Reading 2-IV: Standards of Professional Conduct & Guidan recognized, center, div, membership, class

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Session 1: Ethical and Professional Standards
Reading 2-IV: Standards of Professional Conduct & Guidance: Duties to Employers

LOS B.: Additional Compensation Arrangements.

 

 

 

An analyst belongs to a nationally recognized charitable organization, which requires dues for membership. The analyst has worked out a deal that he provides money management advice in lieu of paying dues. For this arrangement to comply with the standards, the analyst needs consent from:

A) his supervisor in the organization only.

B) both his supervisor in the organization and his regular place of work.

C) his supervisor in his regular place of work only.

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An employee/employer relationship does not necessarily mean monetary compensation for services. If the analyst is performing services for the organization, then the analyst must treat the position as if he were an employee and obtain consent from both his supervisor in the organization and in his regular place of work.

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Jane Talbot, CFA, is a portfolio manager at Cavalier Investments. Talbot manages the account of Wendall Wilcox. The performance of Wilcox's portfolio has been below that of the benchmark portfolio, the S& 500, for the past several years. In an effort to enhance his portfolio's performance, Wilcox offers to pay Talbot $2,000 each year that his portfolio's return exceeds that of the S& 500. Wilcox suggests this arrangement last for the next three years. The amount that Wilcox agrees to pay Talbot is in addition to the compensation that Talbot will receive from his employer and the standard fee that Wilcox will pay Cavalier for managing his portfolio over the three-year period. Talbot agrees to the arrangement proposed by Wilcox and informs Cavalier in writing of the terms of the agreement under which she will receive additional compensation. According to CFA Institute Standards of Professional Conduct Talbot must disclose:

A) both the nature and amount of compensation only.

B) the nature of the compensation only.

C) the nature and amount of compensation plus the duration of the agreement.

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Procedures for compliance for Standard IV(B) indicate that the written report should state the terms of any oral or written agreement under which Talbot will receive additional compensation including the nature of the compensation, the amount of compensation and the duration of the agreement.

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Selma Brown, CFA, is a portfolio manager for Mainland Securities. Rick Wood, one of her clients and owner of Wood Fitness Centers, offers to permit Brown and her immediate family to use the facilities at his fitness centers at no cost during 2003. To get this benefit, Brown must achieve on Wood’s portfolio at least a 2-percentage point return above the total return on the S&’s 500 index during 2002. Brown orally informs her immediate supervisor of the nature and duration of the proposed arrangement.

Arnold Turley, a CFA Institute member, is a portfolio analyst at Mainland Securities. He was just elected to the Board of Directors for Omega Services, which pays him $1,000 plus expenses for attending each of its quarterly board meetings. Turley e-mails Mainland’s compliance officer informing her of this arrangement with Omega and receives a reply informing him that the agreement is acceptable.

Did Brown or Turley violate CFA Institute Standards of Professional Conduct?

A) Brown: Yes, Turley: No.

B) Brown: No, Turley: No.

C) Brown: Yes, Turley: Yes.

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Brown violated Standard IV(B), Additional Compensation Arrangements, because she must disclose in writing other benefits to be received for services that are in addition to compensation conferred by her employer. Turley did not violate Standard IV(B) because he received consent from his employer in writing, which includes e-mail.

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An analyst needs to inform his supervisor in writing of which of the following?

A) A client and the analyst alternate paying for lunch at a local sandwich shop.

B) An annual bonus, sent to the analyst by a client, which varies with the performance of the client's portfolio that the analyst manages as an employee even though no verbal or written agreement exists about the bonus.

C) Both the lunch and the bonus mentioned in the other answers.

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Standard IV(B) requires that members disclose to their employer in writing all benefits that they receive in addition to their regular compensation for services they perform on behalf of their employer. Since the bonus varies with the performance of the client’s portfolio, there is a clear link to the services of the analyst. The analyst is not required to report the lunch since it is not linked to performance.

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Rolf Lindquist, a CFA charterholder, is a portfolio manager at Midwestern Investment Management, a firm catering to high-net-worth individual clients. Lindquist has worked in the investment industry for 10 years, the first four years with KMGR and the last six with Midwestern. In advertising material, Lindquist reports his investment performance over the last 10 years without identifying the first four years as being achieved at KMGR.

Lindquist sits on the board of directors of Western Inns, a hotel chain. In return for his services on the board, he receives free lodging from Western when he travels for business and pleasure. He currently holds no Western stock in any of his clients’ portfolios, although in the recent past some of these portfolios have included Western. Lindquist discusses his Western directorship with his supervisor, but because he does not receive any monetary compensation, he does not formally disclose this arrangement in writing to his employer or his clients.

Lindquist manages the portfolio of Martha Olson. Last year, Lindquist beat the benchmark portfolio for Olson by 180 basis points. In return for that performance, Olson gives Lindquist two third-row tickets to the NCAA basketball championship. Lindquist discloses this gift to his supervisor. Lindquist also receives a two-week, expense-paid trip to Paris from Boston and Co., a brokerage firm, in return for providing Boston with business during the year.

Lindquist also manages the portfolio of Jerry Chandler, a conservative investor with a low tolerance for risk. Lindquist recommends the purchase of equity index put options on the equity portion of Chandler’s portfolio. Lindquist educates Chandler on the risks and rewards of such a strategy, including the risk that equity prices will increase and that this would cause the value of the put options will fall.

Midwestern has developed a proprietary model that has been thoroughly researched and is known throughout the industry as the Midwestern model. The model is purely quantitative and screens stocks into buy, hold, and sell categories. The basic philosophy of the model is thoroughly explained to clients. The director of research frequently alters the model based on rigorous research—an aspect that is disclosed to clients, although the specific alterations are not continually disclosed. Portfolio managers then make specific sector and security holding decisions, purchasing only securities that are indicated as "buys" by the model. Lindquist has conducted some research on his own and feels the model would be improved by adding some factors. Based on his research, he applies his own version of the model, which is occasionally in conflict with the Midwestern model. Lindquist discloses his model to his own clients, but not to his supervisor.

Regarding the Paris trip, Lindquist:

A) cannot accept the gift under any circumstances.

B) cannot accept the gift without disclosing it to his employer.

C) can accept the gift if he determines, in consultation with his employer, that accepting the gift would not compromise his objectivity.

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According to Standard I(B) concerning independence and objectivity, Lindquist cannot accept gifts that reasonably could be expected to compromise his independence and objectivity. Acceptance of such a gift would call into question his independence and objectivity; his first obligation is to his clients, not to Boston and Co. (Study Session 1, LOS 2.a)

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With regard to the Chandler portfolio, Lindquist violated:

A) Standard III(C): Suitability, but not Standard III(A): Loyalty, Prudence, and Care.

B) Standard III(A): Loyalty, Prudence, and Care, but not Standard I(D): Misconduct.

C) neither Standard III(C): Suitability, nor Standard III(A): Loyalty, Prudence, and Care.

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Lindquist’s actions conform to Standard III(C): Suitability, Standard V(A): Diligence and Reasonable Basis, and Standard III(A): Loyalty, Prudence, and Care. Lindquist must take into account the risk level of the portfolio in its entirety, not individual securities within the portfolio. Although purchasing index put options is, by itself, inherently risky, in the context of a diversified portfolio it may well conform to a conservative client’s risk tolerance by hedging some of the risk of owning equities. Lindquist may rightly determine that such a strategy is consistent with Chandler’s investment policy statement. If properly constructed originally and properly explained to the client, no change in the investment policy statement is needed. (Study Session 1, LOS 2.a)

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With regard to Lindquist’s seat on the board of Western Inns, he violated:

A) no standards.

B) Standard VI(A): Disclosure of Conflicts, and Standard IV(B): Additional Compensation Arrangements.

C) Standard VI(A): Disclosure of Conflicts, but not Standard IV(B): Additional Compensation Arrangements.

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Under Standard IV(B), Lindquist is required to disclose in writing to his employer any benefits (monetary or non-monetary) he receives for services that are in addition to compensation or benefits provided by his employer. An informal discussion with his supervisor does not conform to the requirement that the notice be in writing. Under Standard VI(A), he is also required to disclose the arrangement to his clients because a directorship is a conflict of interest that could reasonably be expected to impair his objectivity. He must do so even if he currently holds no shares of Western in his clients’ portfolios because it may impair his objectivity in recommending the stock for inclusion in clients’ portfolios in the future. Lindquist violated Standard I(B) because clients could reasonably assume his objectivity is in question. (Study Session 1, LOS 2.a)

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Which of the following standards is not violated in Lindquist’s version of the Midwestern model?

A) Standard V(A): Diligence and Reasonable Basis.

B) Standard IV(C): Responsibilities of Supervisors.

C) Standard I(C): Misrepresentation.

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The ad hoc model is not part of the formal research process and does not formulate an adequate basis for a recommendation. Lindquist’s recommendations are not supported by appropriate research because Lindquist’s version of the model obtains different results than the original model. These discrepancies have not been adequately researched. Lindquist’s supervisor is responsible for policing the analyst’s research. The fiduciary-duties standard covers a lot of ground, and it would not be hard to argue that by misrepresenting his research as that of a company standard, he is breaching a duty to the firm’s clients, who expect their investments to be chosen by the “Midwestern Model.” The plagiarism standard is not relevant here, because Lindquist has permission to use the model, and is not misrepresenting the work of others as his own work. In fact, Lindquist’s actions represent the opposite of plagiarism, pawning off his own work as the work of others. (Study Session 1, LOS 2.a)

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Lindquist’s actions in advertising his investment performance:

A) conform to all standards.

B) conform to standards concerning performance presentation as long as Lindquist does not claim compliance with CFA Institute Global Investment Performance Standards.

C) violate Standard III(D): Performance Presentation.

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Lindquist failed to conform to Standard III(D) by releasing misleading information concerning his historical performance at Midwestern. KMGR may use a different management style than Midwestern, rendering historical performance of little value to Midwestern clients. Claiming compliance with CFA Institute GIPS would only compound the problem. Misrepresenting performance results as occurring at one firm when they actually occurred at a previous employer is a violation of the presentation standards. (Study Session 1, LOS 2.a)

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Regarding the NCAA tickets, what action must Lindquist take to avoid a violation of Standard IV(B): Additional Compensation Arrangements?

A) Obtain written consent from all parties involved.

B) Disclose his receipt of the tickets to all other clients with the same investment objective as the Olson account.

C) None. Lindquist’s actions do not violate Standard IV(B).

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Lindquist may accept this gift from a client as long as he obtains written consent from all parties involved. (Study Session 1, LOS 2.a)

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David Saul, CFA, heads the trust department at Savage National Bank. Fairway Enterprises invites Saul to sit on its Board of Directors. In return for his services on the Board, Fairway offers to provide Saul and his family with access to the facilities at Wilmont Country Club at no cost. Saul will not receive any monetary compensation for his services on the Board. According to CFA Institute Standards of Professional Conduct, which of the following actions must Saul take?

A) Saul must disclose in writing to Savage Bank the terms of the offer whether or not he accepts the offer to serve on the Board of Directors.

B) Saul must reject the offer to serve on the Board of Directors.

C) Saul must obtain written consent from all parties to only if he decides to accept the offer to serve on the Board of Directors.

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Standard IV(B) requires that members obtain written consent from all parties involved before accepting 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. In this situation, Saul may also be obligated to disclose his participation on Fairway's Board to clients, prospective clients, and employer under Standard VI(A), Disclosure of Conflicts.

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Jan Hirsh, CFA, is employed as manager of a college endowment fund. The college’s endowment is held by the brokerage firm Advisors, Inc. Over the years, Hirsh has developed a solid relationship with Advisors. Because of this relationship, Advisors has given her their Platinum level service for her personal account. Advisors ordinarily gives the Platinum level only to clients who do a minimum of $2,500 of commission business in a year. Hirsh has never reached the $2,500 commission level and probably will never do so. According to Standard IV(B), Additional Compensation Arrangements, Hirsh needs to:

A) inform her supervisor verbally about the Platinum account.

B) inform her supervisor in writing about the Platinum account.

C) do none of the actions listed here.

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Having the Platinum account is a benefit from her managing the endowment, which led to the relationship with Advisors. Members should report to their employers any additional compensation or benefits they receive for their services. This must be in writing. Doing $2,500 in business alone will not negate her obligation unless she explicitly tells Advisors that she is willing to accept whatever penalties accompany a Platinum account when a client does less business.

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Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. He places trades for the fund with Worldwide Brokerage. Worldwide suggests to Calaveccio that they are willing to provide him with additional compensation for order flow. Is this permissible under the Code and Standards?

A) Yes, if he receives written consent from TrustCo and discloses the arrangement to his clients and prospects.

B) Yes, if he discloses the arrangement in writing to TrustCo.

C) No, such an arrangement is in violation of the Code and Standards.

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In conformance with Standard IV(B) Additional Compensation Arrangements, Calaveccio is required to obtain written consent from TrustCo, his employer. In conformance with Standard VI(C) Referral Fees, he is also required to disclose the additional compensation to clients and prospects. Written permission from his clients and prospects is unnecessary.

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An analyst working at an investment firm has a client that rents limousines. The client tells the analyst that as long as he is the client’s analyst, he can have free use of a limousine several times a year. The analyst needs to:

A) do nothing since the offer is not linked to the performance of the client's portfolio.

B) explicitly refuse such an offer.

C) inform his supervisor in writing of the offer if the analyst intends to accept the offer.

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Standard IV(B) requires that members disclose to their employer in writing all benefits that they receive in addition to their regular compensation for services they perform on behalf of their employer. They also need to get consent from their employer in writing. The written report to the employer should include the details of any written or oral agreement for extra compensation. The analyst does not have to refuse the offer.