Views on improving the integrity of global capital markets
31 August 2018

Ethics in Practice: Trading Illiquid Securities. Case and Analysis–Week of 27 August

CFA Institute Ethical Decision-Making Framework

Check the analysis of this week’s case (27 August) to see if you made the right choice.


Zhang Zhi Ruo is an investment advisor offering clients fixed-income investment advice through numerous separately managed accounts and two pooled investment vehicles. She charges clients an advisory fee for assets under management (AUM) and does not charge clients based on trading activity. Zhang generally invests her fixed-income portfolios in nonrated, tax-exempt, and thinly traded municipal bonds that are issued to finance the construction of senior living facilities, schools, and prisons. Zhang often holds a controlling institutional position in the bonds held across client accounts. Zhang frequently arranges for authorized cross-trading in these securities to facilitate portfolio management and provide liquidity for terminating clients. By effecting cross trades among clients, rather than trading in the secondary market, Zhang provides selling clients with liquidity in an otherwise illiquid market while maintaining her controlling position in the securities.

At the end of each month, Zhang prices the holdings in each client’s portfolio by obtaining bid-side evaluation quotes (bid price) from the various broker–dealers who underwrote each of the bonds. Frequently, Zhang challenges the prices quoted by the broker–dealers as too low and, in certain instances, the broker–dealers revise their quotes to Zhang’s proposed alternative price. When arranging cross trades, Zhang selects broker–dealers who are willing to execute cross trades at favorable, predetermined, spreads that are narrower than the average bid/ask spread of trades in the same or similar securities executed in the secondary market. The trades are executed at the bid price obtained from month-end valuation purposes.

Zhang’s actions are

  1. inappropriate.
  2. appropriate because Zhang charges an advisory fee for AUM and therefore does not benefit from the cross trades.
  3. appropriate because Zhang is valuing thinly traded securities in her clients’ portfolios using price quotes from the underwriting broker–dealers who are familiar with the securities.
  4. appropriate because Zhang seeks best execution by using broker–dealers who are willing to execute the cross trades at favorable bid/ask spreads that are narrower than spreads in the secondary market.


This case relates to CFA Institute Standard III(B): Fair Dealing, which requires CFA Institute members to deal fairly and objectively with all clients when taking investment action. Zhang’s actions violate this standard. By cross-trading securities at the bid price, rather than obtaining and using an average or midpoint between the bid and ask prices, Zhang’s use of the bid price in the transactions favored the buying clients over the selling clients. At the same time, Zhang favored the selling clients in those instances in which she successfully challenged the valuations of the securities as too low. Cross-transactions subsequently executed at these higher price levels disadvantaged Zhang’s buying clients, who ended up paying more than they would have had the bonds been available for purchase in the secondary market at terms similar to prior trades. Zhang’s disclosure of these practices would not help in this case as disclosure does not cure or excuse treating clients unfairly. It is not clear from the facts why Zhang challenged the price of the securities as too low, but this also represents a conflict of interest for Zhang in that a higher valuation presumably benefited her investment performance history. It’s also not clear that Zhang inappropriately influenced or manipulated the bond prices quoted by simply asking the brokers to reconsider their initial price. The brokers only occasionally revised the price upward. Zhang did not personally hold a controlling position but held the position by virtue of her many clients’ investments.

Although Zhang did not benefit from the cross trades as her fees were based on AUM, Zhang failed to discharge adequately her best price and best execution obligations for her selling clients. Seeking valuation of thinly traded securities using broker–dealer quotes is appropriate; however, in this case, Zhang used quotes from the broker–dealers who were the original underwriters of the securities and not the executing broker–dealers who were trading the same or similar securities and who would have a better idea about recent bid/ask trading activity. Finally, even if the bid/ask spreads are narrower, Zhang failed to undertake any assessment as to whether the securities were available on better terms for buying clients in the secondary market. If the prices are too high, the valuation is inappropriate. Choice A is the best answer.

This case is based on a 10 August 2018 administrative action by the US SEC.

Have an idea for a case for us to feature? Send it to us at

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. The Ethics in Practice series gives you an opportunity to “exercise” your ethical decision-making skills. 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 using the CFA Institute Ethical Decision-Making Framework and through the lens of the CFA Institute Code of Ethics and Standards of Professional Conduct. Then join the conversation and let us know which of the choices you believe is the right one and explain why. Later in the week, we will post an analysis of the case and you can see how your response compares.

Image Credit: ©CFA Institute

About the Author(s)
Jon Stokes

Jon Stokes is the Director of Ethics and Standards Education at CFA Institute. His responsibilities include design and creation of on-line ethics education, development and maintenance of the CFA Institute Code of Ethics and Standards of Professional Conduct, and the design and management of the CFA Institute Ethical Decision-Making and Giving Voice to Values education programs. Stokes holds a JD degree.

Leave a Reply

Your email address will not be published. Required fields are marked *

By continuing to use the site, you agree to the use of cookies. more information

The cookie settings on this website are set to "allow cookies" to give you the best browsing experience possible. If you continue to use this website without changing your cookie settings or you click "Accept" below then you are consenting to this.