Standard VI(A) – Disclosure of Conflicts

All issues that could reasonably be expected to compromise their independence and objectivity or conflict with their respective duties to their clients, prospective clients, and employer must be disclosed fully and fairly by Members and Candidates.

Application 1: Personal Stock Ownership

Ryan Hernandez frequently speculates on penny stocks. His most recent purchase is 50,000 shares at 10 cents per share of Horizon Media Group (HPG). He intends to sell these stocks if the price of HPG stock reaches his target price estimate of $1 per share.

Two weeks after his purchase, his employer asks him to write a report on Horizon Media Group. Hernandez’s research and analysis point toward HPG being significantly undervalued, and he issues a “Strong Buy” recommendation of the stock.

Hernandez disseminates his research report. The price of Horizon Media Group’s stock stays neutral at 10 cents after disseminating his report. Hernandez does not disclose his ownership in Horizon Media to his employers because he does not consider his ownership to be material.

Has Hernandez violated Standard VI(A) – Conflict of Interest?

1. No, because his ownership – worth $5,000 – would not be considered material.
2. Yes, because his gain would be substantial if there were an upward movement in the price.
3. No, because the stock price was unchanged following the dissemination of his report on Horizon Media.

Solution

The correct answer is B.

Although Hernandez’s holdings would not be considered material, Hernandez must disclose his ownership in Horizon Media to his employers. This is because Hernandez stands to benefit substantially from an upward movement in price. The recent purchase of the stock may question Hernandez’s Objectivity and independence.

Application 2: Conflict of Interest and Compensation Agreements

Jeffrey Clark, CFA, is the CFO of Alliance Premium Brokers. Axion Corporation has approached Clark to promote its publicly traded stock. Axion offers Clark a higher-than-average commission for each stock sold to Alliance Premium Brokers clients. Stock promoters and listed companies have previously approached Clark to recommend their stocks. Clark ensures that all his clients and the firm’s compliance department are aware of the additional compensation offered by Axion Corporation.

Is Clark compliant with Standard VI(A) – Conflict of Interest?

1. Yes, because he disclosed the nature of his compensation to his employer and clients.
2. No, because recommending stocks and receiving additional compensation creates a conflict of interest.
3. No, because Clark’s promotion of Axion stock compromises his independence and Objectivity.

Solution

The correct answer is A.

Clark is compliant with Standard VI(A) – Conflicts of Interest because he fully disclosed his additional compensation arrangements to his clients and compliance department. His clients have the necessary information to evaluate his recommendation of Axion Corporation stock. Clark’s employers have the necessary information to evaluate his Objectivity regarding his additional compensation arrangement with Axion.

LOS 6(a): Evaluate practices, policies, and conduct relative to the CFA Institute Code of Ethics and Standards of Professional Conduct.

LOS 6(b): Explain how the practices, policies, or conduct does or does not violate the CFA Institute Code of Ethics and Standards of Professional Conduct.