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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. 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(A), Loyalty, Prudence, and Care.

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

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Answer and Explanation

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 either of the other standards listed.

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An analyst thinks that a major change in the tax law will benefit holders of utility company stocks. She immediately begins calling all her clients and telling them of the upside potential of investing in such assets now. Based upon this information, this is most likely:

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

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

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

D) congruent with Standard V(A), Diligence and Reasonable Basis.

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Answer and Explanation

According to Standard III(C), the analyst needs to determine the suitability of an investment for each client. It is doubtful that all her clients are identical in their needs. According to the information, the analyst mentions the upside potential but does not mention the downside risk. Although the information says that she thinks that the change in the tax law will benefit holders of utility company stocks and says nothing of how she arrived at this conclusion, we do not know if she has or has not made her decision on a reasonable basis.

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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) appropriate given the obvious potential of the therapy.

B) only permissible if the account holders are contacted first before the shares are purchased.

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

D) a violation of the Standard concerning fiduciary duties.

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Answer and Explanation

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).

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In light of Singhs comments during his telephone call to Patel prior to his uncles death, which of the following actions that Patel can take comply with CFA Institute Standards of Professional Conduct?

A) Patel may change the current portfolio strategy and begin trading based upon Singhs expectations because he advised her to do so.

B) Patel must adhere, in principle, to the existing strategy but may begin altering the accounts composition based upon Singhs expectations.

C) Patel must adhere to the existing portfolio strategy until she meets with Singh to develop a new portfolio strategy based upon updated financial information but may place trades which are consistent with the existing strategy.

D) Patel must not place any trades in the account until she meets with Singh to develop a new portfolio strategy based on the updated information.

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Answer and Explanation

According to Standard III(C) Suitability, Patel must observe the written investment objectives now in effect as determined in cooperation with the client and may trade only on that basis. Because the anticipated change in Singhs financial condition was subject to an event of indeterminable timing, she should continue to honor the existing written investment objectives until a change (1) is warranted by an actual increase in the clients total financial assets and (2) has been agreed upon with her client.

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According to CFA Institute Standards of Professional Conduct, may Patel reallocate Singhs portfolio toward technology stocks after his Uncle dies but before the meeting with Singh?

A) No, because Patel and Singh must meet and revise the investment policy statement and portfolio strategy before reallocating.

B) No, because Patel must wait until the next annual meeting to reallocate.

C) Yes, because the funds have actually been transferred and the timing is no longer uncertain.

D) Yes, because the total value of the municipal bonds received into the account will be too large relative to the other assets in the portfolio.

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Answer and Explanation

According to Standard III(C) Suitability, investment recommendations and actions must be consistent with a clients written objectives and constraints (usually in the form of an investment policy statement (IPS)). Because Singhs written IPS would not allow the large allocation to technology stocks prior to receiving the inheritance, the IPS must be updated by Singh and Patel prior to taking any actions that deviate from the original IPS. Patel will violate Standard III(C) by reallocating the portfolio before meeting with Singh.

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Did Patel violate any CFA Institute Standards of Professional Conduct when she purchased the NetWin stock for Singhs portfolio or for the other clients portfolios?

Net income

Depreciation expense

A) No No

B) Yes Yes

C) Yes No

D) No Yes

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Answer and Explanation

According to Standard III(C) Suitability, Patel must analyze the appropriateness and suitability of NetWin.com stock on a case-by-case basis before buying it. This will necessarily consider the basic characteristics of the security and how these will affect overall portfolio characteristics relative to the existing investment strategy for each portfolio. Patel has not analyzed the effect that the stock will have on any of the individual portfolios in question and has thus violated the Standard. Patel cannot look at aggregate measures to determine the appropriate weight that the security should represent in the individual portfolios because the portfolios are being managed individually, not in aggregate.

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Which of the following is least accurate regarding the promotional announcement of Patel passing the Level 3 exam?

A) The fact that a promotional announcement was made violates the restrictions on misrepresenting the meaning of the CFA designation.

B) The promotional announcement uses the letters CFA as a noun and hence is an improper use of the designation.

C) The announcement is likely a violation because passing the level 3 exam does not entitle Patel to use the CFA designation.

D) The announcement violates the Code of Ethics because it implies that obtaining a CFA charter leads to superior performance.

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Answer and Explanation

An announcement that a member of a firm has received the right to use the CFA® designation is not a violation of the Code or Standards. However, Standard VII(B) requires that any reference to the Charter must not misrepresent or exaggerate the meaning or implications of the CFA designation. A Charterholder cannot claim that holding a Charter leads to superior performance results. The letters CFA can only be used as an adjective (never a noun, as in he is a CFA). Finally, passing all three exams does not give one the right to use the designation. All criteria must be met (e.g., experience requirements) before Patel can use the designation.

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With respect to the choice of broker, did Patel violate any CFA Institute Standards of Professional Conduct?

A) Yes, since Patel is obligated to seek the best possible price and execution for all clients.

B) Yes, since Patel has inappropriately directed trades to a personal friend at a high-priced brokerage firm.

C) Yes, since Patel failed to properly notify Singh that using TradeRight would lead to higher commissions and opportunity costs.

D) No.

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Answer and Explanation

Since Singh directed Patel to use TradeRight, this should be considered client-directed brokerage. While Patel should inform Singh of the implications of that choice, Patel has no option but to follow the clients direction according to Standard III(A) Loyalty, Prudence, and Care. Singh was fully aware of the fees charged by TradeRight relative to other brokerage firms and elected to use TradeRight anyway. Investment managers are obligated to seek the best price and execution in the absence of client direction.