CFAI 1- Ethics and Standards Flashcards
Can you help with advice your friend or neighbour to manage his portfolio when you have a contract?
YES you can if you don’t receive any compensation, if you do you need to ask a permission to both your employers. é permitido trabalhar num negócio da concorrência se for divulgado por escrito para o empregador e para o novo beneficiário do trabalho do membro se ambos concordarem com os termos.
Can we accept in any situation gifts or money?
Yes if the member informs his or her employer in writing. FULL disclosure is a guiding principle in many standards. Computer email is an acceptable format for disclosure .
What should professionals recommendations be based on to avoid violations?
1- their firm research
2- another person research, where conclusions are based on research complying with the standard of diligence,thoroughness
3- research prepared for general distribution by a bank or brokerage
4-quantitative methods
Is it imperative that a research discloses all the methods used etc on the paper?
No, the clients may request it to the bank or brokerage
The Six Components to the Code of Ethics
A Act with integrity, competence, diligence, respect, and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets.
P Place the integrity of the investment profession and the interests of clients above their own personal interests.
J Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions, and engaging in other professional activities.
E Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession.
R Promote the integrity of, and uphold the rules governing, capital markets.
M Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.
PEJMAR
Priority - Your client’s interests always come first.
Encourage - Practice and encourage others to act professionally and ethically to reflect credit on yourself and the profession.
Judgment - use reasonable care and judgment when performing all professional activities.
Maintain - keep your knowledge up to date and encourage other professionals to do the same.
Actions - employ integrity, competence, diligence, and respect in an ethical manner with everyone.
Rules - promote the integrity of capital markets by following the rules.
The Standards of Professional Conduct
I. Professionalism
II. Integrity of Capital Markets
III. Duties to Clients and Prospective Clients
IV. Duties to Employers
V. Investment Analysis, Recommendations, and Action
VI. Conflicts of Interest
VII. Responsibilities as a CFA Institute Member or CFA Candidate
Let’s say an analyst resides in a country where securities laws are less strict and conducts business in a country where the laws are stricter. Now assume the analyst is a CFA charterholder, meaning he or she is bound by the Code and Standards. Which laws and standards apply?
Rule of Thumb: When applicable law is stricter than the Code and Standards, members and candidates must adhere to applicable law. If conduct is governed by local laws that are less strict than the Standards, members and candidates must adhere to the Code and Standards.
Max value of gift that a member can accept without a full disclousure?
The Handbook suggests that members may accept modest gifts, which it specifically defines as being anything worth less than US$100, as long as they do not affect objectivity.
When information is disclosed selectively, i.e. just to a handful of investment analysts, or perhaps on a conference call, or in an email, the information may still be regarded as nonpublic?
When information is disclosed selectively, i.e. just to a handful of investment analysts, or perhaps on a conference call, or in an email, the information may still be regarded as nonpublic. Companies are bound by specific procedures designed to make the information truly public and to ensure a system of fairness in which all market participants are given a chance to act on the information.
Questions on the exam are likely to address a CFA member’s fiduciary duty to, for example, act in the best interests of pension fund holders, and whether the member is really doing his or her duty if he or she doesn’t trade on insider information
However, the guiding principle is that a CFA member’s duty to the investing public (by not acting on inside information) is greater than other duties.
Mosaic Theory
A securities analyst will be motivated to identify mispriced stocks and will be gathering information to such an extent that exposure to nonpublic information is a possibility. However, the work of an analyst depends on the free flow of information. As a defense to a charge that nonpublic information is being used to trade on a stock, the mosaic theory suggests that the analysis of a company form a mosaic; that is, by assembling small bits of nonpublic information together, large and meaningful conclusions can be drawn. The idea behind the mosaic theory is that each individual piece of information is nonmaterial by itself: an individual piece of information would not move the price of the security if disseminated in a public press release. Taken together, however, the bits of information can form a meaningful mosaic. This practice is perfectly legitimate, and it is encouraged.
Think of the mosaic theory as a way for analysts to do their jobs and use nonpublic information without feeling like they are at risk for liability under insider trading law. On the exam, hypothetical examples will carry identifying words - i.e. “material” or “nonmaterial” - to guide you to the right answer (material: trading restricted, non-material: no trading restrictions).
Firewalls
“Firewall” is a common term applied to the barriers created to prevent sensitive information from being disseminated between departments of a firm. As applied to insider trading, the assumption is that certain departments (e.g. corporate underwriting) may have access to material nonpublic information that would be useful to those in other departments (e.g. investment management and research). The guiding principle is that only certain individuals need to know certain things, and thus no one else should have any access
Minimum elements of a corporate firewall:
Segregation of Personnel - Someone involved with investment banking should not be doing research and trading, and vice versa.
Confinement of Material Nonpublic Information - Employees have access only on a need-to-know basis.
Control of Interdepartmental Communications - The compliance or legal functions of a firm might serve as a clearing house through which all interdepartmental memoranda are sent.
Monitoring of Employee Trading - Those with particularly sensitive jobs might be required to pre-clear, that is, to receive permission in advance.
Restricted List - The creation and maintenance of a restricted list can help limit employee trading as needed.
Heightened Restrictions under Certain Conditions - For example, additional restrictions might be placed when material nonpublic information is received in the course of underwriting a new preferred stock placement.
How a broker or advisor proceeds with a hot issue (an IPO that trades at a premium in the secondary market, due to an imbalance of demand for the issue) is of particular importance, because with hot issues the broker is basically handing the recipients an automatic profit. CAN THE MEMBER JOIN AN IPO THAT IS OVERSUBSCRIBED?
On the exam, be prepared for questions looking at cases in which an IPO is oversubscribed. This means that more shares have been requested than the broker has available. If this situation comes up, know the term “pro rata”. This term is a Latin phrase meaning “in proportion”. With an oversubscribed IPO, a broker would allocate shares pro rata based on a fair allocation system. It’s also very important to remember that the CFA member is obligated to forego shares for personal use (or the use of immediate family) in order to uphold a standard to place client interests first.
Given that a pro rata procedure process is not always practical, the best way to comply with the Standard would be to select IPO participants at random from the entire client list and to establish a cycle where everyone must participate once before being chosen again.
Members and Candidates must keep information about current, former and prospective clients confidential unless:
the information concerns illegal activities on the part of the client or prospective client,
disclosure is required by law, or the client or prospective client permits disclosure of this information.
Disclosure
In cases where local rules and regulations differ with the GIPS:
- firms are strongly encouraged to comply with GIPS standards in addition to any local standards;
- firms must disclose all conflicts between GIPS and local, in its notes accompanying the performance summary;
- complying with local standards does not necessarily mean that a firm has complied with GIPS.
Jonathan Hollis is an analyst of oil-and-gas companies for Specialty Investment Management. He is currently recommending the purchase of ABC Oil Company shares and has published a long, well-thought-out research report to substantiate his recommendation. Several weeks after publishing the report, Hollis receives a call from the investor-relations office of ABC Oil saying that Thomas Andrews, CEO of the company, saw the report and really liked the analyst’s grasp of the business and his company. The investor-relations officer invites Hollis to visit ABC Oil to discuss the industry further. ABC Oil offers to send a company plane to pick Hollis up and arrange for his accommodations while visiting. Hollis, after gaining the appropriate approvals, accepts the meeting with the CEO but declines the offered travel arrangements.
Several weeks later, Andrews and Hollis meet to discuss the oil business and Hollis’s report. Following the meeting, Hollis joins Andrews and the investment relations officer for dinner at an upscale restaurant near ABC Oil’s headquarters.
Upon returning to Specialty Investment Management, Hollis provides a full review of the meeting to the director of research, including a disclosure of the dinner attended.
Comment: Hollis’s actions did not violate Standard IV(B). Through gaining approval before accepting the meeting and declining the offered travel arrangements, Hollis sought to avoid any potential conflicts of interest between his company and ABC Oil. Because the location of the dinner was not available prior to arrival and Hollis notified his company of the dinner upon his return, accepting the dinner should not impair his objectivity. By disclosing the dinner, Hollis has enabled Specialty Investment Management to assess whether it has any impact on future reports and recommendations by Hollis related to ABC Oil.
Deion Miller is the research director for Jamestown Investment Programs. The portfolio managers have become critical of Miller and his staff because the Jamestown portfolios do not include any stock that has been the subject of a merger or tender offer. Georgia Ginn, a member of Miller’s staff, tells Miller that she has been studying a local company, Excelsior, Inc., and recommends its purchase. Ginn adds that the company has been widely rumored to be the subject of a merger study by a well-known conglomerate and discussions between them are under way. At Miller’s request, Ginn prepares a memo recommending the stock. Miller passes along Ginn’s memo to the portfolio managers prior to leaving for vacation, and he notes that he has not reviewed the memo. As a result of the memo, the portfolio managers buy Excelsior stock immediately. The day Miller returns to the office, he learns that Ginn’s only sources for the report were her brother, who is an acquisitions analyst with Acme Industries, the “well-known conglomerate,” and that the merger discussions were planned but not held.
Comment: Miller violated Standard IV(C) by not exercising reasonable supervision when he disseminated the memo without checking to ensure that Ginn had a reasonable and adequate basis for her recommendations and that Ginn was not relying on material nonpublic information.
Evelyn Mastakis is a junior analyst who has been asked by her firm to write a research report predicting the expected interest rate for residential mortgages over the next six months. Mastakis submits her report to the fixed-income investment committee of her firm for review, as required by firm procedures. Although some committee members support Mastakis’s conclusion, the majority of the committee disagrees with her conclusion, and the report is significantly changed to indicate that interest rates are likely to increase more than originally predicted by Mastakis. Should Mastakis ask that her name be taken off the report when it is disseminated?
Comment: The results of research are not always clear, and different people may have different opinions based on the same factual evidence. In this case, the committee may have valid reasons for issuing a report that differs from the analyst’s original research. The firm can issue a report that is different from the original report of an analyst as long as there is a reasonable and adequate basis for its conclusions.
Generally, analysts must write research reports that reflect their own opinion and can ask the firm not to put their name on reports that ultimately differ from that opinion. When the work is a group effort, however, not all members of the team may agree with all aspects of the report. Ultimately, members and candidates can ask to have their names removed from the report, but if they are satisfied that the process has produced results or conclusions that have a reasonable and adequate basis, members and candidates do not have to dissociate from the report even when they do not agree with its contents. If Mastakis is confident in the process, she does not need to dissociate from the report even if it does not reflect her opinion.
With respect to the Global Investment Performance Standards, which of the following is one of the nine sections containing investment performance provisions?
A.Real Estate.
B.Derivatives.
C.Legal and Ethical Considerations.
A
•Fundamentals of Compliance: Several core principles create the foundation for the GIPS standards, including properly defining the firm, providing compliant presentations to all prospective clients, adhering to applicable laws and regulations, and ensuring that information presented is not false or misleading. Two important issues that a firm must consider when becoming compliant with the GIPS standards are the definition of the firm and the firm’s definition of discretion. The definition of the firm is the foundation for firm-wide compliance and creates defined boundaries whereby total firm assets can be determined. The firm’s definition of discretion establishes criteria to judge which portfolios must be included in a composite and is based on the firm’s ability to implement its investment strategy.
- Input Data: Consistency of input data used to calculate performance is critical to effective compliance with the GIPS standards and establishes the foundation for full, fair, and comparable investment performance presentations. For periods beginning on or after 1 January 2011, all portfolios must be valued in accordance with the definition of fair value and the GIPS Valuation Principles.
- Calculation Methodology: Achieving comparability among investment management firms’ performance presentations requires uniformity in methods used to calculate returns. The GIPS standards mandate the use of certain calculation methodologies to facilitate comparability.
- Composite Construction: A composite is an aggregation of one or more portfolios managed according to a similar investment mandate, objective, or strategy. The composite return is the asset-weighted average of the performance of all portfolios in the composite. Creating meaningful composites is essential to the fair presentation, consistency, and comparability of performance over time and among firms.
- Disclosure: Disclosures allow firms to elaborate on the data provided in the presentation and give the reader the proper context in which to understand the performance. To comply with the GIPS standards, firms must disclose certain information in all compliant presentations regarding their performance and the policies adopted by the firm. Although some disclosures are required for all firms, others are specific to certain circumstances and may not be applicable in all situations. Firms are not required to make negative assurance disclosures (e.g., if the firm does not use leverage in a particular composite strategy, no disclosure of the use of leverage is required). One of the essential disclosures for every firm is the claim of compliance. Once a firm meets all the requirements of the GIPS standards, it must appropriately use the claim of compliance to indicate compliance with the GIPS standards. The 2010 edition of the GIPS standards includes a revised compliance statement that indicates if the firm has or has not been verified.
- Presentation and Reporting: After constructing the composites, gathering the input data, calculating returns, and determining the necessary disclosures, the firm must incorporate this information in presentations based on the requirements in the GIPS standards for presenting investment performance. No finite set of requirements can cover all potential situations or anticipate future developments in investment industry structure, technology, products, or practices. When appropriate, firms have the responsibility to include in GIPS-compliant presentations information not addressed by the GIPS standards.
- Real Estate: Unless otherwise noted, this section supplements all of the required and recommended provisions in Sections 0–5. Real estate provisions were first included in the 2005 edition of the GIPS standards and became effective 1 January 2006. The 2010 edition of the GIPS standards includes new provisions for closed-end real estate funds. Firms should note that certain provisions of Sections 0–5 do not apply to real estate investments or are superseded by provisions within Section 6. The provisions that do not apply have been noted within Section 6.
- Private Equity: Unless otherwise noted, this section supplements all of the required and recommended provisions in Sections 0–5. Private equity provisions were first included in the 2005 edition of the GIPS standards and became effective 1 January 2006. Firms should note that certain provisions in Sections 0–5 do not apply to private equity investments or are superseded by provisions within Section 7. The provisions that do not apply have been noted within Section 7.
- Wrap Fee/Separately Managed Account (SMA) Portfolios: Unless otherwise noted, this section supplements all of the required and recommended provisions in Sections 0–5. Firms should note that certain provisions in Sections 0–5 of the GIPS standards do not apply to wrap fee/SMA portfolios or are superseded by provisions within Section 8. The provisions that do not apply have been noted within Section 8.
According to the Fundamentals of Compliance section of the Global Investment Performance Standards, issues that a firm must consider when claiming compliance include all of the following except:
A.replicating performance.
B.properly defining the firm.
C.documenting firm policies and procedures used in establishing and maintaining compliance with the Standards.
Resposta A
Fundamentals of Compliance—Requirements
0.A.1
Firms must comply with all the requirements of the GIPS standards, including any updates, Guidance Statements, interpretations, Questions & Answers (Q&As), and clarifications published by CFA Institute and the GIPS Executive Committee, which are available on the GIPS standards website (www.gipsstandards.org) as well as in the GIPS Handbook.
0.A.2
Firms must comply with all applicable laws and regulations regarding the calculation and presentation of performance.
0.A.3
Firms must not present performance or performance-related information that is false or misleading.
0.A.4
The GIPS standards must be applied on a firm-wide basis.
0.A.5
Firms must document their policies and procedures used in establishing and maintaining compliance with the GIPS standards, including ensuring the existence and ownership of client assets, and must apply them consistently.
0.A.6
If the firm does not meet all the requirements of the GIPS standards, the firm must not represent or state that it is “in compliance with the Global Investment Performance Standards except for . . .” or make any other statements that may indicate partial compliance with the GIPS standards.
0.A.7
Statements referring to the calculation methodology as being “in accordance,” “in compliance,” or “consistent” with the Global Investment Performance Standards, or similar statements, are prohibited.
0.A.8
Statements referring to the performance of a single, existing client portfolio as being “calculated in accordance with the Global Investment Performance Standards” are prohibited, except when a GIPS-compliant firm reports the performance of an individual client’s portfolio to that client.
0.A.9
Firms must make every reasonable effort to provide a compliant presentation to all prospective clients. Firms must not choose to whom they present a compliant presentation. As long as a prospective client has received a compliant presentation within the previous 12 months, the firm has met this requirement.
0.A.10
Firms must provide a complete list of composite descriptions to any prospective client that makes such a request. Firms must include terminated composites on the firm’s list of composite descriptions for at least five years after the composite termination date.
0.A.11
Firms must provide a compliant presentation for any composite listed on the firm’s list of composite descriptions to any prospective client that makes such a request.
0.A.12
Firms must be defined as an investment firm, subsidiary, or division held out to clients or prospective clients as a distinct business entity.
0.A.13
For periods beginning on or after 1 January 2011, total firm assets must be the aggregate fair value of all discretionary and non-discretionary assets managed by the firm. This includes both fee-paying and non-fee-paying portfolios.1
0.A.14
Total firm assets must include assets assigned to a sub-advisor provided the firm has discretion over the selection of the sub-advisor.
0.A.15
Changes in a firm’s organization must not lead to alteration of historical composite performance.
0.A.16
When the firm jointly markets with other firms, the firm claiming compliance with the GIPS standards must be sure that it is clearly defined and separate relative to other firms being marketed, and that it is clear which firm is claiming compliance.
FUNDAMENTALS OF COMPLIANCE RECOMMENDATIONS
0.B.1
Firms should comply with the recommendations of the GIPS standards, including recommendations in any updates, Guidance Statements, interpretations, Questions & Answers (Q&As), and clarifications published by CFA Institute and the GIPS Executive Committee, which will be made available on the GIPS website (www.gipsstandards.org) as well as in the GIPS Handbook.
0.B.2
Firms should be verified.
0.B.3
Firms should adopt the broadest, most meaningful definition of the firm. The scope of this definition should include all geographical (country, regional, etc.) offices operating under the same brand name regardless of the actual name of the individual investment management company.
0.B.4
Firms should provide to each existing client, on an annual basis, a compliant presentation of the composite in which the client’s portfolio is included.
G&F Advisors claims compliance with the Global Investment Performance Standards (GIPS) in its marketing materials. The compliant presentation includes a footnote which indicates that the firm has been verified by an independent third party. An additional note states that G&F is in compliance with the GIPS standards except for its private equity investments. It is likely that G&F violated the GIPS standards?
A.No, because the footnotes meet the requirements of the Standards.
B.No, because the provisions do not apply to the private equity investments.
C.Yes, because they cannot claim compliance unless all requirements of the Standard are met.
C is correct. Firms must meet all the requirements set forth in the GIPS standards and cannot claim partial compliance.
Smith, a research analyst with a brokerage firm, decides to change his recommendation for the common stock of Green Company, Inc., from a “buy” to a “sell.” He mails this change in investment advice to all the firm’s clients on Wednesday. The day after the mailing, a client calls with a buy order for 500 shares of Green Company. In this circumstance, Smith should:
A.Accept the order.
B.Advise the customer of the change in recommendation before accepting the order.
C.Not accept the order because it is contrary to the firm’s recommendation.
The correct answer is B. This question involves Standard III(B)–Fair Dealing. Smith disseminated a change in the stock recommendation to his clients but then received a request contrary to that recommendation from a client who probably had not yet received the recommendation. Prior to executing the order, Smith should take additional steps to ensure that the customer has received the change of recommendation. Answer A is incorrect because the client placed the order prior to receiving the recommendation and, therefore, does not have the benefit of Smith’s most recent recommendation. Answer C is also incorrect; simply because the client request is contrary to the firm’s recommendation does not mean a member can override a direct request by a client. After Smith contacts the client to ensure that the client has received the changed recommendation, if the client still wants to place a buy order for the shares, Smith is obligated to comply with the client’s directive.
Jamison is a junior research analyst with Howard & Howard, a brokerage and investment banking firm. Howard & Howard’s mergers and acquisitions department has represented the Britland Company in all of its acquisitions for the past 20 years. Two of Howard & Howard’s senior officers are directors of various Britland subsidiaries. Jamison has been asked to write a research report on Britland. What is the best course of action for her to follow?
A.Jamison may write the report but must refrain from expressing any opinions because of the special relationships between the two companies.
B.Jamison should not write the report because the two Howard & Howard officers serve as directors for subsidiaries of Britland.
C.Jamison may write the report if she discloses the special relationships with the company in the report.
The correct answer is C. This question involves Standard VI(A)–Disclosure of Conflicts. The question establishes a conflict of interest in which an analyst, Jamison, is asked to write a research report on a company that is a client of the analyst’s employer. In addition, two directors of the company are senior officers of Jamison’s employer. Both facts establish that there are conflicts of interest that must be disclosed by Jamison in her research report. Answer B is incorrect because an analyst is not prevented from writing a report simply because of the special relationship the analyst’s employer has with the company as long as that relationship is disclosed. Answer A is incorrect because whether or not Jamison expresses any opinions in the report is irrelevant to her duty to disclose a conflict of interest. Not expressing opinions does not relieve the analyst of the responsibility to disclose the special relationships between the two companies.
Bronson provides investment advice to the board of trustees of a private university endowment fund. The trustees have provided Bronson with the fund’s financial information, including planned expenditures. Bronson receives a phone call on Friday afternoon from Murdock, a prominent alumnus, requesting that Bronson fax him comprehensive financial information about the fund. According to Murdock, he has a potential contributor but needs the information that day to close the deal and cannot contact any of the trustees. Based on the CFA Institute Standards, Bronson should:
A.Send Murdock the information because disclosure would benefit the client.
B.Not send Murdock the information to preserve confidentiality.
C.Send Murdock the information, provided Bronson promptly notifies the trustees.
The correct answer is B. This question relates to Standard III(A)–Loyalty, Prudence, and Care and Standard III(E)–Preservation of Confidentiality. In this case, the member manages funds of a private endowment. Clients, who are, in this case, the trustees of the fund, must place some trust in members and candidates. Bronson cannot disclose confidential financial information to anyone without the permission of the fund, regardless of whether the disclosure may benefit the fund. Therefore, answer A is incorrect. Answer C is incorrect because Bronson must notify the fund and obtain the fund’s permission before publicizing the information.
Willier is the research analyst responsible for following Company X. All the information he has accumulated and documented suggests that the outlook for the company’s new products is poor, so the stock should be rated a weak “hold.” During lunch, however, Willier overhears a financial analyst from another firm whom he respects offer opinions that conflict with Willier’s forecasts and expectations. Upon returning to his office, Willier releases a strong “buy” recommendation to the public. Willier:
A.Violated the Standards by failing to distinguish between facts and opinions in his recommendation.
B.Violated the Standards because he did not have a reasonable and adequate basis for his recommendation.
C.Was in full compliance with the Standards.
The correct answer is B. This question relates to Standard V(A)–Diligence and Reasonable Basis. The opinion of another financial analyst is not an adequate basis for Willier’s action in changing the recommendation. Answer C is thus incorrect. So is answer A because, although it is true that members and candidates must distinguish between facts and opinions in recommendations, the question does not illustrate a violation of that nature. If the opinion overheard by Willier had sparked him to conduct additional research and investigation that justified a change of opinion, then a changed recommendation would be appropriate.
Albert and Tye, who recently started their own investment advisory business, have registered to take the Level III CFA examination. Albert’s business card reads, “Judy Albert, CFA Level II.” Tye has not put anything about the CFA designation on his business card, but promotional material that he designed for the business describes the CFA requirements and indicates that Tye participates in the CFA Program and has completed Levels I and II. According to the Standards:
A.Albert has violated the Standards, but Tye has not.
B.Tye has violated the Standards, but Albert has not.
C.Both Albert and Tye have violated the Standards.
The correct answer is A. Standard VII(B)–Reference to CFA Institute, the CFA Designation, and the CFA Program is the subject of this question. The reference on Albert’s business card implies that there is a “CFA Level II” designation; Tye merely indicates in promotional material that he is participating in the CFA Program and has completed Levels I and II. Candidates may not imply that there is some sort of partial designation earned after passing a level of the CFA exam. Therefore, Albert has violated Standard VII(B). Candidates may communicate that they are participating in the CFA Program, however, and may state the levels that they have completed. Therefore, Tye has not violated Standard VII(B).
•Which one of the following actions will help to ensure the fair treatment of brokerage firm clients when a new investment recommendation is made?
A.Informing all people in the firm in advance that a recommendation is to be disseminated.
B.Distributing recommendations to institutional clients prior to individual accounts.
C.Minimizing the time between the decision and the dissemination of a recommendation.
•The correct answer is C. This question, which relates to Standard III(B)–Fair Dealing, tests the knowledge of the procedures that will assist members and candidates in treating clients fairly when making investment recommendations. The step listed in C will help ensure the fair treatment of clients. Answer A may have negative effects on the fair treatment of clients. The more people who know about a pending change, the greater the chance that someone will inform some clients before the information’s release. The firm should establish policies that limit the number of people who are aware in advance that a recommendation is to be disseminated. Answer B, distributing recommendations to institutional clients before distributing them to individual accounts, discriminates among clients on the basis of size and class of assets and is a violation of Standard III(B).
•The mosaic theory holds that an analyst:
A.Violates the Code and Standards if the analyst fails to have knowledge of and comply with applicable laws.
B.Can use material public information and nonmaterial nonpublic information in the analyst’s analysis.
C.Should use all available and relevant information in support of an investment recommendation.
•The correct answer is B. This question deals with Standard II(A)–Material Nonpublic Information. The mosaic theory states that an analyst may use material public information and nonmaterial nonpublic information in creating a larger picture than shown by any individual piece of information and the conclusions the analyst reaches become material only after the pieces are assembled. Answers A and C are accurate statements relating to the Code and Standards but do not describe the mosaic theory.
•Jurgen is a portfolio manager. One of her firm’s clients has told Jurgen that he will compensate her beyond the compensation provided by her firm on the basis of the capital appreciation of his portfolio each year. Jurgen should:
A.Turn down the additional compensation because it will result in conflicts with the interests of other clients’ accounts.
B.Turn down the additional compensation because it will create undue pressure on her to achieve strong short-term performance.
C.Obtain permission from her employer prior to accepting the compensation arrangement.
•The correct answer is C. This question involves Standard IV(B)–Additional Compensation Arrangements. The arrangement described in the question—whereby Jurgen would be compensated beyond the compensation provided by her firm, on the basis of an account’s performance—is not a violation of the Standards as long as Jurgen discloses the arrangement in writing to her employer and obtains permission from her employer prior to entering into the arrangement. Answers A and B are incorrect; although the private compensation arrangement could conflict with the interests of other clients and lead to short-term performance pressures, members and candidates may enter into such agreements as long as they have disclosed the arrangements to their employer and obtained permission for the arrangement from their employer.
•One of the discretionary accounts managed by Farnsworth is the Jones Corporation employee profit-sharing plan. Jones, the company president, recently asked Farnsworth to vote the shares in the profit-sharing plan in favor of the slate of directors nominated by Jones Corporation and against the directors sponsored by a dissident stockholder group. Farnsworth does not want to lose this account because he directs all the account’s trades to a brokerage firm that provides Farnsworth with useful information about tax-free investments. Although this information is not of value in managing the Jones Corporation account, it does help in managing several other accounts. The brokerage firm providing this information also offers the lowest commissions for trades and provides best execution. Farnsworth investigates the director issue, concludes that the management-nominated slate is better for the long-run performance of the company than the dissident group’s slate, and votes accordingly. Farnsworth:
A.Violated the Standards in voting the shares in the manner requested by Jones but not in directing trades to the brokerage firm.
B.Did not violate the Standards in voting the shares in the manner requested by Jones or in directing trades to the brokerage firm.
C.Violated the Standards in directing trades to the brokerage firm but not in voting the shares as requested by Jones.
•The correct answer is B. This question relates to Standard III(A)–Loyalty, Prudence, and Care—specifically, a member’s or candidate’s responsibility for voting proxies and the use of client brokerage. According to the facts stated in the question, Farnsworth did not violate Standard III(A). Although the company president asked Farnsworth to vote the shares of the Jones Corporation profit-sharing plan a certain way, Farnsworth investigated the issue and concluded, independently, the best way to vote. Therefore, even though his decision coincided with the wishes of the company president, Farnsworth is not in violation of his responsibility to be loyal and to provide care to his clients. In this case, the participants and the beneficiaries of the profit-sharing plan are the clients, not the company’s management. Had Farnsworth not investigated the issue or had he yielded to the president’s wishes and voted for a slate of directors that he had determined was not in the best interest of the company, Farnsworth would have violated his responsibilities to the beneficiaries of the plan. In addition, because the brokerage firm provides the lowest commissions and best execution for securities transactions, Farnsworth has met his obligations to the client in using this brokerage firm. It does not matter that the brokerage firm also provides research information that is not useful for the account generating the commission because Farnsworth is not paying extra money of the client’s for that information.
•Grey recommends the purchase of a mutual fund that invests solely in long-term US Treasury bonds. He makes the following statements to his clients:
I.“The payment of the bonds is guaranteed by the US government; therefore, the default risk of the bonds is virtually zero.”
II.“If you invest in the mutual fund, you will earn a 10% rate of return each year for the next several years based on historical performance of the market.”
Did Grey’s statements violate the CFA Institute Code and Standards?
A.Neither statement violated the Code and Standards.
B.Only statement I violated the Code and Standards.
C.Only statement II violated the Code and Standards.
•The correct answer is C. This question involves Standard I(C)–Misrepresentation. Statement I is a factual statement that discloses to clients and prospects accurate information about the terms of the investment instrument. Statement II, which guarantees a specific rate of return for a mutual fund, is an opinion stated as a fact and, therefore, violates Standard I(C). If statement II were rephrased to include a qualifying statement, such as “in my opinion, investors may earn . . . ,” it would not be in violation of the Standards.
•Anderb, a portfolio manager for XYZ Investment Management Company—a registered investment organization that advises investment firms and private accounts—was promoted to that position three years ago. Bates, her supervisor, is responsible for reviewing Anderb’s portfolio account transactions and her required monthly reports of personal stock transactions. Anderb has been using Jonelli, a broker, almost exclusively for brokerage transactions for the portfolio account. For securities in which Jonelli’s firm makes a market, Jonelli has been giving Anderb lower prices for personal purchases and higher prices for personal sales than Jonelli gives to Anderb’s portfolio accounts and other investors. Anderb has been filing monthly reports with Bates only for those months in which she has no personal transactions, which is about every fourth month. Which of the following is most likely to be a violation of the Code and Standards?
A.Anderb failed to disclose to her employer her personal transactions.
B.Anderb owned the same securities as those of her clients.
C.Bates allowed Anderb to use Jonelli as her broker for personal trades.
•The correct answer is A. This question involves three of the Standards. Anderb, the portfolio manager, has been obtaining more favorable prices for her personal securities transactions than she gets for her clients, which is a breach of Standard III(A)–Loyalty, Prudence, and Care. In addition, she violated Standard I(D)–Misconduct by failing to adhere to company policy and by hiding her personal transactions from her firm. Anderb’s supervisor, Bates, violated Standard IV(C)–Responsibilities of Supervisors; although the company had requirements for reporting personal trading, Bates failed to adequately enforce those requirements. Answer B does not represent a violation because Standard VI(B)–Priority of Transactions requires that personal trading in a security be conducted after the trading in that security of clients and the employer. The Code and Standards do not prohibit owning such investments, although firms may establish policies that limit the investment opportunities of members and candidates. Answer C does not represent a violation because the Code and Standards do not contain a prohibition against employees using the same broker for their personal accounts that they use for their client accounts. This arrangement should be disclosed to the employer so that the employer may determine whether a conflict of interest exists.
Which of the following statements is correct under the Code and Standards?
A.CFA Institute members and candidates are prohibited from undertaking independent practice in competition with their employer.
B.Written consent from the employer is necessary to permit independent practice that could result in compensation or other benefits in competition with a member’s or candidate’s employer.
C.Members and candidates are prohibited from making arrangements or preparations to go into a competitive business before terminating their relationship with their employer.
The correct answer is B. Under Standard IV(A)–Loyalty, members and candidates may undertake independent practice that may result in compensation or other benefit in competition with their employer as long as they obtain consent from their employer. Answer C is not consistent with the Standards because the Standards allow members and candidates to make arrangements or preparations to go into competitive business as long as those arrangements do not interfere with their duty to their current employer. Answer A is not consistent with the Standards because the Standards do not include a complete prohibition against undertaking independent practice.
Michelieu tells a prospective client, “I may not have a long-term track record yet, but I’m sure that you’ll be very pleased with my recommendations and service. In the three years that I’ve been in the business, my equity-oriented clients have averaged a total return of more than 26% a year.” The statement is true, but Michelieu only has a few clients, and one of his clients took a large position in a penny stock (against Michelieu’s advice) and realized a huge gain. This large return caused the average of all of Michelieu’s clients to exceed 26% a year. Without this one investment, the average gain would have been 8% a year. Has Michelieu violated the Standards?
A.No, because Michelieu is not promising that he can earn a 26% return in the future.
B.No, because the statement is a true and accurate description of Michelieu’s track record.
C.Yes, because the statement misrepresents Michelieu’s track record.
The correct answer is C. This question relates to Standard I(C)–Misrepresentation. Although Michelieu’s statement about the total return of his clients’ accounts on average may be technically true, it is misleading because the majority of the gain resulted from one client’s large position taken against Michelieu’s advice. Therefore, this statement misrepresents the investment performance the member is responsible for. He has not taken steps to present a fair, accurate, and complete presentation of performance. Answer B is thus incorrect. Answer A is incorrect because although Michelieu is not guaranteeing future results, his words are still a misrepresentation of his performance history.
•Stewart has been hired by Goodner Industries, Inc., to manage its pension fund. Stewart’s duty of loyalty, prudence, and care is owed to:
A.The management of Goodner.
B.The participants and beneficiaries of Goodner’s pension plan.
C.The shareholders of Goodner.
•The correct answer is B. Under Standard III(A)–Loyalty, Prudence, and Care, members and candidates who manage a company’s pension fund owe these duties to the participants and beneficiaries of the pension plan, not the management of the company or the company’s shareholders.
•Which of the following statements is a stated purpose of disclosure in Standard VI(C)–Referral Fees?
A.Disclosure will allow the client to request discounted service fees.
B.Disclosure will help the client evaluate any possible partiality shown in the recommendation of services.
C.Disclosure means advising a prospective client about the referral arrangement once a formal client relationship has been established.
•The correct answer is B. Answer B gives one of the two primary reasons listed in the Handbook for disclosing referral fees to clients under Standard VI(C)–Referral Fees. (The other is to allow clients and employers to evaluate the full cost of the services.) Answer A is incorrect because Standard VI(C) does not require members or candidates to discount their fees when they receive referral fees. Answer C is inconsistent with Standard VI(C) because disclosure of referral fees, to be effective, should be made to prospective clients before entering into a formal client relationship with them.
•Rose, a portfolio manager for a local investment advisory firm, is planning to sell a portion of his personal investment portfolio to cover the costs of his child’s academic tuition. Rose wants to sell a portion of his holdings in Household Products, but his firm recently upgraded the stock to “strong buy.” Which of the following describes Rose’s options under the Code and Standards?
A.Based on his firm’s “buy” recommendation, Rose cannot sell the shares because he would be improperly prospering from the inflated recommendation.
B.Rose is free to sell his personal holdings once his firm is properly informed of his intentions.
C.Rose can sell his personal holdings but only when a client of the firm places an order to buy shares of Household.
•The correct answer is B. Standard VI(B)–Priority of Transactions does not limit transactions of company employees that differ from current recommendations as long as the sale does not disadvantage current clients. Thus, answer A is incorrect. Answer C is incorrect because the Standard does not require the matching of personal and client trades.
•A former hedge fund manager, Jackman, has decided to launch a new private wealth management firm. From his prior experiences, he believes the new firm needs to achieve US$1 million in assets under management in the first year. Jackman offers a $10,000 incentive to any adviser who joins his firm with the minimum of $200,000 in committed investments. Jackman places notice of the opening on several industry web portals and career search sites. Which of the following is correct according to the Code and Standards?
A.A member or candidate is eligible for the new position and incentive if he or she can arrange for enough current clients to switch to the new firm and if the member or candidate discloses the incentive fee.
B.A member or candidate may not accept employment with the new firm because Jackman’s incentive offer violates the Code and Standards.
C.A member or candidate is not eligible for the new position unless he or she is currently unemployed because soliciting the clients of the member’s or candidate’s current employer is prohibited.
•Answer C is correct. Standard IV(A)–Loyalty discusses activities permissible to members and candidates when they are leaving their current employer; soliciting clients is strictly prohibited. Thus, answer A is inconsistent with the Code and Standards even with the required disclosure. Answer B is incorrect because the offer does not directly violate the Code and Standards. There may be out-of-work members and candidates who can arrange the necessary commitments without violating the Code and Standards.
•Carter works for Invest Today, a local asset management firm. A broker that provides Carter with proprietary research through client brokerage arrangements is offering a new trading service. The broker is offering low-fee, execution-only trades to complement its traditional full-service, execution-and-research trades. To entice Carter and other asset managers to send additional business its way, the broker will apply the commissions paid on the new service toward satisfying the brokerage commitment of the prior full-service arrangements. Carter has always been satisfied with the execution provided on the full-service trades, and the new low-fee trades are comparable to the fees of other brokers currently used for the accounts that prohibit soft dollar arrangements.
A.Carter can trade for his accounts that prohibit soft dollar arrangements under the new low-fee trading scheme.
B.Carter cannot use the new trading scheme because the commissions are prohibited by the soft dollar restrictions of the accounts.
C.Carter should trade only through the new low-fee scheme and should increase his trading volume to meet his required commission commitment.
•Rule has worked as a portfolio manager for
•Answer A is correct. The question relates to Standard III(A)–Loyalty, Prudence, and Care. Carter believes the broker offers effective execution at a fee that is comparable with those of other brokers, so he is free to use the broker for all accounts. Answer B is incorrect because the accounts that prohibit soft dollar arrangements do not want to fund the purchase of research by Carter. The new trading scheme does not incur additional commissions from clients, so it would not go against the prohibitions. Answer C is incorrect because Carter should not incur unnecessary or excessive “churning” of the portfolios (excessive trading) for the purpose of meeting the brokerage commitments of soft dollar arrangements.
•Rule has worked as a portfolio manager for a large investment management firm for the past 10 years. Rule earned his CFA charter last year and has decided to open his own investment management firm. After leaving his current employer, Rule creates some marketing material for his new firm. He states in the material, “In earning the CFA charter, a highly regarded credential in the investment management industry, I further enhanced the portfolio management skills learned during my professional career. While completing the examination process in three consecutive years, I consistently received the highest possible scores on the topics of Ethics, Alternative Investments, and Portfolio Management.” Has Rule violated Standard VII(B)–Reference to CFA Institute, the CFA Designation, and the CFA Program in his marketing material?
A.Rule violated Standard VII(B) in stating that he completed the exams in three consecutive years.
B.Rule violated Standard VII(B) in stating that he received the highest scores in the topics of Ethics, Alternative Investments, and Portfolio Management.
C.Rule did not violate Standard VII(B).
•Answer B is correct according to Standard VII(B)–Reference to CFA Institute, the CFA Designation, and the CFA Program. CFA Program candidates do not receive their actual scores on the exam. Topic and subtopic results are grouped into three broad categories, and the exam is graded only as “pass” or “fail.” Although a candidate may have achieved a topical score of “above 70%,” she or he cannot factually state that she or he received the highest possible score because that information is not reported. Thus, answer C is incorrect. Answer A is incorrect as long as the member or candidate actually completed the exams consecutively. Standard VII(B) does not prohibit the communication of factual information about completing the CFA Program in three consecutive years.
•Stafford is a portfolio manager for a specialized real estate mutual fund. Her firm clearly describes in the fund’s prospectus its soft dollar policies. Stafford decides that entering the CFA Program will enhance her investment decision-making skill and decides to use the fund’s soft dollar account to pay the registration and exam fees for the CFA Program. Which of the following statements is most likely correct?
A.Stafford did not violate the Code and Standards because the prospectus informed investors of the fund’s soft dollar policies.
B.Stafford violated the Code and Standards because improving her investment skills is not a reasonable use of the soft dollar account.
C.Stafford violated the Code and Standards because the CFA Program does not meet the definition of research allowed to be purchased with brokerage commissions.
•Answer C is correct. According to Standard III(A)–Loyalty, Prudence, and Care, the CFA Program would be considered a personal or firm expense and should not be paid for with the fund’s brokerage commissions. Soft dollar accounts should be used only to purchase research services that directly assist the investment manager in the investment decision-making process, not to assist the management of the firm or to further education. Thus, answer A is incorrect. Answer B is incorrect because the reasonableness of how the money is used is not an issue; the issue is that educational expense is not research.
•Long has been asked to be the keynote speaker at an upcoming investment conference. The event is being hosted by one of the third-party investment managers currently used by his pension fund. The manager offers to cover all conference and travel costs for Long and make the conference registrations free for three additional members of his investment management team. To ensure that the conference obtains the best speakers, the host firm has arranged for an exclusive golf outing for the day following the conference on a local championship-caliber course. Which of the following is least likely to violate Standard I(B)?
A.Long may accept only the offer to have his conference-related expenses paid by the host firm.
B.Long may accept the offer to have his conference-related expenses paid and may attend the exclusive golf outing at the expense of the hosting firm.
C.Long may accept the entire package of incentives offered to speak at this conference.
•Answer A is correct. Standard I(B)–Independence and Objectivity emphasizes the need for members and candidates to maintain their independence and objectivity. Best practices dictate that firms adopt a strict policy not to accept compensation for travel arrangements. At times, however, accepting paid travel would not compromise one’s independence and objectivity. Answers B and C are incorrect because the added benefits—free conference admission for additional staff members and an exclusive golf retreat for the speaker—could be viewed as inducements related to the firm’s working arrangements and not solely related to the speaking engagement. Should Long wish to bring other team members or participate in the golf outing, he or his firm should be responsible for the associated fees.
•Andrews, a private wealth manager, is conducting interviews for a new research analyst for his firm. One of the candidates is Wright, an analyst with a local investment bank. During the interview, while Wright is describing his analytical skills, he mentions a current merger in which his firm is acting as the adviser. Andrews has heard rumors of a possible merger between the two companies, but no releases have been made by the companies concerned. Which of the following actions by Andrews is least likely a violation of the Code and Standards?
A.Waiting until the next day before trading on the information to allow time for it to become public.
B.Notifying all investment managers in his firm of the new information so none of their clients are disadvantaged.
C.Placing the securities mentioned as part of the merger on the firm’s restricted trading list.
•Answer C is correct. The guidance to Standard II(A)–Material Nonpublic Information recommends adding securities to the firm’s restricted list when the firm has or may have material nonpublic information. By adding these securities to this list, Andrews would uphold this standard. Because waiting until the next day will not ensure that news of the merger is made public, answer A is incorrect. Negotiations may take much longer between the two companies, and the merger may never happen. Andrews must wait until the information is disseminated to the market before he trades on that information. Answer B is incorrect because Andrews should not disclose the information to other managers; no trading is allowed on material nonpublic information.
•Pietro, president of Local Bank, has hired the bank’s market maker, Vogt, to seek a merger partner. Local is currently not listed on a stock exchange and has not reported that it is seeking strategic alternatives. Vogt has discussed the possibility of a merger with several firms, but they have all decided to wait until after the next period’s financial data are available. The potential buyers believe the results will be worse than the results of prior periods and will allow them to pay less for Local Bank.
Pietro wants to increase the likelihood of structuring a merger deal quickly. Which of the following actions would most likely be a violation of the Code and Standards?
A.Pietro could instruct Local Bank to issue a press release announcing that it has retained Vogt to find a merger partner.
B.Pietro could place a buy order for 2,000 shares (or four times the average weekly volume) through Vogt for his personal account.
C.After confirming with Local’s chief financial officer, Pietro could instruct Local to issue a press release reaffirming the firm’s prior announced earnings guidance for the full fiscal year.
Answer B is correct. Through placing a personal purchase order that is significantly greater than the average volume, Pietro is violating Standard IIB–Market Manipulation. He is attempting to manipulate an increase in the share price and thus bring a buyer to the negotiating table. The news of a possible merger and confirmation of the firm’s earnings guidance may also have positive effects on the price of Local Bank, but Pietro’s actions in instructing the release of the information does not represent a violation through market manipulation. Announcements of this nature are common and practical to keep investors informed. Thus, answers A and C are incorrect.
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•During a round of golf, Rodriguez, chief financial officer of Mega Retail, mentions to Hart, a local investment adviser and long-time personal friend, that Mega is having an exceptional sales quarter. Rodriguez expects the results to be almost 10% above the current estimates. The next day, Hart initiates the purchase of a large stake in the local exchange-traded retail fund for her personal account.
A.Hart violated the Code and Standards by investing in the exchange-traded fund that included Mega Retail.
B.Hart did not violate the Code and Standards because she did not invest directly in securities of Mega Retail.
C.Rodriguez did not violate the Code and Standards because the comments made to Hart were not intended to solicit an investment in Mega Retail.
Answer A is correct. Hart’s decision to invest in the retail fund appears directly correlated with Rodriguez’s statement about the successful quarter of Mega Retail and thus violates Standard II(A)–Material Nonpublic Information. Rodriguez’s information would be considered material because it would influence the share price of Mega Retail and probably influence the price of the entire exchange-traded retail fund. Thus, answer B is incorrect. Answer C is also incorrect because Rodriguez shared information that was both material and nonpublic. Company officers regularly have such knowledge about their firms, which is not a violation. The sharing of such information, however, even in a conversation between friends, does violate Standard II(A).
•Park is very frustrated after taking her Level II exam. While she was studying for the exam, to supplement the curriculum provided, she ordered and used study material from a third-party provider. Park believes the additional material focused her attention on specific topic areas that were not tested while ignoring other areas. She posts the following statement on the provider’s discussion board: “I am very dissatisfied with your firm’s CFA Program Level II material. I found the exam extremely difficult and myself unprepared for specific questions after using your product. How could your service provide such limited instructional resources on the analysis of inventories and taxes when the exam had multiple questions about them? I will not recommend your products to other candidates.”
A.Park violated the Code and Standards by purchasing third-party review material.
B.Park violated the Code and Standards by providing her opinion on the difficulty of the exam.
C.Park violated the Code and Standards by providing specific information on topics tested on the exam.
Answer C is correct. Standard VII(A)–Conduct as Members and Candidates in the CFA Program prohibits providing information to candidates or the public that is considered confidential to the CFA Program. In revealing that questions related to the analysis of inventories and analysis of taxes were on the exam, Park has violated this standard. Answer B is incorrect because the guidance for the standard explicitly acknowledges that members and candidates are allowed to offer their opinions about the CFA Program. Answer A is incorrect because candidates are not prohibited from using outside resources.
•Paper was recently terminated as one of a team of five managers of an equity fund. The fund had two value-focused managers and terminated one of them to reduce costs. In a letter sent to prospective employers, Paper presents, with written permission of the firm, the performance history of the fund to demonstrate his past success.
A.Paper did not violate the Code and Standards.
B.Paper violated the Code and Standards by claiming the performance of the entire fund as his own.
C.Paper violated the Code and Standards by including the historical results of his prior employer.
Answer B is correct. Paper has violated Standard III(D)–Performance Presentation by not disclosing that he was part of a team of managers that achieved the results shown. If he had also included the return of the portion he directly managed, he would not have violated the standard. Thus, answer A is incorrect. Answer C is incorrect because Paper received written permission from his prior employer to include the results.
Mosaic Theory
An analyst can collect information from various public sources and cross that information to create material information. He can trade on that non public material information if he is abble to explain how did he got that info from public non material information.
