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Jacques Lepage, CFA, is a portfolio manager for MontBlanc Securities and holds 4 million shares of AirCon in client portfolios. Lepage issues periodic research reports on AirCon to both discretionary and nondiscretionary accounts. In his October investment report, Lepage stated, "In my opinion, AirCon is entering a phase, which could put it ‘in play’ as a takeover target. Nonetheless, this possibility appears to be fully reflected in the market value of the stock."

Jacques Lepage, CFA, is a portfolio manager for MontBlanc Securities and holds 4 million shares of AirCon in client portfolios. Lepage issues periodic research reports on AirCon to both discretionary and nondiscretionary accounts. In his October investment report, Lepage stated, "In my opinion, AirCon is entering a phase, which could put it ‘in play’ as a takeover target. Nonetheless, this possibility appears to be fully reflected in the market value of the stock."

One month has passed since Lepage’s October report and AirCon has just announced the firm’s executive compensation packages, which include stock options (50% of which expire in one year), personal use of corporate aircraft (which can be used in conjunction with paid vacation days), and a modest base salary that constitutes a small proportion of the overall package. While he has not asked, he believes that the directors of MontBlanc will find the compensation excessive and sells the entire position immediately after the news. Unbeknownst to Lepage, three days earlier an announcement was made via Reuters and other financial news services that AirCon had produced record results that were far beyond expectations. Moreover, the firm has established a dominant position in a promising new market that is expected to generate above-average firm growth for the next five years.

A few weeks after selling the AirCon holdings, Lepage bought 2.5 million shares of Spectra Vision over a period of four days. The typical trading volume of this security is about 1.3 million shares per day, and his purchases drove the price up 9% over the 4-day period. These trades were designated as appropriate for 13 accounts of differing sizes, including performance-based accounts, charitable trusts, and private accounts. The shares were allocated to the accounts on a pro rata basis at the end of each day at the average price for the day.

One of the investment criteria used in evaluating equity holdings is the corporate governance structure of the issuing company. Because Lepage has dealt with this topic extensively, he has been asked to present a talk of corporate governance issues to the firm’s portfolio managers and analysts at the next monthly meeting. At the meeting, Lepage makes the following comments:

"When evaluating the corporate governance policies of a company, you should begin by assessing the responsibilities of the company’s board of directors. In general, the board should have the responsibility to set long-term objectives that are consistent with shareholders’ interests. In addition, the board must be responsible for hiring the CEO and setting his or her compensation package such that the CEO’s interests are aligned with those of the shareholders. In that way the board can spend its time on matters other than monitoring the CEO. A firm with good corporate governance policies should also have an audit committee made up of independent board members that are experienced in auditing and related legal matters. The audit committee should have full access to the firm’s financial statements and the ability to question auditors hired by the committee."

Determine whether Lepage’s statements in his presentation to MontBlanc’s portfolio managers and analysts regarding the responsibilities of the board of directors and the audit committee are correct or incorrect.
A . Only the statement regarding the board is correct.
B . Only the statement regarding the audit committee is correct.
C . Both statements are correct or both statements are incorrect.

Answer: B

Explanation:

Lepage’s first statement is incorrect- While it is a noble goal for a board to structure management compensation packages to align the managers’ interests with those of the shareholders, best practices in corporate governance dictate that the board must continue to evaluate the effectiveness of management in managing the firm in accordance with shareholders’ interests. Lepage’s second statement is correct. Good corporate governance practices provide the audit committee independence from firm management and the authority to hire an auditor and scrutinize the auditor’s work, including any financial statements produced internally. (Study Session 1, LOS 1.b)

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