NASAA Series 63Ethical Practices and ObligationsMedium
A client has a discretionary account with an investment adviser. The client explicitly states to the IAR, 'I do not want to invest in any tobacco-related companies.' Despite this, the IAR purchases shares of a major tobacco corporation for the client's account, believing it to be a strong growth opportunity. This action is a clear instance of:
- ADiscretionary authority abuse.
- BMarket timing.
- CSuitability violation based on risk tolerance.
- DSelling away.
Show answer & explanationAnswer & explanation
Correct answer: A. Discretionary authority abuse.
While discretionary authority allows an IAR to make trading decisions without prior client approval, it does not permit them to disregard a client's specific investment restrictions or ethical preferences. Purchasing tobacco stocks after the client explicitly forbade it is an abuse of that authority.
Why the other options are wrong
- B. Market timing is attempting to predict market movements, not a direct violation of client instructions.
- C. While it could be argued as a suitability issue broadly, the direct violation is of the client's explicit instruction within the scope of discretionary authority, making 'abuse of discretionary authority' more precise.
- D. Selling away involves transactions outside the firm's supervision, which is not the issue here.
Discretionary Authority Abuse
Misusing the power granted by a client to make investment decisions on their behalf, typically by disregarding explicit client instructions, restrictions, or acting contrary to the client's best interests, even if within the technical bounds of the investment policy statement.
- Discretionary authority is not absolute.
- Client-imposed restrictions must always be followed.
- Actions must remain in the client's best interest.
- Violates fiduciary duty.
Memory trick: Discretion has its lines, don't cross them.