Reading 2-V: Standards of Professional Conduct & Guidance 2011, Investment, research, center, member

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Session 1: Ethical and Professional Standards
Reading 2-V: Standards of Professional Conduct & Guidance: Investment Analysis, Recommendations, and Actions

LOS B.: Communication with Clients and Prospective Clients.

 

 

In the preparation of a research report, a CFA Institute member may emphasize certain matters, touch briefly on others, and omit some altogether:

A) provided that the analyst both has a reasonable basis and is unconstrained by the Mosaic theory.

B) provided that the analyst has a reasonable basis for his or her actions.

C) under no circumstances.

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According to Standard V(B), the analyst must use reasonable judgment in identifying relevant factors when communicating with clients and prospects . The Mosaic theory does not apply here.

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An analyst finds a stock that has had a low beta given its historical return, but its total risk has been commensurate with its return. When writing a research report about the stock for clients with well-diversified portfolios, according to Standard V(B), Communication with Clients and Prospective Clients, the analyst needs to mention:

A) both the historical beta and total risk and return.

B) the relationship of the historical total risk to return only.

C) the relationship of the historical beta and return only.

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Using reasonable judgment, an analyst may exclude certain factors from research reports. Since the report will be delivered to clients with well-diversified portfolios, total risk is not as important as beta. Given that the total risk has been only commensurate with historical return, furthermore, then the analyst is not negligent by not mentioning it.

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Nicole Wise, CFA, is an analyst at Chicago Securities. She attends a meeting with management of one of the companies that she covers. During the meeting, management expresses great optimism about the company’s recent acquisition of a new business. Wise is excited about these prospects and issues a research report that states that the company is about to achieve significant success with the new acquisition. Wise has:

A) violated CFA Institute Standards of Professional Conduct because she did not check the accuracy of the statements that management made.

B) violated CFA Institute Standards of Professional Conduct because she misrepresented the optimism by turning it to certainty.

C) not violated CFA Institute Standards of Professional Conduct because she had reasonable reason to believe that the statements in her report were true.

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Standard V(B), Communication with Clients and Prospective Clients. Members must distinguish between fact and opinion in the presentation of a research report or investment recommendation. Wise violated the standard because she misrepresented management’s enthusiasm by turning it into certainty.

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An analyst who routinely purges the files that support his research and recommendations:

A) is acting in accordance to Standard III(E), Preservation of Confidentiality.

B) may be violating Standard V(C), Record Retention.

C) is acting in accordance to Standard IV(A), Loyalty to Employer.

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According to Standard V(C), a member shall “maintain appropriate records” to support recommendations. Neither of the other choices would apply to this action.

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Janet Coleman, a CFA Institute member, is an analyst at a regional brokerage firm. She is preparing a research report on Standard Power and Light. Due to deregulation, utility companies face increased competition. During the past year, three of the five utility companies in her region have cut their dividends by 50%, on average, to provide more internal funds for investment purposes. In a discussion with Standard's chief executive officer, Coleman learned that Standard expects to have a record amount of capital expenditures during the next year. Although Standard subsequently issued a press release about its capital expenditure plans, it did not make any public statements about a change in dividend policy. Coleman reasons that the management of Standard will be under pressure to cut its dividends within the next year to remain competitive. Coleman issues a research report in which she states:

"We expect Standard Power and Light will experience an initial decrease of $3 a share in its stock price when it cuts its dividend from $2 to $1 a share by the second quarter. We expect that Standard will strengthen its competitive position by using more internally generated funds to finance its investment opportunities. If investors buy the stock now at around $50 a share, their total return should be at least 20% on the stock."

Based on CFA Institute Standards of Professional Conduct, which of the following statements about Coleman's actions is CORRECT?

A) Coleman violated the Standards because she used material inside information.

B) Coleman violated the Standards because she failed to separate opinion from fact in her research report.

C) Coleman did not violate the Standards.

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Coleman's statement that Standard will cut its dividend from $2 to $1 a share is an opinion, not a fact. She should distinguish between facts and opinions in research reports.

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Roger Halpert, CFA, prepares a company research report in which he recommends a strong "buy." He has been careful to ensure that his report complies with the CFA Institute Standard on research reports. According to CFA Institute Standards of Professional Conduct, which of the following statements about how Halpert can communicate the report is most correct?

A) Halpert can transmit his report by computer on the Internet.

B) Halpert can make his report in person.

C) Halpert can make his report in person, by telephone, or by computer on the Internet.

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A report can be made via any means of communication, including in-person recommendation, telephone conversation, media broadcast, and transmission by computer such as on the Internet.

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An analyst has several groups of clients who are categorized according to their specific needs. Compared to research reports distributed to all of the clients, reports for a specific group:

A) will not be allowed because it violates the Standard III(B), Fair Dealing.

B) may generally exclude more basic facts.

C) will definitely include more basic facts.

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According to Standard V(B), an analyst can use reasonable judgment regarding the exclusion of some facts and should include more basic facts for reports to wider audiences. The key issue is that analysts should tailor their reports to the intended audience.

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Midland Investment Banking issues a prospectus for its open-end Midland Gold Fund. In the prospectus, the investment policy is disclosed as, "We will maintain an investment posture of 50% or more in gold stocks and/or bullion, depending upon market conditions." This policy is maintained until the price of gold falls by 20%, leaving the fund 40% invested in gold stocks and bullion. Management decides that since the allocation was affected by market conditions, no action to either change the investment policy or to rebalance the portfolio is required. This decision is:

A) in violation of the Standard concerning disclosure of investment processes.

B) in violation of the Standard concerning fiduciary duties to clients.

C) under the circumstances, not in violation of the Code and Standards.

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Standard V(B) Communication with Clients and Prospective Clients requires members to disclose "general principles and investment processes" to clients and to "promptly disclose any changes that might significantly affect those processes." Under the Standard, Midland management is required either to: 

1. rebalance the portfolio in a timely manner so as to maintain compliance with the investment policy or 
2. communicate an intended change in that policy well in advance of the actual change so as to afford investors time to act prior to the change in investment policy taking place. 

Midland is in violation of the Standard.