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Fred Stroh is an international equity analyst for EmerWorld Capital Management (ECM). Stroh has been studying the opportunities associated with the rumors of proposed joint ventures involving U.S. firms and firms partially owned by the government in a recently democratized country. Clients of Stroh have called him to ask about the investment possibilities. This concerns Stroh somewhat as he has had great difficulty in finding and acquiring reliable information about the quality and accessibility of the inputs and labor in local markets. Furthermore, there is still considerable uncertainty about which U.S. firms will be offered partnerships, what the conditions of those partnerships will entail, and the accounting rules that will govern the new ventures. However, Stroh is confident that there will be demand for the output in local and international markets.
Stroh begins his investigation and e-mails an old friend who was an entrepreneur in the U.S. and moved to the recently democratized country when he went into partial retirement. Although Stroh had not been in contact with the friend for several years, the friend writes back and says that this is a great time to invest in the country. He says that there will be national elections soon, and it seems that a pro-business chief executive for the country will be elected. The friend includes website URL addresses which link to reports from reputable news sources concerning the election. Stroh goes to those sites and sees that recent opinion polls in the country show that the pro-business candidate has a majority in the polls taken and is believed to be able to easily win the election.
Stroh calls his friend, and asks if the labor costs and input availability in the country gave the country a comparative advantage in some areas. The friend says yes, and that APX Corp. is planning to partner with the country’s government to expand a plant for making car parts. APX is also in talks to make a tender offer for a French glass manufacturing firm, which was one of the few non-nationalized and foreign owned firms in the country. None of APX’s intentions were known to outsiders of the firm. Stroh asks his friend how sure he is of the information, and the friend says that he has been hired as a consultant for APX and has been a negotiator in the tender offer dealings, which are going well. Stroh warns his friend that he may be saying too much, and his friend says that there are no rules in the country associated with trading on this type of information. The friend says he has some other useful information, but first asks if Stroh thought investing in APX was a good idea. Stroh responds by saying that based on the information just provided, and his training as an analyst and a CFA charterholder, the analysis would indicate that his friend should buy APX. The friend then says that IMI Corp. has decided not to enter into any partnerships in the country. Stroh then asks about how sure his friend was of IMI withdrawing from partnering in the country, and the friend says that although he has no contacts in IMI, it was his own research that lead to that conclusion. Stroh corroberated his friend's research findings.
Stroh continues his investigation. In his research he finds through public documents that APX has purchased the land next to the car parts plant. Some of APX’s managers are already working in the parts plant itself. He also finds that APX representatives have been visiting the headquarters of the French glass manufacturer. In public documents, APX is projecting a big increase in its production of engine parts and windshields.
Stroh calls the CFO of IMI and during the conversation learns that IMI has decided to withdraw its bid to be a joint venture partner, but that the formal announcement of the withdrawal will not occur for another week. The CFO declines to give a reason. Stroh also finds that official statistics verify the friend’s assertion that the country’s labor and raw material supplies do give it a comparative advantage in the types of activities APX is seeking to engage in.
Not wanting to miss an opportunity, Stroh completes his industry analysis and concludes that EmerWorld will issue a buy recommendation on APX. In the recommendation he says that APX is planning on expanding its production of car parts and windshields by acquiring new manufacturing plants in a country that offers great cost advantages, but does not mention his gathering the information concerning the land acquisition and the APX managers working in the existing plant because he wants to conceal his research methods. Stroh also says the advantages to APX are exceptionally good because a new pro-business chief executive will soon be elected. Upon the announcement of IMI to not partner in the country, Stroh issues a sell recommendation on IMI. Stroh says in the sell recommendation that IMI’s management does not seem competent because it will not be capitalizing on the opportunities in the country and apparently cannot recognize a good opportunity when it sees one. Which of the following pieces of information would Stroh have been able to use to trade upon?

A) The plan by APX to partner in the car parts production in the country.

B) The labor and materials comparative advantage of the country.

C) IMI withdrawing from partnering in the country.

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All of the pieces of information related to APX purchasing the other company, APX partnering in the car parts industry, and IMI withdrawing from partnering in the country are all insider information and therefore cannot be used to trade upon.  The only information that can be used is the information pertaining to the labor and materials comparative advantage since this was public information that Stroh could verify based on publicly available statistics. (Study Session 1, LOS 2.a,b)

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The statement Stroh made in his recommendation of APX concerning the election of a pro-business chief executive was:

A) appropriate because it did not relate directly to the firms themselves.

B) not appropriate because of the way it was mentioned in the recommendation.

C) appropriate because it was based on information from the public websites of reliable news agencies.

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According to Standard V(B), Communication with Clients and Prospective Clients, investment analysis and recommendations should clearly differentiate facts from opinions. Although it is a widely held opinion that the pro-business candidate would win, no one can predict the future. None of the other reasons are valid. (Study Session 1, LOS 2.a,b)

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With respect to the given information and the sell recommendation of IMI, which of the following statements would NOT be allowable in the sell recommendation under the Standards?

A) IMI is now abandoning its plan to partner in the country.

B) Research indicated IMI was likely to withdraw from any partnership agreements within the country.

C) IMI’s executives cannot recognize a good opportunity when they see it.

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Stroh has no reasonable basis for saying that IMI’s executives cannot recognize a good opportunity when they see it. The CFO of IMI did not give a reason for their not partnering in the country. IMI may have better opportunities elsewhere. Had the CFO said that the statistics concerning comparative advantages were not valid, for example, Stroh might have more of a basis to be critical of the management. The other statements are facts that Stroh can provide adequate support for. (Study Session 1, LOS 2.a,b)

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When Stroh answered his friend’s question concerning whether the friend should invest in APX, Stroh was in violation of all of the following Standards EXCEPT:

A) Standards VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program.

B) Standard III(C) Suitability.

C) Standard III(B) Fair Dealing.

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The Standard III(B) indicates that members shall deal fairly and objectively with all clients when disseminating recommendations and material changes. Fair dealing requires that members make every effort to treat all clients, whether they are individuals or institutions, in a fair and impartial manner. By essentially making a recommendation to his friend first, Stroh breached the standard because he disadvantaged his clients in favor of his friend. Also, Stroh still had to verify what the friend said about the comparative advantage was true. Standard V(A), Diligence and Reasonable Basis, and that the investment would be appropriate for his friend Standard III(C), Suitability. Mentioning his training, which included the CFA designation, was not inappropriate. (Study Session 1, LOS 2.a,b)

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Stroh attempted to maintain the confidence of his research methods by not revealing them in his report. By doing so, Stroh:

A) may have violated the standards related to known limitations of his analysis and material misrepresentation by omitting the source of his information and other facts that led to his conclusions.

B) is neither helping nor harming the consumers of his report, as long as he reaches logical conclusions from the information the sources provide.

C) is exercising discretion in order to maintain a competitive edge.

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Standard V(A), Diligence and Reasonable Basis, and Standard V(B), Communication with Clients and Prospective Clients. Known limitations of the analysis and conclusions should be documented in research reports. Material misrepresentations should also be avoided by including all pertinent information and by distinguishing between opinion and fact in the analysis and conclusions of a report. Stroh may have violated the standards related to known limitations in his analysis by rushing to provide a recommendation. Stroh felt somewhat unable to perform an analysis given the lack of essential data, but completed a report where the conclusions are largely driven by information derived from conversations that were not included or referenced in the report. These missing facts may also be construed as material misrepresentation. However, at no time should material nonpublic information be used for, or reported in, recommendations that are produced by Stroh or ECM. (Study Session 1, LOS 2.a,b)

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With respect to Stroh’s recommendations, the mosaic principle could play a role with respect to the use of which piece of information?

A) The purchase of the glass manufacturing company in the country.

B) The partnering of APX with the government’s car parts operations.

C) The comparative advantage of the country in manufacturing.

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Stroh could not use the information concerning the car parts partnering, the purchase of the glass manufacturing company, or IMI's withdrawal from partnering because some or all of this information was passed on to him via insiders with the information being material nonpublic information and therefore cannot be traded upon. The Mosaic principle could only play a role in the material public information regarding the comparative advantage of the country. (Study Session 1, LOS 2.a,b)

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An analyst writes a report and includes the forecasts of an econometric model developed by the firm’s research department. The analyst identifies the source of the forecast and includes all the relevant statistics concerning the model and his opinion of the model’s accuracy. With respect to Standard V(A), Diligence and Reasonable Basis, the analyst has:

A) violated the Standard by including quantitative details in a report.

B) complied with the Standard.

C) violated the Standard by not testing the model himself.

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Including quantitative details in a report is not a violation of the Standard. The analyst has more of an obligation to give an opinion on the accuracy of the model than withhold such an opinion. Although the analyst should use reasonable care to verify information included in a report, retesting models developed by the research department of a firm is not explicitly required.

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Several years ago, Hilton and Ross, a full service investment firm, managed the initial public offering of eCom, Inc. Now, eCom wants Hilton and Ross to underwrite its secondary public offering. A senior manager at Hilton and Ross asks Brent Whitman, CFA, one of its equity analysts, to write a favorable research report on eCom to help make the underwriting a success. Whitman conducts a thorough analysis of eCom and concludes that the company has serious problems that do not suggest a favorable financial outlook. Nevertheless, Whitman writes a favorable report because he is fearful of losing his job. Hilton and Ross publicly distribute a report that only contains a buy recommendation and a brief description of the basic characteristics of eCom. Whitman has violated:

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

B) Both Standard I(B) Independence and Objectivity and Standard V(A) Diligence and Reasonable Basis.

C) Standard I(B) Independence and Objectivity, only.

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Whitman violated Standard V(A) Diligence and Reasonable Basis because he did not have a reasonable and adequate basis for issuing a favorable recommendation. Whitman violated Standard I(B) Independence and Objectivity because he did not act independently in issuing his recommendation but instead was influenced by senior management at Hilton and Ross.

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An analyst receives a research report from a colleague. The colleague’s report has an elaborate table with performance data on publicly traded stocks. The colleague says the data in the table consists of measures provided by Standard & Poor’s. The analyst finds the table a useful reference for a report she is writing. She uses several pieces of data from the table. The analyst is potentially in violation of:

A) Standard I(C), Misrepresentation, concerning the use of the work of others.

B) no particular standard because this is appropriate activity.

C) Standard V(A), Diligence and Reasonable Basis, if she does not first verify the data in the table is accurate.

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Since the data in the table supposedly comes from Standard & Poor’s, a recognized data source, the analyst does not have to cite the source of the data. However, the analyst needs to use reasonable care and verify that the data is accurate by going back to the source. Had the analyst printed the table prepared by her colleague without acknowledgement, the analyst would have violated Standard I(C), Misrepresentation.

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An analyst notices that for most years that a given class of assets has an abnormally high rate of return, the asset class often has an abnormally low rate of return the next year. Based upon this information, according to Standard V(A), Diligence and Reasonable Basis, the analyst can recommend:

A) neither of these choices.

B) short selling assets that have had a good previous year to all clients.

C) an increased allocation of Treasury bills (T-bills) for all portfolios of assets that have increased dramatically in the previous year.

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An analyst should not make a recommendation based only upon a statistical anomaly. Furthermore, none of the other choices would be appropriate. Clients with low risk tolerance should not short sell assets. The analyst cannot make a recommendation to all clients because each client has different characteristics and portfolios. The one answer that may have some merit is to increase the allocation of T-bills in portfolios that have had recent, dramatic increases. This would be for the purposes of maintaining a balanced portfolio. But the decision to rebalance must be made on a case-by-case basis and not for all portfolios.

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Peggy Green, CFA, is a research analyst following Brown Co. All the information she has gathered suggests the stock should be rated a weak "hold." During a recent lunch, Green overheard another analyst say that the stock should be rated a "buy." Green returns to her office and issues a "buy" recommendation. Green:

A) has violated CFA Institute Standards of Professional Conduct because she did not have a reasonable and adequate basis for making this recommendation.

B) violated CFA Institute Standards of Professional Conduct because she did not seek approval of the change from her firm's compliance director.

C) has violated CFA Institute Standards of Professional Conduct because she failed to distinguish between fact and opinion.

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Analysts are required to have a reasonable and adequate basis, supported by appropriate research and investigation, for their recommendations.

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An analyst receives a report from his research department that summarizes and interprets a recent speech from the chairman of the U.S. Federal Reserve. The summary says that the chairman thinks inflation is under control. Based upon this summary, the analyst says in his next newsletter that inflation is under control. This is a violation of:

A) Standard V(A), Diligence and Reasonable Basis, and Standard V(B), Communication with Clients and Prospective Clients.

B) Standard V(A), Diligence and Reasonable Basis, only.

C) none of the Standards listed here.

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The analyst should verify that the research department has interpreted the chairman’s speech correctly. The analyst must make it clear that the statement concerning inflation is only an opinion. No one knows if that is true or not at any point in time. Based upon the given information, we cannot say that the analyst is violating only one standard. The analyst may also be violating plagiarism in accordance with Standard I(C), Misrepresentation. Hence, the answer citing the two standards and not limiting violations to just those two standards is the best answer.

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An analyst has found an investment with what appears to be a great return-to-risk ratio. The analyst double-checks the data for accuracy, keeps careful records, and is careful to not make any misrepresentations as he simultaneously sends an e-mail to all his clients with a “buy” recommendation. According to Standard V(A), Diligence and Reasonable Basis, the analyst has:

A) violated the Standard if he does not verify whether the investment is appropriate for all the clients.

B) fulfilled all obligations.

C) violated the Standard by communicating the recommendation via e-mail.

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If the analyst had been an investment manager, it would have been inappropriate for him to make a blanket recommendation for all of his clients without considering the unique needs of each. However, the analyst is merely stating that given the qualities of the investment, it is an attractive buy. He has kept adequate records, and made fair disclosure of his rating decision.

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A client calls his money manager and asks the manager to liquidate a large portion of his assets under management for an emergency. The manager warns the client of the risk of selling many assets quickly but says that he will try to get the client the best possible price. This is a violation of:

A) none of the Standards listed here.

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

C) Standard III(C), Suitability.

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The money manager has done his duty. He has warned the client of the risk and made no explicit promises concerning what he can and cannot do.

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Susan Plumb is the supervisor of her firm’s research department. Her firm has been seeking the mandate to underwrite Wings Industries’ proposed secondary stock offering. Without mentioning that the firm is seeking the mandate, she asks Jack Dawson to analyze Wings common stock and prepare a research report. After reasonable effort, Dawson produces a favorable report on Wings stock. Plumb then adds a footnote describing the underwriting relationship with Wings and disseminates the report to the firm’s clients. According to CFA Institute Standards of Professional Conduct, these actions are:

A) a violation of Standard V(A), Diligence and Reasonable Basis.

B) a violation of Standard VI(A), Disclosure of Conflicts.

C) not a violation of any Standard.

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The fact that the firm is seeking the mandate does not preclude the research department from performing analytical work on the security. As long as the final recommendation is based upon reasonable facts, not the desire to obtain the mandate, there is no violation.