Standard IV (C) – Responsibilities of Supervisors

Members and Candidates must make reasonable efforts to ensure that anyone subject to their supervision or authority complies with applicable laws, rules, regulations, and the Code and Standards.

Members and Candidates with supervisory responsibilities must make reasonable efforts to prevent and detect any violations of laws, rules, and regulations.

Any Member or Candidate that has a degree of control or influence over employees must exercise supervisory responsibility. Members and Candidates are expected to understand the Code and Standards and implement this knowledge in their supervisory responsibilities.

Members and Candidates in a supervisory role should inform the firm’s management of an ineffective compliance system and recommend corrective measures. If a Member or Candidate is unable to discharge their supervisory responsibilities due to the absence or inadequacy of the firm’s compliance system, they should decline (in writing) any supervisory duties.

Compliance Recommendations

Recommendation for Members and Candidates

Members and Candidates are encouraged to recommend that their employer adopt a code of ethics.

Once a code of ethics has been developed, Members or Candidates in a supervisory role should:

• Distribute the contents of the code of ethics to the relevant employees.
• Have continuous training programs regarding compliance policies.
• Issue frequent reminders of the firm’s compliance procedures.
• Set up a professional conduct evaluation for all employees.
• Review employee actions to identify any compliance violations.
• Take action to enforce compliance procedures once a violation has taken place.

If a violation is discovered, a supervisor should:

• Respond promptly.
• Investigate the scope of the violation.
• Increase supervision or place limitations on the employee’s actions pending the outcome of the investigation.
• Periodically review and update compliance procedures to prevent future violations. 

Recommendation for Firms

• Restrict the activities of an employee under investigation.
• Implement a code of ethics that consists of principle-based ethical concepts that are applicable on a firm-wide basis (all employees). The code of ethics should be complemented by compliance procedures and policies that are relevant to the firm.

Adequate compliance procedures should:

• Be clearly written and tailored to the firm’s operations.
• Be easy to understand.
• Assign a compliance officer to implement the firm’s compliance procedures.
• Detail the supervisory hierarchy and assign duties among supervisors.
• Have a system of checks and balances.
• Outline the scope of procedures.
• Outline permitted conduct.
• Outline procedures for reporting violations and sanctions.
• Implement incentives to promote ethical behavior.

Application 1: Supervising Research Activities

Joy Silverstone, CFA is the head of research at KK Securities. She recently had a meeting with her team of equity analysts regarding a change in her recommendation of SenSen Motors. She is about to issue a report that downgrades SenSen Motors from a buy to sell. KK Securities has no formal procedures on the dissemination of a change in investment recommendations – there is an unwritten “trust” policy among the group of analysts.

An analyst in her team, Ferdinand Glassman, proceeds to inform one of the firm’s largest institutional investors about the change in the recommendation – before it has been widely disseminated. The institutional investor proceeds to sell a portion of their holdings in SenSen Motors.

Has Silverstone violated Standard IV(C) – Responsibility of Supervisors and Standard III(B) – Fair Dealing?

     A. She has violated both standards.

     B. She has violated Standard IV(C) – Responsibility of Supervisors only.

     C. She has violated Standard III(B) – Fair Dealing only.

Solution

The correct answer is B.

Silverstone has violated Standard IV(C) – Responsibility of Supervisors by failing to implement procedures to prevent the premature dissemination of changes in investment recommendations. As the head of research, she should ensure that KK Securities has adequate procedures on the dissemination of investment recommendations.

In this case, Glassman (not Silverstone) has violated Standard III(B) – Fair Dealing by giving one client preferential treatment. Standard III(B) – Fair Dealing requires that Members and Candidates give all clients an equal opportunity to take investment actions.

Application 2: Supervising Trading Activities

Fabien Edwards is a junior trader at Stevenson Brokerage. Edwards is primarily responsible for executing large trades on behalf of Stevenson’s largest retail clients.

Francesca Duplass is the compliance officer responsible for monitoring the firm’s trading activity. Both Duplass’ and Edwards’ bonus compensations are linked to the trading volume generated over a financial year.

Duplass has noticed increased trading in the client accounts that Edwards handles. She observes that block orders that could have been completed in one trading session have been split over several trades. Duplass fails to investigate the increased trading activity and does not bring this to the attention of the head of compliance.

Has Duplass violated Standard IV(C) – Responsibility of Supervisors?

     A. No, because she is not directly responsible for the increased trading activity.

     B. No, because she does not know the circumstances surrounding the increased trading activity; therefore she does not need to investigate further.

     C. Yes, because she fails to adequately review and investigate Edwards’ trading activity.

Solution

The correct answer is C.

Duplass’s failure to investigate the ‘suspicious’ trading activity, especially when there is an incentive to “over-trade” violates Standard IV(C) – Responsibility of Supervisors. Duplass should be conscious of actual and potential conflicts of interest that may arise between his self-interest and discharging supervisory duties. In this case, it appears that Duplass would benefit from failing to act appropriately in her supervisory role.

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.