CFA Institute Code of Ethics and Standards of Professional Conduct as told through the lens of J.C. Chandor’s Margin Call
Ethics never loses its relevance. It must be told and retold as, too often, the important lessons that it imparts individuals and institutions (un) willingly set aside. Ethical lapses can lead and have led to the irrevocable damage of a firm, its employees and clients. This is the theme of Margin Call, a story of a harried twenty four hour period during which an investment bank reckons with its fate due to a risk assessment of its balance sheet by one of its younger, but exceptionally bright traders. The film opened in theaters and became available On-Demand through cable television this past Friday 21 October, 2011. Herewith, a review of the film through the prism of the Code and Standards.
- Eric Dale (Stanley Tucci) is a senior risk manager who is unceremoniously terminated from his job at an investment bank. Dejected, he packs up his office and walks to the elevator with his personal belongings, escorted by security. At the elevator, he bids farewell to two junior analysts on his team, Peter Sullivan (Zachary Quinto) and Seth Bregman (Penn Badgly). Just before the elevator door closes, he asks Sullivan to look at something on which he had been working that resides on a flash drive, warning him to ‘be careful’. To which of the Code and Standards is Dale adhering?
I. Conflicts of Interest
II. Diligence and Reasonable Basis
III. Record Retention
V. Fair Dealing
1. II, V
2. II, III
3. II, III, IV
4. III, IV
Explanation: At this point in the film, we don’t know what is on the flash drive any more than we do the implications of ‘being careful’. Based upon Dale’s actions alone, it would appear that his activity conforms to Standard V INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS as he was exercising diligence and thoroughness on a particular project and was ensuring that what turns out to be a critical record is retained at the firm.
- Peter Sullivan decides to wrap up some work, staying later and foregoing the opportunity to have drinks with his colleagues. He eventually reviews the contents of the flash drive. The camera zooms in on his furrowed brow and look of increasing disbelief as he parses the numbers. Shocked at his discovery, he calls Seth and asks that he and their boss, Will Emerson, Head of Trading (Paul Bettany) return to the office immediately.. When they do, he shares his findings, namely, that for the past week to ten days, Value at Risk limits have been breached and that cumulative losses could well exceed the entire value of the firm. Moreover, the scenario that he uncovers through expanding upon the work of Eric Dale relates to the activities only of his trading floor, implying potentially greater losses on a firm-wide basis. With which Standard of Professional Conduct did Sullivan comply?
1. Duties to Clients-Loyalty, Prudence and Care
2. Duties to Employers-Loyalty
3. Conflicts of Interest-Disclosure of Conflicts
4. Integrity of Capital Markets
Explanation: the fact that Sullivan shares his research and conclusions with Emerson who, as we learn, brings in more senior management to vet his findings and plan how to deal with them demonstrates his loyalty to the firm as the standard “requires members and candidates to protect their firm by refraining from any conduct that would injure the firm, deprive it of profit, or deprive it of the member’s or candidate’s skills and ability.” Had Sullivan done nothing, either by not investigating the contents of the flash drive or by not acting upon his conclusions, he could well have violated this standard. Indeed, Sullivan’s loyalty, diligence and thoroughness result in an all-night strategy session where senior management weigh in on how to deal with these tidings the following trading day. Sarah Robertson (Demi Moore), the firm’s Chief Risk Officer, Sam Rogers (Kevin Spacey), Division Head, Jared Cohen (Simon Baker) and John Tuld (Jeremy Irons), the firm’s CEO display varying degrees of bewilderment and finger pointing as everyone attempts to plan his or her most advantageous exit from a soon-to-be listing ship.
- As successive members of senior management learn of Sullivan’s conclusions, they ask that he communicate “in English” when he shares his results, professing a lack of understanding of what the more junior analysts actually do. By their comments, what Standard(s) do these individuals appear to violate?
I. Duties to Clients-Loyalty, Prudence and Care
II. Duties to Employers-Responsibilities of Supervisors
III. Investment Analysis, Recommendations, and Actions
IV. Conflicts of Interest-Priority of Transactions
1. I, II, IV
2. I, II, III
3. I, IV
4. I, II
Explanation: while senior management is not wrong in asking for clarity in an explanation from a qualified, but more junior analyst, statements professing ignorance at the latter’s activities begs the question of whether proper supervision is taking place and, by implication, whether the client’s best interests are being served.
- John Tuld, the firm’s CEO is addressing the group at 4:00 A.M. Peter Sullivan has reviewed the implication of the firm’s trading positions, offering a rather bleak assessment. Tuld and senior management discuss how to deal with the firm’s book. He and Rogers engages in a heated discussion of the implications of unwinding a substantial portion of the mortgage backed securities on the company’s balance sheet.
SAM ROGERS: John, let’s just say we pull that off, which is saying something... the real
question is... who are we selling this to?
JOHN TULD: The same people you’ve been selling this to for the last two years... and whoever else will buy it.
SAM ROGERS: If you do this you’ve killed that market for years. It’s over.
JOHN TULD (Nods.)
SAM ROGERS: And you are selling something you know
has no value.
JOHN TULD (cuts him off cold): We are selling to willing buyers at a
current fair market price, so that WE may survive, Sam.
Which of the following Standards of Professional Conduct would be violated if the traders proceed with the proposed course of action?
I. Integrity of Capital Markets – Market Manipulation
II. Duties to Clients – Loyalty, Prudence, and Care/Fair Dealing/Suitability
III. Investment Analysis, Recommendations, and Actions – Diligence and Reasonable Basis
IV. Professionalism – Independence and Objectivity/Misrepresentation/Misconduct
1. II, IV
2. II, III, IV
3. I, II, III, IV
Explanation: Tuld is putting the interests of the firm before those of its clients. As the viewer learns, the traders execute the strategy planned in the small hours, initiating a wave of selling which becomes ever more difficult as the day progresses and the rest of the market learns of what is happening. As to market manipulation, selling hard to value securities is a case of transaction-based manipulation “where the member or candidate knew or should have known that his or her actions could very well affect the pricing of a security.” Over the course of the trading day, bid/offer spreads widen. Clearly, this conduct lacks reasonable basis, independence and objectivity. The interests of the client are not being addressed, the suitability of the trades is questionable at best and representative of misconduct at worst. The reputational damage, as Rogers clearly states, is irrevocable.
Unlike Too Big To Fail which views the financial market boondoggle of 2008 at the public policy level or Wall Street 2: Money Never Sleeps which situates the reemergence of a rogue trader in the same historical context, Margin Call treats the subject matter at the firm level and is a case study in the misapplication of the Code and Standards. Indeed, misalignment of incentives is common. Talk of compensation peppers the dialog. Rogers motivates the traders with the carrot of a $1.4M bonus if they achieve a 93% or greater close ratio with their clients and an additional $1.3M bonus if the floor achieves this target. In a telling discussion between Rogers and Tuld at the conclusion of the trading day in the executive dining room, Tuld holds forth on the many market crashes over history (1637, 1798, 1819, 1837, 1857, 1884, 1901, 1907, 1929, 1937, 1974, 1987, 1992, 1997, 2000 and the present debacle), driving home the cyclicality of finance and that “we just can’t help ourselves”. Indeed, he echoes an earlier conversation between Emerson and Bregman about how the industry’s packaging of all manner of MBS feeds the man in the street’s frenzy for spending what they don’t have (e.g. inflating house prices so as to make them into a virtual bank account in the form of a home equity loan). The players appear to rationalize their behavior, but do have a point. The average person was to a degree complicit in the housing bubble. So lucrative was it that proper perspective was lost. That is a key take-away of Margin Call. Viewers of all levels of sophistication will appreciate and learn from the ethical implications of the film. Even if you sooner associate tranche with a pissaladière than with a mortgage backed security, you will find it a good view.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: While this article is a review of a movie that deals with risk management and complex credit investments, I personally have no investments in any securitized products.