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CFA

Institute – Ethical and Professional Standards


Summary of Selected Examples – by Standard – Standards of Practice Handbook – 11th edition

Standard I: Professionalism
A. Knowledge of the Law - Key Points

Notification of Known Violations
If confronted with potential legal violation, notify supervisor; get legal counsel. However, reliance on
counsel’s advice does not absolve member / candidate from requirement to comply with law /
regulation. (Example - brokerage firm is handling an underwriting, earnings are being overstated in
prospectus.)

Dissociating from a Violation
In cases where an investment banking firm is handling an underwriting, and there is concealment,
member / candidate should report to supervisor and counsel, and dissociate from underwriting.

Dissociating from a Violation
If member / candidate is asked to use promotional material which is incorrect (Example would be
improperly computed composite information), member / candidate should ask firm to recalculate, and
refrain from distributing incorrect information. Remember to always adhere to the stricter of local
securities laws / regulations or Code and Standards.

Following the Highest Requirements
Member / candidate works in developing country with no prohibitions on insider trading. More strict
rule – follow the Standards – must follow II(A) – Material Nonpublic Information.

Following the Highest Requirements
Member / candidate works for a U.S.-based adviser, but lives and works as a registered adviser in small
island nation which prohibits participation in IPOs for the adviser’s personal account. More strict rule
applies here.

Laws and Regulations Based on Religious Tenets
Fixed income hedge fund is being sold to high-net-worth clients. Some potential clients from Middle
East are interested, but are looking for investments that comply with Islamic law. Firm must be aware of
differences between cultural and religious laws / requirements – be proactive in efforts to acknowledge
where the new fund may not be suitable for certain clients.

Reporting Potential Unethical Actions
Portfolio manager for high-net-worth portfolios as large global investment manager observes a lot of
new portfolios / relationships coming from a country in Europe where the firm has not had prior
business. A broker in that country is responsible for the new business – the broker receives allocated
payments for research, but the portfolios do not invest in securities in the broker’s country. This
potential unethical activity should be reported to supervisor / compliance. Disclosure of broker
relationship and research payments should be advocated.

© 2017 AdaptPrep 1
Standard I: Professionalism
B. Independence and Objectivity – Key Points

Travel Expenses
Special chartered flights and/or accommodations are OK as long as your independence and objectivity
are not compromised (Example – mining analyst visiting mines).

Research Independence
In securing new investment banking business, member / candidate can agree to provide research
coverage, but not always favorable coverage – the coverage must be totally independent.

Research Independence and Intrafirm Pressure
Do not ever be pressured from another division within your own firm to produce a favorable research
report in order to protect an investment banking relationship. Firm in question is considering a new
debt offering. Situation can be avoided by putting firm on a restricted list for sales force.

Research Independence and Issuer Relationship Pressure
Analyst is concerned that issuing a negative research report will result in management retaliation – not
including in earnings release conference calls, lack of access to top management, etc. Analyst should
resist this pressure, and stress that recommendation is based on relative valuation, which may include
management qualitative issues.

Research Independence and Sales Pressure
Do not “push a product” based on “inventory” at your firm, or based on internal pressure or
compensation.

Research Independence and Prior Coverage
Boss tells analyst to take over coverage of a firm, but that the prevailing buy recommendation must not
be changed. Analyst must issue only recommendations that reflect independent and objective opinion.

Gifts and Entertainment from Related Party versus from Client
Do not accept any substantial gifts, particularly from those firms or brokers who may receive favored
treatment in the future. This is different than accepting additional compensation from a client, as long
as the compensation arrangement is disclosed to supervisor. Gifts in a client relationship are deemed
less likely to influence objectivity / independence.

Travel Expenses from External Manager
Investment manager of a pension plan completed search for a firm to manage foreign equity allocation
of the plan’s diversified portfolio. Penguin Advisors was selected, but Penguin had recently sponsored
an “investment fact finding trip to Asia”. Manager’s selection may have been tainted by possible
conflict. Basic expenses should have been reimbursed and trip should have been made a matter of
public record. There should be concern about public perception.

Research Independence and Compensation Arrangements
Do not agree to write a research report for a flat fee plus a “bonus” based on new investors who buy the
stock. This arrangement would be a violation.

© 2017 AdaptPrep 2

Recommendation Objectivity and Service Fees
Trust manager is considering promoting a new family of funds, who have offered to pay the bank a .25%
service fee. Manager accepts offer and team of portfolio managers are instructed to exclusively
promote these funds. Two years later they are underperforming. This is a violation - Fee arrangement
affected objectivity, also violation of VI(A) – Disclosure of Conflicts.

Recommendation Objectivity
Research analyst is doing sensitivity analysis on securitized subprime mortgages. Key calculation
assumption is housing price appreciation, which drives “prepays”. He wants to include a scenario run
with negative appreciation, but his manager believes assumptions are too “dire”. Analyst continues
research and does not recommend the purchase of this securitization. Analyst’s actions are in alignment
with Standard I(B). This also relates to Standard V(A) – Reasonable Basis.


Standard I: Professionalism
C. Misrepresentation – Key Points

Representing the Firm’s Abilities
Do not “over-promise” investment services that your firm can provide. “We can perform all the
financial and investment services you need.”

Disclosure of Issuer-Paid Research
Do not promote research efforts as independent, without disclosing any contractual relationships with
companies covered.

Correction of Unintentional Errors
Making a misrepresentation unknowingly is NOT a violation. Analyst creates and distributes marketing
material. Firm claims GIPS compliance. Total assets in a composite are stated incorrectly due to a typo.
Correct action – once error is discovered, cease distribution and inform those who have received. Firm
must also comply with GIPS Guidance Statement on Error Correction.

Non-correction of Known Errors
President of an investment management firm allows bio to be distributed to clients indicating he has an
advanced degree which he does not have. Even though he is not directly responsible for
misrepresentation of credentials, it is a violation of I(C ). Do not exaggerate credentials, and watch your
firm, to ensure promotional materials are accurate. To knowingly distribute information which
misrepresents the truth is a violation.

Plagiarism
Do not copy sections of another firm’s research report without acknowledgement.

Misrepresentation of Information
Investment adviser sells IO strips to public pension plan clients, describing them as “guaranteed” by the
U.S. government. Underlying mortgages are guaranteed, but neither the investor’s investment nor the
IO interest stream is guaranteed. Violation of I(C ) – misrepresenting terms and character of the
investment.

© 2017 AdaptPrep 3
Potential Information Misrepresentation
The term guarantee IS appropriate in cases of principal “guarantees” on CD’s, as long as within FDIC
limits.

Plagiarism
Boss tells analyst “use [other firm’s] report, change a few words, sign your name, and get it out.” This is
a violation of I(C ). Alternatively, he could properly identify the source, add own analysis and
conclusions.

Plagiarism
In the case of quantitative models, if using a modified version of a model, you must still acknowledge
the original source of the idea. You CAN take credit for “added value” or innovative thinking.



Plagiarism
Analyst wants to include in firm’s marketing materials “plain language” descriptions of various financial
concepts, without reference to original authors. Violation of I(C ) – Best option would be describe in
own words, or cite sources from which descriptions are quoted.

Plagiarism
Research analyst learns about a study through a mainstream media outlet, and wants to cite it in her
research. Should she cite the source as well as author of study? Important reference is author – no
need to report how information was received. There is value in verification – getting the original study.

Misrepresentation of Information
It is OK to rely on third-party research, and it is OK to repackage it as in-house research, but do not imply
authorship of the report, which would mislead clients.

Misrepresentation of Information
Investment team member must be concerned about the degree of accuracy in materials. For example:
description of structured securities to offshore clients. Investment manager is qualified to recognize
degree of accuracy in investment materials that characterize the portfolio, and cannot misrepresent the
quality and risks of an investment.

Avoiding a Misrepresentation
Fixed income portfolio manager concludes that highly structured mortgages she is analyzing are
complex, and the team cannot distinguish between good and bad investment options, since deals can
have more than a dozen layers. In order to comply with I(C ), no investment in securities that team
cannot effectively understand.

© 2017 AdaptPrep 4
Standard I: Professionalism
D. Misconduct – Key Points

Professionalism and Competence
Excessive drinking at lunch and subsequent intoxication at work is a violation, since it reflects poorly on
the individual, employer, and investment industry.

Fraud and Deceit
Analyst submits reimbursement forms to his firm’s self-funded health insurance program with altered
amounts to increase the amounts reimbursed. This is a violation because it involved fraud and deceit in
the workplace and reflects on the individual’s integrity.

Fraud and Deceit
Analyst volunteers with local charities and assists them in procuring vehicles, but overcharges them and
receives a commission. This is a violation because it involves dishonesty, fraud and misrepresentation.

Personal Actions and Integrity
Analyst is also an environmental activist, and participates in non-violent protests. She has been arrested
on several occasions for trespassing on property of a large petrochemical plant accused of damaging
environment. The Standard does not apply to such acts of civil disobedience.

Professional Misconduct
Analyst works on the buy-side trading desk of an investment management firm, concentrating on in-
house trades for a hedge fund subsidiary. She observes that reported performance appears to be in
error. She has identified an error in policies, procedures, and compliance practices in the firm’s
operations. She should gather proof and report the concerns internally, and if still not satisfied, should
consider reporting the unethical activity to the regulators.


Standard II: Integrity of Capital Markets
A. Material Nonpublic Information – Key Points

Acting on Nonpublic Information
President of family business accepts a tender offer to sell family business at double market price of
shares. He tells his sister, firm Treasurer, who tells daughter (owns no stock) who tells husband.
Husband tells broker. --Husband violated II(A), and so did broker.

Acting on Nonpublic Information
If you hear information and have sufficient knowledge to determine that the information is both
material and nonpublic, you cannot trade on, or communicate the information. Example – Elevator
conversation – overhears company executives talking about earnings.

Controlling Nonpublic Information
In an investment banking relationship, it is appropriate to receive inside information. Set up information
barriers. Example – conference call, assisting with secondary offering, earnings drop, salespeople and
portfolio managers overhear and trade on information. Salespeople / portfolio managers who traded
on information violated II(A).

© 2017 AdaptPrep 5
Acting on Nonpublic Information
Utilizing advance copies of published investment information is a violation. Example – Receiving fax
copy of weekly investment column, in advance.

Acting on Nonpublic Information
Individual learns that a company has fired its CFO for misappropriation of funds. He checks further and
determines that the information has not yet been made public. It is a violation of II(A) to trade on this
information.

Selective Disclosure of Material Information
Information communicated from a company to a small group forum is NOT “public dissemination” and
cannot be used.

Determining Materiality
Investor is considering options on hold versus sell shares of oil and gas exploration company, and
receives generally unreliable information (through her doctor) that a takeover bid is in the works. This is
not material nonpublic information – no prohibition on trading the stock.

Applying the Mosaic Theory
Perceptive analysis is OK, and you can make a “sell recommendation” based on this perceptive analysis.
Example, buy-side analyst covering a specific industry has concerns about a specific company’s
expensive new designs are not selling. “Mosaic theory” – no violation.

Applying the Mosaic Theory
It is acceptable to reach a conclusion about the value of a firm by piecing together a number of
nonmaterial or public bits of information.

Analyst Recommendations as Material Nonpublic Information
“Best analyst” covering auto industry is preparing to be interviewed on a global financial news TV
program, and mentions to show’s producers and interviewing journalist the change in recommendation
that he will be discussing. Journalist sells her holdings before going on the air. Trades violated Standard
II(A) – trading based on material nonpublic information.

Acting on Nonpublic Information
Portfolio manager’s research department prepares an unfavorable analysis on a company, and manager
decides to liquidate fund’s holdings in this company. He knows the action will be viewed negatively by
the marketplace and stock price will plunge. He contacts family members and tells them to see before
he liquidates fund’s holdings. This is a violation of Standard II(A).

Acting on Nonpublic Information
Extending the prior example, the portfolio manager sells his own holdings prior to liquidating the fund’s
holdings. This is also a violation of Standard II(A).

Acting on Nonpublic Information
Retired investment professional talks with a friend who is a senior executive at a major bank, who tells
him that they are preparing to announce excellent quarterly earnings. Investor doubles his position in
the bank. Earnings are released but bank also announces additional loan loss reserves, and stock price
drops 60%. This is still a violation of Standard II(A).

© 2017 AdaptPrep 6
Standard II: Integrity of Capital Markets
B. Market Manipulation – Key Points

Independent Analysis and Company Promotion
Systematic publication of supposedly independent analyses and recommendations that are inaccurate
and highly promotional and speculative is a violation of the Standard. It is also a violation of Standard
V(A) – Diligence and Reasonable Basis, and possibly Standard VI(A) – Disclosure of Conflicts.

Personal Trading Practices and Price
Employee of broker/dealer took a large ownership interest in several publicly traded microcap stocks
and held the positions in various brokerage accounts in which the broker/dealer had a controlling
interest. He manipulated the stock price by artificially increasing the bid price for the stock through his
own transactions between accounts. This is a violation of the Standard.

Creating Artificial Price Volatility
Analyst has a number of hedge funds as important clients, and many of them hold short positions in a
specific stock. Analyst prepares to issue a negative report on the stock, but alerts his sales force in
advance, and the hedge funds are able to cover their short positions before all other clients are notified.
The report sensationalizes all the negatives, to create even more downward pressure on the stock. This
is a violation of the Standard, also a violation of Standard V(A) – Diligence and Reasonable Basis.

Personal Trading and Volume
It is a violation to trade large portions of a stock back and forth between two funds, to slowly increase
the price, and generate interest in the stock.

“Pump-Priming” Strategy
Chairman of a new futures exchange is launching a new bond futures contract. He is trying to convince
investors, traders, hedgers, etc. to use his contract and to demonstrate that it has the best liquidity. He
enters into agreements with some members committing them to a minimum trading volume in
exchange for much lower commissions. This is a violation of the Standard, because it is an attempt to
mislead market participants about the actual liquidity of the market. If the strategy is fully disclosed to
the market, it is not a violation.

Creating Artificial Price Volatility
Analyst is researching a company and attempts to get the company to update its earnings guidance by
creation of an unrealistically high earnings projection. Her goal is to try to fuel a quick gain in the stock
price. This is a violation of the Standard, and by previewing her intentions to only a select group of
clients, it is also a violation of Standard III(B) – Fair Dealing.

Pump and Dump Strategy
It is a violation to log on to several investor chat rooms on the internet to start rumors about a company
expanding its operations, in order to intentionally mislead market participants.

© 2017 AdaptPrep 7
Manipulating Model Inputs
Analyst supervises a structured finance team for a bank. His responsibilities include packaging new
structured investment products and managing relationships with rating agencies. He uses all positive
scenarios as model inputs, minimizing downside risk. His compensation is based on level of ratings
assigned and successful sale of new structured products, with no link to long-term performance. There
is an economic downturn leading to several defaults of the products. This is a violation of the Standard
because he manipulated the inputs of a model to minimize risks, and achieve higher ratings. There was
too much focus on short-term gain.


Standard III: Duties to Clients
A. Loyalty, Prudence, and Care – Key Points

Identifying the Client – Plan Participants
Investment manager at a bank is a trustee for a client’s pension plan. Client’s firm is target of a hostile
takeover attempt. Investment manager purchases a lot of the stock in open market for the employee
pension plan (even though he believes the stock to be overvalued), with the promise from the client that
“other accounts” will be placed at the bank. All the activity causes the stock price to rise and the
takeover bid is abandoned. This is a violation of Standard III(A) – member / candidate must act
prudently and solely in interests of plan participants and beneficiaries.

Client Commission Practices
Be sure that client brokerage is used for services that directly benefit the client, and that none of the
brokerage goes to cover general overhead. Also be sure to obtain best price and execution.

Brokerage Arrangements
It is OK to direct new client trades exclusively through one broker, as long as you receive best price and
execution, and the practice is disclosed.

Brokerage Arrangements
You cannot receive better terms from a brokerage firm for personal transactions.

Client Commission Practices
Analyst goes on a trip sponsored by a research firm with a small broker / dealer affiliate that uses the
clearing facilities of a larger brokerage house. Analyst also uses commission dollars for vacation part of
trip. Analyst is not sure that the execution is competitive, but directs trading desk to start giving the
brokerage firm commission business. This violates Standard III(A) – analyst is not exercising her duty of
loyalty to her clients.

Excessive Trading
Do not make excessive trades over and above what is necessary to accomplish client’s investment
objectives, in order to make minimum commission levels.

Managing Family Accounts
Asset manager has father and brother and fee-paying accounts, and he must treat as all other accounts,
including during IPO allocation.

© 2017 AdaptPrep 8
Identifying the Client
When acting as an expert witness, be cautious as to whom the client is. The standard of independence
and objectivity applies. Do not let the law firm influence testimony.

Identifying the Client
Mutual fund portfolio manager and private wealth manager do not “share responsibility” for the client.
Investment adviser is bound by duty of loyalty to client, and mutual fund manager is to manage the fund
according to the IPS of the fund.


Standard III: Duties to Clients
B. Fair Dealing – Key Points

Selective Disclosure
Do not notify “best clients” of any recommendations in advance of sending to all clients.

Fair Dealing between Funds
Fair dealing with clients extends to not giving priority to trades for a commingled fund over all other
funds, or to discretionary accounts over nondiscretionary accounts. Orders must be placed on a
systematic basis – fair to all clients.

Fair Dealing and IPO Distribution
In an IPO distribution, it is a violation of Standard III(B) to not treat customers fairly by taking shares for
yourself and/or not properly prorating shares offered among all clients.

Fair Dealing and Transaction Allocation
Chief investment officer for a money management firm purchases mortgage-backed securities (MBS) for
several accounts, and fails to allocate to one account. Trades turn out to be profitable and manager
later allocates only profitable trades to one client, and spreads losing trades to other clients. This is a
violation of Standard III(B). Also, any potential conflicts regarding both parties in agency cross-
transactions must be disclosed.

Selective Disclosure
Any analyst’s opinion regarding potential for significant upside earnings surprise must be shared with all
clients, otherwise it is violation of Standard III(B). Treat all clients fairly.

Additional Services for Select Clients
It is not a violation to disseminate recommendation to all clients, and then discuss it in more detail with
large institutional clients.

Minimum Lot Allocations
Regarding allocations of a new bond offering, there is no violation of Standard III(B) in cases where the
total allocation is far below the amount requests, as long as each client receives at least the minimum
lot size of the issue.

© 2017 AdaptPrep 9
Standard III: Duties to Clients
C: Suitability – Key Points

Investment Suitability – Risk Profile
Do not apply the same investment strategy to two different clients – financial circumstances and
objectives will differ.

Investment Suitability – Entire Portfolio
When determining of an investment is suitable, look at entire portfolio. A covered call option strategy
for a risk-averse client may be totally appropriate, if client is educated on all possible outcomes.

IPS Updating
If client receives a substantial inheritance, this will increase client’s ability and perhaps willingness to
assume risk. IPS should be updated and investment objectives need to be changed.

Following an Investment Mandate
A manager of a high-income mutual fund who purchases a zero-dividend stock is not following the
mandate of the fund being managed. This is a violation of Standard III(C ).

IPS Requirements and Limitations
A chief investment officer is managing the investment portfolio for an insurance subsidiary. IPS provides
for highly liquid investments. He invests 4% of assets in a venture capital opportunity with a minimum
three-year lock-up period. This violates Standard III(A) – Loyalty, Prudence, and Care as well as Standard
III(C ).

Submanager and IPS Reviews
Investment manager’s business has grown substantially, and decision is made to hire a submanager to
handle international investments. Manager sends out an RFP, receives several questionnaires, and
selects firm with lowest fees. In basing his decision only on fee structure, he may be violating Standard
III(C ). Manager should also consider Standard V(A) – Diligence and Reasonable Basis, in determining
proper review process for submanager selection.

Investment Suitability – Risk Profile
It is a violation of Standard III(C ) to invest client assets in high risk investments in order to reap short-
term rewards offered by your firm’s new bonus compensation system. This is also potentially a violation
of Standard VI(A) – Disclosure of Conflicts.

Investment Suitability
An investment advisory fund offers lower than normal management fees to attract new clients to a new
hedge fund, which consists of two top-performing funds managed by a friend of his. Prior performance
of these funds has been excellent. No investors are turned away. This is a violation of Standard III(C ) –
the risk profile of the new fund may not be suitable to all clients. This is also a potential violation of
Standard V(A) – Diligence and Reasonable Basis.

© 2017 AdaptPrep 10
Standard III: Duties to Clients
D. Performance Presentation – Key Points

Performance Calculation and Length of Time
A claim of firm performance should account for performance of all account categories, not just the best
one. Do not include an assurance or guarantee regarding future compound growth rate – this would
also violate Standard I(C ) – Misrepresentation.

Performance Calculation and Asset Weighting
It is a violation to claim GIPS compliance and not meet all the GIPS standards. Firms must meet all
requirements, make mandatory disclosures, and meet any other firm-specific requirements.

Performance Presentation and Prior Fund / Employer
It is acceptable to include a manager’s past performance at a prior firm in present firm’s marketing
materials, but the source of the historical performance must be clearly disclosed.

Performance Presentation and Simulated Results
If you develop a selection methodology and test it by applying it retroactively, you must clearly state
that the results were simulated. Violation example – advertisement including performance results, with
no mention that results are simulated.

Performance Calculation and Selected Accounts Only
A presentation to prospective clients shows rates of return over a 5-year period by a composite of the
firm’s discretionary accounts that have a “balanced” objective. This was a manipulation, since it was a
narrow range of accounts in the composite. This violates Standard III(D) – performance record is
distorted.


Standard III: Duties to Clients
E. Preservation of Confidentiality – Key Points

Possessing Confidential Information
Do not divulge confidential information about clients. Example – potential contributor to a medical
center asks for internal reports on how the endowment fund is managed – if information is shared, it is a
violation.

Disclosing Confidential Information
If you have an advisory customer who is considering a charitable donation, do not share that
information with a preferred charity.

Disclosing Possible Illegal Activity
If you have knowledge that a client has violated tax and fiduciary regulations and laws, inform
supervisor, and employer, regarding steps to take to remedy the violations. You and employer should
seek legal counsel.

© 2017 AdaptPrep 11
Disclosing Possible Illegal Activity
Money manager manages money for a family-owned real estate development firm. He believes there is
embezzlement. Appropriate action is to check with compliance department or counsel to determine
whether securities regulations required reporting this information.


Standard IV: Duties to Employers
A: Loyalty – Key Points

Soliciting Former Clients
Do not violate employee-employer principle which states that you must act solely for employer’s
benefit. Example – if changing firms, do not solicit current / prospective clients while still employed at
“old” firm.

Former Employer’s Documents and Files
When departing “old” firm, do not take any employer records, even if you originally prepared them,
without consent of your “old” firm. (This includes – client lists, account statements, performance
record, recommendations, computer models, personal computer spreadsheets.)

Addressing Rumors
There is a rumor that an asset management firm’s equity management business is going to be sold. If
employees are contemplating forming an employee buyout, consult legal counsel to determine proper
action.

Ownership of Completed Prior Work
“Handshake” agreements carry weight. Example – you agree to do research for a firm part-time on a
flat fee basis. If you are subsequently hired by another firm on a full-time basis, you cannot take the
prepared research with you.

Ownership of Completed Prior Work
If you are not paid, you still have a duty of loyalty to the firm. Example – unpaid summer intern; you
cannot take anything with you, such as copies of firm’s software.

Soliciting Former Clients
If you start at a new firm, you are not allowed to contact former clients through old client lists. “Simple
knowledge of names and existence of former clients is not confidential information”. Code does not
prohibit you from reconstructing your old lists from memory.

Starting a New Firm
If you are starting a new business, and need to register it with regulatory authorities while with your
“old” firm, that is OK. Preparations should be done on your own time outside the office.

Competing with Current Employer
Several employees are preparing to leave their current employer. They cannot respond to an RFP if
existing employer is also responding, unless they have permission from existing employer as well as
entity sending out the RFP.

© 2017 AdaptPrep 12
Externally Compensated Assignments
If you serve in a public service capacity, albeit for nominal compensation, while employed elsewhere as
a full-time investment professional, it is appropriate to discuss this with your employer and reach a
mutual understanding. Time commitment of the other position is the important factor.

Soliciting Former Clients
It is not a violation of Standard IV(A) to obtain phone numbers of former clients through public records
and to contact them to solicit business, upon leaving current employer.

Whistleblowing Actions
Trader works on buy-side trading desk and handles in-house trades for a hedge fund subsidiary. She
notes that during a market downturn many of the securities involved in the hedge fund’s strategy
decline markedly in value, but the reported performance of the hedge fund does not reflect the decline.
She approaches head of trading as well as the compliance officer, and is told to stay away. She should
consult firm’s whistleblowing policy to determine next steps. This is not a violation of Standard IV(A),
however this also relates to Standard I(D) – Misconduct and Standard IV(C ) – Responsibilities of
Supervisors.

Soliciting Former Clients
Former clients may be contacted, it it is prohibited to use client records built and kept by former
employer. Publicly available information is acceptable to be used to contact former clients.

Notification of Code and Standards
Assistant trader is concerned by remarks by the head trader about “unloading junk” and putting it all in
a CDO. Assistant trader discusses with supervisor, and reviews the company’s procedures /
requirements for reporting potential violations of firm policy / securities laws. She is prepared to go
through whistleblower process.


Standard IV: Duties to Employers
B. Additional Compensation Arrangements – Key Points

Notification of Client Bonus Compensation
Any additional compensation provided by a client must be disclosed to your employer. You must inform
your employer in writing, detailing the arrangement, which could possibly detract from work on other
accounts. Employer must give consent before any benefits are received.

Notification of Outside Compensation
If you are a Board member of a company whose stock you may recommend to clients, and receive any
supplemental benefits, this must be disclosed to your employer. Example – unlimited family
membership of exercise facilities.

Prior Approval for Outside Compensation
Oil and gas analyst accepts invitation to visit a company to write a report. He refuses travel on the firm’s
plane, but does have dinner with the CEO at an upscale restaurant. Upon returning to his firm, he
provides a full review of the meeting to the director of research, including a disclosure of the dinner
attended. This is not a violation of Standard IV(B). He has enabled his company to assess his ability to
remain independent re future reports and recommendations.

© 2017 AdaptPrep 13
Standard IV: Duties to Employers
C. Responsibilities of Supervisors – Key Points

Supervising Research Activities
A research head changes her recommendation from buy to sell. She orally advises selected executives
in her firm who trade for their own accounts as well as certain discretionary client accounts. This is a
violation of Standard (V(C ) – she failed to reasonably and adequately supervise the actions of those
accountable to her.

Supervising Research Activities
Before distributing a “memo” recommending a stock, be sure there is a reasonable and adequate basis
for the recommendation, and also be sure the information is not material nonpublic information.

Supervising Trading Activities
Trainee trader assists a customer in paying for securities of a stock by using anticipated profits from
immediate sale of the same stock. It is not even on the firm’s recommended list. Vice president
responsible for supervising compliance with securities laws has her compensation partly based on
commission revenues. Violation of Standard IV(C ) – supervisors must be particularly sensitive to
potential conflicts / supervisory responsibilities.

Supervising Trading Activities and Record Keeping
Portfolio manager frequently places S&P 500 Index purchase and sale orders, and assigns the positions
later, given more favorable execution prices to certain funds / clients. The president of the investment
firm has violated Standard IV(C ) by failing to adequately supervise the activities, and by failing to
establish record keeping and reporting procedures to detect violations.

Accepting Responsibility
Trader works on buy-side trading desk and handles in-house trades for a hedge fund subsidiary. She
notes that during a market downturn many of the securities involved in the hedge fund’s strategy
decline markedly in value, but the reported performance of the hedge fund does not reflect the decline.
She approaches head of trading as well as the compliance officer, and is told to stay away. She should
consult firm’s whistleblowing policy to determine next steps. Standard IV(C ) states that the supervisor
and compliance officer have responsibility to review the concerns brought forth by the trader. Dismissal
of concerns violates the Standard and undermines firm’s ethical operations.

Inadequate Procedures
Supervisor has responsibility to have an appropriate review process regarding work of contracted
analysts. Contract analyst creates a report based on a few news articles, with insufficient research. This
is also a violation of Standard V(A) – Diligence and Reasonable Basis.

Inadequate Supervision
Chief investment officer of a state retirement fund moves the real estate allocation to a classmate’s
firm, to help him out. The decision appears to be somewhat arbitrary. The actions highlight the need
for proper policies and procedures in place to detect inappropriate actions such as this.

© 2017 AdaptPrep 14
Standard V: Investment Analysis, Recommendations, and Actions
A. Diligence and Reasonable Basis – Key Points

Sufficient Due Diligence
Research all relevant factors in a situation, and do not take on more work than can be adequately
handled. Violation Example – Tax loophole closing; estimate values of oil and gas exploration firms; do
research later.

Sufficient Scenario Testing
Do not misrepresent a company’s prospects. Violation example – in presentation to brokers, employee
exaggerates production level scenarios, instead of giving a range of production scenarios.

Developing a Reasonable Basis
Contract analyst creates a report based on a few news articles, with insufficient research. This is also a
violation of Standard V(A), and also a violation of Standard IV(C ) – Responsibilities of Supervisors – this
related to the firm’s inadequate procedures.

Timely Client Updates
If managing a pension fund, screening equity managers within a region, be sure that you are updating
information on a timely basis. Client must always receive information in the form of an updated report.

Group Research Opinions
If your research is reviewed by senior management and changes are made, this is OK. Example – junior
analyst produces report on expected interest rates in mortgage market – fixed-income investment
committee makes changes.

Reliance on Third-Party Research
If working for a small firm and you use third-party research, this is OK, but make reasonable effort to see
that research is sound, objective, and reasonably based.

Due Diligence in Submanager Selection
Investment manager’s business has grown substantially, and decision is made to hire a submanager to
handle international investments. Manager sends out an RFP, receives several questionnaires, and
selects firm with lowest fees. In just looking at fee structure, this may be a violation of Standard V(A).
Also see Standard III(C ) – Suitability – ability of the selected adviser to meet client needs.

Sufficient Due Diligence
An investment advisory fund offers lower than normal management fees to attract new clients to a new
hedge fund, which consists of two top-performing funds managed by a friend of his. Prior performance
of these funds has been excellent. No investors are turned away. This is a violation of Standard V(A) –
there was not a thorough analysis or deep enough due diligence. See also Standard III(C ) – Suitability.

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Sufficient Due Diligence
Research analyst is doing sensitivity analysis on securitized subprime mortgages. Key calculation
assumption is housing price appreciation, which drives “prepays”. He wants to include a scenario run
with negative appreciation, but his manager believes assumptions are too “dire”. Analyst continues
research and does not recommend the purchase of this securitization.
--Analyst’s actions are in alignment with Standard V(A). This also relates to Standard I(B) –
Independence and Objectivity.

Use of Quantitatively Oriented Models
Analyst outsources some quantitative modeling work to trusted third parties. After implementing the
various models, various components of the strategy were successful, but some portions of the model
worked at cross-purposes with other portions, and the strategy failed dramatically. This is a violation of
Standard V(A) – Members / candidates must understand models they recommend and be able to
explain them to clients – there was inadequate review.

Successful Due Diligence / Failed Investment
Investment adviser analyzes a fund’s track record; principals involved in managing the fund, fees
charged, and risk profile, and recommends the fund to a client and secures a position in it. There is
subsequently a big loss in the fund. There is no violation. Adviser should explain to client again the
analysis process and that past performance offers no guarantees.


Standard V: Investment Analysis, Recommendations, and Actions
B. Communication with Clients and Prospective Clients – Key Points

Sufficient Disclosure of Investment System
Money manager is marketing an exclusive and expensive investment advice letter to high-net-worth
individuals. To simplify the product, he only includes his top-five “buys” and “sells” without detailing the
investment modeling and portfolio structuring scheme. This is a violation of the Standard – she must
inform clients of basis process and logic.

Providing Opinions as Facts
If discussing reserves, such as gold reserves, be careful to not confuse opinion with fact. It is a violation
to recommend a buy based on the “fact” that a company has a certain number of ounces of gold to be
mined.

Proper Description of a Security
It is a violation of the Standard to not properly describe the basic characteristics and risks of an
investment strategy, including how the structure was created and the degree of leverage. A discussion
of how a strategy will perform must be balanced, to indicate how it does in both rising and falling
interest rate environments.

Notification of Fund Mandate Change
If a mutual fund manager is lifting the maximum permissible market-cap ceiling of stocks he can
purchase, to increase liquidity since the fund is growing, all potential and present clients must be
notified.

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Notification of Fund Mandate Change
It is a violation of the Standard to extend a fund’s small-cap universe to include non-U.S. companies
without advising all interested parties.

Notification of Changes to the Investment Process
Valuation model cannot be changed without communication to firm’s clients.

Notification of Changes to the Investment Process
A capital management firm loses the chief architect of its multifactor valuation system, and elects to
develop a product for passive equity management. This is a substantial change to investment process,
and all clients must be informed.

Notification of Changes to the Investment Process
An asset management firm changes the responsibility for stock selection - shifting from individual
analysts to a committee. This change is important enough that all clients must be notified.

Sufficient Disclosure of Investment System
Investment director for an asset management firm has decided to supplement needs for small and mid-
cap management by hiring outside fund managers. This change in investment process must be
disclosed.

Notification of Changes to the Investment Process
Chief investment officer of a retirement fund directs some funds to an old friend, but does not
adequately disclose the relationship or the reason for the change. This is a violation of the Standard. He
has attempted to hide the nature of his decision by making only a limited disclosure.


Standard V: Investment Analysis, Recommendations, and Actions
C: Record Retention – Key Points

Record Retention and IPS Objectives and Recommendations
Keep appropriate records to show that a client’s portfolio is following IPS. Example – client upset due to
tech losses – percentage of tech stocks in the benchmark index was 35% - IPS states that the benchmark
was appropriate for client’s investment objectives.

Record Retention and Research Process
Document all information that goes into a report, including secondary or third-party research of other
analysts. Example – include documentation on interviews with all parties, onsite visits, customer
surveys, secondary research.

Records as Firm, Not Employee, Property
If you develop an analytical model, document assumptions and reasoning. If you change firms, you
cannot take documentation with you without “old” firm‘s permission.

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Standard VI: Conflicts of Interest
A. Disclosure of Conflicts – Key Points

Conflict of Interest and Business Relationships
Disclose all special relationships in research reports. Example – Analyst is asked to write research report
on a firm which has been represented by your firm’s M&A department for several years, and some
officers sit on Boards of subsidiaries. This threatens independence and objectivity and must be
disclosed.

Conflict of Interest and Business Stock Ownership
Investment management firm sells a 25% interest in its partnership to a multinational bank holding
company. After sale, president of investment firm changes recommendation of the 25% “holder” from
“sell” to “buy”. This new relationship must be disclosed to all clients.

Conflict of Interest and Personal Stock Ownership
Analyst recommends purchase of a stock. After his initial report, wife inherits substantial amount of the
stock. He has been asked to write a follow-up report. Best practice would be to avoid conflict by asking
employer to assign another analyst.

Conflict of Interest and Personal Stock Ownership
Analyst purchases 100,000 shares of a mining company for 30 cents a share. Even without owning the
stock, analyst would recommend it in her report as a “buy”. Although analyst does not consider the
holding material, it must be disclosed in the report and to her employer before the report is written.

Conflict of Interest and Compensation Arrangement
Clients must be informed of changes in compensation arrangements which may create a conflict
between compensation and clients’ IPS. Firms may pay employees based on performance, but pressure
to achieve short-term performance goals may be in basic conflict with client objectives.

Conflict of Interest and Options and Compensation Arrangements
Securities firm works with small companies doing IPOs / secondary offerings. To compensate for small
corporate finance fees, securities firm often takes “agent’s options” – rights to acquire added 10% of
current offering. To avoid violating Standard VI(A), report must indicate volume / expiration date of
agent options outstanding, and if employee is personally eligible for some of the options, this must be
disclosed. Also be careful not to violate duty of independence and objectivity – Standard I(B).

Conflict of Interest and Compensation Arrangements
Representative with a broker/dealer is approached by stock promoter with an offer to receive additional
compensation for sales of his firm’s stock to clients. Representative accepts the offer without disclosing
to clients or employer. This violates Standard VI(A) – arrangement must be disclosed to employer.

Conflict of Interest and Directorship
Senior portfolio manager just became a trustee for a non-profit foundation. Since assets under
management are relatively small, portfolio manager does not believe it necessary to inform employer.
This is a violation – another issue is time involvement of the non-profit responsibilities. Approval from
compliance officer or supervisor is required before position is accepted.

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Conflict of Interest and Personal Trading
If you buy a security linked to a security you are recommending, this must be disclosed to clients.
Example – analyst recommends an equity-linked note that replicates the performance of an underlying
Russian equity. Ownership of the Russian security must be disclosed to the analyst’s employer.

Conflict of Interest and Requested Favors
Chief investment officer of a state retirement fund moves the real estate allocation to a classmate’s
firm, to help him out. The decision appears to be somewhat arbitrary. The actions highlight the need
for proper policies and procedures in place to detect inappropriate actions such as this. Standard VI(A)
requires disclosing to employer his personal relationship with classmate. This also relates to Standard
IV(C ) – Responsibilities of Supervisors, and Standard V(B) – Communication with Clients and Prospective
Clients.

Conflict of Interest and Business Relationships
Trust manager is considering promoting a new family of funds, who have offered to pay the bank a .25%
service fee. Manager accepts offer and team of portfolio managers are instructed to exclusively
promote these funds. This is a violation of Standard VI(A) – portion of service fee being paid to bank
must be disclosed. This also relates to Standard I(B) – Independence and Objectivity.


Standard VI: Conflicts of Interest
B. Priority of Transactions – Key Points

Personal Trading
Do not delay issuing a recommendation in order to purchase stock personally, to the disadvantage of
the employer.

Trading for Family Member Account
Regarding purchases of “hot” issue, acquire shares for mutual fund being managed first, then for a
family member’s (husband’s) account. Portfolio manager must also disclose trading in husband’s
account to her employer, due to conflict between personal and employer’s interests.

Family Accounts as Equals
If allocating IPO shares to clients, if one of your clients is a family member, handle their allocation just as
other clients

Personal Trading and Disclosure
Entry-level employee has low-paying job serving both research and investment management
department. He buys an expensive car and begins to wear expensive clothes. Director of investment
management department, responsible for monitoring employee stock transactions, finds that this
employee has made large gains by buying stocks before they go on the firm’s recommended list.
Employee has violated Standard VI(B), and supervisor has violated Standard IV(C) – Responsibilities of
Supervisors, by failing to obtained signed quarterly personal transaction forms. If employee had
communicated advance recommendations to others who traded the security, this is a violation of
Standard II(A) – Material Nonpublic Information.

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Trading Prior to Report Dissemination
If making a “sell” recommendation, it is a violation to establish a personal “put” position on the stock.
Violation example – sizeable “put” placed 7 minutes after broadcast to internal branches around the
country publicizing negative comments about a stock. It is a violation of Standard VI(B) – firm cannot
trade for its own account until clients have opportunity to receive and assimilate recommendations.


Standard VI: Conflicts of Interest
C. Referral Fees – Key Points

Disclosure of Referral Arrangements
Broker/dealer has established a referral arrangement with an investment counseling firm. Securities
firm refers all prospects to the investment firm. In exchange, investment firm makes available on a
regular basis all security recommendations and reports of its research staff. Investment firm calculates
$20,000 annual incremental cost for services provided. Referrals from securities firm to investment firm
resulted in annual fee income of $200,000. Directing all trades through this securities firm cost clients
an additional $10,000. It is a violation of Standard VI(C ) to not inform prospects of referral fee
arrangements.

Disclosure of Interdepartmental Referral Arrangements
Internal and external referral fees must be disclosed. Example – employee of trust department of a
bank receives compensation for each referral he makes to his firm’s brokerage and personal financial
management department. This must be disclosed to client at time of the referral.

Disclosure of Referral Arrangements and Informing Firm
Portfolio manager asks trading desk to direct a large portion of its commission to a small broker/dealer
run by one of manager’s classmates. Pricing is not competitive, and research is not particularly helpful.
Firm receives back referrals of wealthy clients. This is a violation of Standard VI(C ) – employer must be
informed of referral arrangement.

Disclosure of Referral Arrangements and Employer Compensation
Portfolio manager receives additional monetary compensation for generating new business. The assets
will be invested in proprietary products, such as affiliate company mutual funds. There is no need to
disclose to potential clients a bonus for finding new clients / assets. However, portfolio manager must
disclose to clients that he is compensated for selling firm products.

Disclosure of Referral Arrangements and Outside Organizations
Portfolio manager for a local investment advisory firm is on the advisory board of his child’s school, and
wishes to donate to the school a part of his service fee from new clients referred by parents of students
at the school. He obtains approval from his firm, thus no violation of Standard VI(C ).

Disclosure of Referral Arrangements and Outside Parties
Sponsor of a state employee pension hires a consultant to solicit proposals from various advisers. It later
turns out that he is accepting kickbacks from investment managers after they are awarded new pension
allocations. Consultant is in violation of Standard VI(C ) by not disclosing any such fees being paid to
him.

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Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate
A. Conduct as Participants in CFA Institute Programs – Key Points

Sharing Exam Questions
If a CFA exam proctor gives some candidates advance information about the exam the night before, this
is a violation by the proctor, and also by the candidates. This compromises the integrity and validity of
the CFA exam.

Bringing Written Material into Exam Room
Writing a formula on the palm of your hand (prior to the exam) is a violation.

Writing after Exam Period End
Continuing to complete exam after time was called is a violation of Standard VII(A).

Sharing Exam Content
Candidate wrote in her blog after the exam about the difficulty of the exam – this is not a violation. She
also revealed portions of the Body of Knowledge that were covered / not covered. This is a violation of
Standard VII(A).

Sharing Exam Content
Candidate begins a discussion thread on an internet form about the most challenging exam questions.
This is a violation.

Sharing Exam Content
Exam prop providers cannot solicit information from candidates regarding details on exam questions.

Sharing Exam Questions
It is a violation to try to tip off a friend in a different time zone, details about the exam.

Discussion of Exam Grading Guidelines and Results
Graders must sign a CFA Institute Grader Agreement, agreeing not to reveal or discuss the exam
materials with anyone except CFA Institute staff or other graders.

Compromising CFA Institute Integrity as a Volunteer
Program Chair for CFA Society only schedules companies that are clients to make presentations to the
Society. This is a violation of Standard VII(A) – it compromises the reputation and integrity of CFA
Institute.

Compromising CFA Institute Integrity as a Volunteer
Do not give clients advance information of anything learned through a CFA Institute volunteer position.
Example – advance knowledge of changes to GIPS – volunteer wants to assist her clients in keeping up
with changes to standards. This is a violation of Standard VII(A) – she may only factually state
involvement with the committee, but she cannot infer any special advantage to clients from such
participation.

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Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate
B. Reference to CFA Institute, the CFA Designation, and the CFA Program –
Key Points

Passing Exams in Consecutive Years
It is OK to state in advertising that principals passed all three Levels on first try, but do not link this fact
to the notion of superior performance. (Example – mutual fund performance)

Right to Use CFA Designation
If you fail to pay your CFA Institute dues, and / or fail to file PCS, you cannot state or imply that you are
an active CFA charterholder. (Membership can be reactivated.)

“Retired” CFA Institute Membership Status
If you are a CFA charterholder and “retire”, you must reclassify your membership with CFA Institute, and
continue paying dues, in order to retain the right to use the designation.

CFA Logo – Individual Use Only
You cannot incorporate the CFA logo into a company name. The logo is only appropriate on a business
card or letterhead of an individual CFA charterholder.

Stating Facts about CFA Designation and Program
It is OK to state how much you learned from the CFA program, and to state that many firms require
employees to be CFA charterholders. This effectively recommends the CFA program.

Order of Professional and Academic Designations
If you have more than one designation, the order of designation is a matter of personal preference.
Example – Ph.D., CFA

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