Ethical and Professional Standards

Review

Weighting 15% to 20%

 Ethical and Professional Standards Review

Ethical and Professional Standards:

❑ Ethics and Trust in the Investment
Profession
❑ Code of Ethics and Standards of
Professional Conduct
❑ Guidance for Standards I–VII
❑ Introduction to the Global Investment
Performance Standards
❑ Ethics Application
© Kaplan, Inc. 2
 Ethics and Trust in the Investment Profession
Ethics
• Shared beliefs about good or bad behavior
Professions
• Require specialized knowledge
• Focus on ethical behavior
Code of ethics
• Written set of moral principles
• May include rules or standards
Ethical vs. legal standards
• Some illegal actions may be ethical
(e.g., civil disobedience)
• Some unethical actions may be legal
(e.g., preferential allocation of IPOs)
• Ethical principles often set higher
standards than laws and regulations
© Kaplan, Inc.
Ethical conduct
• Follows moral principles
• Consistent with society’s ethical
expectations
• Improves outcomes for stakeholders
Challenges to ethical conduct
• Situational influences
• Rules-based compliance culture
Professionalism in investment
management
• Suitability standard: Recommend
investments consistent with clients’ risk
tolerance and return requirements
• Fiduciary standard (stronger): Act in best
interests of clients
3
 Complete questions: ET1 – ET4

Time allocated: 6 minutes

6 4 2 1

Approximate minutes remaining

If you need extra time, simply pause the presentation near the end of the allotted time.

© Kaplan, Inc. 4
 Ethics and Trust in the Investment Profession
ET1. Ethics least likely involves the study of:
A. moral principles.
B. laws and regulations.
C. good and bad behavior.

© Kaplan, Inc. 5
 Ethics and Trust in the Investment Profession
ET2. A profession’s code of ethics will most likely:
A. guarantee a minimum standard of service to clients.
B. guarantee a minimum standard of acceptable behavior from
members.
C. communicate the shared principles and expected behavior of
members.

© Kaplan, Inc. 6
 Ethics and Trust in the Investment Profession
ET3. Which of the following is most likely to determine the ethical
quality of a person’s behavior?
A. Internal traits.
B. Situational influences.
C. Rules-based compliance procedures.

© Kaplan, Inc. 7
 Ethics and Trust in the Investment Profession
ET4. It is most likely that ethical standards:
A. must comply with legal standards.
B. may conflict with legal standards.
C. are less strict than legal standards.

© Kaplan, Inc. 8
 Code of Ethics and Standards of Professional Conduct
• Self disclosure
• Written complaints
• Evidence of misconduct
• CFA exam proctor
• Analysis of exam results
Inquiry
• Monitoring of websites/social media

• Disciplinary Review Committee

• CFA Institute conducts inquiries
related to professional conduct

CFA Institute may decide:

1. That no disciplinary sanctions are appropriate
2. To issue a cautionary letter
3. To discipline the member or candidate

Sanctions may include condemnation by member’s peers or

suspension of candidate’s participation in the CFA Program

© Kaplan, Inc. 9
 Code of Ethics and Standards of Professional Conduct
Code of Ethics
• Act in an ethical manner
• Integrity is paramount and
clients always come first
• Use reasonable care and be
independent
• Be a credit to the investment
profession
• Uphold capital market rules
and regulations
• Be competent
© Kaplan, Inc.
Standards of Professional Conduct
I: Professionalism
A. Knowledge of the Law
B. Independence and Objectivity
C. Misrepresentation
D. Misconduct
II: Integrity of Capital Markets
A. Material Nonpublic Information
B. Market Manipulation
III: Duties to Clients
A. Loyalty, Prudence, and Care
B. Fair Dealing
C. Suitability
D. Performance Presentation
E. Preservation of Confidentiality
IV: Duties to Employers
A. Loyalty
B. Additional Compensation Arrangements
C. Responsibilities of Supervisors
V: Investment Analysis,
Recommendations, and Actions
A. Diligence and Reasonable Basis
B. Communications With Clients and
Prospective Clients
C. Record Retention
VI: Conflicts of Interest
A. Disclosure of Conflicts
B. Priority of Transactions
C. Referral Fees
VII: Responsibilities as a CFA Institute
Member or CFA Candidate
A. Conduct as Participants in CFA Institute
Programs
B. Reference to CFA Institute, the CFA
Designation, and the CFA Program
10
 Complete questions: ET5 – ET7

Time allocated: 5 minutes

5 4 3 2 1

Approximate minutes remaining

If you need extra time, simply pause the presentation near the end of the allotted time.

© Kaplan, Inc. 11
 Code of Ethics and Standards of Professional Conduct
ET5. Which of the following statements about CFA Institute’s
Professional Conduct Program is least accurate?
A. Professional Conduct staff conducts professional conduct
inquiries.
B. The involved member or candidate must accept the
disciplinary sanction proposed by the CFA Institute staff.
C. Candidates who have violated the Code and Standards may be
suspended from participating in the CFA program.

Member or candidate may reject proposed sanction and

refer matter to a hearing panel

© Kaplan, Inc. 12
 Code of Ethics and Standards of Professional Conduct
ET6. According to the Code of Ethics, members of the CFA Institute
are required to act with integrity, competence, dignity, and in an ethical
manner when dealing with which of the following groups?
A. Clients and employers only.
B. Clients, prospective clients, and employers only.
C. Clients, prospective clients, public, employers, and employees.

© Kaplan, Inc. 13
 Code of Ethics and Standards of Professional Conduct
ET7. Which of the following requirements of members is least likely
to be explicitly stated in the CFA Institute’s Code of Ethics?
A. Uphold capital market rules.
B. Maintain knowledge of applicable laws. ← Standard I(A)
C. Maintain and improve professional competence.

© Kaplan, Inc. 14
 Guidance for Standards I–VII
Standard I: Professionalism
I(A): Knowledge of the Law
• Understand and comply with all laws, rules,
regulations (including Code & Standards)
governing professional activities
• Comply with more strict law, rule, regulation
• Do not knowingly assist in violation, otherwise
dissociate from activity
Guidance
• Most strict
• First, notify supervisor or compliance
• May confront wrongdoer directly
• Dissociate if necessary
• Inaction may be construed as participation
• No requirement to report violations to governmental
authorities, but this may be appropriate in certain cases
© Kaplan, Inc.
I(B): Independence and Objectivity
• Use reasonable care, judgment to achieve, maintain
independence in professional activities
• Do not offer, solicit, accept any compensation that
could compromise independence, objectivity
Guidance
• Modest gifts are okay
• Distinguish between gifts from clients and gifts from
entities trying to influence
• May accept gift from clients, but must disclose to
employer and must get permission if gift is for future
performance
• Investment banking relationships – do not bow to
pressure to issue favorable research
• For issuer-paid research, flat fee structure is preferred
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 Guidance for Standards I–VII
Standard I: Professionalism

I(C): Misrepresentation I(D): Misconduct

• Do not make misrepresentations relating to • Do not engage in any professional conduct involving
investment analysis, recommendations, dishonesty, fraud, deceit, or commit any act that reflects
actions, or other professional activities adversely on professional reputation, integrity, or
competence

Guidance
• Standard covers oral, written, or electronic Guidance
communications This Standard covers conduct that may not be
• Do not misrepresent qualifications, services of illegal, but could adversely affect a member’s
self or firm, or performance record, ability to perform duties
characteristics of an investment
• Do not guarantee a certain return
• No plagiarism – written or oral communications

© Kaplan, Inc. 16
 Complete questions: ET8-ET13

Time allocated: 9 minutes

9 6 4 3 2 1

Approximate minutes remaining

If you need extra time, simply pause the presentation near the end of the allotted time.

© Kaplan, Inc. 17
 Guidance for Standards I–VII

ET8. To comply with the requirements of the Standard concerning

knowledge of the law, members and candidates are least likely
required to:
A. learn the applicable laws and regulations.
B. dissociate from illegal or unethical activity.
C. report violations to the relevant authorities.

Not required by the Standards unless it is required by local law.

© Kaplan, Inc. 18
 Guidance for Standards I–VII

ET9. A member resides in a country with securities laws that are

stricter than the CFA Institute’s Code and Standards. The member
does business for a client in another country with securities laws that
are less strict than the Code and Standards. What rules does the
member apply?
A. The laws of the client’s country.
B. The laws of the member’s country.
C. The Code and Standards.

If any of these differ, apply the strictest.

© Kaplan, Inc. 19
 Guidance for Standards I–VII

ET10. Bob Smith, CFA, is an unpaid, non-executive board member of Atlantic

Technologies. Smith discovers that Atlantic has inappropriately accelerated the
recognition of contract revenues to achieve desired quarterly financial results.
Smith consults the firm’s legal counsel and confirms that this conduct is illegal.
Smith urges the board of directors to restate the financial statements, but they
decide not to do so. According to the CFA Institute’s Standards of Professional
Conduct, Smith:
A. should immediately inform CFA Institute of the illegal action.
B. should promptly dissociate himself from Atlantic’s actions by resigning
as a director.
C. does not have to take any additional action because he has discharged his
duty by bringing the matter to the attention of the other board members.

© Kaplan, Inc. 20
 Guidance for Standards I–VII

ET11. Which of the following procedures is least likely recommended

to comply with the Standard concerning independence and
objectivity?
A. Do not accept business-related dinner invitations with a
securities issuer. Ordinary entertainment is OK
B. Restrict investment firm employees from purchasing equity IPOs.
C. Pay for transport and hotel expenses when meeting with issuers
of securities.

© Kaplan, Inc. 21
 Guidance for Standards I–VII

ET12. Marc Randall, a recent university graduate and a Level I

candidate in the CFA Program, joins Inz Investments as an analyst
trainee. After two weeks, Randall is asked to assist with a presentation
to a potential client. During the meeting, Randall’s supervisor states,
“You can be sure that our investments will always outperform Treasury
bonds because our research staff has substantial experience in the
industry, like Marc.” This statement most likely violates the Standard
concerning:
A. duties to clients.
B. misrepresentation.
C. performance presentation.

© Kaplan, Inc. 22
 Guidance for Standards I–VII

ET13. Which of the following actions would least likely violate the
Standard concerning misconduct?
A. Regularly being intoxicated at work.
B. Dishonest behavior that does not result in legal prosecution.
C. Personal bankruptcy due to a failed business venture.

Not a violation if it does not involve dishonesty or deceit

© Kaplan, Inc. 23
 Guidance for Standards I–VII
Standard II: Integrity of Capital Markets
II(A): Material Nonpublic Information
• Members in possession of nonpublic information
that could affect an investment’s value must not act
or cause someone else to act on the information
Guidance
• “Material” – if disclosure of information would affect a
security’s price or if reasonable investors would want the
information before making an investment decision
• Information is “nonpublic” until it has been made available to
the marketplace
• Information made available to analysts is considered
nonpublic until it is made available to investors in general
• Mosaic Theory
© Kaplan, Inc.
II(B): Market Manipulation
• Do not engage in practices that distort prices or
artificially inflate trading volume with intent to
mislead market participants
Guidance
• Do not engage in transaction-based manipulation –
give false impression of activity/price movement;
gain dominant position in an asset to manipulate
price of the asset or a related derivative
• Do not distribute false, misleading information
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 Guidance for Standards I–VII
Standard III: Duties to Clients
III(A): Loyalty, Prudence, and Care
• Act with reasonable care and exercise prudent judgment
• Act for benefit of clients and place their interests before
employer’s or own interests
Guidance
• Take investment actions in client’s best interests
• Exercise prudence, care, skill, and diligence
• Follow applicable fiduciary duty
• Manage pools of client assets according to terms of
governing documents
• Make investment decisions in context of total portfolio
• Vote proxies responsibly and disclose proxy voting
policies to clients
• “Soft dollars” must benefit client
© Kaplan, Inc.
III(B): Fair Dealing
Deal fairly, objectively with all clients when:
• Providing investment analysis
• Making investment recommendations
• Taking investment action
• Engaging in other professional activities
Guidance
• Different levels of service are okay as long as
disclosed, and do not disadvantage any clients
• Investment recommendations: All clients must
have fair chance to act on every recommendation
• Investment actions: Treat all clients fairly –
consider investment objectives, circumstances
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 Guidance for Standards I–VII
Standard III: Duties to Clients

III(C): Suitability III(D): Performance Presentation

• Know client’s risk and return objectives, and • When communicating investment performance
financial constraints information, ensure that information is fair, accurate,
• Update information regularly and complete
• Make investment recommendations or take
investment actions that are consistent with
the stated objectives and constraints
• Look at suitability in a portfolio context
Guidance
• Do not misstate performance or mislead
Guidance clients about investment performance
• When in an advisory relationship, gather client • Do not state or imply ability to achieve returns
information at the outset and prepare IPS similar to those achieved in the past
• Update IPS at least annually
• Consider whether leverage (derivatives) is suitable for
client
• If managing a fund to an index or other mandate, invest
according to mandate

© Kaplan, Inc. 26
 Guidance for Standards I–VII
Standard III: Duties to Clients

III(E): Preservation of Confidentiality

Keep current and prospective client information confidential, unless:
• Illegal activities are suspected
• Disclosure is required by law
• Client or prospect allows disclosure of the information

Guidance
• In some cases, it may be required by law to report activities to relevant authorities
• This standard extends to former clients
• Exception: May provide confidential information to CFA Institute for an investigation
under Professional Conduct Program

© Kaplan, Inc. 27
 Complete questions: ET14-ET19

Time allocated: 9 minutes

9 6 4 3 2 1

Approximate minutes remaining

If you need extra time, simply pause the presentation near the end of the allotted time.

© Kaplan, Inc. 28
 Guidance for Standards I–VII
ET14. John Miller is a fund manager of a small cap fund and an emerging market
fund. Based on his analysis, he decided to reduce the holding of Fisher Company
in the small cap fund. To avoid adverse reaction on the share price of Fisher,
Miller starts trading the shares of Fisher back and forth between the two funds to
generate significant trading volume and increase the share price. If other
investors become interested in the shares of Fisher, Miller can sell the shares in
the fund without inducing a large price decrease. This would benefit the investors
of the small cap fund for which Miller is responsible. Miller’s actions most likely
violate the Standard concerning:
A. suitability.
B. market manipulation.
Intent to deceive market participants
C. fair dealing.

© Kaplan, Inc. 29
 Guidance for Standards I–VII

ET15. Mel Avid, CFA, directs a significant amount of its commission-

related business to Ezekiel Brokerage. In return for the business
given, Ezekiel pays for new office furniture for Avid. Avid has:
A. not violated the Code and Standards.
B. violated the Standard concerning referral fees.
C. violated the Standard concerning loyalty, prudence, and care.

Only allowed if the goods or services benefit clients.

© Kaplan, Inc. 30
 Guidance for Standards I–VII
ET16. Unez Airlines publicly guides analysts that it is comfortable with a projected
earnings per share of $3.10 for the final quarter. The consensus forecast puts
Unez’s EPS at $3.15. Iago Rubin, CFA, an analyst at Fargus Investments,
believes Unez’s management has underestimated earnings so the announcement
of actual EPS will cause a surge in the stock price. Among the more
knowledgeable analysts, the earnings projection is said to be $4.00 per share.
Rubin puts the $3.10 estimate in a research report that he distributes to all clients
of Fargus, but privately discusses the $4.00 estimate with the larger institutional
clients of Fargus. Rubin has most likely violated the Standard related to:
A. fair dealing, by discussing the higher estimate with larger institutional
investors.
B. preservation of confidentiality, because he should not disclose the EPS
provided by Unez’s management.
C. diligence and reasonable basis, because he should have used $3.15 in the
report instead of $3.10.
© Kaplan, Inc. 31
 Guidance for Standards I–VII

ET17. According to the Standard concerning suitability, members and

candidates are required to update information about clients with a
minimum frequency of which of the following?
A. Quarterly.
B. Annually.
C. Prior to each change in investment recommendation.

© Kaplan, Inc. 32
 Guidance for Standards I–VII

ET18. Which of the following actions, if not disclosed, is most likely to

violate the Standard concerning performance presentation? An
investment firm:
A. presents investment performance using composites of similar
portfolios.
B. includes terminated portfolios as part of the historical performance
results, which makes the performance results look better.
C. includes a 10-year performance history in its marketing
brochure, which includes two years of simulated results and
eight years of actual performance.
Permitted, but must be disclosed.

© Kaplan, Inc. 33
 Guidance for Standards I–VII

ET19. Danny Jefferson is a portfolio manager who is being sued by one of his
clients for inappropriate investment advice. Jefferson settles out of court with the
client. When investigated by the Professional Conduct Program (PCP) of CFA
Institute, Jefferson discloses confidential information about the settlement and the
client to PCP. Jefferson:
A. violated the Standard concerning suitability by providing inappropriate advice.
B. violated the Standard concerning preservation of confidentiality by disclosing
the information.
C. did not violate the Code and Standards.

Members and candidates may share confidential information with PCP

unless doing so would violate local law.

© Kaplan, Inc. 34
 Guidance for Standards I–VII
Standard IV: Duties to Employers

IV(A): Loyalty
• Must act for the benefit of their employer

Guidance
Loyalty – Independent Practice:
• If planning to engage in independent practice, notify employer of services provided, expected duration, and compensation
• Do not proceed without consent from employer
Loyalty – Leaving an Employer:
• If seeking new employment, act in best interest of employer until resignation is effective
• Do not take records or files without permission
• Simple knowledge of names of former clients is okay
• No prohibition on use of experience or knowledge gained at former employer
Loyalty – Whistleblowing:
• Permitted only if it protects client or integrity of capital markets
• Not permitted for personal gain

© Kaplan, Inc. 35
 Guidance for Standards I–VII
Standard IV: Duties to Employers
IV(B): Additional Compensation Arrangements
• Do not accept gifts, benefits, compensation, consideration
that competes with, or creates a conflict of interest with,
employer’s interest unless written consent obtained from all
parties involved
Guidance
• Compensation and benefits include direct compensation
by the client and other benefits received from third parties
• For written consent from “all parties involved,” email is
acceptable
© Kaplan, Inc.
IV(C): Responsibilities of Supervisors
• Must make reasonable efforts to detect and
prevent violations
Guidance
• Supervisors must take steps to prevent
employees from violating laws, rules,
regulations, or the Code and Standards
• Supervisors must make reasonable efforts to
detect violations
36
 Complete questions: ET20-ET25

Time allocated: 9 minutes

9 6 4 3 2 1

Approximate minutes remaining

If you need extra time, simply pause the presentation near the end of the allotted time.

© Kaplan, Inc. 37
 Guidance for Standards I–VII

ET20. If a member is disillusioned with her current employer, which of

the following actions is least appropriate under the CFA Institute’s
Code and Standards?
A. Organizing a management buyout of the firm.
B. Planning to go into independent practice before informing her
employer.
C. Taking copies of spreadsheets she prepared in her capacity as
an analyst. Property of the firm

© Kaplan, Inc. 38
 Guidance for Standards I–VII

ET21. Mary Tse, CFA, works as an analyst at an international

securities firm. In her spare time, she also teaches finance courses at
a local university. She receives compensation from the university for
her teaching. She does not inform the firm of the teaching activities. Is
Tse violating the Code and Standards?
No conflict with her firm’s interests
A. No.
B. Yes, she violates the Standard concerning misconduct by engaging
in dishonest behavior.
C. Yes, she violates the Standard concerning additional compensation
arrangements by not seeking written consent from her employer.

© Kaplan, Inc. 39
 Guidance for Standards I–VII

ET22. Brian Johnson, a CFA Institute member, is a portfolio manager for

Nationwide Management, which manages individual, as well as institutional
accounts. Several of his wealthy friends have asked him to review their investment
portfolios. On his own time, Johnson examines their portfolios and makes several
recommendations. He did not receive any monetary compensation from his
friends. As a token of their appreciation for his help, his friends have been giving
him free tickets to theatre performances. As Johnson was only helping his friends
on his own time, he did not see the need to inform his employer. Did Johnson
violate his duty to Nationwide?
A. Yes. Conflict with his firm’s interests
B. No, because Johnson provided investment advice on his own time.
C. No, because Johnson received no monetary compensation for his services.

© Kaplan, Inc. 40
 Guidance for Standards I–VII

ET23. Wayne Zeller is a portfolio manager with High Performance Investments.

Zeller manages the portfolio of David Whitman. Zeller has consistently achieved
returns for Whitman’s portfolio that exceed its benchmark. Whitman tells Zeller
that “any year that my portfolio achieves at least a 20% return, I will give you
$20,000.” Which of the following actions best describes the requirements of the
Standard concerning additional compensation arrangements?
A. Zeller should decline the arrangement because it might impede his
independence and objectivity.
B. If Zeller chooses to accept the arrangement, he must disclose the gift to his
employer.
C. Before Zeller may accept the arrangement, he must obtain written
consent from his employer.
This is an “additional compensation arrangement”
because it depends on future performance.
© Kaplan, Inc. 41
 Guidance for Standards I–VII

ET24. Which of the following statements most accurately describes

the responsibilities of CFA Institute members who have a supervisory
role? Supervisors:
A. must exercise reasonable supervision over their subordinates.
B. must make sure their subordinates do not make investment
decisions for clients.
C. are relieved of their duty under the Standard related to supervisory
responsibilities if they delegate these responsibilities to another
member.

© Kaplan, Inc. 42
 Guidance for Standards I–VII

ET25. Wanda Kirby, CFA, recently joined Allegheny Investments as a senior

analyst. Because of her extensive experience in the investments business and her
knowledge of the Code and Standards, Allegheny’s management asks her to
assume supervisory responsibility. Kirby reviews Allegheny’s existing compliance
system and determines that it is inadequate to allow her to clearly discharge her
supervisory responsibility. Kirby should most appropriately:
A. accept supervisory responsibility if Allegheny is willing to improve the
compliance system.
B. accept supervisory responsibility on the condition that she will not be held
responsible for violations, as the compliance system is inadequate.
C. decline supervisory responsibility until Allegheny adopts reasonable
procedures to allow her to adequately exercise such responsibility.

© Kaplan, Inc. 43
 Guidance for Standards I–VII
Standard V: Investment Analysis, Recommendations, and Actions
V(A): Diligence and Reasonable Basis
• Exercise diligence, independence, and thoroughness
• Have a reasonable and adequate basis, supported
by appropriate research, for any investment analysis,
recommendation, or action
Guidance
• Make reasonable efforts to cover all relevant issues
when arriving at an investment recommendation
• Determine soundness when using secondary or
third-party research
• Group research and decision making: As long as
there is reasonable basis, member does not
necessarily have to agree with the opinion
© Kaplan, Inc.
V(B): Communication With Clients and Prospective
Clients
• Disclose basic format and general principles of investment
processes and promptly disclose any changes that might
affect them materially
• Identify limitations, risks, and important factors and include
them in communications with clients/prospective clients
• Distinguish between fact and opinion in the presentation of
investment analysis and recommendations
Guidance
• Distinguish between facts and opinions
• Include basic characteristics of the security
• Inform clients of any change in investment processes
• Suitability of investment – portfolio context
• All communication covered, not just reports
44
 Guidance for Standards I–VII

Standard V: Investment Analysis, Recommendations, and Actions

V(C): Record Retention

• Develop and maintain appropriate records to support their investment analysis,
recommendations, actions, and other investment-related communications

Guidance
• Maintain records to support research, and the rationale for conclusions and actions
• Records are firm’s property and cannot be taken when member leaves without firm’s consent
• If no regulatory requirement or firm policy, CFA Institute recommends retention period of seven years

© Kaplan, Inc. 45
 Guidance for Standards I–VII

Standard VI: Conflicts of Interest

VI(A): Disclosure of Conflicts

• Must make full and fair disclosure to clients, prospects, or employer of all matters that could reasonably
be expected to impair their independence and objectivity or interfere with respective duties

Guidance
Disclose to clients:
• All matters that could impair objectivity – allow clients to judge motives, biases
• For example, between member or firm and issuer, investment banking relations, broker/dealer
market-making activities, significant stock ownership, board service
Disclose to employers:
• Conflicts of interest – ownership of stock analyzed/recommended, board participation, financial and
other pressures that may influence decisions
• Also covers conflicts that could be damaging to employer’s business

© Kaplan, Inc. 46
 Guidance for Standards I–VII
Standard VI: Conflicts of Interest
VI(B): Priority of Transactions
• Investment transactions for clients and employers must
have priority over investment transactions in which a
Member or Candidate is the beneficial owner
Guidance
• “Beneficial owner” – has direct / indirect personal
interest in the securities
• Client, employer transactions take priority over
personal transactions (including beneficial ownership)
• Family member accounts that are client accounts must
be treated as other client accounts
© Kaplan, Inc.
VI(C): Referral Fees
• Must disclose to employer, clients, and
prospective clients
Guidance
• Disclosure allows clients and employers to evaluate
full cost of service and any potential biases
• Disclosure is to be made prior to entering into any
formal agreement for services
• Disclose the nature of the consideration
47
 Complete questions: ET26-ET31

Time allocated: 9 minutes

9 6 4 3 2 1

Approximate minutes remaining

If you need extra time, simply pause the presentation near the end of the allotted time.

© Kaplan, Inc. 48
 Guidance for Standards I–VII
ET26. Peter Chan, CFA, is a strong believer in astrology. He often consults his
favorite astrologer, who has a reputation of giving accurate predictions for stock
prices. The astrologer tells Chan to buy shares of Kim Industries and that the
company will soon be taken over by a larger rival. Chan buys the shares for his
personal account. He also tells his friend Michael Wong, an analyst, about the
stock tip. Chan convinces Wong of the astrologer’s past accuracy. Wong issues a
“buy” recommendation on Kim Industries and states that Kim is a likely takeover
target. Two weeks later, Kim receives an offer from a larger rival for a 100%
takeover and its stock price increases 50%. Which of the following statements is
most accurate?
A. Only Chan violated the Code and Standards.
B. Only Wong violated the Code and Standards.
C. Both Chan and Wong violated the Code and Standards.
Diligence and Reasonable Basis does not restrict a
member or candidate’s personal investments.
© Kaplan, Inc. 49
 Guidance for Standards I–VII

ET27. Will Michael is a telecom analyst at a securities firm. The telecom group
has three other analysts. Michael and the other three analysts have different
opinions on United Telecom. The group currently has a “Buy” recommendation
on the stock. The government has announced new regulations in the telecom
industry that Michael believes will severely limit the company’s growth. The
other three analysts believe the regulations will have limited effects on earnings
and decide to keep the “Buy” recommendation. Michael’s most appropriate
course of action is to:
A. continue to be associated with the group’s recommendation.
B. request to be transferred to another research team.
C. ask the group not to include his name in the report because he disagrees
with the recommendation.
Not required to dissociate from a group decision
as long as it has a reasonable basis.
© Kaplan, Inc. 50
 Guidance for Standards I–VII

ET28. Which of the following actions is most likely to violate the Standard
concerning record retention?
A. Simon develops a five-factor model and documents the assumptions
that make up the model. When he joins another firm, he uses a similar
model based on documentation he retained that supports the model’s
assumptions.
B. Janet, an investment analyst, bases her investment recommendations on a
variety of sources. She retains copies of all the information that she has
gathered by scanning them and storing them electronically.
C. Ito, a small investment firm, uses the services of Alvin, a well-regarded
investment research firm. Ito makes its investment recommendations based
on the research reports from Alvin. Ito retains the research reports and
evaluates the rationale for their investment recommendations.
Must re-create records from public sources
© Kaplan, Inc. (also violated Loyalty if he did not have consent to take firm property) 51
 Guidance for Standards I–VII

ET29. Alex Grant covers European equities for Universal Brokerage. Universal
specializes in American and European equities. While on a holiday in Brazil, he
learns that an efficient way to gain exposure to the Brazilian stock market is to
purchase equity-linked notes that are based on the performance of Brazilian
stocks. Believing that his firm would not be interested in emerging market
securities, Grant purchases some equity-linked notes without informing his
employer. Two months later, Grant is assigned to cover the Brazilian market, as
several clients are interested. Grant prepares an analysis of the Brazilian stock
market and recommends several equity-linked notes, including the one he
purchased earlier. Grant most likely:
A. did not violate the Standards of Professional Conduct.
B. violated the Standard concerning disclosure of conflicts.
C. violated the Standard concerning diligence and reasonable basis.

© Kaplan, Inc. 52
 Guidance for Standards I–VII

ET30. Joanne Chu is a portfolio manager for Pacific Investment

Trust Company. She manages several client portfolios, including
her father’s portfolio, for which Chu charges a fee. According to the
CFA Institute’s Standards of Professional Conduct, if Chu buys a
security for her clients’ accounts, she should most appropriately
allocate the shares:
A. to her other clients first, and then to her father.
B. on a pro rata basis among her father and her other clients.
C. on a pro rata basis to her other clients, but she should not
allocate shares to her father.

Treat family members who are paying clients the same as any other client.

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 Guidance for Standards I–VII

ET31. Wes Smith, CFA, refers many of his clients to Bill Towers, CFA,
for accounting services. In return, Towers performs routine services
for Smith, such as his tax returns, for no charge. To comply with the
Code and Standards, Towers must:
A. discontinue his services for Smith.
B. disclose to prospects referred by Smith that he performs services
for Smith.
C. disclose to prospects referred by Smith the estimated value
of the services he provides to Smith.

© Kaplan, Inc. 54
 Guidance for Standards I–VII
Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate

VII(A): Conduct as Participants in CFA Institute Programs

• Must not engage in any conduct that compromises the reputation or integrity of CFA Institute or
the CFA designation or the integrity, validity, or security of CFA Institute programs

Guidance
Conduct includes:
• Cheating on exams
• Disregarding rules and policies or security measures related to exam administration
• Giving confidential information to candidates or public, including exam questions, topic areas tested or not tested on exam
• Improper use of CFA designation to further personal and professional objectives
• Misrepresenting the CFA Institute Professional Development Program or the Professional Conduct Statement

© Kaplan, Inc. 55
 Guidance for Standards I–VII
Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate

VII(B): Reference to CFA Institute, the CFA Designation, and the CFA Program
• Must not misrepresent or exaggerate the meaning or implications of membership in
CFA Institute, holding the CFA designation, or candidacy in the CFA program

Guidance
CFA Institute membership:
• Complete PCS annually Failure to comply results in an inactive
• Pay membership dues annually member status
Using the CFA designation:
• Don’t misrepresent or exaggerate the meaning of holding the CFA designation
Reference to the CFA program:
• May reference participation but no partial designation
• Okay to say “passed all levels on first attempt,” but do not imply superior ability
Improper use of the CFA marks:
• The “Chartered Financial Analyst” and “CFA” marks must be used after a charterholder’s name.

© Kaplan, Inc. 56
 Complete questions: ET32-ET37

Time allocated: 9 minutes

9 6 4 3 2 1

Approximate minutes remaining

If you need extra time, simply pause the presentation near the end of the allotted time.

© Kaplan, Inc. 57
 Guidance for Standards I–VII

ET32. Mary White sits on various committees in the CFA Institute. Due to her
position in these committees, she has advance knowledge of pending revisions
to the Standards of Professional Conduct and to the Global Performance
Presentation Standards. White tells her clients that she can help them keep up
with any revisions made to the Standards due to her standing in the committees.
According to the Standards of Professional Conduct, White most likely:
A. did not violate the Standards of Professional Conduct.
B. violated the Standards because she used her position with CFA Institute
to benefit herself and her clients.
C. violated the Standards because she did not have an adequate basis to inform
clients.

© Kaplan, Inc. 58
 Guidance for Standards I–VII

ET33. Peter Chan is an independent financial advisor who has just

received his CFA Charter. In his biography contained in promotion
material, Chan writes, “Having passed all three exams in
consecutive attempts, I have demonstrated the qualifications and
superior knowledge to look after your investments.” Did Chan
violate the Code and Standards?
A. No, because what Peter states in the promotional material is
factual information.
B. Yes, because he misrepresents his qualifications.
C. Yes, because he improperly references the CFA
designation.

© Kaplan, Inc. 59
 Guidance for Standards I–VII

ET34. Mary Tsang received her CFA charter and her Ph.D. degree
in Finance in the same year. She wants to put both of her
accomplishments on her business card. To comply with the Code
and Standards, Tsang:
A. must put CFA immediately after her name on the business card,
followed by Ph.D.
B. must choose between putting either the CFA designation or the
Ph.D. designation on her business card.
C. may list both of these qualifications on her business card,
in either order.

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 Guidance for Standards I–VII

ET35. To comply with the Standard concerning reference to CFA

Institute, the CFA Designation, and the CFA Program:
A. only active CFA Charterholders may refer to their participation in
the CFA Program.
B. use of the CFA designation must be accompanied by an accurate
explanation of its requirements.
C. use of the CFA designation may be accompanied by an
accurate explanation of its requirements.

© Kaplan, Inc. 61
 Guidance for Standards I–VII

ET36. Pauline Wella has passed the Level I CFA exam and
registered for the Level II exam. Which of the following references to
Wella’s participation in the CFA Program is least appropriate
according to the Code and Standards?
A. Adding “CFA I” to her business card. ← No partial designation
B. Neglecting to disclose her participation in the CFA Program to her
employer.
C. Including on her resume: “Level II candidate in the CFA Program.”

© Kaplan, Inc. 62
 Guidance for Standards I–VII

ET37. Diane Summers, CFA, and Jon Parsons, CFA, have just joined
Valco & Co., an investment firm. On the first day of her employment,
Summers verbally informs her supervisor, who is not a member of CFA
Institute, that she is obligated to comply with the Code and Standards.
Parsons does not notify his supervisor about his obligation to comply with
the Code and Standards because his supervisor is a CFA charterholder
who is aware of the requirements of the Code and Standards. According
to the CFA Institute’s Standards of Professional Conduct:
A. Parsons violated the Standards, but Summers did not.
B. both Summers and Parsons have violated the Standards.
C. neither Summers nor Parsons has violated the Standards.

Informing employer about Code and Standards is recommended, but not required.

© Kaplan, Inc. 63
 Global Investment Performance Standards (GIPS)
Reasons for creating GIPS
• Standardized calculation and reporting practices to aid comparability
• Avoid misrepresentation of performance of investment firms and to provide relevant information so that
prospective clients are able to evaluate past performance

GIPS objectives
• To establish industry best practice
• Obtain global acceptance of calculation and presentation standards —fair, comparable format with full disclosure
• Ensure consistent, accurate performance data —reporting, marketing, presentations
• Promote fair competition
• Promote global industry “self-regulation”
• Removal of misleading practices: Representative accounts, survivorship bias, varying time periods

Parties affected by GIPS

• Firms—GIPS apply to investment management firms
• Prospective and current clients—Intended to serve prospective and current clients of investment
management firms

© Kaplan, Inc. 64
 Global Investment Performance Standards (GIPS)
Composites: construction and purpose
• A composite is a grouping of individual discretionary portfolios with similar investment objective, strategy, or
mandate
• A composite must include all portfolios (current and past) that the firm has managed in accordance with this
particular strategy
• Each discretionary account must be assigned to one and only one composite
• Composites must be identified prior to reporting period
• Composite creation is important for consistency and comparability of performance over time and among firms

Firm’s definition and discretion

• To claim compliance, firm defined as the “distinct business entity” held out to clients
• If client restricts account such that manager cannot execute strategy, firm may classify account as
non-discretionary and not include it in a composite

Verification (voluntary)
• Provide assurance that compliance with GIPS is on a firm-wide basis
• If firm chooses to verify compliance, verification must be performed by a third party, on a firm-wide basis
© Kaplan, Inc. 65
 Ethical and Professional Standards

Complete questions: ET38 – ET43

Time allocated: 9 minutes

9 6 4 3 2 1

Approximate minutes remaining

If you need extra time, simply pause the presentation near the end of the allotted time.

© Kaplan, Inc. 66
© CFA Institute. Reproduced and republished with permission from CFA Institute. All rights reserved.

ET38. A firm that does not adopt the GIPS standards could
mischaracterize its overall performance by presenting a
performance history:
A. that includes terminated portfolios.
B. composed of a single top-performing portfolio.
C. for an investment mandate over all periods since the firm’s
inception.

© Kaplan, Inc. 67
© CFA Institute. Reproduced and republished with permission from CFA Institute. All rights reserved.

ET39. Which of the following statements regarding GIPS compliance

is correct?
A. Asset owners that manage assets can claim compliance with
the GIPS standards.
B. Software that calculates performance in a manner consistent with
the GIPS standards can claim compliance with GIPS standards.
C. Firms can comply with the GIPS standards by limiting their
compliance claims to the provisions they have chosen to follow.

© Kaplan, Inc. 68
© CFA Institute. Reproduced and republished with permission from CFA Institute. All rights reserved.

ET40. Each composite of a GIPS compliant firm must consist of:

A. multiple portfolios.
B. portfolios selected on an ex post basis.
C. portfolios managed according to a similar investment
strategy.

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 Global Investment Performance Standards (GIPS®)

ET41. GIPS least likely require that:

A. firms must provide compliant presentation to all prospective
clients.
B. discontinued composites must be included in the composite list for
at least five years.
C. the firm must perform its own verification that it has complied
with all the GIPS requirements.

Verification is optional, but if chosen it must

be performed by an independent third party.

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 Global Investment Performance Standards (GIPS®)

ET42. For a client portfolio that an investment manager determines is

nondiscretionary, GIPS:
A. requires the manager to include it in a composite.
B. prohibits the manager from including it in a composite.
C. gives the manager a choice of whether or not to include it in a
composite.

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 Global Investment Performance Standards (GIPS®)

ET43. The eight major sections of the GIPS standards for firms least
likely include:
A. input data and calculation methodology.
B. definition of the firm.
C. fundamentals of compliance.

© Kaplan, Inc. 72