Exam Review - Question 22 Question ID#: 39252 An analyst meets with a new client. During the meeting, the analyst sees that the new client’s portfolio is heavily invested in one over-the-counter stock. The analyst has been following the stock and thinks it will perform well in the long run. The analyst arranges through a brokerage firm to simultaneously sell a large number of shares of the stock via a series of cross trades from the new client’s portfolio to various existing clients. He arranges the trades to be executed at a price that approximates the current market price. This action is: A) a violation of Standard III(A), Loyalty, Prudence, and Care. B) not in violation of the Standards. C) a violation of Standard III(B), Fair Dealing. D) a violation of Standard V(A), Diligence and Reasonable Basis. Your answer: C was incorrect. The correct answer was B) not in violation of the Standards. There is no violation. It is in the best interest of the client to be diversified and selling via a series of cross trades will likely reduce price impact costs when compared to selling directly into the market. The analyst appears to have reasonable basis for putting the securities in the accounts of other clients. My problem with the Ethics questions are that the explanations they give seem like they could easily be argued another way. For example: For the question above: The analyst approximating the current market price seems shady and unfair. Selling to ‘various exisiting clients,’ where is the reasonable basis there? Even if the stock is a ‘good’ stock how do we know it is right for ‘various clients’ who all have different risk and return needs/wants?
The client will likely benefit from a more diversified portfolio, but I agree that the question does nothing to suggest the suitability of the current investment. The fact that the analyst is able to sell the stock at current market prices seems legitimate. I don’t think that there is a problem there. Its not like he/she is selling at favorable prices to a friend.
I would have thought as a client, if you received a cross trade (on either side) you’d be delighted by avoiding the spread so I can’t see a fair dealing issue. Also the broker is under an obligation to seek the best execution for the trade. If you’re aware of a way of obtaining a cheaper and quicker execution than putting an order into the market, it would be in your client’s best interest to do so. I can’t see any potential issue arising from this: A) not relevant here C) Not a violation - the internal cross gets the best price for the client D) Not a violation - the analyst has been “following the stock” and formed a basis for the decision. Also agree with above - they would benefit for diversified holdings