Pamela Cain, chief financial officer and compliance officer for Ace Choices Investment Advisors, has just finished reviewing the brokerage account statement for one of Ace Choices's portfolio managers, Kacey Thomas. When a disgruntled board member of Tartarus Surgical
Apparatus (TSA) informed her of Thomas's possible misconduct, Cain decided to investigate Thomas's relationship with TSA, a company whose stocks Thomas recently bought for all her portfolios. As a result, Cain obtained and is now reviewing Thomas's brokerage statements, which were not previously submitted by Thomas. Cain is concerned about possible violations of the company's standards of professional conduct and her responsibilities as a compliance officer and member of CFA Institute to act on those violations.
Ace Choices is a medium-size, rapidly growing money manager registered with the U.S. Securities and Exchange Commission to manage both separate accounts and mutual funds. Ace Choices has subscribed to the CFA Institute Code of Ethics and Standards of Professional Conduct by incorporating the CFA Institute Code and Standards into the firm's compliance manual.
Thomas has been a portfolio manager for Ace Choices for almost five years. She loves the job because of the people she meets and the money she is able to earn. She has been particularly pleased to keep up her friendship with Janie Johnson, a former college classmate and now the president of TSA, a rapidly growing local biotech company. Over the past five years, Johnson has provided Thomas with information on attractive stocks in Thomas's field biotechnology—on which Thomas capitalized for her Ace Choices portfolios and her personal portfolio. Because she was able to act more quickly on her personal trades than her Ace Choices trades, Thomas has often purchased stocks of the companies recommended by Johnson for her own account prior to purchasing them for her clients. As a result, the performance of her personal portfolio has been better than the performance of her other
portfolios.
Three years ago, Johnson asked Thomas to serve as an outside director for TSA and, despite TSA's uncertain prospects at the time, Thomas eagerly accepted the offer. Because TSA was in shaky financial condition until recently, the company compensated its directors with stock options rather than cash payments. For the past several years, directors received options exercisable into 200,000 shares in TSA stock. TSA's shares were not traded anywhere, however, so this compensation was essentially worthless, and Thomas has not reported her relationship with TSA to Ace Choices. This year, with TSA's sales setting records and earnings up, directors started receiving quarterly director fees of $5,000.
Several months ago, the TSA board voted to issue shares of stock to the public to raise needed cash. The market for initial public offerings (IPOs) was very hot, with valuations of biotech companies at record levels; so, TSA top managers believed the moment was opportune to go
public. A public market for TSA shares was very appealing to many board members. Thomas, for example, was eager to exercise her stock options so that she could cash in on their value. She had just begun construction of a new home, which was putting significant pressure on her cash flow. Thomas voted, with the majority of the board, to go public as soon as possible—before the new-issue market soured.
Shortly before the public offering date, Thomas received a frantic phone call from Johnson asking for a favor. Johnson indicated that the IPO market had reversed course in the preceding few days; valuations of biotech companies were falling rapidly. Johnson was afraid that investor interest in TSA had slowed so much that the IPO would be threatened. Johnson asked Thomas to commit to purchasing a large amount of the TSA offering for her Ace Choices accounts to provide enough support for the offering to proceed as planned. Thomas had previously decided that TSA was a questionable investment for her accounts.
As a TSA director, however, she also wanted to see a successful IPO, so she offered to reevaluate that decision. In this reevaluation, TSA's stock price seemed high to Thomas. Moreover, if she wanted to achieve the desired volume, TSA stock would then represent a higher percentage of
Thomas's Ace Choices portfolios than most holdings. Nevertheless, Thomas decided to purchase the shares as Johnson suggested, and when the IPO was effective, she placed the order for the separate accounts and the mutual funds that she managed.

 

1. Explain what violations of the CFA Institute Code and Standards have occurred and the steps that Thomas should have taken to avoid the violations. 

2. What responsibility does Cain, as a compliance officer, have? What actions should Cain take now?
3. Identify possible violations and state what actions are required to correct the potential violations, and make a short policy statement a firm could use to prevent the violations.