Reading 2-III: Standards of Professional Conduct & Guidan management

1215

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

LOS B.: Fair Dealing.

 

 

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

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

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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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1215

An analyst meets with a new client. During the meeting, the analyst sees that the new client’s portfolio is heavily invested in one over-the-counter stock. The analyst has been following the stock and thinks it will perform well in the long run. The analyst arranges through a brokerage firm to simultaneously sell a large number of shares of the stock via a series of cross trades from the new client’s portfolio to various existing clients. He arranges the trades to be executed at a price that approximates the current market price. This action is:

A) not in violation of the Standards.

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

C) a violation of Standard III(B), Fair Dealing.

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There is no violation. It is in the best interest of the client to be diversified and selling via a series of cross trades will likely reduce price impact costs when compared to selling directly into the market. The analyst appears to have reasonable basis for putting the securities in the accounts of other clients.

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Which of the following would be a violation of Standard III(B), Fair Dealing?

A) Having well defined guidelines for pre-dissemination.

B) Trading for regular accounts before discretionary accounts.

C) Limiting the number of employees privy to recommendations and changes.

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Do not discriminate against a client when disseminating investment recommendations. If the firm offers different levels of service, this fact must be offered and disclosed to all clients. The other choices are necessary parts of the Standard. The Standard actually says to have published personal guidelines for pre-dissemination, which implies that the guidelines be well-defined.

1215

All of the following are violations of Standard III(B), Fair Dealing, EXCEPT a member:

A) places a trade for the firm account before issuing a buy recommendation.

B) places a trade for her discretionary accounts before placing a trade for her non-discretionary accounts.

C) telephones clients in distant cities the day after a buy recommendation is mailed to all clients because their mail service is later than the member's local clients.

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Standard III(B) states, "Members shall deal fairly and objectively with all clients and prospects when providing investment analysis, making investment recommendations, taking investment action, or in other professional activities.”

The term “fairly” implies that members should take care not to discriminate against a client when disseminating investment recommendations. All the responses, except for the telephoning of distant clients (which has the effect of putting them in the same position as local clients), describe a situation in which a client or group of clients is receiving preferential or detrimental treatment that is unfair.

1215

Which of the following statements regarding allocating trades is CORRECT? It is permissible under the Standards to allocate trades:

A) based upon compensation arrangements.

B) based upon any method the firm deems suitable so long as the allocation procedure has been disclosed to all clients.

C) on a pro-rata basis over all suitable accounts.

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It is permissible to allocate trades on a pro-rata basis over all suitable accounts. It is not permissible to base allocations upon compensation arrangements. Any method is not necessarily suitable, and disclosure does not absolve the member from ensuring that the allocation is necessarily fair.

1215

In securing the shares for all accounts under her management, Linda Kammel of Northwest Futures purchased three blocks of shares at three different prices. She then allocated these shares by placing shares from the first block in accounts with surnames beginning with A-G. The second was allocated over accounts H-P, and the third over Q-Z. This action is:

A) consistent with her responsibilities under the Code and Standards.

B) not permissible under the Code and Standards.

C) permissible only if the clients are informed of the allocation procedure.

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Standard III(B) requires a member to deal fairly with all clients when taking investment actions. Since she knew at the outset that she was going to place shares in all accounts, regardless of the first letter of the surname, all accounts must participate on a pro-rata basis in each block in order to conform to the Standard. Her actions constitute a violation of the Standard concerning fair dealing.

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A money management firm has the following policy concerning new recommendations: When a new recommendation is made, each portfolio manager estimates the likely transaction size for each of their clients. Clients are notified of the new recommendation in the order of their estimated transaction size—largest first. All clients have signed a form where they acknowledge and consent to this allocation procedure. With respect to Standard III(B), Fair Dealing, this is:

A) not a violation because the clients have signed the consent form.

B) a violation of the standard.

C) not a violation because the clients are aware of the policy.

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Such a policy is a violation of the Standard and client acknowledgement and/or consent does not change that fact.

1215

Which of the following statements is least accurate regarding being a part of Standard III(B), Fair Dealing?

A) Shorten the time between decision and dissemination.

B) Maintain a list of clients and their holdings.

C) At the same time notify clients for whom an investment is suitable of a new investment recommendation.

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All of these are part of Standard III(B) except notifying clients at the same time. Standard III(B) states that clients for whom the investment is suitable should be notified at approximately the same time.