Ethics Case Study of the Week: Mutual Fund Share Purchases

By Gary Sarkissian posted 06-06-2022 08:00 AM

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 Standard I(C) Misrepresentation.

Mutual Fund Share Purchases
Avery is the founder and CEO of World Series Asset Management (WSAM), a firm that provides investment recommendations to its clients in retirement plans or charitable organizations. Avery advertises that WSAM selects the most economical share class for each client when purchasing mutual fund shares. Avery claims that WSAM uses a proprietary calculator for share class selection that is “designed to provide customers with the least costly share class option over the anticipated holding period of the investment.”

The calculator is designed to analyze client-specific data points, such as the client’s current mutual fund family holdings and planned future purchases as well as fund-specific information programmed into the system by WSAM personnel. But WSAM employees sometimes fail to code the share class calculator correctly, which leads to clients purchasing more expensive share classes when less expensive share classes are available. In addition, WSAM does not use the share class calculator for certain legacy retirement plan clients but attempts to find the lowest cost share class for these clients through detailed analysis of each individual account. Avery’s actions are

 A. acceptable because WSAM’s share class calculator identifies the lowest cost share class when used correctly.
 B. acceptable because WSAM provides a more thorough, personalized service when the share cost calculator is not used.
 C. acceptable as long as WSAM achieves the goal of identifying the lowest cost share class for each client, regardless of method used.
 D. acceptable as long as WSAM does not benefit by receiving greater compensation when more expensive share classes are identified for clients.
 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 relates to misrepresentation of services. Avery and WSAM advertise that the company uses a proprietary share class selection calculator to achieve the goal of purchasing the most economical mutual fund share class for each client. But the calculator is sometimes used incorrectly, and for certain clients, it is not used at all. In addition, when coded incorrectly, the calculator does not recommend the most economical share class available. The fact that the calculator works when coded properly does not mitigate the fact that errors by WSAM employees render its claim misleading that the firm purchases the least costly shares for its clients.

For some clients, WSAM does determine and purchase the most economical share class but does not use the share class selection calculator as advertised and described to clients. Although the goal of purchasing economical share classes for clients is achieved through other methods, Avery and WSAM are still misleading clients by stating that the share class calculator is used when it is not. WSAM advertises its proprietary tool as an inducement to investors to hire WSAM and as a benefit to existing clients. Clients and potential clients are entitled to rely on WSAM’s description of its services when choosing an investment manager. When the process is materially changed without notification to clients or prospects, Avery is violating CFA Institute Standard I(C): Misrepresentation, which prohibits CFA Institute members from making any misrepresentations relating to investment recommendations or actions.

Even if WSAM does not benefit when more expensive share classes are purchased, clients are harmed because more expensive share classes can negatively impact the overall return of the investment. Because the claims of Avery and WSAM are misleading, Avery’s actions are unacceptable. Choice E is the best response.

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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.