Ethical and Professional Standards

Ethical and Professional Standards
Dr. Derek K. Chan

HKU
1
Ethical and Professional Standards
Contents in Brief
1. Introduction
2. Code of Ethics
3. Standards of Professional Conduct
2
1. Introduction
3
Introduction
• Regular and affiliate members of the Association for
Investment Management and Research (AIMR) and its
constituent analyst societies, CFA charterholder members,
and CFA candidates are required to conduct themselves in
accordance with the AIMR Code of Ethics and Standards
of Professional Conduct.
• A member who fails to comply with these obligations may
be subjected to disciplinary sanction by the Board of
Governors of AIMR, acting through its Professional
Standards Policy Committee, which is responsible for
enforcing the Code of Ethics and the Standards of
Professional Conduct in accordance with the AIMR Rules
of Procedure. 4
2. Code of Ethics
5
Code of Ethics
• Code of Ethics of AIMR
– The Code of Ethics establishes the framework for ethical decision
making in the investment profession.
• Four components of the Code of Ethics
1. Act with integrity, competence, dignity, and in an ethical manner
when dealing with the public, clients, prospects, employers,
employees and fellow members.
2. Practice and encourage others to practice in an ethical manner that
will reflect credit on members and their profession.
3. Strive to maintain and improve their competence and the
competence of others in the profession.
4. Use reasonable care and exercise independent professional
judgment.
6
3. Standards of Professional Conduct
7
Standards of Professional Conduct
AIMR Professional Conduct Program
• AIMR’s primary efforts in the area of ethics and professional conduct
are:
 Promote high standards of ethics and professional conduct globally.
 Educate member on day-to-day ethical issues.
 Increase ethical awareness within the investment profession.
 Illustrate how to apply the Code and Standards in daily investment
practice.
 Provide global leadership in the development of a code of ethics
and standards of professional conduct.
 Bring disciplinary action against members who violate the Code
and Standards.
8
Standards of Professional Conduct
• Five Categories of Professional Conduct Standards

I. Fundamental Responsibility
II. Relationship with and Responsibility to the Profession
III. Relationship with and Responsibility to the Employer
IV. Relationship with and Responsibility to the Clients and
Prospects
V. Relationship with and Responsibility to the Investing Public
9
Standard of Professional Conduct
• For each standard, focuses are

 The Purpose and Scope of the Standard
 The Applications of the Standard
 Compliance Procedures
10
Standard I: Fundamental Responsibilities
11
• I(A): Maintain knowledge of and comply with all

applicable laws, rules, and regulations (including AIMR’s
Code of Ethics and Standards of Professional Conduct) of
any government, government agency, regulatory
organization, licensing agency, or professional association
governing the members’ professional activities.
• I(B): Not knowingly participate or assist in any violation
of such laws, rules, or regulations.
• Note: AIMR recognizes that a member may not realize there is a

violation because he/she might not be aware of all the facts giving rise
to the violation. 12
• International Application of the Code and

Standards
– Members who practice in multiple jurisdictions may be
subject to varied securities laws and regulations.
– Rule of Thumb for members (including regular and
affiliate members of AIMR and its subsidiaries), CFA
Charterholders, and candidates in the CFA program:
• If the applicable laws are more strict than the requirement of
the Code and Standards, they must adhere to the applicable
laws.
• If there are no laws or the applicable laws are less strict than
the requirement of the Code and Standards, they must adhere
to the Code and Standards.
13
In Sum
• I(A): Know and comply with all “the rules”.
• Apply the strictest applicable rules of
– Home country
– Foreign country
– Local government
– AIMR’s Code and Standards
• I(B): Do not knowingly aid and abet others to break “the
rules”.
14
• Applications: Distinguish between conducts that

conform or violate the Code and Standards
– Situation 1: An analyst, who received information
contradictory to a registration statement, feels that a
standard or law has been violated.
• The analyst must seek the advice of the firm’s counsel. If the
analyst feels that the attorney is competent and unbiased and
follows the counsel’s advice, Standard I has not been violated.
15
• Applications
– Situation 2: An analyst, who discovered a client has
knowingly misstated information on a prospectus,
knows that a standard or law has been violated.
• The analyst should report the finding to the appropriate
supervisory person in the analyst’s firm. If the situation is not
remedied, then the analyst should dissociate from the situation.
The analyst should also seek advice to see what other actions,
such as notifying the proper regulatory agency, should be taken.
16
• Applications
– Situation 3: An analyst lives or works in a foreign
country or works with foreign firms outside the
analyst’s own country.
• The analyst is covered by the stricter of the following laws and
rules: his own country, the foreign country, or AIMR’s Code
and Standards.
• E.g. An analyst mistakenly believes that only her own nation’s
less strict laws apply to her behavior when dealing with clients
living in more strict countries. Standard I(A) has been violated.
17
• Compliance Procedures:
I(A): Members can acquire and maintain knowledge about
applicable laws, rules, and regulations in the following
ways:
– Maintain current files on applicable statutes, rules,
regulations and important cases in readily accessible
manner.
– Keep informed about changes in these laws, rules,
regulations and case law.
– Review written compliance procedures on a regular
basis.
18
I(B): When members suspect others of planning or
engaging in ongoing illegal activities, they should
– Consult counsel to determine if the conduct is, in fact,
illegal.
– Dissociate from any illegal or unethical activity.
Note:
– Inaction combined with continuing association with those involved
in illegal conduct may be construed as illegal conduct.
– The Code and Standards do not require that members report legal
violations to the appropriate governmental or regulatory
organizations, but such disclosure may be prudent in certain
circumstances.
19
Note (Cont’d):
– If advice of counsel is sought and it turns out to be erroneous, the
fact that the professional made a good faith effort not to violate the
Code, Standards, or the law may be used as a defense against
charges that he or she violated this Standards provided that:
• The advice was sought from someone that was competent to
render it (i.e., a specialist in the relevant law).
• All the relevant facts were told to counsel.
• The advice was followed without material deviations.
• The professional had no reason to believe that the counsel’s
advice was erroneous.
20
Standard II: Relationship with and
Responsibilities to the Profession
21
Standard II: Relationship with and
Responsibilities to the Profession
• Three Standards of Relationship with and

Responsibilities to the Profession:
 II(A) Use of Professional Designation
 II(B) Professional Misconduct
 II(C) Prohibition against Plagiarism
22
Standard II (A): Use of Professional Designation
• II(A.1): AIMR member may reference their membership

only in a dignified and judicious manner. The use of the
reference may be accompanied by an accurate explanation
of the requirement that have been met to obtain
membership in these organizations.
23
Standard II (A): Use of Professional Designation
• II(A.2): Those who have earned the right to use the

Chartered Financial Analyst designation may use the
marks “Chartered Financial Analyst” or “CFA” and are
encouraged to do so, but only in a proper, dignified, and
judicious manner. The use of the designation may be
accompanied by an accurate explanation of the
requirements that have been met to obtain the right to use
the designations.
• Note: No partial designation.
24
Standard II(A): Use of Professional Designation
• II(A.3): Candidates in the CFA Program, as defined in the
AIMR Bylaws, may reference their participation in the CFA
Program, but the reference must clearly state that an
individual is a candidate in the CFA Program and cannot
imply the candidate has achieved any type of partial
designation.
25
In Sum
• II(A): Use the CFA designation correctly.
• II(A) limits the use of the CFA designation for those who
have passed all three levels of the CFA program. There is
no designation for someone who has passed one or more
levels of the exam.
• To say they are candidates, they must be registered to take
the next scheduled CFA exam.
• CFA candidates cannot state when they expect to receive
the CFA charter.
26
• Application
– Situation 1: Advertisements relating to CFA
Charterholders
• Advertisements should be limited to a statement of fact
regarding the designation.
• E.g. Advertisements cannot mention that an individual passed
all three exams on the first try or that the designation implies
superior performance capabilities.
– Situation 2: Advertisement relating to CFA Candidates
• To be a candidate for the CFA designation, the individual must
be enrolled to take the next scheduled exam.
27
– Only the CFA mark or the words “Chartered Financial Analyst”
should appear after the charterholder’s name.
– The designation cannot be listed in a type set larger than that used
for the charterholder’s name.
– Description of the designation should be limited to a concise
description of the requirement and/or organization conferring the
designation, and the use of the CFA designation should not be used
in any way to mislead employers, clients, prospects, or the public.
– Candidate may state that they are Level I (II or III) candidates if
they registered for the next exam.
– The “CFA” designation should only be as an adjective and never as
a noun or in pluralized form “CFAs”. A person is a CFA
charterholder, not a CFA.
– To indicate the current membership, one must complete the CFA
program, abide by AIMR’s Professional Conduct Program and
maintain active membership in AIMR (and pay all dues!).
28
Standard II(B): Professional Misconduct
• II(B.1): Members shall not engage in any professional

conduct involving dishonesty, fraud, deceit, or
misrepresentation or commit any act that reflects adversely
on their honesty, trustworthiness, or professional
competence.
• II(B.2): Members and candidates should not engage in any
conduct or commit any act that compromises the integrity
of the CFA designation or the integrity or validity of the
examinations leading to the award of the right to use the
CFA designation.
29
In Sum
• Standard I addresses the overall obligation to comply
with laws and rules governing your professional
activities. Standard II(B) extends beyond technical
compliance.
• Standard II(B) concerns personal integrity and behavior
that reflect adversely on the entire profession.
• Violations of Standard II(B) include felony convictions
or dishonest activities (even if not related to
professional activities) that reflect negatively and
poorly on professional conduct and competence.
• II(B): Be honest, even in your personal life.
30
• Applications
– Situation 1: Poor personal behavior
• E.g. Excessive lunchtime drinking and being intoxicated at
work.
– Situation 2: Misdemeanor convictions
• Multiple minor convictions suggest a gross disregard for the
law and reflect poorly on your competent, judgment and
performance.
• E.g. Minor stealing or drug-related offenses.
– Situation 3: Unprosecuted behavior
• Any activities that involve dishonesty, fraud, or
misrepresentation is a violation of Standard II(B), even in the
absence of a criminal conviction.
• E.g. Altering receipts, taking kickbacks, and arranging for
unrecognized fee splitting.
– Situation 4: Cheating or helping others cheat on CFA exam
31
Member should encourage their employers to:
– Make clear that dishonest personal behavior reflects
poorly on the profession.
– Adopt a code of ethics to which every employee must
subscribe.
– Conduct background checks on potential employees to
ensure that they are of good character and eligible to
work in the investment industry.
32
Standard II(C): Prohibition against Plagiarism
• II(C): Members should not copy or use, in substantially the

same form as the original, material prepared by another
without acknowledging and identifying the name of the
author, publisher, or source of such material. Members
may use, without acknowledgment, factual information
published by recognized financial and statistical reporting
services or similar sources.
33
In Sum
• II(C): Do not plagiarize.
• Plagiarism is taking a research report or study done by
another firm or person without citing the original analysts
and releasing the material as one’s own original analysis.
• Plagiarism is not acting with integrity.
• Violations of Standard II(C) also include:
– Citing quotes attributable to “investment experts”
without specific reference.
– Presenting statistical forecasts, charts, graphs, or
methodologies prepared by others without stating the
sources. 34
• Applications:
– Situation 1: Adding or improving on an existing report
from outside the firm without specific reference
– Situation 2: Modifying another analyst’s mathematical,
computerized, or quantitative model
• E.g. Adjusting someone else’s model does not create a new
model and the revising analyst must cite the original source of
model.
– Situation 3: Present the firm’s own research
• E.g. Representative of a firm does not need to attribute the
source to the firm’s research own staff.
35
– Maintain copies of any materials prepared by others
that were relied on in preparing a report.
– Attribute quotations (including table, projection, and
new methodologies) used other than those from
recognized financial and statistical reporting services.
– Attribute the source when paraphrasing or summarizing
materials prepared by others.
36
Standard III: Relationship with and
Responsibilities to the Employer
37
Standard III: Relationship with and
• Five Standards for Relationship with and
– III(A) Obligation to Inform Employer of Code and
Standards
– III(B) Duty to Employer
– III(C) Disclosure of Conflicts to Employer
– III(D) Disclosure of Additional Compensation
Arrangements
– III(E) Responsibilities of Supervisors
38
Standard III(A) Obligation to Inform Employer
of Code and Standards
• III(A.1): Members shall inform their employer in writing,
through their direct supervisor, that they are obligated to
comply with the Code and Standards and are subject to
disciplinary sanctions for violations thereof.
• III(A.2): Members shall deliver a copy of the Code and
Standards to their employer if the employer does not have
a copy.
• Note: This procedure is not necessary only if the employer has stated,
in writing, that the firm’s policies already include AIMR’s Code and
Standards.
39
In sum
• III(A): Inform your employer about the Code and the
Standards.
• III(A) requires members to notify their employer
(immediate “direct” supervisor) in writing (form of
communication that can be documented, even email) of the
Code and Standards that control members’ professional
practices.
40
• Applications
– Situation: An analyst’s boss tells her to do something
violating the Code and Standards
• Members should not assume that their supervisors, even they
may be AIMR members, are aware of their obligation to obey
the Code and Standards.
41
– Members should notify their immediate supervisors in
writing of the Code and Standards and the member’s
responsibility to follow them.
– Members should also make a written request that the
Code and Standards be adopted and disseminated
throughout the firm.
– Members who are supervisors should inform new
employees about the high degree of ethical conduct
expected of them.
42
Standard III(B) Duty to Employer
• III(B): Members shall not take any independent practice

that could result in compensation or other benefit in
competition with their employer unless they obtain written
consent from both their employers and the persons or
entities for whom they undertake independent practice.
43
In Sum
• III(B): Do not do “outside” work without your employer’s
written approval.
• III(B) requires members to secure written permission
from both their employers and the outside firms to whom
members sell their services but not stopping members
entering into an independent business or consulting
agreement.
• Activities that may violate III(B):
– Misappropriation of trade secrets; misuse of confidential
information; conspiracy to bring about a mass resignation of other
employees; self-dealing (i.e., appropriating for oneself a business
opportunity or information that belongs to the employer);
misappropriation of clients or clients lists.
44
• Applications
– Situation 1: Consult on your own time
• Also require the written consent from both employers and clients.
– Situation 2: As an independent investment advisor and
get hired by a brokerage firm
• Need to obtain your employer’s written consent and disclose the
new job in writing to your clients if you want to keep your
existing clients for yourself.
– Situation 3: Starting your own firm
• Before leaving current job, you are in violation of III (B) if you:
– solicit your employer’s clients,
– take home client lists, investment statements, marketing
presentations, or
– copy your employer’s computer models or other property.
45
– When participating in independent practice for
compensation, members should provide written
statements to their employer regarding the types of
services offered, the expected duration of the service,
and the compensation.
– Members should disclose to their prospective clients the
identity of their primary employers, the fees the
primary employer would charge for the same service,
and clearly state that they would be performing
independently of their employers. No services should
be rendered until the client gives written
acknowledgment indicating he/she has read and
understood the written disclosure.
– Members seeking new employment should not contact
exiting clients or potential clients prior to leaving their
employer. 46
Standard III(C) Disclosure of Conflict to
Employer
• III(C.1): Members shall disclose to their employer all
matters, including beneficial ownership of securities or
other investments, that reasonably could be expected to
interfere with their duty to their employer or ability to
make unbiased and objective recommendations.
• III(C.2): Members shall comply with any prohibition on
activities imposed by their employers if a conflict of
interest exists.
47
Employer
In Sum
• Standard III(C) requires that members obey the firm’s
internal directives and use their own judgment concerning
conflicts that are not covered by their employer’s
guidelines.
• Standard III(C): Disclose conflicts of interests to
employers, clients, and prospects so that their impact can
be assessed and a decision on how to resolve the conflict
be made.
48
Employer
• Applications
– Situation 1: An analyst makes personal trades in
violation of existing company policy
– Situation 2: An analyst fails to inform her employer of
an action that may conflict with the employer’s interest
• E.g. Acting as a trustee of a foundation or charity.
– Situation 3: Direct trades to a brokerage firm even if it
conflicts with the employer’s and/or client’s interest
49
Employer
– Report to employers any beneficial interest and any
special relationship, such as corporate directorships,
that may reasonably be considered a conflict of interest
with their responsibilities.
– Discuss the situation with their firm’s compliance
officer before taking any action that could lead to a
conflict of interest.
50
Standard III(D) Disclosure of Additional
Compensation Arrangements
• III(D): Members shall disclose to their employer in writing
all monetary compensation or other benefits that they
receive for their services that are in addition to
compensation or benefits conferred by a member’s
employer.
51
In sum
• III(D): Disclose all income from an “outside” job.
• Direct compensation: Compensation and benefits are given
by clients.
• Indirect compensation: Compensation and benefits are
received from third party.
• Members should disclose in writing outside
compensation/benefits to employers because these benefits
may affect members’ loyalties and objectivity and create
potential conflicts of interest.
• No arrangement to work for a third party may be entered
into without the employer’s approval.
52
• Applications
– Situation 1: A client offers the portfolio manager an
incentive, such as free vacation, based on performance
of a portfolio
• This arrangement could cause the portfolio manager to pay
undue attention to that client’s account, to the detriment of
other clients.
– Situation 2: An investment manager received a free
membership in a club in exchange for financial advice
offered to the club
• The manager still violates the standard III(D) if she does not
report to supervisor even if there is no monetary compensation.
53
– Members should immediately file a written report to
their employers when receiving benefits in addition to
what their employer is to give them.
– The report includes (1) the source, the description and
the amount of compensation and (2) the duration of the
agreement.
54
Standard III(E) Responsibilities of Supervisors
• III(E): Members with supervisory responsibilities,

authority, or the ability to influence the conduct of others
shall exercise reasonable supervision over those subject to
their supervision or authority to prevent any violation of
applicable statutes, regulation, or provisions of the Code
and Standards. In doing so, members are entitled to rely on
reasonable procedures designed to detect and prevent such
violations.
55
In sum
• III(E): Supervisors must supervise their subordinates. Supervisors must
exercise their responsibility with respect to both persons who hold and
do not hold the CFA designation.
• III(E) requires member with supervisory responsibility to exercise
reasonable supervision by establishing and implementing written
compliance procedures and ensuring these procedures are followed
through periodic review.
• While it is not a violation if a supervisory member is unable to detect
violations that occur, the supervisor should bring an inadequate
compliance system to the attention of the firm’s senior managers and
recommend corrective action.
• If a member cannot discharge supervisory responsibilities because of
poor or nonexistent compliance system, the member should decline in
writing to accept supervisory responsibilities until the firm adopts an
adequate system.
56
• Applications
– Situation 1: Lack of control
• A supervisor fails to exercise adequate supervision.
• E.g. Because of time pressure, a supervisor fails to check
whether an analyst’s investment recommendations are
supported by a reasonable and adequate basis.
– Situation 2: Conflict between the supervisor’s (or firm’s)
self-interest and supervisory responsibility
• E.g. Proper supervision is not exercised because the
supervisor’s income is partially based on improper trading
activities.
57
– Adequate compliance procedures should:
• Be easy to understand.
• Define a compliance officer who has the
enforcement authority and responsibility.
• Implement a system of checks and balances.
• Outline the scope of the procedures, permissible
conduct, and procedures for reporting violations and
sanctions.
58
– Once a compliance program is established,
supervisor and compliance officer should:
• Disseminate the compliance procedures to the
covered staff.
• Periodically update the procedures so that they
comply with the law.
• Continually educate the staff and issue periodic
reminders.
• Incorporate a professional conduct evaluation into
the employee’s performance review.
• Review employee actions to ensure compliance and
identify violators. 59
– When a violation is discovered, a supervisor
should:
• Respond promptly to the violation.
• Conduct thorough investigation.
• Place appropriate limitations on the wrongdoer until
the investigation is complete.
60
Standard IV: Relationships with and
Responsibilities to Clients and Prospects
61
• Standards of Relationships with and
– IV(A) Investment Process
• IV(A.1) Reasonable Basis and Representations
• IV(A.2) Research Reports
• IV(A.3) Independence and Objectivity
62
• Standards of Relationships with and
– IV(B) Interactions with Clients and Prospects
• IV(B.1) Fiduciary Duties
• IV(B.2) Portfolio Investment Recommendations and Actions
• IV(B.3) Fair Dealing
• IV(B.4) Priority of Transaction
• IV(B.5) Preservation of Confidentiality
• IV(B.6) Prohibition against Misrepresentation
• IV(B.7) Disclosure of Conflicts to Clients and Prospects
• IV(B.8) Disclosure of Referral Fees
63
Standard IV(A.1) Reasonable Basis and
Representations
• IV(A.1): Members shall:
– Exercise diligence and thoroughness in making
investment recommendations or in taking investment
actions.
– Have a reasonable and adequate basis, supported by
appropriate research and investigation, for such
recommendations or actions.
– Make reasonable and diligent efforts to avoid any
material misrepresentation in any research report or
investment recommendation.
– Maintain appropriate records to support the
reasonableness of such recommendations or actions.
64
Representations
In Sum
• IV(A.1): Back up recommendations with good reasons; do not make
misrepresentations; and keep good records. E.g., it would be
unprofessional to compare financial ratios prepared under different
accounting rules without some attempt to make them comparable.
• IV(A.1) requires members to establish a reasonable basis for every
investment recommendation, exercise diligence in avoiding any
material misrepresentation, and maintain such records and documents
as are appropriate to support their recommendations.
• Members should ensure that any research report finding is accurate.
Members should not use any information from a source he/she has
reason to suspect that it is not accurate.
• Members have the obligation to consider an individual transaction
within the context of a client’s entire portfolio. This includes the
client’s needs and preferences.
65
Representations
• Applications
– Situation 1: Inappropriate Investments
• E.g. A manager fails to consider each specific investment
within the context of the entire portfolio, such as fail to use
derivatives to hedge risk, fail to consider liquidity of the
investment, or fail to consider foreign exchange risk.
– Situation 2: Turning optimism into certainty
• E.g. An analyst attends an optimistic company meeting and
then writes a research report misrepresenting the optimism by
turning it to certainty.
– Situation 3: Poor research
• E.g. The analyst overhears a conversation and bases a
recommendation on this information.
66
Representations
– Analyze the investment’s basic characteristics. Records
must show the characteristics of the investment (e.g.,
quality rating) and the basis for the recommendation
(quantitative, fundamental, technical, etc).
– Develop and review investment objectives. Analyze the
needs of the portfolio. This include both the needs of
the client and the total portfolio (rather than security-
by-security basis).
– Maintain files to support investment recommendations.
67
Standard IV(A.2) Research Reports
IV(A.2): Members shall:

a) Use reasonable judgment regarding the inclusion or
exclusion of relevant factors in research reports.
b) Distinguish between facts and opinions in research
reports.
c) Indicate the basic characteristics of the investment
involved when preparing for public distribution a
research report that is not directly related to a specific
portfolio or client.
68
In sum
• IV(A.2): Put all relevant facts in research reports; distinguish
facts from opinions; and indicate the basis characteristics of
investments. Capsule recommendations (such as “buy” or “sell”
list) must be supported by background reports or data that are
available to interested parties.
• IV(A.2b) requires that opinions be separated from fact. When
using the past to forecast the future, you must state your
opinions are subject to future events. The most common
violation is the failure to separate the past from the future.
Note that:
• A report needs not be in written form. It could be given in
person, over the phone, or even by computer transmission
(internet).
• Any limitation of analysis should be outlined and all
investment risks mentioned.
69
• Applications
– Situation 1: Investment characteristic are not included
in the report
• E.g. The analyst leaves out the complications of the evaluation
process to simplify his report, or mentions only the upside
potential but not the downside risk of an investment strategy.
This is a violation because in this case the client cannot fully
understand the process and logic behind the recommendation
to implement the recommendation effectively.
– Situation 2: The analyst uses sloppy language in a
report
• E.g. The analyst estimates a sales figure and then in her report
uses language such as, “ based on the fact that sales are such
and such.” This is a violation because the analyst must always
separate fact from opinion.
70
– Members should include in research reports with:
• Expected annual rate of return, calculated on a total return
basis (i.e., include both interest/dividend income and change in
market value).
• Annual income expectations.
• Current rate of return or yield.
• The degree of uncertainty associated with the cash flows and
other risk factors.
• The investment’s marketability or liquidity.
71
– With respect to company analysis, members should
determine:
• The nature of a company’s earning power
• Cash flow
• Dividend potential
• Operating and financial strength and viability
72
Standard IV(A.3) Independence and Objectivity
IV(A.3): Members shall use reasonable care and judgment

to achieve and maintain independence and objectivity in
making investment recommendations or taking investment
action.
Notes:
• Objectivity means unbiased.
• Independence means not influenced by others.
• Independence in fact and in appearance.
• Members should avoid situations that might cause, or be perceived to
cause, a loss of independence.
73
In Sum
– IV(A.3): Maintain independence and objectivity.
– IV(A.3) requires members to avoid situations that
might cause a loss of independence or objectivity in
recommending investments or taking investment
actions.
Note that:
– Gifts from clients can be distinguished from gifts given
by entities seeking to influence member to the possible
detriment of clients.
• Gift from clients in excess of US$100 may be accepted but
must be disclosed to the member’s employer.
– Gifts in a client relationship are considered less likely
to affect a member’s objectivity and independence.
– No gift from non-client, such as companies they
analyze. 74
Applications
– Situation 1: Perks.
• E.g. An analyst receives a vacation gift from a firm to which he
directed trades without notifying her supervisor. This is a triple
violation: the value of the gift exceeds US$100, the gift came
from a non-client, and the giver is trying to influence the
analyst’s behavior.
– Situation 2: Client/analyst conflict.
• E.g. An analyst should not be asked to recommend securities to
help dispose of the firm’s inventory.
– Situation 3: Integrity of opinions.
• E.g. An analyst is given a security to review but is told not to
change the current “buy” recommendation. The analyst’s
recommendation should be her own independent and objective
view. If the analyst does not concur with the buy
recommendation, she should not cover the security.
75
Compliance Procedures:
– Protect integrity of opinions. Reports should reflect the analyst’s
unbiased opinion.
– Disclose all corporate relationships (i.e., directorships,
underwriting arrangements, or acting as a market maker) that
might be perceived to cause a loss of independence.
– Disclose personal holdings and beneficial ownerships.
– Create a restricted list. Firms that pose a conflict should be put on a
restricted list, thus not covered by analysts.
– Restrict special cost arrangements. Members should pay for their
commercial transportation and hotel charges for site visits.
– Limit gifts. US$100 is the maximum acceptable value for a gift or
gratuity.
– Restrict investments. Strict limits should be imposed on private
placement (not objective, not via a public mechanism).
– If members are supervisor. Review procedures and encourage their
firms to supervise employee’s personal investment activities.
76
Standard IV(B.1) Fiduciary Duties
IV(B.1): In relationships with clients, members shall use

particular care in determining applicable fiduciary duty
and shall comply with such duty as to those persons and
interests to whom the duty is owed. Members must act for
the benefit of their clients and place their clients’ interests
before their own.
77
In sum
– A fiduciary is someone who acts for the benefit of
someone else and is in a position of trust.
– Fiduciaries owe undivided loyalty to their clients and
must place client’s interests before their own.
– If fiduciary has direct control or access to the clients’
assets, extra care must be taken, i.e., members should
• Submit to an independent audit at least once a year.
• Submit to each client an itemized statement showing the funds
and securities in custody at least quarterly.
• Disclose to the client where the assets are to be maintained.
• Separate the client’s assets from any other party’s assets.
– IV(B.1): Know and carry out your fiduciary duties.
78
Applications
– Situation 1: Undivided loyalty
• E.g. A manager acts in a way that benefits the pension plan’s
sponsor rather than the beneficiaries of the plan. (Buying the
sponsoring company’s stock with the pension’s funds to
support the stock’s price.)
– Situation 2: Directing brokerage services
• E.g. It is a breach of the Standards when obtaining non-
research services that do not directly benefit the clients.
• Note that a manager receives research that does not directly
benefit the account being traded is permitted provided that the
best prices and executions are received and the practice is
disclosed to the client.
79
– Follow all applicable rules and laws governing
fiduciary duty.
– Establish the investment objectives of the client.
– Diversify.
– Deal fairly with all clients with respect to investment
actions. E.g., if a block of stock is purchased, allocate
to all clients on pro-rata basis at the same price.
– Disclose all possible conflicts of interest.
– Disclose compensation arrangements.
– Preserve the confidentiality of client information.
– Maintain loyalty to the plan beneficiaries.
80
Standard IV(B.2) Portfolio Investment
Recommendation and Actions
IV(B.2): Members shall:
a. Make a reasonable inquiry into a client’s
financial situation, investment experience, and
investment objectives prior to making any
investment recommendations and shall update
this information as necessary, but no less
frequently than annually, to allow the members
to adjust their investment recommendations to
reflect changed circumstances.
81
b. Consider the appropriateness and suitability of
investment recommendations or actions for each
portfolio or client. In determining appropriateness and
suitability, members shall consider applicable relevant
factors, including the needs and circumstances of the
portfolio or client, the basic characteristics of the
investment involved, and the basic characteristics of the
total portfolio. Members shall not make a
recommendation unless they reasonably determine that
the recommendation is suitable to the client’s financial
situation, investment experience, and investment
objectives. 82
c. Distinguish between facts and opinions in the
presentation of investment recommendations.
d. Disclose to clients and prospects the basic
format and general principles of the investment
processes by which securities are selected and
portfolios are constructed and shall promptly
disclose to clients and prospects any changes
that might significantly affect those processes.
83
In sum
– IV(B.2): Know what is suitable for your clients; tell the
client your basic methodology.
– IV(B.2) requires members to carefully consider the
appropriateness and suitability of an investment action
to the needs and circumstances of their clients.
– The most important factor to be considered in matching
appropriateness and suitability of an investment with a
client’s needs and circumstances is measuring the
client’s risk tolerance.
84
Applications
– Situation 1: Investment-related topics
• E.g. An analyst must acquaint the client with both downside
risks and upside potential.
• E.g. When determining the suitability of an investment, the
primary focus should be on the characteristics of the entire
portfolio, not on the specific issue under study.
– Situation 2: Disclosure
• E.g. Clients must be made aware before a portfolio changes its
scope, focus, or valuation methodology.
85
– Know the basic nature of your client.
– Determine your client’s objectives:
• Return objectives (income, capital gains, preserve purchasing
power, etc)
• Risk tolerances (high, medium, low)
– Determine your client’s constraints:
• Liquidity needs
• Time horizon
• Tax considerations
• Regulatory and legal circumstances
• The client’s preferences, circumstances, and unique needs
86
Standard IV(B.3) Fair Dealing
IV(B.3): Members shall deal fairly and objectively with all

clients and prospects when disseminating investment
recommendations, disseminating material changes in prior
investment recommendations, and taking investment action.
87
In Sum
• IV(B.3): Treat clients fairly.
• “Fairly” implies that when disseminating investment
recommendations (e.g. from buy to sell), members should
take care not to discriminate against a client.
• Note that the standard does not require “equally” because of
the impossibility of contacting all clients simultaneously.
• IV(B.3) requires that investment recommendations or material
changes (anything that would change an investment decision)
in prior recommendations should be communicated to :
– Clients known to have purchased or to hold the securities.
– Persons placing orders contrary to the current recommendation.
• Clients in discretionary accounts should be treated the same as
those who are not in discretionary accounts. New issues and
secondary offerings should be allocated to all on a pro rata
basis. 88
Applications
– Situation 1: Dissemination of recommendations
• E.g. An analyst announces to a client or group of clients that he
will be issuing a buy or sell recommendation in the next few
days. IV(B.3) requires that the analyst send the information out
to everyone first, then discuss it with clients.
– Situation 2: Order placement
• E.g. A manager purchased shares for his firm’s inventory
account before the firm’s buy recommendation is released.
IV(B.3) prohibits trading ahead of research reports.
• Note that transactions for clients should take precedence over
transactions that benefit the firm, its officers, or employees.
89
– Limit the number of people privy to recommendations and changes.
– Shorten the time frame between initiation and dissemination.
– Publish personal guidelines for pre-dissemination.
– Execute simultaneous dissemination.
– Establish rules about employee trading activities.
– Establish procedures for determining material changes.
– Maintain a list of clients and their holdings.
– Develop trade allocation procedures (e.g., take orders in first-
come-first-serve basis).
– Make sure one account is not being used to bail out other accounts
from bad investment.
– If the firm offers differing levels of service, this fact should be
disclosed to all clients.
90
Standard IV(B.4) Priority of Transactions
IV(B.4): Transaction for clients and employers

shall have priority over transaction in securities
or other investments of which a member is the
beneficial owner so that such personal
transactions do not operate adversely to their
clients’ or employer’s interests. If members make
a recommendation regarding the purchase or
sale of a security or other investment, they shall
give their clients and employer adequate
opportunity to act on the recommendation before
acting on their own behalf .
91
For purpose of the Code and Standards, a member is
a “beneficial owner” if the member has:
a. a direct or indirect pecuniary interest in the
securities.
b. the power to vote or direct the voting of the
shares of the securities or investments.
c. the power to dispose or direct the disposition of
the security or investment.
92
In sum
• IV(B.4): Transaction priority belongs to the client and
employer.
• IV(B.4) covers the activities of all members who have
knowledge of pending transaction that may be made on
behalf of their clients or employers.
• A member may undertake transactions in accounts for
which the member is a beneficial owner only after the
member’s clients and employer have had an adequate
opportunity to act on the recommendation.
• Personal transactions include those made for the member’s
own account, family accounts, and accounts in which the
member has a direct or indirect pecuniary interest.
93
Applications
– Situation 1: Non-action
• E.g. An analyst does not change a recommendation from buy
to sell so he can sell the stock.
– Situation 2: Deceit
• E.g. An analyst buys stocks just before they are put on the
firm’s recommended buy list.
– Situation 3: Fast action
• E.g. Firm members wait to trade until after the firm’s buy/sell
recommendations are announced but before their clients have
time to act.
– Situation 4: Excess caution
• E.g. Trades are not made for a member’s relative account that
he/she has no beneficial ownership until all other accounts
with the firm are traded. IV(B.4) requires that personal client
accounts should be treated like other accounts. 94
– Define personal transaction (make sure employees understand).
– Define covered investments (securities and its call or put options).
– “Firewalls” (i.e., physical and procedural barriers) should be built
to flow of information from one group or department to other
groups within the firm. E.g., it will be both illegal and unethical for
a research department to inform its trading department of its new
recommendation or changes in opinion before the same
information is made available to the client base.
– Define prohibited transactions (especially IPOs that are over-
subscribed) in which special treatment may be likely.
– Establish reporting procedures and prior-clearance requirements
(when the firm want to liquidate some inventory).
– Ensure that procedures will be enforced and establish disciplinary
procedures.
95
Standard IV(B.5) Preservation of Confidentiality
IV(B.5): Members shall preserve the confidentiality of

information communicated by clients, prospects, or
employers concerning matters within the scope of the
client-member, prospect-member, or employer-member
relationship unless the member receives information
concerning illegal activities on the part of the client,
prospect, or employer.
96
In sum
• IV(B.5): Keep client and employer information confidential.
• IV(B.5) is applicable when the member receives information
on the basis of his or her special ability to conduct a portion
of the client’s business, and that portion of the client’s
business is the subject of the special or confidential
relationship.
• The best approach is never to disclose information received
from a client or employer, except to authorized persons on a
“need to know” basis.
• A member may not hold back confidential client information
concerning the member’s activities from an AIMR
Professional Conduct Program (PCP) investigation into the
member’s behavior. Why? Because AIMR will keep the
client’s information confidential. 97
Applications
– Situation 1: Requests for confidential information
• E.g. An individual who claims to be a potential contributor of a
trust requests the trust’s financial information from an analyst
working with the trust.
– Situation 2: Use of confidential information
• E.g. A financial advisor tells a charity to solicit a client who
told the analyst that he is thinking about a contribution to a
charity.
– Situation 3: AIMR PCP investigations
• To keep AIMR from discovering his behavior, an analyst
claims he cannot reveal his client trading records to the PCP
committee.
98
– Avoid discussing any information received from a
client except to colleagues working on the same project.
99
Standard IV(B.6) Prohibition against
Misrepresentation
IV(B.6): Members shall not make any statements, orally,
or in writing, that misrepresent:
• the services that they or their firms are capable of
performing.
• their qualifications or the qualification of their firm.
• the member’s academic or professional credentials.
Member shall not make or imply, orally or in writing,
any assurances or guarantees regarding any investment
except to communicate accurate information regarding
the terms of the investment instrument and the issuer’s
obligation under the instrument.
100
Misrepresentation
In Sum
• IV(B.6): Do not give guarantees.
• Misrepresentation can be defined as giving a false or
misleading impression about something.
• IV(B.6) prohibits statements or assumptions that an
investment is “guaranteed” or that superior returns can be
expected in the future based on the member’s repeating
past success.
101
Misrepresentation
Applications
– Situation 1: Range of services
• E.g. An analyst says, “my firm can perform all the services you
need,” when, in fact, the firm can’t.
– Situation 2: Misstating one’s qualifications
• E.g. An analyst calls himself a portfolio management specialist
when, in fact, she is just a trainee.
– Situation 3: Promising performance
• E.g. An analyst says an investment is guaranteed to give you a
100% gain.
102
Misrepresentation
– Firms can provide guidance to employees who make
written or oral presentations to clients or prospects by
providing a written list of the firm’s available services
and a description of the firm’s qualifications.
103
Standard IV(B.7) Disclosure of Conflicts to
Clients and Prospects
IV(B.7): Members shall disclose to their clients and
prospects all matters, including beneficial ownership of
securities or other investments, that reasonably could be
expected to impair the member’s ability to make unbiased
and objective recommendations.
104
In sum
• IV(B.7) requires members to be aware of and disclose to
their clients the members’ material ownership of securities,
market-making and underwriting activities, corporate
finance relationships and directorships.
• Members should also disclose to their clients, with the
approval of their employer, any special compensation
arrangements they have with their employer that may
conflict with the interests of the client.
105
Applications
– Situation 1: Failure to disclose
• E.g. An analyst recommends a stock but does not disclose that
he is on the company’s board.
– Situation 2: Self-dealing
• E.g. A manger wants her firm’s analyst to recommend a
company’s stock in hopes of getting the management contract
for the company’s pension fund.
– Situation 3: Changing conditions
• E.g. An analyst recommending a stock just inherited a sizable
number of shares in the company’s stock. The analyst should
disclose his holdings in the next stock report.
106
- Members should:
• report to their employers, clients, and prospects any
material beneficial interest they may have in securities,
corporate directorships, or other special relationship
they may have with the companies they are
recommending.
• make the disclosures before they make any
recommendations or take any investment action
regarding these investments.
107
Standard IV(B.8) Disclosure of Referral Fees
IV(B.8): Members shall disclose to clients and prospects

any consideration or benefit received by the member or
delivered to others for the recommendation of any services
to the client or prospect.
108
In sum
• IV(B.8): Disclose referral fees.
• Appropriate disclosure means telling the client or prospect,
before agreeing to perform services, of any benefit given
or received for recommending the member’s services.
• Such disclosure will help the client
– evaluate any partiality shown in any recommendation
of services; and
– evaluate the full cost of the services.
109
Applications
– Situation: Full disclosure
• E.g. A has an agreement with B that A will recommend
prospective pension and endowment clients to B. For this
service, B will give A free research and direct all trades
generated by the referrals back to A for execution.
110
– Disclose all agreements in writing to any client or
prospect who has been referred.
– Describe in the disclosure the nature of the
consideration and the estimated dollar value of the
consideration.
– Consult a supervisor and legal counsel concerning any
prospective arrangement regarding referral fees.
111
Standard V: Relationships with and
Responsibilities to the Investing Public
112
Standard V: Relationships with and
Two standards of Relationships with and
• V(A) Prohibition against Use of Material
Nonpublic Information
• V(B) Performance Presentation
113
Standard V(A): Prohibition against Use of
Material Nonpublic Information
V(A): Members who posses material nonpublic
information related to the value of a security shall not
trade or cause others to trade in that security if such
trading would breach a duty or if the information was
misappropriated or relates to a tender offer. If members
receive material nonpublic information in confidence, they
shall not breach that confidence by trading or causing
others to trade in securities to which such information
relates. Members shall make reasonable efforts to achieve
public dissemination of material nonpublic information
disclosed in breach of a duty.
114
In sum
• V(A): Do not use material nonpublic information.
• V(A) prohibits a member from taking investment action on the
basis of information that the member knows was disclosed by a
person (tipper) conveying the information in violation of a
confidence or in breach of a duty.
• Even if no duty is breached, a member violates this standard by
taking investment action or passing on material nonpublic
information that the member knows has been misappropriated.
• Members should not trade or cause other to trade in a security
while the member possesses material nonpublic information
relating to a tender offer regarding that security.
– Two exceptions:
• The action involves the purchase of securities on behalf of the entity that is
making the tender offer.
• The action involves the sales of securities to the proposed tender offeror.
115
In sum
• Information is “material” if its disclosure would be likely
to have impact on the price of a security or if reasonable
investors would want to know the information before
making an investment decision.
• Material is “nonpublic” until it has been disseminated to
the marketplace.
116
In sum
• A tipper is breaching a fiduciary duty if he personally
benefits directly or indirectly from the disclosure. Three
types of personal benefits are:
– Pecuniary benefit or a reputational benefit that will
translate into future earnings for the tipper.
– A quid pro quo relationship between the insider and the
recipient of the information.
– A gift of confidential information to, for example, a
relative.
117
In sum
• Taking a large amount of immaterial and publicly available
facts from various sources and fitting them together to
form a complete and significant picture of a corporate
situation is called the Mosaic Theory.
• Mosaic Theory: A good analyst may be able to predict a
corporate action or event based on a perspective assembly
and analysis of material public information or immaterial
nonpublic information. The analyst may use this
information to make investment decisions and make profit
from his research efforts.
118
In sum
• General rules:
1. If you receive the information through your employment, you
are an insider and have a fiduciary duty not to use or disclose it.
2. If you receive it from someone else, who is breaching his/her
fiduciary duty, you should make a reasonable effort to have it
disclosed.
3. Information received on a selective basis from an insider, who is
not breaching his/her fiduciary duty, may be traded but you do
so on your own risk.
4. If you receive the information from a public forum, it has been
disseminated, you can trade on it.
5. If you figure out yourself, you can use it.
119
Applications
– Situation 1: Loose conversations
• E.g. An analyst fails to provide privacy during a telephone
conference call where nonpublic information is discussed.
Firm’s members, who overheard the conversation,
subsequently trade for their client’s accounts. The analyst has
violated V(A) due to lack of adequate procedures to protect the
material nonpublic information.
– Situation 2: Tender offers
• E.g. A CEO tells her brother that she will accept a high priced
tender offer to buy out her firm. The brother tells his broker,
who buys the stock. Even though the broker had no reason to
believe a duty was breached in the transmission of the
information, he violated V(A) because the trade involved
nonpublic information regarding a tender offer.
120
Applications
– Situation 3: Misappropriated information
• E.g. A magazine employee trades on information
contained in one of the magazine’s weekly
investment columns that has not yet been published.
121
– The most common approach to prevent insider
trading by employees is an information barrier
or “firewall” to prevent the flow of information.
The minimum elements of a firewall are:
• Control over interdepartmental communications.
• Review employee trading against “watch,”
“restricted,” and “rumor” lists.
• Restrict proprietary trading while the firm is in
possession of material nonpublic information.
122
– Additional procedures typically used with an
information barrier are:
• Restrict personal and proprietary employee trading.
• Place securities on a restricted list when the firm has
material nonpublic information.
• Disseminate material nonpublic information only to
those with a need to know.
• Designate a supervisor who decides when
information is sufficiently public so that the
securities can be recommended and traded.
123
Standard V(B): Performance Presentation
V(B.1): Members shall not make any statement, orally or

in writing, that misrepresent the investment performance
that they or their firms have accomplished or can
reasonably be expected to achieve.
V(B.2): If members communicate individual or firm
performance information directly or indirectly to clients or
prospective clients, or in a manner intended to be received
by clients or prospective clients, members shall make every
reasonable effort to assure that such performance
information is a fair, accurate, and complete presentation
of such performance.
124
In sum
• V(B): Present your investment performance fairly and
accurately.
• Members are encouraged to adopt AIMR’s Performance
Presentation Standards (PPS) for reporting investment results.
• The PPS are voluntary standards and are intended to promote
full disclosure and fair representation in the reporting of
investment results.
• AIMR’s PPS consist of the following four sections:
– The construction and maintenance of composites (composites are
groups of portfolios or assets that are managed in a similar way)
– The calculation of (total) returns
– The presentation of investment results (e.g., a ten-year performance
record)
– Disclosures (all details, including list and description of composites
and management fees)
125
Applications:
– Situation 1: Misleading statements
• E.g. Based on the recent performance of one trust account, the
manager tells prospective clients that they should be able to
expect a certain return. A misstatement occurs because (i)
current performance results were used rather than long term
results, and (ii) performance was based on only one account
rather than a composite of all similarly managed accounts.
– Situation 2: Erroneous PPS claims
• E.g. A manager claims that returns were calculated in
accordance with AIMR’s PPS while actually they were not. In
particular, the composite’s returns were average-weighted
rather than size-weighted.
126
– Maintain data about the firm’s investment performance
in written form.
– Combine investment accounts into composites
according to investment class and risk groups.
127

Ethical and Professional Standards

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ethical and Professional Standards

Uploaded by

Copyright:

Available Formats

Ethical and Professional Standards

Dr. Derek K. Chan

• Five Categories of Professional Conduct Standards

• For each standard, focuses are

• I(A): Maintain knowledge of and comply with all

• Note: AIMR recognizes that a member may not realize there is a

• International Application of the Code and

• Applications: Distinguish between conducts that

• Three Standards of Relationship with and

• II(A.1): AIMR member may reference their membership

• II(A.2): Those who have earned the right to use the

• Note: No partial designation.

• II(B.1): Members shall not engage in any professional

• II(C): Members should not copy or use, in substantially the

• III(B): Members shall not take any independent practice

• III(E): Members with supervisory responsibilities,

IV(A.2): Members shall:

IV(A.3): Members shall use reasonable care and judgment

IV(B.1): In relationships with clients, members shall use

IV(B.3): Members shall deal fairly and objectively with all

IV(B.4): Transaction for clients and employers

IV(B.5): Members shall preserve the confidentiality of

IV(B.8): Members shall disclose to clients and prospects

V(B.1): Members shall not make any statement, orally or

You might also like