Ethics - Soft dollars

B&S is an investment advisor company that just signed a contract with full discretionary power for the management of assets for Bright Future, a charitable fund. Without consultation, portfolio manager MB, CFA, decides to trade the funds’ assets through a brokerage firm that provides, as an additional benefit, research reports for companies in the microchip industry. These companies represent the main investment interest for most of the B&S clients. The Bright Future portfolio does not hold any equities in the microchip industry, and, because of its risk profile, is unlikely to ever do so. Which of the following activities represents a possible breach with the CFA Institute standards? A) Accepting research reports from the brokerage firm that do not benefit client portfolios. B) Lack of action in consulting with the client before choosing the brokerage firm. C) Exercising a selection principle that does not comply with the idea of best trade price and execution. I had this one wrong and would appreciate your feedback.

B

i think it should be C ???

I agree with C.

I answered B as McLeod did, because the choice of the borkerage firm was done WITHOUT CONSULTATION. It’s ok that some of the research materials do not directly benefit the client, as long as we have informed him. It was obviously wrong, C was correct, and I don’t get it when looking at the proposed solution: The problem refers to the fiduciary duties of the analyst and brokerage contracts involving soft money. Trades placed with a broker that provides the firm with research are implicitly paying for the research. In a competitive marketplace, it is probable that the trades could have been as effectively placed with a broker that was able to provide research that would apply to the holdings of Bright Future. According to Standard III(A) Loyalty, Prudence, and Care, it is permissible to direct trades of the client portfolio through a broker who provides research that does not directly benefit the client portfolio, but the client should be informed about the situation.

I would have said “B”, for the reason given for C: “According to Standard III(A) Loyalty, Prudence, and Care, it is permissible to direct trades of the client portfolio through a broker who provides research that does not directly benefit the client portfolio, but the client should be informed about the situation.” C doesn’t ring any bells for me. Tricky one.

C

nicolargol: The question has nothing to do with the case. read the reframed question below … avoid all other data. Which of the following activities represents a possible breach with the CFA Institute standards? A) Accepting research reports from the brokerage firm that do not benefit client portfolios. B) Lack of action in consulting with the client before choosing the brokerage firm for a fully discretionary account. C) Exercising a selection principle that does not comply with the idea of best trade price and execution.

I choose B. Have the same idea with nicolargol

thanks nicolargol for sharing i got this one wrong too and hope to get it right in the exam!

I call BS on Schweser on this question (or I’m just not getting something). GetSetGo… the problem with your analysis (getting rid of the 'noise" of the case, which may not have anything to do with the question), is that it still yields an ambiguous answer. If I remember correctly, a client could direct their brokerage to a firm that does not provide best execution. So, in other words, both C and B are just fine as long as the client is informed (in the case of B), or the client directed the brokerage (the case of C). Maybe the wording (“exercising a selection principle”) implies that the client is NOT making the choice, but this is a weak distinction. Oddly, even Schweser’s explanation highlights that “B” is a valid choice (here’s the explanation from the Q bank): << The problem refers to the fiduciary duties of the analyst and brokerage contracts involving soft money. Trades placed with a broker that provides the firm with research are implicitly paying for the research. In a competitive marketplace, it is probable that the trades could have been as effectively placed with a broker that was able to provide research that would apply to the holdings of Bright Future. According to Standard III(A) Loyalty, Prudence, and Care, it is permissible to direct trades of the client portfolio through a broker who provides research that does not directly benefit the client portfolio, but the client should be informed about the situation. >> It seems like Schweser potentially made an error here, because this explanation points almost exclusively to B.

^ Agree, good question for learning through debate on here, bad question if it is on the exam since it is ambiguously worded.

Thanks all for your inputs. I definitely think we will not see that type of poor wording on exam day, and the bottom line is that we all agree about the possibility of not directing transactions through a broker that would benefit all the clients, as long as those who don’t benefit are informed. Now back to Corporate Governance!

Like everyone said, poorly worded question, but I think Schweser was trying to imply in the question that the trading firm was only used based on the reports (thus not providing best execution, timeliness etc.). That is an awfully big jump to make though.

C is the correct answer. The whole point of soft dollar standard is to get best trade price and execution for the benefit of the client. It is not necessary to consult with the client before choosing a brokerage firm, as the client does not need to know every detail, as long as what you choose benefit the client.

C - I don’t remember anywhere seeing “consultation with the client” being the preeminent issue concerning soft dollar standards. It’s about getting the best trade price and execution. I think it’s appropriate to get research as long as it benefits clients.