VI(A) Disclosure of Conflicts

（1）Conflict of Interest and Business Relationships

• Hunter Weiss is a research analyst with Farmington Company, a broker and investment banking firm. Farmington’s merger and acquisition department has represented Vimco, a conglomerate, in all of Vimco’s acquisitions for 20 years. From time to time, Farmington officers sit on the boards of directors of various Vimco subsidiaries. Weiss is writing a research report on Vimco.

• Comment:

  • Weiss must disclose in his research report Farmington’s special relationship with Vimco. Broker/dealer management of and participation in public offerings must be disclosed in research reports.
  • Because the position of underwriter to a company entails a special past and potential future relationship with a company that is the subject of investment advice, it threatens the independence and objectivity of the report writer and must be disclosed.

    （2）【IMP】Conflict of Interest and Business Stock Ownership

• The investment management firm of Dover & Roe sells a 25% interest in its partnership to a multinational bank holding company, First of New York. Immediately after the sale, Margaret Hobbs, president of Dover & Roe, changes her recommendation for First of New York’s common stock from “sell” to “buy” and adds First of New York’s commercial paper to Dover & Roe’s approved list for purchase.

• Comment:

  • Hobbs must disclose the new relationship with First of New York to all Dover & Roe clients. This relationship must also be disclosed to clients by the firm’s portfolio managers when they make specific investment recommendations or take investment actions with respect to First of New York’s securities.

    （3）Conflict of Interest and Personal Stock Ownership

• Carl Fargmon, a research analyst who follows firms producing office equipment, has been recommending purchase of Kincaid Printing because of its innovative new line of copiers. After his initial report on the company, Fargmon’s wife inherits from a distant relative US$3 million of Kincaid stock. He has been asked to write a follow-up report on Kincaid.

• Comment:
  • Fargmon must disclose his wife’s ownership of the Kincaid stock to his employer and in his follow-up report.
  • Best practice would be to avoid the conflict by asking his employer to assign another analyst to draft the follow-up report.

• Betty Roberts is speculating in penny stocks（低价股票; 低价股; 仙股; 便士股票） for her own account and purchases 100,000 shares of Drew Mining, Inc., for US$0.30 a share. She intends to sell these shares at the sign of any substantial upward price movement of the stock. A week later, her employer asks her to write a report on penny stocks in the mining industry to be published in two weeks. Even without owning the Drew stock, Roberts would recommend it in her report as a “buy.” A surge in the price of the stock to the US$2 range is likely to result once the report is issued.

• Comment:

  • Although this holding may not be material, Roberts must disclose it in the report and to her employer before writing the report because the gain for her will be substantial if the market responds strongly to her recommendation.
  • The fact that she has only recently purchased the stock adds to the appearance that she is not entirely objective.

    （4）Conflict of Interest and Compensation Arrangements

• Samantha Snead, a portfolio manager for Thomas Investment Counsel, Inc., specializes in managing public retirement funds and defined benefit pension plan accounts, all of which have long-term investment objectives. A year ago, Snead’s employer, in an attempt to motivate and retain key investment professionals, introduced a bonus compensation system that rewards portfolio managers on the basis of quarterly performance relative to their peers and to certain benchmark indexes. In an attempt to improve the short-term performance of her accounts, Snead changes her investment strategy and purchases several high-beta stocks for client portfolios. These purchases are seemingly contrary to the clients’ investment policy statements. Following their purchase, an officer of Griffin Corporation, one of Snead’s pension fund clients, asks why Griffin Corporation’s portfolio seems to be dominated by high-beta stocks of companies that often appear among the most actively traded issues. No change in objective or strategy has been recommended by Snead during the year.

• Comment:
  • Snead has violated Standard VI(A) by failing to inform her clients of the changes in her compensation arrangement with her employer, which created a conflict of interest between her compensation and her clients’ IPSs.
  • Firms may pay employees on the basis of performance, but pressure by Thomas Investment Counsel to achieve short-term performance goals is in basic conflict with the objectives of Snead’s accounts.
  • See also Standard III(C)–Suitability.

• Gary Carter is a representative with Bengal International, a registered broker/dealer. Carter is approached by a stock promoter for Badger Company, who offers to pay Carter additional compensation for sales of Badger Company’s stock to Carter’s clients.
• Carter accepts the stock promoter’s offer but does not disclose the arrangements to his clients or to his employer. Carter sells shares of the stock to his clients.

• Comment:

  • Carter has violated Standard VI(A) by failing to disclose to clients that he is receiving additional compensation for recommending and selling Badger stock.
  • Because he did not disclose the arrangement with Badger to his clients, the clients were unable to evaluate whether Carter’s recommendations to buy Badger were affected by this arrangement.
  • Carter’s conduct also violated Standard VI(A) by failing to disclose to his employer monetary compensation received in addition to the compensation and benefits conferred by his employer. Carter was required by Standard VI(A) to disclose the arrangement with Badger to his employer so that his employer could evaluate whether the arrangement affected Carter’s objectivity and loyalty.

    （5）Conflict of Interest, Options, and Compensation Arrangements

• Wayland Securities works with small companies doing IPOs or secondary offerings. Typically, these deals are in the US$10 million to US$50 million range, and as a result, the corporate finance fees are quite small. To compensate for the small fees, Wayland Securities usually takes “agent options” — that is, rights (exercisable within a two-year time frame) to acquire up to an additional 10% of the current offering. Following an IPO performed by Wayland for Falk Resources, Ltd., Darcy Hunter, the head of corporate finance at Wayland, is concerned about receiving value for her Falk Resources options. The options are due to expire in one month, and the stock is not doing well.

• She contacts John Fitzpatrick in the research department of Wayland Securities, reminds him that he is eligible for 30% of these options, and indicates that now would be a good time to give some additional coverage to Falk Resources. Fitzpatrick agrees and immediately issues a favorable report.

• Comment:

  • For Fitzpatrick to avoid being in violation of Standard VI(A), he must indicate in the report the volume and expiration date of agent options outstanding.
  • Furthermore, because he is personally eligible for some of the options, Fitzpatrick must disclose the extent of this compensation. He also must be careful to not violate his duty of independence and objectivity under Standard I(B).

    （6）Conflict of Interest and Directorship

• Carol Corky, a senior portfolio manager for Universal Management, recently became involved as a trustee with the Chelsea Foundation, a large not-for-profit foundation in her hometown. Universal is a small money manager (with assets under management of approximately US$100 million) that caters to individual investors. Chelsea has assets in excess of US$2 billion. Corky does not believe informing Universal of her involvement with Chelsea is necessary.

• Comment:

  • By failing to inform Universal of her involvement with Chelsea, Corky violated Standard VI(A).
  • Given the large size of the endowment at Chelsea, Corky’s new role as a trustee can reasonably be expected to be time consuming, to the possible detriment of Corky’s portfolio responsibilities with Universal. Also, as a trustee, Corky may become involved in the investment decisions at Chelsea.
  • Therefore, Standard VI(A) obligates Corky to discuss becoming a trustee at Chelsea with her compliance officer or supervisor at Universal before accepting the position, and she should have disclosed the degree to which she would be involved in investment decisions at Chelsea.

    （7）Conflict of Interest and Personal Trading

• Bruce Smith covers eastern European equities for Marlborough Investments, an investment management firm with a strong presence in emerging markets. While on a business trip to Russia, Smith learns that investing in Russian equities directly is difficult but that equity-linked notes that replicate the performance of underlying Russian equities can be purchased from a New York–based investment bank. Believing that his firm would not be interested in such a security, Smith purchases a note linked to a Russian telecommunications company for his own account without informing Marlborough. A month later, Smith decides that the firm should consider investing in Russian equities by way of the equity-linked notes. He prepares a write-up（评论，评述，评介） on the market that concludes with a recommendation to purchase several of the notes. One note he recommends is linked to the same Russian telecom company that Smith holds in his personal account.

• Comment:

  • Smith has violated Standard VI(A) by failing to disclose his purchase and ownership of the note linked to the Russian telecom company.
  • Smith is required by the standard to disclose the investment opportunity to his employer and look to his company’s policies on personal trading to determine whether it was proper for him to purchase the note for his own account.
  • By purchasing the note, Smith may or may not have impaired his ability to make an unbiased and objective assessment of the appropriateness of the derivative instrument for his firm, but Smith’s failure to disclose the purchase to his employer impaired his employer’s ability to decide whether his ownership of the security is a conflict of interest that might affect Smith’s future recommendations.
  • Then, when he recommended the particular telecom notes to his firm, Smith compounded his problems by not disclosing that he owned the notes in his personal account — a clear conflict of interest.

    （8）Conflict of Interest and Requested Favors

• Michael Papis is the chief investment officer of his state’s retirement fund. The fund has always used outside advisers for the real estate allocation, and this information is clearly presented in all fund communications. Thomas Nagle, a recognized sell-side research analyst and Papis’s business school classmate, recently left the investment bank he worked for to start his own asset management firm, Accessible Real Estate.

• Nagle is trying to build his assets under management and contacts Papis about gaining some of the retirement fund’s allocation. In the previous few years, the performance of the retirement fund’s real estate investments was in line with the fund’s benchmark but was not extraordinary. Papis decides to help out his old friend and also to seek better returns by moving the real estate allocation to Accessible. The only notice of the change in adviser appears in the next annual report in the listing of associated advisers.

• Comment:

  • Papis has violated Standard VI(A) by not disclosing to his employer his personal relationship with Nagle.
  • Disclosure of his past history with Nagle would allow his firm to determine whether the conflict may have impaired Papis’s independence in deciding to change managers.
  • See also Standard IV(C) – Responsibilities of Supervisors, Standard V(A) – Diligence and Reasonable Basis, and Standard V(B) – Communication with Clients and Prospective Clients.

    （9）Conflict of Interest and Business Relationships

• Bob Wade, trust manager for Central Midas Bank, was approached by Western Funds about promoting its family of funds, with special interest in the service-fee class. To entice Central to promote this class, Western Funds offered to pay the bank a service fee of 0.25%. Without disclosing the fee being offered to the bank, Wade asked one of the investment managers to review the Western Funds family of funds to determine whether they were suitable for clients of Central. The manager completed the normal due diligence review and determined that the funds were fairly valued in the market with fee structures on a par with their competitors. Wade decided to accept Western’s offer and instructed the team of portfolio managers to exclusively promote these funds and the service-fee class to clients seeking to invest new funds or transfer from their current investments. So as to not influence the investment managers, Wade did not disclose the fee offer and allowed that income to flow directly to the bank.

• Comment:

  • Wade is violating Standard VI(A) by not disclosing the portion of the service fee being paid to Central.
  • Although the investment managers may not be influenced by the fee, neither they nor the client have the proper information about Wade’s decision to exclusively market this fund family and class of investments.
  • Central may come to rely on the new fee as a component of the firm’s profitability and may be unwilling to offer other products in the future that could affect the fees received.
  • See also Standard I(B)–Independence and Objectivity.

    （10）Disclosure of Conflicts to Employers

• Yehudit Dagan is a portfolio manager for Risk Management Bank (RMB), whose clients include retirement plans and corporations. RMB provides a defined contribution retirement plan for its employees that offers 20 large diversified mutual fund investment options, including a mutual fund managed by Dagan’s RMB colleagues. After being employed for six months, Dagan became eligible to participate in the retirement plan, and she intends to allocate her retirement plan assets in six of the investment options, including the fund managed by her RMB colleagues. Dagan is concerned that joining the plan will lead to a potentially significant amount of paperwork for her (e.g., disclosure of her retirement account holdings and needing preclearance for her transactions), especially with her investing in the in-house fund.

• Comment:

  • Standard VI(A) would not require Dagan to disclose her personal or retirement investments in large diversified mutual funds, unless specifically required by her employer.
  • For practical reasons, the standard does not require Dagan to gain preclearance for ongoing payroll deduction contributions to retirement plan account investment options.
  • Dagan should ensure that her firm does not have a specific policy regarding investment — whether personal or in the retirement account — for funds managed by the company’s employees. These mutual funds may be subject to the company’s disclosure, preclearance, and trading restriction procedures to identify possible conflicts prior to the execution of trades.

    VI(B) Priority of Transactions

    （1）Personal Trading

• Research analyst Marlon Long does not recommend purchase of a common stock for his employer’s account because he wants to purchase the stock personally and does not want to wait until the recommendation is approved and the stock is purchased by his employer.

• Comment:

  • Long has violated Standard VI(B) by taking advantage of his knowledge of the stock’s value before allowing his employer to benefit from that information.

    （2）Trading for Family Member Account

• Carol Baker, the portfolio manager of an aggressive growth mutual fund, maintains an account in her husband’s name at several brokerage firms with which the fund and a number of Baker’s other individual clients do a substantial amount of business.

• Whenever a hot issue becomes available, she instructs the brokers to buy it for her husband’s account. Because such issues normally are scarce, Baker often acquires shares in hot issues but her clients are not able to participate in them.

• Comment:

  • To avoid violating Standard VI(B), Baker must acquire shares for her mutual fund first and acquire them for her husband’s account only after doing so, even though she might miss out on participating in new issues via her husband’s account.
  • She also must disclose the trading for her husband’s account to her employer because this activity creates a conflict between her personal interests and her employer’s interests.

    （3）【IMP】Family Accounts as Equals

• Erin Toffler, a portfolio manager at Esposito Investments, manages the retirement account established with the firm by her parents. Whenever IPOs become available, she first allocates shares to all her other clients for whom the investment is appropriate; only then does she place any remaining portion in her parents’ account, if the issue is appropriate for them. She has adopted this procedure so that no one can accuse her of favoring her parents.

• Comment:

  • Toffler has violated Standard VI(B) by breaching her duty to her parents by treating them differently from her other accounts simply because of the family relationship.
  • As fee-paying clients of Esposito Investments, Toffler’s parents are entitled to the same treatment as any other client of the firm.
  • If Toffler has beneficial ownership in the account, however, and Esposito Investments has preclearance and reporting requirements for personal transactions, she may have to preclear the trades and report the transactions to Esposito.

    （4）Personal Trading and Disclosure

• Gary Michaels is an entry-level employee who holds a low-paying job serving both the research department and the investment management department of an active investment management firm. He purchases a sports car and begins to wear expensive clothes after only a year of employment with the firm. The director of the investment management department, who has responsibility for monitoring the personal stock transactions of all employees, investigates and discovers that Michaels has made substantial investment gains by purchasing stocks just before they were put on the firm’s recommended “buy” list. Michaels was regularly given the firm’s quarterly personal transaction form but declined to complete it.

• Comment:

  • Michaels violated Standard VI(B) by placing personal transactions ahead of client transactions.
  • In addition, his supervisor violated Standard IV(C) – Responsibilities of Supervisors by permitting Michaels to continue to perform his assigned tasks without having signed the quarterly personal transaction form.
  • Note also that if Michaels had communicated information about the firm’s recommendations to a person who traded the security, that action would be a misappropriation of the information and a violation of Standard II(A) – Material Nonpublic Information.

    （5）Trading Prior to Report Dissemination

• A brokerage’s insurance analyst, Denise Wilson, makes a closed-circuit（闭路（式）的） TV report to her firm’s branches around the country. During the broadcast, she includes negative comments about a major company in the insurance industry. The following day, Wilson’s report is printed and distributed to the sales force and public customers. The report recommends that both short-term traders and intermediate investors take profits by selling that insurance company’s stock. Seven minutes after the broadcast, however, Ellen Riley, head of the firm’s trading department, had closed out a long “call” position in the stock. Shortly thereafter, Riley established a sizable “put” position in the stock. When asked about her activities, Riley claimed she took the actions to facilitate anticipated sales by institutional clients.

• Comment:

  • Riley did not give customers an opportunity to buy or sell in the options market before the firm itself did. By taking action before the report was disseminated, Riley’s firm may have depressed the price of the calls and increased the price of the puts.
  • The firm could have avoided a conflict of interest if it had waited to trade for its own account until its clients had an opportunity to receive and assimilate Wilson’s recommendations. As it is, Riley’s actions violated Standard VI(B).
    • assimilate：[əˈsɪməleɪt] 同化; 使吸收，使接受(想法、态度等); 吸收; 消化; 透彻理解

      VI(C) Referral Fees

      （1）Disclosure of Referral Arrangements and Outside Parties

• Brady Securities, Inc., a broker/dealer, has established a referral arrangement with Lewis Brothers, Ltd., an investment counseling firm. In this arrangement, Brady Securities refers all prospective tax-exempt accounts, including pension, profit-sharing, and endowment accounts, to Lewis Brothers. In return, Lewis Brothers makes available to Brady Securities on a regular basis the security recommendations and reports of its research staff, which registered representatives of Brady Securities use in serving customers. In addition, Lewis Brothers conducts monthly economic and market reviews for Brady Securities personnel and directs all stock commission business generated by referral accounts to Brady Securities.

• Willard White, a partner in Lewis Brothers, calculates that the incremental costs involved in functioning as the research department of Brady Securities are US$20,000 annually.
• Referrals from Brady Securities last year resulted in fee income of US$200,000 for Lewis Brothers, and directing all stock trades through Brady Securities resulted in additional costs to Lewis Brothers’ clients of US$10,000.
• Diane Branch, the chief financial officer of Maxwell Inc., contacts White and says that she is seeking an investment manager for Maxwell’s profit-sharing plan. She adds, “My friend Harold Hill at Brady Securities recommended your firm without qualification, and that’s good enough for me. Do we have a deal?” White accepts the new account but does not disclose his firm’s referral arrangement with Brady Securities.

• Comment:

  • White has violated Standard VI(C) by failing to inform the prospective customer of the referral fee payable in services and commissions for an indefinite period to Brady Securities.
  • Such disclosure could have caused Branch to reassess Hill’s recommendation and make a more critical evaluation of Lewis Brothers’ services.

    （2）Disclosure of Interdepartmental Referral Arrangements

• James Handley works for the trust department of Central Trust Bank. He receives compensation for each referral he makes to Central Trust’s brokerage department and personal financial management department that results in a sale. He refers several of his clients to the personal financial management department but does not disclose the arrangement within Central Trust to his clients.

• Comment:

  • Handley has violated Standard VI(C) by not disclosing the referral arrangement at Central Trust Bank to his clients.
  • Standard VI(C) does not distinguish between referral payments paid by a third party for referring clients to the third party and internal payments paid within the firm to attract new business to a subsidiary. Members and candidates must disclose all such referral fees.
  • Therefore, Handley is required to disclose, at the time of referral, any referral fee agreement in place among Central Trust Bank’s departments. The disclosure should include the nature and the value of the benefit and should be made in writing.

    （3）Disclosure of Referral Arrangements and Informing Firm

• Katherine Roberts is a portfolio manager at Katama Investments, an advisory firm specializing in managing assets for high-net-worth individuals. Katama’s trading desk uses a variety of brokerage houses to execute trades on behalf of its clients. Roberts asks the trading desk to direct a large portion of its commissions to Naushon, Inc., a small broker/dealer run by one of Roberts’ business school classmates. Katama’s traders have found that Naushon is not very competitive on pricing, and although Naushon generates some research for its trading clients, Katama’s other analysts have found most of Naushon’s research to be not especially useful. Nevertheless, the traders do as Roberts asks, and in return for receiving a large portion of Katama’s business, Naushon recommends the investment services of Roberts and Katama to its wealthiest clients. This arrangement is not disclosed to either Katama or the clients referred by Naushon.

• Comment:

  • Roberts is violating Standard VI(C) by failing to inform her employer of the referral arrangement.

    （4）Disclosure of Referral Arrangements and Outside Organizations

• Alex Burl is a portfolio manager at Helpful Investments, a local investment advisory firm. Burl is on the advisory board of his child’s school, which is looking for ways to raise money to purchase new playground equipment for the school. Burl discusses a plan with his supervisor in which he will donate to the school a portion of his service fee from new clients referred by the parents of students at the school. Upon getting the approval from Helpful, Burl presents the idea to the school’s advisory board and directors. The school agrees to announce the program at the next parent event and asks Burl to provide the appropriate written materials to be distributed. A week following the distribution of the flyers, Burl receives the first school-related referral. In establishing the client’s investment policy statement, Burl clearly discusses the school’s referral and outlines the plans for distributing the donation back to the school.

• Comment:

  • Burl has not violated Standard VI(C) because he secured the permission of his employer, Helpful Investments, and the school prior to beginning the program and because he discussed the arrangement with the client at the time the investment policy statement was designed.

    （5）Disclosure of Referral Arrangements and Outside Parties

• The sponsor of a state employee pension is seeking to hire a firm to manage the pension plan’s emerging market allocation. To assist in the review process, the sponsor has hired Thomas Arrow as a consultant to solicit proposals from various advisers.

• Arrow is contracted by the sponsor to represent its best interest in selecting the most appropriate new manager. The process runs smoothly, and Overseas Investments is selected as the new manager.
• The following year, news breaks that Arrow is under investigation by the local regulator for accepting kickbacks from investment managers after they are awarded new pension allocations. Overseas Investments is included in the list of firms allegedly making these payments. Although the sponsor is happy with the performance of Overseas since it has been managing the pension plan’s emerging market funds, the sponsor still decides to have an independent review of the proposals and the selection process to ensure that Overseas was the appropriate firm for its needs. This review confirms that, even though Arrow was being paid by both parties, the recommendation of Overseas appeared to be objective and appropriate.
• Comment:
  • kickback：回扣; 佣金; (不合法的)酬金
  • Arrow has violated Standard VI(C) because he did not disclose the fee being paid by Overseas. Withholding this information raises the question of a potential lack of objectivity in the recommendation of Overseas by Arrow; this aspect is in addition to questions about the legality of having firms pay to be considered for an allocation.
  • Regulators and governmental agencies may adopt requirements concerning allowable consultant activities. Local regulations sometimes include having a consultant register with the regulatory agency’s ethics board.
  • Regulator policies may include a prohibition on acceptance of payments from investment managers receiving allocations and require regular reporting of contributions made to political organizations and candidates.
  • Arrow would have to adhere to these requirements as well as the Code and Standards.