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 e volve 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 VI(A) Disclosure of Conflicts.
Personal Loans and Client Funds
Morrison serves as the investment adviser to two private funds (the Funds). The private placement memoranda for the Funds permit Morrison to “pursue any objectives, utilize any investment techniques, or purchase any type of security that [Morrison] considers appropriate and in the best interests of the Funds.” Through a mutual associate, Morrison is introduced to an individual from another country who purports to trade international notes for huge profits. Morrison has more than 30 phone calls with the individual to discuss his investment strategy. He conducts internet searches and learns that the individual supposedly owns an oil and gas trading operation under a name he gave to Morrison via email. Morrison never meets the individual in person.
Morrison personally loans $100,000 to the individual and his company under the promise that Morrison will receive $1 million in 25 days. When the payment comes due, Morrison agrees with the individual’s suggestion to roll the purported proceeds into another investment. Morrison then invests $4 million from the Funds’ assets with the individual and his company, which promises to pay $40 million to the Funds in 90 days. Shortly after the Funds’ investment, Morrison receives a payment of $250,000 from the individual. After several months, the individual makes a payment to the Funds of $2.5 million, but no other proceeds of the Funds’ investment are forthcoming. Morrison’s actions are
A. acceptable because the Funds’ mandate allows him to make any type of investment.
B. acceptable because he conducted sufficient due diligence on the investment scheme.
C. unacceptable because he did not disclose a conflict of interest to the Funds.
D. unacceptable because he should not have co-invested in the fund with his clients.
E. none of the above.
What do you think is the correct choice? Click the “Analysis” button below to see the analysis for this case, 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 CFA Institute Standard of Professional Conduct VI(A): Disclosure of Conflicts, which requires CFA Institute members to make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with their duties to clients. Morrison did not disclose to his clients that he had personally loaned $100,000 to the individual and his company. Therefore, he failed to disclose a conflict of interest arising out of his status, through his personal loan, as a creditor of the individual and his company. Morrison’s loan is not, in and of itself problematic. In some cases, co-investing with clients may be appropriate and even advisable. But in this case, the loan was not disclosed. In addition, Morrison had an incentive to invest the Funds’ assets because it would provide money that could be used to repay Morrison personally. Although the mandate of the Funds gave Morrison wide discretion on how he could invest the Funds’ assets, it did not absolve him of disclosing any conflicts of interest with those investments.
The amount of appropriate due diligence an investment adviser must make when investigating a potential investment entails an investigation of the facts and circumstances of each case. Morrison performed limited due diligence on the investment, and the information he obtained is questionable, but it would be difficult to make a definitive call on the reasonableness and due diligence of the investment without further information. But Morrison’s failure to disclose the conflict of interest is apparent. Choice C is the best response.
This case is based on an April 2019 US SEC Enforcement Action.
Image by S K 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.