I have a question regarding one of the research objectivity standards and I would like some insight, possibly from practitioners who can see why this would need to be formalized.
So, standard 7 stipulates that an employee and any immediate family cannot trade against the reccommendations of the firm except when there is significant financial hardship.
I cannot understant the point of this particular requirement. I have X stocks from a firm and I want to buy a car without using my savings. Why would I be prohibited to liquidate just because my firm thinks the stock is a good buy?
The only logic that seems to be behind this one is that, “if you are going against your firm’s recommendation, maybe your firm is not acting in the clients best interest” or something along these lines. However I think there are plenty real life scenarios (like above) where this really does not need to be the case.
Presumably, if you work at X firm, you have some reason to believe that their recommendations are good. As such, if you want to buy a car, then why would you sell shares of a “buy” company and not a “sell” company?
This is double-true if your company has some inside information about a company. Liquidating your shares when your company has inside information looks really really bad–whether the motivation was bad or not.
Think back to July 2001. Your company has a “Super-Duper Strong Buy” on Enron. You unload your shares of Enron at $90. Three months later, the stock is worth zilch. Regulators will come after you, wondering why you did what you did. You better have a good answer as to why you sold Enron instead of some other, “sell” stock. And your bosses better have a darn good reason as to why they allowed you to do that.
Thx for the response Greenman. The thing is, I do understand the reason based on appearances. I do understand that this is a good damage control practice and all that.
What I don’t understand is why this needed to be a CFAI standard, considering that the Institute uses the Codes and Standards not for the benefit of the analyst or the firm but for the benefit of the client or the markets and in general to self regulate.
What I am trying to get at is that this kind of deviates from the spirit of the ethics material and looks more like the kind of policy that an individual firm would likely have to avoid problems like the ones you mentioned.
i think by “firm” they mean any stock whereby you have input or oversight. i’m quite confident that you are allowed to disagree with other analysts in your own firm if you’re merely an analyst covering a sector or so. also, i’m confident that “trade against” means that if you have a buy recommendation on a stock, you can’t short it. you’re allowed to sell the stock for 1000x reasons as long as you don’t initiate a sell rating shortly after you have sold the stock and effectively front-run the recommendation. it is a bit of a gray area but i’m confident that as long as you stay clear of front running recommendations, you can buy and sell freely. it’s not like you’re expected to hold 100% tech stocks just because you cover that sector.
my firm prevents this entirely but disallowing analysts from investing in stocks covered by them. i have to assume most sell side firms do this…
I was just reading this in the CFAI Level II materials. Section VI B, on page 125 of the CFAI materials states that it is allowable to make a transaction counter to current recommendations as long as care is taken to avoid potential conflicts. It is also the topic of #26 in the eoc questions for section 2.
The issue is that you shouldn’t be advocating buying a stock and then selling it in your own investment portfolio. It looks as though you are trying to keep the price high so you can get out.
If you have a genuine reason to adjust your risk tolerance or your financial situation has changed, then it’s fine to sell something as a way of raising money for consumption needs. It’s changing the structure of your investment portfolio that raises red flags on the ethics side of things. Generally one would sell a little of everything, rather than one particular name, but some people concentrate on one name to save on transaction costs.
In practice, as well, people have different time horizons for their risk. If you are going to need money in six months, it may make plenty of sense to sell something you would recommend to someone who is investing with a time horizon of a 5 or 10 years.
Most people don’t have the nuance to understand those differences, so it can look bad for the firm if you do this; that’s why many or most firms restrict or prohibit trading of stocks they cover.