Ethics Question from Schweser Q Bank

Amanda Brad, CFA, is a security analyst at UpTrend, Inc. During a routine visit to a beauty salon, she learns that a major cosmetic company, Lorean, is expected to present a revolutionary formula for facial cream. Brad buys Lorean stock for her portfolio and prepares a special report on the company. Brad also makes a call to Hillary Lang, another security analyst at UpTrend, to inform her about the news. Lang starts trading on her clients’ portfolios. Brad’s report states that given the on-going research activity at Lorean within the last months, investors can expect some successful new products and a sharp increase in the price of the stock. Lang’s actions: A. violate the Standard of Fair Dealing. B. do not violate any Standards because she does not participate in the report preparation and does not know about the source of the info. C. violate the Standards because she trades on inside information. D. violate the Standard of Objectivity and Independence. The correct answer was A) violate the Standard of Fair Dealing. Lang violates Standard III(B), Fair Dealing, which imposes the requirement to start trading on the clients’ portfolios only after the information is disseminated to all clients. Does anyone know why “C” is incorrect?

I am not sure that it is inside information. The facts say she visited a beauty salon, which is a public place. And it is at the beauty salon that she got the information. The facts do not tell you anything else. So, I would say that it is public info. Therefore, the question is whether she must disclose it to all clients.

When I read this I thought you could eliminate B and C immediately. The information is material nonpublic information. She heard it at a Beauty Salon where anyone could have heard about it. I thought D because she did no research on her own to verify these facts

women chattering at a beauty salon does not count as inside information - it may if it had said that the womens husband was president and she saw a folder on information - or something to that affect, but this would not be material nonpublic information - when figuring out if it is inside information you should consider the source of the information

I thought D too.

D too

It’s not D because Lang bases her investment decision on the internal research report which is supposedly trustworthy. Not C because there is no inside information. Not B because she violates Fair Dealing Standard. A because she can’t trade until the report is disseminated to all clients.

Objectivity and Independence doesn’t cover the verification of facts. That’s done in the Reasonable Basis standard. What it does cover is whether or not someone is being inappropriately influenced by something or someone, which leads to the independence and objectivity of the analyst being compromised. Isn’t it obvious why A is correct? She traded in her own portfolio FIRST. Don’t try to think too deeply into the other answers. Also, she has no inside information. Her information from the hair salon is unreliable.

If her information from the hair salon is unreliable, how could she (1) act on the info. (2) do an analysis and disseminate it to clients? I don’t get it. Moreover, I thought that material nonpublic information equals inside information. For example, in this case, a new formula for facial cream is material nonpublic information. Does that mean if the analyst overheard this news at the elevator of Lorean, this is inside information and if the analyst overheard this news at a beauty salon, this is material nonpublic information? I would appreciated anyone who can comment on this since I have been thinking about this the whloe morning and can’t concentrate on my work…

  1. She can act on it by trading on the information, even though there is no reasonable basis for this action. 2) She can do analysis by running a model on what a new product line would do their the company’s financials. There is nothing barring her from doing this even if the information is unreliable. You need to look at the source of the information, how reliable and plausible it is, and ultimately whether the info is considered material and nonpublic. This means looking at the situation and passing jugdement. In this scenario, the beauty salon is very far-removed from the research department of a major comestics maker. However, if the head of research of Lorean was in the salon and made the statement, then reliability increases dramatically (and thus the information would be considered material and nonpublic).