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 III(A) Loyalty, Prudence, and Care.
Margin Calls and Client Loyalty
Gain is a commodities trader with a number of retail clients, including Laube who opens a retail forex account with Gain. Laube’s forex account is self-directed, and Gain does not advise Laube on any trades. Laube signed Gain’s standard customer agreement, which contains provisions relating to margin requirements and liquidation in the event of margin deficits. The agreement authorizes Gain, at his discretion, “to liquidate, without notice, any or all open positions in an account with insufficient margin.” Laube initially purchases two 100,000 US dollar/Swiss franc (USD/CHF) positions, bringing his margin requirement to $4,000. Then Laube purchases two additional 100,000 USD/CHF “pending limit” orders if the trading prices reach a specified level. Because each order has a different limit price, one order will execute before the other. Shortly after placing these limit orders, Laube goes on an extended vacation. While on vacation, the execution on the first limit order triggers, bringing the margin requirement to $6,000. Later, when the limit price is reached, the second order executes, bringing Laube’s margin requirement to $8,000. After the trades, while Laube is still on vacation, his account balance drops to only $6,900. Without notice, Gain liquidates all positions in Laube’s account, realizing a loss of $37,000 from the liquidation. Gain’s actions are
A. appropriate because Gain followed the policy and procedures set forth in Laube’s client agreement.
B. inappropriate because Gain has a duty to act in the best interest of Laube by protecting his financial position.
C. inappropriate because Gain could have met the margin requirement by liquidating only one forex contract.
D. inappropriate because the margin and liquidation policies in the client agreement are misleading.
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 the duties of loyalty, prudence, and care owed to clients in relation to advisers duties to other clients and the markets. Generally, CFA Institute Standard III(A) imposes on CFA Institute members a duty of loyalty, prudence, and care to act in the clients’ best interests. The conduct that fulfills this responsibility, however, depends on the nature of the relationship with the client. In this case, Laube self-directs his trades, which are simply executed by Gain who does not provide investment advice. Laube freely contracts with Gain regarding the consequences of insufficient margins in his account, and these policies and procedures are clearly set forth in the client agreement. There is no indication in the facts that Gain misled Laube about the margin requirements or the liquidation procedures. Margin requirements allow commodity traders to ensure their own financial integrity, which, in turn, contributes to the financial integrity of the entire marketplace.
Gain’s responsibility to protect his own financial position and that of his other customers may supersede any duties he owes to Laube when Laube defaults on his margin requirements. Given the limited nature of the relationship between Laube and Gain, Gain is not obligated to actively monitor Laube’s account to protect Laube’s financial interests. Doing so would require Gain to continuously monitor a potentially deteriorating market or to take on additional risk management measures that Gain has not agreed to and that Laube has not contracted for. Gain also is not obligated to use a less drastic alternative by closing only one forex contract and does not breach a duty to Laube by liquidating all open positions when the parties have contractually agreed that total liquidation to meet a margin deficit may be done at Gain’s discretion without notice. Although the contractual provision authorizing liquidation without notice does not waive Laube’s right to be dealt with in good faith, the margin and liquidation provisions are not an attempt by Gain to waive his duty of loyalty, prudence, and care. They simply set forth the parameters of the relationship. Gain and Laube are each free to negotiate the nature and extent of the relationship. Although Laube suffered significant trading losses from liquidation of his account, Gain liquidates Laube’s open positions for business reasons, to protect the integrity of the market, and in accordance with the terms of the customer agreement. Choice A is the best response.
This case is based on a 2017 US Commodities Futures Trading Commission decision.
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