September 2015 Professional Examination
Paper 2.4: Question & Solutions
Ethics and Professional Standards
Law relating to Securities and Investments
Regulations of Securities and Corporate Finance
Level 2
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SECTION B
Question 2 – Ethics and Professional Standards
State four main exceptions to the prohibition imposed against Insider Dealing in the
Capital market.
(3 marks)
Solution to Question 2
(i)
An individual is not prohibited from dealing if he does so without intending that he or any
other person shall thereby make a profit or a loss e.g. if he deals purely to raise cash.
(ii)
A liquidator, Receiver or Trustee in bankruptcy may discharge his functions which may
involve realizing investments, if he does so in good faith.
(iii)
A stockbroker may carry on his normal business dealings if he does so in good faith and
obtained the information through his bona fide business as a stockbroker.
(iv)
A trustee or personal representative may deal if advised to do so by an appropriate adviser
who does not appear to be himself in a situation to which the prohibitions apply.
(3 marks)
Question 3 – Law Relating to Securities and Investments
3(a) In respect of a Bill of Exchange, what is the essential distinction between a holder for
value, and a holder in due course.
(3 marks)
3(b) Clearly explain the term “Del Credere Agent”
(1 marks)
Solution to Question 3
3(a) A holder for value under S.27 of Bill of Exchange Act 1990 takes the bill subject to
existing rights or equities. While a holder in due course under S.29 of Bill of Exchange
Act 1990 takes the bill free from all existing rights or equities.
(3 marks)
3(b)
“Del Credere Agent” is the type of agent who in consideration of extra commission,
guarantees his principal that any third party introduced by him to the principal will
perform his obligations under the transaction between them.
(1 mark)
Question 4 – Regulations of Securities and Corporate Finance
With reference to SEC Consolidated Rule 357 on margin lending, highlight three
important requirements of a margin agreement between a broker and bank, or broker
and customer.
(3 marks)
Solution to Question 4
In line with SEC Rule 357, the Requirements of a margin agreement are:
A margin agreement between the broker and bank or broker and customer shall amongst
other things provide for the following:
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(a)
(b)
(c)
(d)
Consent of the customer to pledge his securities to the broker as collateral for the
loan
the broker may extend to the customer.
Consent of the broker to pledge to a bank a combination of securities from several
customers who have approved margin accounts opened and operating within its
operations for the purposes of obtaining a margin loan from the bank for onward
lending to its customers.
Consent of the Customer to grant to the Broker permission to re-hypothecate (pledge)
the securities at a bank in order to use the securities as collateral for a loan. The amount
of securities that the broker may use is limited.
Consent of the customer that the broker may re-hypothecate the customer’s securities
with those of other bona fide customers as collateral for a bank loan.
(3 marks)
SECTION C:
Question 5 – Ethics and Professional Standards
ABC STOCK BROKERS LTD
Mr. Ike Ogbonna resumed at ABC Stockbrokers Ltd (a newly established Dealing Member of
the Nigerian Stock Exchange) as General Manager and Chief Operating Officer. He comes with
over fifteen years of work experience in Investment Banking.
Prior to his recent appointment, he was General Manager in charge of Investment Banking at
the Nigerian Global Bank plc. He lost his job when The Asset Management Corporation of
Nigeria (AMCON) took over the management of his bank some years ago. Ike is a Graduate
Member of the Chartered Institute of Stockbrokers (CIS).
Officially, ABC Stockbrokers has an ‘MD/CEO’ in the person of Mrs. Comfort Ayo (FCS).
However, she only comes around during routine annual inspection of the Nigerian Stock
Exchange (NSE) and the Securities and Exchange Commission (SEC). Once in a while she
endorses important documents for the company, and these are usually sent to her at her
Victoria Island office, where she runs another company. Mrs Comfort Ayo is a close ally of the
Chairman of ABC Stockbrokers.
Since his resumption therefore, Ike has run the company freely without interference,
overseeing the day-to-day running of the company, and reporting to the Board of Directors
from time to time. The company has a remote trading workstation in the office with which Ike
trades on the Nigerian Stock Exchange while also attending to other administrative duties. As
a result of his experience in financial services, Ike has succeeded in building a huge clientele
base for his company within a short period.
With the large and growing clientele base, it is easy for Ike to do proprietary trading for ABC
Stockbrokers from the float generated by delaying execution of clients’ purchase orders and
delaying the payment of clients’ sales proceeds after the due date. In situations where he
cannot easily raise cash to pay clients for their sales proceeds or execute their purchase
orders, Ike easily resolves the problem by selling other clients’ stocks, and buying back later.
To avoid raising eyebrows, Ike at the point of opening clients CSCS accounts registers an office
phone number for all his clients. This way, clients do not get trade alert for the transactions.
From proprietary trading, Ike rakes in huge income for his company and posts appreciable
profit at the end of each quarter. He is enjoying huge popularity and receiving accolades from
the Board of Directors. That is not all, Ike smiles to the bank regularly on account of the good
gifts he gets especially from the company’s high networth clients who show their appreciation
to him for giving priority of execution to their trade order and for releasing the cheques for
their sales proceeds promptly.
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As the only trader in the company, and on account of his busy schedule, Ike is regularly helped
by Ifeoma, his dependable Secretary, to execute trade orders on the trading machine when he
is away on marketing calls or busy with other official matters.
Required
5a) Identify the ethical issues raised in this case, with particular reference to the CIS Code and
Standards.
(12 marks)
5b) What recommendations will you make to the Board of Directors to ensure that ABC
Stockbrokers Limited is run professionally and to avoid regulatory sanctions.
(8 marks)
Solution to Question 5 – Ethics and Professional Standards
5a) The following ethical issues are raised in the case discussed above:
1. Mr Ogbonna was practicing stockbroking without a practicing Licence.
He was running a stockbroking Firm as well as trading on Shares without a practising license.
This is contrary to the law (CIS Act 105 of 1992 and CIS Membership Regulations and Code of
Conduct 2005, Rule 5.). The same thing applies to the secretary Ifeoma who also trades when
Mr. Ogbonna is not around or is busy.
2. Mr. Ogbonna was managing the company and trading without the necessary skills and
knowledge. He does not have the competence for the work he was doing. The same thing
applies to Ifeoma, the Secretary who trades also. (CIS Code of Ethics, Article 4.0 & CIIA,
Principles of Ethical Conduct A(5)).
3. (a) The company effectively has no full-time MD/CEO as required by Rules. (NSE Rules and
Regulations for Dealing Members Article 155) . Mrs. Ayo operates like a part-time Staff of
the company. She hardly goes to work. Her time is spent in her other company located at
Victoria Island.
(b) Mrs. Ayo engages in other Business activities which takes her time at the expense of her
duties as the MD/CEO of ABC stockbrokers ltd (CIS Code of Ethics and Professional
Standards, Article 5.2)
4. Mr. Ogbonna was involved in many sharp practices. He delays transactions of his clients to
raise money for his proprietary trading.
When sales are made, he delays the payment for the same purpose. This is unethical. (CIS
code of Ethics Article 11.0)
5. Mr. Ogbonna fraudulently registered wrong telephone numbers for his clients when opening
new CSCS account for them so that they will not get trade alert for their transactions. (CIS
Membership Regulations & Code of Conduct, Article 5 (vi))
6. The company engages in unauthorized sale of customers’ shares and delays in the execution of
clients’ purchase orders. This is unethical and against the Rules. (CIS Membership Regulations
and Code of Conduct, Article 5(xvi); SEC Consolidated Rule 65(5))
7. There is weak Board of Directors and no corporate Governance in the company. This is shown
in the enormous power wielded by Mr. Ogbonna. Nobody checks him. The board of Directors is
ineffective in performing its oversight function on the Management.
8. Mr. Ogbonna collects gratification secretly from his clients in order to give them preferential
treatment. ( CIS Code of Ethics and Professional Standards, Articles 6 & 3.2)
(11/2 mark each)
Total (12 marks)
5b)
i.
The Board of Directors should engage a full-time Managing Director/CEO who will always
be in the office to attend to the day to day running of the company. The person should be
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ii.
iii.
iv.
professionally qualified and Experienced with CIS practicing Licence and Nigerian Stock
Exchange (NSE) Dealing Licence as Authorised Clerk.
The company should employ a Qualified Compliance Officer and also an Internal Auditor (as
required by the NSE Rules) who will control all the unethical practices in the company.
The company should send Mr. Ogbonna to the Nigerian Stock Exchange to train and
become a Dealing Clerk. Until then, only the MD/CEO should be executing trades on behalf
of the company.
The board of Directors should be strengthened by appointing very knowledgeable and
experienced people on the Board so that it will be more alive to its duties. (2 marks each)
Total (8 marks)
Question 6 – Law Relating to Securities and Investments
6(a)
On 10th August, 2015, John was strolling along a street in Victoria Island when he saw
an obviously lost dog which had fallen into a pit and wounded one of its legs. John
helped the dog out and discovered that it had a tag tied around its neck with the
address of the owner. He traced the address and took the dog there. In appreciation,
the owner of the dog, Mr. Isaac, promised to give John N 2,000.00 the following day.
However, Mr. Isaac refused to give John the money and John has decided to sue Mr.
Isaac for breach of contract.
Advise Mr. Isaac.
(5 marks)
6(b)
Bayo offers to sell his B.M.W car to David for N1.5m; what will be the legal position in
the following instances:
6(b1)
Bayo dies before the offer is accepted.
6(b2)
The car was destroyed by fire at a mechanic workshop before David accepts, but David
not realizing this fact; accepts the offer.
(21/2 marks)
6(b3)
David accepts the offer, but the car was destroyed by fire at a mechanics workshop a
day before it was to be delivered.
(21/2 marks)
(2 marks)
Solution to Question 6 – Law Relating to Securities and Investments
6(a)
This is a promise which is made after the performance of the act which prompts the
promise. As Mr. Isaac made the promise after John found and returned the dog, his
consideration is past. Therefore John cannot sue Mr. Isaac for breach of contract.
(5 marks)
6(b1) The death of Bayo before David accepts the offer, terminates the offer.
(2 marks)
6(b2) The contract becomes void because is affected by a common mistake, of res extinct.
(21/2 marks)
6(b3) The contract is void,) it is frustrated by the destruction of the subject matter.
(21/2 marks)
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Question 7 – Regulations of Securities and Corporate Finance
7(a)
The Securities and Exchange Commission (SEC) recently fixed a recapitalization
deadline for capital market operators (CMO) in line with the set minimum capital
requirements. Following this, stockbroking firms, among others, have been considering
a number of options open to them, including mergers & acquisitions, and
reclassification of functions. For instance, some Broker/Dealer firms are currently
pursuing the option of reclassifying as sub-brokers.
Required
With reference to SEC Consolidated Rule 67–75, answer the following questions
comprehensively.
7(a1)
Distinguish clearly between a corporate sub-broker and an individual sub-broker,
highlighting in particular the difference in minimum capital requirements.
(2 marks)
7(a2)
List five important documents required to accompany an application for registration as
an individual sub-broker.
(5 marks)
7(a3)
Discuss the functions of a registered sub-broker, and the fundamental guidelines that
regulate the performance of these function (SEC Rule 68).
(7 marks)
7(b)
With reference to SEC Consolidated Rule 425, outline the procedure for obtaining
approval for merger from SEC by companies.
(4 marks)
Solution to Question 7 – Regulations of Securities and Corporate Finance
7(a)
7(a1) Sub-brokers are individual registered stockbrokers and professional members of the
Chartered Institute of Stockbrokers (CIS) and non-stockbrokers first degree holders who
set up their private firms and deal as investment agents as corporate entities and
individuals in the marketplace.
Sub-brokers act on behalf of a Dealing Member as its agent for assisting investors in
buying, selling or dealing in securities through such Dealing Member.
A Sub-broker could be an Individual Sub-broker or a Corporate Sub-broker. An
Individual
Sub-broker could be a person or a Registered Business Name while a
Corporate Sub-broker is a Corporate Entity.
The minimum capital requirements for sub-brokers are N1 million for corporate subbroker and N500,000 for individual sub-broker.
(2 marks)
7(a2)
An application for registration as an individual sub-broker shall be filed on Form SEC 2 as
provided in schedule III of SEC rules and regulations and shall be accompanied by the
following:
i.
Certified copy of certificate of registration of business name (where
applicable);
ii.
Evidence of minimum net worth of N500,000;
iii.
Sworn undertaking to comply with the provisions of the Act and the
rules and
regulations as may be required from time to time by the
Commission;
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iv.
v.
Evidence of compliance with rule 20(4);
Sworn undertaking to keep proper records and render returns.
(5 marks)
7(a3)
1) A registered sub-broker performs the following functions which is carried out only through its
sponsoring broker/dealer;
(a) Purchasing of securities;
(b) Sale of securities;
(c) Receiving payments from clients in any of the transactions mentioned in (a) and (b)
above only by cheques written in favor of the sponsoring
broker/dealer;
(d) Making payments to clients in any of the transactions mentioned in (a) and (b) above
only by cheques drawn by the sponsoring broker/dealer;
(e) Other services ancillary to (a) to (d) above.
2) The sub-broker should not keep the funds of the client in its custody.
3) All monies received from or on behalf of clients should be duly receipted and remitted to the
sponsoring broker/dealer within two (2) working days.
4) The receipt issued by the sub-broker to clients should bear the names and logos of the subbroker and the sponsoring broker/dealer.
5) All certificates, and warrants received by the sub-broker from client’s for stock broking
transactions, should be forwarded to the sponsoring broker/dealer within two (2) working
days.
(7 marks)
7(b) The Procedure for Obtaining Approval for Mergers is as follows:
Companies proposing a merger, acquisition or other forms of external restructuring shall:a. file with the Securities and Exchange Commission, a merger notification for evaluation by
submitting a report, which shall contain the following:
i.
a letter of intent signed by the merging companies accompanied by board resolutions
of the merging companies supporting the merger;
ii.
a detailed Information Memorandum of the proposed transaction including all the
background studies relating to the merger, and justification for it.
b. file an application in the Federal High Court seeking an order to convene a court ordered
meeting;
c. following the resolution of the shareholders at the court ordered meeting, the applicants
shall file with SEC a formal application for approval of the merger.
d. comply with post-approval requirements.
(4 marks)
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