Ethics Case Study of the Week: Undercover

By Gary Sarkissian posted 10-03-2022 08:00

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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.

Undercover
Albert Serpico is a registered investment advisor representative and securities broker at Knapp NYC, a New York City-based wealth management firm that caters to high net worth individuals. He is also a Level I candidate for the CFA exam. Given his past career as an undercover detective, Serpico is very sensitive to any potential illicit activity among the firms’ clients and is even among the first in his firm to fulfill his annual compliance training requirement.

Recently, Serpico met with his client, Ed Lombardo, to discuss his investment accounts. Lombardo is the owner of Maas Recycling and Salvage (Maas). A week earlier, local news affiliates ran a story that suggested that Maas had committed various environmental violations related to the disposal of toxic chemicals contained in automobiles and other heavy machinery. Serpico was aware of this story prior to his meeting with Lombardo.

In addition, Serpico had knowledge that the head of the local office for the state’s environmental safety enforcement division, Joseph Potts, was involved in a similar controversy involving another salvage business, where Potts rescinded the citations issued against that business. The decision was met with stiff backlash from local residents, including accusations of bribery, and Potts later ended up reversing his action.

Serpico and Lombardo met for lunch at a nearby diner. When Lombardo had to step away to use the restroom, he left his smartphone on the table unlocked and in plain sight of Serpico. Serpico then discovered a text that came through from a sender called “Potts” that contained the following message:

“I think I have a solution to your mess. Should be a win-win. Call me.”

When Lombardo returned, he immediately checked his phone, paused, and told Serpico that he needed to step away to make an important call. Serpico suspected improper dealing between Lombardo and Potts and immediately reported the incident to the local district attorney’s office. In the process, he handed over copies of Lombardo’s account statements to the district attorney to help with detecting any suspicious transactions that might have occurred between Lombardo and Potts.

Based on this information, which of the following is the most accurate statement?

A. Serpico’s actions did not violate Standard III(E) Preservation of Confidentiality as the standard provides an exception relating to disclosure of illegal activity.
B. Serpico violated standard III(A) Loyalty, Prudence, and Care, as he must always act for the benefit of Lombardo.
C. Serpico violated Standard I(D) Misconduct as he presided over illegal activity that occurred in Lombardo’s accounts.
D. Serpico violated Standard III(E).
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. Let us know your thoughts in the comments below. The completion of this case qualifies for 0.25 hour of Standards, Ethics, and Regulation (SER) credit.

Analysis
This case deals with Standard III(E) Preservation of Confidentiality, which states that “Members and Candidates must keep information about current, former, and prospective clients confidential unless: 1) The information concerns illegal activities on the part of the client or prospective client, 2) Disclosure is required by law, or 3) The client or prospective client permits disclosure of the information.”

While Serpico had suspicion given recent events that there might have been impropriety occurring between Lombardo and Potts, the information provided in the case falls short of warranting his action of contacting the local district attorney and forwarding Lombardo’s account statements. Generally speaking, members and candidates must comply with local laws, and if disclosure is required, then those requirements should override. Conversely, if local laws require maintaining confidentiality, even in the case of illegal activities, then members and candidates should not disclose any confidential information.

The most appropriate course of action was for Serpico to first contact his compliance department or appropriate legal counsel before disclosing any confidential information to outside authorities. The correct answer is D.

This case was written by Gary Sarkissian, CFA.

Image by OpenClipart-Vectors from Pixabay

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