Ethics Case Study of the Week: Trading in Warrants

By Gary Sarkissian posted 08-29-2022 08:22

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 in Warrants
Ng is an investment adviser for Lashki Investment Services. Ng places several buy orders for a warrant in the underlying stock of Universal Entertainment Enterprises through a client’s account, causing the price of the warrant to increase significantly. Ng then immediately sells his entire personal holdings in the warrant to the client, making a profit of $14,510 and generating a loss of $13,040 for the client. Ng’s actions violate the CFA Institute Standards of Professional Conduct related to

 A. personal investing.
 B. market manipulation.
 C. loyalty to the client.
 D. personal investing, market manipulation, and loyalty to the client.
 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.

Ng violated the CFA Institute Standards of Professional Conduct related to personal investing, market manipulation, and loyalty to the client. Ramping up the warrant’s price to facilitate the offloading of his personal holdings in the warrant for his own benefit and to the detriment of the client prioritizes Ng’s personal investments over the client’s in violation of CFA Standard VI(B): Priority of Transactions, which states that investment transactions for clients must have priority over personal transactions. The conduct also violates CFA Institute Standard III(A): Loyalty, Prudence, and Care, which requires CFA Institute members to act for the benefit of their clients and place their client’s interests before their own.

Additionally, Ng’s conduct is unfair to other market participants because it interfered with the impartiality and objectivity of the normal price formation and may have affected other investors trading strategy and investment decision in the warrant, all in violation of CFA Standard II(B): Market Manipulation, which prohibits CFA Institute members from engaging in practices that distort prices or artificially inflates trading volume. Choice D is the best response.

This case is based on an October 2019 enforcement action by the Hong Kong Securities and Futures Commission.

Image by carloyuen 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.