The Glenarm Company

The Glenarm Company

by Glen A. Holden, Jr., CFA

Glen A. Holden, Jr., CFA, is at AIG Retirement Services ( VALIC) (USA).

 

LEARNING OUTCOMES
Mastery	The candidate should be able to:
	a.      evaluate the practices and policies presented; b.     explain the appropriate action to take in response to conduct that violates the CFA Institute Code of Ethics and Standards of Professional Conduct.

 

 

 

CASE FACTS

Peter Sherman, CFA, recently joined the Glenarm Company after five years at Pearl Investment Management. He is very excited about the new job and believes he will make a big contribution to Glenarm. His first task is to identify attractive Latin American companies for Glenarm’s emerging markets portfolio. Sherman, knowing many of these companies through his consulting contacts, approaches the task enthusiastically. He believes the Glenarm Company will clearly benefit from his knowledge about these companies and has no need to know about his consulting on the side.

 

Sherman’s Background

Sherman had joined Pearl Investment Management, a small equity-oriented firm, as a junior research analyst. Pearl entered the international investing arena shortly after Sherman arrived, and Sherman performed well as he gained experience, particularly in researching emerging market securities. Sherman also spent some time handling client relations in the account administration department. More than a year ago, Sherman had earned his CFA designation.

Sherman’s role at Pearl grew when several of his boss’s foreign investment banking contacts hired Pearl to research companies and industries in Latin America in order to better position themselves vis-à-vis their local competitors.

When Pearl expanded its research department to accommodate these new proj- ects, the company made Sherman its primary analyst for emerging markets. The firm encouraged Sherman to develop expertise in this area, and he capitalized on his

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position by serving as a consultant to several third-world companies to assist them in attracting US and European investors, an arrangement that Sherman fully disclosed to Pearl. Pearl did not own stock in any of the companies that Sherman consulted with. Shortly after Sherman’s research responsibilities at Pearl expanded, he received a call from John Lawrence, an acquaintance in the local CFA Institute financial analysts society and a partner of the Glenarm Company, one of Pearl’s competitors. Lawrence indicated that his company was looking for an individual with Sherman’s background and asked him if he would be interested in becoming a portfolio manager at Glenarm.

 

Glenarm

The Glenarm Company is a small  equity-oriented  management  firm.  Glenarm was recently investigated, censured, and fined by the US Securities and Exchange Commission for a number of violations related to its portfolio management practices. The latest censure was Glenarm’s third in the past 13 years. The firm’s partners are desperate to rehabilitate their reputation and stem the steady outflow of clients.

No one in the firm other than Lawrence is a member of CFA Institute or the local society, but the Glenarm partners have accepted Lawrence’s reasoning that hiring a CFA charterholder as a portfolio manager will enhance the credentials of the firm, will demonstrate a commitment to professionalism in their practice, and is their best chance to expand their client base. Lawrence believes Sherman is an excellent prospect. The Glenarm partners believe Sherman may be able to bring some business with him if he joins the firm. While at Pearl, Sherman developed client contacts through his duties with the research department and through handling client relations. He also has some knowledge of investment management clients by virtue of his interaction with the portfolio managers. To entice him, Glenarm offers Sherman a large portion of the first-year investment management fee for all the Pearl clients he is able to solicit and bring to Glenarm. Although he has reservations because of Glenarm’s past problems with the SEC, Sherman decides that the opportunity is too good to pass up. Also, he can continue his consulting work. So, he agrees to join Glenarm as a portfolio manager.

 

The Transition

In preparation for his move to Glenarm but while he is still at Pearl, Sherman pays social calls on several local Pearl clients after business hours to inform them that he will be leaving Pearl and encourage them to switch their accounts to Glenarm. He also contacts a number of accounts that Pearl has been actively soliciting but that have not yet committed to hire Pearl as their investment manager. He also contacts prospects that Pearl has rejected in the past as too small or incompatible with the firm’s busi- ness to determine if they are interested in hiring Glenarm. As a result of this activity, Sherman convinces several of Pearl’s clients and prospects to hire Glenarm as their investment management company but to delay any action until he has joined Glenarm.

In his last week at Pearl, Sherman identifies material that he has worked on to take with him to his new job, including:

■       sample marketing presentations he prepared;

■       computer program models for stock selection and asset allocation that he developed;

■       research material on several companies Sherman has been following;

■       news articles he collected that contain potential research ideas; and

■       a list of companies that Sherman suggested in the past deserved further research and possible investment and that were rejected by Pearl.

 

 

Several activities in the case are or could be in violation of the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards). Identify pos- sible violations and state what actions are required by Sherman and/or Glenarm to correct the potential violations, and make a short policy statement a firm could use to prevent the violations.

 

 

 

CASE DISCUSSION

This case depicts violations or possible violations of the CFA Institute Code and Standards related to a member’s duties toward the member’s employer: the duty to disclose to one’s employer additional compensation arrangements and the duty to disclose conflicts of interest to the employer.

 

Loyalty to One’s Employer

Standard IV(A)—Duties to Employer: Loyalty, states that in matters related to their employment, members and candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer. Sherman’s solic- itation of clients and prospects and his plans to take Pearl property for the benefit of Glenarm are a breach of Standard IV(A).

Standard IV(A) does not preclude members from seeking alternative employment, but it does obligate a member to protect the interests of the employer by refraining from any conduct that could deprive an employer of profit or the benefits of the member’s skills and abilities. An employee is free to make arrangements to leave any employer and go into competitive business—so long as the employee’s preparations to leave do not breach the employee’s duty of loyalty to the current employer.

In this instance, Sherman had an obligation to act in the best interests of Pearl while he was still an employee of Pearl. He had a duty not to engage in any activities that would be detrimental to Pearl’s business until his resignation date became effec- tive. The following activities by Sherman violated this duty of loyalty and, as a result, violated Standard IV(A).

Solicitation of Clients and Prospects

Sherman’s solicitation of clients on behalf of Glenarm while he was still employed at Pearl is a clear violation of Standard IV(A). Attempting to lure clients from Pearl to another investment company undermined Pearl’s business, and the fact that such activity was carried out “after hours” or in a social context is irrelevant; the damage to Pearl’s business was the same. Even after leaving Pearl, Sherman must abide by any additional legal and contractual obligations between him and Pearl that would prevent solicitation of clients.

Soliciting potential clients of Pearl was also a violation of Standard IV(A). When engaging in such activity, Sherman was attempting to interfere with Pearl’s business opportunities for his own benefit and the benefit of his future employer. Solicitation of clients and prospects cannot begin until Sherman has left Pearl and begun to work for Glenarm.

Sherman’s contact of prospects that Pearl had not pursued because of their size or investment objectives does not constitute a violation of Standard IV(A) so long as the contacts were not in competition with Pearl in any way. Sherman could solicit business for his new employer on his own time when that activity did not interfere with his responsibilities at Pearl or take away a business opportunity from Pearl.

 

 

Misappropriation of Employer Property

Except with the consent of the employer, departing employees may not take property of the employer. Even material prepared by the departing employee is the property of the employer, and taking that property is a violation of the employee’s duty to the employer. Employees must obtain permission to take with them any work or work product prepared in the course of the employee’s employment or on behalf of the employer.

In this case, all the material mentioned as taken by Sherman was the property of Pearl. Sample marketing material prepared by Sherman, computer program models for stock selection and asset allocation that he developed, and research material and news articles that he collected are all Pearl’s property because Sherman’s efforts in creating or gathering these materials were undertaken in the context of his employment with and for the benefit of Pearl. Even the list of rejected research ideas was Pearl’s property; those ideas were generated by Sherman for Pearl’s consideration and use. The analyst that Pearl hires to replace Sherman might benefit by reviewing the list of ideas considered and rejected by the firm.

Actions Required

Sherman should have refrained from solicitation of any of Pearl’s clients or prospects until he had left Pearl. Sherman should have obtained Pearl’s permission to take copies of any work he prepared on behalf of Pearl in the course of his employment there. Without such permission, Sherman should not have taken any material that could have even remotely been considered Pearl’s property.

Policy Statement for a Firm

“Employees shall not undertake any independent practice that could result in compen- sation or other benefit in competition with the firm unless they obtain written consent from the firm and the person or entity for whom they undertake independent practice. Departing employees shall not engage in any activities that would be in conflict with this policy, including soliciting firm clients or prospects, removing firm property, or misuse of confidential information.”

 

Disclosure of Additional Compensation and Conflicts

Under Standard IV(B)—Duties to Employers: Disclosure of Additional Compensation Arrangements, CFA Institute members and candidates must not accept gifts, benefits, compensation, or consideration that competes with, or might reasonably be expected to create a conflict of interest with, their employer’s interest unless they obtain written consent from all parties involved. Because such arrangements may affect an employ- ee’s loyalties and objectivity and may create conflicts of interest, employers must receive notice of these arrangements so that they can evaluate employees’ actions and motivations.

In the case, Sherman disclosed his consulting arrangements to Pearl but not to Glenarm. Thus, he was violating Standard IV(B). Although Sherman’s consulting activities might have uncovered investment opportunities for Glenarm clients, the arrangements had the potential to affect Sherman’s ability to render objective advice and to divert Sherman’s energies away from managing Glenarm clients’ portfolios. Sherman should have given Glenarm written information on his independent practice so that the firm could make an informed determination about whether the outside activities impaired his ability to perform his responsibilities with the firm.

Sherman’s consulting arrangements are also a violation of Standard VI(A)— Disclosure of Conflicts, and Standard I(B)—Independence and Objectivity. Under Standard VI(A), Sherman must make full and fair disclosure of all matters that could

 

 

reasonably be expected to impair their independence and objectivity or interfere with respective duties to their employer, clients, and prospective clients. Members and candidates must ensure that such disclosures are prominent, are delivered in plain language, and communicate the relevant information effectively. Sherman could wind up receiving consulting fees from the same companies about which he is writing research reports for Glenarm’s internal use. Thus, the consulting could compromise Sherman’s independence and objectivity and would violate Standard I(B).

Actions Required

Sherman must disclose to Glenarm all outside compensation arrangements and describe in detail the activities that gave rise to this compensation. He must obtain written permission in advance of entering into these relationships.

Policy Statement for a Firm

“Employees shall disclose to the firm in writing all monetary compensation or other benefits that they receive for their services that are in addition to compensation or benefits conferred by the firm. Employees shall also disclose all matters that reasonably could be expected to interfere with their duty to this firm or ability to make unbiased and objective recommendations.”