Reading 2-III: Standards of Professional Conduct & Guidan 2011, center, growth, placed, style

1215

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

LOS C.: Suitability.

 

 

Millie Walker, CFA, established an aggressive growth portfolio for her client, Jesse Wilmer, over three years ago. Wilmer was placed on Walker’s employer’s client mailing list, and received monthly account statements and the firm’s newsletter, which regularly informed clients that they should contact their account representative with any change in their personal circumstances or investment objectives. As of January, of this year, Walker had not spoken to Wilmer nor received any correspondence from Wilmer since the account was established. Walker has:

A) not violated the Code and Standards because Wilmer has been reminded regularly about the opportunity to inform Walker about any changes.

B) violated the Code and Standards because the manager has not performed an update of Wilmer's financial situation and investment objectives.

C) not violated the Code and Standards because there has been regular correspondence from Walker's firm to Wilmer.

---

 

Standard III(C) Suitability requires members to update a client’s financial situation and investment objectives regularly. Wilmer’s account has existed for more than three years, and an update is long overdue. Generally offering to do an update is not sufficient to comply with the Standard.

luqian55

thanks a lot

tracylaubb

thx

1215

The best way to determine the suitability of an investment is:

A) to consider the financial situation, investment experience, and investment objectives of the client.

B) based on portfolio performance results, presented as a weighted average, from the biggest financial companies.

C) by administration of a specially designed survey of the client's opinions.

---

Although broad in scope, the best way to determine suitability is to consider the financial situation, investment experience and investment objectives of the client. Both of the other choices deviate from these essential issues.

1215

A broker was sanctioned for unsuitable recommendations and excessive trading involving three accounts under his care. These clients were unsophisticated, inexperienced individual investors with limited means. According to CFA Institute Standard III(C), Suitability, which of the following is least likely to be considered a relevant factor in determining the appropriateness and suitability of investment recommendations or actions for each portfolio or client?

A) Basic characteristics of the total portfolio.

B) Best interests of the investment professional.

C) Needs and circumstances of the portfolio or client.

---

Determining appropriateness and suitability focuses on the portfolio or client, not on the investment professional. Investment professionals should take particular care to ensure that their goals in selling products or executing security transactions do not conflict with the best interests of the client.

1215

Lance Tuipulotu, CFA, manages investments for 400 individuals and families and often finds his resources stretched. When his largest investors petition him to include a 5% to 7% allocation of non-investment-grade bonds in their portfolios, he decides he needs additional help to meet the request. He considers various independent advisors to use as submanagers, but determines that the most qualified advisors would be too expensive. Reasoning that a lower-cost provider would enable him to pass the savings along to his clients, he chooses that provider to invest the new bond allocation. Tuipulotu has violated:

A) Standard III(C) "Suitability" by failing to consider the appropriateness of the non-investment-grade bonds.

B) Both Standard III(C) "Suitability" and Standard V(A) "Diligence and Reasonable Basis."

C) Standard V(A) "Diligence and Reasonable Basis" by letting fee structure determine the selection of the submanager.

---

Both Standard III(C) "Suitability" and Standard V(A) "Diligence and Reasonable Basis" were violated. Tuipulotu must perform a full IPS review to determine the appropriateness of the new portfolio allocations. Submanagers should not be selected by cost structure alone, as the quality and appropriateness of the submanager is Tuipulotu’s responsibility.

1215

Stephen Rangen, a former broker, had three accounts consisting of unsophisticated, inexperienced individual investors with limited means. One of these accounts was an elderly couple. The clients wanted to invest in safe, income-producing investments. They relied heavily on Rangen’s advice and expected him to initiate most transactions in their respective accounts. In managing their accounts, Rangen pursued the following strategies: (1) bought U.S. treasury strips and non-dividend paying over-the-counter stocks, (2) used margin accounts, and (3) concentrated the equity portion of their portfolios in one or two stocks. Rangen’s approach led to extremely high turnover rates in all three accounts. The Securities and Exchange Commission sanctioned Rangen for unsuitable recommendations and excessive trading in several accounts.

For this specific situation, which of the following is least likely to be an appropriate compliance procedure involving Standard III(C), Suitability? The broker should:

A) develop an investment policy statement for each client.

B) avoid using material nonpublic information received in confidence to benefit clients.

C) assess and document each client's risk tolerance.

---

The prohibition against use of material nonpublic information refers to Standard II(A), not Standard III(C), Suitability.

---

For this specific situation, all of the following are appropriate compliance procedures involving Standard III(C), Suitability, EXCEPT:

A) complying with any prohibitions on activities imposed by their employer if a conflict of interest exists.

B) reviewing investment policy statements regularly.

C) educating clients about selecting appropriate asset allocations and strategies.

---

Standard VI(A), Disclosure of Conflicts, refers to complying with any prohibitions on activities imposed by their employer if a conflict of interest exists and, therefore, is unrelated to Standard III(C).

---

For this specific situation, which of the following policy statements should be adopted to ensure that future violations of this kind do not occur?

A) Before advising individual clients, managers should review the recommendations provided by the firm's research department. From this set of recommendations, they should select those securities that provide the expected highest return on investment. Managers should review the investor's portfolio at least monthly to see if existing securities should be replaced with those more recently recommended. Managers should turnover portfolios frequently and concentrate holdings within portfolios in order to achieve the highest possible returns for clients.

B) Before making any recommendations or taking any investment actions, managers should formulate an investment policy for a client. They should consider the type and nature of the client and should obtain and analyze necessary information on the client's objectives (risk and return) and constraints. Managers should maintain and review regularly the investor's objectives and constraints to reflect any changes in the client's circumstances. Where appropriate, managers should properly diversify portfolios.

C) When making recommendations or taking investment actions, managers should seek to minimize the client's portfolio risk. Managers should review the recommendations of the firm's research department to identify securities with low volatility. In making asset allocation recommendations or decisions for discretionary accounts, managers should weight the portfolios towards dividend-paying stocks and other income-producing assets such as bonds and mortgage REITS. Managers should review portfolios at least semi-annually.

---

Standard III(C) requires that members shall “make a reasonable inquiry into a client’s financial situation, investment experience, and investment objectives prior to making any investment recommendations and shall update this information regularly to allow the members to adjust their investment recommendations to reflect changed circumstances.” The other policy statements focus on maximizing returns or minimizing risk. These statements may be inconsistent with the needs and circumstances of each individual client.

---

1215

A portfolio manager must determine the client’s constraints, which may include all of the following EXCEPT the client’s:

A) tax considerations.

B) mortgage payment.

C) liquidity needs.

---

The mortgage payment per se is of interest to the portfolio manager only insofar as it affects the bigger picture issues such as liquidity needs, cash flow, etc.

1215

Procedures for compliance with Standard III(C), Suitability, include determining all of the following with respect to a client EXCEPT:

A) liquidity needs.

B) social habits and interests.

C) return objectives.

---

The procedures for compliance with Standard III(C) include determining all of the aspects of a client’s investment objectives and constraints mentioned above, but do not include gathering information about the client’s social habits and interests.

1215

Bob Hatfield, CFA, has his own money management firm with two clients. The accounts of the two clients are equal in value. Hatfield has been trading on the clients’ behalf with a single brokerage firm for several years. Because of his many years of business, the brokerage firm occasionally gives Hatfield shares in an initial public offering (IPO) to sell to his clients. Hatfield has a policy of allocating the IPO shares equally between the portfolios of the two clients. This policy is:

A) congruent with Standard III(C), Suitability.

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

C) a violation of Standard III(C), Suitability.

---

According to Standard III(C), the analyst must consider the appropriateness and suitability of an investment recommendation for each portfolio or client. Having a fixed policy of adding investments to portfolios without evaluating their suitability is a violation of Standard III(C). The action does not violate Standard III(B)