Client Tip, Revenue Pressure, and the Investment Committee
A portfolio manager at a registered investment adviser manages $800 million for 120 clients. A long-standing client who is a director of a listed company tells the manager, in a private call, that the company will announce a takeover bid for a competitor at a 40% premium next week and asks the manager to ‘buy some of the competitor for my account before it moves.’ The manager’s firm has a policy prohibiting trading on material nonpublic information, but the compliance manual does not specifically address client-originated tips. The client’s account is the firm’s largest, generating 18% of revenue. The competitor’s stock is already on the firm’s approved list and is held in several discretionary accounts. The manager also sits on the firm’s investment committee, which meets tomorrow to review the approved list.
1. Identify the regulatory and ethical issues and the immediate steps the manager should take.
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The director has disclosed material nonpublic information about a pending tender offer and asked the manager to trade on it. Under the misappropriation theory, the director owes a duty to the company; passing the information to the manager and asking for a trade is a breach, and the manager can be liable as a tippee if he knows or should know that. Trading for the client, for the firm, or for any discretionary account would violate the firm’s MNPI policy and potentially securities law. The manager should not trade, should not repeat the information, and should immediately escalate to the CCO and legal counsel. The competitor should be placed on the restricted list, and the manager should document the call and the instructions received. The investment committee discussion should be deferred or conducted without the manager and without reference to the tip. The manager should tell the client, in a careful and documented way, that he cannot act on the information and that the request cannot be followed. Whether to report the client to the regulator is a legal decision for the firm, not a unilateral one.
2. The client argues, ‘It is my information and my account; you work for me.’ How should the manager respond, and what conflicts arise from the client’s revenue share?
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The manager should explain that fiduciary duty does not require or permit an illegal act. The information belongs to the director’s company, not to the client, and the client’s status as a director creates a duty of confidentiality. The manager’s duty to the client is to provide lawful investment advice, not to execute a trade that could expose both the client and the firm to insider-trading liability. The client’s revenue share creates a conflict: the account generates 18% of firm revenue, so there is pressure to accommodate the request. That pressure must not influence the decision. The manager should document the conflict, involve compliance, and consider whether the firm can continue to serve the client if the request persists. The investment committee seat creates a second conflict because the manager could influence firm-wide trading. Recusal from any discussion of the competitor is appropriate until compliance clears the matter.
3. What controls should the firm adopt to prevent recurrence?
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The firm should amend its MNPI policy to cover client-originated tips explicitly, including a clear prohibition on trading and on passing information to others. It should require prompt escalation to the CCO, maintain a restricted list, and document all wall-crossing or tip reports. Training should use realistic scenarios involving large clients and revenue pressure. The firm should monitor trading in restricted and watch-list names, review personal and proprietary trading, and require attestations. It should also define consequences for clients who attempt to induce illegal trades and for employees who fail to escalate. Finally, the investment committee should have a standing agenda item on restricted names and conflicts, so that a single manager cannot steer the approved list around an MNPI issue.