Ethics Case Study of the Week: When the Fees Keep Flowin’…

By Gary Sarkissian posted 04-11-2022 08:00

CFA Institute’s Code of Ethics and Standards of Professional Conduct outline 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 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 the circumstances, continuous learning remains imperative in an evolving investment industry and an adapting regulatory environment. 

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 Standards III(A) Loyalty, Prudence, and Care and IV(C) Responsibilities of Supervisors.

When the Fees Keep Flowin’…
St. Petersburg Investment Partners (PIP) is an investment management firm with several branch offices that provides investment advice to thousands of advisory clients. Raymond is one of hundreds of financial advisers working at PIP, and Jaynes is his branch manager. The client agreement for all PIP client accounts states that PIP will provide “ongoing investment advice and monitoring of securities holdings,” and that the PIP financial adviser assigned to the account will “manage the assets of the account according to the client’s objectives.” The client agreement also states that account management includes regular review of the account to determine whether keeping the client in an advisory account is suitable for the client or whether the client should consider moving to a brokerage-only account with lower fees. A key parameter for making this evaluation is account inactivity, defined as no trading for at least 12 months.

Bower is PIP’s chief compliance officer responsible for drafting and implementing the firm’s compliance policies and procedures. The compliance procedures require each PIP financial adviser to “continually monitor their client accounts, discuss with client’s reasons for inactivity, and document all conversations and meetings with clients to demonstrate on-going management.” After 12 months of inactivity, the compliance procedures require compliance staff to contact the branch managers to confirm in writing that advisory services are being provided to clients. A routine regulatory audit indicates that for the past several years, more than 150 of Raymond’s advisory accounts had no securities trading activity for at least 12 months and these accounts paid PIP approximately $1 million in advisory fees.

Choose a response and provide an explanation that supports your choice.

A. Only Raymond violated the CFA Institute Code and Standards.
B. Raymond and Jaynes both violated the CFA Institute Code and Standards.
C. Raymond, Jaynes, and Bower all violated the CFA Institute Code and Standards.
D. Neither Raymond, Jaynes, nor Bower violated the CFA Institute Code and Standards.
E. None of the above.

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 involves the improper management of client accounts because of a failure to comply with the policies and procedures established by PIP. Although PIP informs its clients that it will continually monitor their account for inactivity to determine whether the clients would be better off in less expensive brokerage-only account, that does not happen with Raymond’s clients. Raymond does not note or discuss the inactivity in at least 150 accounts as promised, violating his duty to his clients under CFA Institute Standard III(A): Loyalty, Prudence, and Care.

PIP’s compliance procedures indicate that compliance personnel are also expected to monitor client inactivity and contact branch managers about inactive accounts, which also did not happen in Raymond’s case. Bower, as chief compliance officer, failed to supervise his compliance staff properly to ensure the implementation of firm policy, a violation of CFA Institute Standard IV(C): Responsibilities of Supervisors.

Presumably, once informed of the account inactivity, the branch manager is responsible for following up with the financial adviser to determine whether a change to a brokerage-only account is warranted. Neither Raymond nor Bower, who are explicitly responsible for monitoring account inactivity, bring Raymond’s 150 inactive accounts to Jaynes’s attention. It is unclear from the facts whether Jaynes has direct responsibility for monitoring account inactivity. But Jaynes does have overall responsibility for managing his branch’s advisers to make sure they are managing client accounts appropriately and complying with rules, regulations, and firm policies and procedures. Because his supervision of Raymond is ineffective, leading to a compliance breakdown, Jaynes has also violated CFA Institute Standard IV(C): Responsibilities of Supervisors.

The failure to appropriately manage client accounts in this case resulted in a breakdown from Raymond, Jaynes, and Bower in fulfilling their professional responsibilities under the CFA Institute Code and Standards. C is the best choice.

This case is based on a September 2019 US SEC enforcement action.

Image by Steve Buissinne 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.