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Patricia Spraetz is the chief financial officer and compliance officer at Super Selection
Investment Advisors. Super Selection is a medium-sized money management firm which has
incorporated the CFA Institute Code of Ethics and Standards of Practice into the firm's
compliance manual.
Karen Jackson is a portfolio manager for Super Selection. She is not a CFA charterholder.
Jackson is friendly with David James, president of AMD, a rapidly growing biotech company.
James has provided Jackson with recommendations in the biotech industry, which she buys
for her own portfolio before buying them for her clients. For three years, Jackson has also
served on AMD's board of directors. She has received options and fees as compensation.
Recently, the board of AMD decided to raise capital by voting to issue shares to the public.
This was attractive to board members (including Jackson) who wanted to exercise their stock
options and sell their shares to get cash. When the demand for initial public offerings (IPO)
diminished, just before AMD's public offering, James asked Jackson to commit to a large
purchase of the offering for her portfolios. Jackson had previously determined that AMD
was a questionable investment but agreed to reconsider at James' request. Her reevaluation
confirmed the stock to be overpriced, but she nevertheless decided to purchase AMD for her
clients' portfolios.
Which of the following actions are most appropriate for Spraetz?
A)
If, after her investigation Spraetz finds that Jackson has committed violations,
Spraetz must report them to senior management and seek legal counsel for
possible legal and regulatory implications. If the upper management does not follow
through and take action, Spraetz has fulfilled her supervisory duties and need not
take any further action.
B)
Spraetz, as the chief compliance officer, must set company policy in clear terms and
monitor the actions of the employees. In case of violations, she should investigate
thoroughly, initiate disciplinary action, and issue guidelines that must be followed in
order to prevent future violations. She must not only detect violations through a
continuous monitoring process but also provide guidance for proper conduct
consistent with the firm's policy manual.
C)
Even though Spraetz does not supervise Jackson, as the compliance officer of the
firm she is responsible for identifying violations. Spraetz is not responsible for
preventing them and should not go beyond their documentation for senior
management. Thus, she should record the violations but need not take any further
action.
Sean O'Brien, CFA, works for Paradigm Portfolios as a portfolio manager. He manages a
high-yield (junk bond) fund as well as 14 large private accounts. O'Brien's compensation for
the high-yield fund is performance based, while the private-account compensation is based
upon a percentage of assets. The company's compensation packages are a closely guarded
secret, and kept in-house.
O'Brien routinely takes personal positions in securities held in the high-yield fund, a practice
allowed by Paradigm. On his way to work, he learns over the radio that a hurricane is
heading toward the location of Villa Real Resorts in Mexico. Landfall is expected by Dec. 23,
which could potentially ruin the lucrative Christmas vacation season. If the hurricane hits as
expected, it will have a devastating affect on cash flows, and O'Brien believes Villa Real might
default on its bonds. Both O'Brien and the high-yield fund hold Villa Real bonds. After
arriving at the office, O'Brien sells off the fund's Villa Real holdings, then immediately
liquidates his own position.
Periodically O'Brien buys convertible bonds in the high-yield fund. When these are converted
into common equity he typically does not vote the proxies, saying, "the fund is not an equity
fund, and the equities are usually sold within the year."
Before accepting a new account, O'Brien conducts a thorough investigation into his client's
financial situation, investment experience, and investment objectives. The information is
updated annually through a survey mailed to the client and returned to Paradigm, and
O'Brien follows up with a telephone call to the client. Judy Smith's portfolio was deemed
suitable for the inclusion of high-yield bonds based upon the initial investigation, and
reaffirmed at the last three annual updates. It is three months since Smith's last annual
update, and the high-yield market has been weak. Smith files a lawsuit alleging malfeasance
on the part of O'Brien.
In the course of effecting money-market transactions for the accounts, O'Brien routinely
places numerous trades, allocating the paper with marginally higher yields to the high-yield
fund and the remainder to the private accounts.