Alan Powers, CFA, is a trader with Rogers Securities. His sister works for Potter Steel and has told him that Potter’s earnings, which will be released two days from now, are significantly less than expectations. Powers receives a buy order for the firm’s client accounts for a block of Potter shares. According to the Code and Standards, Powers’ most appropriate action is to: A) enter the trade without mentioning the coming earnings disappointment. B) ask his compliance officer to place Potter stock on the firm’s restricted list because he has material nonpublic information, to avoid making the trade. C) inform only the firm’s head of trading that the trade would not be in clients’ best interest, without disclosing the information. Which one is the most appropriate action many thanks
A is correct. B sounds correct but the key phrase is “to avoid making the trade”. You have used the material non-public information to avoid losing your client money. Not losing money is still a gain.
Definitely A. You cannot act on non-pubic material information. B is wrong - you can disclose the info to compliance officer but by placing the stock in restricted list you would be acting on the inside info. C is wrong for the same reason. Basically, you should act as if you didn’t have this inside info.
But by entering the trade he is not acting in the best interest of the client, and the question doesn’t ask you to focus only on material non public information.
sgupta0827 Wrote: ------------------------------------------------------- > But by entering the trade he is not acting in the > best interest of the client, and the question > doesn’t ask you to focus only on material non > public information. I think material non-public trumps Loyalty/Prudence in this situation. I don’t have the book in front of me, but I suspect it says something about “acting in the best interest of clients, given that it is legal.” In this case, even though its in the clients’ best interest, it wouldn’t be legal.
Standard II(A) is pretty clear - you can’t act on material non-public information and under no circumstances you can disclose it to clients (there are no exceptions mentioned regarding best interests of the client). The only alternative left is to execute trades in the way you would if you didn’t have that info. My interpretation is that in this case integrity of capital markets has priority over best interests of the clients (though I don’t think its mentioned explicitly). The explanation with legality also doesn’t seem completely accurate. Imagine you operated in some developing country where acting on inside information was legal - you would still have to abide by the strictest rule i.e. standard II(A) and enter the trade for the client.
Beatnik, I understand what you’re saying - by legal I meant according to Standard I (A), which would encompass the Standards as well.
Definitely A. B would be protecting clients through violation of the Material Non-Public Information Standard!!
so let’s say regardless of that inquiry from his client… would it be appropriate if the broker approches his compliance officer as soon as he receives the material non-public information to put the stock on the restricted list, to avoid conflicts of interest in the future?
I would say no to the restricted list…this would be “acting” on the info. In some problems I’ve done, I’ve seen the term “continue to carry out unsolicited trades”…by placing it on the restricted list, you would be benefiting your clients at the detriment of the market as a whole (since nobody else has that info). Sound about right? Flok Wrote: ------------------------------------------------------- > so let’s say regardless of that inquiry from his > client… would it be appropriate if the broker > approches his compliance officer as soon as he > receives the material non-public information to > put the stock on the restricted list, to avoid > conflicts of interest in the future?
This is a fine example of CFAI ethics being irrelevant. Powers sister must be a high mucky-muck to have this information and there is only one reason for her to be breaking her fiduciary duty to the company by disclosing earnings numbers early - she wants to help Powers break the law. So Powers has been approached with a solicitation to commit securities fraud and given all the illegally obtained info he needs to do it and Powers first thought is…would CFAI approve?! Here’s a harder question than the one asked - Powers sister calls him and gives him disappointing earnings numbers. The next day, his 70-year old buddy Jones who dabbles in stock options calls him up and says he wants to buy a boatload of puts on Potter Steel because he has “a bad feeling”. If Powers doesn’t execute the trade (according to above reasoning) he has violated CFAI’s policy. If Powers does execute the trade, and the SEC decides that this is unusual activity it will take them 5 minutes to figure out that Powers sister is the CFO of Potter and that Powers likely tipped off Jones. Powers will be in compliance with CFAI but facing serious legal trouble including the prospect of real jail time. Powers needs to rat out his sister and ask the company to disclose earnings numbers. His sister is jeopardizing his career and more and CFAI’s ethics just no longer apply when the stakes are this high (having a PCP inquiry and going to jail are just way different).