Reading - 2 - LOS a, b: Q82-Q87

82、In August 2005, the following events occurred related to Aggregate Opportunities, Inc.:

§ Aug. 8: The Wall Street Journal reported that Aggregate Opportunities had inflated its 2004 earnings due to questionable accounting practices. The story was based on interviews with unnamed sources within Aggregate and its auditor, Millennium Partners. On that day the stock fell 42 percent to $12.50 from $21.55.

§ Aug. 10: At 9 a.m., Aggregate revealed in a conference call to analysts a restatement of earnings for the previous three fiscal years that almost completely erased the reported net income for fiscal years 2002, 2003, and 2004. Aggregate’s chief financial officer personally selected the small group of analysts participating in this call. Company officers said the restatement resulted from questionable accounting practices for off-balance sheet limited partnerships. At 1 p.m., the company issued a news release containing the information provided in the conference call. By the end of the trading day the stock had fallen 74 percent to $3.25.

§ Aug. 11: At 10 a.m., Aggregate’s Chief Financial Officer Buster Lockhart, CFA, publicly announced his resignation, and the Securities and Exchange Commission said it was pursuing an investigation.

During July and August of 2005, the following actions were taken:

§ July 20: Michael Cho, CFA, a highly respected analyst with 25 years of experience covering Aggregate’s industry, had spent several days reading Aggregate’s 10-K and 10-Q documents and other analysis published by some of his competitors at major brokerage houses. Based on his reading and conversations with Aggregate management concerning nonmaterial, nonpublic information, Cho concluded that Aggregate had inflated its earnings. On July 20, Cho issued a detailed research report to his clients and concluded that Aggregate should be sold. He subsequently participated in the Aug. 10 conference call, although it only confirmed what he had already detailed in his July research report.

§ Aug. 2: Equity analyst Harold Black, a CFA charterholder, received from his brother information that Aggregate might restate its earnings. Black’s brother is a senior partner at Millennium Partners. Based on this information, Black immediately prepared a new research report that advised his clients to sell Aggregate, but did not liquidate his personal holdings in the company.

§ Aug. 4: Bob Watkins, a CFA Level II candidate and portfolio manager, was golfing at his club. Approaching the third tee, he heard the chief executive officer and chief financial officer of Aggregate discussing company finances. Concealing himself behind a tree, Watkins overheard them discussing the upcoming Wall Street Journal article and the earnings restatement. Based on this conversation, he immediately sold all Aggregate holdings in his clients’ portfolios. Later that day, Watkins told his friend Juan Martinez, CFA, what he learned about Aggregate and how he learned it. Martinez, a subscriber to Cho’s research, then read Cho’s report on Aggregate. Immediately after finishing Cho’s report, Martinez sold the fund’s entire stake in Aggregate. Watkins and Martinez were not participants in the Aug. 10 conference call.

§ Aug. 8: Barb Henderson, a CFA charterholder, read the Wall Street Journal article in the morning and immediately issued a sell recommendation for Aggregate. On Aug. 10, she participated in the conference call and heard the details of the earnings restatement.

§ Aug. 10: Lisa Sanders, CFA, participated in the Aggregate conference call. At 10 a.m., she changed her recommendation on Aggregate from hold to sell and informed all of her clients. At 1 p.m., Sanders sold Aggregate from her personal account.

In issuing a sell recommendation for Aggregate, Henderson:

A)   violated Standard V(B): Communication with Clients and Prospective Clients because she failed to distinguish between fact and opinion.

B)   violated Standard V(A): Diligence and Reasonable Basis because she lacked sufficient reason to justify the downgrade.

C)   violated none of the Standards.

D)   violated Standard II(A): Material Nonpublic Information because she took investment action prior to the analyst conference call.

The correct answer was C)

The information published in the Wall Street Journal was public information, so Henderson did not violate Standard II(A). While Henderson did not do any independent research, the Journal is a credible source, and even the hint of an accounting scandal can be enough to sink a stock. As such, using the story to justify a downgrade did not violate Standard V(A) or Standard V(B).

83、In selling his clients' holdings in Aggregate, Watkins:

A)   did not violate Standard II(A): Material Nonpublic Information because the information did not involve a tender offer.

B)   violated Standard II(A): Material Nonpublic Information by taking investment action.

C)   did not violate Standard II(A): Material Nonpublic Information because he had not yet earned his CFA designation and is not bound by the Standards.

D)   did not violate Standard II(A): Material Nonpublic Information because there was no breach of duty.

The correct answer was B)

Watkins violated the CFA Institute Standards because the information was both material and nonpublic. It does not matter if the information was not misappropriated, not received in a breach of duty or not related to a tender offer. Watkins still cannot trade or cause others to trade. CFA candidates are indeed subject to the CFA Institute Standards. While the misappropriated information did not involve a tender offer, Watkins’ use of it still violated the Standards simply because it was material nonpublic information.

84、In advising his clients to sell Aggregate, Black:

A)   violated Standard III(B): Fair Dealing because he did not take his own advice and sell the stock.

B)   violated Standard V(A): Diligence and Reasonable Basis because he did not have sufficient information to spur investment action.

C)   did not violate Standard I(B): Independence and Objectivity, but his supervisor violated Standard IV(C): Responsibilities of Supervisors.

D)   violated Standard VI(A): Disclosure of Conflicts because he did not tell his clients the tip came from his brother, and his brother violated Standard III(A): Loyalty, Prudence, and Care.

The correct answer was C)     

Black’s conduct does not violate Standard I(B), because a reasonable person would not call his independence into question, even though his ethics are suspect. Black’s supervisor should have asked Black where he got the information before the research report was circulated, and the failure to do so means that the supervisor violated Standard IV(C). Black is also clearly in violation of Standard II(A): Material Nonpublic Information, because he would clearly have known that the information received from his Brother was both material and nonpublic. However, Standard II(A) is not one of the choices. Black’s failure to follow his own advice does not violate Standard III(B). Ignoring all of the other details, knowledge that an earnings restatement is possible could certainly be considered a reasonable basis to dump a stock, so Black did not violate Standard V(A). Standard VI(A) pertains only when a relationship would impair investment judgment, and that is not the case here.

85、After changing her recommendation on Aggregate, Sanders:

A)   violated Standard II(A): Material Nonpublic Information by taking investment action based on information not accessible to the public.

B)   did not violate Standard II(A): Material Nonpublic Information because the information was disclosed to a select group of analysts.

C)   violated Standard VI(B): Priority of Transactions by trading Aggregate from her own account.

D)   violated Standard III(B): Fair Dealing by not disseminating the information to all clients and prospective clients equally.

The correct answer was A)     

The way in which Aggregate handled the conference call was an instance of selective dissemination, Members and Candidates must be aware that disclosure to selected analysts is not necessarily public disclosure. Thus, until the material information is made public, Sanders cannot trade or cause others to trade. Once the information is made public, Sanders must disseminate the information to her clients first, and give them adequate time to act on the recommendation before trading for her own account. In the absence of knowledge of any company policy with stricter requirements, 3 hours is probably sufficient, and we cannot assume she violated Standard VI(B). Standard III(B) does not require equal dissemination of information but rather fair dissemination. Nothing in the question indicated that Sanders disseminated the information unfairly.

86、In selling his fund's stake in Aggregate, Martinez:

A)   violated Standard III(A): Loyalty, Prudence, and Care by using information obtained from Watkins.

B)   violated Standard V(A): Diligence and Reasonable Basis because he failed to use sufficient diligence in his research.

C)   violated Standard II(A): Material Nonpublic Information by using information obtained from Watkins.

D)   violated no standards.

The correct answer was C)

Martinez was aware of how Watkins obtained the information; therefore, Martinez violated II(A) by trading on material nonpublic information. Martinez has no fiduciary duty to Watkins, and as such did not violate Standard III(A). It would be difficult to argue that Cho’s thorough research is not sufficient reason to trade Aggregate stock, so Martinez did not violate Standard V(A).

87、Which statement about violations of the Code and Standards is TRUE?

A)   Martinez did not violate the Standard regarding use of material nonpublic information and did not violate the fiduciary-duties standard.

B)   Cho did not violate the Standard regarding use of material nonpublic information, and neither did Watkins.

C)   Henderson violated the reasonable-basis standard, but Sanders did not violate the Standard regarding use of material nonpublic information.

D)   Aggregate’s CFO violated the fair-dealing Standard, but Black did not violate the fiduciary-duties Standard.

The correct answer was D)

Aggregate’s selective disclosure did violate the fair-dealing Standard, and while Black violated a number of Standards, his brother’s fiduciary duty cannot be imposed on him. Black did not violate the fiduciary-duties Standard. While Cho did not violate the insider-trading standard because he came to his conclusions through the mosaic method, Watkins certainly did because he misappropriated the information. Martinez violated the Standard on material nonpublic information. Henderson did not violate the reasonable-basis Standard. Sanders did violate the insider-trading Standard.