Standard 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 and Candidates are responsible for informing their clients, employers, and prospective clients of any benefits received for referrals of clients. Additionally, Members and Candidates must disclose any payments made to others for referrals. These disclosures allow clients and employers to evaluate any bias in the recommendation of any services or business and the full cost of services rendered.

Compliance Recommendations

Members and Candidates should encourage their employers to develop policies and procedures regarding referral fees. Employers should have their employees disseminate approved referral fee programs to their clients. Additionally, Members and Candidates should provide their employers with periodic updates (at least quarterly) of the amount and nature of any referral compensation received.

Application 1: Disclosure of Interdepartmental Referral Agreements

Britney Sullivan works in the research department at Zeus Investment Bank. She receives compensation for each referral she makes to the brokerage department that results in any trading activity. She refers numerous clients to the brokerage department at Zeus Investment Bank but fails to disclose this arrangement to her clients.

Has Sullivan violated Standard VI(C) – Referral Fees?

     A. No, because she only needs to disclose referral arrangements to her employer.

     B. No, because the referral arrangements and payments are made within the firm.

     C. Yes, because she did not disclose the referral arrangements to her clients.

Solution

The correct answer is C.

Sullivan has violated Standard VI(C) – Referral Fees by failing to disclose the referral arrangement at Zeus Investment Bank. Standard VI(C) – Referral Fees does not distinguish between compensation paid to external or internal referees. Members and Candidates must disclose all referral compensation. Therefore, Sullivan is required to disclose, at the point of referral, the internal referral compensation in place. The disclosure must include the amount and nature of the compensation.

Application 2: Disclosure of Referral Arrangements and Informing Firm

Phillip Evans is a portfolio manager at Bridging Finance Corporation. Evans has routinely asked the trading desk to direct a small portion of its trading activity to Jaystar Brokerage, a mid-size broker/dealer headed by his brother-in-law. Jaystar’s commissions are above the industry average and the traders find the research provided to be uninformative. Evan’s brother-in-law reciprocates this arrangement by frequently recommending Bridging Finance Corporation and Evans to all his clients. This arrangement is not disclosed to his employer or client’s referred to by Jaystar Brokerage.

Has Evans violated Standard VI(C) – Referral Fees?

       A. Yes, because he fails to disclose to his employer the nature and value of the referral arrangement.

       B. No, because his brother-in-law reciprocates by referring his clients to Bridging Finance Corporation.

       C. No, because he is prohibited from receiving any referral compensation.

Solution

The correct answer is A.

Evans has violated Standard VI(C) – Referral Fees by failing to inform his employer of the referral arrangement. Evans must disclose the nature and value of the referral arrangements to his employer; conversely, his brother-in-law must disclose the arrangement to his clients. Standard VI(C) – Referral Fees does not prohibit any referral compensation; however, full and timely disclosures are required.

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.