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Gordon McKinney, CFA, works in the trust department of a bank. The bank's trust account
holds a large block of a particular company. McKinney learns from a market news service
that this company is going to buy back one million shares at a 15% premium to the market
price on a first-come-first-served basis. McKinney immediately tells his mother-in-law to
tender her shares but waits until the end of the day to tender the trust's shares. McKinney
has most likely violated the Standard concerning:
A) material nonpublic information.
B) priority of transactions.
C) loyalty.
Hunter Harrison, CFA, has recently been promoted to Chief Investment Officer (CIO) of
Ironclad Investments, an investment adviser and pension consultant for medium and large
corporate pension clients. Ironclad recently hired a compliance officer to update its
compliance manual, which is consistent with the CFA Institute Code and Standards. Harrison
serves as a director on several non-profit and corporate boards of directors, some of which
have their pension assets managed by Ironclad. As part of his new job duties, Harrison will
oversee Ironclad's research analysts and portfolio managers, including Michelle Myers, who
passed the Level II CFA examination last year and is registered for the next exam. Myers is a
portfolio manager who regularly meets with clients and prospects. Myers is also a partner in
a software company that sells retirement and benefit administration services to institutional
clients, some of which are also clients of Ironclad to whom Myers has recommended the
software company. Myers has disclosed her partnership interest in the software company to
Ironclad, including the potential for additional compensation and the possible conflicts of
interest, but not to her clients.
One of Myers' software clients, Breakthrough Pharmaceuticals (Breakthrough), is a publicly
traded corporation that is also held in many of Ironclad's client portfolios. In the course of
their business relationship, Breakthrough's CEO informs Myers that the company has been
having difficulty making retirement benefit payments, and its pension plan has recently gone
from "overfunded" to "significantly underfunded" as a result of market conditions.
Breakthrough's CEO indicates to Myers that he is attempting to source additional short-term
financing to make retiree benefit payments and will disclose the significant "underfunded
status" of the pension plan in the upcoming financial statements. Myers, concerned that
Breakthrough's current pension troubles and short-term liquidity issues will negatively affect
its earnings and consequently the performance of the company's stock, informs Harrison of
the impending disclosure. Harrison allows Myers to sell 1,800,000 shares of Breakthrough
stock for clients, causing the price to drop by 5%. When the pension troubles are later
disclosed in the company's financial statements, Breakthrough's stock price drops an
additional 18%.
Harrison, as CIO, is chairman of Ironclad's proxy voting committee. Myers is also a member
of the committee. Ironclad, as a discretionary investment manager, votes proxies through
the proxy voting committee on behalf of clients. Ironclad is currently reviewing proxies for
several companies covered in research, including technology companies Advanced DSL
(Advanced), InterConnect Inc. (InterConnect), Speedy Chip Technology (Speedy Chip), and
Wavelength Digital (Wavelength). Each company's current proxy contains voting proposals
pertaining to employee stock option expensing methods. This issue is particularly important
to Ironclad because several of its investment personnel recently participated in an industry
forum that supported increased disclosure for company stock options. The panel concluded
that such disclosure will provide investors with a more complete estimate of corporate
earnings. Ironclad, through its clients, owns approximately 4% of the outstanding shares of
Advanced and InterConnect and approximately 6% of the outstanding shares of Speedy Chip
and Wavelength.
Harrison serves on the board of directors for InterConnect and Wavelength, while Myers
provides consulting services for Speedy Chip. Harrison receives cash compensation and
stock options for his services, while Myers receives restricted stock and stock options. The
investment bank that led the public offering of InterConnect and Speedy Chip and seven of
nine sell-side analysts covering the companies have "sell" ratings on the stocks. Ironclad's
analysts have also issued "sell" recommendations on the companies due to, among other
issues, lack of earnings transparency and low earnings quality. Contrary to committee
consensus, Harrison and Myers vote client proxies "against" the expensing of employee
stock options for InterConnect, Wavelength, and Speedy Chip. Harrison increases his clients'
positions in both InterConnect and Wavelength, citing "growth opportunities" and
"consensus opinion." Neither Harrison nor Myers has disclosed these compensation
arrangements to Ironclad.