In the ethical dilemma question about John -

John Peters had just arrived at the Memphis branch offices of Bull Steins (BS) brokerage firm. BS is one of the top 50 firms in the industry with a wide range of financial products. Five years prior, John graduated from Midwest State University and went to Marell and Pew Brokerage. While there, he learned that in finance one must follow the letter and spirit of the law. BS started courting John after working at Marell for four years because he had a good reputation and an investment portfolio worth approximately $100 million with some 400 investors.

A hard worker, John acquired his clients through various networking avenues, including family, the country club, cocktail parties, and serving on boards of charitable organizations. He called one client group the Sharks. These were investors who took risks, made multiple transactions every month, and looked for short-term, high-yield investments. The second group he called Cessnas, because most of them owned twin-engine planes. This group was primarily employed in the medical field but included a few bankers and lawyers. He called the final group the Turtles because they wanted stability and security. This group would normally trade only a few times a year.

John was highly trained and was not only comfortable discussing numbers with bankers and medical billing with physicians, but also had the people skills to convey complex financial products and solutions in understandable terms to his Turtles, who were primarily older and semiretired. This was one of the main reasons Al Dryer had wanted to hire him. Youve got charisma, John, and you know your way around people and financial products, Dryer explained.

At Marell and Pew, Skyler was Johns trainer. Skyler had been in the business for 15 years and had worked for three of the top brokerage firms in the world. She had chosen to stay at Marell and Pew for so many years because of her family. Skyler quickly taught John some complicated tricks of the trade. For example, Your big clients (Sharks and Cessnas) will like IPOs (initial public offerings) but you have to be careful about picking the right ones, Skyler said. Before suggesting one, look at who is on their board of directors, cross-reference them to other IPO boards in the last 57 years. Next, cross-check everyone to see where the connections are, especially if they have good ties to the SEC (Securities and Exchange Commission). Finally, you want to check these people and the companies they have been associated with. Check every IPO these people were involved in and what Moodys ratings were prior to the IPO. As you know, Moodys is one of two IPO rating companies in the United States and theyre hurting for revenue because of the financial downturn. If you see a bias in how they rate because of personal relations to the IPO people, youve got a winner, Skyler smiled.

During his five years at the company, Skyler had taught John about shorting, naked shorting, and churning. She explained shorting by using an example. If I own 1,000 shares at $100/share and you think the stock is going to tank (go down), you borrow my shares at $100/share, sell them, and the next week the stock goes down to $80/ share. You call your broker and buy back the 1,000 shares at $80 and give me my 1,000 shares at $80/ share. Do you see what happened? Skyler asked. You borrowed my shares and sold them for $100,000. The following week, when the company stock fell to $80, you repurchased those 1,000 shares for $80,000 and gave them back to me. In the meantime, you pocketed the difference of $20,000. Skyler went on, Naked short selling is the same as shorting, but you dont pay any money for the stock, explained Skyler. There is a three-day grace period between buying and selling. That means you have at least three days of FREE MONEY!

Al Dryer instructed John to wait to resign until late on Friday so that BS could send out packets to each of his accounts about switching companies. John thought about this but was told by others this was standard practice. But what about the noncompete clause I signed? It says I cant do that, said John to a few brokers not associated with either firm. Their response was, Its done all the time. On Friday John did what BS asked, and nothing happened. Six months went by, and Johns portfolio had increased to $150 million. Other brokers began imitating Johns strategy. For example, for his Sharks, John would buy and sell at BS and call some of his buddies to do the same thing using money from his SHARKS. Another tactic involved selling futures contracts without providing evidence that he held the shares sold (naked shorting). While much of what he was doing was risky, John had become so successful that he guaranteed his Turtles against any loss.

Several years later John was buying and selling derivatives, a form of futures contract that gets its value from assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or even an index of weather conditions. While his risk-taking Shark group had expanded threefold, Johns Cessna pool had all but dried up. However, his Turtles had grown dramatically to an average worth of $500,000. The portfolio he managed had topped $750 million, a lot more than he had when he started at BS ($500 million in Sharks and $250 million for Turtles).

This year is going to be better than last year, said John to some of the brokers at BS. But expenses had been rising fast. Johns expense account included country club memberships, sports tickets, trips for clients, etc. Instead of charging the firm, John would always pay them from his own pocket. By indirectly letting his clients know it was his money he was spending on them, his clients were grateful for his largess and those who would have grumbled about delays in the delivery of securities purchased were less apt to do so. John saw a great opportunity to make his heavy hitters happy with him. Unbeknownst to them, he would buy and sell stocks for these clients and later surprise them with the profits.

By this time, John was training new hires at BS, which would have taken away a lot of his personal and professional time if he had done it right. But John had a lot of other things on his mind. He had decided to get married and adopt children. His soon-to-be wife, Leslie, quit her job to be a fulltime mom and was designing their new 18,000- square-foot home. With all these activities going on at once, John was not paying attention to the four new brokers and their training. Because John was a senior partner, he had to sign off on every trade they made. It became so time-consuming to manage everything that he spent an hour a day just signing the four other brokers trades.

Then one Monday morning John received a call from the SEC asking about some trades made by the four new brokers. It appears to us there may be some nonpublic information your brokers have concerning several IPOs, the agent said. If they do have such information, this could be considered insider information. John, Im calling you because we go way back to our college days, but I have to know, said the agent. John thanked him and went straight to the new brokers and asked them about the IPO. One of the new brokers replied, John, you told us that in order to excel in this business, you need to be an expert on knowing exactly where things become legal and illegal. You said trust me, Ive been doing this for 15 years, and Ive never had a problem. We just did what youve taught us.

John knew that if they did have insider information, hed probably be found partially responsible because he was supposed to be training them. At the very minimum, the SEC would start checking his trades over the past several years. He also knew that, when subjected to scrutiny, some of his past trades might be deemed questionable as well. What should John do?

QUESTIONS EXERCISES

What is/ are Johns ethical issues?

Are there any legal considerations for John?

Discuss the implications of each decision John has made and will make.

Question 3. Discuss the implications of each decision John has made and will make - was not answered.