Views on improving the integrity of global capital markets
20 September 2018

Ethics in Practice: Trading in Mutual Funds. Case and Analysis–Week of 17 September

CFA Institute Ethical Decision-Making Framework

Check the analysis of this week’s case (17 September) to see if you made the right choice.

Case

Cherrington is a registered representative with a US broker/dealer who has a number of individual clients, including his mother. Cherrington trades mutual fund shares for his mother’s account, which has a long-term investment horizon. All of these funds have similar long-term risk and return objectives. Cherrington split $731,265 in investment funds in his mother’s account among 42 different mutual funds in 11 fund families. For the majority of mutual fund purchases, he sold the funds within 92 to 274 days of purchasing them. Cherrington earned $24,747 in sales charges for these trades but discounted the fees 10% because it was his mother’s account. Cherrington’s actions are

  1. unacceptable because Cherrington treated clients unfairly by discounting the fees in his mother’s account.
  2. acceptable because mutual funds are safe long-term investments.
  3. unacceptable because the trades resulted in unsuitable investments.
  4. acceptable because Cherrington diversified his mother’s investments among funds with a strategy that matched her long-term strategy and outlook.

Analysis

This case relates to Standard III(C): Suitability, which requires CFA Institute members to determine that an investment is suitable for a client’s financial objectives, mandates, and constraints before taking any investment action. In this case, Cherrington is trading mutual fund shares in funds with a similar long-term risk and return objectives as his mother’s account, which would seem to make these investments suitable for his mother’s account. But although mutual funds are generally safe and conservative investments, the short-term nature of the trades conflicts with his mother’s long-term investment horizon. In addition, the new mutual funds’ objectives and risks were similar to the funds that were sold, such that the $24,747 in sales charges, even discounted by 10%, outweighed any marginal benefit from the new mutual funds. Finally, splitting his mother’s investment funds into 42 different mutual funds in 11 fund families generated higher sales charges because his mother was unable to take advantage of savings from breakpoints that likely were available for larger investments. For all of these reasons, Cherrington’s investments for his mother’s account were unsuitable. Clients can be charged different fees; they do not have to be equal for all accounts. Fee discounts can be made for many reasons, and Cherrington may have given other similar or even more generous discounts. A discounted fee does not necessarily mean that clients are being treated unfairly. Choice C 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 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. 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.

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