You are a broker and you need to do an allocation of an oversubscribed IPO. Some of your close family members (even your wife) have an fee paying discretionary account with your firm (just like any other client).
Should you allocate the oversubscribed IPO evenly for all of your clients (including your wife) or should you exclude family members?
Excluding family members wouldnt be fair, isn’t it? as your family members have same status like other clients. and if they are not allocated on pro rata they may charge the firm on unfair treatment?
I’m referring to question no 81 of Code of Ethics in CFA text.
I believe you shouldn’t exclude your wife if she has a fee paying discretionary account.
However, I also believe you have to consider whether the IPO will be suitable for each particular client and you have to have a pre-determined method of distributing the IPO shares, for example pro-rata based on mandate size.
I think that as long as your wife’s account is discretionary, fee paying and ranks equally with other accounts, and the IPO meets the suitability criteria, then allocation should be faily for your wife and other accounts.
The fact the you are a beneficiary owner (lets say you are married in community of property) should not matter as long as the account is fee paying and ranks equally with the other firm’s accounts - though I stand to be corrected here???
Thanks to S2000magician , who provided a solid response last March:
“If you have beneficial interest, you have to treat the account as your own. That your wife is a client of the firm takes a back seat to the fact that you have beneficial interest. Don’t allocate shares to her account until after you’ve satisfied all of your other clients’ needs.”
Additionally, michaelwcao was kind enough to point out the following in a post last May:
"See here - page 81 of Standards of Practice Handbook (10th ed.):
If the issue is oversubscribed, then the issue should be prorated to all subscribers. This action should be taken on a round-lot basis to avoid odd-lot distributions. In addition, if the issue is oversubscribed, members and candidates should forgo any sales to themselves or their immediate families in order to free up additional shares for clients. If the investment professional’s family-member accounts are managed similarly to the accounts of other clients of the firm, however, the family-member accounts should _ not _ be excluded from buying such shares."
This is simply untrue. It is a discretionary fee paying account, and must be treated like any other fee paying account. To do otherwise would be disadvantaging one client over another, which is obviously a heavily regulated matter. If I remember well there have been several of these cases in the past years curricula.
In practice the method of distribution must be clearly described and validated in internal policies, pro rata being the most likely. A clear policy should mitigate the conflict of interests and allow for level playing field. Of course remaining compliant with suitability requirements, but this seems obvious since the client account subscribed to the IPO in the first place.
Yes, I work at compliance, no one else would dare use the words regulation or compliant.
Thanks for the feedback, and I see your point. Respectfully, however, your analysis is missing the key point in which we are hanging our hats and trying to get across (as well as the CFAI, see page 215 of Volume 1) - beneficial interest. I do see where you’re coming from, and the nuance can be tricky to spot. I’ve done my best to draw a roadmap to the CFAI and our conclusion below. I hope it helps.
Additionally, if you could share some insight in what you see and how you interpret the notion of “pre-clearance” as discussed below and how it impacts the concept of beneficial interest. Thanks.
According to Standard III (B) Fair Dealing’s guidance with respect to investment action (see CFAI Volume 1 page 83), if family-member accounts are managed similarly to that of other clients you should not discriminate (see direct quote below).
“If the issue is oversubscribed, then the issue should be prorated to all subscribers. This action should be taken on a round-lot basis to avoid odd-lot distributions. In addition, if the issue is oversubscribed, members and candidates should forgo any sales to themselves or their immediate families in order to free up additional shares for clients. If the investment professional’s family-member accounts are managed similarly to the accounts of other clients of the firm, however, the family-member accounts should not be excluded from buying such shares.”
However, leaving it at that neglects to consider Standard VI (B) Priority of Transactions guidance as it pertains to situations that arise in which the Member or Candidate is the beneficial owner (certainly beneficial interest exists between spouses). See below and reference pages 158 and 159 in Volume 2 of the CFAI text specifically.
“Members or candidates may undertake transactions in accounts for which they are a beneficial owner only after their clients and employers have had adequate opportunity to act on a recommendation. Personal transactions include those made for the member’s or candidate’s own account, for family (including spouse, children, and other immediate family members) accounts, and for accounts in which the member or candidate has a direct or indirect pecuniary interest, such as a trust or retirement account. Family accounts that are client accounts should be treated like any other firm account and should neither be given special treatment nor be disadvantaged because of the family relationship . If a member or candidate has a beneficial ownership in the account, however, the member or candidate may be subject to preclearance or reporting requirements of the employer or applicable law.”
Further, Recommended Procedures for Compliance goes on to discuss and refine the CFAI’s stance:
“Limited participation in equity IPOs: Some eagerly awaited IPOs rise significantly in value shortly after the issue is brought to market. Because the new issue may be highly attractive and sought after, the opportunity to participate in the IPO may be limited. Therefore, purchases of IPOs by investment personnel create conflicts of interest in two principal ways. First, participation in an IPO may have the appearance of taking away an attractive investment opportunity from clients for personal gain—a clear breach of the duty of loyalty to clients. Second, personal purchases in IPOs may have the appearance that the investment opportunity is being bestowed as an incentive to make future investment decisions for the benefit of the party providing the opportunity. Members and candidates can avoid these conflicts or appearances of conflicts of interest by not participating in IPOs.
Reliable and systematic review procedures should be established to ensure that conflicts relating to IPOs are identified and appropriately dealt with by supervisors. Members and candidates should preclear their participation in IPOs, even in situations without any conflict of interest between a member’s or candidate’s participation in an IPO and the client’s interests. Members and candidates should not benefit from the position that their clients occupy in the marketplace—through preferred trading, the allocation of limited offerings, or oversubscription.”
I think the whole key point here is that it does not concern a personal transaction. A personal transaction is indeed, in broad terms, a transaction made in an account where you have a beneficial interest. However, this is a discretionary mandate, which is never subjected to the personal transaction rules, since you, as an account holder handed over the power to manage it to a professional.
In this case it concerns an employee conflict of interests (since you actually work for the professional and make investment decisions related to the account).
In that sense it is plausible to require a form of preclearence under internal conflict of interest guidelines, just like all personal conflicts of interests need to be reported. That does not rule out the abovementioned requirement to treat the account similarly when allocating the IPO.