JustasS

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 has a fiduciary duty to each client.

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

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

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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.

JustasS

Stephen Rangen, a former broker, had three accounts consisting of unsophisticated, inexperienced individual investors with limited means. One of these accounts was an elderly couple. The clients wanted to invest in safe, income-producing investments. They relied heavily on Rangen’s advice and expected him to initiate most transactions in their respective accounts. In managing their accounts, Rangen pursued the following strategies: (1) bought U.S. treasury strips and non-dividend paying over-the-counter stocks, (2) used margin accounts, and (3) concentrated the equity portion of their portfolios in one or two stocks. Rangen’s approach led to extremely high turnover rates in all three accounts. The Securities and Exchange Commission sanctioned Rangen for unsuitable recommendations and excessive trading in several accounts.For this specific situation, which of the following is least likely to be an appropriate compliance procedure involving Standard III(C), Suitability? The broker should:

A) develop an investment policy statement for each client.

B) avoid using material nonpublic information received in confidence to benefit clients.

C) assess and document each client's risk tolerance.

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The prohibition against use of material nonpublic information refers to Standard II(A), not Standard III(C), Suitability.

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For this specific situation, all of the following are appropriate compliance procedures involving Standard III(C), Suitability, EXCEPT:

A) reviewing investment policy statements regularly.

B) complying with any prohibitions on activities imposed by their employer if a conflict of interest exists.

C) educating clients about selecting appropriate asset allocations and strategies.

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Standard VI(A), Disclosure of Conflicts, refers to complying with any prohibitions on activities imposed by their employer if a conflict of interest exists and, therefore, is unrelated to Standard III(C).

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For this specific situation, which of the following policy statements should be adopted to ensure that future violations of this kind do not occur?

A) Before making any recommendations or taking any investment actions, managers should formulate an investment policy for a client. They should consider the type and nature of the client and should obtain and analyze necessary information on the client's objectives (risk and return) and constraints. Managers should maintain and review regularly the investor's objectives and constraints to reflect any changes in the client's circumstances. Where appropriate, managers should properly diversify portfolios.

B) Before advising individual clients, managers should review the recommendations provided by the firm's research department. From this set of recommendations, they should select those securities that provide the expected highest return on investment. Managers should review the investor's portfolio at least monthly to see if existing securities should be replaced with those more recently recommended. Managers should turnover portfolios frequently and concentrate holdings within portfolios in order to achieve the highest possible returns for clients.

C) When making recommendations or taking investment actions, managers should seek to minimize the client's portfolio risk. Managers should review the recommendations of the firm's research department to identify securities with low volatility. In making asset allocation recommendations or decisions for discretionary accounts, managers should weight the portfolios towards dividend-paying stocks and other income-producing assets such as bonds and mortgage REITS. Managers should review portfolios at least semi-annually.

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Standard III(C) requires that 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 update this information regularly to allow the members to adjust their investment recommendations to reflect changed circumstances.” The other policy statements focus on maximizing returns or minimizing risk. These statements may be inconsistent with the needs and circumstances of each individual client.

JustasS

A broker was sanctioned for unsuitable recommendations and excessive trading involving three accounts under his care. These clients were unsophisticated, inexperienced individual investors with limited means.In this situation, all of the following would be components of an effective compliance process EXCEPT:

A) using margin accounts.

B) diversifying portfolios where appropriate.

C) educating clients in the basics of investment characteristics.

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Using margin accounts would be inappropriate in this situation because it would increase the risk of loss and require clients to pay interest on the margin loan, adding to the cost to maintain the account. Trading on margin is inappropriate for unsophisticated, inexperienced individual investors with limited means.

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In this situation, which of the following would NOT be a component of an effective compliance process?

A) Educate clients on how to select investments because this can help clients accomplish their investment policy statement goals.

B) Examine risk tolerance carefully because risk tolerance is an important element in determining an appropriate investment policy statement.

C) Use concentrated portfolios consisting of only a few assets because this approach reduces trading costs.

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In this case, the broker increased the risk of loss for the clients beyond that consistent with the client objectives by concentrating much of their equity in particular securities. A component of an effective compliance process would be to develop diversified portfolios to reduce portfolio risk.

JustasS

The Securities and Exchange Commission (SEC) sanctioned Stephen Rangen, a former broker, for unsuitable recommendations and excessive trading in several accounts.  His clients were unsophisticated, inexperienced individual investors with limited means.  As such, they relied heavily on Rangen’s advice and expected him to initiate any transactions in their respective accounts.  The SEC found that Rangen’s trading methods were contrary to his clients’ goals.  For example, he used margin accounts and concentrated their equity holdings in particular securities.  Rangen claimed that his actions were justified because his clients were aware of the risks.
Which of the following statements best describes why Rangen’s argument, that his clients were aware of the risks, did NOT meet the requirements of the Code and Standards? Rangen failed to:

A) deal fairly and objectively with his clients when taking investment action.

B) make recommendations that were consistent with his clients' financial needs.

C) disclose to his clients all matters that reasonably could be expected to impair his ability to make unbiased and objective recommendations.

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Rangen did not fulfill the obligation he assumed when he agreed to counsel these clients. That is, he did not make recommendations that were consistent with their financial needs. According to Standard III(C), Suitability, Rangen must “consider the appropriateness and suitability of investment recommendations or actions for each portfolio or client.” This is true even if his clients wanted to speculate and were aware of the risks.

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Rangen bought U.S. Treasury strips and over-the-counter stocks that did not produce income as sought by his clients.  Rangen claimed that his actions were justified because his firm’s research department recommended the purchase of the Treasury strips. Also, he claimed the stocks that he bought were all in the top-rated categories of his firm’s research division.  Which of the following statements best describes why Rangen’s arguments, in which he attempted to shift the blame to his employer, did NOT meet the requirements of the Code and Standards?  

A) Rangen misrepresented the basic characteristics of the investments that he bought for his clients' accounts.

B) Rangen did not use reasonable care and judgment to achieve and maintain independence and objectivity in taking investment actions.

C) Rangen's duty was to make only recommendations that were in the best interests of his clients.

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Rangen cannot shift the blame to his employer. He had an obligation to consider not only his firm's recommendations, but also his clients' investment objectives and financial situations. He failed to consider relevant factors relating to his clients. Rangen violated Standard III(C) because he initiated investment actions without properly considering whether these actions were suitable to his clients' financial situations and investment objectives.

JustasS

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

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

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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.

JustasS

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

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

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

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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.

JustasS

Kim Lee manages a variety of accounts at Superior Investments. Some are permitted to invest in tax-exempt issues only; others may not invest in a stock unless it pays dividends. Lee is researching a biotech firm specializing in the analysis of "mad cow" disease. While touring company facilities and meeting with management, she learns that they believe they may have found a way to reverse the disease. Moreover, one manager conjectured, "Suppose that we reversed the disease in someone who didn't even have it? We might then be able to boost that individual's IQ into the stratosphere!" Lee returns to her office and buys shares for all accounts under her supervision. This action is:

A) a violation of the Standard concerning appropriateness and suitability of investment actions.

B) appropriate given the obvious potential of the therapy.

C) a violation of the Standard concerning fiduciary duties.

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Given the variety of accounts under her supervision, it is not likely the shares of a speculative biotech firm would be suitable for all accounts. Placing such shares in all accounts indicates that she has failed to consider the appropriateness and suitability of the investment for each account, and this places her in violation of Standard III(C).

JustasS

Bob Hatfield, CFA, has his own money management firm with two clients. The accounts of the two clients are equal in value. Hatfield has been trading on the clients’ behalf with a single brokerage firm for several years. Because of his many years of business, the brokerage firm occasionally gives Hatfield shares in an initial public offering (IPO) to sell to his clients. Hatfield has a policy of allocating the IPO shares equally between the portfolios of the two clients. This policy is:

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

B) a violation of Standard III(B), Fair Dealing.

C) a violation of Standard III(C), Suitability.

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According to Standard III(C), the analyst must consider the appropriateness and suitability of an investment recommendation for each portfolio or client. Having a fixed policy of adding investments to portfolios without evaluating their suitability is a violation of Standard III(C). The action does not violate Standard III(B)

JustasS

A broker was sanctioned for unsuitable recommendations and excessive trading involving three accounts under his care. These clients were unsophisticated, inexperienced individual investors with limited means. According to CFA Institute Standard III(C), Suitability, which of the following is least likely to be considered a relevant factor in determining the appropriateness and suitability of investment recommendations or actions for each portfolio or client?

A) Best interests of the investment professional.

B) Basic characteristics of the total portfolio.

C) Needs and circumstances of the portfolio or client.

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Determining appropriateness and suitability focuses on the portfolio or client, not on the investment professional. Investment professionals should take particular care to ensure that their goals in selling products or executing security transactions do not conflict with the best interests of the client.

JustasS

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.