Ethics Case Study of the Week: Trading on Pandemic Information

By Gary Sarkissian posted 08-08-2022 09:53 AM

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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.

Trading on Pandemic Information
Burlingame is a high-ranking government official who, because of her work with the intelligence agencies, is regularly briefed on potential threats to the country, both from a military and economic perspective. During a recent briefing, she receives information from the intelligence community about the strong likelihood of the onset of a global pandemic in next three months. She recognizes that the pandemic will result in widespread economic shock and have a devastating negative effect on global capital markets. Burlingame contacts her investment adviser, O’Donnell, and directs him to liquidate her investments. O’Donnell should

A. sell the investments as directed by the client.
B. not execute the trades because they are a product of material nonpublic information.
C. refuse to execute the trades because Burlingame’s request is not in line with her previously established investment objectives, mandates, and constraints.
D. execute the trades but disclose any possible illegal activity to appropriate authorities.
E. none of the above.

What do you think is the correct choice? The “Analysis” section below will walk through the reasoning and provide the correct answer. Also, 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.

Analysis
The circumstances of this case indicate that Burlingame is seeking to liquidate her investments based on material nonpublic information received about the economy because of her government position. CFA Institute Standard of Professional Conduct II(A): Material Nonpublic Information (MNPI) prohibits CFA Institute members who possess material nonpublic information from acting or causing others to act on that information. Obviously, the information about the oncoming pandemic is both material (because it will have an effect on securities prices and a reasonable investor would want to know the information before making an investment decision), and nonpublic (because it is not widely distributed to the investing public). Clearly Burlingame is in possession of MNPI and the facts suggests Burlingame is seeking to trade on this information to avoid losses to her portfolio.

The key issue in this case is whether O’Donnell is in possession of MNPI or is aware that Burlingame is seeking to trade based on material nonpublic information. The CFA Institute Ethical Decision-Making framework, in part, asks you to identify relevant facts before deciding on a course of conduct to follow to act in an ethical manner. In the facts provided, there is no indication that O’Donnell is in possession of MNPI or that Burlingame has told O’Donnell the reasons for wanting to liquidate her portfolio (B). CFA Institute Standard III(E): Preservation of Confidentiality would allow O’Donnell to disclose illegal activity on the part of Burlingame to the authorities (D). But as noted, there is no indication from the facts that O’Donnell is aware that Burlingame is trading on MNPI. If Burlingame, as a government official, has trading protocols placed on her, O’Donnell should know and understand those to ensure that the trading is done within those parameters.

Generally, anytime an advisory client seeks to change their investment portfolio, it is appropriate for their adviser to conduct a suitability analysis to determine whether the directive is consistent with the previously provided investment goals, objectives, risk tolerances, and so on of the client (C). This is consistent with CFA Institute Standard III(C): Suitability, which requires CFA Institute members to determine whether an investment is suitable for the client’s financial situation and consistent with the client’s written objectives, mandates, and constraints before taking an investment action. Burlingame’s request to liquidate her portfolio diverges from her long-term financial goals. This request may raise a red flag for O’Donnell. But, ultimately, if Burlingame demands that the trades be made, O’Donnell, without any evidence of illegal activity, must meet his duty to his client by following her directives. Choice A is the best response given the facts provided.

Image by cromaconceptovisual 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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