Reading 2-II: Standards of Professional Conduct & Guidan decided, position, 2010, class, center

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Session 1: Ethical and Professional Standards
Reading 2-II: Standards of Professional Conduct & Guidance: Integrity of Capital Markets

LOS B.: Market Manipulation.

 

 

 

Steve Waters, a CFA Level I candidate, has decided to enter into a long position of Farmco stock. Since Farmco is thinly traded, Waters is concerned the order will overwhelm the liquidity of Farmco and the price will surge. Waters engages in a series of block trades in order to accomplish the purchase. According to Standard II(B), Market Manipulation, Waters has engaged in:

A) transaction-based manipulation, but not information-based manipulation.

B) neither transaction-based manipulation nor information-based manipulation.

C) both transaction-based manipulation and information-based manipulation.

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Waters is not in violation of Standard II(B), Market Manipulation. Transaction-based manipulation includes, but is not limited to, transactions that artificially distort prices or volume. Information-based manipulation includes, but is not limited to, spreading false rumors about a firm in order to induce others to trade.

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Which of the following is a violation of Standard II(B), Market Manipulation?

A) Overstating an earnings projection in order to increase the price of a stock.

B) Implementing a trading strategy to exploit differences in market power and information.

C) Engaging in a block trade to limit the effect on the price of a thinly traded security.

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Standard II(B), Market Manipulation, is not intended to prohibit transactions that are done in order to minimize income taxes or trading strategies that are not intended to distort prices or artificially inflate trading volume. Overstating earnings projections in order to increase the price of a stock is a direct violation.

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Mark Williamson is “bearish” on ABC Manufacturing Company. Williamson is so convinced that ABC is overpriced, two weeks ago, he shorted 100,000 shares. Today, Williamson is “surfing” several popular investment bulletin boards on the internet and posting false derogatory comments about company management. According to Standard II(B), Market Manipulation, Williamson has engaged in:

A) transaction-based manipulation, but not information-based manipulation.

B) both transaction-based manipulation and information-based manipulation.

C) information-based manipulation, but not transaction-based manipulation.

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Williamson is in violation of Standard II(B), Market Manipulation, by engaging in information-based manipulation. Information-based manipulation includes, but is not limited to, spreading false rumors about a firm in order to induce others to trade.

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All of the following are violations of Standard II(B), Market Manipulation, EXCEPT:

A) exploiting differences in market inefficiencies.

B) securing a controlling interest in an equity security in order to influence the price of a related derivative instrument.

C) disseminating misleading information about the development of new products and technologies.

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Standard II(B), Market Manipulation, prohibits practices that distort prices or artificially inflate trading volumes with the intent to mislead market participants. The Standard is not intended to prohibit legitimate trading strategies that exploit differences in market inefficiencies.

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Ron Taylor, a CFA Level I candidate, trades cotton contracts for a small commodity broker. Taylor convinces a government cotton inspector to issue a warning that the Texas cotton crop is in danger from insect infestation. The price of cotton soars. Taylor immediately shorts cotton futures. Once the position is created, the government inspector issues a second report reversing his original opinion and cotton prices plummet.

Cedric Sims, a CFA Level III candidate, would like to generate a tax loss on a security held in his personal portfolio; however, he believes the security has significant upside potential. To avoid the wash sale provisions of the income tax code, Sims sells the security and simultaneously creates a synthetic long position using derivatives.

With regards to Standard II(B), Market Manipulation, which of the following statements concerning Taylor’s and Sims’s conduct is TRUE?

A) Neither Taylor nor Sims is in violation of Standard II(B).

B) Both Taylor and Sims are in violation of Standard II(B).

C) Taylor is in violation of Standard II(B), but Sims is not in violation.

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Taylor is in violation of Standard II(B), Market Manipulation, by creating a scheme that caused others to trade on false information. Sims is not in violation of Standard II(B). The Standard does not prohibit transactions conducted for tax purposes.

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