Subject 1. Case facts
Note: You don't need to memorize the particulars of these cases for the Level II exam. It's important, however, to understand how to analyze a case and recommend compliance procedures.
Summary of the case
Peter Sherman, CFA, recently joined the Glenarm Company after five years at Pearl Investment Management. While he was at Pearl he developed outside consulting positions with several Latin American companies. The outside consulting activity was disclosed to Pearl.
His first task is to identify attractive Latin American companies for Glenarm's emerging markets portfolio. Sherman, knowing many of these companies through his consulting contacts, approaches the task enthusiastically. He believes the Glenarm Company will clearly benefit from his knowledge about these companies and has no need to know about his consulting on the side.
Sherman joined Pearl Investment Management, a small equity-oriented firm, as a junior research analyst. Pearl entered the international investing arena shortly after Sherman arrived, and Sherman performed well as he gained experience, particularly in researching emerging market securities. Sherman also spent some time handling client relations in the account administration department. More than a year ago, Sherman earned his CFA designation.
Sherman's role at Pearl grew when several of his boss's foreign investment banking contacts hired Pearl to research companies and industries in Latin America in order to better position themselves vis-à-vis their local competitors. When Pearl expanded its research department to accommodate these new projects, the company made Sherman its primary analyst for emerging markets. The firm encouraged Sherman to develop expertise in this area, and he capitalized on his position by serving as a consultant to several third-world companies to assist them in attracting U.S. and European investors, an arrangement that Sherman fully disclosed to Pearl. Pearl did not own stock in any of the companies that Sherman consulted with.
Shortly after Sherman's research responsibilities at Pearl expanded, he received a call from John Lawrence, an acquaintance in the local CFA Institute's financial analysts society and a partner of the Glenarm Company, one of Pearl's competitors. Lawrence indicated that his company was looking for an individual with Sherman's background and asked him if he would be interested in becoming a portfolio manager at Glenarm.
The Glenarm Company is a small equity-oriented management firm. Glenarm was recently investigated, censured, and fined by the U.S. SEC for a number of violations related to its portfolio management practices. The latest censure was Glenarm' s third in the past 13 years. The firm's partners are desperate to rehabilitate their reputation and hope that hiring a CFA charterholder would enhance the credentials of the firm and expand their client base.
The Glenarm partners believe Sherman may be able to bring some business with him if he joins the firm. While at Pearl, Sherman developed client contacts through his duties with the research department and through handling client relations. He also has some knowledge of investment management clients by virtue of his interaction with the portfolio managers. To entice him, Glenarm offers Sherman a large portion of the first-year investment management fee for all the Pearl clients he is able to solicit and bring to Glenarm. Although he has reservations because of Glenarm' s past problems with the SEC, Sherman decides that the opportunity is too good to pass up. Also, he can continue his consulting work. So, he agrees to join Glenarm as a portfolio manager.
In preparation for his move to Glenarm but while he is still at Pearl, Sherman pays social calls on several local Pearl clients after business hours to inform them that he will be leaving Pearl and encourage them to switch their accounts to Glenarm. He also contacts a number of accounts that Pearl has been actively soliciting but that have not yet committed to hire Pearl as their investment manager and also contacts prospects that Pearl has rejected in the past as too small or incompatible with the firm's business to determine if they are interested in hiring Glenarm. As a result of this activity, Sherman convinces several of Pearl's clients and prospects to hire Glenarm as their investment management company but to delay any action until he has joined Glenarm. In his last week at Pearl, Sherman identifies material that he has worked on to take with him to his new job, including
- Sample marketing presentations he prepared,
- Computer program models for stock selection and asset allocation that he developed,
- Research material on several companies Sherman has been following,
- News articles he collected that contain potential research ideas, and
- A list of companies that Sherman suggested in the past deserved further research and possible investments and that were rejected by Pearl.
- Identify possible violations.
- State what actions are required by Sherman and/or Glenarm to correct the potential violations.
Study notes from a previous year's CFA exam:
1. Case facts