Reading 2-III: Standards of Professional Conduct & Guidan management

1215

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

LOS B.: Fair Dealing.

 

 

Calvin Moore, CFA, has been transferred from the brokerage house of the Browning Company to the portfolio management department. In portfolio management, Moore learns that clients are grouped into three divisions according to portfolio value, divided as follows:

• Group 1 up to $10,000
• Group 2 from $10,001 to $100,000
• Group 3 more than $100,000

When recommendations are announced or trades are initiated, a particular sequence is followed in communicating to these groups. At the next monthly meeting, Moore suggests that the sequencing practice is a breach of CFA Institute Standards. One of Moore’s co-workers replies that the grouping approach helps the company in applying the Standard regarding portfolio recommendations.  He further suggests that because Browning’s overall performance is more strongly affected by actions taken on the high value portfolios, that these portfolios should take priority over the small value portfolios. What should Moore do?  Moore should:

A) do nothing since there is no breach with the Standards.

B) prepare a written report to the CEO describing the problem.

C) disassociate himself from the problem and seek legal advice.

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Taking a special approach in disseminating information in relation to initiating trades is a breach of Standard III(B), Fair Dealing. Given the fact that Moore works in the department and has already unsuccessfully tried to prevent the practice from continuing, he needs to disassociate himself and seek legal advice.

1215

Bjorn Sandvik, CFA, completes a research report with a buy recommendation for Acorn Properties. In the early afternoon, Sandvik e-mails this recommendation to his clients who had responded to his request that they provide Sandvik with their e-mail addresses. Later that afternoon, the printed recommendation is forwarded to the postal service for normal delivery to all customers, who receive the mailing 1 to 3 days later. Sandvik has:

A) violated the Code and Standards by sending the e-mail recommendation to only some of his clients.

B) not violated the Code and Standards because he acted fairly in disseminating research information to his clients.

C) violated the Code and Standards by sending the e-mail recommendation in advance of the printed report.

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Standard III(B) Fair Dealing requires that members deal fairly with all clients in disseminating investment recommendations. It does not require uniform or equal treatment. Sandvik’s approach in sending e-mail correspondence to those of his clients who had given him their e-mail addresses, having made the request to all of his clients, and sending regular mail correspondence the same day, is fair to all of his clients.

1215

Which of the following most accurately states a limitation that the Fair Dealing standard imposes?

A) Clients should not be discriminated against when disseminating investment recommendations.

B) Referral fees may be disclosed after proceeding with an agreement for service.

C) Before trading on her own portfolio, a CFA charterholder must wait for employer and client deals to be executed.

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Standard III(B) Fair Dealing states that the dissemination of information and recommendations to clients must be handled fairly. The other choices are related to Standard VI(B) Priority of Transactions and Standard VI(C) Referral Fees.

1215

Rey Sanchez, CFA, covers the specialty chemical industry for Rock Advisory Associates. Until today he has had a buy recommendation on ChemStar, and many of the firm’s customers have purchased shares based upon his recommendation. The firm’s client accounts are divided into two fundamental categories: trading and buy-and-hold accounts. The firm holds discretionary trading authority over the trading accounts, but not the buy-and-hold accounts. Sanchez has recently come to believe that the fundamentals are changing for the worse at ChemStar, and is preparing a sell recommendation. He calls a meeting of the firm’s portfolio managers with accounts holding ChemStar and tells them of the pending release of the sell recommendation. On this basis, the portfolio managers sell all positions in the discretionary accounts but not in the buy-and-hold accounts. Sanchez completes and mails the report to all clients two days later, and, shortly thereafter, many of the buy-and-hold accounts sell their ChemStar positions. With regard to these actions, Sanchez is:

A) not in violation of the Standard on Fair Dealing; the portfolio managers are in violation of the Standard on Fair Dealing.

B) in violation of the Standard on Fair Dealing; the portfolio managers are in violation of the Standard on Fair Dealing.

C) in violation of the Standard on Fair Dealing; the portfolio managers are not in violation of the Standard on Fair Dealing.

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Sanchez is in violation of the Standard III(B), Fair Dealing, since he has disseminated his recommendation preferentially to the portfolio managers in advance of making the report available to all clients who hold shares of ChemStar. The portfolio managers are in violation of the Standard since they are effectively giving preferential treatment to the trading accounts over the buy-and-hold accounts in the placement of orders based upon the change in recommendation.

1215

Concerning Standard III(B), Fair Dealing, which of the following actions is NOT a valid procedure for compliance with the Standard?

A) Limit the number of people that are involved and are privy to the fact that an investment recommendation is going to be disseminated.

B) Communicate investment recommendations simultaneously within the firm and to customers, where possible.

C) Communicate investment recommendations to all customers including those accounts for which the securities are not eligible for purchase.

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To ensure compliance with the Standard, members should seek to communicate investment recommendations to all clients who have indicated an interest and also those for whom the securities are suitable. There is no need to communicate recommendations to clients for whom the securities are deemed unsuitable. The standard does not prohibit a firm from offering various levels of service.

1215

Which of the following statements regarding allocating trades is CORRECT? It is permissible under the Standards to allocate trades:

A) based upon compensation arrangements.

B) based upon any method the firm deems suitable so long as the allocation procedure has been disclosed to all clients.

C) on a pro-rata basis over all suitable accounts.

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It is permissible to allocate trades on a pro-rata basis over all suitable accounts. It is not permissible to base allocations upon compensation arrangements. Any method is not necessarily suitable, and disclosure does not absolve the member from ensuring that the allocation is necessarily fair.

1215

In securing the shares for all accounts under her management, Linda Kammel of Northwest Futures purchased three blocks of shares at three different prices. She then allocated these shares by placing shares from the first block in accounts with surnames beginning with A-G. The second was allocated over accounts H-P, and the third over Q-Z. This action is:

A) consistent with her responsibilities under the Code and Standards.

B) not permissible under the Code and Standards.

C) permissible only if the clients are informed of the allocation procedure.

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Standard III(B) requires a member to deal fairly with all clients when taking investment actions. Since she knew at the outset that she was going to place shares in all accounts, regardless of the first letter of the surname, all accounts must participate on a pro-rata basis in each block in order to conform to the Standard. Her actions constitute a violation of the Standard concerning fair dealing.

1215

A money management firm has the following policy concerning new recommendations: When a new recommendation is made, each portfolio manager estimates the likely transaction size for each of their clients. Clients are notified of the new recommendation in the order of their estimated transaction size—largest first. All clients have signed a form where they acknowledge and consent to this allocation procedure. With respect to Standard III(B), Fair Dealing, this is:

A) not a violation because the clients have signed the consent form.

B) a violation of the standard.

C) not a violation because the clients are aware of the policy.

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Such a policy is a violation of the Standard and client acknowledgement and/or consent does not change that fact.

1215

Which of the following statements is least accurate regarding being a part of Standard III(B), Fair Dealing?

A) Shorten the time between decision and dissemination.

B) Maintain a list of clients and their holdings.

C) At the same time notify clients for whom an investment is suitable of a new investment recommendation.

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All of these are part of Standard III(B) except notifying clients at the same time. Standard III(B) states that clients for whom the investment is suitable should be notified at approximately the same time.

1215

An investment advisor goes straight from a research seminar to a meeting with a prospective new client with whom she has never been in contact. The advisor is very excited about the information she just received in the seminar and begins showing the prospect the new ideas her firm is coming up with. This is most likely a violation of:

A) both of these.

B) Standard III(B), Fair Dealing.

C) Standard III(C), Suitability.

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It is a violation of Standard III(B) because the advisor should act first on behalf of existing clients whose needs and characteristics she already knows. It is a violation of Standard III(C) because she has never met the prospect and does not know if the new ideas are appropriate for the prospect. Thus, “both of these” is the best response.