Ethics - Professionalism Flashcards
(88 cards)
1
Q
What is “Standard 1(A): Knowledge of the Law” capture?
A
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.
2
Q
How must members behave when there is a conflict between rules or laws?
A
In the event of conflict, Members and Candidates must comply with the more strict law, rule, or regulation.
3
Q
True or False:
Members and Candidates must not knowingly participate or assist in and must dissociate from any violation of such laws, rules, or regulations.
A
True
4
Q
True or False:
The standard requires that all members be experts on standards and laws.
A
False:
This standard does not require members and candidates to become experts, however, in compliance.
5
Q
What must candidates or members due during times of changing regulations?
A
During times of changing regulations, members and candidates must remain vigilant in maintaining their knowledge of the requirements for their professional activities.
6
Q
What must a candidate do when “applicable law” and “code and standards” require different conduct?
A
When applicable law and the Code and Standards require different conduct, members and candidates must follow the more strict of the applicable law or the Code and Standards.
7
Q
What is “applicable law”?
A
“Applicable law” is the law that governs the member’s or candidate’s conduct. Which law applies will depend on the particular facts and circumstances of each case.
8
Q
What is meant by the “more strict law”?
A
The “more strict” law or regulation is the law or regulation that imposes greater restrictions on the action of the member or candidate or calls for the member or candidate to exert a greater degree of action that protects the interests of investors.
9
Q
True or False:
The applicable laws governing the responsibilities of a member or candidate should be viewed as the minimal threshold of acceptable actions.
A
True
10
Q
True or False:
Members and candidates are responsible for violations in which they knowingly participate or assist.
A
True
11
Q
What must a CFA member do if:
A member or candidate has reasonable grounds to believe that imminent or ongoing client or employer activities are illegal or unethical.
A
the member or candidate must dissociate, or separate, from the activity. In extreme cases, dissociation may require a member or candidate to leave his or her employment.
12
Q
What steps must a CFA member take to stop an illegal or unethical activity?
A
The first step should be to attempt to stop the behavior by bringing it to the attention of the employer through a supervisor or the firm’s compliance department.
If this attempt is unsuccessful, then members and candidates have a responsibility to step away and dissociate from the activity.
13
Q
What could dissociation entail?
A
Dissociation practices will differ on the basis of the member’s or candidate’s role in the investment industry. It may include:
- removing one’s name from written reports or recommendations
- asking for a different assignment, or refusing to accept a new client or continue to advise a current client.
14
Q
True or False:
Inaction combined with continuing association with those involved in illegal or unethical conduct may be construed as participation or assistance in the illegal or unethical conduct.
A
True
15
Q
True or False:
CFA Institute strongly encourages members and candidates to report potential violations of the Code and Standards committed by fellow members and candidates.
A
True
16
Q
Applicable Law:
Member resides in NS country, does business in LS country; LS law applies
How must a CFA member act?
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
A
Member must adhere to the Code and Standards.
Because applicable law is less strict than the Code and Standards, the member must adhere to the Code and Standards.
17
Q
Applicable Law:
Member resides in NS country, does business in MS country; MS law applies.
How must a CFA member act?
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
A
Member must adhere to the law of MS country.
Because applicable law is stricter than the Code and Standards, member must adhere to the more strict applicable law.
18
Q
Applicable Law:
Member resides in LS country, does business in NS country; LS law applies.
How must a CFA member act?
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
A
Member must adhere to the Code and Standards.
Because applicable law is less strict than the Code and Standards, member must adhere to the Code and Standards.
19
Q
Applicable Law:
Member resides in LS country, does business in MS country; MS law applies.
How must a CFA member act?
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
A
Member must adhere to the law of MS country.
Because applicable law is stricter than the Code and Standards, member must adhere to the more strict applicable law.
20
Q
Applicable Law:
Member resides in LS country, does business in NS country; LS law applies, but it states that law of locality where business is conducted governs.
How must a CFA member act?
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
A
Member must adhere to the Code and Standards.
Because applicable law states that the law of the locality where the business is conducted governs and there is no local law, the member must adhere to the Code and Standards
21
Q
Applicable Law:
Member resides in LS country, does business in MS country; LS law applies, but it states that law of locality where business is conducted governs.
How must a CFA member act?
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
A
Member must adhere to the law of MS country.
Because applicable law of the locality where the business is conducted governs and local law is stricter than the Code and Standards, member must adhere to the more strict applicable law.
22
Q
Applicable Law:
Member resides in MS country, does business in LS country; MS law applies.
How must a CFA member act?
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
A
Member must adhere to the law of MS country.
Because applicable law is stricter than the Code and Standards, member must adhere to the more strict applicable law.
23
Q
Applicable Law:
Member resides in MS country, does business in LS country; MS law applies, but it states that law of locality where business is conducted governs.
How must a CFA member act?
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
A
Member must adhere to the Code and Standards.
Because applicable law states that the law of the locality where the business is conducted governs and local law is less strict than the Code and Standards, member must adhere to the Code and Standards.
24
Q
Applicable Law:
Member resides in MS country, does business in LS country with a client who is a citizen of LS country; MS law applies, but it states that the law of the client’s home country governs.
How must a CFA member act?
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
A
Member must adhere to the Code and Standards.
Because applicable law states that the law of the client’s home country governs (which is less strict than the Code and Standards), member must adhere to the Code and Standards.
25
Applicable Law:
Member resides in MS country, does business in LS country with a client who is a citizen of MS country; MS law applies, but it states that the law of the client’s home country governs.
How must a CFA member act?
-----------------------------------------------------
NS: country with no securities laws or regulations
LS: country with less strict securities laws and regulations than the Code and Standards
MS: country with more strict securities laws and regulations than the Code and Standards
Member must adhere to the law of MS country.
Because applicable law states that the law of the client’s home country governs and the law of the client’s home country is stricter than the Code and Standards, the member must adhere to the more strict applicable law.
26
True or False:
Members and candidates should make reasonable efforts to understand the applicable laws—both country and regional—for the countries and regions where their investment products are developed and are most likely to be distributed to clients.
True
27
True or False:
When in doubt about the appropriate action to undertake, it is recommended that a member or candidate seek the advice of compliance personnel or legal counsel concerning legal requirements. If a potential violation is being committed by a fellow employee, it may also be prudent for the member or candidate to seek the advice of the firm’s compliance department or legal counsel.
True
28
Background:
Michael Allen works for a brokerage firm and is responsible for an underwriting of securities. A company official gives Allen information indicating that the financial statements Allen filed with the regulator overstate the issuer’s earnings. Allen seeks the advice of the brokerage firm’s general counsel, who states that it would be difficult for the regulator to prove that Allen has been involved in any wrongdoing.
What action must be taken?
Although it is recommended that members and candidates seek the advice of legal counsel, the reliance on such advice does not absolve a member or candidate from the requirement to comply with the law or regulation. Allen should report this situation to his supervisor, seek an independent legal opinion, and determine whether the regulator should be notified of the error.
29
Background:
Lawrence Brown’s employer, an investment banking firm, is the principal underwriter for an issue of convertible debentures by the Courtney Company. Brown discovers that the Courtney Company has concealed severe third-quarter losses in its foreign operations. The preliminary prospectus has already been distributed.
What action must be taken?
Knowing that the preliminary prospectus is misleading, Brown should report his findings to the appropriate supervisory persons in his firm. If the matter is not remedied and Brown’s employer does not dissociate from the underwriting, Brown should sever all his connections with the underwriting. Brown should also seek legal advice to determine whether additional reporting or other action should be taken.
30
Background:
Kamisha Washington’s firm advertises its past performance record by showing the 10-year return of a composite of its client accounts. Washington discovers, however, that the composite omits the performance of accounts that have left the firm during the 10-year period, whereas the description of the composite indicates the inclusion of all firm accounts. This omission has led to an inflated performance figure. Washington is asked to use promotional material that includes the erroneous performance number when soliciting business for the firm.
What action must be taken?
She must dissociate herself from the activity. If discussing the misleading number with the person responsible is not an option for correcting the problem, she can bring the situation to the attention of her supervisor or the compliance department at her firm.
If her firm is unwilling to recalculate performance, she must refrain from using the misleading promotional material and should notify the firm of her reasons. If the firm insists that she use the material, she should consider whether her obligation to dissociate from the activity requires her to seek other employment.
31
Background:
James Collins is an investment analyst for a major Wall Street brokerage firm. He works in a developing country with a rapidly modernizing economy and a growing capital market. Local securities laws are minimal—in form and content—and include no punitive prohibitions against insider trading.
What action must be taken?
Collins must abide by the requirements of the Code and Standards, which might be more strict than the rules of the developing country. He should be aware of the risks that a small market and the absence of a fairly regulated flow of information to the market represent to his ability to obtain information and make timely judgments. He should include this factor in formulating his advice to clients. In handling material nonpublic information that accidentally comes into his possession, he must follow Standard II(A)–Material Nonpublic Information.
32
Background:
Laura Jameson works for a multinational investment adviser based in the United States.
Jameson lives and works as a registered investment adviser in the tiny, but wealthy, island nation of Karramba.
Karramba’s securities laws state that no investment adviser registered and working in that country can participate in initial public offerings (IPOs) for the adviser’s personal account.
Jameson, believing that, as a US citizen working for a US-based company, she should comply only with US law, has ignored this Karrambian law.
In addition, Jameson believes that as a charterholder, as long as she adheres to the Code and Standards requirement that she disclose her participation in any IPO to her employer and clients when such ownership creates a conflict of interest, she is meeting the highest ethical requirements.
As a registered investment adviser in Karramba, Jameson is prevented by Karrambian securities law from participating in IPOs regardless of the law of her home country. In addition, because the law of the country where she is working is stricter than the Code and Standards, she must follow the stricter requirements of the local law rather than the requirements of the Code and Standards.
33
Background:
Amanda Janney is employed as a fixed-income portfolio manager for a large international firm. She is on a team within her firm that is responsible for creating and managing a fixed-income hedge fund to be sold throughout the firm’s distribution centers to high-net-worth clients. Her firm receives expressions of interest from potential clients from the Middle East who are seeking investments that comply with Islamic law. The marketing and promotional materials for the fixed-income hedge fund do not specify whether or not the fund is a suitable investment for an investor seeking compliance with Islamic law. Because the fund is being distributed globally, Janney is concerned about the reputation of the fund and the firm and believes disclosure of whether or not the fund complies with Islamic law could help minimize potential mistakes with placing this investment.
What must she do?
As the financial market continues to become globalized, members and candidates will need to be aware of the differences between cultural and religious laws and requirements as well as the different governmental laws and regulations. Janney and the firm could be proactive in their efforts to acknowledge areas where the new fund may not be suitable for clients.
34
Background:
Krista Blume is a junior portfolio manager for high-net-worth portfolios at a large global investment manager. She observes a number of new portfolios and relationships coming from a country in Europe where the firm did not have previous business and is told that a broker in that country is responsible for this new business.
At a meeting on allocation of research resources to third-party research firms, Blume notes that this broker has been added to the list and is allocated payments for research. However, she knows the portfolios do not invest in securities in the broker’s country, and she has not seen any research come from this broker. Blume asks her supervisor about the name being on the list and is told that someone in marketing is receiving the research and that the name being on the list is OK.
She believes that what may be going on is that the broker is being paid for new business through the inappropriate research payments, and she wishes to dissociate from the misconduct.
What must she do?
Blume should follow the firm’s policies and procedures for reporting potential unethical activity, which may include discussions with her supervisor or someone in a designated compliance department. She should communicate her concerns appropriately while advocating for disclosure between the new broker relationship and the research payments.
35
Background:
Colleen White is excited to use new technology to communicate with clients and potential clients. She recently began posting investment information, including performance reports and investment opinions and recommendations, to her Facebook page. In addition, she sends out brief announcements, opinions, and thoughts via her Twitter account (for example, “Prospects for future growth of XYZ company look good! #makingmoney4U”). Prior to White’s use of these social media platforms, the local regulator had issued new requirements and guidance governing online electronic communication. White’s communications appear to conflict with the recent regulatory announcements.
What must she do?
White is in violation of Standard I(A) because her communications do not comply with the existing guidance and regulation governing use of social media. White must be aware of the evolving legal requirements pertaining to new and dynamic areas of the financial services industry that are applicable to her. She should seek guidance from appropriate, knowledgeable, and reliable sources, such as her firm’s compliance department, external service providers, or outside counsel, unless she diligently follows legal and regulatory trends affecting her professional responsibilities.
36
What does Standard 1B: "Professionalism - Independence and Objectivity" entail?
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.
37
Are any gifts acceptable?
Modest gifts and entertainment are acceptable, but special care must be taken by members and candidates to resist subtle and not-so-subtle pressures to act in conflict with the interests of their clients.
38
Generally speaking, what is the "best practice" regarding gifts?
Best practice dictates that members and candidates reject any offer of gift or entertainment that could be expected to threaten their independence and objectivity.
39
True or False:
Portfolio managers have a responsibility to respect and foster the intellectual honesty of sell-side research.
True
40
True or False:
Members and candidates who are responsible for hiring and retaining outside managers and third-party custodians should not accepts gifts, entertainment, or travel funding that may be perceived as impairing their decisions.
True
41
What is the general best practice regarding travel funding?
best practice dictates that members and candidates always use commercial transportation at their expense or at the expense of their firm rather than accept paid travel arrangements from an outside company. Should commercial transportation be unavailable, members and candidates may accept modestly arranged travel to participate in appropriate information-gathering events, such as a property tour.
42
Analyze the situation:
Steven Taylor, a mining analyst with Bronson Brokers, is invited by Precision Metals to join a group of his peers in a tour of mining facilities in several western US states. The company arranges for chartered group flights from site to site and for accommodations in Spartan Motels, the only chain with accommodations near the mines, for three nights. Taylor allows Precision Metals to pick up his tab, as do the other analysts, with one exception—John Adams, an employee of a large trust company who insists on following his company’s policy and paying for his hotel room himself.
The policy of the company where Adams works complies closely with Standard I(B) by avoiding even the appearance of a conflict of interest, but Taylor and the other analysts were not necessarily violating Standard I(B). In general, when allowing companies to pay for travel and/or accommodations in these circumstances, members and candidates must use their judgment. They must be on guard that such arrangements not impinge on a member’s or candidate’s independence and objectivity. In this example, the trip was strictly for business and Taylor was not accepting irrelevant or lavish hospitality. The itinerary required chartered flights, for which analysts were not expected to pay. The accommodations were modest. These arrangements are not unusual and did not violate Standard I(B) as long as Taylor’s independence and objectivity were not compromised. In the final analysis, members and candidates should consider both whether they can remain objective and whether their integrity might be perceived by their clients to have been compromised.
43
Analyze the situation:
Susan Dillon, an analyst in the corporate finance department of an investment services firm, is making a presentation to a potential new business client that includes the promise that her firm will provide full research coverage of the potential client.
Dillon may agree to provide research coverage, but she must not commit her firm’s research department to providing a favorable recommendation. The firm’s recommendation (favorable, neutral, or unfavorable) must be based on an independent and objective investigation and analysis of the company and its securities.
44
Analyze the situation:
Walter Fritz is an equity analyst with Hilton Brokerage who covers the mining industry. He has concluded that the stock of Metals & Mining is overpriced at its current level, but he is concerned that a negative research report will hurt the good relationship between Metals & Mining and the investment banking division of his firm. In fact, a senior manager of Hilton Brokerage has just sent him a copy of a proposal his firm has made to Metals & Mining to underwrite a debt offering. Fritz needs to produce a report right away and is concerned about issuing a less-than-favorable rating.
Fritz’s analysis of Metals & Mining must be objective and based solely on consideration of company fundamentals. Any pressure from other divisions of his firm is inappropriate. This conflict could have been eliminated if, in anticipation of the offering, Hilton Brokerage had placed Metals & Mining on a restricted list for its sales force.
45
Analyze the situation:
Walter Fritz has concluded that Metals & Mining stock is overvalued at its current level, but he is concerned that a negative research report might jeopardize a close rapport that he has nurtured over the years with Metals & Mining’s CEO, chief finance officer, and investment relations officer. Fritz is concerned that a negative report might result also in management retaliation—for instance, cutting him off from participating in conference calls when a quarterly earnings release is made, denying him the ability to ask questions on such calls, and/or denying him access to top management for arranging group meetings between Hilton Brokerage clients and top Metals & Mining managers.
Fritz’s analysis must be objective and based solely on consideration of company fundamentals. Any pressure from Metals & Mining is inappropriate. Fritz should reinforce the integrity of his conclusions by stressing that his investment recommendation is based on relative valuation, which may include qualitative issues with respect to Metals & Mining’s management.
46
Analyze the situation:
As support for the sales effort of her corporate bond department, Lindsey Warner offers credit guidance to purchasers of fixed-income securities. Her compensation is closely linked to the performance of the corporate bond department. Near the quarter’s end, Warner’s firm has a large inventory position in the bonds of Milton, Ltd., and has been unable to sell the bonds because of Milton’s recent announcement of an operating problem. Salespeople have asked her to contact large clients to push the bonds.
Unethical sales practices create significant potential violations of the Code and Standards. Warner’s opinion of the Milton bonds must not be affected by internal pressure or compensation. In this case, Warner must refuse to push the Milton bonds unless she is able to justify that the market price has already adjusted for the operating problem.
47
Analyze the situation:
Jill Jorund is a securities analyst following airline stocks and a rising star at her firm. Her boss has been carrying a “buy” recommendation on International Airlines and asks Jorund to take over coverage of that airline. He tells Jorund that under no circumstances should the prevailing buy recommendation be changed.
Jorund must be independent and objective in her analysis of International Airlines. If she believes that her boss’s instructions have compromised her, she has two options: She can tell her boss that she cannot cover the company under these constraints, or she can take over coverage of the company, reach her own independent conclusions, and if they conflict with her boss’s opinion, share the conclusions with her boss or other supervisors in the firm so that they can make appropriate recommendations. Jorund must issue only recommendations that reflect her independent and objective opinion.
48
Analyze the situation:
Edward Grant directs a large amount of his commission business to a New York–based brokerage house. In appreciation for all the business, the brokerage house gives Grant two tickets to the World Cup in South Africa, two nights at a nearby resort, several meals, and transportation via limousine to the game. Grant fails to disclose receiving this package to his supervisor.
Comment: Grant has violated Standard I(B) because accepting these substantial gifts may impede his independence and objectivity. Every member and candidate should endeavor to avoid situations that might cause or be perceived to cause a loss of independence or objectivity in recommending investments or taking investment action. By accepting the trip, Grant has opened himself up to the accusation that he may give the broker favored treatment in return.
49
Analyze the situation:
Theresa Green manages the portfolio of Ian Knowlden, a client of Tisbury Investments. Green achieves an annual return for Knowlden that is consistently better than that of the benchmark she and the client previously agreed to. As a reward, Knowlden offers Green two tickets to Wimbledon and the use of Knowlden’s flat in London for a week. Green discloses this gift to her supervisor at Tisbury.
Green is in compliance with Standard I(B) because she disclosed the gift from one of her clients in accordance with the firm’s policies. Members and candidates may accept bonuses or gifts from clients as long as they disclose them to their employer because gifts in a client relationship are deemed less likely to affect a member’s or candidate’s objectivity and independence than gifts in other situations. Disclosure is required, however, so that supervisors can monitor such situations to guard against employees favoring a gift-giving client to the detriment of other fee-paying clients (such as by allocating a greater proportion of IPO stock to the gift-giving client’s portfolio).
Best practices for monitoring include comparing the transaction costs of the Knowlden account with the costs of other accounts managed by Green and other similar accounts within Tisbury. The supervisor could also compare the performance returns with the returns of other clients with the same mandate. This comparison will assist in determining whether a pattern of favoritism by Green is disadvantaging other Tisbury clients or the possibility that this favoritism could affect her future behavior.
50
Analyze the situation:
Tom Wayne is the investment manager of the Franklin City Employees Pension Plan. He recently completed a successful search for a firm to manage the foreign equity allocation of the plan’s diversified portfolio. He followed the plan’s standard procedure of seeking presentations from a number of qualified firms and recommended that his board select Penguin Advisors because of its experience, well-defined investment strategy, and performance record. The firm claims compliance with the Global Investment Performance Standards (GIPS) and has been verified. Following the selection of Penguin, a reporter from the Franklin City Record calls to ask if there was any connection between this action and the fact that Penguin was one of the sponsors of an “investment fact-finding trip to Asia” that Wayne made earlier in the year. The trip was one of several conducted by the Pension Investment Academy, which had arranged the itinerary of meetings with economic, government, and corporate officials in major cities in several Asian countries. The Pension Investment Academy obtains support for the cost of these trips from a number of investment managers, including Penguin Advisors; the Academy then pays the travel expenses of the various pension plan managers on the trip and provides all meals and accommodations. The president of Penguin Advisors was also one of the travelers on the trip.
Wayne can probably put to good use the knowledge he gained from the trip in selecting portfolio managers and in other areas of managing the pension plan, his recommendation of Penguin Advisors may be tainted by the possible conflict incurred when he participated in a trip partly paid for by Penguin Advisors and when he was in the daily company of the president of Penguin Advisors.
To avoid violating Standard I(B), Wayne’s basic expenses for travel and accommodations should have been paid by his employer or the pension plan; contact with the president of Penguin Advisors should have been limited to informational or educational events only; and the trip, the organizer, and the sponsor should have been made a matter of public record. Even if his actions were not in violation of Standard I(B), Wayne should have been sensitive to the public perception of the trip when reported in the newspaper and the extent to which the subjective elements of his decision might have been affected by the familiarity that the daily contact of such a trip would encourage. This advantage would probably not be shared by firms competing with Penguin Advisors.
51
Analyze the situation:
Javier Herrero recently left his job as a research analyst for a large investment adviser. While looking for a new position, he was hired by an investor-relations firm to write a research report on one of its clients, a small educational software company. The investor-relations firm hopes to generate investor interest in the technology company. The firm will pay Herrero a flat fee plus a bonus if any new investors buy stock in the company as a result of Herrero’s report.
If Herrero accepts this payment arrangement, he will be in violation of Standard I(B) because the compensation arrangement can reasonably be expected to compromise his independence and objectivity. Herrero will receive a bonus for attracting investors, which provides an incentive to draft a positive report regardless of the facts and to ignore or play down any negative information about the company. Herrero should accept only a flat fee that is not tied to the conclusions or recommendations of the report. Issuer-paid research that is objective and unbiased can be done under the right circumstances as long as the analyst takes steps to maintain his or her objectivity and includes in the report proper disclosures regarding potential conflicts of interest.
52
Analyze the situation:
Two years ago, Bob Wade, trust manager for Central Midas Bank, was approached by Western Funds about promoting its family of funds, with special interest in the service-fee class of funds. To entice Central to promote this class, Western Funds offered to pay the bank a service fee of 0.25%. Without disclosing the fee being offered to the bank, Wade asked one of the investment managers to review Western’s funds to determine whether they were suitable for clients of Central Midas Bank. The manager completed the normal due diligence review and determined that the new funds were fairly valued in the market with fee structures on a par with competitors. Wade decided to accept Western’s offer and instructed the team of portfolio managers to exclusively promote these funds and the service-fee class to clients seeking to invest new funds or transfer from their current investments.
Now, two years later, the funds managed by Western begin to underperform their peers. Wade is counting on the fees to reach his profitability targets and continues to push these funds as acceptable investments for Central’s clients.
Comment: Wade is violating Standard I(B) because the fee arrangement has affected the objectivity of his recommendations. Wade is relying on the fee as a component of the department’s profitability and is unwilling to offer other products that may affect the fees received.
53
Analyze the situation:
Bob Thompson has been doing research for the portfolio manager of the fixed-income department. His assignment is to do sensitivity analysis on securitized subprime mortgages. He has discussed with the manager possible scenarios to use to calculate expected returns. A key assumption in such calculations is housing price appreciation (HPA) because it drives “prepays” (prepayments of mortgages) and losses. Thompson is concerned with the significant appreciation experienced over the previous five years as a result of the increased availability of funds from subprime mortgages. Thompson insists that the analysis should include a scenario run with –10% for Year 1, –5% for Year 2, and then (to project a worst-case scenario) 0% for Years 3 through 5. The manager replies that these assumptions are too dire because there has never been a time in their available database when HPA was negative.
Thompson conducts his research to better understand the risks inherent in these securities and evaluates these securities in the worst-case scenario, an unlikely but possible environment. Based on the results of the enhanced scenarios, Thompson does not recommend the purchase of the securitization. Against the general market trends, the manager follows Thompson’s recommendation and does not invest. The following year, the housing market collapses. In avoiding the subprime investments, the manager’s portfolio outperforms its peer group that year.
Thompson’s actions in running the worst-case scenario against the protests of the portfolio manager are in alignment with the principles of Standard I(B). Thompson did not allow his research to be pressured by the general trends of the market or the manager’s desire to limit the research to historical norms.
54
Analyze the situation:
Adrian Mandel, CFA, is a senior portfolio manager for ZZYY Capital Management who oversees a team of investment professionals who manage labor union pension funds.
A few years ago, ZZYY sought to win a competitive asset manager search to manage a significant allocation of the pension fund of the United Doughnut and Pretzel Bakers Union (UDPBU).
UDPBU’s investment board is chaired by a recognized key decision maker and long-time leader of the union, Ernesto Gomez.
To improve ZZYY’s chances of winning the competition, Mandel made significant monetary contributions to Gomez’s union reelection campaign fund.
Even after ZZYY was hired as a primary manager of the pension, Mandel believed that his firm’s position was not secure.
Mandel continued to contribute to Gomez’s reelection campaign chest as well as to entertain lavishly the union leader and his family at top restaurants on a regular basis.
All of Mandel’s outlays were routinely handled as marketing expenses reimbursed by ZZYY’s expense accounts and were disclosed to his senior management as being instrumental in maintaining a strong close relationship with an important client.
Mandel not only offered but actually gave monetary gifts, benefits, and other considerations that reasonably could be expected to compromise Gomez’s objectivity. Therefore, Mandel was in violation of Standard I(B).
55
Analyze the situation:
Adrian Mandel, CFA, had heard about the manager search competition for the UDPBU Pension Fund through a broker/dealer contact. The contact told him that a well-known retired professional golfer, Bobby “The Bear” Finlay, who had become a licensed broker/dealer serving as a pension consultant, was orchestrating the UDPBU manager search. Finlay had gained celebrity status with several labor union pension fund boards by entertaining their respective board members and regaling them with colorful stories of fellow pro golfers’ antics in clubhouses around the world. Mandel decided to improve ZZYY’s chances of being invited to participate in the search competition by befriending Finlay to curry his favor. Knowing Finlay’s love of entertainment, Mandel wined and dined Finlay at high-profile bistros where Finlay could glow in the fan recognition lavished on him by all the other patrons. Mandel’s endeavors paid off handsomely when Finlay recommended to the UDPBU board that ZZYY be entered as one of three finalist asset management firms in its search.
Mandel lavished gifts, benefits, and other considerations in the form of expensive entertainment that could reasonably be expected to influence the consultant to recommend the hiring of his firm. Therefore, Mandel was in violation of Standard I(B).
56
Analyze the situation:
Amie Scott is a performance analyst within her firm with responsibilities for analyzing the performance of external managers.
While completing her quarterly analysis, Scott notices a change in one manager’s reported composite construction.
The change concealed the bad performance of a particularly large account by placing that account into a new residual composite. This change allowed the manager to remain at the top of the list of manager performance. Scott knows her firm has a large allocation to this manager, and the fund’s manager is a close personal friend of the CEO. She needs to deliver her final report but is concerned with pointing out the composite change.
Scott would be in violation of Standard I(B) if she did not disclose the change in her final report. The analysis of managers’ performance should not be influenced by personal relationships or the size of the allocation to the outside managers. By not including the change, Scott would not be providing an independent analysis of the performance metrics for her firm.
57
Analyze the situation:
Jill Stein is head of performance measurement for her firm. During the last quarter, many members of the organization’s research department were removed because of the poor quality of their recommendations. The subpar research caused one larger account holder to experience significant underperformance, which resulted in the client withdrawing his money after the end of the quarter. The head of sales requests that Stein remove this account from the firm’s performance composite because the performance decline can be attributed to the departed research team and not the client’s adviser.
Stein must maintain her independence and objectivity and refuse to exclude specific accounts from the firm’s performance composites to which they belong. As long as the client invested under a strategy similar to that of the defined composite, it cannot be excluded because of the poor stock selections that led to the underperformance and asset withdrawal.
58
What does "Standard 1C: Professionalism - Misrepresentation" entail?
Members and Candidates must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities.
59
What is a "misrepresentation"?
A misrepresentation is any untrue statement or omission of a fact or any statement that is otherwise false or misleading.
60
True or False:
Standard I(C) prohibits members and candidates from guaranteeing clients any specific return on volatile investments.
True:
Most investments contain some element of risk that makes their return inherently unpredictable. For such investments, guaranteeing either a particular rate of return or a guaranteed preservation of investment capital (e.g., “I can guarantee that you will earn 8% on equities this year” or “I can guarantee that you will not lose money on this investment”) is misleading to investors.
61
True or False:
Standard I(C) does not prohibit members and candidates from providing clients with information on investment products that have guarantees built into the structure of the products themselves or for which an institution has agreed to cover any losses.
True
62
What does Standard I(C) not require that a benchmark always be provided in order to comply.?
Some investment strategies may not lend themselves to displaying an appropriate benchmark because of the complexity or diversity of the investments included.
63
How are candidates supposed to act on social media regarding communication?
When communicating through social media channels, members and candidates should provide only the same information they are allowed to distribute to clients and potential clients through other traditional forms of communication. The online or interactive aspects of social media do not remove the need to be open and honest about the information being distributed.
64
What is the definition of "Plagiarism"?
Plagiarism is defined as copying or using in substantially the same form materials prepared by others without acknowledging the source of the material or identifying the author and publisher of such material.
65
How must candidates cite their work?
members and candidates must give credit where it is clearly due.
Analysts should not use undocumented forecasts, earnings projections, asset values, and so on.
Sources must be revealed to bring the responsibility directly back to the author of the report or the firm involved.
66
Can a candidate use a model or research report from a member who has left the firm?
Research and models developed while employed by a firm are the property of the firm. The firm retains the right to continue using the work completed after a member or candidate has left the organization. The firm may issue future reports without providing attribution to the prior analysts. A member or candidate cannot, however, reissue a previously released report solely under his or her name.
67
What steps are recommended for avoiding plagiarism?
To avoid plagiarism in preparing research reports or conclusions of analysis, members and candidates should take the following steps:
Maintain copies: Keep copies of all research reports, articles containing research ideas, material with new statistical methodologies, and other materials that were relied on in preparing the research report.
Attribute quotations: Attribute to their sources any direct quotations, including projections, tables, statistics, model/product ideas, and new methodologies prepared by persons other than recognized financial and statistical reporting services or similar sources.
Attribute summaries: Attribute to their sources any paraphrases or summaries of material prepared by others. For example, to support his analysis of Brown Company’s competitive position, the author of a research report on Brown might summarize another analyst’s report on Brown’s chief competitor, but the author of the Brown report must acknowledge in his own report the reliance on the other analyst’s report.
68
Analyze the Situation:
Anthony McGuire is an issuer-paid analyst hired by publicly traded companies to electronically promote their stocks. McGuire creates a website that promotes his research efforts as a seemingly independent analyst. McGuire posts a profile and a strong buy recommendation for each company on the website indicating that the stock is expected to increase in value. He does not disclose the contractual relationships with the companies he covers on his website, in the research reports he issues, or in the statements he makes about the companies in internet chat rooms.
Comment: McGuire has violated Standard I(C) because the website is misleading to potential investors. Even if the recommendations are valid and supported with thorough research, his omissions regarding the true relationship between himself and the companies he covers constitute a misrepresentation. McGuire has also violated Standard VI(A)–Disclosure of Conflicts by not disclosing the existence of an arrangement with the companies through which he receives compensation in exchange for his services.
69
Analyze situation:
Hijan Yao is responsible for the creation and distribution of the marketing materials for his firm, which claims compliance with the GIPS standards. Yao creates and distributes a presentation of performance by the firm’s Asian equity composite that states the composite has ¥350 billion in assets. In fact, the composite has only ¥35 billion in assets, and the higher figure on the presentation is a result of a typographical error. Nevertheless, the erroneous material is distributed to a number of clients before Yao catches the mistake.
Once the error is discovered, Yao must take steps to cease distribution of the incorrect material and correct the error by informing those who have received the erroneous information. Because Yao did not knowingly make the misrepresentation, however, he did not violate Standard I(C). Because his firm claims compliance with the GIPS standards, it must also comply with the GIPS Guidance Statement on Error Correction in relation to the error.
70
Analyze the situation:
Syed Muhammad is the president of an investment management firm. The promotional material for the firm, created by the firm’s marketing department, incorrectly claims that Muhammad has an advanced degree in finance from a prestigious business school in addition to the CFA designation. Although Muhammad attended the school for a short period of time, he did not receive a degree. Over the years, Muhammad and others in the firm have distributed this material to numerous prospective clients and consultants.
Comment: Even though Muhammad may not have been directly responsible for the misrepresentation of his credentials in the firm’s promotional material, he used this material numerous times over an extended period and should have known of the misrepresentation. Thus, Muhammad has violated Standard I(C).
71
Analyze the situation:
Cindy Grant, a research analyst for a Canadian brokerage firm, has specialized in the Canadian mining industry for the past 10 years. She recently read an extensive research report on Jefferson Mining, Ltd., by Jeremy Barton, another analyst. Barton provided extensive statistics on the mineral reserves, production capacity, selling rates, and marketing factors affecting Jefferson’s operations.
He also noted that initial drilling results on a new ore body, which had not been made public, might show the existence of mineral zones that could increase the life of Jefferson’s main mines, but Barton cited no specific data as to the initial drilling results. Grant called an officer of Jefferson, who gave her the initial drilling results over the telephone. The data indicated that the expected life of the main mines would be tripled. Grant added these statistics to Barton’s report and circulated it within her firm as her own report.
Comment:
Grant plagiarized Barton’s report by reproducing large parts of it in her own report without acknowledgment.
72
Analyze the situation:
When Ricki Marks sells mortgage-backed derivatives called “interest-only strips” (IOs) to public pension plan clients, she describes them as “guaranteed by the US government.” Purchasers of the IOs are entitled only to the interest stream generated by the mortgages, however, not the notional principal itself.
One particular municipality’s investment policies and local law require that securities purchased by its public pension plans be guaranteed by the US government.
Although the underlying mortgages are guaranteed, neither the investor’s investment nor the interest stream on the IOs is guaranteed. When interest rates decline, causing an increase in prepayment of mortgages, interest payments to the IOs’ investors decline, and these investors lose a portion of their investment.
Comment: Marks violated Standard I(C) by misrepresenting the terms and character of the investment.
73
Analyze the situation:
Khalouck Abdrabbo manages the investments of several high-net-worth individuals in the United States who are approaching retirement.
Abdrabbo advises these individuals that a portion of their investments be moved from equity to bank-sponsored certificates of deposit and money market accounts so that the principal will be “guaranteed” up to a certain amount. The interest is not guaranteed.
Comment: Although there is risk that the institution offering the certificates of deposits and money market accounts could go bankrupt, in the United States, these accounts are insured by the US government through the Federal Deposit Insurance Corporation. Therefore, using the term “guaranteed” in this context is not inappropriate as long as the amount is within the government-insured limit. Abdrabbo should explain these facts to the clients.
74
Analyze the situation:
Steve Swanson is a senior analyst in the investment research department of Ballard and Company. Apex Corporation has asked Ballard to assist in acquiring the majority ownership of stock in the Campbell Company, a financial consulting firm, and to prepare a report recommending that stockholders of Campbell agree to the acquisition.
Another investment firm, Davis and Company, had already prepared a report for Apex analyzing both Apex and Campbell and recommending an exchange ratio. Apex has given the Davis report to Ballard officers, who have passed it on to Swanson. Swanson reviews the Davis report and other available material on Apex and Campbell. From his analysis, he concludes that the common stocks of Campbell and Apex represent good value at their current prices; he believes, however, that the Davis report does not consider all the factors a Campbell stockholder would need to know to make a decision. Swanson reports his conclusions to the partner in charge, who tells him to “use the Davis report, change a few words, sign your name, and get it out.”
Comment: If Swanson does as requested, he will violate Standard I(C). He could refer to those portions of the Davis report that he agrees with if he identifies Davis as the source; he could then add his own analysis and conclusions to the report before signing and distributing it.
75
Analyze the situation:
Claude Browning, a quantitative analyst for Double Alpha, Inc., returns from a seminar in great excitement. At that seminar, Jack Jorrely, a well-known quantitative analyst at a national brokerage firm, discussed one of his new models in great detail, and Browning is intrigued by the new concepts. He proceeds to test the model, making some minor mechanical changes but retaining the concepts, until he produces some very positive results. Browning quickly announces to his supervisors at Double Alpha that he has discovered a new model and that clients and prospective clients should be informed of this positive finding as ongoing proof of Double Alpha’s continuing innovation and ability to add value.
Comment: Although Browning tested Jorrely’s model on his own and even slightly modified it, he must still acknowledge the original source of the idea. Browning can certainly take credit for the final, practical results; he can also support his conclusions with his own test. The credit for the innovative thinking, however, must be awarded to Jorrely.
76
Analyze the situation:
Fernando Zubia would like to include in his firm’s marketing materials some “plain-language” descriptions of various concepts, such as the price-to-earnings (P/E) multiple and why standard deviation is used as a measure of risk. The descriptions come from other sources, but Zubia wishes to use them without reference to the original authors. Would this use of material be a violation of Standard I(C)?
Comment: Copying verbatim any material without acknowledgement, including plain-language descriptions of the P/E multiple and standard deviation, violates Standard I(C). Even though these concepts are general, best practice would be for Zubia to describe them in his own words or cite the sources from which the descriptions are quoted. Members and candidates would be violating Standard I(C) if they either were responsible for creating marketing materials without attribution or knowingly use plagiarized materials.
77
Analyze the situation:
Through a mainstream media outlet, Erika Schneider learns about a study that she would like to cite in her research. Should she cite both the mainstream intermediary source as well as the author of the study itself when using that information?
n all instances, a member or candidate must cite the actual source of the information. Best practice for Schneider would be to obtain the information directly from the author and review it before citing it in a report. In that case, Schneider would not need to report how she found out about the information. For example, suppose Schneider read in the Financial Times about a study issued by CFA Institute; best practice for Schneider would be to obtain a copy of the study from CFA Institute, review it, and then cite it in her report. If she does not use any interpretation of the report from the Financial Times and the newspaper does not add value to the report itself, the newspaper is merely a conduit of the original information and does not need to be cited. If she does not obtain the report and review the information, Schneider runs the risk of relying on second-hand information that may misstate facts. If, for example, the Financial Times erroneously reported some information from the original CFA Institute study and Schneider copied that erroneous information without acknowledging CFA Institute, she could be the object of complaints. Best practice would be either to obtain the complete study from its original author and cite only that author or to use the information provided by the intermediary and cite both sources.
78
Analyze the situation:
Paul Ostrowski runs a two-person investment management firm. Ostrowski’s firm subscribes to a service from a large investment research firm that provides research reports that can be repackaged by smaller firms for those firms’ clients. Ostrowski’s firm distributes these reports to clients as its own work.
Comment: Ostrowski can rely on third-party research that has a reasonable and adequate basis, but he cannot imply that he is the author of such research. If he does, Ostrowski is misrepresenting the extent of his work in a way that misleads the firm’s clients or prospective clients.
79
Analyze the situation:
Tom Stafford is part of a team within Appleton Investment Management responsible for managing a pool of assets for Open Air Bank, which distributes structured securities to offshore clients. He becomes aware that Open Air is promoting the structured securities as a much less risky investment than the investment management policy followed by him and the team to manage the original pool of assets. Also, Open Air has procured an independent rating for the pool that significantly overstates the quality of the investments. Stafford communicates his concerns to his supervisor, who responds that Open Air owns the product and is responsible for all marketing and distribution. Stafford’s supervisor goes on to say that the product is outside of the US regulatory regime that Appleton follows and that all risks of the product are disclosed at the bottom of page 184 of the prospectus.
Comment: As a member of the investment team, Stafford is qualified to recognize the degree of accuracy of the materials that characterize the portfolio, and he is correct to be worried about Appleton’s responsibility for a misrepresentation of the risks. Thus, he should continue to pursue the issue of Open Air’s inaccurate promotion of the portfolio according to the firm’s policies and procedures.
The Code and Standards stress protecting the reputation of the firm and the sustainability and integrity of the capital markets. Misrepresenting the quality and risks associated with the investment pool may lead to negative consequences for others well beyond the direct investors.
80
Analyze the situation:
Trina Smith is a fixed-income portfolio manager at a pension fund. She has observed that the market for highly structured mortgages is the focus of salespeople she meets and that these products represent a significant number of trading opportunities. In discussions about this topic with her team, Smith learns that calculating yields on changing cash flows within the deal structure requires very specialized vendor software. After more research, they find out that each deal is unique and that deals can have more than a dozen layers and changing cash flow priorities. Smith comes to the conclusion that, because of the complexity of these securities, the team cannot effectively distinguish between potentially good and bad investment options. To avoid misrepresenting their understanding, the team decides that the highly structured mortgage segment of the securitized market should not become part of the core of the fund’s portfolio; they will allow some of the less complex securities to be part of the core.
Comment: Smith is in compliance with Standard I(C) by not investing in securities that she and her team cannot effectively understand. Because she is not able to describe the risk and return profile of the securities to the pension fund beneficiaries and trustees, she appropriately limits the fund’s exposure to this sector.
81
Analyze the situation:
Robert Palmer is head of performance for a fund manager. When asked to provide performance numbers to fund rating agencies, he avoids mentioning that the fund manager is quite liberal in composite construction. The reason accounts are included/excluded is not fully explained. The performance values reported to the rating agencies for the composites, although accurate for the accounts shown each period, may not present a true representation of the fund manager’s ability.
Comment: “Cherry picking” accounts to include in either published reports or information provided to rating agencies conflicts with Standard I(C). Moving accounts into or out of a composite to influence the overall performance results materially misrepresents the reported values over time. Palmer should work with his firm to strengthen its reporting practices concerning composite construction to avoid misrepresenting the firm’s track record or the quality of the information being provided.
82
What does "Standard 1D: Professionalism - Misconduct" entail?
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.
83
What steps does the CFA recommend to limit misconduct?
1. Develop or Adopt a Code of Ethics
2. Disseminate a list of potential violations with disciplinary sanctions.
3. Check all employee references
84
Analyze the situation:
Simon Sasserman is a trust investment officer at a bank in a small affluent town. He enjoys lunching every day with friends at the country club, where his clients have observed him having numerous drinks. Back at work after lunch, he clearly is intoxicated while making investment decisions. His colleagues make a point of handling any business with Sasserman in the morning because they distrust his judgment after lunch.
Comment: Sasserman’s excessive drinking at lunch and subsequent intoxication at work constitute a violation of Standard I(D) because this conduct has raised questions about his professionalism and competence. His behavior reflects poorly on him, his employer, and the investment industry.
85
Analyze the situation:
Howard Hoffman, a security analyst at ATZ Brothers, Inc., a large brokerage house, submits reimbursement forms over a two-year period to ATZ’s self-funded health insurance program for more than two dozen bills, most of which have been altered to increase the amount due. An investigation by the firm’s director of employee benefits uncovers the inappropriate conduct. ATZ subsequently terminates Hoffman’s employment and notifies CFA Institute
Comment: Hoffman violated Standard I(D) because he engaged in intentional conduct involving fraud and deceit in the workplace that adversely reflected on his integrity.
86
Analyze the situation:
Jody Brink, an analyst covering the automotive industry, volunteers much of her spare time to local charities.
The board of one of the charitable institutions decides to buy five new vans to deliver hot lunches to low-income elderly people.
Brink offers to donate her time to handle purchasing agreements. To pay a long-standing debt to a friend who operates an automobile dealership—and to compensate herself for her trouble—she agrees to a price 20% higher than normal and splits the surcharge with her friend. The director of the charity ultimately discovers the scheme and tells Brink that her services, donated or otherwise, are no longer required.
Comment: Brink engaged in conduct involving dishonesty, fraud, and misrepresentation and has violated Standard I(D).
87
Analyze the situation:
Carmen Garcia manages a mutual fund dedicated to socially responsible investing. She is also an environmental activist. As the result of her participation in nonviolent protests, Garcia has been arrested on numerous occasions for trespassing on the property of a large petrochemical plant that is accused of damaging the environment.
Comment: Generally, Standard I(D) is not meant to cover legal transgressions resulting from acts of civil disobedience in support of personal beliefs because such conduct does not reflect poorly on the member’s or candidate’s professional reputation, integrity, or competence.
88
Analyze the situation:
Meredith Rasmussen works on a buy-side trading desk of an investment management firm and concentrates on in-house trades for a hedge fund subsidiary managed by a team at the investment management firm.
The hedge fund has been very successful and is marketed globally by the firm. From her experience as the trader for much of the activity of the fund, Rasmussen has become quite knowledgeable about the hedge fund’s strategy, tactics, and performance.
When a distinct break in the market occurs and many of the securities involved in the hedge fund’s strategy decline markedly in value, Rasmussen observes that the reported performance of the hedge fund does not reflect this decline.
In her experience, the lack of effect is a very unlikely occurrence. She approaches the head of trading about her concern and is told that she should not ask any questions and that the fund is big and successful and is not her concern. She is fairly sure something is not right, so she contacts the compliance officer, who also tells her to stay away from the issue of the hedge fund’s reporting.
Comment: Rasmussen has clearly come across an error in policies, procedures, and compliance practices within the firm’s operations. According to the firm’s procedures for reporting potentially unethical activity, she should pursue the issue by gathering some proof of her reason for doubt. Should all internal communications within the firm not satisfy her concerns, Rasmussen should consider reporting the potential unethical activity to the appropriate regulator.
