Ethics Case Study of the Week: Buyside Collective Bargaining?

By Gary Sarkissian posted 07-19-2021 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 II(B) Market Manipulation.

Buyside Collective Bargaining?
Paulson is a portfolio manager at Isaac Investment Advisers, managing four funds that invest in UK equities. In anticipation of an initial public offering (IPO) by the Shore Group, an online retailer of short-term vacation rentals, Paulson conducts extensive research on the company and meets with Shore Group management. He discusses the company and its future prospects with other market participants to gauge the level of interest in the IPO. Along with this research, Paulson relies on his experience of previous IPOs a well as his expertise gained from investing in the specific sector and the wider market to determine a valuation of the new shares. Paulson then discloses his planned order for the stock, including its price limit and its size, with the firm managing the IPO process for Shore Group.

Afterward, he contacts fund managers at competitor firms to suggest that they coordinate their efforts and cap their orders for an allocation of shares at the same price limit. In an email to another fund manager he states, “Some collective bargaining from the buy side is not a bad thing. The fact is there are relatively few funds with reasonable firepower in the small-cap IPOs. To protect our investors, I think we should do more of this — not be bullied by the brokers who say, ‘This is coming at X price! Like it or not.’” Paulson’s actions are

A. appropriate because he is working to get the best stock price for his clients.
B. inappropriate because he is trading on material nonpublic information obtained by meeting with company management.
C. appropriate because he conducted thorough due diligence on the Shore Group IPO.
D. inappropriate because he shares the confidential information of Isaac Investment Advisers with the firm managing the IPO for Shore Group.
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. 

Paulson’s actions to coordinate with fellow fund managers to affect the price of the Shore Group’s IPO is an attempt at market manipulation. CFA Institute Standard II(B): Market Manipulation prohibits CFA Institute members from engaging in practices that distort prices with the intent to mislead market participants. Paulson’s actions to coordinate with fellow fund managers to affect the price of the Shore Group IPO are an attempt at market manipulation. His actions undermine the proper price formation process of the IPO, which would cause harm to market participants. His actions could cause harm to issuers and existing shareholders because they could result in less capital being raised and existing shareholdings being valued at less than they otherwise might have been.

IPOs play a vital role in helping companies raise capital in the financial markets and are predicated on natural market forces determining pricing. Issuers and investors expect the prices to be fair and reflective of genuine market demand. When investors attempt to undermine this price formation process by artificially driving down the price of an IPO, the efficiency, functioning, and stability of the financial markets are threatened. Paulson has a duty to protect the integrity of capital markets even over his responsibilities to his clients. Meeting with company management is a normal part of the due diligence process.

The facts of the case do not indicate that he received material nonpublic information in meeting with company management. The research Paulson conducts appears to show that he exercised diligence, independence, and thoroughness in analyzing the Shore Group IPO. Sharing the price limit and order size with the firm running the Shore Group IPO is part of the process to determine at what price to offer an IPO by gauging demand from institutional investors. Because the responses do not address market manipulation, choice E is the best response.

This case is based on a February 2019 Enforcement Action by the Financial Conduct Authority.

Image by Michelle Raponi 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.