CMFAS RES 1A Ethics, Codes & Standards of Professional Conduct question: firm underwrites

CMFAS RES 1AEthics, Codes & Standards of Professional Conduct

A firm underwrites a new share issue and, at the same time, its brokers recommend that firm's discretionary clients buy the shares to help the placement succeed. The primary ethical problem is:

A No conflict arises, because underwriting a share issue is a lawful and regulated activity
B A best-execution failure, as clients may pay more than the market price
C Insider trading, as brokers know the issue terms before the public
D The firm's placement interest conflicting with clients' need for unbiased, suitable advice

Show the answer and explanation

Answer: D. The firm's placement interest conflicting with clients' need for unbiased, suitable advice

The firm has an incentive to offload the underwritten shares, which may bias the advice given to clients. This conflict must be identified, managed (e.g. through independence and disclosure) and the recommendation must still be suitable for each client.

Common mistake

Underwriting being lawful (A) does not remove the conflict of interest it creates for advice to clients.

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