Level 1 CFA® Exam Ethics, Standard VI (B)
In this lesson, we go back to one of the most important rules that we have already formulated. Remember the hierarchy with the client at the very top, the employer just below, and you at the very bottom? Standard VI (B) reminds us of this hierarchy in the context of investment transactions and possible conflicts of interest.
The main idea is to maintain the right hierarchy of priority of transactions – always give the priority of transactions to your clients and then to your employer. Leave your personal interest at the very end of the course of your investment actions.
PRIORITY OF TRANSACTIONS:
- clients
- employer
- your personal interest
This hierarchy and the priority of transactions that follows does not mean, however, that you are banned from investing for your own account. Standard VI (B) does not prohibit you from making transactions and earning from them. What it takes care of is that you do not leave your client or employer at a disadvantage.
Your duty comes first with the client and then with the employer. They are entitled to use your skills and abilities, which are to bring them profit.
Still, you can invest for your own account and earn a profit. Note that when we talk about your personal account, we also mean the account of your spouse, parent, or any other member of your family (unless – of course – such an account has the status of a client account, which we already explained in the lesson on Standard III (B)).
Generally speaking, Standard VI (B) further elaborates on conflicts of interest, and precisely on conflicts of interest resulting from personal trading.
It is required that you avoid any real or potential conflicts of interest, or even appearances of such conflicts, that are connected with transactions made for your own account relative to those made on your client’s behalf.
There are 3 major principles that you should always keep in mind as far as possible conflicts of interest and their avoidance are concerned.
Let’s have an example and try to see what these principles are:
Suppose you’re a portfolio manager. You advise your client to invest in a number of securities that are compatible with the objectives included in her IPS. Additionally, you strongly recommend that she invests in the shares issued by a vigorous and innovative start-up. It so happens that you own some shares of the start-up for your own. You properly disclose the information to the client. The start-up’s shares perfectly match your client’s IPS and, after your recommendation and disclosure, your client consents that you include some of the shares in her portfolio. After you buy some shares for your client, you find out that – for some reason – you need to sell your shares. Now, the question is whether you may sell your shares or not? How exactly should you act in this situation?
(...)
Restrictions & Blackouts
Some restrictions may be imposed on investment professionals. It may be the case with IPOs or private placements, which may be the source of immediate conflicts.
Such compliance procedures may also allow for some restricted periods (or blackouts) for those involved in the investment decision-making process. So as not to put the client at a disadvantage, you are forbidden to take investment actions that are banned from you during this period.
Upon request, clients should be made familiar with all the procedures regulating the personal trading of investment professionals.
Acting upon Nonpublic Information
In the context of the priority of transactions, acting upon nonpublic information is also worth mentioning.
Needless to say, material nonpublic information must not be spread to anybody – be it a client, the employer, or any other person. It must not be made advantage of. That is why you are not allowed to act upon receiving such information neither to your own nor to anybody else’s benefit.
For material nonpublic information, see the lesson in which we explain Standard II (A).
- Always give the priority of transactions to your clients and then to your employer.
- Avoid any real or potential conflicts of interest or even appearances of such conflicts.
- You are not entirely banned from investing for your own account, however. As a rule, you can still invest and earn a profit.
- Some restrictions may be imposed on investment professionals with respect to their personal trading. In such cases, you must obey.
CFA Exam: Priority of Transactions
To ensure that client interest always comes first – avoid any potential conflict of interest or the appearance of a conflict of interest that may arise from your personal transactions.
EXAMPLES of CONFLICTS related to TRANSACTIONS:
- placing personal transactions ahead of client transactions,
- personal trading not to yours but to, e.g., your spouse account (that is not a client account),
- participation in IPOs (some IPOs may be highly attractive and awaited, they may rise significantly in value shortly after the issue is brought to market, the opportunity to buy such an IPO may be limited),
- taking advantage of your professional knowledge and familiarity with a corporate client (i.e., reasonable expectation of what such a company intends to do) to trade for your personal account before trading for client accounts,
- accepting private placements as favors or gifts (it may influence future investment decisions and actions or reward past business deals),
- failing to disclose your holdings in which you have a beneficial interest (such holdings should be reported upon commencement of the employment and then at least annually),
- failing to provide duplicate confirmations of transactions (duplicate copies or confirmations of all personal securities transactions and copies of periodic statements for all securities accounts should be supplied; it allows independent verification and reduces the likelihood of unethical behavior).