Please help understand the correct answer to a Qbank ethics test question. In the question, an investment advisor overhears a conversation of her client with a CEO of a certain company, where the latter says their earnings are higher than expected (and the earnings release is expected to be published soon). Later this client contacts the advisor and asks her to purchase shares of that company. The question asks whether the advisor should satisfy this request. The correct answer is that the advisor must refuse the request until the information is made public. Do not understand the logic of the answer! My reasoning was that the advisor would not be acting on any material non-public information - she would be acting on the request of her client, and she could not be 100% sure that her client acted on that material non-public information.
If you witness someone breaking the window of a car and stealing it do you assume it is just their car and they lost the keys? If you have access to non public material information can you act on it "because you were going to buy that stock anyway". I definitely see your side of it but I think in these cases, the less you think about it, the better. As in science… the simplest solution is usually the correct one.
At the time the investment advisor heard the conversation, he is provided with non-public information, so code of ethics says you cannot trade on that info. If your client “coincidentally” asks you to trade on that stock, you should tell him why you are not allowed to do it. Of course, trade the stock after the information release. Now you have a back up of why you are trading on that stock.
Harrogath explained it well. It is simple, because the Advisor overheard the conversation, he is exposed to material non-public information, and cannot act on those information. The best option as Harrogath put it is to decline and give reason for his/her action. He can trade only when the information is publically available.
Thanks, completely agree with your perspective in the context of investment recommendations, proprietary trading and personal trading restrictions. But let me re-formulate the question to get rid of its ambiguity: (1) If we replace the investment advisor with a trader with no fiduciary duty, whose job is to execute the client’s orders, and (2) say, the conversation, which was overheard, occurred between the CEO and Client A, and the stock purchase request came from Client B, for whom we do not know a priori whether he possesses any material non-public information, would this restriction still hold, in your opinion?
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A trader without fudicial duty can execute the trade (the trader will definitely not be a CFA charterholder or a candidate in the CFAI programme). (Thats my view though).
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The trader has an obligation to honoure the trade as he’s not aware if investor B is in possession of Material Non-Public information.
Waiting for others opinion on this, but these are my views.
If you are not aware of sensitive information a client possess, how can you do or don’t do any thing? The standard is applicable when you are aware of material non-public information. In this very instant, thousands of transactions in the open market are being made with material non-public information, however, local laws and professional codes prohibit or encourage not to trade on that information.
Also note that in many countries you can go to jail if you trade on insider information, and if that trade caused material losses, you are simply lost.
Harrogath, what if the client does not have material non-public information, how are we suppose to handle that. If you say No to his trade execution demand, you’re making him loose the potential gain on that trade.
The issue now is, you cannot clearly state that the client is in possession of Material Non-public information.
So because the trader knows about Material Non-public information about the particular stock, does that mean he cannot trade on that stock at all, even though his/her client without the knowledge of this information asked the trader to trade those stocks on his/her behalf.
Please i need more clarity on this.
That’s exactly what I mean as well.
It has to do with being aware of material non public information. Because the investment advisor was aware of the fact that her client is in possession of material and non public information, she (advisor) cannot act on it, despite the client’s request. The advisor, and client would be guilty of insider trading.
Had the investment advisor been unaware of the coversation between her client and CEO, the advisor coould have gone ahead since she was not aware of any material non public information leaks.
As a rule of thumb, people in possession of material non public information should not act on it. Doesn’t matter how they obtained the information.
If I understand you correctly, and if this is what this restriction is about, then it would be interesting to see how our advisor discriminates between clients - i.e. rejects the request of the client A, who is aware of the info, and accepts the request of the client B, who’s not aware of anything - for the same stock.
We need to separate different scenarios:
Scenario 1: You are a portfolio manager and you trade assets on behalf of your clients (so no single client asks you trade any stock). Thus, you, as a portfolio manager, found material non-public information. Conclusion: You must not trade on that info despite of that trade would be great for clients’ wealth. You are prohibited.
Scenario 2: You are a portfolio manager and let’s say a client asks you to trade on a particular stock. Also, both you and your client are aware of material non-public information about this stock the client wants to trade. Conclusion: You must not trade on that info. You are prohibitted.
Scenario 3: You are a portfolio manager and your client asks you to trade on a particular stock. You are sure your client is in possession of material non-public information, but you have no idea what that info is. Conclusion: You must refuse to complete your client request. I tell you why. The goal of the rule of not trading material non-public information is to protect other investors who are on the market, and this has been proved by many researches that trading these infos harm the whole market and reduce the investors’ confidence to invest.
Scenario 4: You are a portfolio manager and one of your clients is in possession of material non-public information, however, you have no idea this is true, nor you have no clue this could be really happening (many clients simply don’t share their situations and just request for certain trades). Thus, you are not aware that material non-public information is being used on that specific trade. Conclusion: You must fill that request because is your job and it is in the best interest of your client in that moment.
Hope this clarify the spectrum of possibilities.
no it wont be discrimation, check harrogath’s response which includes 4 different scenrios. it clarifies your question impecably.
Nice one Harrogath , your answer for Scenario 1 seems explicit, but i will like you to reaffirm my curiosoty.
Scenario: A porfolio manager has a knowledge of a material non-public information about a particular stock, and a client of his who is not in posession of the same information asked him to trade the stock on his behalf.
So the best response is for the portfolio manager to reject to trade the stock due to his exposure to Material Non-public information about the stock.
Am assuming this is what you meant by your explanation.
So in a nutshell , the client get to bear the loss of potential profit due to the portfolio manager’s exposure to material non-public info which the client has nothing to do with or have no knowledge of. That seems cruel to me.
olajideanuoluwa001,
I would set the case you state as scenario 5. Sometimes, clients have “hunches” about certain stocks, they do their own research, watch the news, etc (only public information), so they decide to trade on a stock actively in addition to their diversified portfolios. Let’s assume the portfolio manager, who manages the client portfolio, is in possession of material non-public information about the same stock the client wants to trade , however he have not traded on that information never before.
Should the portfolio manager refuse to trade on that specific stock if the client asks him to trade it? If the portfolio manager is reasonably sure the client is not in possession of material non-public information, he can consider the request as a coincidence and complete the desired transaction.
Every good and ethical investment professional must have a back up of why he is taking or not taking a certain investment decision, so sometimes is very hard to trade on material non-public info and not be targeted as an irresponsible trader (or even worse) who violated not only ethical standards but also the local laws.
The main point of this question is that the covered person knows that the client is making the decision using material non-public information. It isn’t about the covered person having material non-public knowledge, specifically. This question explicitly states that the covered person has heard the client receive insider information (and the client wants to act on it). It is no different than a client telling you that their friend is the CEO, so the CEO gave the client a hot tip-- you did not hear the information yourself, but you know the client is acting on material non-public information-- you cannot be complicit and you must try to prevent this from happening.
The standards specifically say that you must not knowingly participate in violations of the standards or laws, and you mustn’t knowingly aid others in actions that would be classified as such. You must also uphold the integrity of the capital markets by not allowing the client to trade on the basis of the insider information.
This is my (summarized) take on the particular question-- you cannot allow the client to violate the law and or the standards.
I do think, though, that if a covered person has material information, but the client does not (have any insider knowledge), the situation is different (in some special cases). I think the covered person could purchase shares for the client, so long as the client, without any insider knowledge, has directed the covered person to do so (and without solicitation from the covered person). I view it to as similar (but not identical) to the situation in which market makers can take the opposite side of unsolicited trades during periods of restricted trading.
Interested to see what some of the heavy hitters like S2000 think…
Now its making sense to me, Thanks for your contribution guys. I just want to establish the fact that the portfolio manager can trade the particular stock in which he/she have material non-public information on, as long as he is sure the client has no knowledge of it.
Thanks for your contribution again.
Thank you guys, this solution is finally clear now.
You should understand, though, that the manager cannot act on the information of his or her own accord. Essentially, if you (PM) have the insider information-- you CANNOT make any decisions and/or any actions based on it . However, IF a client (who has no knowledge of the insider information) instructs you to act on their behalf (and you have not influenced them or given them knowledge in any form)-- I believe this is okay, so long as proper documentation is in place.
It is not enough to say “my client doesn’t know the insider information, so I can trade on it…” That is wrong.
The client must also ask you to act on their behalf in a manner consistent with your current relationship (again, only if the client is without knowledge of the information and if the client is free from your solicitation).
I am reasonably comfortable with this conclusion (this is just my take), but I’d be interested to see S2000’s take on this-- if anyone wants to send him a message and have him briefly peruse the thread, that could clarify some items. I also think Harrogath’s situation #5 covers this topic…
Sorry if I’m hijacking this thread, what about this scenario:
You are about to buy a stock, but you overhear the CEO saying that their earnings are about to take a dip. Do you buy the stock anyway or do you refrain? If you buy, there’s always the argument that the number of shares you bought were lesser than the number you would’ve bought had you not known about the earnings dip. And if you don’t buy the shares at all, then are you not acting on material non-pubilc information?