Ethics Case Study of the Week: The Shaky Tenant

By Gary Sarkissian posted 07-18-2022 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 among industry participants.  

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 ethics case to help reinforce the code and standards.  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.

The Shaky Tenant
Skyway Capital Management is a boutique investment manager focused on investing in commercial real estate assets including real estate investment trusts (REITs).  Marvin Devins is the portfolio manager for the Skyway Industrial Real Estate Fund, which primarily invests in warehouses and other forms of logistical properties.  One of Devins’ holdings is Causeway Industrial Properties, Inc., a small-cap REIT that manages mission-critical industrial properties located in dense coastal urban markets.

Devins was scheduled to join a number of other Causeway investors for a lunch meeting with Causeway’s CEO, Angela Duffy.  During the lunch session, Duffy reaffirmed with all attendees the strong credit quality of Causeway’s tenants and highlighted the consistent strength in property occupancy across its portfolio.  In a separate meeting after lunch with just Devins and another major investor, however, Duffy inadvertently disclosed her concern regarding Causeway’s tenant, Prime-O Retail, an online internet retailer and the largest-sized tenant relative to Causeway’s annual base rent.  Duffy informed both investors that Prime-O was recently suffering from deteriorating rent coverage due to increased competition, higher wage costs, and inventory mismanagement, and that any inability to pay its rent would adversely affect Causeway’s dividend coverage.

Upon returning back from his trip, Devins refrained from making any changes to his position in Causeway until the firm released its next public filing that included details surrounding Prime-O’s rent condition.  Devins did, however, inform Beatrice Allston, the equity analyst who covers Causeway, of the unstable rent situation with Prime-O.  Allston immediately issued an updated research note to Skyway’s team of portfolio managers in which she downgraded Causeway’s stock rating to “Sell” due to the “concerning elevated exposure to a major tenant whose business potentially faces competitive headwinds.”  Upon reading Allston’s note, Julia Fletcher, manager of Skyway’s Small Cap REIT fund, decided to sell out her entire position in Causway and reinvest the proceeds in another REIT.

Based on the information in this case, which statement is correct?

 A. Devins did not violate the code and standard, as he refrained from making any changes to the fund’s position in Causeway.
 B. Devins violated the code and standards, but Allston was in compliance.
 C. Fletcher violated the standards as she acted upon Allston’s trade recommendation.
 D. Devins and Allston violated the 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 relates to standard II(A) Material Nonpublic Information, which states that “Members and Candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information.” When Devins learned of Causeway’s challenges with respect to its largest tenant, Prime-O Retail, he had an obligation to neither act nor cause anyone else to act on that material nonpublic information. His decision to abstain from making any changes to his holdings in Causeway after his meeting with Duffy was in harmony with the code and standards, however his compliance falters once he discloses the situation to Allston. In addition, members and candidates should make a reasonable effort to achieve public dissemination upon receiving material nonpublic information. Upon receipt of the information concerning Prime-O, Devins should have advised Causeway to disseminate that information to the investing public in a timely fashion.

Allston also violated the standards when she acted on the information conveyed by Devins by issuing a change in recommendation to Skyway’s portfolio managers that ultimately led to another manager trading out of Causeway’s stock without knowing that the recommendation was influenced by the material nonpublic information. The correct answer is D.

This case was written by Gary Sarkissian, CFA.

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