in the best interests of Pearl while he was still an employee of Pearl. He had a duty not to engage in any activities that would be detrimental to Pearl's business until his resignation date became effective. The following activities by Sherman violated this duty of loyalty and, as a result, violated Standard IV(A).

Solicitation of clients and prospects

  • Soliciting clients: Sherman's solicitation of clients on behalf of Glenarm while he was still employed at Pearl is a clear violation. Attempting to lure clients from Pearl to another investment company undermined Pearl's business, and the fact that such activity was carried out "after hours" or in a social context is irrelevant; the damage to Pearl's business was the same. Even after leaving Pearl, Sherman must abide by any additional legal and contractual obligations between himself and Pearl that would prevent solicitation of clients.
  • Soliciting potential clients: It was also a violation. When engaging in such activity, Sherman was attempting to interfere with Pearl's business opportunities for his own benefit and the benefit of his future employer. Solicitation of clients and prospects cannot begin until Sherman has left Pearl and begun to work for Glenarm.
  • Contacting prospects: It is acceptable for Sherman to contact prospects that Pearl had not pursued because of their size or investment objectives so long as the contacts were not in competition with Pearl in any way. Sherman could solicit business for his new employer on his own time when that activity did not interfere with his responsibilities at Pearl or take away a business opportunity from Pearl.

Misappropriation of employer property

Except with the consent of the employer, departing employees may not take property of the employer. Even material prepared by the departing employee is the property of the employer, and taking that property is a violation of the employee's duty to the employer. Employees must obtain permission to take with them any work or work product prepared in the course of the employee's employment or on behalf of the employer.

In this case, all the material mentioned as taken by Sherman was the property of Pearl. Sample marketing material prepared by Sherman, computer program models for stock selection and asset allocation that he developed, and research material and news articles that he collected are all Pearl's property because Sherman's efforts in creating or gathering these materials were undertaken in the context of his employment with and for the benefit of Pearl. Even the list of rejected research ideas was Pearl's property; Sherman generated those ideas for Pearl's consideration and use. The analyst that Pearl hires to replace Sherman might benefit by reviewing the list of ideas considered and rejected by the firm.

Actions required

Sherman should have refrained from solicitation of any of Pearl's clients or prospects until he had left Pearl. Sherman should have obtained Pearl's permission to take copies of any work he prepared on behalf of Pearl in the course of his employment there. Without such permission, Sherman should not have taken any material that could have even remotely been considered Pearl's property.

Standard IV (B) - Duties to Employers: Additional Compensation Arrangements

Because such arrangements may affect an employee's loyalties and objectivity and may create conflicts of interest, employers must receive notice of these arrangements so that they can evaluate employees' actions and motivations.

In this situation, Sherman disclosed his consulting arrangements to Pearl but not to Glenarm. Thus, he was violating Standard IV (B). Although Sherman's consulting activities might have uncovered investment opportunities for Glenarm clients, the arrangements had the potential to affect Sherman's ability to render objective advice and to divert Sherman's energies away from managing Glenarm clients' portfolios. Sherman should have given Glenarm written information on his independent practice so that the firm could make an informed determination about whether the outside activities impaired his ability to perform his responsibilities with the firm.

Actions required

Sherman must disclose to Glenarm all outside compensation arrangements and describe in detail the activities that gave rise to this compensation. He must obtain written permission in advance of entering into these relationships.

Standard VI (A) - Disclosure of Conflicts, and Standard I (B) - Independence and Objectivity

Sherman's consulting arrangements also violated these two standards. Sherman has the obligation to disclose all matters that reasonably could be expected to interfere with his duty to Glenarm or ability to make unbiased and objective recommendations. Sherman could wind up receiving consulting fees from the same companies about which he is writing research reports for Glenarm's internal use. Thus, the consulting could compromise Sherman's independence and objectivity.

Study notes from a previous year's CFA exam:

2. Case discussion