Reading 2-VI: Standards of Professional Conduct & Guidanc 2011, investment, research, writing, center

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Session 1: Ethical and Professional Standards
Reading 2-VI: Standards of Professional Conduct & Guidance: Conflicts of Interest

LOS A.: Disclosure of Conflicts.

 

 

Abner Flome, CFA, is writing a research report on Paulsen Group, an investment advisory firm. Flome’s brother-in-law holds shares of Paulsen stock. Flome has recently interviewed for a position with Paulsen and expects a second interview. According to the Standards, Flome’s most appropriate action is to disclose in the research report:

A) his brother-in-law’s holding of Paulsen stock and that he is being considered for a job at Paulsen.

B) that he is being considered for a job at Paulsen.

C) his brother-in-law’s holding of Paulsen stock.

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The possibility of employment with Paulsen creates a potential conflict of interest which Flome must disclose. Standard VI(A) Disclosure of Conflicts does not require disclosure of his brother-in-law’s ownership of Paulsen stock.

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The following scenarios refer to two analysts who are employed at Global Securities, a large brokerage firm.

• Paula Linstrom, CFA, is instructed by her supervisor to write a research report on Delta Enterprises. Delta's stock is widely held by institutional and individual investors. Although Linstrom does not own any of Delta's stocks, she believes that one of her friends may own 10 shares of Delta. The stock currently sells for $25 per share. Linstrom does not believe that informing her employer about her friend's possible ownership of Delta shares is necessary.
• Hershel Wadel, a member of CFA Institute, is asked by his supervisor to write a research report on Gamma Company. Wadel's wife inherited 500 shares of Gamma Company from her father when he died five years ago. Gamma stock currently sells for $35 per share. Wadel does not believe that informing his employer about his wife's ownership of Gamma shares is necessary.

According to CFA Institute Standards of Professional Conduct, which the following statements about Linstrom and Wadel's conduct is most accurate?

A) Only one of these analysts must disclose a potential conflict of interest.

B) Neither of these analysts must disclose a potential conflict of interest.

C) Both of these analysts must disclose a potential conflict of interest.

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The possibility that Linstrom’s friend may own a few shares of Delta's stock, worth a low dollar amount, does not create a conflict of interest such potential ownership could not reasonably be expected to interfere with her duty to employer or ability to make unbiased and objective recommendations. On the other hand, Wadel has a beneficial interest in his wife's ownership of Gamma shares. Standard VI(A) Disclosure of Conflicts requires that Wadel disclose this information so that his employer can make the proper determination.

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To comply with the CFA Institute Standards, employees have a duty to disclose possible conflicts of interest to:

A) both their employer and their clients.

B) neither employers nor clients, but the member must use "prudent judgment."

C) only their employer.

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According to Standard VI(A), Disclosure of Conflicts, employees have a duty to disclose to both their employer and their clients all matters which may impair their independence and objectivity or interfere with their duties to employer, clients, and prospects.

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Lee Hurst, CFA, is an equity research analyst for a long-term investment fund. His annual bonus is linked to quarterly trading profits. Under a new policy, the quarterly assessment period is switched to a monthly assessment period. According to the Code and Standards, best practices dictate:

A) requiring Hurst to obtain permission from each client prior to implementation of the new policy.

B) keeping the policy change private as a trade secret.

C) updating disclosures when the policy change is implemented.

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Standard VI(A) "Disclosures of Conflicts" recognizes this policy as a potential conflict of interest as members and candidates could be incentivized to favor short-term trading gains over long-term value creation. Best practices dictate updating disclosures when the policy change is implemented. The long-term investors should know how members and candidates are compensated, especially when there is the potential for conflicts of interest.

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Ray Stone, CFA, follows the Amity Paving Company for his employer. Which of the following scenarios is Stone least likely to have to disclose to his employer.

A) The fact that Stone's son worked at Amity as a laborer during the summer while in school.

B) Stone's ownership of Amity securities.

C) Stone's personal relationship with the CEO of Amity.

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Members are required to disclose to their employer all matters that reasonably could interfere with their objectivity. Personal friendships with corporate executives and personal ownership of securities could reasonably interfere with objectivity, but it is unlikely that a child’s employment in a labor function would reasonably interfere with a parent’s objectivity.

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Fern Baldwin, CFA, as a representative for Fernholz Investment Management, is compensated by a base salary plus a percentage of fees generated. In addition, she receives a quarterly performance bonus on a particular client’s fee if the client’s account increases in value by more than 2 points over a benchmark index. Baldwin had a meeting with a prospect in which she described the firm’s investment approach but did not disclose her base salary, percentage fee, or bonus.

Baldwin has:

A) violated the Standards by not disclosing her salary, fee percentage, and performance bonus.

B) violated the Standards by not disclosing her performance bonus.

C) not violated the Standards because there is no conflict of interest with a potential prospect in the employment arrangements.

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Standard VI(A) requires members to disclose all matters that could reasonably be expected to impair the member’s ability to make unbiased and objective recommendations. Compensation based on a percentage of fees generated does not create an inherent bias. If, however, a performance bonus is paid for investment results, it may unduly encourage the manager to take more risk than is proper and prudent, and so the existence of the bonus opportunity must be disclosed to the client.