Question 1

Michael Smyth is Senior Vice President of equity investments at Systematic Investment Advisors, Inc. (SIA). He manages a team of analysts and portfolio managers and is responsible for maintaining and developing client relationships. SIA is located in a small European country and provides investment management services to high net worth individuals. Smyth is also a Level III Candidate for the CFA designation.

One of Smyth’s clients is the Muller-Durand family. He had a long relationship with Helmut Muller. Before Muller’s untimely death, he gave Smyth full discretion over his portfolio based on an investment policy statement that had been refined continuously over the years.

• Muller was the president of a publicly traded manufacturing company, Comax, and 20% of his portfolio’s assets were invested in Comax equity. His contract with Comax prohibited his selling his Comax shares while he was employed.

• Muller had little liquidity needs. His children were grown and his salary at Comax was sufficient to cover his annual expenditures as well as contribute to his investment portfolio.

• A former Chartered Accountant, Muller had been extremely knowledgeable and comfortable with the investment decision-making process.

• Smyth owns 10,000 shares of Comax and serves on Comax’s board.

• Smyth played golf with Muller on a regular basis and, with Muller’s help, developed many client relationships from these outings.

SIA has a soft dollar arrangement with a local brokerage firm, First Brokerage, owned by Smyth’s sister.

• Muller had agreed in writing that all trades in his portfolio would be directed to First Brokerage.

• Smyth purchased new carpets for his office with client brokerage. He believes that his managers make better investment decisions when their environment is pleasant and comfortable.

• Smyth attended an industry conference in the Bahamas with soft dollars. The program is devoted to improving management of the investment advisory firm. He believes that a well-run firm makes better investment decisions.

• Smyth consistently uses soft dollars to purchase research reports from an independent research firm that does in-depth analysis of a company’s financial reporting. Several of his managers have commented on the quality and usefulness of these reports to their analysis and decision-making.

Smyth has an appointment to meet with Muller’s widow, Wilhelmina Durand. Durand was an artist who had left management of their financial assets to her husband. She is meeting with Smyth to better understand her financial position.

Part 1)

Which of the following Standards is most relevant regarding Smyth’s meeting with Durand?

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

B)   Standard III(C), Suitability.

C)   Standard III(E), Preservation of Confidentiality.

D)   Standard III(B), Fair Dealing.

Part 2)

Standard VI(A), Disclosures of Conflicts, requires Smyth to disclose all matters, including beneficial ownership of securities of other investments, that could be expected to impair the member’s ability to make unbiased and objective recommendations. Which of the following matters would least likely be disclosed to Durand?

A)   Smyth played golf with Muller on a regular basis and developed client relationships.

B)   SIA has a soft dollar arrangement with a brokerage firm owned by Smyth’s sister.

C)   Smyth owns shares in Comax.

D)   Smyth is a director of Comax.

Part 3)

Which of the following best describes Smyth’s compliance with the CFA Institute Soft Dollar Standards in his use of client brokerage?

A)   Purchase of research reports and attending the conference are allowable uses of client brokerage.

B)   Purchase of both research reports and carpeting are allowable uses of client brokerage.

C)   Purchase of research reports is an allowable use of client brokerage.

D)   All purchases made by Smyth are allowable use of client brokerage.

Part 4)

Smyth would like to continue to direct brokerage from Durand’s portfolio to his sister’s brokerage firm. In order to continue the arrangement and comply with the CFA Institute Soft Dollar Standards, which of the following disclosures are required?

A)   Smyth must clearly disclose that his duty as the investment manager is to continue to seek to obtain best execution.

B)   Smyth must clearly disclose, with specificity and in “plain language,” its policies with respect to all Soft Dollar Arrangements.

C)   Smyth must disclose that directed brokerage arrangements that require the investment manager to commit a certain percentage of brokerage might affect his ability to seek to obtain best execution.

D)   Smyth must provide a description of the product or service obtained through brokerage generated from the client’s account.

Part 5)

After determining Durand’s risk and return objectives, liquidity needs, tax considerations, and unique circumstances, Smyth has decided that he must reduce Durand’s holdings of Comax shares. He has several other clients, whom he met through Muller, who also have significant holdings in Comax. Smyth has also decided to reduce his own holdings in Comax since his term as a director of Comax will be up in June. He does not plan to seek reappointment but as a member of the audit committee he is privy to information about a tender offer. Smyth realizes this is a complex situation.

Which of the following Standards would be least likely to help Smyth decide what actions with respect to selling shares of Comax would be in compliance with the CFA Institute Standards of Practice?

A)   Standard III(C), Suitability.

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

C)   Standard III(B), Fair Dealing.

D)   Standard VI(B), Priority of Transactions.

Part 6)

Since Smyth is a director of Comax and a member of the audit committee, what additional Standard is specifically applicable to Smyth’s decision to sell his and his clients’ shares of Comax?

A)   Standard II, Integrity of Capital Markets.

B)   Standard VII, Responsibilities as a CFA Institute Member or CFA Candidate.

C)   Standard IV, Duties to Employers.

D)   Standard V, Investment Analysis, Recommendations and Action.

Part 1)

Which of the following Standards is most relevant regarding Smyth’s meeting with Durand?

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

B)   Standard III(C), Suitability.

C)   Standard III(E), Preservation of Confidentiality.

D)   Standard III(B), Fair Dealing.

The correct answer was B) Standard III(C), Suitability.

Standard III(C), Suitability, is most relevant for Smyth’s meeting with Durand. This Standard requires Smyth to make a reasonable inquiry into Durand’s financial situation, investment experience, and investment objectives prior to making any recommendations about her portfolio. Smyth must also consider the appropriateness of the existing portfolio and investment policy statement for Durand. Standard III(A) also has some relevance since Smyth is in a position of trust with respect to Durand and Smyth must ensure that his and SIA’s goals do not conflict with Durand’s.

This question tested from Session 1, Reading 2, LOS a, b

Part 2)

Standard VI(A), Disclosures of Conflicts, requires Smyth to disclose all matters, including beneficial ownership of securities of other investments, that could be expected to impair the member’s ability to make unbiased and objective recommendations. Which of the following matters would least likely be disclosed to Durand?

A)   Smyth played golf with Muller on a regular basis and developed client relationships.

B)   SIA has a soft dollar arrangement with a brokerage firm owned by Smyth’s sister.

C)   Smyth owns shares in Comax.

D)   Smyth is a director of Comax.

The correct answer was A) Smyth played golf with Muller on a regular basis and developed client relationships.

Smyth’s playing golf with Muller is not a conflict with respect to his relationship with Durand and he need not disclose to her that he played golf with Muller. Muller was his client at the time and there was full disclosure that Smyth developed new client relationships. All the other matters must be disclosed. Smyth must get Durand’s approval to continue to direct brokerage from her portfolio to his sister’s firm. As a director and shareowner of Comax, he has a potential conflict of interest when making a recommendation regarding Durand’s Comax shares.

This question tested from Session 1, Reading 2, LOS a, b

Part 3)

Which of the following best describes Smyth’s compliance with the CFA Institute Soft Dollar Standards in his use of client brokerage?

A)   Purchase of research reports and attending the conference are allowable uses of client brokerage.

B)   Purchase of both research reports and carpeting are allowable uses of client brokerage.

C)   Purchase of research reports is an allowable use of client brokerage.

D)   All purchases made by Smyth are allowable use of client brokerage.

The correct answer was C) Purchase of research reports is an allowable use of client brokerage.

The primary principles regarding use of client brokerage are (1) brokerage is the property of the client and (2) the investment manager has an ongoing responsibility to seek to obtain best execution, minimize transaction costs, and use client brokerage to benefit clients. Consequently, contingent on disclosure of the soft dollar arrangement to clients whose portfolios might be affected, the CFA Institute Soft Dollar Standards permit client brokerage only to be used to purchase research; that is, goods and services, the primary use of which directly assists the investment manager in the investment decision-making process and not in the management of the firm. Therefore, the only allowable use of soft dollars by Smyth is purchase of the research reports. The purchase of the carpeting to create a more pleasant environment would, at best, only contribute indirectly to the investment manager and use of client brokerage is not permitted. Conferences may sometimes be considered research if their programs are designed to improve the investment decision-making process. In Smyth’s case, the conference he attended only had sessions on the management of the investment management firm, not the investment decision-making process.

This question tested from Session 1, Reading 2, LOS a, b

Part 4)

Smyth would like to continue to direct brokerage from Durand’s portfolio to his sister’s brokerage firm. In order to continue the arrangement and comply with the CFA Institute Soft Dollar Standards, which of the following disclosures are required?

A)   Smyth must clearly disclose that his duty as the investment manager is to continue to seek to obtain best execution.

B)   Smyth must clearly disclose, with specificity and in “plain language,” its policies with respect to all Soft Dollar Arrangements.

C)   Smyth must disclose that directed brokerage arrangements that require the investment manager to commit a certain percentage of brokerage might affect his ability to seek to obtain best execution.

D)   Smyth must provide a description of the product or service obtained through brokerage generated from the client’s account.

Your answer: B was correct!

Investment managers are required to clearly disclose, with specificity and in “plain language,” its policies with respect to all Soft Dollar Arrangements. Because brokerage is an asset of the client, not the investment manager, the practice of client-directed brokerage does not violate the CFA Institute Soft Dollar Standards. However, directed brokerage arrangements have no required disclosures beyond those required for other soft dollar arrangements. Several disclosures are recommended. Because directed brokerage may impede the investment manager’s ability to seek to obtain best execution, which is one of the investment manager’s fundamental responsibilities, it is recommended that investment managers disclose his duty to seek to obtain best execution and that arrangements to commit a certain percentage of brokerage may affect his ability to do so. For all soft dollar arrangements, it is recommended, but not required, that, on request from the client, investment managers provide a description of the product or service obtained through brokerage generated from the client’s account.

This question tested from Session 1, Reading 2, LOS a, b

Part 5)

After determining Durand’s risk and return objectives, liquidity needs, tax considerations, and unique circumstances, Smyth has decided that he must reduce Durand’s holdings of Comax shares. He has several other clients, whom he met through Muller, who also have significant holdings in Comax. Smyth has also decided to reduce his own holdings in Comax since his term as a director of Comax will be up in June. He does not plan to seek reappointment but as a member of the audit committee he is privy to information about a tender offer. Smyth realizes this is a complex situation.

Which of the following Standards would be least likely to help Smyth decide what actions with respect to selling shares of Comax would be in compliance with the CFA Institute Standards of Practice?

A)   Standard III(C), Suitability.

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

C)   Standard III(B), Fair Dealing.

D)   Standard VI(B), Priority of Transactions.

Your answer: B was incorrect. The correct answer was A) Standard III(C), Suitability.

Standard III (C), Suitability, is the standard least likely to provide Smyth with guidance when he considers selling Durand’s holdings of Comax. This standard describes members’ responsibilities in developing appropriate recommendations and taking suitable actions. To reach the point where he has decided to sell Durand’s shares, Smyth would already have met these requirements. He has determined Durand’s and his other clients’ requirements and has recommended an appropriate and suitable investment action. His concern is how to implement his recommendation and be in compliance with the Standards of Professional Conduct.

Smyth has several problems with respect to selling shares of Comax from Durand’s portfolio and the portfolios of his other clients. First, he must comply with Standard III(B) and deal fairly and objectively with all clients and prospects when taking this investment action. Smyth must disclose his ownership of Comax to all affected clients according to Standard VI(A) and ensure that transactions for clients take precedence over transactions on his own behalf according to Standard VI(B).

This question tested from Session 1, Reading 2, LOS a, b

Part 6)

Since Smyth is a director of Comax and a member of the audit committee, what additional Standard is specifically applicable to Smyth’s decision to sell his and his clients’ shares of Comax?

A)   Standard II, Integrity of Capital Markets.

B)   Standard VII, Responsibilities as a CFA Institute Member or CFA Candidate.

C)   Standard IV, Duties to Employers.

D)   Standard V, Investment Analysis, Recommendations and Action.

Your answer: A was correct!

As a director and member of Comax’s audit committee, Smyth possesses material nonpublic information about a tender offer, which is information related to the value of Comax shares. Therefore, Smyth must be particularly concerned about complying with Standard II(A), Material Nonpublic Information. Under this standard, Smyth may not trade nor cause others until the information becomes public.

This question tested from Session 1, Reading 2, LOS a, b

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Question 1

Michael Smyth is Senior Vice President of equity investments at Systematic Investment Advisors, Inc. (SIA). He manages a team of analysts and portfolio managers and is responsible for maintaining and developing client relationships. SIA is located in a small European country and provides investment management services to high net worth individuals. Smyth is also a Level III Candidate for the CFA designation.

One of Smyth’s clients is the Muller-Durand family. He had a long relationship with Helmut Muller. Before Muller’s untimely death, he gave Smyth full discretion over his portfolio based on an investment policy statement that had been refined continuously over the years.

• Muller was the president of a publicly traded manufacturing company, Comax, and 20% of his portfolio’s assets were invested in Comax equity. His contract with Comax prohibited his selling his Comax shares while he was employed.
• Muller had little liquidity needs. His children were grown and his salary at Comax was sufficient to cover his annual expenditures as well as contribute to his investment portfolio.
• A former Chartered Accountant, Muller had been extremely knowledgeable and comfortable with the investment decision-making process.
• Smyth owns 10,000 shares of Comax and serves on Comax’s board.
• Smyth played golf with Muller on a regular basis and, with Muller’s help, developed many client relationships from these outings.

SIA has a soft dollar arrangement with a local brokerage firm, First Brokerage, owned by Smyth’s sister.

• Muller had agreed in writing that all trades in his portfolio would be directed to First Brokerage.
• Smyth purchased new carpets for his office with client brokerage. He believes that his managers make better investment decisions when their environment is pleasant and comfortable.
• Smyth attended an industry conference in the Bahamas with soft dollars. The program is devoted to improving management of the investment advisory firm. He believes that a well-run firm makes better investment decisions.
• Smyth consistently uses soft dollars to purchase research reports from an independent research firm that does in-depth analysis of a company’s financial reporting. Several of his managers have commented on the quality and usefulness of these reports to their analysis and decision-making.

Smyth has an appointment to meet with Muller’s widow, Wilhelmina Durand. Durand was an artist who had left management of their financial assets to her husband. She is meeting with Smyth to better understand her financial position.

Part 1)

Which of the following Standards is most relevant regarding Smyth’s meeting with Durand?

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

B)   Standard III(C), Suitability.

C)   Standard III(E), Preservation of Confidentiality.

D)   Standard III(B), Fair Dealing.

Part 2)

Standard VI(A), Disclosures of Conflicts, requires Smyth to disclose all matters, including beneficial ownership of securities of other investments, that could be expected to impair the member’s ability to make unbiased and objective recommendations. Which of the following matters would least likely be disclosed to Durand?

A)   Smyth played golf with Muller on a regular basis and developed client relationships.

B)   SIA has a soft dollar arrangement with a brokerage firm owned by Smyth’s sister.

C)   Smyth owns shares in Comax.

D)   Smyth is a director of Comax.

Part 3)

Which of the following best describes Smyth’s compliance with the CFA Institute Soft Dollar Standards in his use of client brokerage?

A)   Purchase of research reports and attending the conference are allowable uses of client brokerage.

B)   Purchase of both research reports and carpeting are allowable uses of client brokerage.

C)   Purchase of research reports is an allowable use of client brokerage.

D)   All purchases made by Smyth are allowable use of client brokerage.

Part 4)

Smyth would like to continue to direct brokerage from Durand’s portfolio to his sister’s brokerage firm. In order to continue the arrangement and comply with the CFA Institute Soft Dollar Standards, which of the following disclosures are required?

A)   Smyth must clearly disclose that his duty as the investment manager is to continue to seek to obtain best execution.

B)   Smyth must clearly disclose, with specificity and in “plain language,” its policies with respect to all Soft Dollar Arrangements.

C)   Smyth must disclose that directed brokerage arrangements that require the investment manager to commit a certain percentage of brokerage might affect his ability to seek to obtain best execution.

D)   Smyth must provide a description of the product or service obtained through brokerage generated from the client’s account.

Part 5)

After determining Durand’s risk and return objectives, liquidity needs, tax considerations, and unique circumstances, Smyth has decided that he must reduce Durand’s holdings of Comax shares. He has several other clients, whom he met through Muller, who also have significant holdings in Comax. Smyth has also decided to reduce his own holdings in Comax since his term as a director of Comax will be up in June. He does not plan to seek reappointment but as a member of the audit committee he is privy to information about a tender offer. Smyth realizes this is a complex situation.

Which of the following Standards would be least likely to help Smyth decide what actions with respect to selling shares of Comax would be in compliance with the CFA Institute Standards of Practice?

A)   Standard III(C), Suitability.

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

C)   Standard III(B), Fair Dealing.

D)   Standard VI(B), Priority of Transactions.

Part 6)

Since Smyth is a director of Comax and a member of the audit committee, what additional Standard is specifically applicable to Smyth’s decision to sell his and his clients’ shares of Comax?

A)   Standard II, Integrity of Capital Markets.

B)   Standard VII, Responsibilities as a CFA Institute Member or CFA Candidate.

C)   Standard IV, Duties to Employers.

D)   Standard V, Investment Analysis, Recommendations and Action.