bmaggie

Patricia Spraetz is the chief financial officer and compliance officer at Super Selection Investment Advisors.  Super Selection is a medium-sized money management firm which has incorporated the CFA Institute Code of Ethics and Standards of Practice into the firm's compliance manual.

Karen Jackson is a portfolio manager for Super Selection.  She is not a CFA charterholder.  Jackson is friendly with David James, president of AMD, a rapidly growing biotech company.  James has provided Jackson with recommendations in the biotech industry, which she buys for her own portfolio before buying them for her clients.  For three years, Jackson has also served on AMD's board of directors but has never notified Super Selection of this fact.  She has received options and fees as compensation.

Recently, the board of AMD decided to raise capital by voting to issue shares to the public.  This was attractive to board members (including Jackson) who wanted to exercise their stock options and sell their shares to get cash.  When the demand for initial public offerings (IPO) diminished, just before AMD's public offering, James asked Jackson to commit to a large purchase of the offering for her portfolios.  Jackson had previously determined that AMD was a questionable investment but agreed to reconsider at James' request.  Her reevaluation confirmed the stock to be overpriced, but she nevertheless decided to purchase AMD for her clients' portfolios.

 Which of the following statements is FALSE?

A) Jackson did not violate Standard III(A) on Fiduciary Duty to clients because she was bound by her fiduciary duty to AMD and its stockholders as a board member. Therefore, when she reversed her decision to buy AMD shares for Super Selection's clients, portfolios on James' request, her obligation to AMD took precedence.

B) Jackson violated Standard IV(B) regarding Disclosure of Additional Compensation by not disclosing additional compensation in the form of cash and stock options received from AMD, as its board member to her employer.

C) Jackson violated Standard VI(A) regarding Conflicts of interest by not disclosing her board membership and ownership of stock options to her employer.

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Jackson has violated Standard III(A) because her first obligation is to her firm's clients. Standard VI(A) addresses precisely these kinds of situations regarding potential conflict of interest. Given this conflict of interest, Jackson also compromised her objectivity in violation of Standard I(B). Her fiduciary duty to her clients takes precedence over her fiduciary duty to AMD's stockholders under the CFA Institute Code and Standards. By not disclosing her relationship with AMD, she also violated Standard IV(B). Making past personal security transactions ahead of purchase of the same securities for her clients has put Jackson in violation of Standard VI(B). This standard clearly prohibits such actions.

bmaggie

The Securities and Exchange Commission (SEC) sanctioned Stephen Rangen, a former broker, for unsuitable recommendations and excessive trading in several accounts.  His clients were unsophisticated, inexperienced individual investors with limited means.  As such, they relied heavily on Rangen’s advice and expected him to initiate any transactions in their respective accounts.  The SEC found that Rangen’s trading methods were contrary to his clients’ goals.  For example, he used margin accounts and concentrated their equity holdings in particular securities.  Rangen claimed that his actions were justified because his clients were aware of the risks. 

Which of the following statements best describes why Rangen’s argument, that his clients were aware of the risks, did NOT meet the requirements of the Code and Standards? Rangen failed to:

A) make recommendations that were consistent with his clients' financial needs.

B) deal fairly and objectively with his clients when taking investment action.

C) disclose to his clients all matters that reasonably could be expected to impair his ability to make unbiased and objective recommendations.

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Rangen did not fulfill the obligation he assumed when he agreed to counsel these clients. That is, he did not make recommendations that were consistent with their financial needs. According to Standard III(C), Suitability, Rangen must “consider the appropriateness and suitability of investment recommendations or actions for each portfolio or client.” This is true even if his clients wanted to speculate and were aware of the risks.

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Rangen bought U.S. Treasury strips and over-the-counter stocks that did not produce income as sought by his clients.  Rangen claimed that his actions were justified because his firm’s research department recommended the purchase of the Treasury strips. Also, he claimed the stocks that he bought were all in the top-rated categories of his firm’s research division.  Which of the following statements best describes why Rangen’s arguments, in which he attempted to shift the blame to his employer, did NOT meet the requirements of the Code and Standards? 

A) Rangen misrepresented the basic characteristics of the investments that he bought for his clients' accounts.

B) Rangen did not use reasonable care and judgment to achieve and maintain independence and objectivity in taking investment actions.

C) Rangen's duty was to make only recommendations that were in the best interests of his clients.

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Rangen cannot shift the blame to his employer. He had an obligation to consider not only his firm's recommendations, but also his clients' investment objectives and financial situations. He failed to consider relevant factors relating to his clients. Rangen violated Standard III(C) because he initiated investment actions without properly considering whether these actions were suitable to his clients' financial situations and investment objectives.

bmaggie

While copying some of her research materials at work, Mary Jones comes across a few incomplete research notes written by one of her colleagues. As a result of reading the notes, and without further review, Jones immediately changes one of her stock recommendations from sell to buy. Which of the following CFA Institute Standards has Jones violated?

A) Standard V(A), Diligence and Reasonable Basis.

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

C) Standard I(B), Independence and Objectivity.

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Jones has violated Standard V(A) by failing to exercise diligence and thoroughness.

bmaggie

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 model’s 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 consider the suitability of the investment.

C) is not clear enough about the model results.

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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.

bmaggie

The Konkol Company implements a new methodology for portfolio valuation that is licensed to them by ABC Statistics. Konkol complies with the CFA Institute Code and Standards by:

A) not discussing the new methodology with clients because there is no need to, as it will not change their risk and yield preferences.

B) discussing the new methodology with clients only when a change in the security selection process is involved.

C) discussing the new methodology with the clients, in its entirety.

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Standard V(B), Communication with Clients and Prospects, requires any change in the scope, valuation methodology, or focus of the portfolio to be discussed with clients.

bmaggie

John McNeal, CFA, has a friend named Stan Green, a journalist at Investment News, a weekly magazine. In one of their conversations, Green tells McNeal about material nonpublic problems at Brightstar.com, a heavily traded firm. Green has written a special article about Brightstar.com’s problems that will appear in the next issue of Investment News. According to the Standards, can McNeal act on the information Green has shared with him?

A) Yes, McNeal can trade on the information but should ask Green to disseminate the information immediately.

B) Yes, McNeal can trade on the information, because it is already public.

C) No, McNeal cannot trade on the information.

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McNeal cannot trade on the information before the article is published. Trading on the information received from the journalist before the magazine is published is trading on material nonpublic information, a breach of Standard II(A).

bmaggie

Member compliance on issues relating to corporate governance or to soft dollars is primarily addressed by the Standard concerning:

A) Loyalty, Prudence, and Care.

B) Disclosure of Referral Fees.

C) Disclosure of Conflicts to Clients and Prospects.

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Fiduciary duty on issues relating to corporate governance or to soft dollars is primarily addressed by Standard III(A), Loyalty, Prudence, and Care.

bmaggie

Rickard Advisors recently had a trading error in a customer account that was subsequently covered by Rickard. The firm felt embarrassed by the disclosure of this error, and, in order to induce the client to continue its relationship, Rickard offers the client preferential access to a new issue that is expected to be “hot.” Which Standard is violated, if any?

A) The Standard concerning Fair Dealing.

B) The Standard concerning Fiduciary Duty.

C) The Standard concerning Independence and Objectivity.

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Rickard is in violation of the Standard concerning Fair Dealing by offering the client preferential access to a “hot” new issue. There is no obvious violation of Fiduciary Duty, since there is no evidence that Rickard is placing its own financial interest ahead of the client.

bmaggie

Scott Andrews, CFA, is a stockbroker selling an oversubscribed stock issue. Which of the following best describes Andrews' actions regarding this sale? Andrews:

A) cannot offer an oversubscribed issue of stock to any clients.

B) can only offer this security to clients for which it is appropriate on a first come first serve basis.

C) can offer this security on a prorated basis to all clients for which the security is appropriate.

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Standard III(B), Fair Dealing, applies. When new issues or secondary offerings are available or are being offered by the firm or if the firm is part of a selling syndicate, all clients for whom the security is appropriate are to be offered a chance to take part in the issue. If the issue is oversubscribed, then the issue is to be prorated to all subscribers.

bmaggie

The use of client brokerage by an investment manager to obtain certain products and services to aid the manager in the investment decision-making process is called:

A) quid pro quo practices.

B) trading practices.

C) soft dollar practices.

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Directing client brokerage for research and/or services is called soft dollar practices.