Ethical and Professional Standards Flashcards
Ethics is most accurately described as a:
A set of moral principles that adhere to legal standards.
B set of moral principles and rules of conduct that guide behavior.
C benchmark for behavior based on an individual’s perception of right and wrong.
B Ethical conduct is behavior that follows moral principles. Moral or ethical principles are beliefs in regards to what is acceptable versus unacceptable behavior – what an individual expects of himself.
The investment management profession is most similar to more established professions such as medicine or law with respect to:
A recognition by regulators.
B requiring practitioners to be licensed.
C the need to adapt to societal and technological changes.
C Technological and societal changes are forcing all professions to adapt and evolve in order to retain the public’s trust.
The investment management profession is relatively young and lags behind more established professions with respect to being recognized by regulators. Although many investment management practitioners do have professional certifications, there is no licensing requirement such as those that exist for doctors and lawyers.
Which of the following most likely presents the biggest challenge to trust in the investment management profession?
A Practitioners are not required to join a professional body
B Clients are at an informational disadvantage relative to practitioners
C Practitioners are joining professional bodies other than CFA Institute
A Unlike doctors and lawyers, practitioners in the investment management industry are not required to undertake specific training or join a professional body that is dedicated to furthering their professional development. The lack of such a requirement presents a challenge to the public’s trust in the investment management profession.
Many investment management practitioners are joining professional bodies other than CFA Institute. For example, it is not uncommon for practitioners in this industry to join professional bodies that represent actuaries and accountants. Having practitioners joining any professional body is likely to improve the public’s trust in the investment management profession.
While it is true that clients are at an informational disadvantage relative to investment management practitioners, this is also true for all other professions. Just as clients are less knowledgeable about investment risks, fees, etc., patients are relatively uninformed about health issues compared to their doctors. The key to earning and retaining trust in the profession is to manage this asymmetry by giving clients the information that they need to make decisions that are in their interest.
Which of the following would most likely be a challenge to ethical behavior?
A A desire to protect clients’ assets
B Placing too much importance on external motivations
C Underestimating the extent to which external factors shape thinking
C Challenges to ethical behavior include one’s overconfidence in their own personal ethical standards and a decision maker’s underestimation of the effect of external factors that shape thinking.
The external factors, including environmental or cultural, that shape thinking and decision making are most likely referred to as:
A situational influences.
B behavioral biases.
C the ethical decision-making framework.
A The proper term for these external influences is situational influences. These are factors shaping our thinking, decision making, and general behavior. Situational influences, such as loyalty or bonus systems, can shape thinking and behavior within the investment industry.
Which of the following is most likely a challenge to promoting ethics and trust in the investment profession?
A Short-term situational influences are difficult to recognize and consider
B Situational influences cannot motivate individuals to act more ethically
C Individuals tend to place a high level of importance on their internal traits and intrinsic motivations
C A key challenge to ethical behavior is that individuals often place too much emphasis on their internal traits and intrinsic motivations, which have little predictive ability regarding whether someone will behave ethically in a specific situation. In general, individuals are overconfident in their ability to act morally in situations that require sound judgment.
Short-term situational influences are relatively easy to recognize and consider. In many situations, individuals focus on short-term influences and fail to adequately consider long-term consequences.
While situational influences often cause individuals to behave unethically, these pressures can also induce people to act more ethically.
To promote ethical behavior, an investment management firm’s code of conduct should most likely:
A foster a strong culture of compliance.
B emphasize the importance of loyalty to fellow employees.
C encourage employees to include consideration of long-term consequences in their decision-making process.
C Individuals tend to find it easier to recognize and consider short-term situational influences when making decisions. To promote ethical behavior, codes of conduct should encourage employees to consider the potential long-term consequences of their decisions.
Loyalty, either to fellow employees or one’s employer, is a strong situational influence that can cause individuals to act unethically or refrain from reporting unethical behavior in order to demonstrate the strength of their commitment.
While a strong compliance policy is necessary to develop an ethical culture, placing too much emphasis on compliance can lead to decisions that meet the literal requirements for compliance, even if they are not necessarily ethical.
Which statement most accurately represents CFA Institute’s guidance on what is expected and required of Members and Candidates to meet high ethical standards, as it relates to ethical versus legal standards?
A All ethical behavior is legal
B Illegal behavior may be ethical
C A legal framework is required to ensure ethical behavior
B Ethical behavior and legal behavior do not perfectly overlap.
Ethical behavior may not always be deemed legal. Similarly, it is possible to commit illegal acts that are ethical. Laws, particularly newly enacted ones, are not sufficient to ensure that individuals act in an ethical manner.
Which of the following statements about ethics in the investment profession is least likely correct?
A Ethics involves making good choices
B Ethics involves a set of moral and legal principles
C Situational influences can shape individual ethical behaviors
B Ethics is a set of moral principles that are established without consideration of legal principles.
Which of the following statements is most accurate? An optimal ethical decision-making framework:
A culminates with decisions and actions.
B considers situational influences in the initial phase.
C allows individuals to move through the various phases of the decision-making process in a non-sequential manner.
C The decision-making process is typically iterative, meaning that individuals will not necessarily go through the various phases of the framework in sequential order. For example, it may be necessary to go back to the identification phase based on insights that were developed in the consideration phase.
A general framework for ethical decision-making begins with the identification phase before moving onto the consideration phase, after which decisions are made and actions are taken. It is important to include a reflection phase that considers whether the decision had its intended effect or any unanticipated consequences.
CFA charterholders and candidates in the CFA program must act for the ultimate benefit of:
A society
B capital markets.
C their employer.
A The CFA Institute Code of Ethics states that members and candidates must “promote the integrity and viability of the global capital markets for the ultimate benefit of society.”
Which of the following statements is most likely correct regarding the CFA Institute Professional Conduct Program?
A The sanctions imposed by CFA Institute include public censure
B Members and candidates are not required to disclose their involvement in civil litigation on which the courts have yet to rule
C Members and candidates must accept the sanctions proposed by CFA Institute’s Professional Conduct Program staff upon concluding that a violation has occurred.
A CFA Institute may impose sanctions ranging from public censure to revocation of a member’s right to use the CFA designation.
Members or Candidates must self-disclose on the annual Professional Conduct Statement all matters that question their professional conduct, which could include involvement in unresolved civil litigation.
If Professional Conduct Program staff conclude that a violation has occurred, they will propose a sanction that the member or candidate may reject or accept. If the proposed sanction is rejected, the case is referred to the Disciplinary Review Committee, which is the final authority on such matters.
Which of the following statements is most accurate? When Professional Conduct Program (PCP) staff rules that a member of CFA Institute has violated the Standards, the next step in the disciplinary process is for:
A the proposed sanction to be imposed.
B the member to decide if he or she will accept the proposed sanction.
C the Disciplinary Review Committee to review the ruling issued by PCP staff.
B Members and candidates deemed by PCP staff to have violated the Standards are not required to accept the ruling and proposed sanction, but rather may decide to reject this decision and the proposed sanction.
If the ruling is rejected, the matter is then referred to a panel composed of DRC members, which will either uphold or overturn the PCP staff’s recommendation.
Jim Joyner, CFA, a portfolio manager with Breakstone Asset Management, works with individual investors. CFA Institute’s Disciplinary Review Committee (DRC) recently ruled that Joyner had violated the Standards, and affirmed the Profession Conduct Program staff’s recommendation that his membership be suspended for two years. Which of the following statements is most accurate? Joyner:
A may appeal the DRC’s ruling.
B may continue to work with clients while his suspension is in effect.
C must not engage in any professional activities while his suspension is in effect.
B The range of sanctions that CFA Institute may impose on members and candidates who violate the Standards does not include a prohibition on professional activities. In this example, Joyner may continue to work with clients during his suspension, but he must not use the CFA designation until such time as his membership is reinstated. Joyner may not appeal the ruling issued by the DRC, which is the final authority on such matters.
Which of the following statements is most accurate? A disciplinary sanction is sent to the Disciplinary Review Committee for review directly after:
A the Designated Officer deems a sanction is warranted.
B the member or candidate rejects the Designated Officer’s sanction.
C evidence of misconduct is obtained by Professional Conduct Program staff.
B For a sanction to be sent to the Disciplinary Review Committee (DRC), the following must occur:
The member or candidate is believed to have broken the Code or Standards.
The Professional Conduct staff is made aware of the alleged transgression and conducts inquiries.
The Designated Officer decides that a sanction is warranted and proposes a specific sanction to the member or candidate.
The member or candidate rejects the sanction.
The DRC hearing panel acts as an arbitrator.
Allan McDonald, CFA, has recently filed for personal bankruptcy after incurring catastrophic costs to provide medical treatment for his mother. No fraudulent acts were committed. Which of the following statements is most accurate? McDonald has:
A not violated the Standards and is not required to disclose this information to his employer.
B already violated the Standards and is required to disclose this information to his employer.
C not violated the Standards, but will if he does not disclose this information to his employer.
A According to Standard I(D) - Misconduct, members and candidates must not engage in “any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their professional reputation, integrity, or competence.”
In isolation, a personal bankruptcy that did not involve any dishonest, fraudulent, or deceitful acts would not be considered a violation of this Standard. In this example, there is no evidence that McDonald has violated this Standard. Although employers may require individuals to reveal whether they have filed for personal bankruptcy, this Standard does not create any such obligation, and there is no evidence that McDonald’s employer requires such disclosure in this example.
Debra Long, CFA, an independent equity analyst, has been offered compensation by a company to issue a research report on its stock. Do the Standards most likely allow Long to accept this offer?
A No
B Yes, if the compensation is structured as a flat fee based on the report’s conclusions, which both parties must agree on prior to the report being written
C Yes, if the compensation is structured as a flat fee that both parties agree on prior to the report being written and is not linked to the report’s conclusions
C The arrangement mentioned in this example is referred to as issuer-paid research and it is allowable within the limits of Standard I(B) - Independence and Objectivity under certain conditions. Specifically, analysts should negotiate compensation that is structured as a flat fee and is not linked to any of the conclusions or recommendations contained in their report. This fee should be negotiated and agreed upon before any work begins.
Frank Mariotta, CFA, manages portfolios for several clients of Vesuvius Investments. A client offers Mariotta the use of one of his luxury resort properties if the client’s portfolio outperforms the S&P 500 by at least 100 basis points for 2 consecutive quarters. Mariotta accepts the client’s offer without disclosing the arrangement to his supervisor, who had previously approved a similar arrangement between the same client and another portfolio manager at Vesuvius. Has Mariotta most likely violated the Standards?
A Yes
B No, because his supervisor approved a similar arrangement with the same client
C No, because his interests are already aligned with the interests of his client and his firm
A In general, Standard I(B) - Independence and Objectivity allows members and candidates to accept gifts from clients on the grounds that their interests are already aligned and the client is already providing compensation. However, in this example, Mariotta violates this Standard by failing to inform his supervisor of the gift. Disclosure is required so that employers may assess whether any such gifts have resulted in preferential treatment for the client. The fact that his supervisor approved a similar arrangement between the same client and another portfolio manager does not eliminate Mariotta’s duty to disclose his own arrangement.
James Heil, CFA, is updating his investment firm’s compliance manual, which contains the following policy:
“Research analysts must not knowingly omit or misrepresent information or give a wrong impression of this firm or any security, in oral representations, advertising, electronic communications, or publicly disseminated written materials.”
Is this policy most likely consistent with the recommendations for compliance with the Standards?
A Yes
B No, because Standard I(C) - Misrepresentation only references written materials
C No, because Standard I(C) - Misrepresentation includes written materials, whether publicly disseminated or not
C
Rosa Garrett, CFA, works as an investment banker for a large firm based in New York. Garrett is asked by her supervisor to work on an acquisition project for two companies based in India. Not knowing the laws and regulations for mergers and acquisitions based in India, Garrett goes to her firm’s library, where she finds reference books for the laws and regulations of India that are a couple of years old. She is told by a paralegal in the firm that only a few minor changes have been made over the years, which the Indian government will not notice if the firm violates, as they are highly inefficient and probably use old reference books anyway when approving the legality of the acquisition. If Garrett uses these reference books, has she most likely violated the Standards?
A Yes
B No, because the laws and regulations have not changed significantly
C No, because it is the responsibility of the firm to have up to date reference materials
A Even if the violations seem minor, charterholders and candidates must adhere to all laws and regulations. Even if it is her firm’s responsibility to provide reference materials, it is Garrett’s responsibility to follow all up-to-date laws and regulations according to Standard I(A) - Knowledge of the Law.
Hillary Goff, CFA, is an investment banker with Robertson & Davis, a financial services firm with multiple lines of business. When making presentations to potential new investment banking clients in a range of industries, she promises that her firm will provide full research coverage if the potential client signs on as an investment banking client. Goff does not mention that the two analysts currently employed by her firm both cover companies in various subsectors of the transportation sector. Goff most likely violated the Standards with respect to:
A misrepresentation only.
B independence and objectivity only.
C both misrepresentation and independence and objectivity.
A Goff has violated Standard I(C) - Misrepresentation by giving prospective clients the impression that her firm is currently capable of providing full research coverage when it only employs two analysts who both cover the transportation sector.
Goff does not violate Standard I(B) - Independence and Objectivity by promising research coverage as such promises are consistent with this Standard as long as the subsequent research is not influenced by any commercial relationship between the companies.
Kevin Tomey, CFA, is a research analyst covering the mining sector for a major investment bank. Most of the companies Tomey covers have facilities in remote locations. As part of his research of Astralica Minerals, he accepts the company’s offer to fly with some of its executives on a plane that it has chartered due to the lack of any commercial flights to the location of its facility. During the course of his two-day visit, Tomey stays at the company’s custom-built lodgings and attends a dinner with the executives who accompanied him on the charter flight. Neither Tomey personally or his firm reimburses Astralica for the costs associated with his travel and accommodation. Has Tomey most likely violated the Standards?
A No
B Yes, by dining with Astralica executives
C Yes, by accepting the travel and accommodation
A According to Standard I(B) - Independence and Objectivity, members and candidates “must not offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another’s independence and objectivity.”
However, this Standard does not prohibit acceptance of travel and accommodation in certain circumstances. Specifically, the guidance for this Standard tells us that, in the absence of commercial alternatives, “members and candidates may accept modestly arranged travel to participate in appropriate information-gathering events, such as a property tour.” In this example, Tomey does not appear to have foregone any commercial alternative travel or accommodation in order to accept the company’s offer. Additionally, he does not violate this Standard by dining with company executives as there is no indication that he has accepted a lavish or extraordinary meal.
Mary Ciccarelli, CFA, is an equity analyst with Strathairn Capital, a financial services firm with multiple lines of business, including sell-side research and investment banking. Ciccarelli’s supervisor, Dale Jackman, informs her that the firm’s review committee will not allow a “sell” rating to be published for Riverdale Industries (RVI), one of the firms she covers. In order to adhere with the recommendations for compliance with the Standards, Ciccarelli should most likely:
A encourage her firm to cease all trading of RVI shares.
B refuse to disseminate any further information about RVI to clients.
C encourage her firm to disseminate only factual information about RVI to clients.
C The recommendations for compliance with Standard I(B) - Independence and Objectivity include the creation of a restricted list in cases when a member or candidate’s employer “is unwilling to permit dissemination of adverse opinions about a corporate client.” In such cases, “members and candidates should encourage the firm to remove the controversial company from the research universe and put it on a restricted list so that the firm disseminates only factual information about the company.”
This is a list that includes all companies the firm is in an investment banking relationship with. Only factual information about those companies is to be given out to clients – no buy or sell information. This is because investment bankers are “temporary insiders” of these companies, privy to inside information, and this information must not be disseminated within the investment firm.
How would acts of civil disobedience by a CFA Institute Member be most accurately characterized, relating to its legality, ethics, and compliance with CFA Institute Standards?
A Civil disobedience may be legal, but is unethical and violates CFA Institute Standards in many cases
B Civil disobedience may be legal, but violates CFA Institute Standards when it results in a criminal conviction
C Civil disobedience may be illegal, but it also may be ethical and does not violate CFA Institute Standards in many instances
C CFA Institute does not prohibit civil disobedience. Much of it may, in fact, be illegal. However, these actions may still be ethical if, for example, they involve protesting laws that a member or candidate considers to be unethical.
With respect to the Code and Standards, the critical factor is whether members or candidates have adhered to Standard I(D) - Misconduct, which prohibits them from committing “any act that reflects adversely on their professional reputation, integrity, or competence.”
Hamid Bashir, CFA, lives and works in Emergia, a country with a developing economy and securities laws that are less stringent than the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards). Over the past year, Bashir has joined a group of financial professionals advocating for Emergia to adopt the legal framework of Fortania, where securities laws are more stringent than the Code and Standards. Bashir should most likely adhere to:
A Fortania’s laws.
B Emergia’s laws.
C the Code and Standards.
C Standard I(A) - Knowledge of the Law requires members and candidates to adhere to the most stringent requirements imposed by the laws, rules, and regulations governing their activities or the Code and Standards. In this example, Bashir lives and works in a country with securities laws that impose less stringent requirements and must therefore adhere to the Code and Standards. Bashir is not required to adhere to Fortania’s laws, as they do not currently apply to his professional activities.
Ken Bush, CFA, has recently joined the fixed income department of a regional bank. After observing some activities that he believes to be illegal, Bush does not report his suspicions to his firm’s compliance department, choosing instead to immediately resign and report his suspicions to regulators. Has Bush most likely violated the Standards?
A No
B Yes, by resigning without reporting his suspicions to his firm’s compliance department
C Yes, by reporting his suspicions to regulators without reporting his suspicions to his firm’s compliance department
A Standard I(A) - Knowledge of the Law requires members and candidates to dissociate from any violation of laws, rules, regulations, or the Standards themselves.
This Standard does not require members and candidates to report their suspicions to legal or regulatory authorities (unless such action is specifically required by law and there is no evidence of such a requirement in this example). The guidance for this Standard recommends that members and candidates who have observed what they believe to be illegal or unethical activities begin by reporting these concerns by their firm’s compliance department. While Bush may have reported his suspicions to regulators and resigned his position earlier than might be required by this Standard, he has not violated it by doing so.
Al Quimby, CFA, has used a quantitative model developed by Flathead Associates for several years, after obtaining written permission from the company to do so. Over the years, he has made several revisions to the model and back-tested it using commonly available data from Standard and Poor’s (S&P). When issuing reports based on insights derived from the amended model, it is most likely that Quimby:
A must only cite Flathead as a source.
B must cite Flathead Associates and S&P as sources.
C is not required to cite either Flathead or S&P as sources.
A Standard I(C) - Misrepresentation prohibits plagiarism, which is the act of “copying or using in substantially the same form materials prepared by others without acknowledging the source of the material or identifying the author and publisher of such material.” Further, members and candidates “must not copy (or represent as their own) original ideas or material without permission and must acknowledge and identify the source of ideas or material that is not their own.”
In this example, Quimby must acknowledge Flathead as the original source of the model, despite the fact that he has made his own amendments. However, this Standard does not require Quimby to cite statistics obtained from “recognized financial and statistical reporting services” such as S&P.
Denise Gates, CFA, owns a small investment advisory firm specializing in individual accounts. Due to her firm’s relatively small size, Gates obtains investment research from a larger investment research firm, for which she used to work. Gates is familiar with the firm’s research methods, which she believes to be sound, and repackages the reports she obtains to be distributed to her clients and presented as her firm’s work. Has Gates most likely violated the Standards?
A No
B Yes, with respect to misrepresentation
C Yes, with respect to independence and objectivity
B Gates violates Standard I(C) - Misrepresentation by presenting the reports to clients as if they had been prepared by her firm.
There is no indication that Gates has violated Standard I(B) - Independence and Objectivity. Her obligation to her clients is to ensure that she is satisfied that the research she passes along to them has a reasonable and adequate basis. There is no indication that her choice of third-party providers was unduly influenced by her previous work relationship.
James Tong, CFA, an analyst based in London, UK, recently published a research report on Plus Alpha Pharmaceuticals recommending the company’s stock. Soon after the report was issued, Plus Alpha invites Tong for discussions with some of its senior executives at the company’s headquarters in Paris, France. Tong makes the trip on the company’s corporate airplane and stays at a modest hotel that the company booked and prepaid for him. Tong later reimburses Plus Alpha for the costs of both his travel and accommodations and submits a full report to his employer in accordance with firm policy. Has Tong most likely violated the Standards?
A No
B Yes, with respect to his accommodation
C Yes, with respect to his travel arrangements
C It does not appear that Tong has violated Standard I(B) - Independence and Objectivity with respect to his accommodation as there is no evidence that he asked the company to prepay his hotel costs, or that he was even aware of this arrangement, and he was right to reimburse this expense.
However, Tong violates this Standard by accepting a flight on the Plus Alpha’s corporate airplane when commercial alternatives were available. Reimbursing the company for the cost does not eliminate the impact that such a lavish and unnecessary arrangement could have on his objectivity. As noted in the recommended procedures for compliance with this Standard, “when attending meetings at an issuer’s headquarters, members and candidates should pay for commercial transportation and hotel charges. No corporate issuer should reimburse members or candidates for air transportation.” While Tong’s actions are consistent with his firm’s policies, they do not absolve him of the responsibilities created by this Standard to avoid arrangements that could compromise his independence and objectivity.
Fred Lange, CFA, a senior portfolio manager for a major Midwest banking organization, frequently goes out to lunch with clients and consumes alcoholic beverages on most of those occasions. Lange’s coworkers are aware of his habits, but Lange’s drinking has not compromised his ability to do work, as he is regularly recognized for his professional achievements. One afternoon after returning from lunch with a client, Lange misstates his fund’s performance in a conversation with a prospective client. This misstatement is quickly corrected by Lange’s colleague, Jennifer Helton. Has Lange most likely violated the Standards?
A No
B Yes, with respect to misconduct
C Yes, with respect to misrepresentation
A It does not appear that Lange has violated Standard I(C) - Misrepresentation, as there is no evidence that he deliberately misstated his fund’s performance. Lange has not violated Standard I(D) - Misconduct, as his actions do not appear to constitute conduct that “reflects adversely” on his “professional reputation, integrity, or competence.” Of note, although it appears that Lange regularly consumes alcohol, there is no evidence that he does so to excess or that such consumption has affected his performance at work.
Jessica Walters is a portfolio manager for a large investment firm based in London. One of Walters’ clients, Elaine Meyers, is the wife of a top executive at Veridian Dynamics (VDN). Walters notices that Meyers’s portfolio has significantly outperformed those of her other clients this year, due largely to some well-timed trades of VDN shares. Walters is suspicious and believes Meyers is acting on material nonpublic information provided by her husband when trading VDN shares, but Walters decides not to take action, as she has no proof to substantiate her suspicions. Several months after noticing the suspect trades, Walters has not discussed the matter with anyone. Has Walters most likely violated the Standards?
A Yes, by failing to take any further action
B Yes, by not publically disclosing the possible violation
C No, because she lacked proof that a violation had occurred
A Standard I(A) - Knowledge of the Law states that when there is doubt about the action to take, it is best to seek the advice of compliance personnel or legal counsel. She is not required to publicly disclose her suspicions, but she also has a reasonable basis for discussing them with legal authorities, her firm’s compliance department, and/or her personal lawyer. By failing to take any further action, Walters has most likely violated this Standard.
Jim Babcock, CFA, is a portfolio manager for Walton Investments. A client is impressed with Babcock’s first quarter performance and has offered him tickets to a sold-out concert if Babcock can continue to outperform the client’s benchmark over the second quarter of the year. Babcock discloses the details of this proposed arrangement to his supervisor, who has granted written permission. Has Babcock most likely violated the Standards?
A No
B Yes, by accepting an offer the incentivizes short-term returns
C Yes, by failing to disclose this arrangement to his other clients
A According to Standard I(B) - Independence and Objectivity, members and candidates “must not accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another’s independence and objectivity.”
In this case, there is no evidence of the comprise of independence and objectivity since both Babcock’s and the client’s interests are already aligned. As long as any such gifts are disclosed to one’s employer, Standard I(B) - Independence and Objectivity is not violated. The employer can then assess whether the gifts in question have resulted in preferential treatment for the client who has provided them (to the detriment of other clients).
David Dryer, CFA, lives and conducts his professional work in a jurisdiction where betting on sporting events is illegal. Twice a year, Dryer travels to Las Vegas, where such gambling is legal, to make sizable bets on the outcomes of several professional basketball games. On his most recent trip to Las Vegas, Dryer incurred significant losses that he has not disclosed to his employer. Has Dryer most likely violated the Standards?
A No
B Yes, by failing to disclose his gambling losses to his employer
C Yes, by engaging in an activity that is illegal in the jurisdiction where he conducts his professional activities
A Standard I(D) - Misconduct prohibits members and candidates from engaging in “any professional conduct involving dishonesty, fraud, deceit.” Members and candidates are further prohibited from committing “any act that reflects adversely on their professional reputation, integrity, or competence.”
Dryer has not violated this Standard in this example. Although betting on sporting events is illegal in the jurisdiction where he conducts his professional activities, he has not violated any laws by gambling in a jurisdiction where this activity is legal. Dryer is not required to report his gambling losses to his employer unless this development has impaired his ability to continue meeting his professional obligations in compliance with all applicable laws, rules, and regulations.
Joe Brunt, CFA, is a senior analyst with a major credit rating agency. Kaylee Whiteside is the CFO of Optimal Dynamics, which recently became a client of Brunt’s firm. Whiteside offers Brunt the use of her vacation home for one week every quarter that her company’s corporate credit rating is either maintained at its current level or upgraded. Brunt agrees to this arrangement on the condition that the evaluation period be extended from every quarter to every year. Has Brunt most likely violated the Standards?
A Yes
B No, because his interests are already aligned with his client’s interest
C No, because the compensation does not create short-term performance incentives
A According to Standard I(B) - Independence and Objectivity, members and candidates must not “offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another’s independence and objectivity.” Although this Standard allows for the possibility of accepting gifts from clients on the grounds that incentives are already aligned, this exception is not applicable in this example. Brunt has an obligation to issue a credit rating based on diligent and objective analysis but, by accepting Whiteside’s offer, he has compromised his ability to do so. The issue of incentives for short-term versus long-term performance is discussed in the context of Standard VI(A) - Disclosure of Conflicts but is not relevant to this example.
April Flores, a Level I CFA candidate, has been asked to process transactions that she believes may be illegal. As a first step, she raises her concerns with her firm’s compliance department. Two months later, Flores has not heard anything further on this matter and continues to process the types of trades that she had reported. Flores has most likely:
A not violated the Standards.
B violated the Standards by failing to immediately report her concerns to regulators.
C violated the Standards by failing to sufficiently dissociate from activities that she believes may be illegal.
C According to Standard I(A) - Knowledge of the Law, members and candidates “must not knowingly participate or assist in and must dissociate from any violation of such laws, rules, or regulations.” In this example, Flores takes an appropriate first step by reporting her concerns to her firm’s compliance department. This Standard does not require members and candidates to immediately report their concerns to regulators and/or legal authorities. However, by continuing to process these types of trades after hearing nothing further from her firm’s compliance department for two months, Flores has violated this Standard. As noted in the curriculum, “inaction combined with continuing association with those in illegal or unethical conduct may be construed as participation or assistance in the illegal or unethical activity.” Flores has taken some action but failed to sufficiently dissociate from the activities that she believes may be illegal.
April McFarland is the Chief Compliance Officer for Xavier Investments. Recently, she implemented a firmwide policy allowing Xavier employees to accept meals and entertainment, provided it could not be considered lavish, and prohibiting them from accepting any gifts. The most accurate assessment of this policy is that it is:
A identical to the recommendations for compliance with the Standards.
B less strict that the recommendations for compliance with the Standards.
C more strict that the recommendations for compliance with the Standards.
C According to the recommendations for compliance with Standard I(B) - Independence and Objectivity, members and candidates must “limit the acceptance of gratuities and/or gifts to token items.” By prohibiting the acceptance of any gifts, the policy in this example is more strict.
Note that this Standard does not prohibit the acceptance of “customary, ordinary business-related entertainment as long as its purpose is not to influence or reward the members or candidates.”
Samantha Bjork, CFA, has been offered an equity analyst position at a firm that has not adopted a formal code of ethics. Which of the following statements is most likely correct? Bjork:
A must refuse to accept a position with any firm that has not adopted a code of ethics.
B may accept the position and should encourage the firm to adopt a code of ethics if she does.
C must refuse to accept a position with any firm that has not adopted the CFA Institute’s Code of Ethics.
B According to the recommended procedures for compliance with Standard I(A) - Knowledge of the Law, members and candidates “should encourage their supervisors or managers to adopt a code of ethics.” There is no prohibition against working for a firm that had not adopted either its own code of ethics or CFA Institute’s.
Alex Holland, CFA, has recently been hired as a quantitative analyst by Oakview Capital. Holland replaced Sheila Colter, CFA, who accepted a similar role with another firm. Holland is preparing a report that includes recommendations based on a model developed by Colter during her time at Oakview. What of the following statements is most accurate? Holland:
A is not required to cite Colter in his report.
B must cite Colter in his report unless he has her written permission not to do so.
C must cite Colter in his report unless he has made material changes to the model.
A In general, Standard I(C) - Misrepresentation requires members and candidates to cite the sources of their work. However, as noted in the guidance for this Standard, “models developed while employed by a firm are the property of the firm. The firm retains the right to continue using the work completed after a member or candidate has left the organization. The firm may issue future reports without providing attribution to the prior analysts.” In this example, Holland is not required to cite Colter in his report, but he must not remove her name from any reports that were published during her tenure at Oakview.
In accordance with the recommended procedures for compliance with Standard I(B) - Independence and Objectivity, members and candidates should most likely encourage their firm to:
A prohibit employee purchases of equities sold as part of an initial public offering (IPO).
B prohibit employees from accepting gifts such as business entertainment from investment banking clients.
C limit their employees to providing only factual information about companies when they are unwilling to publish adverse opinions.
C The purpose of Standard I(B) - Independence and Objectivity is to protect the integrity of members’ and candidates’ work and opinions from the effects of real or perceived conflicts of interest. In order to promote compliance with this Standard, members and candidates should encourage their firms to create restricted lists of firms about which they will not allow their employees to issue adverse opinions (perhaps out of concern that such opinions could damage an investment banking relationship). Firms should limit themselves and their employees to providing only factual information about companies on such a list.
Trevor Hamlin, CFA, is an independent equity analyst who often provides ratings for companies that are not covered by analysts at major firms. Recently, Hamlin agreed to write a research report on Timtron Industries. The compensation package consisted of an upfront fee, plus the cost of his commercial flight and accommodation at a luxury hotel, where he stayed while visiting their facilities located in a major metropolitan area. In his report, Hamlin made the following disclosure: “As compensation for writing this issuer-paid research report, I received a flat fee of $50,000 that was paid before I began my research and was not contingent on my conclusions. Additionally, my travel costs were reimbursed.” Has Hamlin most likely violated the Standards?
A No
B Yes, with respect to travel funding
C Yes, by accepting payment from the firm he covered
B According to Standard I(B) - Independence and Objectivity, members and candidates must not “offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another’s independence and objectivity.” In this example, Hamlin compromised his independence and objectivity by accepting the opportunity to stay in a luxury hotel, which would not be the only accommodation available in a major metropolitan area. In order to avoid violating this Standard, Hamlin should have insisted on regular accommodation.
Hamlin did not violate this Standard by accepting an upfront payment from Timtron Industries in exchange for writing a report on the company. Analysts can maintain their objectivity while writing issuer-paid research by structuring their compensation in such a way that they have no incentive to be biased. In this example, Hamlin was paid prior to writing his report, with no possibility of earning more or less depending on what he published.
Jill Gordon, CFA, manages several portfolios as a portfolio manager for Danilo Investments. One of her clients, who is pleased with her recent performance, offers her the use of a vacation condominium in Mexico for two weeks. Gordon immediately reports this offer to Danilo’s head of compliance, who approves of the arrangement. Has Gordon most likely violated the Standards?
A No
B Yes, by accepting a gift of greater than nominal value
C Yes, by failing to disclose the arrangement to other clients and prospective clients
A Standard I(B) - Independence and Objectivity does not prohibit members and candidates from accepting gifts or other forms of compensation from clients, provided that they disclose such arrangements to their employer, who can then assess whether the member’s or candidate’s ability to remain independent and objective has been compromised. There is no requirement to disclose such arrangements to other clients or prospective clients.
It is not improper to accept an additional benefit from a client, and there is no limitation on what may be accepted. Other clients need not be notified. The only requirement is that the employer grants permission, and it is the employer’s job to monitor the portfolio manager’s behavior to ensure that he or she is properly taking care of all clients.
Sebastian Brady, CFA, is a respected equity analyst covering firms in the mining sector for Aculytics Research. CGI Capital, an investment firm, is hosting an upcoming conference and has invited Brady to be one of the speakers at this event. CGI offers to cover the travel and accommodation costs as well as conference registration fees for all invited speakers. Additionally, CGI is offering selected speakers, including Brady, the opportunity to attend a major sporting event being played in the same city a few hours after the conference ends, at no cost to those invited or their firms. Which of the following statements is most accurate? Brady:
A must decline the entire offer.
B may accept the entire offer as long as he fully discloses the terms to his employer.
C may only accept the offer to cover his travel and accommodation expenses and conference registration fee.
C Standard I(B) - Independence and Objectivity requires members and candidates to “use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities.”
Acceptance of reimbursement for conference-related expenses is acceptable as long as independence and objectivity are not compromised. In this example, it is acceptable that Brady’s conference-related expenses are paid by CGI. He is performing a service by giving the talk, and these expenses are not excessive and would not compromise his objectivity. However, the invitation to attend the major sporting event is lavish and must be declined.
Ashley Powell, CFA, works as a manager of an international equity fund and has a personal portfolio that includes the stocks of several Chilean companies. Powell also has a strong Twitter following. After reading an article about a violent clash between striking Chilean miners and local police, Powell publishes a blog post that includes her opinion that “the current level of labor unrest could cause investors to pull their capital out of the Chilean market.” Although the mining strike covered in the article she read has attracted attention from several international media outlets, Powell is aware that the number of days lost to labor disruptions has steadily declined in Chile over the past decade and she expects this trend to continue, but she does not include this information in her blog post. Over the subsequent month, the main Chilean equity benchmark falls 2.3%. Has Powell most likely violated the Standards?
A No
B Yes, with respect to misrepresentation
C Yes, with respect to market manipulation
B Standard I(C) - Misrepresentation prohibits members and candidates from making “any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities.” Misrepresentation includes creating a misleading impression by omitting facts and relevant inputs. In this example, Powell has violated this Standard by failing to refer to the general decline in days lost to labor disruptions in Chile over the past decade, as this omission may mislead her readers regarding the true state of affairs in that country - particularly at a time when a single incident is attracting a disproportionate share of the media’s attention.
Powell does not appear to have acted to distort prices with the intention of misleading investors, and it is therefore unlikely that she has violated Standard II(B) - Market Manipulation. There is no evidence that Powell has taken advantage of lower valuations to purchase shares either for herself or her fund. Indeed, it is not clear that the 2.3% decline in the benchmark index of Chilean equities represents a poor performance relative to how other asset classes with similar risk profiles performed over the same period.
Joe Jacoby, CFA, is discussing with a colleague his understanding of what CFA Institute considers market manipulation, in regards to CFA Institute Standards. He describes two types of market manipulation:
Type 1: “Transactions that artificially affect prices or volume to give an inaccurate impression of activity or price movement in a financial instrument”
Type 2: “Securing a controlling position in a financial instrument with the intent to exploit and manipulate the price of a related derivative and/or underlying financial asset”
Which of the following statements is most likely correct?
A Type 1 is an example of information-based manipulation
B Type 2 is an example of information-based manipulation
C Type 1 and Type 2 are both examples of transaction-based manipulation
C According to the guidance for Standard II(B) - Market Manipulation, both types of transactions described here are examples of transaction-based manipulation. By contrast, information-based manipulation involves activities such as spreading false rumors in order to cause others to trade a certain way.
Brad Scheig, CFA, an independent investment advisor, has several clients who hold shares in Energex Frontier (ENGX), an energy exploration company that frequently bids on natural gas leases in auctions. In an effort to boost performance for his client accounts, Scheig visits several online investor forums and anonymously posts comments implying that ENGX will soon be awarded several highly-coveted leases, although he knows from a private conversation with the company’s CEO that the firm has already been informed that it will not be awarded these leases when the auction results are announced the next day. Before the end of the trading day, Scheig liquidates his clients’ holdings of ENGX shares. Scheig has most likely violated the Standards with respect to:
A market manipulation only.
B material nonpublic information only.
C market manipulation and material nonpublic information.
C Standard II(B) - Market Manipulation prohibits members and candidates from engaging in “practices that distort prices or artificially inflate trading volume with the intent to mislead investors.” In this example, Scheig has violated this Standard by attempting to artificially inflate the price of ENGX shares.
Scheig has also violated Standard II(A) - Material Nonpublic Information because he has come into possession of information that is both material and nonpublic information (that ENGX will not be awarded the leases) and acted on it by selling shares held in his clients’ accounts.
Peter Jayne, CFA, an equity analyst, is attending a meeting with the CFO of a large, publicly-traded company. The meeting is also being attended by other analysts and investors. The CFO is updating the group about her company’s financials and refers to a plant closure that has yet to be publicly announced. Which of the following statements is most accurate? Jayne:
A may act on this information.
B must not trade or cause others to trade on this information.
C may update his recommendation about the company and share this update with his clients.
B According to Standard (A) - Material Nonpublic Information, members and candidates “who possess material nonpublic information that could affect the value of an investment must not act or cause other to act on the information.”
In this example, the information revealed by the CFO is clearly material, but it is also nonpublic. Although it has been mentioned in a gathering of analysts and investors, this information is still considered nonpublic. As noted in the guidance for this Standard, “information that is made available to analysts remains nonpublic until it is made available to investors in general.
Emily Champlain, CFA, is the CEO of an online securities exchange. In order to attract interest in new weather derivatives, Champlain issues a press release announcing an agreement that she brokered with a group of exchange members that will ensure a guaranteed minimum trading volume in these securities for the first three months that they are traded on the exchange. With interest in weather derivatives still below expectations after this initial period, Champlain convinces the group to extend their agreement for an additional three months, but no subsequent press release is issued. Has Champlain most likely violated the Standards?
A No
B Yes, by brokering an agreement to provide artificial liquidity
C Yes, by failing to notify investors that the agreement was extended
C According to Standard II(B) - Market Manipulation, member and candidates must not “artificially inflate trading volume with the intent to mislead market participants.” In this example, Champlain does not violate this Standard by brokering an agreement to ensure a minimum trading volume because this information has been disclosed to investors and there is therefore no intention to mislead. However, Champlain does violate this Standard when she extends the term of the agreement without announcing this. She has misled investors who are under the impression that the agreement expired after the initial three-month period.
Sarah Allen, CFA, is a respected independent equity analyst with a well-deserved reputation as an expert on Peruvian investments. She has a large number of followers on Twitter. During a recent trip to Lima, Allen’s mobile phone was stolen and, although she filed a report with the local police, no details of the incident were made public. During the course of filing her report, Allen spoke with a senior police officer, who informed her that he was recently ordered by the Ministry of Justice to terminate an investigation into allegations of corrupt government procurement practices. Upon returning to her hotel, Allen posted the following tweet: “Interesting trip to Lima. My next report will address the Peruvian government’s efforts to maintain the rule of law.” The next morning, Allen noticed that Peruvian stock prices had fallen sharply. That afternoon, Allen received an email from a client thanking her for having recently issued a “buy” recommendation on a stock, adding “I considered it to be too expensive when your recommendation came out last week, but I bought it this morning after seeing that it was trading at a much more attractive earnings multiple.” One week later, Peruvian asset prices returned to their previous levels. Has Allen most likely violated the Standards?
A No
B Yes, with repect to market manipulation
C Yes, with respect to material non-public information
A Allen has not violated the Standards.
According to Standard II(B) - Market Manipulation, members and candidates “must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.” In this example, Allen’s tweet simply stated that she considered her Lima trip to be “interesting” and revealed the topic of her next research report. It is not reasonable to conclude that she wrote this with the intention of misleading market participants, and there is no evidence that her previously-issued “buy” recommendation was based on misleading or incorrect information. Indeed, it is not reasonable to conclude that any subsequent changes in market prices were attributable to her actions.
According to Standard II(A) - Material Nonpublic Information, members and candidates “who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information.” In this example, Allen’s only action in the aftermath of receiving (unverified) material non-public information was to disclose that she would be writing her next research report on the topic of “the Peruvian government’s efforts to maintain the rule of law,” which is not material information.
Christina Joseph, CFA, an analyst with a major securities dealer, has just received credible information from a private conversation about a regulatory decision that will have a significant impact on the share prices of mining companies when it is announced tomorrow. Joseph’s firm acts as a market maker for the shares of several of the companies that are likely to be affected by this decision. In order to comply with the CFA Standards, Joseph should most likely ask her firm to:
A limit its trading activities to the shares of companies on its restricted list.
B suspend arbitrage trading in the shares of companies that may be affected until the information is made public.
C cease all proprietary trading in the shares of companies that may be affected until the information is made public.
B Standard II(A) - Material Nonpublic Information requires members and candidates who acquire material nonpublic information to refrain from acting or causing others to act on this information. In practice, this means taking steps to prevent the appearance of market manipulation. In this example, Joseph should request that her firm place the companies that may be affected on a restricted list and suspend arbitrage trading in their shares until the information is made public.
Choice A is incorrect because Joseph’s firm should not limit its trading activities to the shares of companies on its restricted list. There is no reason to suspend or curtail trading in the shares of companies that do not appear on this list.
Choice C is incorrect because it would be wrong for Joseph’s firm to cease all proprietary trading because suspending its market making activities would send a clear signal that the firm possessed material nonpublic information.
Charles Telford, CFA, is a research analyst for Edgemont Investments, and one of the companies he covers is Jackson Dynamics (JDN). Knowing that many of Edgemont’s clients own JDN shares, Telford increases his projection of the company’s next quarterly earnings in order to augment their returns. Neither Telford or any members of his immediate family owns any JDN shares and his compensation is unaffected by the returns on clients’ portfolios. Has Telford most likely violated the Standards?
A No, because he served the clients’ interests
B Yes, with respect to market manipulation only
C Yes, with respect to market manipulation and independence and objectivity
B Telford acted with the intention of artificially manipulating the price of JDN shares, which is a violation of Standard II(B) - Market Manipulation.
There is no indication that Telford violated Standard I(B) - Independence and Objectivity.
Diane Golden, CFA, manages a pension fund that holds a large position in RBM Electronics common stock. Golden also holds RBM shares in her personal account. Golden, along with several analysts from her fund, participates in a conference call with RBM’s CFO, who mentions that the firm will be switching microchip suppliers. Golden believes that this change, which had not been publicly disclosed before the call, will positively impact RBM’s share price. Which of the following statements is most accurate? Golden:
A may purchase RBM shares for the pension fund only.
B must not purchase RBM shares for either her personal account or the pension fund.
C may purchase RBM shares for her personal account after purchasing shares for the pension fund.
B Standard II(A) - Material Nonpublic Information prohibits members and candidates from acting on or causing others to act on material information that has not been publicly disclosed. In this example, Golden must not purchase RBM shares for either her personal account or on behalf of the pension fund until the information mentioned by the CFO on the conference call has been broadly distributed to the wider investment community. Golden should encourage such distribution.
Richard Golic, CFA, is a research analyst covering firms in the consumer electronics sector for G&G Investments. Golic finds that he is able to provide his clients with more insightful analysis by consulting with a network of industry experts, who he compensates. His analysis of these consultations informs the research reports that he distributes to his clients. Has Golic most likely violated the Standards?
A No
B Yes, with respect to independence and objectivity
C Yes, with respect to material nonpublic information
A Standard II(A) - Material Nonpublic Information allows members and candidates to maintain a network of experts and provide compensation for their work, provided they do not solicit, act on, or cause others to act on material nonpublic information.
Compensating industry experts for their work does not constitute a violation of Standard I(B) - Independence and Objectivity.
Phylicia Chan, CFA, lives and works in a country where laws and regulations governing the activities of financial professionals have historically been less stringent than the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards). In order to demonstrate its commitment to ethical practices, her company considered adopting a code of conduct based on the Code and Standards, but decided not to do so last month when the country’s parliament passed several new laws, due to come into effect next year, that create even stricter requirements. Chan has been asked to make trades that she believes are intended to distort the price of securities. As she considers what to do, Chan should most likely adhere to:
A the Code and Standards.
B her country’s current laws.
C her country’s recently-passed laws.
A Standard I(A) - Knowledge of the Law requires members and candidates to follow the highest requirements imposed by the various laws, rules, and regulations that govern their activities or the Code and Standards.
In this example, Chan believes that she has been asked to act in a manner that would violate Standard II(B) - Market Manipulation and she must adhere to the Standards rather than her country’s current laws, which are less stringent. Chan is not required to adhere to her country’s new laws until they are formally enacted next year.
A firm places the shares of one of its investment banking clients on a restricted list and is in possession of material nonpublic information about the issuer. Which of the following statements is most accurate?
A The firm’s employees may still execute clients’ orders to trade the issuer’s shares
B The firm’s employees must liquidate any beneficial ownership of the issuer’s shares
C The firm must not disseminate any information about the issuer until the material nonpublic information has been published
A The recommended procedures for compliance with Standard II(A) - Material Nonpublic Information include placing the shares of corporate clients on a restricted list when a firm is in possession of material nonpublic information. Firms should closely monitor and limit (if not prohibit) proprietary trading by the firm and personal trading by its employees of shares on the restricted list. However, employees can still execute unsolicited orders for clients wanting to trade shares issued by a firm on their firm’s restricted list. Employees are not required to liquidate any beneficial ownership of the shares of firms on such a list. Additionally, firms may still disseminate information about companies on their restricted list, but they should limit this activity to providing factual and public information.
Which of the following measures is most consistent with the recommendations for compliance with Standard II(A) - Material Nonpublic Information?
A Increasing the number of employees with knowledge of which stocks are on the firm’s restricted list
B Establishing a firewall to ensure that information shared with buy-side analysts is not also shared with sell-side analysts
C Designating a compliance officer for research analysts to consult about which information should be shared with members of the investment banking department
C According to the recommendations for compliance with Standard II(A) - Material Nonpublic Information, firewalls should be established to prevent the communication of material nonpublic information, for example, between research analysts and members of a firm’s investment banking department. It is further recommended that a compliance officer be designated to “review and approve communications between departments.”
Firewalls should not be used to prevent information shared with buy-side analysts from also being shared with sell-side analysts. Rather, firms should adopt disclosure policies designed with the intention of sharing information fairly with all analysts.
It is recommended that firms use a restricted list and place companies on it when they are in possession of material nonpublic information. However, broad distribution of this list is not desirable, as such a practice “often triggers the sort of trading the list was developed to avoid.”
Which of the following statements is most accurate? A CFA charterholder:
A will always satisfy the Standards by adhering to all applicable laws.
B must adhere to the Standards whenever there is no applicable law or regulation governing his or her professional activities.
C may act on material nonpublic information in cases where applicable laws permit such activity and his or her employer has provided written consent.
B Standard I(A) - Knowledge of the Law requires members and candidates to “understand and comply with all applicable laws, rules, and regulations (including the Code and Standards) of any government, regulatory organization, licensing agency, or professional association governing their professional activities.” In cases where the Standards and applicable laws impose or permit different actions, members and candidates “must comply with the more strict law, rule, or regulation.”
It is therefore possible to violate the Standard even when adhering to applicable laws if those laws impose a less strict requirement. Members and candidates must never act on material nonpublic information. Such action is explicitly prohibited by Standard II(A) - Material Nonpublic Information.
Nicole Stream, CFA, works for an investment firm that claims to report in compliance with the Global Investment Performance Standards (GIPS). Stream handles the presentation of investment results as well as portfolio management duties. Immediately following distribution of the prior quarter’s composite results to all clients, Stream discovers there has been a typographical error that resulted in a material overstatement of the value of assets in one of the firm’s composites. The erroneous data information distributed to clients before the error is discovered. Has Stream most likely violated the Standards?
A No
B Yes, with respect to misrepresentation
C Yes, with respect to performance presentation
A According to Standard I(C) - Misrepresentation, members and candidates “must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities.”
According to Standard III(D) - Performance Presentation, members and candidates “must make reasonable efforts to ensure that it is fair, accurate, and complete.”
In this example, there was no intention to knowingly misrepresent the value of the composite’s assets, and there is no evidence that Stream failed to make a reasonable effort to ensure that the information provided to clients was accurate.
Errors can occur and this one was unintentional. As long as corrective action is taken, the Standards have not been violated.
Camilla Carter, CFA, is an investment advisor with Sandhurst Wealth Management. At a weekend social gathering, Carter speaks with her friend Elma Harvey, who reveals that Greg Fallon, one of Carter’s clients, and his wife had divorced. The following week, Fallon called Carter to order her to purchase a large number of shares for his account. The two had not previously discussed this potential trade. Rather than executing the order immediately, Carter tells Fallon that she has heard that he is getting a divorce and would like to meet with him to discuss possible changes to his investment objectives and constraints before making any more trades on his behalf. Has Carter most likely violated the Standards?
A No
B Yes, by failing to maintain client confidentiality
C Yes, by failing to immediately execute her client’s trade order
Standard III(C) - Suitability requires members and candidates to “make a reasonable inquiry into a client’s or prospective client’s investment experience, risk and return objectives, and financial constraints prior to making any investment recommendation or taking any investment action.” Members and candidates are additionally required to “reassess and update this information regularly.”
In this example, Carter does not violate this Standard by not immediately executing Fallon’s unsolicited trade order because she has reasons to believe that his financial circumstances have changed significantly (or will change in the near future). It may be that Fallon’s investment objectives and constraints will not be affected, or Carter may have been misinformed, but her decision to request a meeting before executing this trade is consistent with this Standard.
Additionally, Carter has not violated Standard III(E) - Preservation of Confidentiality, as there is no evidence that she has disclosed any information communicated to her by her client.
In which of the following circumstances would it be most appropriate to reveal confidential information about a client?
A The information has already been disclosed in media reports
B The information is not directly relevant to any financial transactions
C The client has not consented to the disclosure of information, but such action is required by law
C According to Standard III(E) - Preservation of Confidentiality, members and candidates may, in fact must, disclose confidential client information in circumstances when such disclosure is required by law. This obligation would apply even if the client did not consent to this disclosure. The fact that information has been reported in the media or does not pertain directly to any financial transactions does not mitigate the obligation to keep it confidential.
Which of the following statements is least likely to be consistent with the recommendations for compliance with Standard III(E) - Preservation of Confidentiality? Members and candidates:
A are only required to maintain the confidentiality of information about current clients.
B may share confidential information about a current client if this disclosure is authorized by the client.
C should seek legal advice before disclosing any confidential information about a client who is suspected of violating the law.
A Standard III(E) - Preservation of Confidentiality prohibits members and candidates from disclosing confidential information about current, former, and prospective clients unless one or more of the following three conditions are met:
The information relates to illegal acts committed by the client.
Applicable laws require this information to be disclosed.
The current, former, or prospective client has authorized the disclosure of this information.
Kenneth Watson, CFA, a commodities analyst based in New York, is preparing to write a research report on Midwest Grains. He is preparing to travel to the company’s headquarters in Chicago, Illinois, for interviews with executives. Watson accepts the company’s offer to cover the costs of his hotel, which is not lavish, and meals while he is staying in Chicago. During his visit, Watson speaks with analysts from other firms that have also accepted the company’s offer. Has Watson most likely violated the Standards?
A No
B Yes, with respect to independence and objectivity
C Yes, with respect to both indepence and objectivity as well as fair dealing
B Standard I(B) - Independence and Objectivity prohibits members and candidates from accepting travel and accommodation from companies that they cover when it is possible to make alternative arrangements. In this example, there is no reason why Midwest Grains should pay for Watson’s hotel or meals. Either he or his firm should cover these costs.
Standard III(B) - Fair Dealing is not applicable in this example because Watson did not favor one client over another.
Trevor Holland, CFA, has three clients who placed orders to purchase shares in an oversubscribed initial public offering (IPO). All three clients have similar investment objectives and constraints, and Holland considers the IPO shares to be suitable for the small-cap growth style that he applies when managing each of their accounts. On the day of the IPO, Holland is able to acquire 1,200 shares in a block trade and, since Client Z is his sister, he is considering three possible allocations, shown below along with each client’s order size. Holland’s stated policy establishes a minimum lot size of 100 shares when allocating a block trade.
Client X Client Y Client Z Order size 10,000 5,000 3,000 Allocation A 700 300 200 Allocation B 400 400 400 Allocation C 800 400 0
A Allocation A
B Allocation B
C Allocation C
A As noted in the guidance for Standard III(B) - Fair Dealing, in cases when a member or candidate is allocating shares acquired in an oversubscribed IPO among accounts that include those belonging to their family members, “the family-member accounts should not be excluded from buying such shares” as long as those accounts are managed similarly to other clients’ accounts. Allocation C, which provides no shares to Client Z, Holland’s sister, would be inconsistent with this guidance.
Allocation B, which provides an equal number of shares to each client, is also inconsistent with the recommendation that shares be allocated on a pro rata basis according to order size.
Allocation A is most consistent with this Standard. If shares were allocated on a strict pro rata basis according to order size, the allocations would be calculated as follows:
nClient X=10,00010,000+5,000+3,000×1,200=667
nClient Y=5,00010,000+5,000+3,000×1,200=337
nClient Z=3,00010,000+5,000+3,000×1,200=200
Rounding to the nearest round lot (100 shares), we get 700 shares for Client X, 300 shares for Client Y, and 200 shares for Client Z.
Given Holland’s policy of a 100-share minimum lot size, the appropriate allocation is 700 shares for Client X, 300 shares for Client Y, and 200 shares for his sister, Client Z.
Heather McLean, CFA, lives and works as a portfolio manager in Bernugal, a small, island country that has become a popular tax haven after liberalizing its financial markets. Since these changes were enacted, Bernuguese law no longer imposes a fiduciary duty on any investment professionals. Which of the following statements is least accurate? McLean must adhere to:
A Bernuguese laws.
B the CFA Standards, which impose a fiduciary duty.
C the CFA Standards by acting in the best interests of her clients.
B Standard III(A) - Loyalty, Prudence, and Care requires members and candidates to always acts in the best interests of clients. However, this Standard does not impose a fiduciary duty. Standard I(A) - Knowledge of the Law requires members and candidates to understand and comply with all applicable laws, rules, and regulations.
Allison Ostrander, CFA, works for a major trust company and is proud of her investment performance over the past 8 years. Her managed portfolios have averaged a 12% annual return over this time period and she regularly informs her clients of the prior performance. She also shares this information with prospective clients, adding that they should expect an annual return of at least 8% in the future based on her performance history. Has Ostrander most likely violated the Standards?
A No
B Yes, with respect to performance presentation only
C Yes, with respect to performance presentation and misrepresentation
C Standard III(D) Performance Presentation requires members and candidates to communicate performance information in a manner that is “fair, accurate, and complete.” According to the guidance for this Standard, members and candidates “should not state or imply that a client will obtain or benefit from a rate of return that was generated in the past.”
Standard I(C) - Misrepresentation prohibits members and candidates from providing any assurances or implied guarantees regarding the future performance of volatile investments.
In this example, Ostrander has violated both of the Standards discussed above.
Lisa Binstein is giving a seminar instructing financial professionals on their obligations to clients. Binstein makes the following two statements:
Statement 1: “When an investment manager is responsible for managing a pension plan, the actual clients are the beneficiaries of the pension plan rather than the plan sponsor.”
Statement 2: “There may be circumstances in which an actual client may not exist.”
Which of the following is the most accurate assessment of Binstein’s statements?
A Both Statement 1 and Statement 2 are consistent with the Standards
B Both Statement 1 and Statement 2 are inconsistent with the Standards
C Statement 1 is consistent with the Standards, and Statement 2 is inconsistent with the Standards
A In order to fulfill the obligation to clients created by Standard III(A) - Loyalty, Prudence, and Care, it is important to identify the actual client.
Statement 1 is correct. When managing pension funds, the manager’s responsibility is to the ultimate beneficiaries, not the sponsor.
Statement 2 is also correct. There are situations in which an actual client may not exist. For example, if a member or candidate is managing a fund or an index, he or she may not know the actual client or investor requirements or risk profiles. In this case, the investment mandate must be followed.
Anita Vizquel, CFA, is a sole practitioner providing investment advisory services. Based on extensive and ongoing research, Vizquel believes that Viatex Brokerage provides the best execution at a competitive price and she uses the firm for the majority of her clients’ trades. In recognition of her loyalty, Viatex provides Vizquel with soft dollar commissions in the form of research reports that Vizquel finds very relevant for some, but not all, of her clients. Has Vizquel violated the CFA Standards?
A No
B Yes, by using Viatex for the majority of her client’s trades
C Yes, by accepting research reports that do not benefit all of her clients
A According to Standard III(A) - Loyalty, Prudence, and Care, Vizquel is allowed to accept soft dollar commissions in the form of research if the brokerage provides high quality execution at a reasonable price. This is true even if the research does not directly benefit the client for whom trading is done, as in this example. It is reasonable to conclude that Vizquel would have chosen Viatex to process trades regardless of whether she had a referral fee arrangement with the firm.
Similarly, Vizquel does not violate this Standard by using Viatex for the majority of her client’s trade. As noted above, Vizquel is confident, based on her extensive and ongoing research, that Viatex provides the best execution at a competitive price.
Bruce Adams, CFA, has just finished meeting with his client Martin Stanford, a 42-year-old executive with a below-average willingness to take investment risk despite having a high level of wealth and a long time horizon. Adams arranges a meeting with his supervisor, Lynn Lavictoire, during which they discuss Stanford’s file in detail. Later that evening, Adams calls his father, a retired investment advisor, to ask for advice on helping clients become more aware of their ability to take additional investment risk. Has Adams violated the CFA Standards?
A No
B Yes, by speaking with his father
C Yes, by speaking with Lavictoire
A Standard III(E) - Preservation of Confidentiality requires members and candidates to keep client information confidential. However, Adams’ discussion of the details of Stanford’s case with his supervisor is not a violation of this Standard. In the conversation with his father, Adams asks for advice on a general topic, and there is no evidence to suggest that confidential information about Stanford, or any other client, was disclosed.
Gary Elkdale, CFA, advises individual investors for Redemption Wealth Management. Last year, one of his clients, Sharon Hines, filed a written complaint with Redemption accusing Elkdale of breaching the terms of her investment policy statement (IPS) by purchasing shares of a technology company that subsequently filed for bankruptcy. After the complaint was filed, Elkdale vigorously defended his decision to his firm’s compliance department, providing documentation supporting his claim that this transaction offered an opportunity for diversification and was consistent with the overall portfolio strategy agreed to by Hines. Because he was confident that the complaint would not be upheld, Elkdale claimed that he was not the subject of a written complaint when completing his annual Professional Conduct Statement. Later, Redemption’s compliance department cleared Elkdale of any wrongdoing. Has Elkdale most likely violated the Standards?
A No
B Yes, with respect to suitability
C Yes, with respect to misrepresentation
C By falsely reporting that he was not the subject of a written complaint in his Professional Conduct Statement prior to the matter being resolved, Elkdale violated Standard I(C) - Misrepresentation. He should not assume there was no wrongdoing before it was officially declared by the compliance department.
There is no indication that Elkdale violated Standard III(C) - Suitability, which requires members and candidates to “judge the suitability of investments in the context of the client’s total portfolio.”
Which of the following statements is most accurate? Standard III(D) - Performance Presentation:
A discourages the presentation of single representative accounts.
B requires the same performance information to be presented to all audiences.
C prohibits statements regarding the expected future performance of risky securities.
A According to the recommendations for compliance with Standard III(D) - Performance Presentation, members and candidates should present the performance of weighted average composites of portfolios managed according to similar mandates rather than the performance of a single representative account.
This Standard does not require the same performance information to be presented to all audiences. Members and candidates are allowed and encouraged to account for each audience’s level of knowledge and sophistication. Although members and candidates must not make misleading statements about reasonably expected future returns, it is not accurate to say that this Standard prohibits all statements about the expected future performance of risky securities.
According to Standard III(D) - Performance Presentation, “when communicating investment performance information, Members and Candidates must make reasonable efforts to ensure that it is fair, accurate, and complete.”
The Standard requires full disclosure of performance data to clients as well as prospective clients. When communicating investment performance information, members and candidates must ensure that not only is it fair and accurate but also complete.
Jeri Hosmer, CFA, has been researching Digger Energy (DGE) and has a client for whom the company’s stock is a suitable investment. She establishes her client’s position by placing a series of smaller orders over the course of a two-week period. Although her intention was to minimize the price impact associated with acquiring a relatively large number of thinly-traded shares, DGE’s stock price increased significantly over that period. Has Hosmer most likely violated the Standards?
A No
B Yes, with respect to market manipulation
C Yes, with respect to loyalty, prudence, and care
A As noted in the guidance for Standard II(B) - Market Manipulation, it is “not intended to preclude transaction undertaken on legitimate trading strategies.” The price of thinly-traded shares can be significantly affected by large trades and Hosmer does not violate this Standard by structuring the purchase as a series of smaller trades.
Although her client may have ended up paying a higher price on a volume-weighted average basis than she would have preferred, there is no evidence that Hosmer has violated Standard III(A) - Loyalty, Prudence, and Care.
Ann Vendig, CFA, manages investments for a family partnership. Vendig has discovered evidence of transactions diverting the partnership’s assets into the personal account of one of its members and suspects that this activity violates applicable laws. As a first step, she consults with her firm’s compliance department. Has Vendig most likely complied with the Standards?
A Yes
B No, because she did not report her suspicions to the relevant legal authorities
C No, because she did not report the activity to members of the partnership who have been affected by these transactions
A In this circumstance, per Standard III(E) - Preservation of Confidentiality, the first step is to consult the compliance department and/or seek independent legal advice regarding how to proceed. There may be applicable laws or regulations which would ultimately require Vendig to report her suspicions to the relevant legal authorities, but she would not violate this Standard by consulting with her firm’s compliance department before deciding on an appropriate next step.
Irma Ehrlich, CFA, is an advisor who works with individual investors. Recently, three of Ehrlich’s clients submitted buy orders for shares of Brightwell Manufacturing (BWM). Ehrlich was able to complete a block purchase order of BWM shares, which she allocated among the three clients on a pro rata basis according to order size. Each client was assigned a different execution price based on the time their order was received. Has Ehrlich most likely violated the Standards?
A No
B Yes, with her method of allocating shares
C Yes, with her method of assigning execution prices
C Standard III(B) - Fair Dealing requires members and candidates to “deal fairly with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.” Ehrlich violates this Standard by assigning different execution prices for shares acquired in a block trade. As noted in the recommended procedures for compliance, all clients participating in a block trade should be assigned the same price and charged the same commission.
However, Ehrlich’s decision to execute a block trade and assign the shares on a pro rata basis according to order size is consistent with this Standard.
Matthew Brolin, CFA, is a portfolio manager with Bluenose Investments and has recently made a significant purchase of shares in Invotech Corp. In a television interview this morning, Brolin claimed that he had a private conversation with Invotech’s CEO, who told him that they will be announcing a major expansion next week. Invotech’s share price increased by 14% over the course of the trading day. In reality, Brolin has never spoken with Invotech’s CEO or any of the company’s senior executives. Brolin has most likely violated the CFA Standards with respect to:
A market manipulation.
B preservation of confidentiality.
C material nonpublic information.
A According to Standard II(B) - Market Manipulation, member and candidates must not “engage in practices that distort prices… with the intent to mislead market participants.” By fabricating a positive rumor about a company in which he had just made a significant investment, Brolin has committed information-based manipulation.
Brolin has not violated Standard III(E) - Client Confidentiality because Invotech’s CEO is not a client and this “information” has no basis in reality.
It is unlikely that Brolin has violated Standard II(A) - Material Nonpublic Information, which applies to factual information.
William Thorpe, CFA, is a portfolio manager who serves both individual and institutional clients. Due to a heavy workload, Thorpe is struggling to keep up with his clients. One task which takes up a large amount of Thorpe’s time is proxy voting. Which of the following statements is least likely correct, as it relates to Thorpe’s responsibility regarding voting of proxies? Thorpe:
A must vote proxies in an informed and responsible manner.
B is required to vote proxies only when specifically instructed to do so by his clients.
C may choose not to vote proxies based on an analysis of the net benefit such action would provide the client.
B According to Standard III(A) - Loyalty, Prudence, and Care, members and candidates “have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and Candidates must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests.”
Proxies have economic value and Thorpe must vote them responsibly on behalf of his clients, even when he is not specifically instructed to do so. While this obligation applies to votes on non-routine matters, members and candidates are not required to vote proxies in cases when a cost-benefit analysis shows that the client would not benefit.
Victor Costa, CFA, managing director of Venturion Investments, knows that his firm has been struggling for the last two years during an economic downturn. Costa was given a report to market the firm, which showed the firm to have the best returns in the firm’s history. While speaking with potential new clients, Costa hands out the report to attempt to bring new clients into the firm. Has Costa most likely violated the Standards?
A Yes
B No, because he did not create the research report
C No, because he did not know the actual return figures for the firm
A While Costa may not have explicitly known the report was misleading or false, given the economic condition and general knowledge he had, he should have known there was something wrong or biased with the performance report. By handing out the report, he violates Standard III(D) - Performance Presentation and Standard I(C) - Misrepresentation.
Last year, Tom Ennis, CFA, set up an irrevocable trust for his long-time client, Sam Bennett, to transfer his company’s shares to his son Taylor, 23, in a tax-efficient manner. The terms of the trust specify that Taylor Bennett cannot access any of the assets held in trust while his father is alive, but the assets are no longer legally part of Sam Bennett’s estate. As trustee, Ennis has sole authority to exercise proxy votes for the shares held in trust until Sam Bennett’s death. Recently, Sam Bennett asked Ennis to vote with management on an important matter to be decided at his company’s shareholder meeting next week. The next day, Taylor Bennett asks Ennis to vote the proxies against management on this matter. In order to comply with the CFA Standards, Ennis should most likely:
A abstain from voting.
B vote with management.
C vote against management.
C Standard III(A) - Loyalty, Prudence, and Care requires members and candidates to act in the best interest of their client. In this example, when exercising the proxies, Ennis’ client is Taylor Bennett because he is the ultimate beneficiary of the assets being held in trust. Because the trust is irrevocable, Sam Bennett has given up control over them. Ennis must therefore vote against management’s proposal in accordance with Taylor Bennett’s wishes. Ennis would also be violating this Standard by abstaining from voting on an important matter, particularly after receiving instructions on how to vote from his client.
Jack Fahey, CFA, is a portfolio manager of Pacific Sunrise Investments, which does not claim compliance with the Global Investment Performance Standards (GIPS). When presenting the historical performance of his small-cap growth composite, Fahey notes that only fee-paying accounts are included, but he does not mention that both discretionary and non-discretionary accounts are included. Has Fahey most likely violated the Standards?
A Yes, with respect to performance presentation only
B Yes, with respect to both performance presentation and misrepresenation
C No, because Pacific Sunrise Investments does not claim compliance with GIPS
B According to Standard I(C) - Misrepresentation, members and candidates “must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities.”
Standard III(D) - Performance Presentation requires members and candidates to make reasonable efforts to present performance information in a manner that is “fair, accurate, and complete.”
In this example, Fahey violates both of these Standards by failing to note that the small-cap growth composite includes both discretionary and non-discretionary accounts, as the composite’s performance may misrepresent his abilities as a portfolio manager. The compliance status of Fahey’s firm with GIPS is irrelevant to whether he has personally violated these Standards.
Teddy Larson, CFA, a portfolio manager with Pedigo Investments, exercises proxies on behalf of his clients most of the time, but not in every case. When Larson does exercise these proxies, he often does so in accordance with management’s recommendations. Has Larson most likely violated the Standards?
A No
B Yes, by failing to vote all proxies
C Yes, by often voting proxies in accordance with management’s recommendations
A According to the guidance for Standard III(A) - Loyalty, Prudence, and Care, members and candidates are required to exercise proxies on behalf of clients “in an informed and responsible manner.” Voting in accordance with management does not necessarily constitute a violation of this Standard, as long as care was taken to ensure that the vote was cast in the interest of the client. This Standard does not require proxies to be voted in cases when a cost-benefit analysis shows that the client would not benefit from such action.
