Views on the integrity of global capital markets
04 January 2018

Ethics in Practice: Guilty or Not Guilty Is the Question! Case for Next 3 Weeks

CFA Institute Ethical Decision-Making Framework

How did you do with this case over the holidays (ran 18 December thru 4 January)? Analysis is now posted below! And be sure to check back for a new case on Monday, 8 January.

Have you joined the conversation yet and told us which answer you think is correct and why?

Enjoy this week’s ethics case for the next 3 weeks (originally published on 18 December)! Analysis will be posted 5 January. Be sure to join and then follow the conversation. Happy Holidays and Peaceful New Year to all!

Case

Sunset Financial Services is a broker/dealer that has historically sold mutual funds and insurance products to individual investors. In 2011, the firm began selling private placements to clients as well. Norma Desmond, vice president of Sunset, is responsible for conducting due diligence on the private placements and placing them on an approved list that Sunset investment advisers can view on the firm’s internal website. Desmond relies on third-party due diligence reports to assess the viability and appropriateness of the private placements for Sunset’s clients. Tom Gillis is one of Sunset’s investment advisers that reviews the internal list of approved private placements and sells several of these investments to his clients. Gillis does not create any sales materials for these private placements but instead relies on sponsor-created sales materials to give to his clients. Has Desmond or Gillis engaged in any misconduct? Join the conversation and tell us what you believe is the correct answer and use the Ethical Decision-Making Framework to help explain your choice.

  1. Desmond is guilty of misconduct in selecting the private placements for Sunset to sell.
  2. Desmond is NOT guilty of misconduct in selecting the private placements for Sunset to sell.
  3. Gillis is guilty of misconduct in providing sponsor-created sales material to clients.
  4. Gillis is NOT guilty of misconduct in providing sponsor-created sales material to clients.

Analysis

The Ethical Decision-Making Framework includes questions — such as What is the ethical issue involved? To whom is a duty owed? What are the important Facts? — that help investment professionals analyze situations from an ethical standpoint. The ethical issue involved in this case for both Desmond and Gillis relate to diligence and reasonable basis. Desmond bases her evaluation of private placements on third-party due diligence reports without conducting the analysis herself. Gillis gives sponsor-created sales material to clients without producing his own information on the private placements for his clients. Both Desmond and Gillis owe a duty to the clients of Sunset Financial to act with diligence and reasonable basis in investigating the private placement investments and recommending them to clients. CFA Institute Standard V(A): Diligence and Reasonable Basis states that CFA Institute members “must exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions.” Determining whether Desmond and Gillis met their responsibilities under Standard V(A) requires examining the relevant facts.

In this case, not much background is provided, making it difficult to tell whether either engaged in misconduct. It is acceptable for Desmond to rely on third-party due diligence reports to evaluate investments as long as she take steps to ensure those reports are from a reputable source and have a reasonable and sound basis. It is not clear what steps Desmond took to evaluate the quality of the third-party due diligence provider. Without a critical evaluation of the third-party due diligence provider, she may have violated Standard V(A). Similarly, it is acceptable for Gillis to rely on Desmond to fulfill her responsibilities to conduct thorough due diligence of potential client investments. Gillis can assume that investments listed on Sunset’s approved private placement list have been thoroughly vetted by the firm through Desmond without having to go back and conduct the due diligence himself unless he has reason to question the validity of the process. It is also not necessarily improper for Gillis to rely on sponsor-created marketing material to provide information to clients, as long as Gillis, compliance, or other personnel at Sunset have thoroughly reviewed the material to ensure that it meets all applicable disclosure requirements and contains no misrepresentations. If Gillis simply forwards the material to clients without such a review, then he could be violating his duty of diligence to clients by potentially disseminating inaccurate or misleading materials to clients. Because of the lack of information provided in the case, an argument could be made that under certain circumstances, any of the responses could be chosen.

This case is based on a Financial Industry Regulatory Authority (FINRA) enforcement action from 2013.

Have an idea for a case for us to feature? Send it to us at ethicscases@cfainstitute.org.

More About the Ethics in Practice Series

Just as you need to practice to become proficient at playing a musical instrument, public speaking, or playing a sport, practicing assessing and analyzing situations and making ethical decisions develops your ethical decision-making skills. To promote “ethical exercise,” we are excited to introduce Ethics in Practice.

Each week, we post a short vignette, drawn from real-world circumstances, regulatory cases, and CFA Institute Professional Conduct investigations, along with possible responses/actions. We then encourage you to assess the case through the lens of the Ethical Decision-Making Framework and the CFA Institute Code of Ethics and Standards of Professional Conduct and let us know which of the choices you believe is the right thing to do and why. If you are not a CFA Institute member, you can post your choice and reasoning in the comments section below. For CFA Institute members, we would like you to join the conversation in our new Member App and post your responses there. Later in the week, we will post an analysis of the case and you can see how your response compares.

CFA Institute Member App

The Member App gives CFA Institute members access to a content from multiple CFA Institute publications, including these weekly Ethics in Practice posts. Best of all, the app allows in-app submission of Continuing Education credits, which members can earn by reading and participating in the conversation for each case. (0.25 CE, 0.25 SER). The app is available in the Apple and Google Play stores. After downloading, simply log in using your CFA Institute website credentials (e.g., john.doe@cfainstitute.org + password).

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Image Credit: ©CFA Institute

About the Author(s)
Jon Stokes

Jon Stokes is the director of ethics education at CFA Institute. He is responsible for development and maintenance of the CFA Institute Code and Standards, as well as the design and management of the CFA Institute Ethical Decision Making training programs. Stokes holds a JD degree.

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