Views on improving the integrity of global capital markets
09 May 2019

Ethics in Practice: Handling Employee Misconduct. Case and Analysis–Week of 6 May

How did you do evaluating this week’s (6 May) case? Check out the analysis below. Note that Ethics in Practice will not be published the week of 13 May. We will return the week of 20 May.

Case

Stansfield is hired by Roudabush Securities Inc. (RSI) to manage a staff of investment advisers. Delorme, one of the investment advisers Stansfield supervises has been with RSI for more than 30 years and is the sister-in-law of the owner of the firm. Delorme is involved in a pump-and-dump trading scheme with an investment adviser outside of RSI in which Delorme buys or encourages her clients to buy speculative “penny” stocks to boost demand and price of the securities controlled by the outside adviser. In return, Delorme receives compensation from the outside adviser. Stansfield becomes aware of these activities from Delorme’s emails, which are flagged by the email monitoring system Stansfield put in place to detect misconduct on the part of his subordinates.

He limits her trading in the last hour of the day and restricts her from trading in certain penny stocks, but he allows her to continue to interact with customers, process orders, and make investment recommendations and decisions for her clients. He tells colleagues that because of Delorme’s senior position at the firm, he wants to “be gentle” in terms of restrictions and not take excessively harsh action. But during this time, Delorme continues to act as an accomplice in the stock manipulation scheme. Eventually, two clients complain to RSI about the securities bought for their accounts when they become worthless. The complainants note that the deals had to be handled through a different broker/dealer, apparently because of RSI’s trading restrictions on Delorme.

Finally, the local regulator notifies RSI that they are investigating Delorme’s conduct. RSI policies do not specify whether an employee’s supervisor, compliance personnel, or the firm’s legal department have responsibility for investigating misconduct. Nevertheless, Stansfield begins an internal investigation into Delorme’s conduct. RSI policies do not specify how the results of the investigation are to be documented or reported or who within the firm has responsibility to address potential employee misconduct once discovered.

Stansfield’s actions with respect to Delorme are

  1. acceptable because he put an effective email monitoring system in place to detect misconduct.
  2. acceptable because he restricted Delorme’s activities once alerted of potential misconduct.
  3. acceptable because he takes the initiative to investigate Delorme’s activities in the face of ambiguous firm policies.
  4. unacceptable.
  5. none of the above.

Analysis

This case relates to effective exercise of supervisory responsibility. CFA Institute Standard IV(C): Responsibilities of Supervisors states that CFA Institute members must make reasonable efforts to ensure that those subject to their supervision comply with applicable laws, rules, and regulations as well as with the CFA Institute Code of Ethics and Standards of Professional Conduct. Effective supervisors enact policies and procedures to encourage compliance and investigate and punish employee misconduct when it arises. In this case, a number of red flags alert Stansfield to Delorme’s misconduct, including emails, client complaints, and a regulatory investigation. In the face of these red flags, Stansfield must promptly initiate an assessment to determine the extent of wrongdoing and take steps to ensure that the misconduct does not continue. Stansfield’s policies and compliance practices (email monitoring system) successfully reveal Delorme’s misconduct, and he initiates an investigation. He does then take some steps to limit Delorme’s activity. But because he is deferential to Delorme’s seniority, the measures he takes are inadequate, and Delorme works around the restrictions to continue the misconduct.

In addition, RSI’s compliance policies are vague and incomplete when it comes to addressing misconduct. They lacked any reasonable coherent structure to provide guidance to supervisors and other staff for investigating possible misconduct, and they lacked reasonable procedures regarding the investigation and handling of red flags. If a CFA Institute member cannot discharge supervisory responsibilities effectively because of an inadequate compliance system, he or she should not accept a supervisory position until an adequate compliance system is put in place. Given the nature of Delorme’s misconduct and the clear danger to client interests, Stansfield should have taken stronger action to remove Delorme from the investment management process. Additionally, in the face of RSI’s inadequate compliance system, Stansfield should not have accepted supervisory responsibility. Choice D is the best response.

This case is based on a March 2019 US SEC Enforcement Action.

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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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