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CFA Institute’s Code of Ethics and Standards of Professional Conduct codify 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 are certain to 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 what circumstances we face, continuous learning remains imperative in an investment industry that continues to evolve with products undergoing innovation and a regulatory environment continuing to adapt. 

For that reason, each week we will feature a sample case from CFA Institute’s Ethics in Practice Casebook.  Each case is built upon a real-life example that may involve a regulatory matter or even a CFA Institute Professional Conduct investigation.  At the end of the case is a multiple-choice question that addresses the ethical nature of the actions taken in that case.  

This week’s case involves Standard V(A) Diligence and Reasonable Basis.


Guilty or Not Guilty Is the Question!
Sunset Financial Services is a broker/dealer that has historically sold mutual funds and insurance products to individual investors. In 2011, the firm began selling private placements to clients as well. Norma Desmond, vice president of Sunset, is responsible for conducting due diligence on the private placements and placing them on an approved list that Sunset investment advisers can view on the firm’s internal website. Desmond relies on third-party due diligence reports to assess the viability and appropriateness of the private placements for Sunset’s clients. Tom Gillis is one of Sunset’s investment advisers that reviews the internal list of approved private placements and sells several of these investments to his clients. Gillis does not create any sales materials for these private placements but instead relies on sponsor-created sales materials to give to his clients. Has Desmond or Gillis engaged in any misconduct? Decide what you believe is the correct answer and use the Ethical Decision-Making Framework to help explain your choice.

A.  Desmond is guilty of misconduct in selecting the private placements for Sunset to sell.
B.  Desmond is NOT guilty of misconduct in selecting the private placements for Sunset to sell.
C.  Gillis is guilty of misconduct in providing sponsor-created sales material to clients.
D.  Gillis is NOT guilty of misconduct in providing sponsor-created sales material to clients.

What do you think is the correct choice?  Feel free to discuss in the comments below and make sure to check back later this week as we post the analysis.  The completion of this case qualifies for 0.25 hour of Standards, Ethics, and Regulation (SER) credit. 

[Update 4/30/2020]
Welcome back!  Here is the analysis of this case:

Analysis
The Ethical Decision-Making Framework includes questions — such as What is the ethical issue involved? To whom is a duty owed? What are the important Facts? — that help investment professionals analyze situations from an ethical standpoint. The ethical issue involved in this case for both Desmond and Gillis relate to diligence and reasonable basis. Desmond bases her evaluation of private placements on third-party due diligence reports without conducting the analysis herself. Gillis gives sponsor-created sales material to clients without producing his own information on the private placements for his clients. Both Desmond and Gillis owe a duty to the clients of Sunset Financial to act with diligence and reasonable basis in investigating the private placement investments and recommending them to clients. CFA Institute Standard V(A): Diligence and Reasonable Basis states that CFA Institute members “must exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions.” Determining whether Desmond and Gillis met their responsibilities under Standard V(A) requires examining the relevant facts.

In this case, not much background is provided, making it difficult to tell whether either engaged in misconduct. It is acceptable for Desmond to rely on third-party due diligence reports to evaluate investments as long as she take steps to ensure those reports are from a reputable source and have a reasonable and sound basis. It is not clear what steps Desmond took to evaluate the quality of the third-party due diligence provider. Without a critical evaluation of the third-party due diligence provider, she may have violated Standard V(A). Similarly, it is acceptable for Gillis to rely on Desmond to fulfill her responsibilities to conduct thorough due diligence of potential client investments.  Gillis can assume that investments listed on Sunset’s approved private placement list have been thoroughly vetted by the firm through Desmond without having to go back and conduct the due diligence himself unless he has reason to question the validity of the process.

It is also not necessarily improper for Gillis to rely on sponsor-created marketing material to provide information to clients, as long as Gillis, compliance, or other personnel at Sunset have thoroughly reviewed the material to ensure that it meets all applicable disclosure requirements and contains no misrepresentations. If Gillis simply forwards the material to clients without such a review, then he could be violating his duty of diligence to clients by potentially disseminating inaccurate or misleading materials to clients. Because of the lack of information provided in the case, an argument could be made that under certain circumstances, any of the responses could be chosen.

This case is based on a Financial Industry Regulatory Authority (FINRA) enforcement action from 2013.


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© 2018 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.