hinsafdar

Kim Lee is a research analyst at Superior Investments and 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!" After returning to her office, Lee issues a research report describing the compound as an "IQ booster with huge potential." This statement:

A) is reasonable given the information she was provided by the company.

B) is allowable but only if quoted verbatim from her conversations with management.

C) lacks a reasonable and adequate basis in fact.

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Standard V(A) requires that a member have a "reasonable and adequate basis" before making an investment recommendation. Extrapolating on the basis of the conjecture of one member of the management team, without independent corroboration, is clearly in violation of this Standard. She is also in violation of Standard V(B) concerning the use of reasonable judgment regarding what is included or excluded in a communication with a client or prospective client.

hinsafdar

One year ago, Karen Jason left the employment as a portfolio manager of Howe Advisors. The departure was contentious and both parties threatened legal action. As a result, both parties signed a settlement in which Jason was paid a pro rated bonus, but agreed not to work on the portfolios of any existing Howe client for two years. The terms of the agreement were that both parties agreed to keep all aspects of the agreement confidential, including the fact that there was hostility surrounding the departure. Jason now works for Torre Advisors, who has the Stein Company as a new client. At the time Jason left Howe, Stein was a client of Howe, although Jason did not personally work on the Stein portfolio. Jason's supervisor at Torre wants Jason to work on the Stein portfolio. Jason should:

A) inform her supervisor that she cannot work on the portfolio because of a non-compete agreement.

B) work on the portfolio because she did not personally work on the portfolio when she was at Howe.

C) inform her supervisor that she cannot work on the portfolio because of a legal agreement, but cannot tell him why.

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Jason must inform her supervisor of the conflict, but she cannot violate the terms of the confidentiality agreement and she cannot work on the portfolio.

hinsafdar

Paul Drake is employed by a company to provide investment advice to participants in the firm's 401(k) plan. Company stock is one of the investment options in the plan. Drake feels that the stock is too risky for employees to own in their 401(k) plan and starts advising them to pull out of the stock. The Treasurer of the company calls Drake and tells him that he will be fired if he continues making such advice because he is violating his fiduciary duty to the company. Drake should:

A) continue to advise employees to sell their stock.

B) make sell recommendations but point out that the company Treasurer has a differing and valid point of view.

C) tell employees that he cannot provide advice on company stock because of a conflict of interest.

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Although Drake is paid by the company, his fiduciary duty is to the plan participants. His advice cannot be compromised by business considerations, otherwise he will be violating the Standard on loyalty, prudence, and care.

hinsafdar

Ned Brenan manages two dozen pension accounts, one of which earned over 25% during the past two years. Brenan tells prospective clients that based on past experience they can expect a 25% return on their funds. Which of the following statements is CORRECT?

A) Brenan has violated Standard of Professional Conduct III(D), Performance Presentation, but Brenan has not violated Standard I(C), Misrepresentation.

B) Brenan has violated both Standard of Professional Conduct III(D), Performance Presentation, and Standard I(C), Misrepresentation.

C) Brenan has not violated Standard of Professional Conduct III(D), Performance Presentation, but Brenan has violated Standard I(C), Misrepresentation.

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Brenan violated Standard of Professional Conduct III(D) by using only one portfolio’s results to create a false impression of all the portfolios, and Brenan violated Standard of Professional Conduct I(C) by creating the impression that a certain return was assured (he should have used the words “might” or “could” instead of “can”).

hinsafdar

While having a conversation with a prospective client, John Henry states that his performance across all of his past clients over the past five years was over 20%, which was 200 basis points higher than his benchmark. He tells the client that while the benchmark may rise or fall over time, his excess performance will remain consistent. Henry violated the Standards of Professional Conduct because:

A) he cannot discuss prospective future performance in any manner.

B) the statement of excess performance is misleading with respect to its certainty.

C) he cannot discuss performance without clearly stating that the composite does not conform to GIPS.

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Guaranteeing performance on investments that are inherently volatile is misleading to clients.

hinsafdar

Jose Gonzales, CFA, was recently hired as a quantitative analyst for StatInvest Inc., a national investment research firm covering investments in the U.S. and Canada. Gonzales has worked in similar positions for eleven years. Prior to joining StatInvest, Gonzales worked as an analyst and portfolio manager for Rutherford & Co., a much smaller company that served a regional market.
In his first assignment with StatInvest, Gonzales must put together a report that will be distributed to investors on a monthly basis. The report will center on investments within the North American industrial sector. Gonzales begins by rebuilding a quantitative stock selection model that he created and used while at Rutherford & Co. The model was originally designed to select stocks in the consumer products sector based on fundamental, technical, and quantitative factors. Gonzales has kept the primary algorithms for stock screening the same in the new model but has updated the key identifiers to coincide with the industrial sector rather than the consumer products sector.
Once the model is complete, Gonzales backtests the model to determine its accuracy and consistency in selecting investments with positive performance. He determines that in each of the last ten years, the model would have indicated a buy on the single best performing stock for the year. The model would have also indicated a buy on several stocks that had zero or slightly negative returns. Satisfied with the results, Gonzales begins to write his first report. Following are several excerpts from the report:
StatInvest’s model for selecting industrial sector stocks is based on a computerized algorithm that selects securities according to a factor screening mechanism. Dozens of fundamental, technical, and quantitative factors are used as selection criteria to recommend long and short positions.
If StatInvest’s industrial sector model had existed ten years ago, investors would have had an average annual rate of return of 23% over the 10-year period. This estimate is based on backtesting of our model, which consistently recommended the top-performing stocks for each year over the past decade.
The current buy recommendations include Pearson Metals, Nuvo Chemical Co., and Luna Mining. These three investment opportunities will provide returns in excess of 15% over the next 12 months. However, if a significant number of market participants develop (or are already using) models similar to StatInvest’s model, returns on these three company’s common stock could be different from our expectations.
After the report is issued, Gonzales backs up his electronic files on a disk and has the disk archived in the firm’s offsite storage facility along with all of the hard copy files supporting his model and the recommendation. Gonzales also begins to compile records to support investment recommendations he issued while working at Rutherford & Co. so that similar recommendations may be issued for StatInvest’s consumer products division. All of the recommendations had an adequate basis at the time of issuance and were issued only a short time ago. After reanalyzing that relevant information and looking for significant changes in the company’s financial positions, Gonzales determines that the recommendations are still valid. After Gonzales compiles the supporting documentation, he issues the recommendations.
Several clients who have been subscribing to Gonzales’s monthly report have expressed a desire to have their portfolios professionally managed. Gonzales refers all clients expressing such an interest to Samantha Ovitz, CFA, a portfolio manger and partner of Ryers & Ovitz Inc. In return for the referrals, Ryers & Ovitz subscribes to several periodic reports published by StatInvest, including the industrial sector report written by Gonzales. Ovitz does not disclose the referral arrangement to clients and prospects, however, because the funds used to pay for StatInvest research are allocated from a general overhead account and not directly from client fees and because StatInvest’s reports have a general disclaimer stating that “all referrals provided by StatInvest are in exchange for some benefit, whether monetary, in kind, or other compensation.”
Ovitz is a board member of her local CFA society, and through her position often speaks to local media regarding the society’s events as well as current issues in the investment community. Ovitz has often been quoted in the press expressing her disagreement with long-standing policies of CFA Institute. Despite her disagreements, however, Ovitz is also known to heavily promote the CFA designation in her dealings with the media. In a recent interview with a local newspaper, Ovitz noted the superior track record of CFA charterholders vs. non-charterholders with respect to investment performance and ethical business practices. After reading the article, the chairman of the local CFA Society board called Ovitz to thank her for doing such an excellent job of maintaining the prestigious image of the CFA designation.By developing the quantitative model to select stocks in the industrial sector, did Gonzales violate any CFA Institute Standards of Professional Conduct?

A) Yes, because the underlying premise of the model is not based on adequate research or a reasonable basis.

B) No.

C) Yes, because the basic model is the property of his former employer and Gonzales has not obtained permission to use the model.

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Gonzales has recreated the model that he developed while working for his previous employer. He did not take the model or its supporting documentation from his employer. Instead he has reproduced them from memory and customized the model to fit his current requirements. Therefore he has not violated Standard I(C) Misrepresentation, by committing plagiarism, nor Standard IV(A) Loyalty, because he recreated the model at StatInvest and did not simply copy the model and use it for his new employer’s gain. By updating the key identifiers to reflect the industrial sector, and by backtesting the model, Gonzales has complied with Standard V(A) by having a reasonable and adequate basis, supported by appropriate research and investigation, for his analysis. (Study Session 1, LOS 2.a,b)

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In his first report on investments in the industrial sector, did Gonzales’s description of the stock selection model or its historical results violate any CFA Institute Standards of Professional Conduct?

Model description

Historical results

A) No Yes

B) Yes Yes

C) No No

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The description provided by Gonzales is an accurate depiction of the process by which the model selects stocks to recommend for either a purchase or sell. Gonzales does not provide every detail regarding the individual factors used to screen the stocks or how the algorithm works since these are proprietary details. In describing the historical results of the model, however, Gonzales has violated Standard III(D) Performance Presentation and Standard I(C) Misrepresentation. In his report, Gonzales omitted the fact that the model selected several stocks with zero or negative returns. By not including this result in the report, Gonzales is not portraying a fair, accurate, and complete performance record (a violation of Standard III[D]) and thus intentionally misleads his clients with the recommendations (a violation of Standard I[C]). Clients are lead to believe that the model only picks top performers and thus the recommendations in the report imply that they will fall into this category. (Study Session 1, LOS 2.a,b)

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In his first report on investments in the industrial sector, did Gonzales’s three investment recommendations violate any CFA Institute Standards of Professional Conduct?

A) Yes, because he provided an inherent guarantee of investment performance that cannot reasonably be expected.

B) No.

C) Yes, because he failed to distinguish between fact and opinion with regard to expected performance.

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Gonzales has provided a guarantee that the investment returns are going to provide a return in excess of 15%. This is a misrepresentation of the risk inherent in the stocks and is thus a violation of Standard I(C) Misrepresentation, which prohibits such misrepresentations. (Study Session 1, LOS 2.a,b)

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With regard to his record retention actions and his reissuance of past investment recommendations, has Gonzales violated any CFA Institute Standards of Professional Conduct?

Record retention

Past recommendations

A) Yes No

B) No Yes

C) No No

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Standard V(C) Record Retention, requires members and candidates to maintain records supporting their research and investment recommendations. Gonzales has kept a copy of both his electronic and hard copy files used to generate his report and has thus complied with the Standard with regard to his record retention practices. The fact that the records are stored offsite is not relevant as long as they are being appropriately maintained. Gonzales has also not violated any Standards by compiling research to support an investment recommendation he made while at another firm. As long as he did not reissue the recommendation without supporting documentation or take (without permission) the supporting documentation from the previous employer, he has not violated the Standards. (Study Session 1, LOS 2.a,b)

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Does the referral arrangement between StatInvest and Ryers & Ovitz Inc. violate any CFA Institute Standards of Professional Conduct?

A) Yes, because Ryers & Ovitz pays for the research out of a general overhead account, which disadvantages some clients.

B) No.

C) Yes, because the referral arrangement is not properly disclosed to clients and prospects of Ryers & Ovitz Inc.

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Ovitz cannot rely on disclosures made by StatInvest but must disclose the referral arrangement to clients and prospects herself. It does not matter that a general overhead account is designated as the source of funds for the research purchased from StatInvest. Ryers & Ovitz Inc. and StatInvest have an agreement which provides a form of compensation to both parties and may pose a cost to the client either directly or indirectly. In order to assess the full cost of either firms’ services, the client must be aware of the referral arrangement. By not actively disclosing the agreement, Ovitz has violated Standard VI(C) Referral Fees. (Study Session 1, LOS 2.a,b)

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In her dealings with the local media, has Ovitz violated any CFA Institute Standards of Professional Conduct?

A) Yes, because her comments regarding her disagreement with CFA Institute policies compromise the reputation of the organization.

B) Yes, because she has improperly exaggerated the meaning of the CFA designation.

C) No.

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Standard VII(A) prohibits members and candidates from taking any action that compromises the integrity or reputation of CFA Institute, the CFA designation, or the CFA exam. Members and candidates are allowed, however, to disagree with CFA Institute policies and express their lack of agreement. Therefore Ovitz did not violate Standard VII(A). Ovitz did violate Standard VII(B) which prohibits members and candidates from exaggerating the meaning of the CFA designation. Ovitz has implied that CFA charterholders are better investment managers and more ethical than other investment professionals, which overstates the implications of being a charterholder. (Study Session 1, LOS 2.a,b)

hinsafdar

Preston Partners is an investment management firm that adopted the Code and Standards as part of its policy manual. Gerald Smithson, CFA, has recently added the stock of Utah Biochemical Company and Norgood PLC to all his client's investment portfolios. Shortly afterwards Utah Biochemical and Norgood announced a merger that increased the share price of both companies. Smithson contends he saw the president of Utah Biochemical dining with the chairman of Norgood, but did not overhear their conversation. Smithson researched both companies extensively and determined that each company was a good investment. He put in a block trade for shares in each company. Preston's policies were not clear in this area as he allocated the shares by starting with his largest client accounts and working down to the small accounts. Some of Smithson's clients were very conservative personal trust accounts, others were pension funds who had aggressive investment objectives. Which standard was NOT broken?

A) Standard IV(C)--Responsibilities of Supervisors.

B) Standard V(A)--Diligence and Reasonable Basis.

C) Standard III(C)-- Suitability.

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Standard V(A)—Diligence and Reasonable Basis was not broken because Smithson conducted thorough and diligent research. Standard III(C)-- Suitability, Smithson failed to consider the needs of his conservative and aggressive clients. Standard IV(C)--Responsibilities of Supervisors, Preston Partners didn't have policies explaining how to allocate shares among clients.

hinsafdar

Sharon Pope has been asked by the Chief Investment Officer to develop a firm-wide policy for proxy voting. Which of the following would NOT be acceptable to include in the policy statement?

A) Voting proxies may not be necessary in all instances.

B) Portfolio managers of active funds must vote in all proxies; portfolio managers of index funds should vote only when they have a definitive opinion.

C) The value of proxy voting must be maximized.

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Proxies for stocks in passively managed funds must also be voted. A cost-benefit analysis may show that voting all proxies may not benefit all clients.

hinsafdar

Which of the following statements about a member's use of client brokerage commissions is NOT correct? Client brokerage commissions:

A) should be commensurate with the value of the brokerage and research services received.

B) may be directed to pay for the investment manager's operating expenses.

C) should be used by the member to ensure that fairness to the client is maintained.

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Brokerage commissions are the property of the client and may only be used for client benefit.

hinsafdar

Randal Brooks is the chief economist for a large brokerage firm. In the aftermath of a national tragedy, Brooks feels that it is very possible that the stock market will drop significantly and not recover for several years. However, he does not believe that this is the most likely scenario but merely that the risk of investing in equities has increased. He decides to write a market commentary to the brokerage clients that discusses the reasons why the market will remain stable and talks about why he, as a private citizen, feels patriotic. He does not mention the increase risk in equities. Brooks has:

A) violated the Standards by not including all of the relevant factors in the research report and making patriotic statements.

B) violated the Standards by not including all of the relevant factors in the research report, but not by making patriotic statements.

C) not violated the Standards.

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By not mentioning the increased risk of the market, Brooks has violated the Standard on using reasonable judgment in a research report. However, the patriotic statements do not violate the Standards.