Recommended Procedures for Compliance
Members or candidates should disclose special compensation arrangements with the employer that might conflict with client interests, such as bonuses based on short- term performance criteria, commissions, incentive fees, performance fees, and referral fees.
If the member’s or candidate’s firm does not permit such disclosure, the member or candidate should document the request and may consider dissociating from the activity.
Members’ and candidates’ firms are encouraged to include information on compensation packages in firms’ promotional literature. If a member or candidate manages a portfolio for which the fee is based on capital gains or capital appreciation (a performance fee), this information should be disclosed to clients. If a member, a candidate,
or a member’s or candidate’s firm has outstanding agent options to buy stock as part of the compensation package for corporate financing activities, the amount and expiration date of these options should be disclosed as a footnote to any research report published by the member’s or candidate’s firm.
Application of the Standard
Example 1 (Conflict of Interest and Business Relationships):
Hunter Weiss is a research analyst with Farmington Company, a broker and investment banking firm. Farmington’s merger and acquisition department has represented Vimco, a conglomerate, in all of Vimco’s acquisitions for 20 years. From time to time, Farmington officers sit on the boards of directors of various Vimco subsidiaries. Weiss
is writing a research report on Vimco.
Comment: Weiss must disclose in his research report Farmington’s special relationship with Vimco. Broker/dealer management of and participation in public offerings must be disclosed in research reports. Because the
position of underwriter to a company entails a special past and potential future relationship with a company that is the subject of investment advice, it threatens the independence and objectivity of the report writer and must
be disclosed.
Example 2 (Conflict of Interest and Business Stock Ownership):
The investment management firm of Dover & Roe sells a 25% interest in its partnership to a multinational bank holding company, First of New York. Immediately after the sale, Margaret Hobbs, president of Dover & Roe, changes her recommendation for First of New York’s common stock from “sell” to “buy” and adds First of New York’s
commercial paper to Dover & Roe’s approved list for purchase.
Comment: Hobbs must disclose the new relationship with First of New York to all Dover & Roe clients. This relationship must also be disclosed to clients by the firm’s portfolio managers when they make specific investment
recommendations or take investment actions with respect to First of New York’s securities.
Example 3 (Conflict of Interest and Personal Stock Ownership):
Carl Fargmon, a research analyst who follows firms producing office equipment, has been recommending purchase of Kincaid Printing because of its innovative new line of copiers. After his initial report on the company, Fargmon’s wife inherits from a distant relative US$3 million of Kincaid stock. He has been asked to write a follow- up
report on Kincaid.
Comment: Fargmon must disclose his wife’s ownership of the Kincaid stock to his employer and in his follow- up report. Best practice would be to avoid the conflict by asking his employer to assign another analyst to
draft the follow- up report.
Example 4 (Conflict of Interest and Personal Stock Ownership):
Betty Roberts is speculating in penny stocks for her own account and purchases 100,000 shares of Drew Mining, Inc., for US$0.30 a share. She intends to sell these shares at the sign of any substantial upward price movement of the stock. A week later, her employer asks her to write a report on penny stocks in the mining industry
to be published in two weeks. Even without owning the Drew stock, Roberts would recommend it in her report as a “buy.” A surge in the price of the stock to the US$2 range is likely to result once the report is issued.
Comment: Although this holding may not be material, Roberts must disclose it in the report and to her employer before writing the report because the gain for her will be substantial if the market responds strongly to her
recommendation. The fact that she has only recently purchased the stock adds to the appearance that she is not entirely objective.
