Standard 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 must always take priority over transactions made on behalf of the Member or Candidate’s firm or personal transactions. The main objective of this standard is to prevent any potential conflicts of interest or the appearance of conflict concerning personal transactions.

Avoiding Potential Conflicts

Members and Candidates are permitted to make personal investments as long as:

• Their clients are not disadvantaged by the trade or investment.
• The Member or Candidate does not benefit personally from trades taken on behalf of the client.
• The Member or Candidate is compliant with all relevant laws and regulations.

Members and Candidates are allowed to take investment actions that are contrary to investment recommendations provided to clients.

Personal Trading Secondary to Trading for Clients

Standard VI (B) – Priority of Transactions emphasizes that client and employer transactions come before all personal investments. A Member or Candidate with similar investment holdings does not necessarily create a conflict of interest. Personal investments or transactions must never lead to unfavorable outcomes for clients.

Standards for Nonpublic Information

Members and Candidates in the knowledge of pending transactions (by their clients or employers) or any nonpublic information are prohibited from sharing these details with any individual whose association to the Member or Candidate makes the Member or Candidate a beneficial owner. Member and Candidate must not disclose nonpublic information that is considered material; this would be a violation of Standard II(A) – Material Nonpublic Information.

Impact on All Accounts with Beneficial Ownership

Members and Candidates are permitted to take investment action in accounts for which they are beneficial owners only after they have given their clients and employers an adequate opportunity to act on a recommendation. Family accounts that are client accounts should be treated like any other client account – the account should neither be favored nor disadvantaged.

Compliance Recommendations

Members and Candidates are encouraged to urge their employers to establish policies and procedures that are designed to mitigate potential conflicts of interest or the appearance of a conflict of interest regarding personal transactions.

All firms should adopt the following basic procedures to address conflicts of interest regarding personal transactions:

• Limiting participation in IPO’s: This conflict can be addressed by Members and Candidates avoiding participation in IPO’s altogether.
• Restricting participation in private placements: Strict limits should be placed on employee investments in private placements. Suitable supervisory and review procedures should be established to promote compliance.
• Establishing blackout/restricted periods: Members or Candidates involved in the decision-making process should establish blackout periods to allow clients to take investment action. This procedure is implemented to prevent employees with nonpublic information from “front-running” (making personal transactions before client transactions).
• Reporting requirements: Supervisors should establish reporting procedures for employees that address disclosure requirements of personal holdings or beneficial ownerships, confirmation of trades to the firm, and employee and preclearance protocols.
• Disclosure of policies: Members and Candidates should fully disclose to clients their firm’s policies regarding personal investments and trading policies.

Application 1: Family Account as Equals

Gia Davies, a senior trader at InvestCorp Brokerage, has recently helped her sister open up a standard fee-paying brokerage account with InvestCorp’s Brokerage Divison. One of InvestCorp’s investment banking clients, InfoTrak Inc., is set to go public, through an initial public offering, in the next few weeks.

Which of Davies’s actions would most likely violate Standard VI (B) – Priority of Transactions?

      A. Taking no action and allowing her sister’s account to be treated like any other standard fee-paying account.

      B. Increasing the allocation of InfoTrak’s shares in her sister’s brokerage account.

      C. Failing to disclose the family relationship to the compliance team.

Solution

The correct answer is B.

Davies increasing her sister’s allocation in InfoTrak’s shares would be a violation of Standard VI (B) – Priority of Transactions. Her sister is a fee-paying client and should be treated like any other client – she should not receive favorable treatment. Her allocation should be treated in the same manner as any other fee-paying client.

Application 2: Personal Trading and Disclosure

Benjamin Cook was a research intern at a prominent active management firm. During his eight-month-long internship, he purchases a luxury car and several designer accessories. Regina Perry, chief compliance officer at the firm, is responsible for monitoring personal stock trades for all employees. She investigates Cook’s personal trades and finds that Cook had made significant profits by selling (shorting) stocks just before they were put on the firm’s “SELL” list.

Cook had omitted several of his personal transactions on his monthly personal trading form. In addition, he failed to submit his personal trading forms over the last two months of his internship.

Have Cook and (or) Perry violated Standard VI(B) – Priority of Transactions?

       A. Neither Cook nor Perry has violated Standard VI(B) – Priority of Transactions.

       B. Cook violated Standard VI(B) – Priority of Transactions.

       C. Both Cook and Perry have violated Standard VI(B) – Priority of Transactions.

Solution

The correct answer is B.

Cook violated Standard VI(B) – Priority of Transactions by placing his personal trades before his client’s trades.

Additionally, Perry, the chief compliance officer, has violated Standard IV(C) – Responsibility of Supervisors by allowing Cook to continue his duties without accurate and infrequent submission of his personal transaction form. Note that, if Cook had passed on the firm’s recommendations to an individual who traded the security, the use of the information would be a violation of Standard II(A) – Material Nonpublic Information.

Reading 46: Guidance for The Standards of Professional Conduct (I-VII)

LOS 46 (a) Demonstrate a thorough knowledge of the CFA Institute Code of Ethics and Standards of Professional Conduct by applying the Code and Standards to specific situations.