Cases on market integrity and duties to clients
Market cases ask whether information was material and nonpublic, or whether trading was meant to mislead. Client cases ask whether the client came first, was treated fairly against other clients, got suitable investments and honest performance figures, and was protected in confidence.
Before this: Professionalism cases: law, independence, misrepresentation, misconduct, competence
On the exam
- Evaluate practices, policies, and conduct relative to the CFA Institute Code of Ethics and Standards of Professional Conduct
- Explain how the practices, policies, and conduct do or do not violate the CFA Institute Code of Ethics and Standards of Professional Conduct
Evaluate and explain conduct under Standards II and III. Expect an unprompted tip, a pro rata allocation (the one calculation in this module), an unsuitable client request and an incomplete composite. The usual wrong answers trade first, allocate by fee level, or follow the client without discussion.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
How do market and client cases differ?
Market cases (Standard II) ask what you know and what you do with it. Client cases (Standard III) ask whose interest comes first and whether each client is treated fairly. Use the five-step method: the stem, then the decisive fact, then the Standard.
- Integrity of capital markets Memorize Standard II
- II(A) Material nonpublic information do not act or cause others to act
- II(B) Market manipulation no practice meant to mislead the market
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- Duties to clients Memorize Standard III
- III(A) Loyalty, prudence and care clients first; act in their interest
- III(B) Fair dealing fair is not equal; pro rata
- III(C) Suitability IPS, objectives, constraints
- III(D) Performance presentation fair, accurate, complete
- III(E) Preservation of confidentiality with three exceptions
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Try this 0 of 3
- Spot that the warehouse tip is not a mosaic, first time
- Allocate the hot issue fairly first time
- Get every case right first time
Case 1 of 3 The supplier's warehouse
Jonah Whitlock, CFA, covers Pinewood Toys, a listed toy maker, for Saltmarsh Investors. As part of his industry research, he visits Carrow Logistics, which stores Pinewood's products. The warehouse manager mentions, unprompted, that Pinewood has just canceled 60% of its holiday orders. Pinewood has not announced it. Saltmarsh holds Pinewood shares in many client accounts.
Step 1 of 5 Material and nonpublic?
What is the information about the canceled orders?
Read the case, then answer each step. 3 cases.
Case A: the supplier’s warehouse
An analyst covering a listed toy company visits a logistics supplier as part of industry research. The supplier’s manager mentions, unprompted, that the toy company has just canceled 60% of its holiday orders, which has not been announced. The analyst’s firm holds the stock for clients.
- Decisive facts: the information is specific, reliable and likely to move the price, so it is material. It has not been announced, so it is nonpublic.
- Standard: II(A) Material Nonpublic Information.
- Most complete answer: do not trade or tip. Encourage the company to make the information public, inform compliance, which may place the stock on a restricted list, and document.
Material nonpublic information must pass two tests: a reasonable investor would find it important, and it has not yet been released. Selling the stock for clients first would not cure the problem. It would use the information.
The case is not mosaic theory , although the source is a research visit. Mosaic theory allows an analyst to combine public information with nonmaterial nonpublic information to reach a conclusion. A specific, material fact handed over unprompted is a tip. It does not matter that the analyst did not ask for it.
Case B: the hot new issue
A manager receives 20,000 bonds from an oversubscribed new bond issue. Eligible client orders total 50,000. The manager fills the five largest fee-paying accounts in full and gives nothing to smaller accounts.
- Decisive fact: allocation was based on account size and fee level.
- Standard: III(B) Fair Dealing. Neighbor: VI(B) is about the manager’s own trades, which are not described.
- Answer: allocate pro rata at the same price.
Fair dealing does not mean equal amounts for every client. It means a fair method applied to everyone with the same interest. For an oversubscribed issue, each eligible order receives the same percentage.
Case C: the retiree’s request
A retired client with modest savings asks her adviser to move 40% of her portfolio into a single biotech stock her nephew recommends. Her investment policy statement stresses capital preservation.
- Decisive fact: the request is material and conflicts with the documented objective.
- Standard: III(C) Suitability.
- Most complete answer: explain the risk, discuss whether her objectives have really changed and update the policy statement if so. If they have not, the adviser may decline or follow firm policy. Document everything.
Suitability is measured against the client’s objectives, constraints and risk tolerance, as written in the investment policy statement. A client’s request does not remove the adviser’s duty to consider it.
Case D: the missing accounts
A firm advertises a composite’s ten-year record, but two accounts that left after poor results were quietly dropped from the composite.
- Decisive fact: the figures are incomplete in a way that makes them look better.
- Standard: III(D) Performance Presentation. Neighbors: I(C) for the misleading effect, III(B) rejected.
- Answer: include the terminated accounts, or correct the presentation.
Performance presentation requires results to be fair, accurate and complete. The investor should be able to rely on them as a full picture.
Case E: the dinner-party remark
A portfolio manager tells a journalist friend over dinner that one of her private clients has just built a large stake in a mid-cap bank.
- Decisive fact: information about the client’s holdings was shared without consent and without a legal duty.
- Standard: III(E) Preservation of Confidentiality.
Confidentiality has three exceptions: the client permits disclosure, the law requires it, or the client is involved in illegal activity. None applies here.
Quick-fire: manipulation and loyalty
| Fact | Standard |
|---|---|
| An analyst buys puts on a small bank, then posts false rumors about it on social media | II(B) market manipulation |
| A manager recommends a fund because it pays him a larger fee, not because it fits | III(A) loyalty to clients (client first) |
Exam tip Information cases ask what you know. Client cases ask whom you serve. Decide which kind it is before you read the options.
Go deeper Mosaic theory versus an unprompted tip
Mosaic theory protects honest research. An analyst may combine public information (filings, prices, trade data) with nonmaterial nonpublic information (a store visit, a supplier’s general comments) and reach a conclusion that is itself material. What the analyst may not do is accept a specific, material fact that is not public. In Case A, the 60% cancellation is a single fact that moves the price, not a piece of a mosaic.
Go deeper Two more short drills
A manager who holds a stock and has a colleague publish a positive note neither of them believes, “to support the price”, has moved into market manipulation. A manager who shows a composite that includes the terminated accounts but adds a footnote explaining the loss has complied with III(D): the figure is complete and the explanation is accurate.
Memorize this
MemorizeWhat each case type requires
| Case | Standard | Required action |
|---|---|---|
| Material and nonpublic information | II(A) | Do not trade or tip; encourage public disclosure; notify compliance |
| Mosaic theory | II(A) | Public data plus nonmaterial nonpublic is fine; a material tip is not |
| Misleading trading or false rumors | II(B) | No manipulation of prices or volume |
| Fair allocation | III(B) | Pro rata, same price, no favoring by fee or size |
| Unsuitable request | III(C) | Explain risk, revisit the IPS, decline or follow policy, document |
| Dropped accounts in results | III(D) | Fair, accurate, complete: include terminated accounts |
| Client confidences | III(E) | Keep confidential unless illegal activity, legal duty or client consent |
Memory hook Information cases: freeze, tell compliance, push for disclosure. Client cases: whose interest first, fair to others, suits this client, honest numbers, private.
Know it cold Material + nonpublic: stop trading and tipping. Allocation: proportional to the order, never to the fee.
MemorizeMaterial and nonpublic: the two tests
| Test | Meaning |
|---|---|
| Material | A reasonable investor would find it important, or it is likely to move the price |
| Nonpublic | Not yet disseminated to the market (an announcement, filing or press release makes it public) |
Memory hook Both words, both tests: price-moving and not yet out. One without the other is fine to use.
Know it cold An unprompted tip is not mosaic theory, however it arrived.
- Integrity of capital markets Memorize Standard II
- II(A) Material nonpublic information do not act or cause others to act
- II(B) Market manipulation no practice meant to mislead the market
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- Duties to clients Memorize Standard III
- III(A) Loyalty, prudence and care clients first; act in their interest
- III(B) Fair dealing fair is not equal; pro rata
- III(C) Suitability IPS, objectives, constraints
- III(D) Performance presentation fair, accurate, complete
- III(E) Preservation of confidentiality with three exceptions
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Quick example
A manager receives 9,000 bonds. Eligible orders total 25,000. Fill rate 9,000 ÷ 25,000 = 36%. A client who ordered 5,000 receives 0.36 × 5,000 = 1,800.
- 9000÷25000×5000= 1800
- 9000ENTER25000÷5000× 1800
ENTER enter (on the HP, puts the number on the stack)
How it is asked
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Information heard at a supplier or trade fair
An analyst hears from a factory foreman that a recall will be announced next week. Action?
Do not trade or share; notify compliance. Trap: selling for clients first.
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Allocation calculation
A manager receives 4,500 shares. Orders are 7,000, 2,500 and 500. The 2,500 client gets?
4,500 ÷ 10,000 = 45%; 0.45 × 2,500 = 1,125. Traps: 1,500 (equal split), 2,500 (full fill).
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Unsuitable request from the client
A retiree wants 40% of her portfolio in one speculative stock; her IPS stresses capital preservation. Action?
Explain the risk, discuss whether objectives changed (update the IPS if so), document. Trap: execute because she asked.
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Incomplete track record
A composite omits two accounts the firm lost after poor results. Standard?
III(D). Trap: III(B).
Exam traps
- Treating information obtained "by accident" or unprompted as fair to use.
- Selling the position for clients first. Acting on material nonpublic information is the violation, whoever benefits.
- Allocating by fee level or account size. Pro rata at the same price is the fair method.
- Executing a material unsuitable request without discussion or documentation.
- Calling a composite that leaves out poor performers a fair dealing problem. It is performance presentation.
Checkpoint
3 exam-style questions. About 90 seconds each.
1A manager receives 6,000 shares of an oversubscribed initial public offering (IPO). Eligible client orders are 10,000, 4,000 and 1,000 shares. Under fair allocation, the client who ordered 4,000 shares most likely receives:
2A buy-side analyst hears from a company's factory foreman at a trade fair that a major product recall will be announced next week. The analyst's most appropriate action is to:
3A manager presents a composite's ten-year record but excludes two accounts that the firm lost after poor results. Which Standard is most likely violated?
Key takeaways
- Material and nonpublic: freeze, notify compliance, encourage disclosure.
- Fair allocation is pro rata at the same price.
- Material unsuitable requests: explain, revisit the IPS, document.
- Honest performance includes terminated accounts.
Quick example
A manager receives 9,000 bonds. Eligible orders total 25,000. Fill rate 9,000 ÷ 25,000 = 36%. A client who ordered 5,000 receives 0.36 × 5,000 = 1,800.
- 9000÷25000×5000= 1800
- 9000ENTER25000÷5000× 1800
ENTER enter (on the HP, puts the number on the stack)
All Ethical and Professional Standards formulas, every lesson
Questions about this lesson?
Where this comes back
- Cases on duties to employers and investment analysis Ethics Application
Questions candidates ask
What are examples of material nonpublic information cases?
An unannounced order cancellation heard from a supplier, a recall mentioned by a factory worker, or a pending merger overheard in an elevator. If the information is specific, reliable and likely to move the price, and it has not been released, do not trade or tip, and tell compliance.
How should a manager allocate an oversubscribed issue?
Pro rata. Divide the shares received by total eligible orders to get a fill rate, then apply it to each order, at the same price. Fee level and account size are not fair bases. Disclose the allocation policy to clients.
What should an adviser do with an unsuitable client request?
Explain the risks, discuss whether the client's objectives have really changed, update the investment policy statement if they have, and document everything. If the request still does not fit, the adviser may decline or follow firm policy.
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