Carol Blackwell, CFA, has been hired to manage trust assets for Blanchard Investments. Blanchard’s trust manager, Thaddeus Baldwin, CFA, has worked in the securities business for more than 50 years. On Blackwell’s first day at the office, Baldwin gives her several instructions.
Instruction 1: Limit risk by avoiding stock options.
Instruction 2: Above all, ensure that our clients’ capital is kept safe.
Instruction 3: We take pride in our low cost structure, so avoid unnecessary transactions.
Instruction 4: Remember that every investment must have the quality to stand on its own.
Baldwin realizes that many of the firm’s practices and policies would benefit from a compliance check. Because Blackwell recently received her CFA charter, Baldwin tells her she is the "perfect person to work with the compliance officer to update the policy on proxy voting and the procedures to comply with Standard VI(B) Priority of Transactions." Baldwin also wants Blackwell to evaluate whether the firm wants to, or can, claim compliance with the soft dollar standards.
Baldwin hands Blackwell a handwritten outline he created, which includes the following statements:
Statement 1: CFA Institute’s soft-dollar rules are not mandatory. In any case, ‘ client brokerage can be used to pay for a portion of mixed-use research.
Statement 2: Investment firms can use client brokerage to purchase research that does not immediately benefit the client. Commissions generated by outside trades are considered soft dollars, but commissions from internal trading desks are not.
During a local society luncheon, Blackwell is seated next to CFA candidate Lucas Walters, who has been assigned the task of creating a compliance manual for Borchard & Sons, a small brokerage firm. Walters asks for her advice.
When Walters returns to work, he is apprised of the following situation: Borchard & Sons purchased 25,000 shares of CBX Corp. for equity manager Quintux Quantitative just minutes before the money manager called back and said it meant to buy 25,000 shares of CDX Corp. Borchard then purchased CDX shares for Quintux, but not before shares of CBX Corp. declined by 1.5%. The broker is holding the CBX shares in its own inventory.
Borchard proposes three methods for dealing with the trading error.
Method 1: Quintux directs additional trades to Borchard worth a dollar value equal to the amount of the trading loss.
Method 2: Borchard receives investment research from Quintux in exchange for Borchard covering the costs of the trading error.
Method 3: Borchard transfers the ordered CBX shares in its inventory to Quintux, which allocates them to all of its clients on a pro-rata basis.
Method 3: Borchard transfers the ordered CBX shares in its inventory to Quintux, which allocates them to all of its clients on a pro-rata basis.
Which method for dealing with the trading error is most consistent with the Code and Standards?
A . Method 1.
B . Method 2.
C . Method 3.
Answer: B
Explanation:
Method 2 is the best answer. Quintux should cover the cost of the trading error, and if Borchard is willing to accept investment research in lieu of cash, that’s all the better for Quintux. If Quintux compensates Borchard with extra trades, its clients are covering the costs of the error, which may violate Standard III (A) Loyalty, Prudence, and Care if directing future trades to Borchard is not in the clients’ best interest. By accepting the CBX shares it did not request and allocating the shares to all client accounts rather than paying for the error, Quintux is violating Standard 111(C) Suitability, since the shares are not likely to be appropriate for all of its client accounts and may not be suitable for any accounts since the shares were obtained as a result of a trading error, not an intentional investment action. Passing on client names is a violation of Standard III(E) Preservation of Confidentiality. (Study Session 1, LOS 2.a)
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