Reading 2-III: Standards of Professional Conduct & Guidan 2011, center, growth, placed, style

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

LOS C.: Suitability.

 

 

Millie Walker, CFA, established an aggressive growth portfolio for her client, Jesse Wilmer, over three years ago. Wilmer was placed on Walker’s employer’s client mailing list, and received monthly account statements and the firm’s newsletter, which regularly informed clients that they should contact their account representative with any change in their personal circumstances or investment objectives. As of January, of this year, Walker had not spoken to Wilmer nor received any correspondence from Wilmer since the account was established. Walker has:

A) not violated the Code and Standards because Wilmer has been reminded regularly about the opportunity to inform Walker about any changes.

B) violated the Code and Standards because the manager has not performed an update of Wilmer's financial situation and investment objectives.

C) not violated the Code and Standards because there has been regular correspondence from Walker's firm to Wilmer.

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Standard III(C) Suitability requires members to update a client’s financial situation and investment objectives regularly. Wilmer’s account has existed for more than three years, and an update is long overdue. Generally offering to do an update is not sufficient to comply with the Standard.

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Stephen Rangen, a broker, has three accounts consisting of unsophisticated, inexperienced individual investors with limited means.  One of these accounts is an elderly couple.  The clients want to invest in safe, income-producing investments. They rely heavily on Rangen’s advice and expect him to initiate most transactions in their respective accounts. In managing their accounts, Rangen pursues the following strategies: (1) buys U.S. treasury strips and non-dividend paying over-the-counter (OTC) stocks recommended by his firm's research department, (2) uses margin accounts, and (3) concentrates the equity portion of their portfolio in one or two stocks.  Rangen’s approach leads to extremely high turnover rates in all three accounts.

Which of the following statements about Rangen is NOT correct?

A) Rangen's conduct violates Standard IV(B), Additional Compensation Arrangements.

B) Rangen has a fiduciary duty to each client.

C) Rangen's conduct violates Standard III(C), Suitability.

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No information in the case suggests that Rangen’s conduct violates Standard IV(B), Disclosure of Additional Compensation Arrangements.

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Which of the following statements about Rangen's conduct is CORRECT? Rangen's conduct:

A) meets the requirements of the Code and Standards because his firm's research department recommended the U.S. Treasury strips and non-dividend paying stocks.

B) meets the requirements of the Code and Standards because his clients are aware of the risks that he is taking in managing their accounts.

C) does not meet the requirements of the Code and Standards because his investment strategy is inconsistent with his clients' objectives.

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Rangen's actions are inconsistent with Standard III(C), Suitability, because his investment actions are neither appropriate nor suitable for each client. Even if his clients were aware of the risks, the portfolios that he constructed are inconsistent with their financial needs. Because he is in a position to control the volume and frequency of transactions in their accounts, he has control over the accounts. Although Rangen relies upon recommendations from his firm’s research department, he cannot shift blame to his employer because he must follow recommendations that are in the best interests of his clients.

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The O’Douls (husband and wife) have decided to work with Jane Mack, CFA, to have her recommend an investment portfolio for them. The O’Douls are novice investors and Mack has determined their asset allocation model falls into the conservative category. After researching various investment options for the O’Douls, Mack has made a recommendation that they divide their account on a 25%/75% basis between shares of a computer peripherals manufacturing company her brokerage firm is underwriting and investment grade corporate bonds. The O’Douls are not aware that Mack’s firm is underwriting an offering of the company in question. Which CFA Institute Standard(s) has Mack violated given her actions?

A) Standard V(A), Diligence and Reasonable Basis, and I(D), Misconduct.

B) Standard III(B), Fair Dealing, and III(A), Loyalty, Prudence, and Care.

C) Standard VI(A), Disclosure of Conflicts, and III(C), Suitability.

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Mack is obliged to disclose the conflict of interest regarding her company’s IPO and to consider both the appropriateness and the suitability of the investment for her client. She has apparently failed in both respects.

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Carol Hull, CFA, is an investment advisor whose prospective client, Frank Peters, presents special requirements. To construct an investment policy statement for Peters, Hull inquires about Peters’ investment experience, risk and return objectives, and financial constraints. Peters states that he has a great deal of investment experience in the capital markets and does not wish to answer questions about his tolerance for risk or his other holdings. Under Standard III(C), Suitability, Hull:

A) may accept Peters’ account but may only manage his portfolio to a benchmark or index.

B) must decline to enter into an advisory relationship with Peters.

C) is permitted to manage Peters’ account without any knowledge of his risk preferences.

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Hull would not violate Standard III(C), Suitability, by managing Peters’ account without knowledge of his risk preferences. She made a reasonable inquiry into Peters’ investment experience, risk and return objectives, and financial constraints, as the Standard requires. If a client chooses not to provide some of this information, the member or candidate can only be responsible for assessing the suitability of investments based on the information the client does provide.

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Karen Jackson is a portfolio manager for Super Selection.  Jackson is friendly with David James, president of AMD, a rapidly growing biotech company. James has provided Jackson with recommendations in the biotech industry, which she buys for her own portfolio before buying them for her clients. For three years, Jackson has also served on AMD's board of directors. She has received options and fees as compensation.

Recently, the board of AMD decided to raise capital by voting to issue shares to the public. This was attractive to board members (including Jackson) who wanted to exercise their stock options and sell their shares to get cash. When the demand for initial public offerings (IPO) diminished, just before AMD's public offering, James asked Jackson to commit to a large purchase of the offering for her portfolios. Jackson had previously determined that AMD was a questionable investment but agreed to reconsider at James' request. Her reevaluation confirmed the stock to be overpriced, but she nevertheless decided to purchase AMD for her clients' portfolios.

Did Jackson violate Standard III(C) concerning Portfolio Recommendations and Actions?

A) Yes, she did not deal fairly with all clients.

B) No.

C) Yes, she did not consider the appropriateness and suitability of investment recommendations or actions for each portfolio or client.

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Jackson violated Standard III(C) because she did not consider her clients' financial situation, investment experience, and investment objectives. If the stock is questionable and overpriced, it is not suitable for any of her clients.

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According to CFA Institute Standards of Professional Conduct, when a client asks her portfolio manager to change the current investment strategy of the client’s portfolio, the manager should:

A) explain the implications of the new strategy after the member manager implements the strategy.

B) obey the client's request without question.

C) examine whether the strategy is appropriate for the client and explain the implications of the new strategy before implementing the strategy.

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According to Standard III(C), Suitability, the member manager must determine that an investment is suitable given the client’s objectives/constraints and within the context of the client’s total portfolio. In this case, the member manager must examine the new strategy to see if it is appropriate for the client, even if the client asked for the change. The member should also explain the implications of the strategy to avoid any misrepresentations that may result from omitting details.

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Bob Hatfield, CFA, has his own money management firm with two clients. The accounts of the two clients are equal in value. One of the clients gets married and the assets of the new spouse and the client are combined. With the larger portfolio of the now married client, Hatfield determines that they can assume a higher level of risk and begins a change in the policy concerning that portfolio. Which of the following would violate Standard III(C), Suitability?

A) Implement a similar policy for the other client who did not just get married.

B) Assess the return objectives of the newly married client and his spouse.

C) Assess the time horizon of the newly married client and his spouse.

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According to Standard III(C), Suitability, the analyst must assess the time horizon, return objectives, tax considerations, and liquidity needs of a client before changing an investment policy. The analyst must notify the client of the new policy. Implementing the policy for the other client may be a violation of the Standard unless that client’s needs are totally reassessed and determined to be identical to the needs of the newly married client.

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Janet Reilly has just approached Betty Miller, CFA, about purchasing 10,000 shares of Brookshire Co., a newly incorporated real estate development firm. Reilly is a retired schoolteacher living off the income from her late husband's life insurance policy. This investment will represent a significant shift in her investment portfolio. Brookshire Co. is a local firm that has recently received a lot of press concerning some exciting, but speculative projects that they have undertaken in the region. Consistent with the Standards, Miller should:

A) not accept the order, because it is not a suitable investment for Reilly.

B) accept Reilly's order, but have her sign a disclaimer absolving Miller of any potential losses.

C) accept Reilly's order after she acquaints Reilly with the downside risks associated with a risky investment of this type.

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Members are required to consider the appropriateness and suitability of investment actions for their clients. The needs and circumstances of the client, and the characteristics of the investment and the portfolio must be taken into account. If Reilly understands the risks of this investment and the rest of her portfolio is adequate for her income needs, Miller can proceed to make the investment.

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What is the required frequency for updating information on each client’s financial situation, investment experiences, and investment objectives?

A) Regularly.

B) Only during the first meeting with the client.

C) Every year.

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Standard III(C) Suitability. Members shall make a reasonable inquiry into a client’s financial situation, investment experience, and investment objectives prior to making any investment recommendations and shall reassess and update this information regularly.

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If an analyst has a policy of making an inquiry into a client’s financial situation, investment experience, and investment objectives regularly, this is:

A) neither of these.

B) a violation of Standard III(E), concerning client confidentiality.

C) congruent with Standard III(C), Suitability.

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Standard III(C) explicitly says that an analyst should make such inquiries and update information regularly. Client confidentiality is addressed in Standard III(E) but that is with respect to how the analyst treats the information once it is obtained.