CHARTERED INSTITUTE OF
STOCKBROKERS
ANSWERS
Examination Paper 2.4
Ethics and Professional Standards
Law relating to Securities and Investments
Regulations of Securities and Corporate Finance
Professional Examination
March 2011
Level 2
1
SECTION A: MULTI CHOICE QUESTIONS
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
C
A
C
D
B
B
A
B
C
C
D
C
D
A
B
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
B
B
D
C
B
B
C
B
C
B
B
D
D
D
D
31
32
33
34
35
36
37
38
39
40
B
D
C
D
A
D
B
D
C
D
(60 marks)
SECTION B: SHORT ANSWER QUESTIONS
Question 2 – Ethics and Professional Standards
i.
Establishment of guidelines to ensure that personnel who have prior knowledge of
investment recommendations do not discuss or take any investment action on the
pending recommendation.
ii.
Setting up of procedures to disseminate information on
recommendation to all their clients at approximately the same time.
iii.
Prompt communication of changes in prior investment advise, based on subsequent
research, to all current clients, and prospective clients.
iv.
Ensuring that personnel do not take advantage of their position in the industry to
the detriment of clients. For instance, keeping information and documents relating
to an attractive up-coming IPO to themselves.
investment
(Any three points = 3 marks)
Total = 3 marks
2
Question 3 – Law Relating to Securities and Investments
i.
ii.
iii.
Certainty of intention/words - which means that it must be clear that the
donor or testator wishes to create a trust.
Certainty of subject matter - which implies that it must be clear what property
is part of the trust?
Certainty of objects - means that it must be clear who the beneficiaries, or
objects, are.
Total = 3 marks
Question 4 – Regulations of Securities and Corporate Finance
4(a)
Front running is the illegal practice (NSE Article 105) of a stockbroker executing orders
on a security for its own account while taking advantage of advance knowledge of
pending orders from its customers.
For example a stockbroker receives several large orders to purchase the shares of XYZ
limited. Before executing these orders, he purchases first for his own account. He
thereafter executes the orders of his clients, which drives up the price. He closes out his
own account at a profit based on the new price level, thereby gaining unfair advantage.
4(b)
i.
ii.
iii.
(2 marks)
Provision for the establishment of investor protection fund.
Establishment of Investment and Securities Tribunal.
Setting of rules and guidelines that would ensure transparency and integrity in
the market.
(Any 2 points = 2 marks)
Total = 4 marks
3
SECTION C: COMPULSORY QUESTIONS
5(a) The following are ethical issues arising from the meeting/ discussion with Dare:
i. Misrepresentation
Dare claimed that his company could provide all the financial services needs of its clients
including banking services. A stockbroking firm is neither licensed nor authorized to
provide banking services.
ii. Price manipulation/ market manipulation
Dare promised to “manage” the share value of his company’s clients so that it would
remain at a respectable level at all times. Although he did not give details of how he
would achieve this, his claim is suggestive of a plan to manipulate price and/ or the
market.
iii. Lack of reasonable basis for investment recommendation
According to Dare, investment recommendations to clients would be based on
discussions and agreement with the client. This is not an independent, objective or
reasonable basis for investment recommendation.
iv. Disloyalty to employer
Dare exhibited clear traits of a disloyal employee. He offered to provide the same
services his company offered to clients at a cheaper rate, secretly.
v. Improper use of professional designation
Dare’s call card reads: Dare Thompson, ACS; Head of Marketing. This is wrong. Since
he passes his CIS final paper just two months ago, he could not have been inducted as
an Associate of the Institute yet. Only Associates are permitted to use the designation,
ACS after their names.
(1½ marks each for 5 points = 7½ marks)
5(b)
i. Misrepresentation (section 9.0)
Members and registered students should accurately present all relevant facts as to avoid
any misrepresentation of their professional services. They shall not make any statements
which misrepresent the services they, or their firms, are capable of performing for clients
and prospective clients, their qualifications, their academic or professional credentials
e.t.c.
(2½ marks)
ii.
Price manipulation/ market manipulation (section 20.2)
Members and registered students must not engage in practices that distort the prices or
artificially inflate trading volume with the intent to mislead market participants. NSE
Article 104 has similar provisions.
(2 marks)
4
iii. Investment Recommendation (sections 8.1 & 8.2)
Members and registered students shall have reasonable basis for, and prepare fair
presentations in their investment research, recommendations, and investment
management and action. They must exercise diligence and thoroughness in their
research and analysis of investments.
(2 marks)
iv. Responsibilities to the employer (section 5.0)
Members and registered students shall display loyalty to their employers. They shall
comply with lawful directions, policies and procedures. They must act for the benefit of
their employers and not deprive their employers of the advantage of their skill and
abilities, divulge confidential information or cause harm to their employers.
(2 marks)
v. Proper use of professional qualifications/designation (section 2.2)
Members are expected to use their CIS qualifications with due care to enhance the
standing of and confidence in such qualification and the Institute.
Graduate members, registered students and affiliates shall not use any designation after
their names.
(2 marks)
= 10½ marks
Total = 18 marks
Question 6 – Law Relating to Securities and Investments
6(a)
The applicable rule is the Royal British Bank VS Turquand or the Indoor Management
Rule. It states that where a company has powers to do an act but its directors or officials
exceed their authority, any outsiders involved in the transaction with the company
should not be prejudiced or made to suffer because of any internal mis-management or
problem within the company.
Therefore Chief Dende must be paid his money.
(7 marks)
6(b1)
An executor is a personal representative who has been named in the Will of the Testator.
An administrator is a personal representative who has been given the authority to act as
such upon his own application as the deceased would not have written a Will.
(4 marks)
6(b2)
A charitable trust is an irrevocable trust established for charitable purposes. Examples
are:
i.
Trust for relief of poverty.
ii.
Trust for advancement of education.
iii.
Trust for advancement of religion and
iv.
Trust for other purposes (not falling under the above three but which are
beneficial to the Community).
(3 marks)
Total = 14 marks
5
Question 7 – Regulations of Securities and Corporate Finance
7(a)
General control issues
The company does not have in place minimum standards on internal control as specified
by NSE Article 15 and SEC Rule 168 B. The NSE Article requires a dealing member to,
among others, establish and maintain a system to supervise and ensure compliance of
the activities of its officers, stockbrokers and employees.
It also provides that, at all times, a stockbroking firm shall have one or more compliance
officers, who shall be identified to the Exchange, shall advise staff on compliance issues,
and report any violations to the Exchange. These are clearly not in place in this firm.
(3 marks)
On the specific transactions identified the following issues are relevant:
I. Maneuvering with intention to defraud
In the first transaction presented, it appears the customer was subjected to unnecessary
pressure to buy shares against her will.
Both NSE Article 106 and SEC Rule 110 address this issue. A dealing member of the
Exchange shall not in connection with any transaction employ any devise, scheme or
artifice to defraud a customer or engage in any act, practice or course of business which
operates or is likely to operate as a fraud or deception.
(2 marks)
II. Late issuance of contract note
According to NSE Article 96, contract notes shall be issued for every purchase or sale of
securities not later than the end of the next trading day (within 24 hours). The current
practice in the firm whereby clients wait for up to two weeks to receive their contract
notes is a clear violation of this provision.
(2 marks)
III. The use of material non-public information/Insider dealing
The stockbroker in question not only used material non-public information as a basis of
investment recommendation, but also encouraged his client to act on inside information.
The following regulations clearly identify and prohibit insider trading and the use of
material non-public information:
•
•
•
•
•
Investment and Securities Act, 2007 (sections 111 and 112)
NSE Article 108
SEC Rule 110
CIS Code and Standards (section 20.1)
Code of conduct of employees of capital market institutions
(2 marks)
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IV. Giving guarantee of investment return
Stockbrokers are prohibited to give any form of guarantee of return on investment to
their clients in line NSE Article 139d, and CIS Code and Standards (section 9.3).
According to the CIS Code & Standards, ‘‘members and registered students shall not
make, orally or in writing, explicitly or implicitly, any assurances or guarantees regarding
the return of any investment except to communicate accurate information regarding the
terms of the investment and the issuer’s obligations under the instrument’’.
Sanctions
(2 marks)
NSE Article 45 and 153 stipulate that the Council may impose on dealing members found
to have contravened any of the provisions of the Articles, any or a combination of
admonition, fine, restitution, suspension and expulsion.
Contravention of the CIS Code and Standards by individual members and registered
students also attract similar sanctions.
(3 marks)
= 14 marks
7(b) Briefly suggest to the MD some simple steps that might be taken to prevent a
recurrence of these types of issues.
i. Appoint a compliance officer.
ii. Conduct a full compliance function review.
iii. Ensure full compliance with SEC Rules, NSE Article and other regulation, and
introduce stiff sanctions for non-compliance.
iv. Ensure adequate training of all staff on Code of Ethics and Standards of
professional practice.
v. Revise and formalise complaint procedures.
vi. Contact NSE/SEC/CIS of possible breaches and discuss possible remedial actions.
vii. Develop a more general culture of ethical conduct and compliance within the firm.
viii. Maintain all appropriate customer and contract records.
(Any four points – 1 mark each)
= 4 marks
Total = 18 marks
7