Standard VI
- VI Conflicts of Interest
- VI(A) Avoid or Disclose Conflicts. Members and Candidates must avoid or make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective clients, and employer. Members and Candidates must ensure that such disclosures are prominent, are delivered in plain language, and communicate the relevant information effectively.
Guidance Members and candidates should avoid actual or potential conflicts of interests to the extent possible. When they cannot reasonably avoid actual or potential conflicts of interest, members and candidates must fully disclose these conflicts to clients, prospects, and their employers. These disclosures must be clearly stated.
Guidance, Disclosure to Clients The requirement that all potential areas of conflict be disclosed allows clients and prospects to judge motives and potential biases for themselves. Disclosure of broker- dealer market making activities would be included here. Board service is another area of potential conflict.
The most common conflict which requires disclosure is actual ownership of stock in companies that the member recommends or that clients hold.
Another common source of conflicts of interest is a member’s compensation/bonus structure, which can potentially create incentives to take actions that produce immediate gains for the member with little or no concern for longer term returns for the client. Such conflicts must be disclosed when the member is acting in an advisory capacity and must be updated in the case of significant change in compensation structure. Any special compensation arrangements, bonus programs, commissions, and incentives should be disclosed.
Guidance, Disclosure of Conflicts to Employers Members must give the employer enough information to judge the impact of the conflict. Take reasonable steps to avoid conflicts, and report them promptly if they occur.
Application of Standard VI(A) Avoid or Disclose Conflicts
Example 1:
An investment management partnership sells a significant stake to a firm that is publicly traded. The partnership has added the firm’s stock to its recommended list and approved its commercial paper for cash management accounts.
Comment:
Members are required to disclose such a change in firm ownership to all clients. Further, any transactions in client accounts involving the securities of the public firm, and any recommendations concerning the public firm’s securities, must include a disclosure of the business relation between it and the partnership.
Example 2:
A member provides clients with research about a company’s stock, and his wife inherits a significant amount of stock in the company.
Comment:
The member must disclose this potential conflict to his employer and in any subsequent reports or recommendations he authors. His employer may prudently choose to reassign the stock.
Example 3:
A member’s investment banking firm receives a significant number of options as partial compensation for bringing a firm public. The member will profit personally from a portion of these options as well.
Comment:
In any research report on the public firm’s securities, the member must disclose the fact that these options exist and include their number and the expiration date(s). Because he will profit personally from these, he must also disclose the extent of his participation in these options.
Example 4:
A member accepts an offer from a stock promoter who will provide additional compensation when the member sells Acme stock to his clients. He does not inform his clients or his employer.
Comment:
The member is in violation of the Standard because he must disclose this additional compensation to those clients to whom he recommends the stock and to his employer. Both have a right to determine for themselves the extent to which this additional compensation might affect the member’s objectivity.
Example 5:
A member who is a portfolio manager for a small investment management firm serving individuals accepts a job as a trustee of an endowment fund that has over €1.5 billion in assets and does not disclose this to her employer.
Comment:
This is a significant position that may require a substantial portion of the member’s time and may involve decisions on security selection and trading. The member is in violation of the Standard by not disclosing this involvement to her employer and by not discussing it with her employer before accepting the position.
Example 6:
A member replaces his firm’s external manager, which has had average results, with a friend’s firm.
Comment:
Taking such action without disclosing to his firm that the new manager is a personal friend is a violation of the Standards.
Example 7:
A member who is a portfolio manager participates in her employer’s defined contribution pension plan through automatic contributions each pay period. The investment choices in the plan are large, diversified mutual funds, including one fund that is managed by her employer.
Comment:
The Standard does not require the member to disclose her personal investments in diversified funds unless this is her firm’s policy, nor does it require preclearance for her automatic payroll deductions. The member should follow her firm’s policies with regard to preclearing and disclosing her investments in firm managed funds.
- VI(B) Priority of Transactions. Investment transactions for clients and employers must have priority over investment transactions in which a Member or Candidate is the beneficial owner.
Guidance
Client transactions take priority over personal transactions and over transactions made on behalf of the member’s firm. Personal transactions include situations where the member is a “beneficial owner.” Personal transactions may be undertaken only after clients and the member’s employer have had an adequate opportunity to act on a recommendation.
Note that family member accounts that are client accounts should be treated just like any client account; they should not be disadvantaged.
Information about pending trades should not be acted on for personal gain. The overriding considerations with respect to personal trades are that they do not disadvantage any clients.
Recommended Procedures for Compliance All firms should have in place basic procedures that address conflicts created by personal investing. The following areas should be included:
- Limited participation in equity IPOs. Members can avoid these conflicts by not participating in IPOs.
- Restrictions on private placements. Strict limits should be placed on employee acquisition of these securities and proper supervisory procedures should be in place. Participation in these investments raises conflict of interest issues, similar to IPOs.
- Establish blackout/restricted periods. Employees involved in investment decision- making should have blackout periods prior to trading for clients, no “front running” (i.e., purchase or sale of securities in advance of anticipated client or employer purchases and sales). The size of the firm and the type of security should help dictate how severe the blackout requirement should be.
- Reporting requirements. Supervisors should establish reporting procedures, including duplicate trade confirmations, disclosure of personal holdings/beneficial ownership positions, and preclearance procedures. Disclosure of policies.
- Members must fully disclose to investors their firm’s personal trading policies.
Members should encourage their firms to adopt such procedures if they have not.
Application of Standard VI(B) Priority of Transactions
Example 1:
A member who is a research analyst does not recommend a stock to his employer because he wants to purchase it quickly for his personal account.
Comment:
He has violated the priority of transactions by withholding this information from his employer and seeking to profit personally at his employer’s expense. The member has likely violated his duty to his employer under Standard IV(A) Loyalty as well.
Example 2:
A member who manages a fund gets hot IPO shares for her husband’s account from syndicate firms, even when the fund is unable to get shares.
Comment:
The member has violated the Standard by this action. She must act in the interest of the shareholders of the fund and place allocated shares there first. She must also inform her employer of her participation in these offerings through her beneficial interest in her husband’s account(s).
Example 3:
A member allows an employee to continue his duties without having signed a required report of his personal trading activity over the last three months. The employee, a CFA candidate, has been purchasing securities for his own account just before firm buy recommendations have been released.
Comment:
The employee has violated the Standard. The member has also violated Standard IV(C) Responsibilities of Supervisors by allowing the employee to continue in his regular duties.
Example 4:
A member reveals a sell rating on some securities in a broadcast to all of her firm’s brokers. The changed rating is sent to clients the next day. Shortly after revealing the change to her firm’s brokers and prior to dissemination to clients, she buys puts on the stock for her firm’s account.
Comment:
The member did not give clients adequate opportunity to act on the change in recommendation before buying the puts for her firm’s account.
- VI(C) Referral Fees. Members and Candidates must disclose to their employer, clients, and prospective clients, as appropriate, any compensation, consideration, or benefit received from, or paid to, others for the recommendation of products or services.
Guidance
Members must inform employers, clients, and prospects of any benefit received for referrals of customers and clients, allowing them to evaluate the full cost of the service as well as any potential partiality. All types of consideration must be disclosed.
Recommended Procedures for Compliance Members should encourage their firms to adopt clear procedures regarding compensation for referrals. Firms that do not prohibit such fees should have clear procedures for approval, and members should provide their employers with updates at least quarterly regarding the nature and value of referral compensation received.
Application of Standard VI(C) Referral Fees Example 1:
Jim Banaji is a banker who receives bonus compensation for each client referred to the bank’s brokerage division. Banaji chooses to not disclose this arrangement to his clients.
Comment:
Banaji has violated Standard VI(C) by not disclosing the referral arrangement at the bank to his clients. Members and candidates must disclose all such referral fees. Therefore, the disclosure should include the nature and the value of the benefit and should be made in writing.
Example 2:
An investment consultant conducts an independent and objective analysis of investment managers for a pension fund and selects the best one. Subsequently, the selected advisor makes a payment to the consultant.
Comment:
This is a violation of the Standard. The potential for a payment should have been disclosed to the pension fund. There are very likely regulatory or legal considerations with regard to such payment as well.