Ethics in Practice: Forex Option Trading. Case and Analysis–Week of 3 June
Check out the analysis to see how you did in analyzing this week’s case (3 June) and determining which CFA Institute Standard was involved.
Gain is a commodities trader with a number of retail clients, including Laube who opens a retail forex account with Gain. Laube’s forex account is self-directed, and Gain does not advise Laube on any trades. Laube signed Gain’s standard customer agreement, which contains provisions relating to margin requirements and liquidation in the event of margin deficits. The agreement authorizes Gain, at his discretion, “to liquidate, without notice, any or all open positions in an account with insufficient margin.” Laube initially purchases two 100,000 US dollar/Swiss franc (USD/CHF) positions, bringing his margin requirement to $4,000. Then Laube purchases two additional 100,000 USD/CHF “pending limit” orders if the trading prices reach a specified level. Because each order has a different limit price, one order will execute before the other. Shortly after placing these limit orders, Laube goes on an extended vacation. While on vacation, the execution on the first limit order triggers, bringing the margin requirement to $6,000. Later, when the limit price is reached, the second order executes, bringing Laube’s margin requirement to $8,000. After the trades, while Laube is still on vacation, his account balance drops to only $6,900. Without notice, Gain liquidates all positions in Laube’s account, realizing a loss of $37,000 from the liquidation. Gain’s actions are
- appropriate because Gain followed the policy and procedures set forth in Laube’s client agreement.
- inappropriate because Gain has a duty to act in the best interest of Laube by protecting his financial position.
- inappropriate because Gain could have met the margin requirement by liquidating only one forex contract.
- inappropriate because the margin and liquidation policies in the client agreement are misleading.
- none of the above.
This case relates to the duties of loyalty, prudence, and care owed to clients in relation to advisers duties to other clients and the markets. Generally, CFA Institute Standard III(A) imposes on CFA Institute members a duty of loyalty, prudence, and care to act in the clients’ best interests. The conduct that fulfills this responsibility, however, depends on the nature of the relationship with the client. In this case, Laube self-directs his trades, which are simply executed by Gain who does not provide investment advice. Laube freely contracts with Gain regarding the consequences of insufficient margins in his account, and these policies and procedures are clearly set forth in the client agreement. There is no indication in the facts that Gain misled Laube about the margin requirements or the liquidation procedures. Margin requirements allow commodity traders to ensure their own financial integrity, which, in turn, contributes to the financial integrity of the entire marketplace.
Gain’s responsibility to protect his own financial position and that of his other customers may supersede any duties he owes to Laube when Laube defaults on his margin requirements. Given the limited nature of the relationship between Laube and Gain, Gain is not obligated to actively monitor Laube’s account to protect Laube’s financial interests. Doing so would require Gain to continuously monitor a potentially deteriorating market or to take on additional risk management measures that Gain has not agreed to and that Laube has not contracted for. Gain also is not obligated to use a less drastic alternative by closing only one forex contract and does not breach a duty to Laube by liquidating all open positions when the parties have contractually agreed that total liquidation to meet a margin deficit may be done at Gain’s discretion without notice. Although the contractual provision authorizing liquidation without notice does not waive Laube’s right to be dealt with in good faith, the margin and liquidation provisions are not an attempt by Gain to waive his duty of loyalty, prudence, and care. They simply set forth the parameters of the relationship. Gain and Laube are each free to negotiate the nature and extent of the relationship. Although Laube suffered significant trading losses from liquidation of his account, Gain liquidates Laube’s open positions for business reasons, to protect the integrity of the market, and in accordance with the terms of the customer agreement. Choice A is the best response.
This case is based on a 2017 US Commodities Futures Trading Commission decision.
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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. 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.
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