Code of Ethics and Standards of Professional Conduct Flashcards by Maria Kassapi

Violations of Code and Standards

> disciplinary sanctions by CFA Institute

Revocation of membership
Revocation of candidacy in the CFA program
Revocation of right to use the CFA designation

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The Code of Ethics

> integrity, competence, diligence, respect, ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the
investment profession, and other participants in the global capital markets
integrity of the profession and the interests of clients above personal interests
use reasonable care and exercise independent professional judgment
practice and encourage others to practice in a professional and ethical manner
promote the integrity and viability of the global capital markets
maintain and improve professional competence + other proffs

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Standards of Professional Conduct

I. Professionalism
A. Knowledge of the Law
B. Independence and Objectivity
C. Misrepresentation
D. Misconduct

II. Integrity of capital markets
A. Material Non-public Information
B. Market Manipulation

III.Duties to clients
A. Loyalty, Prudence, and Care
B. Fair Dealing
C. Suitability
D. Performance Presentation
E. Preservation of Confidentiality

IV. Duties to employers
A. Loyalty
B. Additional Compensation Arrangements
C. Responsibilities of Supervisors

V. Investment analysis, recommendations, and actions
A. Diligence and Reasonable Basis
B. Communication with Clients and Prospective Clients
C. Record Retention

VI. Conflict of interest
A. Conflicts Disclosure
B. Priority of Transactions
C. Referral Fees

VII. Responsibilities as a CFA Institute member or CFA program candidate
A. Conduct as Participants in CFA Institute Programs
B. Reference to CFA Institute, the CFA designation, and the CFA program

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I. Professionalism
A. Knowledge of the Law (Guidance)

Follow the more strict of the applicable law or the Code and Standards
Must comply with applicable law or regulations
Must not engage in conduct that constitute a violation even
though legal
In absence of any applicable law or regulation, adhere to Code and Standards
Members and candidates are responsible for violations knowingly participate or assist
If member believe activities are illegal or unethical:
Must dissociate or separate from activity
May require member to leave employment in severe cases
First step is to bring to employer’s attention
CFA Institute strongly encourages report of violations by members
mindful of where their products are sold
Supervisors should understand applicable laws and regulations of countries or regions of origination
due diligence when transacting cross-border
business

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I. Professionalism
A. Knowledge of the Law (Recommended procedures)

Stay informed (laws, rules, regulations and case law, education)
Review procedures on a regular basis
Maintain current files (reference copies)
Distribution area laws (understand applicable laws)
Legal counsel ( seek the advice of compliance personnel or legal counsel)

Dissociation (resign employment to dissociate)
* Firms (develop/and or adopt a code of ethics)
- Provide information on applicable laws
* Distribute relevant information to employees
- written protocols for reporting suspected violations of laws, regulations, and company policies

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I. Professionalism
I(B): Independence and Objectivity (Guidance)

Buy-side clients
pressure on sell-side analysts
Portfolio managers respect and foster intellectual honesty of sellside research
Fund manager relationships
not accept gifts, entertainment, or travel funding that may be perceived as impairing their decisions
Investment banking relationships
Sell-side firms put pressure on their analysts for favorable research reports
on current or prospective investment banking clients
Firm managers provide an environment in which analysts are neither coerced nor enticed into misleading research
Public companies
Analysts may issue favorable reports by companies they cover
Analysts should perform due diligence when conducting research
Credit rating agency opinions
Provide a service by grading fixed-income products offered by companies
Analysts employed by rating agencies should ensure that procedures are in place to
prevent undue influences from a sponsoring company
Issuer-paid research
Reports bridge the gap created by a lack of coverage
Fraught with potential conflicts
Investors may be misled into thinking research is from an independent
source
Independent analysts must strictly limit type of compensation they accept for conducting
issuer-paid research
Best practice is to accept a flat fee
Travel funding
Best practice is to use commercial transportation
If unavailable, members may accept modestly arranged travel

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I. Professionalism
I(B): Independence and Objectivity (Recommended procedures)

Protect integrity of opinions
Establish policies: research reports reflect the unbiased opinion of the
analyst
Create a restricted list
If the firm is unwilling to disseminate adverse opinions, firms should be removed from
research universe
Restrict special cost arrangements
Members should pay for commercial transportation and hotel charges
Air transportation should not be reimbursed by corporate issuer
Use of corporate aircraft should only be used when it is not possible to use commercial
transportation
Limit gifts
Limit gifts to token items
Customary, ordinary business-related entertainment is acceptable provided it is not
designed to influence the member
Firms consider a value limit for acceptable gifts based on local or regional
customs
-Restrict investments
Firms should develop formal policies related to employee purchases of equity or equityrelated IPOs
Firms should require prior approval for employee participation in IPOs
Strict limits should be imposed on acquiring securities in private placements
Review procedures
Firms should implement effective supervisory and review procedures
Independence policy
Formal written policy on independence and objectivity of research
Ensure that research analysts do not report to and are not controlled by any department
Appointed officer
Firms should appoint a senior officer with oversight responsibilities for compliance with
firm’s code of ethics
Firms should provide every employee with procedures and policies for reporting
potentially unethical behavior and violations of regulations

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I. Professionalism
I(C): Misrepresentation (recommended procedures)

Factual presentations
- Each member must understand limit of firm’s or individual’s capabilities
- Need to be accurate and complete in presentations
- Firms can provide guidance for employees making written or oral presentations
* Written list of the firm’s available services and description of firm’s qualifications
- Firms can specifically designate which employees are authorized to speak on behalf of the firm
* Qualification summary
- Each member should prepare a summary of:
* Qualifications and experience
* List of services they are capable of performing
* Verify outside information
- Members should encourage their employers to develop procedures for verifying
information about third-party firms
* Maintain webpages
- Regularly monitor webpages to ensure they contain current information
- Ensure all reasonable precautions have been taken to protect site’s integrity,
confidentiality, and security
* Plagiarism policy
- Maintain copies
* Keep copies of all research reports and any information relied on in preparing the research report
- Attribute quotations
* Attribute any direct quotations to their sources including:
- Projections
- Tables
- Statistics
- Model/product ideas
- New methodologies
* attributions not required for recognized financial and statistical reporting services
- Attribute summaries
* Attribute to their sources any paraphrases or summaries of material prepared by others

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I. Proffessionalism
I(D): Misconduct

Code of ethics
Develop and/or adopt a code of ethics
Every employee should subscribe
Make clear that inappropriate personal behavior will not be tolerated
List of violations
a list of potential violations and their disciplinary sanctions to all
employees
Employee references
Check references of potential employees

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II(A): Material Nonpublic Information (HIghlights)

Material information
- Disclosure would have an impact on price of a security or if investors want to know the information before making an investment decision
* Specificity of the information
* Extent of difference from public information
* Nature and reliability of the information Nonpublic
- Until disseminated or available to the marketplace in general
- Disseminated is defined as ‘made known to’
- Disclosure at an analysts’ meeting does not make the disclosed information ‘public’

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II(A): Material Nonpublic Information – Guidance

Mosaic Theory
Combination of material public and non-material non-public information to develop a
conclusion about a firm
Analysts are free to act on this mosaic of information
* No violation of the Standard

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II(A): Material Nonpublic Information – Recommended procedures

Achieve public dissemination
Member or candidate should make a reasonable effort to disseminate material
information
Encourage the company to publish the information
If not possible, do not take any investment action based on the information
Adopt compliance procedures
Prevent misuse of material non-public information
Should suit particular characteristics of a firm such as size
Adopt disclosure procedures
Ensure information is disseminated to the marketplace in an equitable manner
Analysts should be treated fairly
Issue press releases
Companies should consider issuing press releases prior to analyst meetings
Meetings should be scripted to decrease chance that further information will be disclosed
If nonpublic information is disclosed the company should promptly issue a press release
Firewall elements
Information barrier used to prevent communication of material nonpublic information
Minimum elements
Substantial control of relevant interdepartmental communications
Review of employee trading through watch, restricted and rumor lists
Documentation of procedures
Heightened reviews of proprietary trading when firm is in possession of material nonpublic information
Appropriate interdepartmental communications
Firms of all sizes and types benefit from improving documentation of their internal
enforcement of firewall procedures
Procedures should compiled and formalized
Physical separation of departments
Firms should consider physical separation of departments and files
Prevention of personnel overlap
Reporting system
Authorized people should review and approve communications between departments
Coordinate process of ‘looking over the wall’
Personal trading limitations
Firms should consider restrictions
Should carefully monitor proprietary and personal trading
Firms should require employees to make reports
Record maintenance
Multi-service firms should maintain written records of communications between various
departments
Firms should place a high priority on training
Proprietary trading procedures
A prohibition on all types of proprietary activity when in possession of material nonpublic information is not appropriate
Communication to all employees
Written compliance policies and guidelines should be circulated to all employees of a firm

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II(B): Market Manipulation (Guidance)

Information-based manipulation
Includes spreading false rumors to induce trading by others
Members must refrain from ‘pumping up’ the price of an investment and then ‘dumping’ it
Transaction-based manipulation
Actions that affect price of a security
securing a controlling, dominant position in a financial instrument to exploit and manipulate the price of a related derivative and/or the underlying asset

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III. Duties to clients
III(A): Loyalty, Prudence, and Care (Recommended procedures)

Regular account information
Should submit an itemized statement to clients at least quarterly
Client assets should be segregated from other party’s assets
Client approval
If unsure about appropriate course of action, disclose in writing to client and obtain client
approval
Firm policies
Address following topics when drafting statements/manuals containing policies and
procedures:
Follow all applicable rules and laws
Establish investment objectives of the client
Consider all the information when taking actions
Diversify
Carry out regular reviews
Deal fairly with all clients with respect to investment actions
Disclose conflicts of interest
Disclose compensation arrangements
Vote proxies
Maintain confidentiality
Seek best execution
Place client interests first

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III. Duties to clients
III(B): Fair Dealing (Recommended procedures)

Develop firm policies
Treat customers and clients fairly
Recommended for all firms who disseminate investment recommendations or take
investment action
Make the firm aware of possible violations of fair-dealing practices
Initial recommendations do not need to be made available to all customers
* Should be based on suitability and known interest
* Not on any preferred or favored status
Fair-dealing compliance procedures
Limit number of people who know a recommendation will be disseminated
Shorten the time frame between decision and dissemination
Publish guidelines for pre-dissemination behavior
Simultaneous dissemination to ensure all clients are treated fairly
Maintain a list of clients and their holdings in order to facilitate notifications to customers
or clients of a change in investment recommendation
Develop and document trade allocation procedures
Disclose trade allocation procedures
Disclose how the firm selects accounts to participate in an order
Procedures must be fair and equitable
Establish systematic account review
Review accounts regularly to ensure no client or customer is being given preferential
treatment
Disclose levels of service
Disclose if the organization offers different levels of service for the same fee or different
fees
Different levels of service should not be offered to clients selectively

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III. Duties to clients
III(C) Suitability (advisory relationship with client)

Investment policy statement
Put needs, circumstances, objectives of each client in a written investment policy statement
Take into account:
Client identification
Investor objectives
Investor constraints
Performance measurement benchmarks
Regular updates
- Investor’s objectives and constraints should be maintained and reviewed periodically
Compare client constraints with capital market expectations to arrive at an appropriate asset allocation
Annual review is reasonable unless economic circumstances dictate otherwise
Suitability test policies
- Firms should be encouraged to develop related policies and procedures
  - Differ according to size of the firm and scope of services provided
- Test procedures
An analysis of the impact on portfolio’s diversification
Comparison of investment risks with client’s assessed risk tolerance
Fit of the investment with the required investment strategy

III. Duties to clients
III(D): Performance Presentation (Recommended procedures)

Apply GIPS Standards
Compliance with GIPS standards is best method to meet obligations under Standard III (D)
Compliance without applying GIPS Standards
Considering knowledge and sophistication of audience
Presenting performance of weighted composite of similar portfolios rather than using a single representative account
Including terminated accounts as part of performance history
Including disclosures that fully explain the performance results being reported
Maintaining data and records used to calculate performance being presented

III. Duties to clients
III(E): Preservation of Confidentiality

Standard applies to information gained during a client relationship even if the
person or entity is no longer a client
Simplest, most conservative, and most effective way to comply
Avoid disclosing any client information except to authorized fellow employees
Before making disclosure of information outside scope of confidential relationship
Check if information is relevant to work being performed for the client
Will it enable the service to the client to be improved?
Follow firm’s electronic information storage procedures
Provide information required by applicable law and Professional Conduct Program
(PCP) investigation (if allowed under applicable law)

IV – Duties to Employers
IV(A): Loyalty (Guidance)

Employer responsibilities
Members are encouraged to provide their employers with a copy of the Code and
Standards
Employers are not adhered to the Code and Standards
Independent practice
Members must abstain from independent competitive activity which conflicts with
interests of their employer
Notify employer of any plan to engage in independent practice
Should not provide services until they receive consent from employer
- Can make preparations to begin such a
  service
Leaving an employer
Continue to act in employer’s best interest
Must not engage in any conflicting activities, until resignation becomes effective
Examples of potential violations:
Misappropriation of trade secrets
Misuse of confidential information
Solicitation of employer’s clients prior to cessation of employment
Self-dealing
Misappropriation of clients or client lists
Can make preparations to go into a competitive business, as long as they do not breach the employee’s duty of loyalty
Simple knowledge of names and existence of former clients
Not confidential information
Firm records cannot be taken
If an independent contractor, oral and written agreement between member and the client
Whistle blowing
Interests of members, candidates and employers are secondary to protecting the
integrity of capital markets and clients’ interests
If conflicts occur (e.g. employer engaged in illegal or unethical activity), activities that
would normally violate a member’s or candidate’s duty to their employer may be justified
Nature of employment
Members and candidates must determine whether they are employees or independent
contractors in order to determine the applicability of Standard IV(A)

IV – Duties to Employers
IV(A): Loyalty (Recommended procedures)

Competition policy
Must understand any restrictions placed by employer offering similar services outside the
firm
Policy may outline procedures for requesting approval or strict prohibition
Termination policy
Must understand termination policies of their employer
Clear procedures regarding resignation process, including how it will be disclosed to
clients and staff
Incident-reporting procedures
Should be aware of firm’s policies related to whistle-blowing
Encourage their firms to adopt industry best practices
Employee classification
Need to understand status within their employer firm
Firms are encouraged to adopt a standardized classification structure
e.g. part-time, full-time, outside contractor
Indicate how firm’s policies apply to each employee class

IV – Duties to Employers
IV(B): Additional Compensation Arrangements (Recommended procedures)

Written report to employer
Specifying any compensation to be received, in addition to compensation or benefits
received from employer
Terms of compensation
- Nature of the compensation
- Approximate amount of compensation
- Duration of the agreement
Compensation includes direct or indirect payments, gifts, or other benefits

IV – Duties to Employers
IV(C): Responsibilities of Supervisors

Must make reasonable efforts to detect and prevent violations of the Code and
Standards by persons acting under your supervision
Does not matter if they do not have a CFA Institute affiliation
Tasks of supervision can be delegated but the supervisor remains responsible
Failure to prevent or detect violations
Not a violation provided reasonable steps were taken to detect and prevent such
violations
Decline to accept supervisory responsibility in writing if there is an inadequate
compliance system
If supervisors detect or receive reports of violations, they must promptly initiate an
investigation to determine the extent of the wrongdoing
Supervisors should take steps to prevent repeat violations

IV – Duties to Employers
Recommended procedures

Code of ethics or compliance procedures:
Recommend employers adopt a code of ethics
- Fundamental, principle-based, ethical and fiduciary concepts
- Implemented by detailed, firm-wide compliance policies and procedures
- Should be written in plain language
Adequate compliance procedures:
Supervisor complies with Standard IV (C) when identifying potential violations and
develops compliance procedures to prevent such violations
Contained within a clearly written and accessible manual
If a violation is discovered, a supervisor should:
- Respond promptly
- Conduct a thorough investigation to determine scope of wrongdoing
- Increase supervision or place appropriate limitations on wrongdoer, pending outcome of
  investigations
- Review procedures for potential changes to prevent recurrence of similar violations

Standard IV – Duties to Employers
IV(B): Additional Compensation Arrangements

Written report to employer:
Specifying any compensation to be received, in addition to compensation or benefits received from employer
Terms of compensation
- Nature of the compensation
- Approximate amount of compensation
- Duration of the agreement
- Compensation includes direct or indirect payments, gifts, or other benefits

Standard IV – Duties to Employers IV(A): Loyalty Guidance

* Employer responsibilities: - Members are encouraged to provide their employers with a copy of the Code and Standards - Employers are not adhered to the Code and Standards * Independent practice: - Members must abstain from independent competitive activity which conflicts with interests of their employer - Notify employer of any plan to engage in independent practice - Should not render services until they receive consent from employer * Can make preparations to begin such a service * Leaving an employer: - Continue to act in employer’s best interest - Must not engage in any conflicting activities, until resignation becomes effective - Examples of potential violations: * Misappropriation of trade secrets * Misuse of confidential information * Solicitation of employer’s clients prior to cessation of employment * Self-dealing * Misappropriation of clients or client lists - Can make preparations to go into a competitive business, as long as they do not breach the employee’s duty of loyalty - Simple knowledge of names and existence of former clients * Not confidential information * Firm records cannot be taken - If an independent contractor, oral and written agreement between member and the client * Whistle blowing - Interests of members, candidates and employers are secondary to protecting the integrity of capital markets and clients’ interests - If conflicts occur (e.g. employer engaged in illegal or unethical activity), activities that would normally violate a member’s or candidate’s duty to their employer may be justified * Nature of employment - Members and candidates must determine whether they are employees or independent contractors in order to determine the applicability of Standard IV(A)

Ethics can be described as

as a set of moral principles that provide guidance for our behavior; these may be moral principles shared by a community or societal group

Standards of conduct

serve as benchmarks for the minimally acceptable behavior required of members of a group.

Martin must obtain written consent from Future to keep his existing clients but need not inform his existing clients of his new part-time employment at Future.unless

conflict of interest arise

Capital Market Theory

Existence of unique optimal risky portfolio * All investors have same economic expectation - Homogeneity of expectations - Everyone should have the same risky portfolio * Different expectations will lead to different risky portfolios Capital market line (CML) * Specific CAL - Uses market portfolio as optimal risky portfolio * Market portfolio - Includes all tradable, investable risky assets, or anything that has value - E.g. stocks, bonds, real estate, human capital

Pricing of Risk and Computation of Expected Risk Return

Systematic risk * Non-diversifiable * Cannot be avoided and is inherent in overall market * E.g. interest rates, inflation, economic cycles, political uncertainty, and widespread natural disasters * Magnified by using leverage Non-systematic risk * Risk limited to a particular asset or industry * E.g. failure of a drug trial, major oil discoveries, or an airliner crash * Avoid through diversification - Choose assets not highly correlated with each other - No reward for a risk that can be diversified away Total variance Total variance = Systematic variance + Non-systematic variance

Pricing of Risk and Computation of Expected Risk

Calculation and interpretation of Beta * Return-generating model - Provides an estimate of an expected return given certain parameters - E.g. multi-factor model using macroeconomic, fundamental and statistical factors Macroeconomic factors: Economic growth, interest rates, inflation rates, productivity employment, and consumer confidence Fundamental factors: Earnings, earnings growth, cash flow generation, investment in research, advertising, and number of patents Statistical factors: Historical and crosssectional data analyzed to identify factors that explain variance and covariance in returns

Beta

* Positive Beta - Return of an asset moves in same direction of market * Negative Beta - Return of an asset moves in opposite direction of market - Unusual to find assets with a consistently negative beta * Risk-free asset - Beta = 0 - Covariance with other assets = 0 - E.g. Treasury bills and gold

The Capital Asset Pricing Model Assumptions

* Investors are risk-averse - Investors expect to be compensated for accepting risk * Investors maximize utility - Investors want higher returns not lower returns * Investors are rational * Markets are frictionless, without transaction costs or taxes * Investors plan for same single holding period * Investors have homogenous expectations or beliefs * All investments are infinitely divisible * Investors are price-takers - No investor is large enough to influence the market

Security Market Line (SML) expected return vs beta

- All properly priced securities plot on SML, including efficient and inefficient securities or assets - Slope = Rm-Rf = Market risk premium

The Capital Asset Pricing Model (CAPM)

E(R)=Rf+β( E(R) - Rf)

The Capital Asset Pricing Model Applications of CAPM

* Estimate of expected return - Use in project appraisal * Portfolio performance evaluation Sharpe ratio = Rp - Rf / sigmap Treynor ratio = Rp - Rf / betap M^2 = (Rp - Rf)* (sigmaM/sigmaP) - (Rm - rF) - Calculate if portfolios outperform market on a risk-adjusted basis * Portfolio matching performance of market = M2 = 0 * Portfolio outperforming market = M2 > 0 Jensen’s Alpha - Based on systematic risk - Actual return – expected return alpha_p = Rp - (Rf + betap(Rm -Rf)]

The Capital Asset Pricing Model Security selection using SML

above SML Undervalued – positive Alpha - Buy below SML Overvalued – negative Alpha - Sell

The Capital Asset Pricing Model Limitations of CAPM

Theoretical limitations: * Only systematic risk is priced into CAPM - Easy to understand - Very restrictive and inflexible * Single-period model - Does not consider multi-period implications - Cannot capture factors that vary over time Practical limitations: * Market portfolio includes non-investable assets such as human capital * Market participants use different proxies * Estimation issues surrounding beta * CAPM is a poor predictor of returns * Investors do not have homogenous expectations * Different SMLs

The Standards of Professional Conduct proscribe The Code of Ethics prescribes

- knowingly violating securities acts and laws. - the other behaviors.