Ethics Case Study of the Week: Fees, fees…and more fees!

By Gary Sarkissian posted 6 days ago

  
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 I(D) Misconduct, I(A) Knowledge of the Law, III(A) Loyalty to Clients, , I(C) Misrepresentation, and V(C) Record Retention.


Fees, fees…and more fees!
Turrow is the CEO and Evans is the chief compliance officer (CCO) at Grand Rapids Partners (GRP), a registered investment adviser with approximately US$900 million in assets under management (AUM). GRP provides financial planning and investment advisory services to around 3,000 clients consisting of high-net-worth individuals, personal and family trusts, and retirement plans. Turrow trained Evans, and Evans has spent all of his investment advisory career at GRP under Turrow’s employ and tutelage. About US$450 million in client assets are held in custody by Jameson, GRP’s broker/dealer.


Turrow is responsible for GRP’s billing, and he calculates and tracks the billing of management fees through manual calculation and Excel spreadsheets, which list the fee rates to be charged to each account. After Turrow calculates the fees and prepares the spreadsheets, Evans is responsible for billing the clients. For the client accounts held by Jameson, Evans typically sends an email to the broker with a spreadsheet listing the account numbers and fees to be charged to each account. The broker posts the fees to the account, deducts the funds, and submits the funds to GRP’s account. Jameson then sends monthly billing statements to the GRP account holders.

Typical management fees are 2% of account assets, with 1% billed annually and the other 1% billed in four quarterly installments. But many clients negotiate their rates with GRP and clients with higher account balances are charged lower percentage rates. In addition, the percentage of fees charged also varies based on the performance of the account. On several occasions, GRP bills its annual fee more than once during a 12-month billing cycle so that clients are billed annual fees for multiple years in advance. And sometimes clients are charged the 2% annual fee rather than a negotiated lower fee, and other clients are billed a full annual fee although assets are held for less than a full year. For accounts in which fees are supposed to be based on performance, GRP often bills the client the maximum agreed-on fee without considering whether the account achieved the required performance. For other accounts, the quarterly billing occurs multiple times during the quarter, causing clients to be double billed.

At times, Turrow instructs Evans to submit extra billings to the broker, claiming these extra billings are for work performed in addition to the regular advisory services or are for an “origination fee.” Evans submits these bills to Jameson without question. Turrow also bypasses Evans on several occasions and personally submits extra billing requests to Jameson directly and has Jameson deposit the fees into his personal banking account. When clients complain about incorrect billing, Turrow, or Evans at the behest of Turrow, tells them that the overbillings are the result of an inadvertent error or the fault of Jameson and refunds the client accounts. Of the characters in this case, who has violated the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards)?

 A. Evans only
 B. Turrow and Evans
 C. Turrow, Evans, and Jameson
 D. Neither Turrow, Evans, or Jameson
 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 intentionally overcharging clients for investment management fees. All three characters in this case have violated the CFA Institute Code and Standards. Turrow submitted overbillings to Jameson for management fees that were not earned and billed clients for work that was not performed. The billings are fraudulent and violated multiple standards relating to misconduct [Standard I(D)], breaking the law [Standard I(A): Knowledge of the Law], loyalty to clients [Standard III(A): Loyalty, Prudence, and Care], misrepresentation [Standard I(C): Misrepresentation], and record retention [Standard V(C)].

Evans knowingly or recklessly provided substantial assistance to Turrow by engaging in the fraudulent billing. Turrow is Evans supervisor, and as CEO of the firm, he calculates and prepares the billings each month. But Evans follows Turrow’s direction without question and failed in his responsibilities as CCO to ensure that clients are charged the agreed-on management fees. The obviously inadequate compliance policies and procedures allow Turrow to easily manipulate the fees charged, submit multiple billings, and circumvent the CCO to submit inappropriate supplemental bills to clients. As a result, Evans’s conduct also violated many of the same standards.

The many billing irregularities, particularly multiple billings within a time period, and the request by Turrow to deposit the fees into his personal account should have raised red flags with Jameson about GRP’s inappropriate billing practices. Jameson, as the broker/dealer, has a duty to GRP, his client, to raise these issues of fraudulent and illegal conduct on the part of the CEO with someone at the investment adviser. Furthermore, Jameson failed to dissociate from the fraudulent behavior of Turrow, thereby violating Standard I(A): Knowledge of the Law. Choice C is the best response.

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




Image by 3D Animation Production Company 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.


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