Reading 2-III: Standards of Professional Conduct & Guida applies, generated, investment, class, 2010

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Session 1: Ethical and Professional Standards
Reading 2-III: Standards of Professional Conduct & Guidance: Duties to Clients and Prospective Clients

LOS A.: Loyalty, Prudence, and Care.

 

 

 

Heidi Krueger, CFA, an investment advisor, applies soft dollars generated from client accounts to purchase a report on the economic impact of world events, and to purchase a new conference table for the office she uses to meet with clients and prospects. Do these purchases violate Standard III(A) Loyalty, Prudence, and Care?

A) Both of these purchases violate the Standard.

B) Only one of these purchases violates the Standard.

C) Neither of these purchases violates the Standard.

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Using soft dollars for the purchase of office furniture does not benefit clients and is a violation. Purchasing research reports with soft dollars is not a violation, but the advisor should ensure that research purchased with client brokerage will benefit her clients.

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c

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Calvin Moore, CFA, has been transferred from the brokerage house of the Browning Company to the portfolio management department. In portfolio management, Moore learns that clients are grouped into three divisions according to portfolio value, divided as follows:

• Group 1            up to $10,000

• Group 2            from $10,001 to $100,000

• Group 3            more than $100,000

When recommendations are announced or trades are initiated, a particular sequence is followed in communicating to these groups.  At the next monthly meeting, Moore suggests that the sequencing practice is a breach of CFA Institute Standards. One of Moore’s co-workers replies that the grouping approach helps the company in applying the Standard regarding portfolio recommendations.  He further suggests that because Browning’s overall performance is more strongly affected by actions taken on the high value portfolios, that these portfolios should take priority over the small value portfolios. What should Moore do?  Moore should:

A) do nothing since there is no breach with the Standards.

B) disassociate himself from the problem and seek legal advice.

C) prepare a written report to the CEO describing the problem.

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Taking a special approach in disseminating information in relation to initiating trades is a breach of Standard III(B), Fair Dealing. Given the fact that Moore works in the department and has already unsuccessfully tried to prevent the practice from continuing, he needs to disassociate himself and seek legal advice.

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Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. Calaveccio places a trade with Quantco Brokerage. While Calaveccio's part of the transaction was conveyed correctly to Quantco, there was a trading error made in Calaveccio's account due to a slip up within Quantco. Calaveccio realizes that the error has taken place, and informs his contact at Quantco. Calaveccio allows Quantco to cover the error, with no cost to TrustCo. This is:

A) a violation of Calaveccio's duty to his employer.

B) permissible under CFA Institute Standards since some trading errors are a fact of life in the securities industry.

C) a violation of Calaveccio's fiduciary duties.

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The issue is similar to an allocation of soft dollars. Clearly, if the broker absorbs the loss, they expect to make up the difference in some way. However, since the error was on the part of Quantco Brokerage, Calaveccio is under no obligation to cover the cost of the trading error. Moreover, no reasonable observer expects that there exists any implied future allocation of trades to Quantco in return for correcting their own mistake. There is no violation of Standard III(A), Loyalty, Prudence, and Care.

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While trading on behalf of a pension account, an analyst receives special research reports from the brokerage firm with whom she is doing the trades. Such an activity is:

A) a violation of only The Code of Ethics.

B) not in itself a violation of Standard III(A), Loyalty, Prudence, and Care, nor the Code of Ethics.

C) a violation of both Standard III(A), Loyalty, Prudence, and Care, and the Code of Ethics.

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An analyst can receive research from a brokerage firm with whom she is trading on behalf of a client. The analyst should inform the client of the arrangement. The client is more likely to violate Standard III(A) by obtaining non-research services or, worse yet, personal benefits from the brokerage firm.

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Alan Cramer, CFA, practices in a country that does not regulate the investment of company retirement plans. He was retained by Bingham Companies to manage their corporate pension plan. Bingham’s management has approached Cramer and requested that Cramer invest the entire plan in Bingham stock.

Cramer may:

A) not invest any of Bingham Company's retirement plan in its own stock regardless of the stock's prospects and in spite of management's request.

B) invest a portion of the retirement plan in Bingham Company stock if the investment is prudent and if he keeps the overall portfolio properly diversified.

C) invest all of the retirement plan assets in Bingham Company stock according to management's request only if Cramer can document that the investment is more prudent than any other investment opportunity he finds.

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Standard III(A), Loyalty, Prudence, and Care, requires members to comply with their fiduciary duty. Retirement plan managers owe their duty to the plan participants, not to the management of the company sponsoring the plan. The fiduciary duty includes the obligation to diversify the plan’s investments, regardless of the quality of the sponsoring company’s stock. Investing in the company’s stock is not prohibited.

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Which of the following is a possible breach of fiduciary duties by a CFA Institute member who manages assets on behalf of a client?

A) Voting all proxies of stocks the client owns.

B) Using directed brokerage.

C) Neither of these breach fiduciary duties.

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Proxies have economic value to the client. To comply with Standard III(A), the analyst is obligated to vote proxies in an informed and responsible manner. A cost benefit analysis may show that voting all proxies may not benefit the client, so voting proxies may not be necessary in all instances. Directed brokerage occurs when the client requests that a portion of the client's brokerage be used to purchase services that directly benefit the client. Although, this may prevent best execution, it does not violate the Standards as it was directed by the client, not the brokerage firm.

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An analyst with his own money management firm trades on behalf of several large pension funds. The analyst now performs all trades through a particular brokerage firm because the brokerage provides his firm with a no-interest line of credit if paid within 60 days. The line of credit is available to all brokerage clients. The brokerage provides the analyst with personal account privileges that he would not otherwise be eligible for. The brokerage also provides the analyst with free research reports on many companies. Which of these benefits are violations of Standard III(A), Loyalty, Prudence, and Care?

A) Neither of these.

B) The research reports.

C) The personal account privileges.

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The personal account privileges are clearly a violation. The no-interest line of credit could be a violation if the analyst does not factor in the benefits when determining the fees of the clients, but it is not a per se violation. Research reports are least likely to be a violation.

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An independent analyst has only one client. One of the client’s largest holdings is a brokerage firm. Because of the large holding by his client, the brokerage firm recently began allowing the analyst to tap into the firm’s computer network to use the firm’s research facilities. This is allowable as long as the analyst:

A) uses the resources to help manage the client's account.

B) discloses the relationship to the client.

C) does both of the actions listed here.

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According to Standard III(A), Loyalty, Prudence, and Care, the analyst must put the client first and inform the client of any possible conflicts of interest. The analyst must channel any benefits derived from his service to the client, back to the client, and inform the client of the benefits

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Which of the following is least likely required of fiduciaries who are responsible for pension plans?

A) Judging investments in the context of the total portfolio.

B) Acting solely in the interest of plan participants.

C) Supporting the sponsor's management during proxy fights.

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Under Standard III(A) Loyalty, Prudence, and Care, fiduciaries must evaluate management’s proposals during proxy fights to see if they are in the best interest of the plan participants. If management’s ideas are justifiable and reasonably ensure plan participants’ betterment, then fiduciaries can support them. If management is only trying to further its own objectives, especially at the cost of plan participants, then fiduciaries must vote against management in proxy fights.