Reading 2-III: Standards of Professional Conduct & Guid

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CFA Institute Area 1-2: Ethical and Professional Standards
Session 1: Code of Ethics and Professional Standards
Reading 2-III: Standards of Professional Conduct & Guidance: Duties to Clients and Prospective Clients
LOS D.: Performance Presentation.

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While it would be customary to report both five-year and ten-year performance data, Seminole Equity Partners has been in existence for only eight years. Because of this, Kurt Dambach does not report ten-year data but reports for both five years and since the inception of the fund. This he notes in a footnote at the bottom of the information sheet. This action is:

A) a violation of the Standard concerning prohibition against misrepresentation.

B) a violation of the Standard concerning performance presentation.

C) in accordance with the Code and Standards since he has indicated the basis in a footnote.

D) a violation of the Standard concerning professional misconduct.

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Answer and Explanation

Members who communicate performance information must ensure that the information is fair, accurate, and complete. Seminole Equitys presentation meets this standard.

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A money management firm has created a new junk-bond fund. When the firm advertised the new fund at its issuance, they used care to accurately compute the returns from the past 10 years for all assets in the fund. The firm used the current portfolio weights to determine an average annual historical return equal to 18% and claim an 18% annual historical return in their advertising literature. With respect to Standard III(D), Performance Presentation, this is:

A) in compliance.

B) a violation because the Standard prohibits computing historical returns on risky assets like junk bonds.

C) a violation because the firm should have used 12 years of data.

D) a violation because the advertisement implies the firm generated this return.

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Answer and Explanation

Reporting the historical returns of all assets now in the fund introduces a survivorship bias. Also, the advertisement is misleading because the fund just came into existence and has no historical record. Thus, the firm has misled the public as to their performance history.

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A money manager and member of CFA Institute is meeting with a prospect. She gives the client a list of stocks and says, These are the winners I picked this past year for my clients. Their double-digit returns indicate the type of returns I can earn for you. The list includes stocks the manager had picked for her clients, and each stock has listed with it an accurately measured return that exceeds 10 percent. Is this a violation of Standard III(D), Performance Presentation?

A) Yes, because the manager cannot reveal historical returns of recent stock picks.

B) No, because the manager had the historical information in writing.

C) Yes, unless the positions listed constitute a complete presentation (i.e., there were no stocks omitted that did not perform in the double digits).

D) No, because the information was to a prospect and not a client.

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Answer and Explanation

Standard III(D) requires fair representations concerning past and potential future performance. Unless the list of the winners includes all the positions that the firm held, the manager is misrepresenting past performance. The following statement is questionable: Their double-digit returns indicate the type of returns I can earn for you, but the action of submitting a partial list is clearly a violation. The manager should have information on past performance in writing. Whether the person is a client or prospect is not important in this instance.