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.