Reading 2-V: Standards of Professional Conduct & Guidance 2011, Investment, likely, center, least

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Session 1: Ethical and Professional Standards
Reading 2-V: Standards of Professional Conduct & Guidance: Investment Analysis, Recommendations, and Actions

LOS B.: Communication with Clients and Prospective Clients.

 

 

Standard V(B), Communication with Clients and Prospective Clients, least likely requires members to:

A) use reasonable judgment regarding the inclusion or exclusion of relevant factors in research reports.

B) disclose the general principles of investment processes used to analyze and select securities, and construct portfolios.

C) make clear buy or sell recommendations on the securities covered in research reports.

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There is no obligation to make buy or sell recommendations on securities that are covered by research reports.

 

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Bertrand Greene, CFA, is preparing a report on Blanding, Inc. Blanding's earnings have increased in each of the last six years by an average of 11.8%. Based on his analysis, Greene projects that Blanding's earnings will increase by 12.5% in each of the next two years. Greene will violate the Code and Standards if he states:

A) "Blanding's earnings will grow at 12.5% annually in each of the next two years."

B) "Blanding's earnings have been compounding at approximately 11.8% annually."

C) "I expect Blanding's earnings growth to increase to 12.5% annually in the next two years."

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Standard V(B) Communication with Clients and Prospective Clients requires members to distinguish between fact and opinion. "Blanding's earnings will grow at 12.5% annually in each of the next two years" states an uncertain future outcome as a fact and thus violates this Standard. Preceding the statement with "I expect..." identifies the forecast properly as an opinion.

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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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An analyst finds a stock with historical returns that are not correlated with interest rate changes. The analyst writes a report for his clients that have large allocations in fixed-income instruments and emphasizes the observed lack of correlation. He feels the stock would be of little value to investors whose portfolios are comprised primariliy of equities. The clients with allocations of fixed income instruments are the only clients to see the report. According to Standard V(B), Communication with Clients and Prospective Clients, the analyst has:

A) violated the Standard concerning fair dealings with all clients.

B) not violated the Standard.

C) violated the article in the Standard concerning facts and opinions.

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Recommending a stock whose return is uncorrelated with interest rate changes is appropriate for the clients described in the problem. Emphasizing the lack of correlation is appropriate as long as the analyst makes no guarantees concerning the relationship in the future. Reporting historical correlation is a presentation of fact, and is not in violation. The analyst is free to show the report only to investors for whom the investment is appropriate.

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Robert Hamilton, a CFA candidate, is preparing a research report on Pets-R-Us for public distribution. Hamilton's preliminary report contains unfavorable earnings forecasts for the next four quarters. As part of his analysis, Hamilton met with Linda Brisson, the president of Pets-R-Us, and asked her to review the preliminary report for factual inaccuracies. Brisson revised Hamilton's earnings forecasts so that the quarterly earnings showed an upward trend and resulted in positive earnings by the fourth quarter. Hamilton included the revised earnings figures in his report without further review. Although the final report included the basic characteristics of Pets-R-Us, it emphasized certain areas such as projected quarterly earnings but only briefly touched on others. According to CFA Institute Standards of Professional Conduct on research reports, Hamilton:

A) violated the Standard because he did not thoroughly review and analyze any information provided by Brisson.

B) violated the Standard because the report did not give similar attention to all areas but instead emphasized quarterly earnings at the expense of other areas.

C) did not violate the Standard.

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Standard V(B) permits Hamilton to ask company management to review his report for factual inaccuracies, but Hamilton should have taken care to thoroughly review and analyze any information provided by the company. Hamilton is not required to give equal emphasis to all areas but can emphasize certain areas, touch briefly on others, and omit certain aspects deemed unimportant.

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Janet Coleman, a CFA Institute member, is an analyst at a regional brokerage firm. She is preparing a research report on Standard Power and Light. Due to deregulation, utility companies face increased competition. During the past year, three of the five utility companies in her region have cut their dividends by 50%, on average, to provide more internal funds for investment purposes. In a discussion with Standard's chief executive officer, Coleman learned that Standard expects to have a record amount of capital expenditures during the next year. Although Standard subsequently issued a press release about its capital expenditure plans, it did not make any public statements about a change in dividend policy. Coleman reasons that the management of Standard will be under pressure to cut its dividends within the next year to remain competitive. Coleman issues a research report in which she states:

"We expect Standard Power and Light will experience an initial decrease of $3 a share in its stock price when it cuts its dividend from $2 to $1 a share by the second quarter. We expect that Standard will strengthen its competitive position by using more internally generated funds to finance its investment opportunities. If investors buy the stock now at around $50 a share, their total return should be at least 20% on the stock."

Based on CFA Institute Standards of Professional Conduct, which of the following statements about Coleman's actions is CORRECT?

A) Coleman violated the Standards because she used material inside information.

B) Coleman did not violate the Standards.

C) Coleman violated the Standards because she failed to separate opinion from fact in her research report.

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Coleman's statement that Standard will cut its dividend from $2 to $1 a share is an opinion, not a fact. She should distinguish between facts and opinions in research reports.

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An analyst who routinely purges the files that support his research and recommendations:

A) is acting in accordance to Standard III(E), Preservation of Confidentiality.

B) is acting in accordance to Standard IV(A), Loyalty to Employer.

C) may be violating Standard V(C), Record Retention.

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According to Standard V(C), a member shall “maintain appropriate records” to support recommendations. Neither of the other choices would apply to this action.

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In preparing research reports, which of the following is least likely required or recommended by the Code and Standards?

A) Send all reports to the firm's legal counsel to ensure compliance with securities laws.

B) Maintain copies of materials that were relied on in preparing the research report.

C) Attribute paraphrases and summaries of material prepared by others.

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Members do not need to send all reports to the firm’s legal counsel to ensure compliance with securities laws.

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Joni Black, CFA, works for a portfolio management firm. Black is a partner of the firm and is primarily responsible for managing several large pension plans. Black has just finished a research report in which she recommends Zeta Corporation as a “Strong Buy.” Her rating is based on solid management in a growing and expanding industry. She just handed the report to the marketing department of the firm for immediate dissemination. Upon returning to her desk she notices a news flash by CNN reporting that management for Zeta Corporation is retiring. Black wishes she did not recommend Zeta Corporation as a “Strong Buy,” but believes the corporation is still a good investment regardless of the management. What course of action for Black is best? Black:

A) should revise the recommendation based on this new information.

B) may send out the report as written as long as a follow up is disseminated within a reasonable amount of time reflecting the changes in management.

C) should report the new information to her immediate supervisor so that they can determine whether or not the marketing department should send out the report as written.

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This question is related to Standard V(B) which states that CFA Institute members should use reasonable judgment regarding the inclusion or exclusion of relevant factors in research reports. The change in management was a relevant factor and must be disclosed before dissemination.

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In the preparation of a research report, a CFA Institute member may emphasize certain matters, touch briefly on others, and omit some altogether:

A) provided that the analyst both has a reasonable basis and is unconstrained by the Mosaic theory.

B) under no circumstances.

C) provided that the analyst has a reasonable basis for his or her actions.

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According to Standard V(B), the analyst must use reasonable judgment in identifying relevant factors when communicating with clients and prospects . The Mosaic theory does not apply here.