CFA Practice Question

CFA Practice Question

Sterling Drachma is a senior investment consultant currently researching a few high risk internet stock companies which recently started trading on NASDAQ. Sterling manages 5 large and private investment accounts for which he has discretionary investment authority. Sterling is about 3 years away from retirement and his retirement portfolio is managed by Franc Escudo. Sterling has concluded from his research that two of the internet stocks he has been following are great buys and instructs Franc to divert part of the retirement investments into these stocks. Franc executes the orders as soon as he receives them. Sterling then instructs his brokers to buy the stocks for the two discretionary accounts that he knows are inclined toward high risk investments. He does not buy any for the remaining three accounts since those are income oriented, lowrisk accounts. In this sequence of events, which of the following is (are) true?

I. Franc has violated Standard III (A) "Loyalty, Prudence, and Care" by investing retirement account funds in the high risk stocks.
II. Sterling has violated Standard III (B) "Fair Dealing" by not treating all his accounts equally.
III. Sterling has violated Standard VI (B) "Priority of Transactions" by trading for his retirement account before trading for his client accounts.
A. I, II and III
B. I and III only
C. III only
Explanation: Franc is managing a personal portfolio and as such must execute the orders of his client. The fact that it is a retirement account makes no difference in this situation. Franc would be in violation if he was managing a pension portfolio or a personal trust portfolio and the investments were deemed in violation of plan directives. Franc, however, should try to understand Sterling's motives in the redeployment of funds since this could prevent his client from what could be reckless investment.

Sterling, for his part, as definitely violated Standard VI (B) "Priority of Transactions" by trading for his retirement account before trading for his client accounts. Personal transactions should never take precedence over client and employer transactions. He has, however, not violated Standard III (B) "Fair Dealing" by not treating all his accounts equally. Standard III (B) requires a fair treatment of all clients, not an equal treatment precisely because different accounts have different investment needs and risk appetites. The internet stocks should only be bought for accounts for which they are a suitable investment.

User Contributed Comments 5

User Comment
siewchoon Can someone help on the explanation of I? What they means by whether it's a retirement account make no difference in this situation? If he was managing pension portfolio or personal trust portfolio, shouldn't these also being classified as personal account?
uviolet means that Franc is obligated to comply to Sterling's instructions to invest in the risky issues from his retirement account even though it is risky. However since sterling is also an investment consultant, he should have first helped his own clients before issuing instructions to Franc to invest for himself.
jpducros "Franc executes the orders as soon as he receives them"..clearly shows that suitability is not studied by Franc. But answer I concerns Loyalty, Prudence and Care...not suitability.
ninad123 I feel Franc should have studied the pros and cons of the investment (suitability) and advised Sterling on the risks and returns of such acts (prudence & care as Sterling is approaching retirement).
manju79 Sterling is a senior analyst who already understands the repercussion of a risky pension investment so late in time. He doesnt need Franc to remind him of that.
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