Ethics Flashcards
10.1 Code of Ethics and Standars of Professional Conduct
– Describe the six components of the Code of Ethics and the seven Standards of Professional Conduct.
– Explain the ethical responsibilities required of CFA Institute members and candidates in the CFA Program by the Code and Standards.
[Evolution of the CFA Institute Code of Ethics and Standards of Professional Conduct]
1- Periodic Updates to the Code and Standards
– The CFA Institute updates its Code and Standards approximately every decade to align with industry changes.
– Major revisions occurred in 2005, 2014, and 2023, with the latest update introducing a new Standard.
2- Role of the Standards of Practice Handbook
– Updates to the Standards of Practice Handbook coincide with changes to the Code and Standards.
– The handbook serves as a guidance tool to help CFA members apply ethical principles in practice.
– Members are encouraged to discuss the Code and Standards with supervisors to ensure compliance.
Key Takeaways
– The CFA Code of Ethics and Standards of Professional Conduct evolve regularly to stay relevant.
– The Standards of Practice Handbook helps professionals apply and interpret ethical guidelines.
– Ongoing discussion and adherence to the Code and Standards are essential for CFA members.
[Summary of the 2023 Revisions to the Code and Standards]
1- Introduction of Standard I(E) – Competence
– A new standard was created, requiring CFA members and candidates to maintain the necessary level of competence to fulfill their professional responsibilities.
2- Enhanced Disclosure in Standard V(B) – Communications with Clients
– The wording was updated to mandate clear disclosures regarding the nature of services provided and their associated costs to clients and prospective clients.
3- Renaming and Clarification of Standard VI(A) – Avoid or Disclose Conflicts
– Previously titled “Disclosure of Conflicts,” this standard was renamed to emphasize a stronger preference for avoiding conflicts rather than simply disclosing them.
Key Takeaways
– The 2023 revisions introduce competence as a formal requirement for CFA professionals.
– Client communication standards now require greater transparency about services and costs.
– The emphasis on avoiding conflicts of interest reflects a stricter ethical stance in professional conduct.
[CFA Institute Professional Conduct Program]
1- Purpose and Oversight
– CFA Institute members and candidates must follow the Code and Standards.
– The Professional Conduct Program (PCP) and the Disciplinary Review Committee (DRC) enforce these standards under the Rules of Procedure, ensuring fairness and confidentiality.
2- Triggers for an Inquiry
– Investigations may be initiated based on:
— Self-disclosure on the annual Professional Conduct Statement.
— Written complaints or CFA Institute staff awareness.
— Examination proctor reports or irregularities in exam scores.
— Social media monitoring by the CFA Institute.
3- Investigation Process
– The Professional Conduct staff conducts investigations by:
— Requesting written explanations from the member.
— Conducting interviews and collecting documents.
4- Possible Outcomes and Consequences
– The Designated Officer may conclude with:
— No disciplinary action.
— A cautionary letter.
— Further proceedings if warranted.
– If disciplinary action is proposed, the member can accept or reject it.
– A rejection leads to a hearing panel, with possible consequences including:
— Public censure.
— Revocation of the CFA charter.
Key Takeaways
– The PCP and DRC ensure compliance with the Code and Standards through investigations.
– Inquiries can arise from multiple sources, including self-disclosures, complaints, and exam monitoring.
– Disciplinary actions range from warnings to revocation of CFA membership, depending on the severity of misconduct.
[Adoption of the Code and Standards]
1- Mandatory Compliance for Individuals, Voluntary for Firms
– CFA Institute members and candidates must follow the Code and Standards.
– Firms are encouraged but not required to adopt the Code and Standards.
– If a firm claims compliance, it must disclose that CFA Institute has not verified its compliance.
2- The Asset Manager Code of Professional Conduct
– Created specifically for firms as a voluntary code of conduct.
– CFA Institute aims for broad adoption of this code among firms.
Key Takeaways
– Individuals must comply with the CFA Code and Standards, but firms are not required to follow them.
– Firms can claim compliance but must clarify that CFA Institute does not verify adherence.
– The Asset Manager Code of Professional Conduct provides an optional ethical framework for firms.
[Adoption of the Code and Standards]
1- Requirements for CFA Members and Candidates
– CFA Institute members and CFA candidates are required to follow the Code and Standards.
– Compliance is mandatory as part of maintaining CFA designation and candidacy.
2- Encouragement for Firms
– Firms are encouraged but not required to adopt the Code and Standards.
– Adoption is voluntary, and firms may claim compliance but must provide appropriate disclosure.
3- Self-Claim Compliance for Nonmembers
– If a nonmember or firm claims compliance, they must include the statement:
“[Insert name of party] claims compliance with the CFA Institute Code of Ethics and Standards of Professional Conduct. This claim has not been verified by CFA Institute.”
– This ensures transparency and prevents misrepresentation of official CFA verification.
Key Takeaways
– CFA members and candidates must follow the Code and Standards, while firms are encouraged but not required to adopt them.
– Firms claiming compliance must disclose that CFA Institute has not verified their adherence.
– Self-claim compliance ensures firms cannot misrepresent official CFA endorsement.
[Adoption of the Code and Standards – Asset Manager Code of Professional Conduct]
1- Purpose and Scope
– The Asset Manager Code of Professional Conduct is designed specifically for firms, providing ethical and professional guidelines for asset managers.
– Unlike the CFA Code and Standards, which apply to individuals, this code is tailored to institutional practices.
2- Key Areas of Guidance for Asset Managers
– Loyalty to Clients → Prioritizing client interests over the firm’s or manager’s personal gain.
– Investment Process → Ensuring a disciplined and transparent approach to investment decisions.
– Trading → Executing trades fairly and efficiently while minimizing conflicts of interest.
– Compliance → Adhering to legal and regulatory requirements, as well as internal policies.
– Performance Evaluation → Providing accurate and reliable performance reporting.
– Disclosure → Maintaining transparency in fees, risks, and conflicts of interest.
Key Takeaways
– The Asset Manager Code of Professional Conduct is a voluntary ethical framework for firms.
– It ensures accountability in key areas such as client loyalty, compliance, and disclosure.
– Adoption of this code helps firms align with industry best practices and enhance investor trust.
[Importance of Ethics in Finance]
1- Role of Ethics in Financial Markets
– Ethics are moral principles guiding behavior in ways that impact others, emphasizing honesty, fairness, diligence, and care.
– Unethical behavior erodes investor trust, making a strong ethical foundation essential beyond laws and regulations.
2- Ethics and Efficient Capital Allocation
– Ethical behavior supports fair and transparent markets, ensuring capital is allocated efficiently.
– Investor confidence depends on trust and integrity, which should be upheld universally, beyond cultural or regional norms.
3- The Indirect Impact of Ethical Behavior
– Individuals and firms must consider the broader consequences of their actions on the financial system.
– Seemingly small unethical actions can contribute to market crises, especially in a globally interconnected economy.
– Those in authority must prioritize client interests over personal or employer interests.
4- Ethical Behavior vs. Legal Compliance
– Ethical principles restrain self-interest that could harm others, going beyond regulatory requirements.
– Legal behavior is required, but ethical behavior is morally correct, ensuring financial professionals act in the best interest of stakeholders.
Key Takeaways
– Ethics are fundamental for maintaining trust, transparency, and fairness in financial markets.
– Unethical actions can lead to systemic risks, affecting the broader investment community.
– Legal compliance is mandatory, but true professionalism requires ethical decision-making beyond the law.
[Integrating Ethics in Decision-Making and Business Practices]
1- The Role of Individual Judgment in Ethics
– Good decision-making requires consideration beyond economic factors—ethics must be a central part of the process.
– Ethical analysis ensures that choices align with fairness, integrity, and long-term sustainability.
2- Importance of a Firm’s Ethical Culture
– A code of ethics must be deeply integrated into business operations.
– Senior management plays a critical role in fostering a culture of integrity, ensuring ethical behavior is prioritized in the workplace.
3- CFA Institute’s Commitment to Ethical Standards
– CFA Institute encourages members to develop, promote, and uphold high ethical standards.
– The Code and Standards provide guidance for maintaining professional integrity.
– Distinguishing right from wrong is essential, as situational pressures can undermine ethical intentions if not carefully managed.
Key Takeaways
– Ethical judgment is essential in financial decision-making.
– A strong ethical culture must be led by senior management to ensure firm-wide integrity.
– The CFA Code and Standards help professionals navigate ethical challenges, reinforcing the importance of principled decision-making.
[CFA Institute Code of Ethics]
1- Act with Integrity and Professionalism
– CFA members must demonstrate integrity, competence, diligence, and ethical behavior in dealings with clients and colleagues.
2- Prioritize Client Interests and Industry Integrity
– The interests of clients and the investment profession must always come before personal gain.
3- Exercise Independent and Reasonable Judgment
– Professionals should apply reasonable care and independent judgment in all investment-related decisions.
4- Maintain Ethical and Professional Conduct
– Ethical behavior and professionalism are essential in all aspects of financial practice.
5- Promote Market Integrity for Societal Benefit
– Upholding market integrity and adhering to regulatory standards ensures capital markets function for the greater good.
6- Commit to Continuous Professional Development
– Members must maintain and enhance their professional competence and support the development of others in the field.
Key Takeaways
– The CFA Code of Ethics emphasizes integrity, professionalism, and client-first principles.
– Practitioners must uphold market integrity and professional competence.
– Ethical judgment and independent decision-making are critical responsibilities for CFA professionals.
[Standards of Professional Conduct – Professionalism]
1- Standard I(A) – Knowledge of the Law
– CFA members and candidates must understand and comply with all applicable laws, rules, and regulations governing their professional activities.
– When conflicts arise between local laws and CFA standards, the stricter standard must be followed.
2- Standard I(B) – Independence and Objectivity
– Professionals must maintain independence and avoid conflicts of interest that could compromise their judgment.
– They should not accept gifts, compensation, or incentives that could influence their decision-making.
3- Standard I(C) – Misrepresentation
– Members must not misrepresent investment performance, qualifications, or professional capabilities.
– False or misleading information in research, marketing materials, or financial analysis is strictly prohibited.
4- Standard I(D) – Misconduct
– Engaging in fraud, dishonesty, or any conduct that reflects poorly on professional integrity is prohibited.
– Personal and professional behavior should uphold the reputation of the investment profession.
5- Standard I(E) – Competence
– CFA professionals must maintain and enhance their knowledge, skills, and abilities to ensure competent and informed decision-making.
– Continuous education and professional development are required to keep up with industry changes.
Key Takeaways
– CFA professionals must comply with laws, uphold integrity, and avoid conflicts of interest.
– Misrepresentation and misconduct can harm clients and damage market trust.
– Competence and continuous learning are essential for ethical and professional conduct.
[Standards of Professional Conduct – Integrity of Capital Markets]
1- Standard II(A) – Material Nonpublic Information
– CFA members and candidates must not act or cause others to act on material nonpublic information that could impact investment decisions.
– Material information includes any data that could significantly affect a security’s price if made public.
– Information is nonpublic until it has been broadly disseminated to the market.
– Best practice: Establish and follow “firewalls” and restricted lists to prevent insider trading.
2- Standard II(B) – Market Manipulation
– Members must not engage in practices that distort market prices or create artificial demand for securities.
– Prohibited actions include:
— Disseminating false or misleading information to influence stock prices.
— Engaging in price manipulation tactics, such as spoofing or wash trading.
– Market integrity depends on fair and transparent trading practices to protect investors.
Key Takeaways
– Trading on material nonpublic information is unethical and illegal, as it undermines market fairness.
– Market manipulation distorts price discovery and investor confidence and is strictly prohibited.
– CFA professionals must ensure compliance with regulations to maintain market integrity and ethical investing.
[Standards of Professional Conduct – Duties to Clients]
1- Standard III(A) – Loyalty, Prudence, and Care
– CFA members must act in the best interests of clients, placing client needs above personal or employer interests.
– Investments should be managed with prudence, diligence, and reasonable care.
– Fiduciary duties require avoiding conflicts of interest and ensuring transparent decision-making.
2- Standard III(B) – Fair Dealing
– Members must provide equal treatment to all clients when disseminating investment recommendations and executing trades.
– No preferential treatment should be given to certain clients over others.
– Fairness applies to allocating investment opportunities and disclosing material changes.
3- Standard III(C) – Suitability
– Investment recommendations must be appropriate for a client’s risk tolerance, objectives, and financial situation.
– For institutional clients, managers must follow the stated investment policy.
– When managing client portfolios, regular suitability reviews should be conducted.
4- Standard III(D) – Performance Presentation
– Performance reports should be fair, accurate, and not misleading.
– Returns must be presented using consistent and objective reporting standards.
– Any limitations or assumptions in performance calculations must be disclosed.
5- Standard III(E) – Preservation of Confidentiality
– Client information must remain confidential, unless:
— Required by law or regulation.
— The client authorizes disclosure.
— There is an illegal activity involved, requiring disclosure to authorities.
Key Takeaways
– CFA professionals must act in their clients’ best interests, ensuring loyalty, fairness, and suitability in all investment decisions.
– Equal treatment of clients is critical in trading, recommendations, and opportunity allocation.
– Client information must remain confidential, with limited exceptions for legal or ethical obligations.
[Standards of Professional Conduct – Duties to Employers]
1- Standard IV(A) – Loyalty
– CFA members and candidates must act in the best interests of their employer and not engage in activities that could harm the firm.
– Employees must not misappropriate company resources, misuse confidential information, or compete against their employer without consent.
– Leaving a firm requires acting ethically by not soliciting clients or taking proprietary information.
2- Standard IV(B) – Additional Compensation Arrangements
– Members must disclose and obtain employer approval before accepting compensation, benefits, or gifts that could create a conflict of interest.
– Compensation must be transparent and aligned with employer policies.
– This applies to direct and indirect payments that may influence professional judgment.
3- Standard IV(C) – Responsibilities of Supervisors
– Supervisors must ensure compliance with the CFA Code and Standards within their organization.
– They should establish adequate compliance systems to prevent unethical behavior.
– If a violation occurs, supervisors are responsible for taking corrective action.
Key Takeaways
– CFA professionals must remain loyal to their employer and avoid actions that harm the firm.
– Any outside compensation or benefits must be disclosed and approved to prevent conflicts of interest.
– Supervisors must implement compliance procedures and enforce ethical standards within the organization.
[Standards of Professional Conduct – Investment Analysis, Recommendations, and Actions]
1- Standard V(A) – Diligence and Reasonable Basis
– CFA professionals must conduct thorough and independent research before making investment recommendations or taking action.
– The basis for investment decisions should be supported by reliable data, analysis, and due diligence.
– Analysts must understand the risks and assumptions behind their recommendations.
2- Standard V(B) – Communication with Clients and Prospective Clients
– Members must ensure clear, accurate, and complete communication of investment recommendations.
– Disclosures should include:
— The investment process and key risks.
— Factors that could impact performance.
— Any significant changes to prior recommendations.
– Transparency builds trust and informed decision-making for clients.
3- Standard V(C) – Record Retention
– Investment professionals must maintain records of research, analysis, and communications to support their recommendations.
– Record-keeping policies should comply with regulatory and firm requirements.
– Proper documentation ensures accountability and transparency in decision-making.
Key Takeaways
– Investment decisions must be based on diligence and a strong analytical foundation.
– Clear and full disclosure of investment risks and processes is essential for client trust.
– Maintaining proper records is crucial for compliance, accountability, and audit purposes.
[Standards of Professional Conduct – Conflicts of Interest]
1- Standard VI(A) – Avoid or Disclose Conflicts
– CFA professionals must avoid conflicts of interest when possible.
– If conflicts cannot be avoided, they must be fully disclosed to clients, employers, and other stakeholders.
– Transparency ensures that clients can make informed decisions about potential biases.
2- Standard VI(B) – Priority of Transactions
– Client transactions must take precedence over personal or firm-related trades.
– Investment professionals must not take advantage of client information for personal gain.
– Trading for personal accounts should only occur after fulfilling client orders.
3- Standard VI(C) – Referral Fees
– Members must disclose any referral fees, compensation, or benefits received for recommending services.
– Clients and employers should be aware of potential conflicts of interest arising from referral relationships.
– Full disclosure ensures that recommendations are made in the client’s best interest rather than personal financial incentives.
Key Takeaways
– Avoiding or disclosing conflicts is critical to maintaining client trust.
– Client interests must always come first, and professionals must not misuse privileged information.
– Referral fees should be transparently disclosed to prevent hidden incentives from influencing recommendations.
[Standards of Professional Conduct – Responsibilities as a CFA Institute Member or CFA Candidate]
1- Standard VII(A) – Conduct as Members and Candidates in the CFA Program
– CFA members and candidates must act ethically and professionally to uphold the integrity of the CFA designation.
– They must not engage in conduct that damages the reputation of the CFA Institute, the designation, or the investment profession.
– This includes avoiding cheating, plagiarism, or misconduct in the CFA exam process.
2- Standard VII(B) – Reference to CFA Institute, the CFA Designation, and the CFA Program
– Members and candidates must accurately represent their CFA status and not mislead others about their credentials.
– Misuse of the CFA designation includes:
— Claiming to be a CFA charterholder without meeting all requirements.
— Implying superior investment performance solely based on earning the CFA designation.
— Incorrectly using “CFA” as a noun instead of an adjective (e.g., “John Smith, CFA charterholder” is correct, but “John Smith is a CFA” is incorrect).
Key Takeaways
– CFA members and candidates must uphold ethical conduct and avoid actions that damage the CFA Institute’s reputation.
– Misrepresenting CFA credentials is strictly prohibited.
– Proper use of the CFA designation ensures credibility and professionalism in the investment industry.
[Standards of Professional Conduct]
1- Professionalism
– Standard I(A) – Knowledge of the law
– Standard I(B) – Independence and objectivity
– Standard I(C) – Misrepresentation
– Standard I(D) – Misconduct
– Standard I(E) – Competence
2- Integrity of Capital Markets
– Standard II(A) – Material nonpublic information
– Standard II(B) – Market manipulation
3- Duties to Clients
– Standard III(A) – Loyalty, prudence, and care
– Standard III(B) – Fair dealing
– Standard III(C) – Suitability
– Standard III(D) – Performance presentation
– Standard III(E) – Preservation of confidentiality
4- Duties to Employers
– Standard IV(A) – Loyalty
– Standard IV(B) – Additional compensation arrangements
– Standard IV(C) – Responsibilities of supervisors
5- Investment Analysis, Recommendations, and Actions
– Standard V(A) – Diligence and reasonable basis
– Standard V(B) – Communication with clients and prospective clients
– Standard V(C) – Record retention
6- Conflicts of Interest
– Standard VI(A) – Avoid or Disclose conflicts
– Standard VI(B) – Priority of transactions
– Standard VI(C) – Referral fees
7- Responsibilities as a CFA Institute Member or CFA Candidate
– Standard VII(A) – Conduct as members and candidates in the CFA program
– Standard VII(B) – Reference to CFA Institute, the CFA designation, and the CFA program
10.2 Guidance for Standards I-VII (1-7)
– Demonstrate a thorough knowledge of the CFA Institute Code of Ethics and Standards of Professional Conduct by applying the Code and Standards to specific situations.
– Recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.
The “Recommended Procedures for Compliance” section provides best practices and suggestions rather than strict requirements. I will ensure that all future outputs reflect this distinction.
[Standard I(A) Knowledge of the Law]
1- Broad Definition
– “Members and Candidates must understand and comply with all applicable laws, rules, and regulations (including the CFA Institute Code of Ethics and Standards of Professional Conduct) of any government, regulatory organization, licensing agency, or professional association governing their professional activities. In the event of a conflict, Members and Candidates must comply with the more strict law, rule, or regulation. Members and Candidates must not knowingly participate or assist in and must dissociate from any violation of such laws, rules, or regulations.”
2- Understanding Compliance Requirements
– Members and candidates must be aware of and comply with all relevant financial laws and regulations.
– The scope of compliance includes:
— 1- Government laws: National and international regulatory frameworks.
— 2- Regulatory organizations: Market-specific bodies (e.g., SEC, FINRA, FCA).
— 3- Licensing agencies: Institutions that issue professional credentials.
— 4- Professional associations: Governing bodies such as the CFA Institute.
3- Handling Legal Conflicts
– If two sets of regulations apply, the stricter rule prevails.
– Example: If local law allows insider trading but CFA standards prohibit it, members must follow CFA standards.
– Ethical responsibility requires members to err on the side of caution when compliance is unclear.
4- Prohibition Against Assisting in Violations
– Members must not knowingly engage in, facilitate, or ignore violations of laws and ethical codes.
– Three key obligations:
— 1- “Knowingly participate” → Direct involvement in illegal activity.
— 2- “Assist in” → Enabling misconduct (e.g., processing fraudulent transactions).
— 3- “Dissociate from” → Taking action to remove oneself from unethical situations.
5- Best Practices for Compliance
— 1- Stay informed: Continuously monitor regulatory updates.
— 2- Report violations: Take appropriate action if unethical activity is detected.
— 3- Avoid unintentional breaches: Lack of knowledge is not a defense.
Key Takeaways
– Members must always comply with the most stringent applicable law.
– Assisting, ignoring, or participating in violations is prohibited.
– Remaining informed and acting with integrity ensures ethical compliance.
[Guidance on Standard I(A) Knowledge of the Law]
1- Compliance with Applicable Laws and Regulations
– Members and candidates must adhere to the more strict law, rule, or regulation in all situations.
– While they are not required to be compliance experts, they must understand how to access compliance guidance.
2- Relationship Between the Code and Standards and Applicable Law
– Members should compare local laws with the CFA Code and Standards.
– The stricter regulation must always be followed, as it provides greater protection to clients and market integrity.
3- Participation in or Association with Violations by Others
– Members are responsible for violations in which they knowingly participate.
– They should first attempt to prevent unethical actions, such as reporting the violation to a supervisor.
– If unethical behavior persists, they must dissociate from the activity, even if it means leaving their job.
– Reporting violations is encouraged but not required under the CFA Code.
4- Investment Products and Applicable Laws
– Members who create investment products must understand the laws where the product is originated and sold.
– They must compare local laws with CFA Standards and follow the stricter rule.
Key Takeaways
– Always comply with the stricter applicable law to protect clients and markets.
– Dissociation from unethical actions is mandatory, while reporting violations is encouraged.
– Investment products must adhere to regulations in all relevant jurisdictions.
[Recommended Procedures for Compliance – Standard I(A) Knowledge of the Law]
1- Members and candidates
– Members and candidates should stay informed regarding laws and regulations through compliance department advice or continuing education. They should also regularly review the firm’s compliance procedures and keep reference copies of applicable laws and rules readily available.
2- Distribution Area Laws
– Members and candidates should also seek to understand the laws where investment products originated and are sold.
3- Legal Counsel
– Members and candidates should seek legal counsel when necessary but should not blindly follow the legal advice.
4- Dissociation
– When dissociating from an activity, the member should document the attempts to stop the action in question.
5- Firms
– Firms should adopt a code of ethics, provide information on applicable laws, and establish procedures for reporting violations.
Expanded Explanation and Best Practices
1- Members and Candidates: Staying Informed on Laws and Regulations
– Members and candidates must actively stay updated on changing laws and regulations.
– Best practices include:
— 1- Regular compliance training to stay current with financial regulations.
— 2- Maintaining access to compliance resources, such as legal reference materials.
— 3- Consulting regulatory updates from institutions like the SEC, FCA, or ESMA.
— 4- Using compliance officers to clarify regulatory questions.
– Example: A wealth manager handling cross-border clients must ensure they follow both domestic tax laws and foreign reporting obligations.
2- Understanding Distribution Area Laws
– It is essential to comply with the laws of both the investment’s country of origin and its distribution area.
– Example: A firm selling mutual funds in both the U.S. and Canada must ensure compliance with both SEC (U.S.) and IIROC (Canada) regulations.
3- Seeking Legal Counsel When Necessary
– Legal advice is important, but CFA members must not blindly rely on it if it conflicts with ethical principles.
– Example: If a legal team suggests loopholes that help clients avoid taxes but violate ethical standards, a CFA member must reject the advice and follow professional integrity.
4- Dissociation from Violations and Documenting Actions
– If a member encounters unethical or illegal activity, they must:
— 1- Report the issue internally to compliance or senior management.
— 2- If the violation persists, dissociate from the activity to avoid complicity.
— 3- Document all actions taken to demonstrate ethical decision-making.
– Example: An investment banker pressured to manipulate IPO pricing should document concerns, report internally, and refuse participation.
5- Firms: Establishing Compliance Programs
– Firms should:
— 1- Develop comprehensive ethics training programs.
— 2- Implement strict reporting mechanisms for ethical breaches.
— 3- Ensure accessibility of compliance guidance for employees.
– Example: A multinational asset management firm should have compliance teams in every jurisdiction to ensure local and global regulatory alignment.
[Standard I(B) Independence and Objectivity]
1- Broad Definition
– “Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. 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.”
2- Ensuring Independence and Objectivity
– Members and candidates must exercise careful judgment in professional activities.
– Independence means making unbiased decisions without external influence.
– Objectivity ensures that recommendations, reports, and analyses are free from personal or external bias.
3- Prohibition Against Gifts, Benefits, or Compensation That Compromise Objectivity
– Members must not accept, solicit, or offer gifts, compensation, or benefits that could reasonably be perceived as influencing their decisions.
– Situations where objectivity may be compromised:
— 1- Receiving gifts from clients: Excessive gifts may create a conflict where the analyst feels obligated to favor the client.
— 2- Accepting benefits from investment firms: Analysts covering securities should not accept incentives from companies they evaluate.
— 3- Offering compensation to gain preferential treatment: Paying for special access to information or deals violates this standard.
– Example: An equity analyst receiving a luxury vacation from a company they cover may feel pressured to issue a favorable rating on its stock.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in situations involving:
— 1- Sell-side research: Analysts must not let investment banking pressure influence reports.
— 2- Credit rating agencies: Ratings should not be swayed by corporate relationships.
— 3- Consulting arrangements: If a professional is consulting while working as an analyst, they must ensure the arrangement does not influence their research.
Key Takeaways
– Independence and objectivity must be maintained in all professional activities.
– Gifts, benefits, and incentives that could create bias must be avoided.
– Professionals should be cautious in areas prone to conflicts, such as research and credit analysis.
[Guidance on Standard I(B) Independence and Objectivity]
1- Ensuring Unbiased Opinions and Recommendations
– Investors must trust that financial professionals provide independent and objective advice.
– Members and candidates must not accept benefits that could:
— 1- Compromise their own objectivity.
— 2- Influence another person’s decision-making.
— 3- Create even the appearance of a conflict of interest.
2- What is Considered a “Benefit”?
– Benefits include:
— 1- Gifts such as luxury items, tickets to events, or invitations to exclusive functions.
— 2- Monetary incentives or allocations to oversubscribed IPOs for personal accounts.
— 3- Indirect benefits, such as:
—- A broker donating to a portfolio manager’s charity in exchange for business.
—- A company inviting analysts to sponsored events to influence coverage.
– Example: An analyst is invited to an all-expenses-paid luxury event hosted by a company they cover. If attendance influences their research report, objectivity is compromised.
3- Are Gifts and Benefits from Outside Parties Prohibited?
– Modest gifts and entertainment are permissible if they align with the employer’s policies.
– Excessive gifts or those meant to gain favor or business advantages are prohibited.
– Example: Accepting a small company-branded gift is reasonable, but a free luxury vacation from a client is inappropriate.
4- Are Gifts and Benefits from Clients Prohibited?
– Gifts from clients may be acceptable if they align with the professional relationship.
– Unacceptable scenario:
— A portfolio manager accepting a vacation from a broker to secure a business deal.
— The manager’s personal benefit outweighs the interests of investors.
– Acceptable scenario:
— A client rewarding a portfolio manager for strong performance with a gift, assuming interests remain aligned.
– Caution: If gifts influence preferential treatment toward specific clients, this creates an ethical issue.
– Example: A portfolio manager receives a bonus from a client for high returns, but if the manager starts prioritizing that client over others, it violates objectivity.
Key Takeaways
– Independence and objectivity must be preserved in all professional dealings.
– Excessive gifts, benefits, or financial incentives that could influence decision-making must be avoided.
– Even the appearance of a conflict of interest can damage professional credibility.
[Relevance of Standard I(B): Sell-Side Research]
1- Importance for Sell-Side Analysts
– This standard is particularly relevant for sell-side analysts who cover publicly traded companies.
– Analysts working in large, diversified firms with investment banking or brokerage divisions face heightened independence and objectivity risks.
– Key concerns include corporate pressure, travel funding, buy-side influence, and investment banking conflicts.
2- Public Companies: Pressure to Maintain Favorable Coverage
– Public company managers may punish analysts who issue negative recommendations by:
— 1- Banning them from conference calls or meetings.
— 2- Restricting access to management and financial data.
– Analysts may subtly favor companies to maintain access to information.
– Example: An analyst fears losing access to a company’s executive team if they issue a sell rating, so they soften their recommendation instead.
3- Travel Funding and Corporate-Sponsored Trips
– Analysts often visit company facilities to gain insights into operations.
– To maintain objectivity, all travel costs (e.g., airfare, accommodation) must be paid by the analyst or their firm.
– Exception: If no commercial transportation is available, limited corporate-sponsored travel may be acceptable under strict conditions.
– Example: A mining company invites analysts to a remote site where no commercial flights operate. If the trip is necessary and modestly arranged, it may be acceptable. However, flying analysts on a private jet to luxury resorts violates objectivity.
4- Buy-Side Clients: Influence on Sell-Side Ratings
– Buy-side clients (e.g., portfolio managers) consume research reports and may pressure analysts to maintain positive ratings.
– Negative ratings can impact portfolio performance, compensation, and client retention.
– Analysts must resist efforts by buy-side clients to alter research conclusions.
– Example: A portfolio manager holding a large position in a company pressures an analyst to revise a “sell” rating to “hold” to prevent stock price declines.
5- Investment Banking Relationships: Conflicts of Interest
– Large financial institutions may offer analyst coverage to attract investment banking deals.
– Analysts must ensure research remains independent from investment banking influence.
– Investment banking employees must not pressure analysts to issue favorable ratings.
– Compensation structures must not tie analyst pay to investment banking revenue.
– Example: An analyst working for a firm’s research division must not feel pressured to issue a positive report just because the investment banking division is handling the company’s IPO.
Key Takeaways
– Sell-side analysts face significant independence risks, particularly from corporate executives, buy-side clients, and investment banks.
– All travel expenses must be covered personally or by the firm to avoid conflicts of interest.
– Analysts must not alter recommendations due to external pressure from portfolio managers or investment bankers.
[Relevance of Standard I(B): Issuer-Paid Research]
1- Conflicts of Interest in Issuer-Paid Research
– Some companies, especially those with little or no analyst coverage, may hire independent analysts to produce reports.
– This creates a conflict of interest because the analyst is being paid by the company they evaluate.
– Investors may perceive issuer-paid research as biased, reducing trust in its independence and objectivity.
2- Permissibility of Issuer-Paid Research
– Issuer-paid research is allowed under strict conditions:
— 1- Analysts must not accept compensation that is tied to report conclusions or recommendations.
— 2- Flat fees should be negotiated upfront to avoid pressure to issue favorable opinions.
— 3- Compensation in the form of warrants or stock options is prohibited, as it creates incentives to mislead investors.
— 4- Full disclosure of compensation arrangements must be included in research reports.
– Example: If an analyst is hired by a small biotech firm to cover its stock, they must disclose that the report was commissioned and ensure conclusions are independent.
3- Conflicts in Credit Rating Agency Opinions
– Credit rating agencies face the same conflicts as issuer-paid research, since analysts are compensated by the companies they evaluate.
– Credit analysts who also provide advisory services (e.g., helping issuers structure financial products) may have incentives to inflate ratings.
– Example: A rating agency assigns AAA ratings to mortgage-backed securities because its firm earns fees from structuring them, leading to misleading risk assessments.
Key Takeaways
– Issuer-paid research and credit ratings create conflicts of interest that must be carefully managed.
– Analysts must not accept contingent compensation and must fully disclose payment arrangements.
– Credit rating agencies must ensure ratings remain independent from their firms’ other business activities.
[Relevance for Buy-Side Activities]
1- Manager Selection/Procurement
– Many institutional investors (e.g., pension funds) choose to allocate funds to external managers rather than managing portfolios internally.
– Members and candidates involved in hiring external managers must not accept gifts or benefits that could influence their decision-making.
– Example: A pension fund analyst reviewing investment managers must not accept expensive gifts from a firm bidding for the contract, as this could create bias in the selection process.
2- Performance Measurement and Attribution
– Buy-side analysts responsible for performance evaluation may face pressure to alter reports in favor of external managers.
– Some managers may attempt to skew performance reports by:
— 1- Offering gifts or incentives to analysts to make their performance appear better.
— 2- Altering benchmarks to show excess returns that do not exist.
– Members and candidates must not offer or accept benefits that could compromise performance integrity.
– Example: A portfolio manager pressures a performance analyst to change the benchmark return so that reported excess returns appear higher, misleading investors.
Key Takeaways
– Buy-side professionals must maintain independence when selecting managers or measuring performance.
– Gifts, benefits, or pressure to manipulate reports violate ethical standards.
– Institutional investors and performance analysts must ensure transparency and objectivity.
[Recommended Procedures for Compliance]
1- Compensation Structures
– Offer compensation packages that do not create incentives for biased reporting.
– Example: An analyst’s bonus should not be tied to issuing positive recommendations for companies the firm does investment banking business with.
2- Travel and Corporate-Sponsored Arrangements
– Restrict the use of special travel arrangements where corporate issuers cover analysts’ travel costs.
– Example: If a company pays for an analyst’s luxury accommodations, it creates a potential conflict of interest.
3- Ensuring Objectivity in Research
– Provide only factual information about corporate clients if they refuse to allow negative opinions.
– Example: If a company pressures analysts to avoid issuing a sell rating, firms must ensure that analysts can publish independent research.
4- Gifts and Benefits Policies
– Establish clear policies on accepting gifts from third parties and clients.
– Example: A portfolio manager should disclose any gifts received from a client, and firms should set monetary limits on acceptable gifts.
5- Restricting Employee Participation in Certain Investments
– Restrict employee participation in IPOs and private placements to prevent conflicts of interest.
– Example: A research analyst should not invest in an IPO they are covering to avoid biased analysis.
6- Formal Independence Policy
– Firms must adopt a formal independence policy to ensure employees make unbiased decisions.
– Example: A firm’s policy should clearly state that analysts must not accept compensation from companies they cover.
7- Enforcement and Oversight
– Appoint a senior officer to enforce compliance with the firm’s code of ethics.
– Example: A compliance officer should regularly review research reports and investigate potential conflicts of interest.
Key Takeaways
– Compensation structures, travel policies, and gift acceptance must be carefully regulated to maintain objectivity and independence.
– Firms should restrict employees from participating in investments where conflicts of interest may arise.
– A formal independence policy and strong compliance oversight are essential to ensuring ethical behavior.
[Standard I(C): Misrepresentation]
1- Broad Definition
– “Members and Candidates must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities.”
2- Avoiding Misrepresentation
– Members and candidates must ensure accuracy and transparency in all professional communications.
– Misrepresentation includes false statements, exaggerations, and omissions that could mislead investors or clients.
– Examples of misrepresentation:
— 1- Overstating professional qualifications or work experience.
— 2- Misrepresenting investment performance by selectively presenting only favorable results.
— 3- Providing misleading research or analysis without sufficient basis.
3- Prohibition Against False or Misleading Statements
– Members must not knowingly misrepresent facts in:
— 1- Marketing materials: Performance results must be presented fairly and accurately.
— 2- Investment reports: All assumptions, methodologies, and data sources must be disclosed.
— 3- Communications with clients: Any projections or estimates must be reasonable and well-supported.
– Example: A portfolio manager claiming to have outperformed a benchmark without disclosing relevant timeframes or risk factors would violate this standard.
4- Situations Requiring Extra Caution
– Members should exercise particular caution in:
— 1- Use of third-party research: Ensure sources are reliable and properly attributed.
— 2- Performance presentation: Avoid cherry-picking or selective data representation.
— 3- Professional credentials: Accurately represent CFA designation and other qualifications.
[Misrepresentation and Plagiarism in Investment Practice]
1- Guidance
– Members and candidates must avoid knowingly making misrepresentations in investment analysis or professional activities.
– False or misleading statements, both oral and written, harm investor trust and should be avoided.
– Materials and websites should be kept current, ensuring key assumptions are included.
– Accidental mistakes are not violations but should be corrected immediately upon discovery.
2- Impact on Investment Practice
– Members must not misrepresent credentials, performance records, or any aspect of their practice.
– Third-party information must be carefully managed, ensuring no implication that external managers’ work is their own.
– Guarantees of specific investment returns are prohibited, except when referring to guarantees by banks or insurance companies.
3- Plagiarism
– Members must acknowledge sources and avoid representing external work as their own.
– Resubmitting research reports without citation is a violation.
– Third-party research can be used if the original source is disclosed.
– Oral communication also falls under this standard, requiring proper attribution.
4- Work Completed for Employer
– Members can use reports or models owned by their employer, even if the original creator is no longer employed.
Key Takeaways
– Misrepresentation and plagiarism undermine professional integrity and must be avoided.
– Members must ensure transparency in their use of third-party information.
– Proper citation is required for both written and oral communication.
– Employer-owned work remains the firm’s property, regardless of employee status.
[Recommended Procedures for Compliance]
1- Understanding Limitations and Qualifications
– Members should understand their own and the firm’s limitations and qualifications.
– Example: A firm should document its competencies and limitations in a written policy to ensure realistic client expectations.
2- Documentation of Qualifications
– Members should prepare a written summary of their qualifications and experience.
– Example: Investment professionals should maintain an up-to-date resume or professional bio detailing their credentials and expertise.
3- Verification of Third-Party Information
– Members should verify distributed third-party information and regularly monitor published webpages.
– Example: Before using external data in research reports, analysts should cross-check sources to ensure accuracy and reliability.
4- Avoiding Plagiarism
– Members should maintain copies of materials used to create research reports, attribute direct quotations to sources, and credit sources for summary reports.
– Example: Analysts should properly cite external reports and data sources when incorporating them into their own research.
Key Takeaways
– Firms and professionals must document their qualifications to ensure transparency and credibility.
– Verifying third-party information is essential to maintaining accuracy in investment research.
– Proper citation and record-keeping help prevent plagiarism and uphold ethical standards.
[Standard I(D): Misconduct]
1- Broad Definition
– “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.”
2- Avoiding Misconduct
– Members and candidates must uphold ethical behavior in all professional activities.
– Professional misconduct includes any actions that harm reputation, integrity, or competence.
– Examples of misconduct:
— 1- Engaging in fraudulent investment schemes or misleading clients.
— 2- Falsifying records, misrepresenting performance, or manipulating financial reports.
— 3- Acting recklessly in a way that endangers client trust or the integrity of financial markets.
3- Professional Reputation and Ethical Behavior
– Members should ensure that their actions, even if legal, do not compromise professional integrity.
– Actions that may be perceived as misconduct:
— 1- Substance abuse during working hours, impairing professional judgment.
— 2- Repeated failure to meet professional responsibilities due to negligence.
— 3- Any activity that undermines confidence in financial markets or the CFA designation.
– Example: A portfolio manager who alters client statements to hide poor performance engages in misconduct.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Handling confidential information: Leaking sensitive data could reflect dishonesty.
— 2- Personal financial dealings: Engaging in insider trading or conflicts of interest damages credibility.
— 3- Work-related social behavior: Excessive or inappropriate conduct at professional events may impact reputation.
– Note: Acts of civil disobedience based on personal beliefs are not considered violations unless they impact professional activities.
[Recommended Procedures for Compliance]
1- Adoption of a Code of Ethics
– Members should encourage their firms to adopt a formal code of ethics.
– Example: A firm should develop a documented code of ethics that outlines professional responsibilities and ethical behavior expectations.
2- Defining Violations and Disciplinary Actions
– Firms should list potential violations and associated disciplinary sanctions.
– Example: A company policy should specify the consequences of unethical behavior, such as warnings, suspensions, or termination.
3- Employee Reference Checks
– Firms should check potential employee references before hiring.
– Example: Employers should verify a candidate’s past employment history and ethical standing to ensure compliance with industry standards.
Key Takeaways
– A clearly defined code of ethics helps establish a strong ethical culture within firms.
– Listing violations and sanctions ensures employees understand the consequences of unethical actions.
– Conducting reference checks helps maintain the integrity and professionalism of the workforce.
[Standard I(E): Competence]
1- Broad Definition
– “Members and Candidates must act with and maintain the competence necessary to fulfill their professional responsibilities.”
2- Maintaining Professional Competence
– Members and candidates must continuously develop their knowledge and skills.
– Competence ensures the ability to provide informed and accurate financial advice.
– Examples of maintaining competence:
— 1- Staying updated on industry regulations, market trends, and financial models.
— 2- Participating in continuing education programs, certifications, or relevant training.
— 3- Seeking guidance from experienced professionals when facing complex investment decisions.
3- Consequences of Lack of Competence
– Members must not provide investment services if they lack sufficient expertise.
– Incompetence can lead to:
— 1- Misleading investment recommendations based on outdated or incorrect information.
— 2- Failure to recognize risks associated with financial products or market changes.
— 3- Legal and reputational consequences due to poor decision-making.
– Example: An analyst who provides valuation advice without understanding relevant accounting standards may mislead clients.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Changing areas of specialization: Moving into a new financial field requires proper education and training.
— 2- Using quantitative models: Analysts must ensure they understand model assumptions and limitations.
— 3- Relying on outdated knowledge: Financial regulations and market conditions change frequently, requiring continuous learning.
[Maintaining Professional Competence]
1- Guidance
– Members and candidates must achieve and maintain the competence necessary to fulfill their professional responsibilities.
– Competence is assessed based on individual roles and circumstances but requires demonstrating relevant knowledge, skills, and abilities.
– Ongoing development and refinement of knowledge and skills are expected as professional responsibilities evolve.
– This standard does not mandate any specific continuing education or professional development program.
2- Competence and Professional Outcomes
– Negative outcomes do not automatically imply a failure to maintain competence.
– Past educational and professional achievements do not guarantee continued competence.
– Meeting this standard requires adapting to new responsibilities and areas of practice.
Key Takeaways
– Competence is essential for fulfilling professional responsibilities.
– Continuous learning and skill refinement are necessary as roles evolve.
– Competence is not solely determined by past achievements but by ongoing professional development.
[Recommended Procedures for Compliance]
1- Continuing Professional Education
– Members should participate in professional education programs, including employer-sponsored training initiatives.
– Example: Firms can offer workshops on financial regulations and ethics to ensure employees remain up to date.
2- Pursuing Professional Certifications
– Members should obtain relevant certifications to enhance their professional competence.
– Example: Earning the CFA designation demonstrates a commitment to ethical and professional excellence.
3- Staying Informed on Industry Developments
– Members should remain informed about professional developments through informal self-directed studies.
– Example: Reading industry publications and research reports helps professionals stay updated on market trends.
4- Developing New Skills
– Members should improve proficiency in new skills as responsibilities evolve.
– Example: An investment analyst learning about fintech trends can adapt to changing industry demands.
5- Attending Conferences and Seminars
– Members should participate in relevant industry events.
– Example: Attending CFA Institute conferences provides networking opportunities and insights into emerging financial topics.
6- Volunteering for Professional Organizations
– Members should contribute to professional organizations to promote industry standards.
– Example: Serving on an ethics committee reinforces a commitment to upholding ethical best practices.
Key Takeaways
– Continuous education and certification help professionals stay relevant and competent.
– Keeping up with industry trends ensures ethical and informed decision-making.
– Volunteering and engaging with professional organizations strengthen the investment community.
[Competence in Professional Responsibilities]
1- Understanding Competence
– Competence is composed of knowledge, skills, and abilities required to perform professional duties effectively.
– The required level of competence varies based on job responsibilities and circumstances.
2- Components of Competence
– Knowledge: The body of information applied to perform a function.
– Skills: The capabilities needed to complete tasks and achieve professional goals.
– Abilities: The attitudes and behaviors that contribute to observable outcomes.
3- Contextual Nature of Competence
– The level of competence required depends on the specific responsibilities being undertaken.
– Different roles may demand varying degrees of knowledge, skills, and abilities.
[Standard II(A): Material Nonpublic Information]
1- Broad Definition
– “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.”
2- Understanding Material Nonpublic Information
– Material information: Information that could influence an investor’s decision to buy, sell, or hold a security.
– Nonpublic information: Information that has not been widely disseminated to the public or the market.
– Examples of material nonpublic information:
— 1- A company’s undisclosed earnings report before its public release.
— 2- Pending mergers, acquisitions, or bankruptcy announcements.
— 3- Regulatory decisions that will significantly impact an industry or firm.
3- Prohibition Against Insider Trading
– Members must not trade on material nonpublic information or share it with others.
– Key violations:
— 1- Trading securities based on privileged information.
— 2- Tipping others (family, friends, colleagues) with confidential investment-related information.
— 3- Encouraging or facilitating insider trading by others.
– Example: An investment analyst who learns about an upcoming merger through private meetings and buys shares before the public announcement violates this standard.
4- Situations Requiring Extra Caution
– Members should take additional precautions when:
— 1- Handling corporate disclosures: Avoid using private meetings or confidential reports for trading decisions.
— 2- Receiving tips from company insiders: Ensure information is publicly available before acting.
— 3- Conducting due diligence: Verify that all information sources comply with ethical standards before making investment decisions.
[Material and Nonpublic Information in Investments]
1- Guidance
– Members and candidates must not act or cause others to act on material nonpublic information.
– Trading on inside information damages market confidence by implying insiders have an unfair advantage.
– This standard prohibits trading based on inside information, including derivatives and mutual fund transactions.
2- What is “Material” Information?
– Information is material if it affects security prices or if reasonable investors would consider it relevant for investment decisions.
– Materiality depends on specificity, difference from public information, nature, and reliability.
– Examples of material information include earnings reports, mergers, new products, and management changes.
3- What Constitutes “Nonpublic” Information?
– Information remains nonpublic until it has been made widely available in the marketplace.
– Selective disclosure (sharing information with only a small group of investors or analysts) classifies the information as nonpublic.
4- Mosaic Theory
– Analysts can use a combination of public and nonmaterial nonpublic information to derive insights.
– Analysts gather information directly from companies, but they should also engage with suppliers and customers.
– Proper documentation is necessary to demonstrate that material nonpublic information was not used.
5- Using Industry Experts
– Analysts’ reports can influence market prices, making their findings material to investors.
– However, since these reports rely on public information and are commissioned by clients, analysts are not required to disclose them publicly.
Key Takeaways
– Trading on material nonpublic information is prohibited to ensure market fairness.
– Materiality is determined by the potential impact on security prices and investor decision-making.
– Nonpublic information is only public once widely disseminated in the marketplace.
– The mosaic theory allows analysts to use legally obtained nonmaterial nonpublic information.
– Industry experts’ reports can influence markets but do not have to be disclosed if based on public information.
[Recommended Procedures for Compliance]
1- Public Dissemination of Information
– Encourage issuing companies to make material nonpublic information publicly available.
– Example: If a company refuses to disclose material information, members should avoid acting on it.
2- Compliance and Disclosure Procedures
– Firms should adopt compliance and disclosure procedures to ensure fair information dissemination.
– Example: Establishing guidelines for when and how material information can be shared.
3- Press Releases for Transparency
– Firms should issue press releases before or immediately after analyst meetings.
– Example: A company should disclose relevant financial updates to all investors simultaneously.
4- Use of Firewalls
– Establish firewalls to prevent unauthorized sharing of material nonpublic information.
– Example: Implementing strict communication controls between departments handling sensitive data.
5- Physical Separation of Departments
– Prevent the overlap of personnel between certain departments in multiservice firms.
– Example: A bank’s commercial lending team should not have direct interactions with its research department.
6- Reporting System for Communication Approval
– Implement a reporting system to review and approve interdepartmental communications.
– Example: A compliance officer should authorize any communication involving confidential information.
7- Monitoring Personal and Proprietary Trading
– Employees must report personal trading activities, and firms should restrict trading on securities when they have material nonpublic information.
– Example: A firm should maintain a restricted list for securities affected by insider information.
8- Record-Keeping of Communications
– Maintain written records of interdepartmental communications to ensure compliance.
– Example: Logs should be kept of research reports and discussions involving sensitive data.
9- Communicating Compliance Policies
– Firms should ensure that compliance policies and guidelines are clearly communicated to all employees.
– Example: Conducting regular training sessions to educate staff on compliance requirements.
Key Takeaways
– Firms should establish strict compliance, disclosure, and reporting systems to ensure market integrity.
– Clear separation of departments and trading restrictions help prevent the misuse of material nonpublic information.
– Record-keeping and transparent communication reinforce ethical compliance within organizations.
[Social Media and Nonpublic Information]
1- Use of Social Media in Investments
– Technology enables members and candidates to access a vast amount of information.
– Not all information obtained from social media is considered public.
2- Access to Nonpublic Information
– Participation in online groups with restricted membership may expose members to nonpublic information.
– Information overheard in private settings, such as a company break room, remains nonpublic and must not be used for investment decisions.
3- Communication with Clients via Social Media
– Members and candidates may use social media to communicate with clients.
– Information shared must be accessible to all clients or open to the investing public.
[Investment Research Reports and Materiality]
1- Materiality of Analyst Reports
– A well-known analyst’s report can influence security prices, making the report material.
– Materiality is determined by the market’s reaction, not just the content of the report.
2- Use of Public Information in Reports
– Reports are based on publicly available information and do not contain inside information.
– Analysts may share reports with paying clients before making them publicly available.
3- Standard II(A) and Analyst Actions
– Standard II(A) does not require analysts to make their work public before acting on it.
– Analysts can act on their own research as long as it does not involve material nonpublic information.
[Proprietary Trading and Ethical Considerations]
1- Handling Proprietary Trading with Material Nonpublic Information
– Firms in possession of material nonpublic information should not completely halt proprietary trading.
– They must implement proprietary trading procedures to ensure compliance with ethical and regulatory standards.
2- Activities to Maintain Market Integrity
– Firms may continue trading to support market liquidity.
– Acting as a market maker for a specific security is permissible to prevent market disruptions.
– Companies should remain passive in the market and only take the contra side of unsolicited customer trades.
3- Prohibited Trading Practices
– Risk-arbitrage trading should be avoided, as it carries a high risk of illegal profits.
– Trading strategies that exploit material nonpublic information violate ethical and legal standards.
[Standard II(B): Market Manipulation]
1- Broad Definition
– “Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.”
2- Understanding Market Manipulation
– Market manipulation refers to deceptive trading practices that create a false or misleading appearance of supply, demand, or price levels.
– It undermines market integrity and investor confidence.
– Examples of market manipulation:
— 1- Spreading false or misleading information to influence stock prices.
— 2- Executing fictitious trades to create the illusion of high demand.
— 3- Engaging in “pump-and-dump” schemes, where prices are artificially inflated and then quickly sold off.
3- Types of Market Manipulation
– Information-based manipulation:
— 1- Spreading rumors, false financial statements, or misleading news to influence stock prices.
— 2- Misrepresenting a company’s earnings or growth prospects.
– Transaction-based manipulation:
— 1- “Wash trading” – executing buy and sell orders to create fake trading volume.
— 2- “Painting the tape” – coordinating trades to mislead investors about market activity.
— 3- “Spoofing” – placing fake orders to manipulate market prices, then canceling them before execution.
– Example: A trader who posts large buy orders to drive prices up but cancels them before execution is engaging in spoofing.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Handling press releases or corporate statements: Ensure accuracy and transparency.
— 2- Engaging in high-frequency or algorithmic trading: Avoid strategies that create misleading price signals.
— 3- Using social media or online forums: Avoid participating in misleading promotions or false hype.
[Market Manipulation and Ethical Standards]
1- Guidance
– Members and candidates must not distort prices or artificially inflate trading volume to mislead market participants.
– Market manipulation erodes investor confidence and includes spreading false information or engaging in deceptive transactions.
2- Information-Based Manipulation
– Involves spreading false rumors to induce trading, commonly seen in “pump-and-dump” schemes.
– May include falsely implying independent reporting when a conflict of interest exists.
3- Transaction-Based Manipulation
– Involves trades designed to artificially affect prices or volume.
– Can include controlling financial instruments to manipulate derivative prices.
– Intent is key in determining violations—legitimate large trades are acceptable if part of a valid trading strategy.
– Broker-dealers may provide liquidity if disclosures are adequate.
Key Takeaways
– Market manipulation harms market integrity and investor trust.
– Spreading false information to influence trading activity is unethical.
– Artificially altering prices or volumes for personal gain violates ethical standards.
– Legitimate trades must be distinguished from manipulative practices through intent and transparency.
[Standard III(A): Loyalty, Prudence, and Care]
1- Broad Definition
– “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.”
2- Understanding Loyalty, Prudence, and Care
– Members must always act in the best interests of their clients, prioritizing client needs over personal or employer interests.
– They must demonstrate a high standard of care in investment decision-making.
– Examples of demonstrating loyalty and prudence:
— 1- Conducting thorough due diligence before making investment recommendations.
— 2- Avoiding conflicts of interest that could compromise client interests.
— 3- Taking investment actions that align with the client’s risk tolerance, objectives, and constraints.
3- Acting with Reasonable Care and Prudence
– Members must exercise sound judgment and diligence in managing client assets.
– Key responsibilities include:
— 1- Regularly reviewing client portfolios to ensure they align with investment objectives.
— 2- Avoiding excessive risk-taking that is inconsistent with client mandates.
— 3- Ensuring clients are fully informed about investment risks and potential conflicts of interest.
– Example: An investment advisor recommending a high-risk product to a conservative investor without proper disclosure violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Managing discretionary accounts: Ensure investment decisions align with client goals.
— 2- Trading on behalf of clients: Avoid any actions that could create conflicts of interest.
— 3- Representing multiple clients with competing interests: Ensure fair treatment and transparency.
[Loyalty, Prudence, and Client Interests]
1- Guidance
– Members and candidates must be loyal to clients and exercise prudent judgment.
– Clients’ interests must take precedence over those of the employer or the member’s own investments.
– Prudence requires diligence, skill, and care in managing investments.
– Ethical obligations extend beyond legal and regulatory requirements.
2- Understanding Loyalty, Prudence, and Care
– Members must adhere to fiduciary responsibilities and regulatory obligations.
– Greater responsibility applies when the member has control over client assets.
3- Identifying the Actual Investment Client
– The client is always the ultimate beneficiary, not necessarily the entity hiring the member.
– No client relationship exists when managing a fund under a stated mandate.
– Members should avoid conflicts of interest in client relationships.
4- Developing the Client’s Portfolio
– Clients must trust managers due to their investment expertise.
– Managers must disclose risks, potential rewards, and conflicts of interest.
– Investment decisions should consider the total portfolio context.
5- Soft Commission Policies
– Investment managers may choose brokers based on personal benefits, such as research services.
– Soft dollar arrangements can be detrimental if brokers charge higher fees without benefiting the client.
– Soft dollar commissions should be used solely for client benefit.
– Directed brokerage requires disclosure if clients are not receiving the best available price.
6- Proxy Voting Policies
– Members have a duty to vote proxies in an informed manner.
– Voting policies should be disclosed to clients.
Key Takeaways
– Loyalty, prudence, and fiduciary duty must guide investment decisions.
– Conflicts of interest should be identified and mitigated.
– Soft commissions must benefit clients, and any directed brokerage must be disclosed.
– Proxy voting must be conducted in clients’ best interests with full transparency.
[Recommended Procedures for Compliance]
1- Regular Client Reporting
– If a member controls a client’s assets, statements should be sent to the client at least quarterly regarding positions and transactions.
– Example: A portfolio manager should provide a detailed quarterly report summarizing asset performance and trading activity.
2- Client-Centric Decision Making
– Members should consider the client’s perspective if uncertain about actions.
– Example: Before making investment decisions, an advisor should assess whether the action aligns with the client’s financial goals and risk tolerance.
3- Adoption of Compliance Policies
– Firms should adopt policies that ensure adherence to applicable laws and ethical guidelines.
– Example: Implementing internal procedures to verify compliance with investment regulations.
4- Establishing Client Investment Objectives
– Members should work with clients to define clear investment objectives.
– Example: A financial advisor should document a client’s return expectations and risk tolerance before constructing a portfolio.
5- Considering All Relevant Information
– Investment decisions should be based on comprehensive and accurate information.
– Example: Before recommending a security, an analyst should evaluate company fundamentals, economic conditions, and market trends.
6- Portfolio Diversification
– Members should diversify investments to reduce risk exposure.
– Example: An asset manager should ensure that a client’s portfolio is not overly concentrated in a single industry or asset class.
7- Conducting Regular Reviews
– Investment portfolios should be reviewed periodically to ensure they remain aligned with client goals.
– Example: A quarterly portfolio review should assess performance relative to benchmarks and adjust allocations as needed.
8- Fair Dealing with Clients
– Members should deal fairly and objectively with all clients.
– Example: Providing equal access to investment opportunities without favoritism.
9- Disclosure of Conflicts of Interest
– Firms should require the disclosure of conflicts of interest and compensation arrangements.
– Example: An investment banker should disclose any personal or financial interest in a deal being recommended to clients.
10- Proxy Voting Policies
– Members should establish and follow clear proxy voting policies in the best interest of clients.
– Example: A portfolio manager should vote proxies in a way that maximizes shareholder value for clients.
11- Maintaining Confidentiality
– Client information should be kept confidential unless disclosure is legally required.
– Example: A financial advisor should not share a client’s financial details without explicit consent.
12- Seeking Best Execution
– Transactions should be executed efficiently to provide clients with the best possible results.
– Example: A trader should ensure that client orders are executed at the most favorable prices and with minimal transaction costs.
13- Placing Client Interests First
– Client interests must always take priority over personal or firm interests.
– Example: An investment advisor should recommend products that best serve the client rather than those that generate higher commissions.
[Soft Commissions and Ethical Considerations]
1- Definition of Soft Commissions
– Soft commissions, also known as soft dollars, refer to arrangements where investment managers direct client brokerage transactions to specific brokers in exchange for research or other services.
– Instead of receiving direct monetary compensation, managers receive non-monetary benefits such as research reports, data, or technology services.
2- How Soft Commissions Work
– The investment manager selects a broker to execute client transactions.
– The broker charges a commission that may be higher than the standard rate.
– In return, the broker provides research services or other benefits to the manager.
– This creates a potential conflict of interest if the benefits received do not directly enhance client outcomes.
3- Ethical Concerns and Violations
– If soft commission arrangements result in higher brokerage costs without a corresponding benefit to the client, it constitutes a violation of Standard III(A) – Loyalty, Prudence, and Care.
– Managers must ensure that any research or services obtained through soft commissions provide direct value to clients.
– Failure to disclose such arrangements can lead to ethical and regulatory breaches.
4- Directed Brokerage and Compliance
– In directed brokerage, a client instructs the manager to use a specific brokerage for transactions.
– This is not a violation of Standard III(A) as long as the brokerage commission remains a client asset and does not benefit the manager personally.
– Managers must disclose to clients if directed brokerage results in suboptimal trade execution.
Key Takeaways
– Soft commissions involve directing trades to brokers in exchange for research or services.
– Such arrangements must benefit clients, or they pose ethical concerns.
– Directed brokerage is permitted if client interests are protected and full disclosure is made.
– Transparency and fiduciary responsibility are critical in handling soft commission arrangements.
[Standard III(B): Fair Dealing]
1- Broad Definition
– “Members and Candidates must deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.”
2- Understanding Fair Dealing
– Fair dealing requires that all clients receive equitable treatment in investment-related activities.
– Members must ensure that no client receives preferential treatment over others.
– Examples of fair dealing:
— 1- Distributing investment recommendations to all clients at the same time, rather than favoring select clients.
— 2- Allocating investment opportunities fairly, without bias toward high-value clients.
— 3- Disclosing conflicts of interest that could affect objectivity in professional actions.
3- Preventing Unfair Advantages
– Members must establish processes to ensure fairness in client interactions.
– Key practices include:
— 1- Implementing systematic methods for distributing investment recommendations.
— 2- Allocating IPO shares or other limited investment opportunities fairly.
— 3- Ensuring all clients have equal access to research and insights.
– Example: A portfolio manager who selectively informs certain clients about a profitable investment opportunity before others violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Handling time-sensitive investment recommendations: Ensure simultaneous distribution to all clients.
— 2- Allocating limited investment opportunities: Use a structured and documented allocation process.
— 3- Offering tiered services: If different service levels exist, ensure disclosures clarify differences in access to investment recommendations.
[Fair Dealing in Investment Recommendations and Actions]
1- Guidance
– Members and candidates must deal fairly and objectively with all clients in investment advice and professional activities.
– No client should be favored over another.
– Different levels of service for different fees are allowed but must be disclosed.
2- Investment Recommendations
– Recommendations must be disseminated so that all clients have a fair opportunity to act.
– Challenges arise with different communication methods (e.g., online reports, emails, phone calls).
– Changes in recommendations should be communicated fairly, especially to clients who acted on the original advice.
3- Investment Action
– Investment actions must be conducted fairly among all clients.
– Oversubscribed issues should be prorated among suitable clients.
– Members and candidates should avoid personal and immediate family investments in oversubscribed issues unless family members are fee-paying clients.
– Firms must disclose their allocation procedures to clients.
Key Takeaways
– Fair dealing ensures no client is given preferential treatment.
– Investment recommendations must be distributed in a way that allows all clients to act fairly.
– Allocation of limited investment opportunities must be done equitably and transparently.
– Disclosure of service levels and allocation policies is required for ethical compliance.
[Recommended Procedures for Compliance]
1- Limiting Access to Recommendations
– Restrict the number of people aware of forthcoming investment recommendations.
– Example: Only authorized analysts and portfolio managers should be informed about pending recommendations to prevent unauthorized trading.
2- Timely Dissemination of Information
– Shorten the time between decision-making and information dissemination.
– Example: A brief summary of an investment recommendation could be released before the full report to ensure timely access for all clients.
3- Guidelines Against Unauthorized Actions
– Publish guidelines prohibiting individuals from acting on pending recommendations.
– Example: Employees should be restricted from making trades based on insider knowledge of future recommendations.
4- Fair and Simultaneous Information Dissemination
– Ensure that all clients receive investment information at approximately the same time.
– Example: A firm should release investment research through a public platform accessible to all clients simultaneously.
5- Maintaining Client Records
– Keep an updated list of clients and their holdings to determine who needs information.
– Example: Portfolio managers should maintain records to ensure proper communication with clients based on their investment profiles.
6- Trade Allocation Policies
– Develop and document trade allocation procedures and disclose them to clients.
– Example: Firms should have clear policies on how shares from block trades are allocated among clients.
7- Order Processing Efficiency
– Process client orders on a first-in-first-out basis unless bundling improves efficiency.
– Example: If multiple clients place orders for the same security, priority should be given based on order entry time unless execution costs can be reduced through bundling.
8- Equal Execution Pricing
– Assign the same execution price and commission for all clients in a block trade.
– Example: When executing a block trade, each client should receive the same average price per share and pay identical fees.
9- Pro Rata Order Allocation
– When a block order cannot be fully executed, allocate orders on a pro rata basis.
– Example: If demand exceeds supply, each client should receive a proportionate share of the executed trades based on their order size.
10- Periodic Account Reviews
– Regularly review client accounts to ensure no preferential treatment.
– Example: Compliance officers should periodically audit trades to confirm fair treatment across all accounts.
11- Disclosure of Fees and Service Levels
– Clearly disclose service levels and associated fees to clients.
– Example: Firms should provide transparency regarding management fees, transaction costs, and advisory charges.
[Standard III(C): Suitability]
1- Broad Definition
– 1- “When Members and Candidates are in an advisory relationship with a client, they must:
— Make a reasonable inquiry into a client’s or prospective client’s investment experience, risk and return objectives, and financial constraints before making any investment recommendation or taking investment action and reassess and update this information regularly.
— Determine that an investment is suitable to the client’s financial situation and consistent with the client’s written objectives, mandates, and constraints before making an investment recommendation or taking investment action.
— Judge the suitability of investments in the context of the client’s total portfolio.”
– 2- When Members and Candidates are responsible for managing a portfolio to a specific mandate, strategy, or style, they must only make investment recommendations or take investment actions that are consistent with the stated objectives and constraints of the portfolio.”
2- Assessing Suitability
– Members must ensure that all investment recommendations align with the client’s financial profile and risk tolerance.
– Suitability requires continuous reassessment as market conditions and client circumstances change.
– Examples of assessing suitability:
— 1- Conducting a thorough client interview to understand investment goals and constraints.
— 2- Ensuring that an investment recommendation aligns with the client’s risk tolerance.
— 3- Reviewing client accounts periodically to ensure portfolio consistency with objectives.
3- Ensuring Compliance with Suitability Standards
– Members must follow structured procedures to ensure recommendations are suitable.
– Key steps include:
— 1- Documenting client investment profiles and updating them regularly.
— 2- Matching investment recommendations with the client’s stated objectives and constraints.
— 3- Considering the client’s overall portfolio before making recommendations.
– Example: An advisor recommending leveraged ETFs to a client with a low-risk tolerance would violate this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Dealing with elderly or inexperienced investors: Ensure full understanding of risks.
— 2- Offering complex investment products: Clearly explain risks and suitability criteria.
— 3- Managing portfolios under a mandate: Ensure all trades align with the stated strategy.
[Suitability and Investment Policy Guidelines]
1- Guidance
– Members and candidates must assess clients’ investment experience, risk-return objectives, and financial constraints.
– Investment recommendations should align with the client’s total portfolio objectives and constraints.
– If managing a portfolio, members must adhere to the designated strategy.
– Suitability is judged using a prudent person approach, acknowledging that even suitable investments may incur losses.
2- Developing an Investment Policy
– A written investment policy statement (IPS) should document financial circumstances, risk attitudes, and objectives.
– The IPS should define the advisor’s role and guide strategic asset allocation.
3- Understanding the Client’s Risk Profile
– Risk tolerance must be measured, and investment strategy risk should be quantified.
– Factors such as leverage and liquidity constraints must be carefully considered.
4- Updating an Investment’s Policy
– The IPS should be reviewed annually or when material changes occur.
– Suitability reviews rely on full disclosure of relevant client information.
5- The Need for Diversification
– Diversification is essential for most portfolios.
– Even if a manager oversees only a portion of a client’s assets, overall portfolio diversification must be considered.
6- Managing to an Index or Mandate
– Some managers operate funds based on mandates rather than managing individual client portfolios.
– These managers must follow fund objectives but are not responsible for determining individual suitability.
Key Takeaways
– Investment recommendations must align with client objectives and constraints.
– A structured IPS is crucial for defining strategy and ensuring suitability.
– Risk assessment should be quantified, and policies should be updated regularly.
– Diversification must be considered at the total portfolio level.
– Managers following an index or mandate are responsible for fund adherence, not individual suitability.
[Recommended Procedures for Compliance]
1- Investment Policy Statement (IPS)
– Members should create an investment policy statement for each client.
– Example: The IPS should specify client type, return and risk objectives, investment constraints (e.g., liquidity, time horizon, proxy voting), and performance benchmarks.
2- Regular Review of Objectives and Constraints
– The investor’s objectives and constraints should be reviewed regularly, at least annually.
– Example: A change in a client’s financial situation should prompt an update to the IPS and adjustments to asset allocation.
3- Suitability Determination Policies
– Firms should establish policies and procedures for determining investment suitability.
– Example: Investment professionals should assess diversification, risk exposure, and investment strategy to ensure alignment with client goals.
[Updating an Investment Policy Statement (IPS)]
1- Purpose of Updating the IPS
– The IPS should reflect changing investment objectives and client circumstances.
– Regular updates ensure that the investment strategy remains suitable and aligned with client needs.
2- Frequency of Updates
– The IPS must be reviewed and updated at least annually.
– Additional updates are required when material changes occur in the client’s investments or personal/financial situation.
3- Important Changes for Individual Clients
– Number of dependents.
– Personal tax status.
– Health conditions.
– Liquidity needs.
– Risk tolerance.
– Amount of wealth.
4- Important Changes for Institutional Clients
– Magnitude of unfunded liabilities in a pension fund.
– Withdrawal privileges in an employee savings plan.
– Distribution requirements of a charitable foundation.
Key Takeaways
– The IPS should be updated at least annually or when significant changes occur.
– Investment suitability depends on monitoring and adjusting for changes in financial circumstances.
– Individual and institutional clients have different factors influencing their investment policies.
Quiz - [Violations in Allocating IPO Shares]
1- Suitability Violation (Standard III(C))
– Investment professionals must ensure that any investment action aligns with a client’s investment objectives, risk tolerance, and overall portfolio strategy.
– Weldon allocated shares to Dumont before conducting a proper suitability assessment through an Investment Policy Statement (IPS).
– Without an IPS or prior knowledge of Dumont’s financial profile, allocating shares was inappropriate and a violation of suitability standards.
2- Fair Dealing Violation (Standard III(B))
– This standard requires fair and objective treatment of all clients in investment decisions.
– Weldon failed to prioritize fair allocation by splitting shares between Dumont and Masters, despite only Masters formally expressing interest in the IPO.
– Because the IPO was oversubscribed, all shares should have gone to clients with documented interest and suitability—in this case, only Masters.
3- Diligence and Reasonable Basis Violation (Standard V(A))
– Investment professionals must base their actions on thorough research and analysis.
– By making trades for Dumont before writing an IPS, Weldon acted without sufficient diligence to justify the investment.
Key Takeaways
– Weldon violated both Fair Dealing and Suitability Standards by improperly allocating IPO shares.
– Investment decisions should always be based on a proper IPS and client-specific analysis.
– Fair allocation policies must ensure shares go to clients with prior documented interest and suitability.
[Standard III(D): Performance Presentation]
1- Broad Definition
– “When communicating investment performance information, Members and Candidates must make reasonable efforts to ensure that it is fair, accurate, and complete.”
2- Ensuring Fair and Accurate Performance Reporting
– Members must present investment performance in a way that is not misleading.
– Performance results should be consistent, transparent, and comparable across clients.
– Examples of fair and accurate performance presentation:
— 1- Disclosing all relevant details, such as fees, benchmarks, and time periods.
— 2- Using standardized methodologies for calculating and reporting returns.
— 3- Clearly distinguishing between actual, hypothetical, and backtested performance results.
3- Prohibition Against Misleading Performance Claims
– Members must avoid exaggerating past performance or omitting key information.
– Key practices to ensure compliance:
— 1- Avoid cherry-picking favorable results while omitting poor performance.
— 2- Clearly disclose the impact of fees, transaction costs, and reinvested dividends.
— 3- Ensure that performance comparisons to benchmarks are valid and relevant.
– Example: An investment manager who reports only the best-performing years of a fund while ignoring significant losses violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Using projected or backtested performance: Clearly disclose assumptions and limitations.
— 2- Reporting past performance: Ensure results are not selectively presented to appear better than they were.
— 3- Comparing performance with benchmarks: Use appropriate benchmarks that reflect the investment strategy.
[Performance Presentation and Disclosure]
1- Guidance
– Members and candidates must ensure that performance information is fair, accurate, and complete.
– Full disclosure should be provided to both clients and prospective clients.
2- Standards for Performance Reporting
– Applies to both past performance and expected future performance.
– Supporting details should be made available to clients and prospects.
– Members must not imply that past returns guarantee or influence future returns.
Key Takeaways
– Performance reporting must be transparent, accurate, and fully disclosed.
– Past performance must not be misrepresented as an indicator of future success.
– Clients should have access to supporting details to assess performance claims.
[Recommended Procedures for Compliance]
1- Consider Audience Knowledge in Performance Presentation
– Managers should tailor performance presentations based on the audience’s level of understanding.
– Example: A retail investor may require simpler explanations than an institutional investor.
2- Use Weighted Composite Performance
– Firms should present performance using a weighted composite instead of a single representative account.
– Example: Aggregating multiple accounts provides a more accurate measure of portfolio performance.
3- Inclusion of Terminated Accounts
– Performance reports should include terminated accounts to ensure transparency.
– Example: Excluding poorly performing closed accounts could mislead investors about past results.
4- Use of Proper Disclosures
– Firms should provide clear disclosures explaining performance results.
– Example: Explaining calculation methodologies and factors influencing returns enhances investor confidence.
5- Maintain Data for Performance Calculations
– Firms must retain data used to calculate performance results.
– Example: Historical trade records, asset valuations, and benchmark comparisons should be archived for audit purposes.
[Standard III(E): Preservation of Confidentiality]
1- Broad Definition
– “Members and Candidates must keep information about current, former, and prospective clients confidential unless:
— The information concerns illegal activities on the part of the client;
— Disclosure is required by law; or
— The client or prospective client permits disclosure of the information.”
2- Importance of Confidentiality
– Maintaining client confidentiality is essential to building trust and professionalism.
– Confidential information includes financial details, investment strategies, and personal data.
– Examples of confidential information:
— 1- A client’s portfolio holdings and transaction history.
— 2- A prospective client’s financial objectives and constraints.
— 3- Discussions regarding mergers, acquisitions, or business strategies.
3- Exceptions to Confidentiality Obligations
– Members may disclose client information only under specific circumstances.
– Situations where disclosure is allowed:
— 1- When the client is engaged in illegal activities (e.g., money laundering or fraud).
— 2- When disclosure is legally mandated (e.g., by regulators or court orders).
— 3- When the client provides explicit consent for disclosure.
– Example: If a government agency subpoenas client records for an investigation, a member must comply with the legal request.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Handling electronic records: Ensure encryption and secure storage to prevent data breaches.
— 2- Discussing client matters: Avoid disclosing sensitive details in public or informal settings.
— 3- Sharing information internally: Limit access to confidential client data only to those who require it.
[Client Confidentiality and Ethical Obligations]
1- Guidance
– Members and candidates must maintain confidentiality for past, current, and prospective clients.
– Exceptions apply if the information involves illegal activities, legal requirements mandate disclosure, or the client grants permission.
2- Status of Client
– Confidentiality obligations extend to past clients, requiring records to remain private.
3- Compliance with Laws
– Members must comply with all legal requirements related to confidentiality.
4- Electronic Information and Security
– Storing client information on personal devices may pose security risks and require additional safeguards.
5- Professional Conduct Investigations by CFA Institute
– Members are encouraged to cooperate with the CFA Institute’s Professional Conduct Program (PCP) in investigations, provided legal conditions allow it.
Key Takeaways
– Confidentiality must be upheld unless legal or ethical exceptions apply.
– Client records, including those of past clients, must remain protected.
– Compliance with confidentiality laws and proper data security measures are essential.
– Cooperation with CFA Institute investigations is expected within legal boundaries.
[Recommended Procedures for Compliance]
1- Restricted Sharing of Client Information
– Client information should only be shared with employees working directly for the same client.
– Example: A portfolio manager should only discuss a client’s investment strategy with the client’s assigned financial advisor.
2- Limited Disclosure Within the Firm
– Disclosure to other firm employees should occur only if it directly benefits the client.
– Example: If a tax specialist’s input is needed for portfolio restructuring, sharing relevant client data may be appropriate.
[Standard IV(A): Loyalty]
1- Broad Definition
– “In matters related to their employment, Members and Candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.”
2- Understanding Loyalty to Employers
– Members must prioritize their employer’s interests while maintaining ethical and professional integrity.
– Loyalty requires protecting confidential information and using skills to benefit the firm.
– Examples of employer loyalty:
— 1- Ensuring that work responsibilities are fulfilled diligently and competently.
— 2- Avoiding conflicts of interest that could harm the firm.
— 3- Refraining from using employer resources for personal gain.
3- Prohibited Actions Under This Standard
– Members must not take actions that harm their employer or misuse confidential data.
– Key violations include:
— 1- Taking proprietary investment strategies or client lists when leaving a firm.
— 2- Engaging in external business activities that compete with the employer without consent.
— 3- Leaking sensitive internal financial information to external parties.
– Example: An analyst leaving a firm and taking confidential client records to a new employer would violate this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Transitioning to a new job: Ensure all intellectual property and confidential data remain with the former employer.
— 2- Engaging in outside employment: Obtain employer approval before working elsewhere in a related field.
— 3- Speaking publicly about the firm: Ensure all statements are authorized and do not disclose proprietary information.
[Employer Responsibilities and Independent Practice]
1- Guidance
– Members and candidates must act in the best interest of their employers and avoid actions that could harm them.
– Confidential information must not be disclosed.
– Client interests take priority, but personal and family obligations do not override work responsibilities.
2- Employer Responsibilities
– Employers have obligations toward employees, including ethical treatment and fair policies.
– Members may provide employers with the CFA Code and Standards for guidance.
– While not required to follow CFA Standards, employers should avoid conflicting ethical guidelines.
– Compensation plans should not incentivize unethical behavior.
3- Independent Practice
– Members must not engage in independent activities that compete with their employer without approval.
– “Practice” refers to any service for which the employer would typically charge.
– Prior approval is required before undertaking competing activities.
– Members may prepare for future independent practice (e.g., business planning, leasing office space) as long as it does not interfere with current job duties.
Key Takeaways
– Members must act in their employer’s best interest and maintain confidentiality.
– Employers should align their policies with ethical standards and avoid conflicts.
– Independent practice must not compete with an employer unless explicitly approved.
– Preparations for independent work are allowed if they do not disrupt job responsibilities.
[Leaving an Employer and Ethical Considerations]
1- Leaving an Employer
– Members should not engage in competitive activities before their resignation is effective.
– Trade secrets and confidential information must not be misused.
– Soliciting the employer’s clients before resignation is prohibited.
– Skills and knowledge gained during employment are not privileged, but employer files remain company property.
– Files must be deleted or returned unless written permission is granted to keep records.
– After departure, members may contact former clients but cannot use employer-provided contact lists.
– Members must comply with any signed non-compete agreements.
2- Whistleblowing
– Protecting capital market integrity and client interests takes precedence over employer loyalty.
– Members may need to “blow the whistle” if the employer engages in unethical or illegal activities.
3- Nature of Employment
– Members may be employees or independent contractors.
– The employment relationship should be clearly defined to set proper expectations.
Key Takeaways
– Competitive activities before formal resignation are unethical.
– Confidential information and client lists remain employer property.
– Whistleblowing is justified when protecting market integrity and client interests.
– Employment status should be explicitly outlined to avoid misunderstandings.
[Recommended Procedures for Compliance]
1- Align Employer Policies with the Code and Standards
– Members should ensure that their employer’s policies do not conflict with the CFA Code and Standards.
– Example: A firm’s trading policy should align with CFA ethical guidelines on fair dealing and transparency.
2- Clearly Defined Competition Policies
– Firms should establish competition policies, including non-compete agreements, for employees and post-employment conditions.
– Example: An investment professional should be aware of any restrictions on working for a competitor after leaving their firm.
3- Understanding Whistle-Blowing Policies
– Members should familiarize themselves with their firm’s whistle-blowing policies.
– Example: Employees should know how to report unethical behavior anonymously and in compliance with regulatory requirements.
4- Confidential and Anonymous Reporting Procedures
– Firms should implement regulations that ensure confidential and anonymous reporting of misconduct.
– Example: A secure hotline or reporting system should be available for employees to report ethical violations without fear of retaliation.
5- Standardized Employee Classification Structures
– Firms should establish standardized classification structures for employees.
– Example: Roles such as part-time employees, full-time staff, and outside contractors should be clearly defined in company policies.
[Standard IV(B): Additional Compensation Arrangements]
1- Broad Definition
– “Members and Candidates must not accept gifts, benefits, compensation, or consideration that competes with or might reasonably be expected to create a conflict of interest with their employer’s interest unless they obtain written consent from all parties involved.”
2- Understanding Additional Compensation Arrangements
– Members must ensure that any external compensation does not interfere with their duty to their employer.
– Any external benefits or payments must be disclosed and approved in writing.
– Examples of additional compensation:
— 1- Receiving performance-based bonuses from clients outside of employer compensation.
— 2- Accepting gifts from third parties that may create bias in professional decision-making.
— 3- Engaging in freelance investment advisory services without employer consent.
3- Ensuring Compliance with This Standard
– Members must seek employer approval before accepting any external compensation.
– Key steps include:
— 1- Providing full disclosure of the nature and source of additional compensation.
— 2- Obtaining written approval from the employer before accepting any external payments.
— 3- Documenting all agreements to ensure transparency and compliance.
– Example: A portfolio manager receiving undisclosed commissions from a mutual fund company for recommending its products violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Accepting gifts or bonuses from clients: Ensure transparency and employer approval.
— 2- Receiving compensation for external consulting: Obtain employer consent to prevent conflicts.
— 3- Participating in outside business ventures: Confirm that activities do not compete with the employer’s interests.
[Accepting Gifts, Benefits, and Compensation]
1- Guidance
– Members and candidates cannot accept gifts, benefits, or compensation that may create a conflict with their employer’s interests unless they obtain written consent from all parties.
– Proper disclosure helps prevent conflicts of interest and ensures transparency.
2- Reporting Requirements
– Members should submit a written report detailing any compensation they plan to receive.
– This applies to both full-time and part-time employees under Standard IV(B).
Key Takeaways
– Written consent is required before accepting compensation that could conflict with employer interests.
– Full disclosure through a written report ensures ethical compliance.
– Standard IV(B) applies to all employees, regardless of their work status.
[Standard IV(C): Responsibilities of Supervisors]
1- Broad Definition
– “Members and Candidates must make reasonable efforts to ensure that anyone subject to their supervision or authority complies with applicable laws, rules, regulations, and the Code and Standards.”
2- Understanding Supervisory Responsibilities
– Members in supervisory roles must take proactive steps to ensure ethical conduct within their organizations.
– Supervisors are responsible for establishing policies and procedures to prevent violations.
– Examples of supervisory responsibilities:
— 1- Implementing internal controls to detect and prevent unethical behavior.
— 2- Providing regular training on compliance with laws and ethical standards.
— 3- Monitoring employee activities to ensure adherence to regulatory requirements.
3- Preventing Violations and Ensuring Compliance
– Supervisors must create an environment where ethical behavior is prioritized.
– Key steps include:
— 1- Developing and enforcing written compliance policies.
— 2- Taking corrective actions when misconduct is identified.
— 3- Reporting violations promptly to the appropriate authorities.
– Example: A manager who ignores signs of insider trading within their team would violate this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Delegating responsibilities: Ensure subordinates are qualified and act ethically.
— 2- Addressing employee misconduct: Take immediate and documented action.
— 3- Overseeing new employees: Provide proper training on ethical and regulatory requirements.
[Supervision and Compliance Responsibilities]
1- Guidance
– Members and candidates must ensure that laws, regulations, and the CFA Code and Standards are followed by those they supervise.
– This responsibility applies even if the supervised employees are not CFA members or candidates.
– Reasonable supervision is assessed on a case-by-case basis.
2- System for Supervision
– Members must establish procedures to detect violations and ensure compliance.
– A violation occurring does not automatically indicate supervisory failure.
– Compliance procedures should be:
– 1- Documented, communicated, and enforced.
– 2- Proportionate to the firm’s size and operations.
– 3- Designed to anticipate potential violations.
– Thorough investigations must follow any suspected wrongdoing.
3- Supervision Includes Detection
– Members should not accept supervisory roles without an adequate compliance system.
– If compliance systems are inadequate, members should decline the responsibility in writing.
– Members may take supervisory roles in firms with sub-standard compliance systems if they aim to improve them.
– Policies must be enforced equally, covering both investment-related and non-investment-related activities.
Key Takeaways
– Supervisors must establish and enforce effective compliance procedures.
– A lack of compliance measures may justify declining supervisory roles.
– Members can accept roles in weak compliance environments to implement improvements.
– All policies must be applied consistently across different activities.
[Recommended Procedures for Compliance]
1- Adoption of a Code of Ethics
– Employers should adopt a clear and accessible code of ethics to protect client interests and the firm’s reputation.
– Example: A firm’s code of ethics should outline broad ethical principles that apply to all employees and demonstrate the firm’s commitment to integrity.
2- Separation of Compliance Procedures
– Compliance procedures should be documented separately from the code of ethics to avoid excessive complexity.
– Example: A separate compliance manual should provide detailed guidance on regulatory adherence and ethical conduct.
3- Sharing the Code of Ethics with Clients
– Firms should communicate their ethical commitments to clients.
– Example: Providing clients with a summary of the code of ethics reassures them of the firm’s integrity in handling investments.
4- Establishment of Clear Compliance Procedures
– Compliance procedures should be well-documented, accessible, and developed by compliance officers.
– Example: Firms should define the supervision hierarchy, implement checks and balances, and outline permissible conduct.
5- Reporting and Investigating Violations
– When a violation occurs, the supervisor should:
— Respond promptly to address the issue.
— Conduct a thorough investigation to assess the extent of any wrongdoing.
— Increase supervision or impose restrictions on the involved parties.
— Review and adjust firm policies to prevent future violations.
– Example: If an employee engages in insider trading, the compliance officer should investigate, restrict the employee’s activities, and revise internal monitoring procedures.
6- Compliance Education and Ethical Incentives
– Firms should provide compliance training and establish an incentive structure that promotes ethical behavior.
– Example: Offering ethics-based performance rewards encourages employees to act in clients’ best interests.
[Supervisory Responsibilities and Compliance Systems]
1- Preventing and Detecting Violations
– Supervisors must take proactive steps to prevent and detect violations through effective compliance systems.
– An effective compliance framework helps ensure adherence to ethical and regulatory standards.
2- Encouraged Actions for Supervisors
– Provide education and training on compliance and ethical responsibilities regularly.
– Reward employees for demonstrating good ethical behavior to reinforce a strong ethical culture.
3- Limitations of Supervisory Authority
– Some supervisors may not have the authority to create compliance policies and procedures.
– Their role is limited to enforcing existing policies rather than establishing them.
– Firms should be encouraged to adopt and maintain adequate compliance systems to support ethical oversight.
[Supervision and Detection of Violations]
1- Responsibility of Supervisors
– Supervisors must make reasonable efforts to detect violations of ethical and regulatory standards.
– Standard IV(C) requires supervisors to enforce compliance but does not hold them accountable for undetected violations if proper efforts were made.
2- Compliance and Accountability
– If an employee’s violation is not detected despite reasonable supervision, it does not constitute a violation of Standard IV(C).
– Supervisors must ensure that compliance procedures are adequate and effective.
3- Continuous Improvement in Compliance
– When violations occur, supervisors should adjust compliance procedures to prevent future infractions.
– Strengthening monitoring and enforcement mechanisms helps reduce the risk of repeated violations.
[Standard V(A): Diligence and Reasonable Basis]
1- Broad Definition
– “Members and Candidates must:
— Exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions.
— Have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action.”
2- Ensuring Diligence in Investment Analysis
– Members must conduct in-depth research before making investment recommendations.
– Independence and objectivity must be maintained throughout the decision-making process.
– Examples of diligent investment practices:
— 1- Conducting fundamental and technical analysis before recommending a security.
— 2- Reviewing and validating third-party research before incorporating it into recommendations.
— 3- Continuously monitoring investment positions to ensure their suitability.
3- Establishing a Reasonable and Adequate Basis
– Members must ensure their decisions are well-supported by credible data.
– Key practices include:
— 1- Using reliable data sources and avoiding unverified information.
— 2- Documenting all research and analysis to justify investment decisions.
— 3- Considering various market conditions and risk factors in recommendations.
– Example: An analyst recommending a stock without verifying the financial statements would violate this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Using third-party research: Verify the credibility and methodology before relying on external sources.
— 2- Making investment recommendations in volatile markets: Ensure sufficient risk analysis.
— 3- Relying on quantitative models: Validate assumptions and ensure accuracy before making decisions.
[Diligence and Reasonable Basis in Investment Analysis]
1- Guidance
– Members and candidates must apply diligence, independence, and thoroughness in investment analysis, recommendations, and actions.
– Research must be appropriate and well-supported before making investment decisions.
2- Defining Diligence and Reasonable Basis
– Clients expect thorough research with a variety of sources to ensure well-founded recommendations.
– Only available information at the time of analysis can be used.
– Even well-informed decisions carry downside risk.
3- Using Secondary or Third-Party Research
– Secondary research (internal) and third-party research should be carefully reviewed.
– Members must assess:
– 1- Assumptions used.
– 2- Rigor and timeliness of analysis.
– 3- Objectivity of the research.
– Members may rely on the firm’s due diligence process if it is robust and sound.
4- Using Quantitatively Oriented Research
– Members should understand quantitative models and their parameters.
– While technical expertise is not mandatory, they must grasp assumptions and limitations.
– Members must be able to explain model usage to clients.
5- Developing Quantitatively Oriented Techniques
– Members should carefully evaluate embedded assumptions and time horizons when using models.
6- Selecting External Advisers and Subadvisers
– Standardized review criteria should be used to evaluate external advisers.
– Considerations include:
– 1- Adviser’s code of ethics.
– 2- Internal controls and quality of published returns.
– 3- Adviser’s adherence to the stated strategy.
7- Group Research and Decision Making
– Group consensus may not always reflect an individual member’s view.
– Members may sign a report if they believe the process was independent and thorough.
Key Takeaways
– Investment recommendations must be based on diligent and independent research.
– Secondary and third-party research must be critically assessed before reliance.
– Quantitative models require understanding of assumptions and limitations.
– External advisers should be reviewed using standardized ethical and performance criteria.
– Group research may differ from personal views, but members can sign off if the process is sound.
[Recommended Procedures for Compliance]
1- Establishing a Reasonable Basis for Reports
– Firms should adopt policies requiring all reports and recommendations to be based on a reasonable basis.
– Example: Investment research should be supported by fundamental analysis, quantitative models, or scenario testing.
2- Implementation of Review Committees
– Firms should create review committees to assess research quality and ensure adherence to written guidelines.
– Example: A committee can evaluate whether analysts have followed the firm’s research methodology before issuing recommendations.
3- Measurable Research Standards
– The quality of research should be based on measurable criteria and scenario testing.
– Example: Analysts should conduct stress tests and sensitivity analyses to validate investment assumptions.
4- External Review for Reasonableness and Adequacy
– Firms should engage outside providers to assess the reasonableness and adequacy of research.
– Example: An independent consulting firm can review an asset manager’s investment strategies to confirm compliance with best practices.
5- Standardized Criteria for External Advisers
– Firms should adopt standardized criteria for evaluating external advisers.
– Example: Due diligence checklists should assess external fund managers based on experience, performance history, and risk management practices.
[Standard V(B): Communication with Clients and Prospective Clients]
1- Broad Definition
– “Members and Candidates must:
— Disclose to clients and prospective clients the nature of the services provided, along with information about the costs to the client associated with those services.
— Disclose to clients and prospective clients the basic format and general principles of the investment processes they use to analyze investments, select securities, and construct portfolios and must promptly disclose any changes that might materially affect those processes.
— Disclose to clients and prospective clients significant limitations and risks associated with the investment process.
— Use reasonable judgment in identifying which factors are important to their investment analyses, recommendations, or actions and include those factors in communications with clients and prospective clients.
— Distinguish between fact and opinion in the presentation of investment analysis and recommendations.”
2- Ensuring Transparent and Effective Communication
– Members must provide clients with clear, accurate, and complete information regarding investment decisions.
– Communication should help clients make informed choices while managing their expectations.
– Examples of effective communication:
— 1- Explaining investment strategies, fees, and risks in plain language.
— 2- Informing clients of any changes in portfolio management or risk factors.
— 3- Clearly separating factual data from opinions in reports and discussions.
3- Maintaining Consistency and Clarity in Client Communication
– Members must ensure that all information provided to clients is reliable and well-supported.
– Key steps include:
— 1- Using standardized disclosures for investment strategies and costs.
— 2- Regularly updating clients on portfolio performance and potential risks.
— 3- Promptly notifying clients of any material changes to investment strategies or policies.
– Example: An advisor who fails to inform clients about increased risk exposure in their portfolios due to market changes violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Communicating complex investment products: Ensure clients fully understand risks and potential returns.
— 2- Adjusting investment strategies: Notify clients about significant modifications and their implications.
— 3- Discussing market forecasts: Clearly differentiate between data-driven projections and personal opinions.
[Client Communication and Disclosure of Costs]
1- Guidance
– Clients and prospective clients must have the opportunity to make fully informed investment decisions.
– Members must clearly communicate the investment process, highlight key factors, and disclose material changes quickly.
– A distinction should be made between fact and opinion when presenting recommendations.
– Limitations of an investment approach should be disclosed.
– Changes to the investment policy statement (IPS) must be communicated as soon as possible.
2- Disclosing Nature of Services and Information about Costs
– Members must disclose the nature and cost of professional services that clients are expected to pay for.
– Best practices suggest listing these costs in a written engagement agreement at the start of the client relationship.
– Ongoing updates must be provided if the nature of services or costs change.
– This applies to all services associated with a client’s portfolio, including those provided by third parties.
3- Level of Detail in Disclosures
– Disclosures must be appropriate, accurate, timely, and complete.
– Specific amounts do not need to be disclosed if unknown in advance (e.g., percentage-based fees).
– Some discretion can be applied based on the client’s level of sophistication.
– Firms are not required to disclose the costs incurred in providing services to clients.
4- Responsibilities of Members and Candidates
– Members should ensure firm-provided disclosures comply with standards and report discrepancies.
– If disclosures are insufficient, members should supplement them or dissociate from misleading activities.
– Employees in non-client-facing roles are not responsible for disclosures made by client-facing employees.
Key Takeaways
– Clients must receive clear, accurate, and timely investment process disclosures.
– Service costs should be disclosed, with best practices favoring written agreements.
– Changes to fees or services require ongoing updates.
– Members must ensure firm disclosures meet ethical standards and report discrepancies.
[Effective Client Communication in Investment Processes]
1- Informing Clients of the Investment Process
– Members must communicate changes in the investment process to clients.
– The use of outside advisers should also be disclosed.
– Communication methods can include in-person meetings, phone calls, reports, or other means.
2- Different Forms of Communication
– Full, in-depth reports may not always be necessary depending on the nature of the recommendation.
– Some recommendations can be condensed (e.g., a stock list without detailed analysis).
– Clients must be notified that additional information is available upon request.
3- Report Presentation
– Reference materials for quantitative research should be accessible.
– Final reports must clearly state the limitations and risks considered.
– Unnecessary details should be omitted to maintain clarity for clients.
4- Distinction between Facts and Opinions in Reports
– Facts and opinions must be clearly separated in investment reports.
– Future estimates (e.g., earnings or dividends) should be explicitly labeled as opinions.
– Limits of statistical projections must be disclosed.
Key Takeaways
– Clients should be kept informed about investment process changes and adviser involvement.
– Communication can be adjusted based on the nature of recommendations, but additional details must be available.
– Reports must highlight risks and limitations while ensuring clarity.
– Facts and opinions must be distinctly labeled to maintain transparency and avoid misrepresentation.
[Recommended Procedures for Compliance]
1- Case-by-Case Evaluation of Reasonable Judgment
– Determining whether a member has exercised reasonable judgment should be assessed on a case-by-case basis.
– Example: A portfolio manager’s decision to overweight a particular sector should be evaluated based on market conditions and supporting research.
2- Maintaining Records for Justification
– Members should keep detailed records to justify their recommendations and research.
– Example: An analyst should document financial models, industry reports, and valuation methods used to support an investment recommendation.
[Standard V(C): Record Retention]
1- Broad Definition
– “Members and Candidates must develop and maintain appropriate records to support their investment analyses, recommendations, actions, and other investment-related communications with clients and prospective clients.”
2- Importance of Record Retention
– Maintaining accurate records ensures transparency, accountability, and compliance with regulations.
– Records help justify investment decisions and protect against disputes or legal issues.
– Examples of essential records:
— 1- Research reports and financial models used for investment recommendations.
— 2- Client communications regarding investment strategies and risk disclosures.
— 3- Trade confirmations, meeting notes, and compliance reports.
3- Establishing a Proper Record-Keeping System
– Members must ensure all investment-related documents are stored securely and easily accessible.
– Key practices include:
— 1- Following firm policies and regulatory requirements for document retention periods.
— 2- Keeping digital or physical records in a manner that prevents unauthorized access or loss.
— 3- Retaining research and analysis used to support investment recommendations.
– Example: A portfolio manager who deletes past research used in client recommendations without maintaining backups violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Managing electronic records: Ensure proper backups and cybersecurity measures.
— 2- Transitioning between firms: Avoid taking confidential client data to a new employer.
— 3- Handling regulatory audits: Maintain well-documented records to demonstrate compliance.
[Record Retention for Investment Professionals]
1- Guidance
– Members and candidates must develop and maintain records to support investment-related communications.
– Relevant records include handwritten notes, drafts, and client communications.
– Records can be stored in hard copy or electronic format.
2- Regulatory Compliance and Retention Standards
– Record-keeping requirements depend on local regulatory standards.
– If no regulatory guidance exists, CFA Institute recommends a minimum retention period of seven years.
Key Takeaways
– Proper record retention ensures compliance and accountability in investment-related communications.
– Both physical and electronic records are acceptable storage formats.
– When no legal requirement applies, maintaining records for at least seven years is recommended.
[Recommended Procedures for Compliance]
1- Firm Ownership of Records
– All records created by a member during employment are the property of the firm.
– Example: Research reports, client data, and investment recommendations belong to the firm, not the individual employee.
2- Restrictions on Taking Records
– Members must obtain employer approval before taking records when leaving a firm.
– Example: A departing analyst cannot take proprietary models or client lists unless explicitly authorized by the firm.
3- Prohibited Use of Prior Firm’s Recommendations
– Members cannot use past recommendations at a new firm if the supporting documentation remains with the previous employer.
– Example: An investment manager switching firms cannot rely on research from their previous employer without documented approval.
Key Takeaways
– Firms retain ownership of records, and employees must seek approval before taking them.
– Unauthorized use of prior firm research and recommendations is a violation of ethical standards.
– Compliance ensures protection of proprietary data and intellectual property.
[Standard VI(A): Avoid or Disclose Conflicts]
1- Broad Definition
– “Members and Candidates must avoid or make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective clients, and employer. Members and Candidates must ensure that such disclosures are prominent, are delivered in plain language, and communicate the relevant information effectively.”
2- Identifying and Avoiding Conflicts of Interest
– Conflicts of interest arise when personal, financial, or professional incentives could influence objective decision-making.
– Members must either avoid conflicts or disclose them in a transparent manner.
– Examples of conflicts of interest:
— 1- Owning stock in a company while providing investment research on that company.
— 2- Receiving undisclosed referral fees or commissions from third parties.
— 3- Managing personal or family accounts ahead of client trades (front-running).
3- Ensuring Full and Fair Disclosure
– Members must provide clear and prominent disclosures regarding any potential conflicts.
– Key practices include:
— 1- Disclosing personal investments that may affect recommendations.
— 2- Informing clients about any external compensation that may influence services provided.
— 3- Using plain language to ensure clients fully understand disclosed conflicts.
– Example: A portfolio manager who recommends a mutual fund without disclosing they receive commissions from the fund provider violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Engaging in outside business activities: Ensure full transparency with employers and clients.
— 2- Receiving gifts or benefits from clients: Disclose and document all gifts to prevent potential bias.
— 3- Working on investment banking deals while providing equity research: Maintain strict independence and disclose any dual roles.
[Disclosure and Management of Conflicts of Interest]
1- Guidance
– Members and candidates must clearly disclose all potential conflicts of interest to clients, prospective clients, and employers.
– While some conflicts are avoidable, others (e.g., compensation structures) are inevitable and must be transparently managed.
– Updates on conflicts should be made when necessary.
2- Disclosure of Conflicts to Employers
– Members must follow employer guidelines and disclose conflicts that may affect their judgment.
– Any situation that could cause a member to act against the employer’s best interests should be reported.
– Even the appearance of a conflict can be problematic.
3- Disclosure to Clients
– Objectivity is essential when advising clients.
– Any relationship between an issuer and a member must be disclosed.
– Members should uncover and disclose all potential conflicts, including nonstandard fee structures.
4- Cross-Departmental Conflicts
– Conflicts can arise between different departments.
– Example: A marketing department may pressure an analyst to give a favorable stock opinion.
– Special caution is needed in broker-sponsored limited partnerships.
5- Conflicts with Stock Ownership
– Members must disclose ownership of stocks they recommend to clients.
– Stock held in diversified mutual funds does not require disclosure unless specifically mandated.
6- Conflicts as a Director
– Serving as a director can create conflicts between duties to clients and shareholders.
– Stock options or payments may incentivize members to prioritize share price increases.
– Board members also gain access to material nonpublic information, adding further ethical risks.
Key Takeaways
– All conflicts of interest must be clearly disclosed to employers, clients, and relevant parties.
– Client advice must remain objective, free from undisclosed external influences.
– Members should be cautious of cross-departmental pressures and stock ownership conflicts.
– Serving as a director can create significant ethical challenges requiring strict transparency.
[Recommended Procedures for Compliance]
1- Disclosure of Compensation Arrangements
– Members and candidates should disclose compensation structures that may create conflicts of interest with clients.
– Example: Compensation models based on commissions, performance fees, or referral fees should be fully disclosed to ensure transparency.
2- Transparency in Promotional Materials
– Firms should include compensation-related disclosures in promotional materials.
– Example: Information about performance fees and stock options should be provided to potential clients to avoid misleading incentives.
3- Managing Conflicts Between Short-Term and Long-Term Goals
– Compensation incentives should align with long-term client interests rather than short-term performance targets.
– Example: A portfolio manager should avoid excessive risk-taking to maximize short-term bonuses at the expense of client portfolios.
[Definition of Beneficial Interest in a Security]
1- Beneficial interest in a security applies when a member or candidate:
– Directly owns the security.
– Has the power to direct voting rights of the security.
– Has the power to sell the security.
[Standard VI(B): Priority of Transactions]
1- Broad Definition
– “Investment transactions for clients and employers must have priority over investment transactions in which a Member or Candidate is the beneficial owner.”
2- Understanding Transaction Priority
– Members must ensure that client and employer interests come before personal investment actions.
– Personal trades must not disadvantage clients or create conflicts of interest.
– Examples of violating transaction priority:
— 1- Executing personal trades ahead of client trades (front-running).
— 2- Trading on behalf of family or personal accounts before executing client transactions.
— 3- Taking advantage of knowledge of large client trades to profit personally.
3- Ensuring Fair Trading Practices
– Members must establish policies that prioritize client transactions over personal trades.
– Key practices include:
— 1- Implementing pre-clearance procedures for personal trades.
— 2- Requiring employees to disclose personal securities holdings and trading activity.
— 3- Ensuring fair allocation of limited investment opportunities, such as IPOs.
– Example: An investment advisor who buys shares for their personal account before placing client orders for the same security violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Handling market-moving trades: Ensure clients execute first before placing personal orders.
— 2- Participating in initial public offerings (IPOs): Avoid conflicts by prioritizing client allocations.
— 3- Trading on material nonpublic information: Ensure no personal gain from privileged knowledge.
[Priority of Transactions and Ethical Trading Practices]
1- Guidance
– Client and employer transactions take priority over transactions for members or candidates.
– This ensures that client interests are placed ahead of personal gain.
2- Avoiding Potential Conflicts
– Members can profit from personal investments if clients are not disadvantaged and regulations are followed.
– Members may trade contrary to firm recommendations if done for legitimate reasons (e.g., personal cash needs).
3- Personal Trading Secondary to Trading for Clients
– Personal transactions must never disadvantage client trades.
– Members and clients may hold similar investments, provided no conflict arises.
4- Standards for Nonpublic Information
– Material nonpublic information must never be shared or used for trading.
5- Impact on All Accounts with Beneficial Ownership
– Clients and employers must have the right to trade first based on recommendations.
– Fee-paying family accounts should be treated like any other client account.
Key Takeaways
– Client and employer trades must come before personal transactions.
– Members can engage in personal trades if clients are not harmed.
– Material nonpublic information must be protected at all times.
– Family accounts paying standard fees should be treated like regular clients.
[Recommended Procedures for Compliance]
1- Restrictions on IPO Participation
– Participation in equity IPOs should be limited to prevent conflicts of interest and ensure client opportunities are prioritized.
– Example: Members must obtain firm approval before investing in IPOs to avoid taking allocation opportunities from clients.
2- Limits on Private Placement Investments
– Restrictions should be placed on private placements to prevent conflicts arising from preferential investment opportunities.
– Example: A member receiving access to a private placement as a reward from a broker should disclose this and ensure no undue influence on recommendations.
3- Prevention of Front-Running
– Investment personnel must not engage in front-running client trades.
– Example: Firms should implement blackout periods to restrict managers from trading ahead of client orders.
4- Establishing Reporting Procedures
– Investment personnel should be required to disclose holdings at least annually and follow preclearance procedures.
– Example: Firms should require duplicate confirmations of transactions to ensure compliance with trading policies.
5- Disclosure of Personal Trading Policies
– Members should disclose personal trading policies to investors to enhance transparency.
– Example: Providing clear guidelines on personal investment restrictions reassures clients that their interests are protected.
Quiz - [Employee Participation in Oversubscribed IPOs and Private Placements]
1- Fair Dealing and Oversubscribed IPOs
– Standard III(B) - Fair Dealing requires CFA members and candidates to act fairly and objectively with clients.
– When an IPO is oversubscribed (demand exceeds available shares), professionals should prioritize clients over personal gains.
– The recommended practice is that employees and their immediate families should not participate in oversubscribed IPOs, ensuring more shares are available for clients.
2- Private Placements and Independence
– Standard I(B) - Independence and Objectivity and Standard VI(B) - Priority of Transactions advise firms to place strict limits on employee participation in private placements.
– Unlike IPOs, private placements are not strictly prohibited, but firms should monitor and control participation to prevent conflicts of interest.
Key Takeaways
– Employees should not participate in oversubscribed IPOs to ensure fairness and client priority.
– Private placements should have strict limits, but a total prohibition is not required.
– Firms must have clear policies to prevent conflicts of interest and ensure compliance with ethical standards.
[Front Running and Blackout Periods]
1- Definition of Front Running
– Front running occurs when an investment professional trades a security for personal gain before executing large client transactions that could impact the security’s price.
– This unethical practice exploits nonpublic knowledge of upcoming trades, leading to unfair advantages.
2- Purpose of Blackout/Restricted Periods
– Blackout periods prevent managers from taking advantage of knowledge about upcoming client trades.
– All individuals involved in the investment decision-making process must adhere to the same restricted period to ensure fairness.
– Restrictions vary by firm and depend on factors such as firm size and securities traded.
3- Example of Front Running
– A portfolio manager knows that a client will purchase a large quantity of XYZ stock, which is expected to increase the stock price.
– Before executing the client’s trade, the manager buys XYZ stock for personal gain.
– Once the client’s large trade pushes the stock price higher, the manager sells at a profit before other investors can react.
– This practice harms clients by increasing their purchase price while giving the manager an unfair advantage.
Key Takeaways
– Front running is unethical and violates fiduciary duty by prioritizing personal gain over client interests.
– Blackout periods help prevent insider abuse by restricting personal trading before client transactions.
– Firms must enforce strict compliance to ensure all decision-makers follow the same trading restrictions.
[Disclosure of Personal Investing Policies]
1- Importance of Policy Disclosure
– Members and candidates must communicate firm policies on personal investing to clients.
– Clear disclosure eliminates conflicts of interest concerns and builds trust.
2- Requirements for Effective Disclosure
– Policies must be specific enough to provide meaningful information.
– Boilerplate or generic language is insufficient; disclosures must be tailored to the firm’s practices.
[Standard VI(C): Referral Fees]
1- Broad Definition
– “Members and Candidates must disclose to their employer, clients, and prospective clients, as appropriate, any compensation, consideration, or benefit received from or paid to others for the recommendation of products or services.”
2- Importance of Disclosing Referral Fees
– Full disclosure ensures transparency and allows clients to assess potential conflicts of interest.
– Referral fees can include direct payments, commissions, bonuses, or non-monetary benefits.
– Examples of referral fee arrangements:
— 1- Receiving commissions for directing clients to specific investment funds.
— 2- Paying a third party for client introductions without proper disclosure.
— 3- Accepting bonuses for referring clients to affiliated financial services.
3- Ensuring Proper Disclosure and Compliance
– Members must clearly communicate referral agreements to all relevant parties.
– Key practices include:
— 1- Providing written disclosure of referral compensation before entering into agreements.
— 2- Ensuring clients understand how referral fees impact recommendations.
— 3- Complying with firm policies and regulatory requirements regarding referral arrangements.
– Example: A financial advisor who refers clients to an asset management firm and receives undisclosed commissions violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Recommending third-party services: Ensure full disclosure of financial incentives.
— 2- Accepting non-monetary benefits: Gifts or preferential treatment from vendors must be disclosed.
— 3- Structuring referral agreements: Confirm compliance with legal and ethical obligations.
[Disclosure of Benefits and Compensation]
1- Guidance
– Members and candidates must disclose any benefit received from or paid to others for recommending products or services.
– Full disclosure allows clients and employers to assess impartiality and costs.
2- Required Disclosure Details
– The type and amount of the benefit must be fully described.
– Transparency ensures that clients and employers can evaluate potential biases.
– Firms should establish clear procedures to enforce proper disclosures.
Key Takeaways
– Any compensation or benefit tied to recommendations must be fully disclosed.
– Transparency helps prevent conflicts of interest and maintains trust.
– Firms should implement structured policies to ensure compliance.
[Recommended Procedures for Compliance]
1- Establishing Referral Fee Policies
– Employers should develop clear procedures for handling referral fees.
– Example: Firms may either prohibit referral fees entirely or require an approval process before they are accepted.
2- Regular Disclosure of Compensation
– Investment professionals should report referral fees and other compensation to their employer at least quarterly.
– Example: A financial advisor receiving referral fees from third-party service providers must disclose the amount and nature of these payments every quarter.
[Standard VII(A): Conduct as Members and Candidates in the CFA Program]
1- Broad Definition
– “Members and Candidates must not engage in any conduct that compromises the reputation or integrity of CFA Institute or the CFA designation or the integrity, validity, or security of CFA Institute programs.”
2- Upholding the Integrity of the CFA Program
– Members and candidates must act ethically and maintain the credibility of the CFA designation.
– Any action that undermines the CFA Institute’s reputation is a violation.
– Examples of misconduct:
— 1- Cheating on CFA exams or attempting to gain unfair advantages.
— 2- Disclosing confidential CFA exam content or questions.
— 3- Making false or exaggerated claims about the CFA designation.
3- Protecting the CFA Institute’s Reputation
– Members and candidates must avoid actions that could damage the credibility of the designation.
– Key practices include:
— 1- Complying with all CFA Institute policies and exam regulations.
— 2- Representing the CFA designation accurately without misrepresentation.
— 3- Reporting any observed violations to maintain program integrity.
– Example: A candidate who shares exam questions on social media violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Discussing CFA exams: Avoid revealing or discussing exam content online or in public forums.
— 2- Using the CFA designation: Ensure proper and ethical usage in resumes and communications.
— 3- Engaging in misconduct: Any fraudulent or dishonest actions related to the CFA Program can lead to disciplinary action.
[Ethical Responsibilities in the CFA Program]
1- Protection of CFA Institute Reputation
– Members and candidates must not compromise the reputation of the CFA Institute, CFA designation, or CFA programs.
– Conduct violations include:
– 1- Cheating or failing to follow examination rules.
– 2- Misusing the CFA designation.
– 3- Misrepresenting information on the Professional Conduct Statement.
2- Confidential Program Information
– Exam content is strictly confidential, including tested questions and topic coverage.
– Discussion of exam specifics is prohibited, even among candidates after the exam.
– The CFA Institute monitors blogs and forums for compliance.
3- Additional CFA Program Restrictions
– Candidates must follow all testing policies.
– Volunteers are prohibited from sharing confidential information.
– CFA exam policies should be reviewed before sitting for the exam.
4- Expressing an Opinion
– Members and candidates may share personal opinions about the exam process, but not about specific content.
Key Takeaways
– CFA exam integrity must be protected at all times.
– Exam content is confidential and cannot be discussed.
– Misuse of the CFA designation and violations of conduct rules harm professional reputation.
– Candidates can express opinions on the exam process, but not on specific exam details.
[Standard VII(B): Reference to CFA Institute, the CFA Designation, and the CFA Program]
1- Broad Definition
– “When referring to CFA Institute, CFA Institute membership, the CFA designation, or candidacy in the CFA Program, Members and Candidates must not misrepresent or exaggerate the meaning or implications of membership in CFA Institute, holding the CFA designation, or candidacy in the CFA Program.”
2- Proper Use of the CFA Designation
– Members and candidates must accurately represent their CFA status without making misleading claims.
– The CFA designation should be used strictly in accordance with CFA Institute guidelines.
– Examples of improper references:
— 1- Claiming to be a “CFA-certified” professional (the correct term is “CFA charterholder”).
— 2- Stating that passing Level I or Level II of the CFA exam guarantees superior investment performance.
— 3- Suggesting that CFA Institute endorses a specific product, strategy, or firm.
3- Avoiding Misrepresentation
– Members and candidates must ensure their use of the CFA designation does not mislead clients or employers.
– Key practices include:
— 1- Using “CFA charterholder” only after earning the full designation.
— 2- Clearly stating CFA exam candidacy (e.g., “CFA Level II Candidate” if registered for the exam).
— 3- Not implying that CFA Institute membership or candidacy alone guarantees competence or expertise.
– Example: A professional who claims to be a CFA charterholder before officially earning the designation violates this standard.
4- Situations Requiring Extra Caution
– Members should be particularly cautious in:
— 1- Listing CFA status on resumes or business cards: Ensure accuracy and proper phrasing.
— 2- Promoting credentials in marketing materials: Avoid implying superior abilities due to CFA candidacy.
— 3- Referring to CFA Institute in endorsements: Do not suggest CFA Institute approves or recommends specific firms or products.
[Proper Use of CFA Membership and Designation]
1- Ethical Communication Regarding CFA Status
– Members and candidates must not misrepresent or exaggerate their CFA membership, designation, or candidacy.
– The CFA designation does not imply superior performance over others.
– This rule applies to all forms of communication.
2- CFA Institute Membership Requirements
To maintain active membership, a CFA member must:
– 1- Annually complete the Professional Conduct Statement.
– 2- Pay applicable membership dues each year.
– Failure to meet these requirements results in loss of active status, prohibiting the use of the CFA designation until reactivated.
3- Proper Use of the CFA Designation
– CFA charterholders must maintain active membership to continue using the designation.
– The CFA designation should not be exaggerated in resumes, business cards, or professional materials.
– Proper formatting examples:
– “John Smith, CFA, PhD”
– “John Smith, PhD, CFA”
– The order of designations is a personal preference.
Key Takeaways
– The CFA designation must not be misrepresented as a sign of superior ability.
– Active CFA Institute membership is required to use the CFA designation.
– Proper formatting and ethical use of the CFA designation maintain professionalism.
[Proper Representation of CFA Candidacy and Marks]
1- Referring to Candidacy in the CFA Program
– Candidates may state they are enrolled in the CFA Program.
– Partial designation is not allowed (e.g., “CFA Level 2” is incorrect).
– Candidates may state which exams they have passed, but cannot imply superior ability due to speed of completion.
2- Proper Usage of the CFA Marks
– CFA charterholders may use:
– “Chartered Financial Analyst®”, “CFA®”, and the CFA Logo.
– CFA marks cannot be used as nouns, only as adjectives (e.g., “John Smith is a CFA” is incorrect; “John Smith is a CFA charterholder” is correct).
– The CFA mark should be capitalized, without periods, and not given excessive prominence (e.g., should not be in a larger or bolder font than the individual’s name).
Key Takeaways
– CFA candidates must not misrepresent their candidacy or suggest partial designation.
– The CFA designation should only be used as an adjective, following proper formatting rules.
– Exaggeration or improper use of CFA marks can lead to ethical violations.
[Recommended Procedures for Compliance]
1- Learning Compliance Requirements
– Members and candidates should familiarize themselves with compliance requirements to prevent violations.
– Example: Employees should undergo periodic training on ethical guidelines and regulatory standards.
2- Use of Compliance Templates
– Firms should create standardized templates to ensure consistency in compliance procedures.
– Example: Pre-approved reporting forms for disclosures can help streamline compliance and reduce errors.
[Summary of Linked CFA Standards and Their Interconnections]
1- Independence and Objectivity (Standard I(B)) & Referral Fees (Standard VI(C))
How They Are Linked:
– Independence and objectivity require members to make unbiased recommendations, free from external influence.
– Referral fees introduce potential conflicts of interest, as undisclosed compensation may bias recommendations.
– To uphold independence, members must disclose any compensation received for recommending products or services.
– Example:
A financial advisor receives referral commissions from a mutual fund company but does not disclose this to clients. As a result, the advisor’s objectivity is compromised, violating both standards. Proper disclosure would ensure transparency and maintain professional integrity.
2- Misrepresentation (Standard I(C)) & Performance Presentation (Standard III(D))
How They Are Linked:
– Misrepresentation prohibits providing false or misleading information in professional activities.
– Performance presentation ensures that investment results are reported fairly, accurately, and completely.
– If performance data is manipulated to appear more favorable, it constitutes misrepresentation.
– Example:
An investment firm advertises a fund’s past returns but excludes periods of underperformance, misleading clients about the true risk and return profile. This violates both standards, as it misrepresents investment results and fails to provide a complete performance history.
[Summary of Linked CFA Standards and Their Interconnections]
3- Market Manipulation (Standard II(B)) & Priority of Transactions (Standard VI(B))
How They Are Linked:
– Market manipulation involves actions that distort prices or trading volumes to mislead investors.
– Priority of transactions ensures that clients’ trades take precedence over personal transactions.
– If a member front-runs (trades before executing client transactions) or manipulates prices to benefit personal trades, both standards are violated.
– Example:
A portfolio manager executes personal trades before placing large client orders, knowing the orders will drive up stock prices. This is both market manipulation and a failure to prioritize client transactions, creating an unfair market advantage.
4- Loyalty to Clients (Standard III(A)) & Suitability (Standard III(C))
How They Are Linked:
– Loyalty to clients requires members to act in clients’ best interests.
– Suitability ensures that investment recommendations align with clients’ financial goals, risk tolerance, and constraints.
– A failure to assess suitability may result in investments that are not in the client’s best interest, violating both standards.
– Example:
An advisor recommends a high-risk derivative product to a client with a conservative investment profile to earn higher commissions. This breaches both loyalty and suitability standards, as the recommendation prioritizes the advisor’s financial gain over the client’s needs.
5- Preservation of Confidentiality (Standard III(E)) & Responsibilities of Supervisors (Standard IV(C))
How They Are Linked:
– Confidentiality requires members to protect client information unless disclosure is legally required.
– Supervisors must ensure that employees comply with ethical standards, including data protection.
– If a firm does not enforce proper confidentiality policies, supervisors are responsible for the breach.
– Example:
An investment firm employee shares a high-net-worth client’s portfolio details with a third party without consent. If the supervisor failed to implement safeguards or training on confidentiality, both the employee and the supervisor would be in violation.
[Analysis of Ethical Considerations in Job Transition]
1- Ethical Standard in Question
– Standard IV(A) – Loyalty:
– Requires CFA members to act in their employer’s best interests until they formally leave.
– Prohibits taking proprietary information, including client lists, for personal gain.
– Allows professionals to use general industry knowledge and relationships but not confidential records.
2- Reviewing a Client List Before Leaving
– Did Weldon Violate the Standard?
– No. Reviewing the client list as part of her job responsibilities while still employed is acceptable.
– Had she copied or taken the list for personal use at her new firm, this would be a violation.
– Ethical professionals may rely on memory and industry knowledge but not on stolen documents.
3- Offering to Solicit Clients Post-Departure
– Did Weldon Violate the Standard?
– No. A departing employee can engage former clients in their new role, as long as they do not use stolen records.
– It is permissible to express intent to contact clients after leaving, as long as no confidential information is taken.
Key Takeaways
Permitted Actions:
– Reviewing client lists as part of regular job duties.
– Using personal knowledge and relationships after leaving.
– Soliciting former clients only after leaving, using publicly available information.
Prohibited Actions:
– Copying, taking, or using confidential client lists after leaving.
– Soliciting clients while still employed at the old firm.
– Misrepresenting relationships or previous employer details.
Final Conclusion
– Weldon did not violate Standard IV(A) because she neither misused confidential information nor took proprietary client records.
– Best Practice: Always wait until formally leaving before soliciting previous clients and ensure outreach is based on public knowledge, not confidential data.
10.3 Application of The Code and Standards : Level 2
– Evaluate practices, policies, and conduct relative to the CFA Institute Code of Ethics and Standards of Professional Conduct.
– Explain how the practices, policies, and conduct do or do not violate the CFA Institute Code of Ethics and Standards of Professional Conduct.
[Ethical Considerations in Broker Recommendations and Referral Fees]
1- Understanding Referral Fees and Fair Recommendations
– A CFA member must fully disclose any compensation, incentives, or benefits received from referring clients to third parties.
– If a firm recommends brokers, but does not receive compensation or a direct benefit, it does not violate ethical standards as long as clients are free to choose their own brokers.
2- No Violation of Standard VI(C) - Referral Fees
– In cases where a firm recommends certain brokers based on research quality rather than financial incentives, this does not constitute a referral arrangement that requires disclosure.
– If no quid pro quo (exchange of favors or compensation) exists between the firm and the brokers, the recommendation does not create a conflict of interest.
3- Why Standard III(A) - Loyalty, Prudence, and Care Does Not Apply
– This standard requires investment professionals to act in their clients’ best interest when managing investments.
– However, if a firm is only providing research and not executing trades, it does not have a duty to ensure best execution—clients are responsible for making their own broker selection.
Key Takeaways
– If no compensation or benefit is received, recommending brokers based on research quality is not a violation.
– Clients must always retain the ability to choose their brokers freely.
– Firms providing only research (not trade execution) do not have an obligation to ensure best execution for clients.
[Ethical Responsibility in Broker Selection and Due Diligence]
1- Standard III(A) - Loyalty, Prudence, and Care
– Investment professionals who manage client assets must act with care and diligence in making investment decisions, including selecting brokers.
– It is the responsibility of the asset manager (Grant) to conduct due diligence on brokers to ensure best execution for client trades.
– Blindly following a research firm’s recommendations without independent verification is a violation of this standard.
2- Why Bashar Did Not Violate Any Standards
– Bashar’s firm provides research and recommendations only; they do not execute trades.
– The firm discloses the sources of its information, ensuring transparency.
– Since they do not direct trades or enforce broker selection, they have no obligation to ensure best execution.
Key Takeaways
– Grant, not Bashar, is responsible for best execution and should have verified the brokers independently.
– A research firm is not in violation if it transparently discloses its recommendations without forcing broker selection.
– Investment managers must always conduct their own due diligence rather than relying solely on external recommendations.
[Independence and objectivity in accepting travel and entertainment expenses]
1- Standard I(B) - Independence and Objectivity
– CFA members must avoid accepting gifts, compensation, or benefits that could compromise their objectivity.
– Accepting paid travel and accommodation from a broker seeking business creates a potential conflict of interest and should be avoided if commercial alternatives exist.
– Best practices dictate that professionals should pay for their own travel expenses to maintain independence.
2- Acceptable business-related entertainment
– The standard does not prohibit customary business-related entertainment, such as meals and standard hospitality, as long as there is no intent to improperly influence decisions.
– In this case, allowing the broker (OFS) to cover only meals and entertainment while Serengeti pays for travel and accommodation is the most ethical approach.
Key takeaways
– To maintain independence, professionals should not accept paid travel and lodging from firms seeking business relationships.
– Modest and customary business entertainment, such as meals, is acceptable if it does not create undue influence (if they are customary, it is okay).
– Ethical decision-making should prioritize avoiding conflicts of interest and maintaining professional objectivity.
[Fair dealing and personal investments]
1- Standard III(B) - Fair Dealing
– This standard requires CFA members to treat all clients fairly when providing investment recommendations or taking investment action.
– There is no violation if Bashar is receiving the same service as all other clients, as fairness is maintained.
– The key issue is whether other clients receive the same level of access and communication regarding trades.
2- Standard I(B) - Independence and Objectivity
– CFA members can invest personal funds with firms they research or recommend, as long as it does not impair their objectivity.
– In this case, no conflict of interest exists, as Bashar’s investment does not create a bias in her professional responsibilities.
3- Standard VI(A) - Avoid and Disclose Conflicts
– Disclosure is required only when a personal investment could lead to a conflict of interest.
– Since Bashar’s personal investment with OFS does not impact her duties or create a conflict, no disclosure is necessary.
Key takeaways
– Fair dealing requires that all clients receive equal access to investment opportunities and information.
– Investing personal funds with a firm is not inherently a violation, as long as it does not impair independence.
– Disclosure is only required when a personal investment creates a potential conflict of interest.
[Fair dealing and preferential treatment]
1- Standard III(B) - Fair Dealing
– This standard requires CFA members to ensure fair and equitable distribution of investment recommendations and material information to all clients.
– Olatunji violated this standard by informing Bashar of the upcoming buy recommendation before it was made public, giving her an unfair advantage.
– Preferential treatment of certain clients or individuals undermines market integrity and must be avoided.
2- Why Other Standards Do Not Apply
– Standard III(E) - Preservation of Confidentiality is not violated because the information shared was not client-specific but rather related to a firm-wide investment recommendation.
– Standard V(B) - Communication with Clients and Prospective Clients does not apply because this case is about timing and fairness of information dissemination, not how information is presented to clients.
Key takeaways
– Fair dealing requires that material investment recommendations be shared with all clients simultaneously.
– Providing early access to investment reports creates an unfair advantage and is a violation.
– Investment professionals must ensure no client or individual receives preferential treatment in trade-related information.
[Knowledge of the law and compliance with stricter regulations]
1- Standard I(A) - Knowledge of the Law
– CFA members must comply with the strictest applicable law or regulation in cases where multiple legal frameworks apply.
– In Urutina, instant messaging (IM) for trade confirmations is prohibited, meaning Ortiz and Sanchez violated local law by using it.
– Additionally, sharing client information with law enforcement is only permitted if required by applicable law. If local regulations prohibit it, compliance with those laws takes priority.
2- Standard III(E) - Preservation of Confidentiality
– This standard allows for disclosure only if required by law.
– However, if local laws (such as in Chiladour or Panaguay) prohibit disclosing client information, Ortiz and Sanchez must comply with the stricter regulation and should not have assisted law enforcement.
Key takeaways
– Investment professionals must always follow the most restrictive law applicable to their actions.
– If local laws prohibit disclosure, client confidentiality must be maintained, even when law enforcement requests information.
– Unawareness of stricter laws is not an excuse, and professionals must proactively ensure compliance.
[Referral fees and disclosure requirements]
1- Standard VI(C) - Referral Fees
– CFA members must disclose any compensation, consideration, or benefits received for referring clients to third parties.
– Even if an arrangement is informal (e.g., paying for dinners and football tickets), it still constitutes a referral benefit and must be disclosed.
– In this case, Ortiz and Sanchez failed to disclose their referral agreements, violating this standard.
2- Standard I(A) - Knowledge of the Law
– When multiple legal frameworks apply, CFA members must follow the most stringent rule.
– Even though no country in this case requires disclosure, the CFA Standards demand a higher level of transparency, meaning Ortiz and Sanchez violated this requirement as well.
3- Potential Violation of Standard IV(C) - Responsibilities of Supervisors
– Supervisors must ensure that employees comply with CFA Standards and firm policies.
– If Maduro failed to inquire about referral arrangements for an extended period, she may have neglected her supervisory duties, leading to a potential violation.
Key takeaways
– All referral benefits, whether monetary or non-monetary, must be disclosed under CFA Standards.
– Even if local laws do not require disclosure, CFA members must adhere to stricter CFA Standards.
– Supervisors have a responsibility to monitor and enforce ethical compliance within their teams.
[Fair dealing and IPO participation]
1- Standard III(B) - Fair Dealing
– CFA members must ensure that all clients receive fair and impartial treatment regarding investment opportunities.
– A violation occurs only if certain clients receive preferential treatment that disadvantages others.
– In this case, all eligible clients have equal access to IPO participation, so there is no unfair advantage.
2- Roadshow attendance does not confer special benefits
– Invitations to IPO roadshows are limited due to capacity constraints, but this does not impact clients’ ability to purchase IPO shares.
– The key issue is whether any client was denied a suitable IPO investment opportunity—since that is not the case, fair dealing has been maintained.
Key takeaways
– Fair dealing focuses on equal access to investment opportunities, not event invitations.
– As long as all suitable clients can participate in IPOs, no violation occurs.
– Attending roadshows alone does not create a material advantage in investment opportunities.
[Additional compensation arrangements and disclosure requirements]
1- Standard IV(B) - Additional Compensation Arrangements
– CFA members may accept performance-based bonuses or other forms of compensation from clients only if they obtain written consent from all relevant parties, including their employer.
– Ortiz and Sanchez failed to disclose their compensation arrangements (use of a beach house as a bonus) to their employer, violating this standard.
– Even if the arrangement is documented in the client’s Investment Policy Statement (IPS), it still requires employer approval.
2- Why Independence and Objectivity (Standard I(B)) is Not Violated
– The bonus does not create a conflict of interest since it is based on objective performance criteria rather than favoritism or improper influence.
– As long as client interests remain aligned with professional obligations, independence is not compromised.
Key takeaways
– All additional compensation arrangements must be disclosed to and approved by the employer in writing.
– Performance-based bonuses from clients are permissible but require transparency.
– The failure to obtain employer consent violates CFA Standards, even if the arrangement is client-approved.
[Fair dealing and client suitability]
1- Standard III(B) - Fair Dealing
– Fair dealing requires CFA members to treat clients fairly and impartially, but it does not mean that all clients must receive identical services.
– If an investment tool, such as Singh’s quantitative model, is only suitable for institutional clients, there is no obligation to offer or disclose it to individual investors.
– The key test is suitability—if the model is not appropriate for high-net-worth individuals, Singh is acting correctly by not offering it.
2- No obligation to offer unsuitable investments
– CFA members are not required to provide equal access to all products; they must ensure that each client receives investment strategies tailored to their specific needs and circumstances.
– Since there is no evidence that the model would be beneficial to individual clients, Singh’s decision does not violate CFA Standards.
Key takeaways
– Fair dealing means ensuring equitable treatment, not necessarily offering the same services to all clients.
– If an investment tool is only suitable for certain client types, there is no requirement to disclose it to others.
– Suitability must always be the primary factor in determining what investment strategies are offered to clients.
[Knowledge of the law and appropriate escalation]
1- Standard I(A) - Knowledge of the Law
– CFA members must comply with all applicable laws, rules, and regulations and must not engage in or ignore activities that violate ethical standards.
– Singh identified a flaw in his model that could negatively impact clients, and failing to correct it promptly would be a violation of CFA Standards.
– Since his supervisor instructed him to delay fixing the issue, Singh must take further action to ensure compliance.
2- The appropriate first step
– The first course of action is to escalate the issue to senior management to seek an appropriate resolution.
– Immediate dissociation from the firm is not required at this stage; instead, Singh should attempt to resolve the issue internally.
– If senior management fails to act, he must consider stronger measures, such as escalating further or even leaving the firm.
Key takeaways
– CFA members must not ignore violations of ethical or legal standards, even if directed by a supervisor.
– The first step in addressing a compliance issue is to escalate it internally to senior management.
– If the issue is not resolved, further action—including possible dissociation from the firm—may be required.
[Loyalty, prudence, and care in client interests]
1- Standard III(A) - Loyalty, Prudence, and Care
– CFA members must act in the best interests of their clients and prioritize client well-being over company directives.
– Singh discovered a critical flaw in his model, but by failing to take immediate corrective action, he violated his duty to clients.
– Simply waiting until the scheduled review or temporarily disabling parts of the model is insufficient; the underlying issue must be resolved promptly.
2- Failure to act against a known violation
– Singh’s loyalty is to clients, not to a supervisor who is instructing him to delay necessary corrections.
– The key issue is not technical model adjustments, but the broader ethical responsibility to ensure fair and accurate investment processes.
Key takeaways
– Investment professionals must take immediate action when they identify an issue that could harm clients.
– Following supervisor instructions does not absolve a CFA member of responsibility if those instructions violate ethical duties.
– Delaying a known fix violates the duty of loyalty and prudence, even if the firm has a review process in place.
[Performance presentation and accuracy]
1- Standard III(D) - Performance Presentation
– CFA members must ensure that performance data are presented accurately, fairly, and without misleading clients.
– It is acceptable to include back-tested returns as long as they are clearly labeled and distinguished from actual portfolio performance.
– Singh follows ethical guidelines by explicitly stating that the first four years of data are back-tested while the last two years are based on actual performance.
2- No ethical concerns regarding portfolio management for family members
– Managing portfolios for family members is only an issue if they receive preferential treatment over other clients.
– Since this case does not mention favoritism, there is no violation of CFA Standards.
Key takeaways
– Performance data must be clearly disclosed and not misleading, especially when including back-tested results.
– Labeling simulated or hypothetical results properly ensures transparency and compliance with ethical standards.
– Managing family portfolios does not raise ethical concerns unless it involves unfair advantages or conflicts of interest.
[Fair dealing and referral fee discounts]
1- Standard III(B) - Fair Dealing
– Fair dealing requires investment professionals to treat all clients fairly when providing investment recommendations and taking investment action.
– Offering discounted fees to referral clients does not violate this standard as long as all clients receive the same investment services and opportunities.
– A violation would occur only if non-referral clients were disadvantaged in terms of investment decisions or access to opportunities.
2- Distinguishing fair business practices from unfair preferential treatment
– Charging different fee structures is a common business practice and is not the same as giving certain clients preferential access to investment opportunities.
– Violations occur when preferential treatment affects investment decisions, not when it applies to pricing differences.
Key takeaways
– Fair dealing applies to investment actions and recommendations, not fee structures.
– Offering discounted fees to referred clients is permissible, as long as all clients receive equal access to investment opportunities.
– Preferential treatment in investment decisions would be a violation, but differentiated fee structures are not.
[Referral fees and proper disclosure]
1- Standard VI(C) - Referral Fees
– CFA members must disclose any compensation, benefits, or considerations received for client referrals BEFORE entering into an agreement.
– JRA violated this standard by only disclosing the referral fee arrangement in the client agreement instead of providing transparency beforehand.
– Disclosure must be made prior to signing the agreement, not just within the contract itself.
2- Responsibility for disclosure is independent
– The fact that Brightman’s lawyers disclosed the referral arrangement does not absolve JRA of its responsibility under the CFA Standards.
– Each party involved in the referral must ensure that clients are fully informed before making a commitment.
Key takeaways
– Referral fee arrangements must be disclosed upfront, not just within contractual agreements.
– Even if another party discloses the referral arrangement, CFA members are still individually responsible for ensuring proper disclosure.
– Transparency in referral compensation is critical for maintaining client trust and ethical compliance.
[Preservation of confidentiality and client consent]
1- Standard III(E) - Preservation of Confidentiality
– CFA members must not disclose confidential client information unless:
— The client provides explicit consent.
— Disclosure is required by law.
— It is requested by CFA Institute as part of a professional conduct investigation.
– JRA violated this standard by sharing client financial data with E&O without consent, even if it was done for seemingly good intentions.
2- Confidentiality agreements do not replace direct client consent
– The fact that clients signed confidentiality agreements with both JRA and E&O separately does not imply that they have agreed to information-sharing between the firms.
– JRA must obtain explicit client approval before sharing tax returns or investment statements, regardless of how closely clients work with their accountants.
– Even if clients “often view” their investment advisor and accountant “as a team,” this does not override the need for formal consent.
3- Misguided justification for information-sharing
– JRA’s reasoning for sharing client information is based on:
— “Greater transparency” to help advisors make better investment policy statements.
— “Know your client” (KYC) principles to ensure a complete financial understanding.
— “More realistic financial planning” for clients’ benefit.
– However, none of these reasons excuse violating client confidentiality. Even if sharing this data helps JRA make better investment decisions, they must first secure explicit client approval.
4- Assumption of consent is a serious violation
– JRA did not just fail to obtain consent—it appears they never even sought it.
– The case explicitly states that “client approval is not needed for this information sharing”, which suggests that JRA never asked clients whether they were comfortable with this practice.
– The correct approach would have been to:
— Disclose the specific information that would be shared.
— Explain why the sharing was necessary.
— Obtain written client approval before proceeding.
Key takeaways
– Client information cannot be shared without explicit consent, even if done for the client’s benefit.
– Separate confidentiality agreements do not imply cross-sharing approval between firms.
– Assuming consent instead of directly obtaining it is a serious ethics violation under CFA Standards.
– All disclosures must be documented and approved in writing to ensure compliance with ethical and legal obligations.
[Referral fees and client disclosure]
1- Standard VI(C) - Referral Fees
– CFA members must fully disclose any compensation, benefits, or considerations received for client referrals before entering into an agreement.
– In this case, JRA did not inform clients about its referral arrangement with Frontline, violating the standard.
– Even though clients continue to receive best execution and pricing, they still have a right to know about any referral agreements that could influence JRA’s decision to use Frontline.
2- Why best execution does not eliminate the need for disclosure
– The fact that Frontline provides best execution and competitive pricing is irrelevant to the requirement for disclosure.
– Clients should be made aware of any relationships that could create a conflict of interest, even if those relationships appear to benefit them.
– The lack of disclosure prevents clients from making an informed decision about whether the referral arrangement impacts JRA’s recommendations.
3- Avoiding misinterpretation of ethical violations
– The question focuses specifically on Standard VI(C) - Referral Fees, not Standard III(A) - Loyalty, Prudence, and Care.
– It is easy to assume the issue is about whether JRA is acting in the best interest of clients, but the ethical violation here is about lack of transparency regarding referral compensation.
– The correct ethical response would have been to disclose the referral relationship upfront, even if the service quality remains unchanged.
Key takeaways
– All referral fee arrangements must be disclosed to clients before entering into an agreement.
– Even if clients receive best execution, they still have the right to know about referral relationships.
– Transparency is critical, and failure to disclose referral fees is a direct violation of CFA Standards.
[Independence and objectivity in referral relationships]
1- Standard I(B) - Independence and Objectivity
– CFA members must avoid offering or accepting any form of compensation, gifts, or benefits that could compromise professional objectivity.
– Jacobs and Riccio violated this standard by making large undisclosed donations to Carroll’s charitable organization, which could improperly influence his recommendations.
– Even though the payments are not made directly to Carroll, the donations could be perceived as an attempt to secure favorable treatment, raising ethical concerns.
2- Why disclosure is critical
– The referred pension fund clients were not informed of these donations, meaning they could not evaluate whether Carroll’s recommendations were truly unbiased.
– Full transparency is necessary to ensure that referral decisions are made solely in the best interest of clients.
– The lack of disclosure creates a potential conflict of interest, even if Carroll genuinely believes JRA is the best advisor for his clients.
3- Clarifying the ethical focus of the case
– This case is about whether Jacobs and Riccio compromised Carroll’s objectivity, not whether Carroll himself violated CFA Standards.
– The question does not focus on Standard IV(B) - Additional Compensation Arrangements, which would be relevant if the issue was Carroll accepting compensation that conflicts with his duties.
– Instead, the ethical violation concerns Jacobs and Riccio offering undisclosed incentives that could lead to biased client recommendations.
Key takeaways
– Any action that could compromise an independent consultant’s objectivity must be avoided or fully disclosed.
– Undisclosed charitable donations to a consultant’s organization create a conflict of interest, even if not a direct payment.
– Client trust depends on transparency, and failing to disclose these donations undermines confidence in investment recommendations.
[Loyalty and obligations after resignation]
1- Standard IV(A) - Loyalty
– CFA members owe a duty of loyalty to their employer until their term of service is officially completed.
– Othan did not violate his previous firm’s policies since he obtained client contact information through personal social media interactions, which were permitted.
– Since he only contacted former clients after resigning, he did not breach his duty to Sack International under CFA Standards.
2- Post-resignation obligations
– Some firms may require departing employees to continue working during a notice period or help train a replacement.
– Employees may also be bound by non-compete agreements restricting client solicitation.
– In this case, Othan was escorted out immediately upon resigning, which implies his employment obligations ended at that moment.
3- Cash incentives for client recruitment
– JRA offered Othan a financial incentive to bring his former clients to the new firm.
– This is not inherently unethical unless Othan misrepresented his prior firm, used confidential client information improperly, or violated any non-compete clauses.
– If no such restrictions were in place, Othan’s actions remain compliant with CFA Standards.
Key takeaways
– Loyalty to an employer ends when employment officially terminates, unless contractual obligations extend beyond resignation.
– Using publicly available or personally obtained client contacts is not a violation, as long as no confidential firm data is used.
– Recruiting former clients is permissible unless restricted by a formal agreement or done in an unethical manner.
[Referral fees and disclosure obligations]
1- Standard IV(B) - Additional Compensation Arrangements
– CFA members must obtain written consent before accepting compensation for any work that competes with their employer.
– In this case, Othan’s interests align with JRA’s, as both want him to recruit clients to his new firm, so this standard is not violated.
2- Standard VI(C) - Referral Fees
– Clients must be informed of any referral fee arrangements so they can evaluate whether their advisor is providing an objective recommendation or acting in self-interest.
– Othan is receiving $500 per client he brings from Sack to JRA but fails to disclose this to the clients, creating a conflict of interest.
– By not informing his former clients about the compensation, he misrepresents himself as an impartial advisor, which is a direct violation of Standard VI(C).
3- Why full transparency is necessary
– Disclosure allows clients to assess whether their advisor’s recommendation is unbiased.
– If Othan were transparent about his compensation, clients could make a fully informed decision about whether to move their accounts to JRA.
– Lack of disclosure raises ethical concerns, as clients might believe the move is purely for their benefit, rather than motivated by Othan’s financial gain.
Key takeaways
– Referral fee arrangements must always be disclosed to clients upfront so they can assess advisor objectivity.
– Failing to disclose compensation creates a conflict of interest, even if the advisor believes the recommendation is in the client’s best interest.
– Transparency is critical to maintaining trust and upholding CFA ethical standards.
[Preservation of confidentiality and internal information sharing]
1- Standard III(E) - Preservation of Confidentiality
– CFA members must not disclose confidential client information unless required by law or authorized by the client.
– At Magadi Asset Management, proprietary traders can see and hear details of individual client orders, which violates client confidentiality.
– Even though this information is kept within the firm, it is still an ethical violation because it is being shared without a strict need-to-know basis.
2- Why internal disclosure is still a violation
– The firm’s goal of “increasing cooperation” and “encouraging collaboration” does not justify sharing sensitive client information.
– Magadi’s own internal policy requires confidentiality to be maintained except on a need-to-know basis, which was not followed in this case.
– There is no valid reason for proprietary traders to have access to individual client orders, as their job is focused on institutional clients.
3- Avoiding misplaced justifications
– The firm’s intention to enhance collaboration does not override its ethical duty to protect client confidentiality.
– Ethical violations can occur even when there is no malicious intent—the key issue is whether client information was shared without explicit consent or necessity.
– Proper compliance procedures should have ensured segregation of information between trading desks to avoid unnecessary exposure.
Key takeaways
– Client confidentiality must be protected at all times, even within the same firm.
– Sharing client order details internally without a need-to-know basis is an ethical violation under CFA Standards.
– Good intentions, such as improving collaboration, do not justify breaches of confidentiality—firms must ensure clear internal policies to prevent such violations.
[Responsibilities of supervisors and enforcement of ethical policies]
1- Standard IV(C) - Responsibilities of Supervisors
– Supervisors must ensure that employees comply with CFA Standards and firm policies to prevent ethical violations.
– Omondi failed in his supervisory duty by allowing client confidentiality breaches to continue under his authority.
– Simply having a policy that prohibits information sharing is not enough—supervisors must actively enforce policies and prevent misconduct.
2- Structural issues contributing to violations
– Magadi’s trading floor arrangement allows proprietary traders to access confidential client information, making policy enforcement ineffective.
– Even though the firm executes client trades before similar proprietary trades, this setup still creates fair dealing concerns under Standard III(B) because it allows preferential treatment for certain groups of clients.
– The correct solution would be to physically separate the trading desks and limit communication between proprietary and retail traders.
3- Misrepresentation of policy effectiveness
– Omondi refers concerned clients to firm policies, implying they adequately protect confidentiality.
– However, because violations continue to occur, this could be considered a violation of Standard I(C) - Misrepresentation.
– A policy that is not enforced is ineffective, and falsely implying otherwise misleads stakeholders about the firm’s compliance with ethical standards.
Key takeaways
– Supervisors are responsible for preventing ethical violations, not just creating policies.
– A weak enforcement structure leads to conflicts of interest and breaches of client trust.
– Firms must implement real safeguards, such as physical separation of trading teams, to prevent front-running and unfair treatment of clients.
[Independence and objectivity in client relationships]
1- Standard I(B) - Independence and Objectivity
– CFA members must not offer, solicit, or accept gifts, favors, or compensation that could compromise their professional judgment.
– Omondi’s promise to donate to the preferred charities of the sovereign wealth fund’s managers creates a conflict of interest by incentivizing them to make investment decisions based on personal gain rather than merit.
– This violates the principle of objective decision-making, as it seeks to influence fund managers improperly.
2- Hiring an unqualified sub-advisor as an ethical violation
– The sub-advisor’s primary qualification is an ability to distribute bribes, which directly violates ethical standards.
– Investment professionals must select advisors based on competence, experience, and qualifications, not political influence or corrupt practices.
– This decision compromises the integrity of the investment process and could expose the firm to legal and reputational risks.
3- Misleading perceptions in ethical decision-making
– The language in this case may downplay the seriousness of the ethical violations, making the charitable donations seem like a minor issue.
– However, the key ethical concern is that both actions—hiring an unqualified sub-advisor and making donations to influence decisions—violate ethical standards.
– It is important to evaluate each unethical act independently rather than assume only the most extreme violation matters.
Key takeaways
– Offering charitable donations in exchange for investment decisions is a violation of independence and objectivity.
– Hiring an unqualified sub-advisor based on political influence rather than merit undermines professional integrity.
– All ethical violations must be analyzed individually, even if some seem more severe than others.
[Communication with clients and prospective clients]
1- Standard V(B) - Communication with Clients and Prospective Clients
– Investment professionals must inform clients about any material changes to the investment process, strategy, or mandate.
– Kirabo’s decision to expand investments into more African markets does not require disclosure because it aligns with the fund’s original mandate.
– However, increasing the cash allocation to 15% must be disclosed, as the fund’s mandate originally capped cash at 10%.
– Additionally, changes to the investment decision-making process must also be disclosed, as they impact how client assets are managed.
2- Distinguishing material vs. non-material changes
– A change is material if it affects risk, return expectations, or how client funds are managed.
– Expanding into more African markets is not material because it remains within the fund’s investment guidelines.
– Raising the cash allocation above the stated limit is material and requires full disclosure.
3- Transparency in investment decision-making
– Clients must be able to evaluate whether changes align with their risk tolerance and investment objectives.
– Even if a change is beneficial, it still requires clear communication to maintain client trust and uphold ethical standards.
Key takeaways
– Any changes that impact the fund’s stated mandate must be disclosed to clients.
– Material changes, such as exceeding asset allocation limits or altering decision-making processes, require full transparency.
– Failure to communicate key changes violates CFA ethical standards and reduces client trust.
[Performance presentation and prior firm disclosures]
1- Standard III(D) - Performance Presentation
– CFA members must ensure that performance data are presented accurately and transparently.
– Kirabo can include past performance from his previous firm in Magadi’s marketing materials, but he must disclose the name of the former firm and his specific role.
– Failing to properly attribute past performance misleads potential clients by not providing full context on where and how the results were achieved.
2- Requirement for written permission from former firms
– Performance data is considered a firm asset, meaning Kirabo must obtain written permission from his former employer before using it.
– Using old performance data without approval violates CFA Standards, even if Kirabo was responsible for managing the investments.
– Proper attribution helps ensure that clients receive accurate and fair representations of an advisor’s track record.
3- Avoiding misleading omissions
– By asking Magadi to exclude the name of his former firm, Kirabo creates a lack of transparency regarding where the performance was generated.
– Prospective clients may assume the results were achieved at Magadi, which could lead to incorrect comparisons or expectations.
– Clear disclosure of when, where, and how past returns were generated is essential for ethical marketing practices.
Key takeaways
– Advisors must fully disclose past performance, including the name of the firm where results were achieved.
– Written permission is required before using prior firm performance data, as it is considered a firm asset.
– Omitting key details about past performance creates a misleading representation and violates ethical standards.
