Reading 2-IV: Standards of Professional Conduct & Guida

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CFA Institute Area 1-2: Ethical and Professional Standards
Session 1: Code of Ethics and Professional Standards
Reading 2-IV: Standards of Professional Conduct & Guidance: Duties to Employers
LOS A.: Loyalty.

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Nick O'Donnell, CFA, unsuspectingly joins the research team at Wickett & Co., an investment banking firm controlled by organized crime. None of the managers at Wickett are CFA Institute members. Because of his tenuous situation at Wickett, O'Donnell begins making preparations for independent practice. He knows he will be terminated if he informs management at Wickett that he is preparing to leave. Consequently, he determines that "if he can just hang on for one year, he will likely have a client base sufficient for him to strike out on his own." This action is:

A) a violation of his duty to disclose conflicts to his employer.

B) a violation of his fiduciary duties.

C) not in violation of the Code and Standards as the employer's violations of the law absolve him from his ordinary duties to this employer under the Code and Standards.

D) not a violation of his duty to employer.

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Answer and Explanation

ODonnell is required to obtain consent from his employer if he is attempting to practice in competition with his employer. Merely undertaking preparations to leave, which do not violate a duty, is not a violation of the Code and Standards.

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Which of the following statements is most correct under the Code and Standards?

A) CFA Institute members are prohibited from undertaking independent practice in competition with their employer.

B) Written consent from the outside prospective client is necessary to permit independent practice that could result in compensation or other benefits in competition with the member's employer.

C) Consent from the employer is necessary to permit independent practice that could result in compensation or other benefits in competition with the member's employer.

D) Members are prohibited from making arrangements or preparations to go into competitive business before terminating their relationship with their employer.

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Answer and Explanation

Members are not prohibited from making arrangements or preparations to go into competitive business before terminating their relationship with their employer. CFA Institute members are not prohibited from undertaking independent practice in competition with their employer provided they have consent from their employer. Members must provide notification to their employer describing the types of services to be rendered, the expected duration, and compensation for the services.

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The following information concerns two analysts at Mega Securities Company.

• Mega recently hired Ron Anderson, CFA, who was previously an independent investment advisor. Anderson wants to keep his existing clients for himself and obtains written consent from Mega to do so. He also informed his existing clients in writing about his new position at Mega.
• Brenda Ford, a CFA Institute member, has been a full-time analyst for Mega for 12 years. She recently started providing investment services, which compete with Mega, to private clients on her own time. Ford obtained written consent for this arrangement from her direct supervisor at Mega. Ford has not disclosed to each of her clients her employment at Mega.

According to CFA Institute Standards of Professional Conduct, have Anderson and Ford violated Standard IV: Duties to Employers?

A) Anderson violated this Standard, but Ford has not.

B) Both Anderson and Ford have violated this Standard.

C) Neither Anderson nor Ford violated this Standard.

D) Ford violated this Standard, but Anderson has not.

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Answer and Explanation

Standard IV(A) requires consent to enter into independent practice. Standard IV(B) Additional Compensation Arrangements states that no compensation may be accepted which may create a conflict of interest without written consent from all parties. Anderson received consent from all parties, Ford did not receive consent from her independent clients.

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Janet Thompson, CFA, is employed as an analyst by Nationwide Securities. According to CFA Institute Standards of Professional Conduct, which of the following statements about Thompson's duty to Nationwide is FALSE? Thompson must refrain from:

A) making arrangements to go into a competitive business before terminating her relationship with Nationwide.

B) engaging in any conduct that would injure Nationwide.

C) being involved in any conduct that would deprive Nationwide of the advantage of Thompson's skills and ability.

D) engaging in independent competitive activity that could conflict with the business of Nationwide unless she receives written consent.

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Answer and Explanation

Standard IV(A) permits Thompson to make preparations to go into a competitive business before terminating her relationship with Nationwide provided that such preparations do not breach her duty of loyalty.

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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 where he provides money management advice in lieu of paying dues. Which of the following must the analyst do?

A) Nothing since he is not an employee of the charitable organization.

B) Resign from the position because the relationship is a conflict with the Standards.

C) Make sure that he keeps his CFA Institute membership a secret.

D) Must treat the charitable organization as his employer.

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Answer and Explanation

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.

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Sue Parsons, CFA, works full-time as an investment advisor for the Malloy Group, an asset management firm. To help pay for her childrens college expenses, Parsons wants to engage in independent practice in which she would advise individual clients on their portfolios. She would conduct these investment activities only on weekends. Which of the following statements about Standard IV(A), Loyalty to Employer, is most accurate? Standard IV(A):

A) precludes Parsons from entering into an independent competitive activity while still employed by Malloy.

B) does not require Parsons to notify Malloy of preparing to undertake independent practice under the current conditions.

C) requires Parsons to notify Malloy in writing about her intention to undertake an independent practice.

D) requires Parsons to obtain written consent from both Malloy and the persons from whom she undertakes independent practice.

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Answer and Explanation

Standard IV(A), Loyalty to Employer, requires that Parsons obtain written consent only from her employer before she undertakes independent practice that could result in compensation or other benefit in competition with Malloy. It is not required to get permission from your employer when only preparing to go into independent practice.

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Grant Starks, CFA, has been working for Advisors, Inc., for eight years. Starks is about to start his own money management business and has given his two-week notice of his resignation. A few days before his resignation takes effect, a current client of Advisors calls him at his office to inquire about some services for her account at Advisors. During the conversation, Starks tells the client that his new business will have lower commissions than Advisors. Starks has most likely violated:

A) Standard IV(A), Loyalty to Employer, by competing with his current employer.

B) Standard VI(B), Priority of Transactions, by violating the priority of transactions.

C) none of these Standards.

D) Standard V(B), Communication with Clients and Prospective Clients, by talking of commissions that are not yet in effect.

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Answer and Explanation

This is a breach of loyalty to his current employer. By telling a current client of his employer about the lower commissions he will charge in his new business, Starks is placing himself in direct competition with Advisors, and this is a violation of Standard IV(A).

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Brian Bellow, a CFA Institute member, is a portfolio manager for Progressive Trust Company. Several friends asked Bellow to review their investment portfolios. On his own time, Bellow examined their portfolios and made several recommendations. He received no monetary compensation from his friends for his investment advice and provided no future investment counsel to them. According to CFA Institute Standards of Professional Conduct, did Bellow violate his duty to Progressive Trust?

A) Yes, because he undertook an independent practice that could result in compensation or other benefit to him.

B) No, because Bellow provided no ongoing investment advice.

C) No, because Bellow provided investment advice to his friends.

D) No, because Bellow received no monetary compensation for his services.

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Answer and Explanation

Standard IV(A) does not preclude providing independent services for compensation while still employed; however, notification to the employer is required describing the type of service, the expected duration, and the compensation. Compensation includes more than just monetary benefits.

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John Hill, CFA, has been working for Advisors, Inc., for eight years. Hill is about to start his own money management business and has given his two-week notice of his resignation from Advisors. A few days before his resignation takes effect, on his lunch hour, he takes out a loan from a bank on behalf of his new business and uses the money to buy some office equipment for his new business. Since he engaged in these transactions while still an employee of Advisors, Hill violated Standard IV(A), Loyalty to Employer, by:

A) none of these actions.

B) engaging in a financial transaction, like taking out a loan, only.

C) purchasing office equipment, only.

D) both taking out the loan and purchasing the office equipment.

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Answer and Explanation

The Standards of Practice under IV(A) expressly says that a departing employee is generally free to make arrangements or preparations to go into a competitive business before terminating the relationship with the employees employer provided that such preparations do not breach the employees duty of loyalty. None of these actions are in conflict with the interests of Advisors, and Hill performed them on his own time.