Ethics Case Study of the Week: Trading Vows (and on Insider Information!)

By Gary Sarkissian posted 09-06-2021 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(A) Material Nonpublic Information.

Trading Vows (and on Insider Information!)
Cho, an accountant in a fund management company, lives with his fiancée Wang, an investment banker
with a global bank. In view of their proximity, Wang cautioned Cho that her work involves confidential material and advised him not to divulge what he may pick up from her work to anyone.

During a weekend holiday, Cho overheard an acquisition deal which Wang was working on. He decided to buy small quantities of the derivatives of the target stock instead of the stock of the target company. The profit from the transaction would help defray expenses of their impending marriage. Both the derivative and the stock did not come under the restricted list of Cho’s employer; and Cho was not yet married to Wang. He went ahead with the purchase, but to his disappointment, the transaction netted him a loss instead. Cho’s actions are

A. acceptable because he bought the derivatives instead of the stock.
B. acceptable as long as he does not divulge the acquisition information to others.
C. acceptable only because he suffered a loss.
D. acceptable because he is merely engaged to Wang.
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.

Cho was clearly in possession of material nonpublic information when he overheard Wang’s conversation. CFA Institute Standard II(A): Material Nonpublic Information says that CFA Institute members who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information. Although Cho bought the derivatives instead of the stock, he is deemed to have acted upon the information.

Even though Cho did not divulge the information to others, thus causing others to act, his decision to act on the information was a clear violation of Standard II(A). Although the transaction did not yield a profit, the loss Cho suffered is irrelevant. The intent was clear. He wanted to profit from the transaction. And he acted upon it.

Whether Cho obtained the information from a total strange or from his fiancée is also irrelevant. Cho came into possession of material nonpublic information, and he should not have acted on it. Wang could have exercised tighter control on her communications to maintain confidentiality. A firewall should have been erected between her work and her personal life at home as well as on holiday. Although her investment actions would no doubt have been subject to close pre- and post-trade monitoring, Wang could have offered her fiancée’s portfolio for scrutiny.

When Cho came into possession of material nonpublic information, he should have communicated this to designated supervisory and compliance personnel in his company. The same should have been done on Wang’s part. Cho must not take investment action on the information or knowingly engage in any conduct that may induce others to privately disclose material nonpublic information. Choice E is the only response.

This case was written by Vineet Vohra, CFA, and Chan Fook Leong, CFA, and is based on a December 2018 Enforcement Action by the US Securities and Exchange Commission.

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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.