Ethics Case Study of the Week: Suitability of Changing an Investment Strategy

By Gary Sarkissian posted 24 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(C) Suitability. 

Suitability of Changing an Investment Strategy
Duri is a registered account representative providing financial advice to retail clients. She is also principal partner of Tabak Accountants. Duri assists a number of advisory clients who want to move their retirement assets from existing superannuation accounts to establish self-managed superannuation funds (SMSFs) that have the goal of investing in direct residential property. When clients express interest in these types of SMSFs, Duri defers to their reasons for wanting to invest in direct property and presumes that they have the time and expertise to manage their superannuation affairs. She reclassifies their investment objectives as “growth” to match their new investment strategy.  Duri charges her clients for establishing the SMSF and recommends that her firm, Tabak Accountants, prepare their annual accounts and tax returns. Duri’s actions are

A. acceptable because she is following the directives of her clients.
B. acceptable if the SMSFs invested in direct residential property provide superior returns to her client’s prior investments.
C. acceptable if the services provided by Tabak Accountants are reasonable and the costs of services are competitive.
D. unacceptable.
E. none of the above.

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 relates to acting in the best interests of clients, specifically ensuring the suitability of their investments. CFA Institute Standard III(C): Suitability requires CFA Institute members in an advisory relationship to make a reasonable inquiry into a client’s investment experience, risk and return objectives, and financial constraints to determine whether an investment is suitable to the client’s financial situation and consistent with the client’s objectives and mandates before taking investment action. In this case, it appears that when Duri’s clients want to switch their retirement assets into an SMSF that invests in direct residential property, Duri defers to their reasoning without any apparent suitability analysis. The case facts do not indicate whether Duri does a number of things:

  • Assesses the reasons for her clients interest in investing in direct property
  • Considers her clients’ financial goals
  • Compares the benefits, risks, and costs associated with establishing an SMSF or owning rental property
  • Considers asset diversification
  • Determines whether clients intend to draw a pension from the SMSF once they reach retirement, and how they can achieve this with an illiquid asset, such as investment property
  • Evaluates whether the clients have the time and expertise to manage their superannuation affairs
  • Considers whether the SMSF investment strategy will remain viable if the clients’ income is reduced or the property is unoccupied for a period of time

Without analyzing these and other factors, it would be inappropriate for Duri to move her clients to the SMSF, even if the investment provided a superior return. If her clients request a change in their investment strategy, it is Duri’s responsibility as their investment adviser to conduct an analysis to ensure that the new direction is suitable and appropriate. It appears that Duri classified all clients as growth investors without undertaking an analysis of whether this classification was true to superficially justify their investment in an SMSF vehicle. With regard to the use of Duri’s firm to provide client’s accounting services for the SMSF investments, Standard III(A): Loyalty, Prudence, and Care requires members to act for the benefit of their clients and place their clients’ interests before their own. It appears that Duri recommended these services to create additional income for herself. At a minimum, Duri’s relationship with Tabak must be fully disclosed to clients as a potential conflict of interest. Choice D is the best response.

This case is based on a February 2019 Enforcement Action by the Australia Securities and Investment Commission.

Image by Paul Brennan from Pixabay  

© 2019 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.