Ethics Case Study of the Week: Know Your Client!

By Gary Sarkissian posted 06-21-2021 08:00


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 feature a sample case from CFA Institute’s Ethics in Practice Casebook.  Many cases are built upon real-life examples that may involve a regulatory matter or even a CFA Institute Professional Conduct investigation.  At the end of each case is a multiple-choice question that addresses the ethical nature of the actions taken in that case.  

This week’s case involves Standard I(A) Knowledge of the Law. 

Know Your Client!
Smith-Pelley is president and CEO of Capital First Investment Group (CFIG), an investment adviser that is a wholly owned subsidiary of Capital First Bank. CFIG uses the 25 branch offices of the bank for its business locations. One client of CFIG, a longtime bank customer and personally known by Smith-Pelley and the board members of the bank, opened an investment account at CFIG with the stated investment objective of income. Although the client did make a few investments over the course of a year, the client engaged in almost exclusively banking activity in the account that involved hundreds of transactions and consisted of $90 million in deposits and $84 million in withdrawals.

The transactions included electronic transfers to and from individuals and entities located in bank secrecy havens or countries identified by the government as presenting a money laundering risk. In addition, Smith-Pelley understood the client to be engaged in a type of international business activity that presented an increased risk of transactions being tainted by corruption or bribery. But because of the client’s longstanding relationship with the bank, Smith-Pelley presumed that the transactions had a legitimate business purpose. Smith-Pelley accepted vague descriptions of the transactions as “for services provided,” “consulting fees,” or “commissions,” and he approved the daily Anti-Money Laundering (AML) reports (required by law when transactions trigger red flags of potentially suspicious activity) without further investigation. Smith-Pelley’s actions are

A. appropriate because the non-securities activity in the client’s CFIG account was consistent with the type of transactions he had engaged in at the bank for many years.
B. appropriate because Smith-Pelley is protecting the confidentiality of client information.
C. appropriate because Smith-Pelley can rely on the clearing firm to report suspicious activity for the account.
D. inappropriate.

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

The facts presented in this case should have raised a number of questions for Smith-Pelley regarding the legitimacy of the client account at CFIG. The high velocity of money movement and low volume of investment activity was inconsistent with maintaining a securities account for the purpose of generating income, as stated in the account documents. The transactions in the account were high-risk transactions for money laundering activity and should have raised a greater level of scrutiny. Rather than investigate as required by law, Smith-Pelley did not ask questions because of the client’s long-standing relationship with the bank.

Smith-Pelley cannot rely on the clearing firm to meet CFIG’s independent obligation to review the transactions for suspicious activity. Duty of loyalty to clients and preservation of confidentiality of client information cannot be used as a shield to allow clients to violate the law or otherwise damage the integrity or viability of global capital markets. Smith-Pelley’s actions violated Standard I(A): Knowledge of the Law, which states that CFA Institute members and candidates must understand and comply with all applicable laws, rules, and regulations covering they professional activities. Smith-Pelley’s failure to adequately comply with the anti-money laundering requirements imposed by law violates this standard. The best choice is D.

This case is based on a June 2018 enforcement action by the US Financial Industry Regulatory Authority (FINRA).

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© 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.