This case relates to diligence and reasonable basis in making investment recommendations and taking investment action. CFA Institute Standard of Professional Conduct V(A): Diligence and Reasonable Basis states that CFA Institute members must exercise diligence and thoroughness in analyzing investments and must have a reasonable and adequate basis supported by appropriate research and investigation for any investment recommendation. The issue in this case is whether Harrelson, Chong, and Broadus complied with the requirements of this standard.
By relying on the statements given by Corix and not conducting an independent investigation into the veracity of the information, Harrelson did not exercise diligence and thoroughness in analyzing the company. Chong seemingly relied on Harrelson’s research to formulate his “buy” recommendation without conducting his own independent research. Investment professionals who rely on third-party research conducted outside their firm by someone who is not their colleague must make reasonable and diligent efforts to determine whether such research is sound. The facts do not indicate that Chong independently verified the statements, critically assessed Harrelson’s research, or had reason to rely on Harrelson’s report based on past experience and familiarity with the quality of Harrelson’s work. Chong also did not appear to recognize that Harrelson’s work was issuer-paid research and thus subject to heightened scrutiny.
Broadus relied on the work of his colleague, Chong, in making the decision to invest in Corix stock for his clients. Investment professionals may rely on the work of colleagues in their firms when making an investment decision, under the assumption that the employer has fully vetted and approved of the diligence, quality, and thoroughness of their fellow colleagues’ work. Investment professionals may also rely on others in their firms to determine whether third-party research is sound and use the information in good faith unless there is reason to question its validity or the processes and procedures used by those responsible for the research. Under the facts provided, Broadus had no reason to be concerned that Chong had not adequately conducted internal research on Corix, or that NHIM was negligent in employing Chong as a research analyst. Under these circumstances, Broadus is entitled to rely on the work of his colleague and thereby meet the requirements of the diligence and reasonable basis standard. Since Harrelson and Chong most likely violated the standard and Broadus did not, choice E is the best response.
This case is based on an enforcement action by the US SEC from August 2019.