Ethics in Practice: Stick to IPS during Volatile Markets? Case for Week of 12 February
Analysis posted below. How did you do in analyzing this week’s case?
It is very important for investment advisers to abide by the investment policy statement (IPS) that they develop for their clients. But what should advisers do when markets get volatile, especially if they are making changes with their own investments? Read on and let us know what you think.
Barry Van Wagenen manages the portfolios of high-net-worth clients. He completes an individualized IPS for each client when opening their account. He then develops a personal asset allocation formula based on each client’s risk tolerance, financial goals, and so forth. Over the past two days, the domestic and global equity securities markets fell more than 6%. Fearing a continued drop in the markets, Van Wagenen liquidates his personal investments and moves to cash until the financial markets stabilize. But he keeps his clients’ portfolios fully invested pursuant to the directives in their IPS. Van Wagenen’s actions are
- unacceptable because he is trading ahead of his clients for his personal account.
- unacceptable because his personal investment decisions do not match the investment recommendations he has made to his clients.
- unacceptable because he is not acting in a diligent and reasonable manner by leaving his clients assets fully invested in a rapidly declining securities market.
- acceptable because he is following his client’s directives, as detailed in their IPS, by keeping them fully invested.
The CFA Institute Ethical Decision-Making Framework provides guidance to investment professionals facing ethical dilemmas. The framework calls for identifying the ethical principle at issue, to whom a duty is owed, the relevant facts, and whether there is a conflict of interest to assist in choosing the appropriate course of conduct. In this case, we need more facts before we can properly analyze whether Van Wagenen’s actions are acceptable. Specifically, what level of investment discretion have Van Wagenen’s clients given him regarding investment decisions and whether the clients’ IPSs address how investment decisions are to be made in the face of rapidly changing market conditions. If Van Wagenen has full investment discretion, failing to adjust his client’s portfolio in a timely manner means Van Wagenen could be in violation of his duty to act with diligence and a reasonable basis — CFA Institute Standard V(A) — and in violation of his duty to his clients of loyalty, prudence, and care — CFA Institute Standard III(A). Similarly, if the IPS states that in the event of a significant market downturn, Van Wagenen has the authority to alter the agreed on asset allocation formula prior to formally revising the IPS, that would also be a strong indicator for Van Wagenen to take action. Under those circumstances, answer C would be the best choice. But if Van Wagenen has limited discretion or the IPS was silent about “emergency” powers to make changes in the portfolio, Van Wagenen’s hands may be tied (answer D). It is also not clear whether Van Wagenen acted diligently in attempting to contact his clients in the face of the volatile markets to determine whether they had any changes to their investment instructions. CFA Institute Standard VI(B): Priority of Transactions states that investment transactions of clients must have priority over personal transactions. This standard does not require that an investment professional’s personal investments match those of his clients because there may be differences in the risk tolerances, financial goals, and so on between the adviser and his or her clients (answer B). Finally, it is not clear that Van Wagenen is “front running” his client accounts because the price of the securities at issue may not be affected by the trades on his personal account (answer A).
The facts for this case are not based on a particular case but reflective of current market volatility.
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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.
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