Ethics question that fooled me

See what you think: Frank Day, CFA, is a retail stock broker … . Day’s clients consist of small to medium-sized individual accounts. Day notices one client, Jiang Li, PhD., is very adept at picking undervalued stocks. Day decides to watch Li’s trades and mimic them in his own account. Day: A. is in violation of Standard 1(D) - Misconduct because he has misappropriated confidental client information. B. is in violation of Standard V(A) - Diligence and Reasonable Basis because he doesn’t have a reasonable basis for his trades. C. Is not in violation of any Standards. D. is in violation of Standard VI(B) - Priority of Transactions because he is front running the client’s account. Let me know what you think, and I can post the book answer and my thoughts.

It has been debated previously, the correct answer being D: The stock broker observes the client picking the undervalued stocks, makes the same pick and acts for himself before acting on the client’s order (only in this way he could benefit of the undervalued stock, as acting on the client’s order would increase the prices of securities in the market), so he front runs. Here is the link: http://www.analystforum.com/phorums/read.php?11,664846,664909#msg-664909

Sorry for re-posting the same question, I didn’t make the connection between the two. Book claims answer is “C” no violation. The book answer explanation implies that “mimic” means the broker traded for himself after he executed the clients trades. Assuming that his clients are truly “small to medium individual accounts” I don’t think that executed the client’s trades first is going to drive the price up on an actively traded stock. Thanks for the explanation.

I see now. Great spin on the question, it fooled me this time around:)

los_cfa08 Wrote: ------------------------------------------------------- > Sorry for re-posting the same question, I didn’t > make the connection between the two. > > Book claims answer is “C” no violation. > > The book answer explanation implies that “mimic” > means the broker traded for himself after he > executed the clients trades. Assuming that his > clients are truly “small to medium individual > accounts” I don’t think that executed the client’s > trades first is going to drive the price up on an > actively traded stock. > > Thanks for the explanation. That’s exactly what I thought. I didn’t see any compromise in confidential information. Map1, this is not front-running because the question never states that the broker puts his trades in advance of the client’s trades. All he’s doing is monitoring the trades–he could be looking at trades made last month for all we know. He’s my process of elimination for the answers: >A. is in violation of Standard 1(D) - Misconduct because he has misappropriated confidental client information. The key thing to question here is, how exactly did he misappropriate confidential information? We are talking about his client: he is the one that opened the account, he’s the one the client calls when he needs assistance. He has no choice but to see what the client is doing. If he were to go to a colleague and divulge his client’s trading activity, then that could be a violation. But all he is doing is emulating the client, and you know what they say, emulation is the sincerest form of flattery. >B. is in violation of Standard V(A) - Diligence and Reasonable Basis because he doesn’t have a reasonable basis for his trades. Balderdash. He’s trading for his account. Why should he punished for that? Self-discretionary accounts (i.e. where the account owner makes his own investment decisions) don’t fall under the standards concerning reasonableness and suitability. Ever tried arguing with your self. >C. Is not in violation of any Standards. >D. is in violation of Standard VI(B) - Priority of Transactions because he is front running the client’s account. There is no indication in the questions that the broker is front running the client. He is “mimicking” the client. That diction is not enough to suggest that he’s front running the client.

I agree - must be c…

gdiddy, thank you very much.