Reading 4/5: Ethics Cases －LOS a, (Part 1) conduct, reading

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CFA Institute Area 1-2: Ethical and Professional Standards
Session 2: Ethical and Professional Standards in Practice
Reading 4/5: Ethics Cases
LOS a, (Part 1): Evaluate professional conduct described in each reading.

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Marc Feldman, CFA, is manager of corporate investor relations for a high-tech startup, zippy.com, in Boise, Idaho. Feldman learns that Larry Smith, controller, is altering the accounting records. Feldman advises some of his personal friends to sell short zippy.com. This action:

A) constitutes professional misconduct but not the use of nonpublic information and is a violation of the Code and Standards.

B) constitutes a violation of the Standard concerning prohibition against misrepresentation.

C) is not a violation of the Code and Standards since Feldman has no way of knowing what the correct accounting numbers are.

D) constitutes the use of material nonpublic information and is a violation of the Code and Standards.

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Answer and Explanation

The information is apparently nonpublic, and is clearly material since the valuation of securities in the market place is predicated upon financial data and other relevant information. Trading or inducing others to trade is a clear violation of Standard II(A).

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Marc Feldman, CFA, is manager of corporate investor relations for a high-tech startup, zippy.com, in Boise, Idaho. Feldman learns that Larry Smith, controller, is altering the accounting records. He decides that any ramifications from such activity is Smith's problem and does not report this fact. According to the CFA Institute Code and Standards he should or is required to do all of the following EXCEPT:

A) urge Smith to cease altering the accounting records.

B) report the activity to the FASB or other relevant regulatory body.

C) dissociate from the activity.

D) determine legality, consulting counsel if necessary.

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Answer and Explanation

As per the Standards of Practice Handbook "The Code and Standards do not require that members report legal violations to the appropriate governmental or regulatory organizations, but such disclosure may be prudent in certain circumstances." In this instance, he would likely be better off discussing the matter with the firm's legal counsel and Smith's superiors.

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Marc Feldman, CFA, is manager of corporate investor relations for a high-tech startup, zippy.com, in Boise, Idaho. Feldman learns that Larry Smith, controller, is altering the accounting records. Knowing the data is incorrect, Feldman releases Smith's financial data to investors. This action:

A) constitutes a violation of Standard III(D) concerning performance presentation.

B) constitutes a violation of his fundamental responsibilities under the Code and Standards.

C) constitutes a violation of the Standard concerning duty to employer.

D) is not a violation of the Code and Standards, since Marc has no way of knowing what the correct accounting numbers are.

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Answer and Explanation

As a CFA Institute member, Feldman is bound, under Standard I(A), not to "knowingly participate or assist in any violation of such laws, rules, or regulations." Since it should be clear that releasing bogus financial information is in contravention of laws, rules, and regulations, and since he knows that the data is purposely distorted, he must not release the data to the public. Doing so places him in violation of the Code and Standards.

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Williams and Fudd is a major London-based brokerage and investment banking firm. Heritage Group, a money management firm, is the first, second, or third largest holder of each of the securities listed on Williams & Fudd's "PrimeShare #10" equity security list.

Williams and Fudd faxed a preliminary copy of a research update bulletin on Yeshe Corp to Heritage at 7 a.m. on Wednesday the 23^rd. The report, a change from a "hold" to a "strong buy", was released to the public at 11 a.m. Between 11:00 and 11:20 a.m., Heritage executed a series of trades with which they bought 1.25 percent of Yeshe's publicly traded stock. This action is:

A) in accordance with the CFA Institute Code and Standards.

B) a violation of the Standard concerning priority of transactions, but would conform if Heritage had waited at least 48 hours after the report was issued.

C) a violation of the Standard concerning fair dealing.

D) a violation of the Standard concerning disclosure of conflict.

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Answer and Explanation

This action, by giving preferential treatment in the dissemination of investment recommendations and material changes to a favored client, is a violation of Standard III(B) concerning fair dealing.

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Williams and Fudd is a major London-based brokerage and investment banking firm. Heritage Group, a money management firm, is the first, second, or third largest holder of each of the securities listed on Williams & Fudd's "PrimeShare #10" equity security list.

On Tuesday morning, August 22, Williams & Fudd released a research report recommending the purchase of Skelmerdale Industries to the public and to its clients. On Wednesday afternoon, August 23, Heritage Group bought 1.5 million shares of Skelmerdale. This action is:

A) a violation of the Standard concerning fair dealing.

B) a violation of the Standard concerning priority of transactions but would conform if Heritage had waited at least 48 hours after the report was issued.

C) a violation of the Standard concerning disclosure of conflicts.

D) in accordance with the CFA Institute Code and Standards.

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Answer and Explanation

These actions are in accordance with both Standards III(B), Fair Dealing, and VI(B), Priority of Transactions. There is no violation.

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Perley & Sons is an investment advisor company that just signed a contract with full discretionary power for the management of assets for Bright Future, a charitable fund. Without consultation, portfolio manager Martin Brown, CFA, decides to trade the funds assets through a brokerage firm that provides, as an additional benefit, research reports for companies in the microchip industry. These companies represent the main investment interest for most of the Perley & Sons clients. The Bright Future portfolio does not hold any equities in the microchip industry, and, because of its risk profile, is unlikely to ever do so. Which of the following activities represents a possible breach with the CFA Institute standards?

A) Exercising a selection principle that does not comply with the idea of best trade price and execution.

B) Accepting research reports from the brokerage firm that do not benefit client portfolios.

C) Lack of action in consulting with the client before choosing the brokerage firm.

D) Not disclosing this information to the Securities and Exchange Commission.

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Answer and Explanation

The problem refers to the fiduciary duties of the analyst and brokerage contracts involving soft money. Trades placed with a broker that provides the firm with research are implicitly paying for the research. In a competitive marketplace, it is probable that the trades could have been as effectively placed with a broker that was able to provide research that would apply to the holdings of Bright Future. According to Standard III(A) Loyalty, Prudence, and Care, it is permissible to direct trades of the client portfolio through a broker who provides research that does not directly benefit the client portfolio, but the client should be informed about the situation.

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Using as his universe all companies in the steel industry, Reynold Anderson analyses the performance of stock prices for the industry. He succeeds in developing a regression model with excellent statistical control measures. The extrapolation from the model shows low risk variance of the securities in this industry. Without the inclusion of non-steel stocks in the portfolio, Anderson concludes that, based on these results, every portfolio can use the steel industry securities to diversify and lower its risk. He persuades his clients to change their current portfolios. Anderson states that, as the models results show, some particular industries, such as car manufacturers, have underpriced stocks, and investors should take advantage of it. Anderson has violated the Standards because he:

A) does not distinguish the opinion, based on his model, from the fact.

B) does not honor his fiduciary duties.

C) does not consider the suitability of the investment.

D) is not clear enough about the model results.

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Answer and Explanation

While any of the answers can be shown to violate CFA Institute Standards, this cannot be determined conclusively from the information given. However, the scenario clearly indicates that Anderson does not distinguish between opinion and fact in communicating to his clients. Therefore, he violates the Standards on this basis.

While any of the answers can be shown to violate CFA Institute Standards, this cannot be determined conclusively from the information given. However, the scenario clearly indicates that Anderson does not distinguish between opinion and fact in communicating to his clients. Therefore, he violates the Standards on this basis.

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While working on her report, Jean Paul, CFA, learns from her friend in the investment banking department that the company she is analyzing can expect a tender offer very soon. Concerning this conclusion, Paul can:

A) trade on it, because she figured it out by herself.

B) trade on it, because it is public information.

C) trade on it, because it concerns a tender offer.

D) not trade on it because it is material nonpublic information.

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Answer and Explanation

According to Standard II(A), Material Nonpublic Information, an analyst is prohibited from trading on information that is both material and nonpublic.

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Mary Hiller, CFA, is a senior analyst at a mutual fund. She is also a member of the Board of the Directors of her daughters Skating Club. She is often asked for advice about the management of the club budget and about possible short-term investments, but she is not paid for this advice. She does not undertake any research to answer these questions, providing information based only on the general practices of the mutual fund at that moment. The only benefit she receives is a free monthly membership for her daughter that would usually cost $182. What should she do before making any recommendations, in order to comply with the CFA Institute requirements?

A) Inform her current clients about her outside consulting.

B) Obtain prior permission from her employer.

C) Discontinue her membership in the Board of the Directors at the Skating Club.

D) Consult only on her free time and do not accept any benefit greater than $100.

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Answer and Explanation

According to Standard IV(A) Loyalty to Employer, it is the employees duty to inform the employer about any type of outside consulting service, including duration and any compensation. Only after receiving permission from her employer, can she proceed.