Has Bracco violated any soft dollar standards regarding the Carobilo family trust?

Johnny Bracco, CFA, is a portfolio manager in the trust department of Canada National (CNL) in Toronto. CNL is a financial conglomerate with many divisions. In addition to the trust department, the firm sells financial products and has a research department, a trading desk, and an investment banking division. Part of the company’s operating procedures manual contains detailed information on how the firm allocates shares in oversubscribed stock offerings. Allocation is effected on a pro rata basis based upon factors such as the size of a client’s portfolio, suitability, and previous notification to participate in IPOs. Additionally, company policy discloses to clients that any trade needs to meet a minimum transaction size in an effort to control trading costs and to comply with best execution procedures.

One of Bracco’s trust accounts is the Carobilo family trust, which contains a portion of nondiscretionary funds managed by Stephen Carobilo. Carobilo has a friend who runs a brokerage firm called First Trades, to which Carobilo tells Bracco to direct trades from the nondiscretionary accounts. Bracco has learned that First Trades charges a slightly higher trading fee than other brokers providing comparable services, and he discloses this to Carobilo.

Due to high prices and limited supplies of oil, Bracco has been following companies in the energy sector. He believes this area of the economy is in turmoil and should present some mispricing opportunities. One company he has been researching is Stiles Corporation, which is working on a new type of hydrogen fuel cell that uses fusion technology to create energy. To date, no one has been able to successfully sustain a fusion reaction for an extended period of time. Bracco has been in close contact with Stiles’ pubic relations department, has toured their laboratories, and has thoroughly researched fusion technology and Stiles’ competitors. Bracco is convinced from his research, based upon various public sources, that Stiles is on the verge of perfecting this technology and will be the first firm to bring it to the marketplace. Jerry McNulty, CFA and vice president of the investment banking division of CNL, has been working with Stiles to raise new capital via a secondary offering of Stiles common shares. One day Bracco happened to be in a stall in the bathroom when McNulty and a colleague came in and discussed the fact that Stiles had perfected the fuel-cell technology, which will greatly increase the price of Stiles1 stock.

Stiles Corporation’s board of directors includes Dr. Elaine Joachim, who is a physics professor at the University of Toronto. She also works part-time for Stiles Corporation as a consultant in their fusion technology laboratory. Her husband is a materials engineer who recently started performing consulting work for Stiles.

A routine audit by the quality control department at CNL discovered trading errors in several of Bracco’s accounts involving an oversubscribed IPO. Some accounts received shares they should not have and others did not receive shares they should have. Bracco and his supervisor Jaime Gun, CFA, are taking responsibility to reverse the incorrect trades. Bracco told Gun, "I’ll correct the trades based on our clients’ investment policy statements, previous notification of intent, and according to the company’s formula for allocating shares on a pro rata basis. In so doing, we will fairly allocate shares so even small accounts that did not meet minimum size requirements will receive some shares of the IPO." Gun replied to Bracco by saying, "I’ll credit short-term interest back to the accounts that should not have received the shares and subtract interest from the accounts that should have received the shares."

That evening, Bracco and his wife attended the company holiday party for CNL employees and their spouses. Jerry McNulty, whose wife was ill and could not come to the party, arrived drunk from a meeting with Stiles’ upper management. During the party McNulty made inappropriate advances toward many of the female employees and joked about the inadequacies of Stiles’ managers.

Has Bracco violated any soft dollar standards regarding the Carobilo family trust? Bracco has:
A . violated soft dollar standards because he did not satisfy the requirement of best execution.
B . violated the soft dollar standards because client brokerage is to be used only for research purposes to benefit the client.
C . not violated any soft dollar standards since Carobilo directed the trades to a specific broker.

View Answer

Answer: C

Explanation:

Bracco has not violated any soft dollar standards. This is an example of client-directed brokerage where the client, in this case Stephen Carobilo, is allowed to direct the investment manager to use a specific broker to execute trades. Moreover, one could take the view that the client benefits in the sense that Stephen Carobilo knows he is helping his friend at First Trades Brokerage by utilizing them as the broker. A commingled fund is a fund that is comprised of different client’s funds. (Study Session 1, LOS Lb)