Ethics Case Study of the Week: Performance, Footnotes, and Benchmarks.

By Gary Sarkissian posted 27 days ago


CFA Institute’s Code of Ethics and Standards of Professional Conduct codify the ethical guidelines for the investment profession that are critical to maintaining the integrity of capital markets and investor trust.  Members, candidates, and even firms make a commitment to uphold these standards as they help elevate ethical decision-making universally around the globe.

As investment professionals, we are certain to face important ethical decisions in our day-to-day activities.  Some scenarios we encounter will be straightforward, while others may be more complex.  No matter what circumstances we face, continuous learning remains imperative in an investment industry that continues to evolve with products undergoing innovation and a regulatory environment continuing to adapt. 

For that reason, each week we will feature a sample case from CFA Institute’s Ethics in Practice Casebook.  Each case is built upon a real-life example that may involve a regulatory matter or even a CFA Institute Professional Conduct investigation.  At the end of the case is a multiple-choice question that addresses the ethical nature of the actions taken in that case.  

This week’s case involves Standard III(D) Performance Presentation. 

Performance, Footnotes, and Benchmarks.
Howard Young is CEO, portfolio manager, and sole owner of Stewardship Investment Advisers (SIA), a registered investment adviser with more than $154 million assets under management and over 250 discretionary accounts. For several years, Young has distributed marketing materials to clients and potential clients that contain gross-of-fee performance for returns on SIA’s managed portfolios. Young believes that gross-of-fees calculations are the most relevant because management fees are negotiable and can vary by client. Young includes a footnote at the end of the brochure disclosing that advisory fees would have to be netted out to show actual performance. The marketing material also includes a table that compares percentage increases in the S&P 500 Index with percentage increases in SIA’s performance. SIA’s performance includes the reinvestment of dividends. Young believes that the S&P 500 is the most appropriate and understandable benchmark because it is commonly reported in the financial press and recognizable by his clients. Has Young engaged in misconduct by using gross-of-fee returns or showing the S&P 500 performance? Decide what you believe is the correct answer and use the Ethical Decision-Making Framework to help explain your choice.

A.  Young is guilty of misconduct in showing gross-of-fee performance.
B.  Young is NOT guilty of misconduct in showing gross-of-fee performance.
C.  Young is guilty of misconduct in providing the S&P 500 as a benchmark.
D.  Young is NOT guilty of misconduct in providing the S&P 500 as a benchmark.

What do you think is the correct choice?  Click the “Analysis” button below to see the analysis, and feel free to discuss in the comments below.  The completion of this case qualifies for 0.25 hour of Standards, Ethics, and Regulation (SER) credit

This case involves the presentation of performance history. CFA Institute Standard III(D): Performance Presentation states that “when communicating investment performance information, members must make reasonable efforts to ensure that it is fair, accurate, and complete.” The goal is to provide credible performance information to clients and prospective clients and to avoid misstating performance or providing misleading performance information. Absent legal or regulatory provisions prohibiting such conduct, presenting gross-of-fee performance results is acceptable as long as there is clear disclosure that relevant fees must be deducted to get the actual performance history. It is unclear from the facts presented whether Young’s footnote is prominent or clear enough to be sufficient to meet this standard. Best practice would be to present both gross and net-of-fee performance history, or in some other way, prominently show the effect of the fees so that the performance information meets the “fair, accurate, and complete” requirement of Standard III(D).

Similarly, presenting a table that includes the S&P 500 performance as a benchmark for returns may be appropriate under certain circumstances. But when it is used as a benchmark for firm performance history that includes reinvested dividends, as in this case, it would not be an “apples-to-apples” comparison and would likely be misleading because the S&P 500 performance history does not include reinvested dividends. If Young wants to use the commonly reported S&P 500 returns over time as his benchmark, he should ensure the SIA’s returns are calculated in a comparable way. At minimum, there should be prominent disclosures of any differences between the benchmark’s and the firm’s returns. It is unclear from the facts presented whether Young has made the necessary disclosures regarding the benchmark. So, to judge whether there has been any misconduct, a thorough examination of the presentation material would be necessary to determine whether Young is presenting performance that is fair, accurate, and complete or whether his presentation misstates performance and is misleading.

This case is based on CFA Institute Professional Conduct enforcement action.

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© 2018 CFA Institute. All rights reserved. You may copy and distribute this content, without modification and for non-commercial purposes, provided you attribute the content to CFA Institute and retain this copyright notice. This case was written as a basis for discussion and is not prescriptive of how a business situation or professional conduct matter should or should not be handled or addressed. Certain characters mentioned are fictional to facilitate discussion, and any resemblance to actual persons is coincidental.