Standard IV(C) – Responsibilities of Supervisors

Members and Candidates are responsible for ensuring that anybody under their supervision or responsibility follows all applicable laws, rules, regulations, and the CFA Institute Code and Standards.

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 for disseminating 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?

1. She has violated both standards.
2. She has violated Standard IV(C) – Responsibility of Supervisors only.
3. 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 for disseminating 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 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?

1. No, because she is not directly responsible for the increased trading activity.
2. No, because she does not know the circumstances surrounding the increased trading activity; therefore, she does not need to investigate further.
3. Yes, because she fails to review and investigate Edwards’ trading activity adequately.

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.

Application 3: Supervising Departments

Loise Losiwa, CFA, is the CEO of the research department at Moninga Inc, an established brokerage firm. Loise has decided to change her recommendation of certain pharmaceutical products from sell to buy. As per Moninga’s procedures, Loise orally discusses with heads of the department under her about her new propositions before the research report is published. As a result of this conversation, one of the heads of departments, Jason Hull, buys pharmaceutical shares for his own account and those of his high net-worth clients. Moreover, some heads of departments spread the word to some of Moninga’s customers.

Loise most likely:

1. violated the CFA Institute Code and Standards.
2. did not violate CFA Institute Code and Standards since she followed the company’s procedures.
3. did violate CFA Institute Code and Standards because she consulted her juniors about her recommendation.

Solution

The correct answer is A.

Loice has violated Standard IV(C) because she failed to reasonably and sufficiently supervise the actions of those under her. She failed to establish reasonable procedures to prevent the dissemination of information by Jason Hull and other heads of departments.

LOS 4(a): Evaluate practices, policies, and conduct relative to the CFA Institute Code of Ethics and Standards of Professional Conduct.

LOS 4(b): Explain how the practices, policies, or conduct does or does not violate the CFA Institute Code of Ethics and Standards of Professional Conduct.