Ethical and Professional Standards 【Reading 2】Sample industry, standards, regulatory, his

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Nicholas Brynne, CFA, is a fixed-income analyst who trades in mortgage-backed securities (MBS). The MBS industry has seen sweeping regulatory changes since Brynne took his current position, and he now feels his understanding of applicable laws and regulatory standards is dated. Brynne must:

A) update his understanding of applicable laws and regulatory standards relating to his position.

B) have all trades reviewed by his compliance department until he has obtained an expert level of knowledge in compliance.

C) rely on his firm’s policies and procedures for guidance on legal and regulatory standards.

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See Standard I(A) "Knowledge of the Law." Brynne should update his understanding of applicable laws and regulatory standards relating to his position, although he is not required to be an expert in compliance. Relying only on firm policies and procedures is not sufficient.

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Susan Nielsen, CFA, works for a rating agency which competes directly with S&P and Moody’s. Her friend, Lance Parker, works for the same company but in a different department which is involved in advisory services for structured products. Nielsen frequently receives pressure from Parker to "put a positive face" on client ratings to help him sell advisory services. She is reluctant to discuss client ratings with Parker and tries to avoid the topic. She consults her company’s compliance department and learns that there are no policies or procedures to discourage Nielsen and Parker from sharing information and is encouraged to consider his advice on company ratings. Nielsen should most likely:

A) advise her firm to develop firewalls and protections to allow the different departments to function independently and avoid talking with Parker about client ratings.

B) continue to consult with Parker on company ratings as the compliance department’s position is that there is no conflict.

C) advise regulators of the potential conflict of interest and seek legal counsel.

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Nielsen should advise her firm to develop firewalls and protections to allow the different departments to function independently. If Nielsen and Parker are going to remain friends, they should stop talking about client ratings.

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After a very successful quarter of high investment returns, Judy O’Berry, CFA, receives several gifts from grateful clients. O’Berry considers the gifts to be of novelty or sentimental value only, but she hears rumors that several junior employees are jealous of the attention she received for the group’s efforts. She decides to consult the company’s compliance rules on gifts and is surprised to learn her firm has no established rules. She consults the Standards of Practice Handbook, and then submits proposed rules on gifts to her company’s compliance department. These rules should contain all of the following EXCEPT:

A) a formal value limit based on local customs.

B) a requirement to disclose the gift.

C) restrictions on all types business entertainment.

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The rules should contain a formal value limit based on local customs. Not all types of business entertainment are forbidden. Only business entertainment which is intended to influence or reward members and candidates should be avoided.

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John McNeal, CFA, has a friend named Stan Green, a journalist at Investment News, a weekly magazine. In one of their conversations, Green tells McNeal about material nonpublic problems at Brightstar.com, a heavily traded firm. Green has written a special article about Brightstar.com’s problems that will appear in the next issue of Investment News. According to the Standards, can McNeal act on the information Green has shared with him?

A) Yes, McNeal can trade on the information but should ask Green to disseminate the information immediately.

B) Yes, McNeal can trade on the information, because it is already public.

C) No, McNeal cannot trade on the information.

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McNeal cannot trade on the information before the article is published. Trading on the information received from the journalist before the magazine is published is trading on material nonpublic information, a breach of Standard II(A).

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The Konkol Company implements a new methodology for portfolio valuation that is licensed to them by ABC Statistics. Konkol complies with the CFA Institute Code and Standards by:

A) not discussing the new methodology with clients because there is no need to, as it will not change their risk and yield preferences.

B) discussing the new methodology with clients only when a change in the security selection process is involved.

C) discussing the new methodology with the clients, in its entirety.

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Standard V(B), Communication with Clients and Prospects, requires any change in the scope, valuation methodology, or focus of the portfolio to be discussed with clients.

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Using as his universe all companies in the steel industry, Reynold Anderson analyses the performance of stock prices for the industry. He succeeds in developing a regression model with excellent statistical control measures. The extrapolation from the model shows low risk variance of the securities in this industry. Without the inclusion of non-steel stocks in the portfolio, Anderson concludes that, based on these results, every portfolio can use the steel industry securities to diversify and lower its risk. He persuades his clients to change their current portfolios. Anderson states that, as the model’s results show, some particular industries, such as car manufacturers, have underpriced stocks, and investors should take advantage of it. Anderson has violated the Standards because he:

A) does not distinguish the opinion, based on his model, from the fact.

B) does not consider the suitability of the investment.

C) is not clear enough about the model results.

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While any of the answers can be shown to violate CFA Institute Standards, this cannot be determined conclusively from the information given. However, the scenario clearly indicates that Anderson does not distinguish between opinion and fact in communicating to his clients. Therefore, he violates the Standards on this basis.

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While copying some of her research materials at work, Mary Jones comes across a few incomplete research notes written by one of her colleagues. As a result of reading the notes, and without further review, Jones immediately changes one of her stock recommendations from sell to buy. Which of the following CFA Institute Standards has Jones violated?

A) Standard V(A), Diligence and Reasonable Basis.

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

C) Standard I(B), Independence and Objectivity.

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Jones has violated Standard V(A) by failing to exercise diligence and thoroughness.

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The Securities and Exchange Commission (SEC) sanctioned Stephen Rangen, a former broker, for unsuitable recommendations and excessive trading in several accounts.  His clients were unsophisticated, inexperienced individual investors with limited means.  As such, they relied heavily on Rangen’s advice and expected him to initiate any transactions in their respective accounts.  The SEC found that Rangen’s trading methods were contrary to his clients’ goals.  For example, he used margin accounts and concentrated their equity holdings in particular securities.  Rangen claimed that his actions were justified because his clients were aware of the risks.
Which of the following statements best describes why Rangen’s argument, that his clients were aware of the risks, did NOT meet the requirements of the Code and Standards? Rangen failed to:

A) deal fairly and objectively with his clients when taking investment action.

B) make recommendations that were consistent with his clients' financial needs.

C) disclose to his clients all matters that reasonably could be expected to impair his ability to make unbiased and objective recommendations.

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Rangen did not fulfill the obligation he assumed when he agreed to counsel these clients. That is, he did not make recommendations that were consistent with their financial needs. According to Standard III(C), Suitability, Rangen must “consider the appropriateness and suitability of investment recommendations or actions for each portfolio or client.” This is true even if his clients wanted to speculate and were aware of the risks.

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Rangen bought U.S. Treasury strips and over-the-counter stocks that did not produce income as sought by his clients.  Rangen claimed that his actions were justified because his firm’s research department recommended the purchase of the Treasury strips. Also, he claimed the stocks that he bought were all in the top-rated categories of his firm’s research division.  Which of the following statements best describes why Rangen’s arguments, in which he attempted to shift the blame to his employer, did NOT meet the requirements of the Code and Standards?  

A) Rangen's duty was to make only recommendations that were in the best interests of his clients.

B) Rangen misrepresented the basic characteristics of the investments that he bought for his clients' accounts.

C) Rangen did not use reasonable care and judgment to achieve and maintain independence and objectivity in taking investment actions.

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Rangen cannot shift the blame to his employer. He had an obligation to consider not only his firm's recommendations, but also his clients' investment objectives and financial situations. He failed to consider relevant factors relating to his clients. Rangen violated Standard III(C) because he initiated investment actions without properly considering whether these actions were suitable to his clients' financial situations and investment objectives.

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Patricia Spraetz is the chief financial officer and compliance officer at Super Selection Investment Advisors.  Super Selection is a medium-sized money management firm which has incorporated the CFA Institute Code of Ethics and Standards of Practice into the firm's compliance manual.
Karen Jackson is a portfolio manager for Super Selection.  She is not a CFA charterholder.  Jackson is friendly with David James, president of AMD, a rapidly growing biotech company.  James has provided Jackson with recommendations in the biotech industry, which she buys for her own portfolio before buying them for her clients.  For three years, Jackson has also served on AMD's board of directors but has never notified Super Selection of this fact.  She has received options and fees as compensation.
Recently, the board of AMD decided to raise capital by voting to issue shares to the public.  This was attractive to board members (including Jackson) who wanted to exercise their stock options and sell their shares to get cash.  When the demand for initial public offerings (IPO) diminished, just before AMD's public offering, James asked Jackson to commit to a large purchase of the offering for her portfolios.  Jackson had previously determined that AMD was a questionable investment but agreed to reconsider at James' request.  Her reevaluation confirmed the stock to be overpriced, but she nevertheless decided to purchase AMD for her clients' portfolios.
Which of the following statements is NOT correct?

A) Jackson violated Standard IV(B) regarding Disclosure of Additional Compensation by not disclosing additional compensation in the form of cash and stock options received from AMD, as its board member to her employer.

B) Jackson did not violate Standard III(A) on Fiduciary Duty to clients because she was bound by her fiduciary duty to AMD and its stockholders as a board member. Therefore, when she reversed her decision to buy AMD shares for Super Selection's clients, portfolios on James' request, her obligation to AMD took precedence.

C) Jackson violated Standard VI(A) regarding Conflicts of interest by not disclosing her board membership and ownership of stock options to her employer.

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Jackson has violated Standard III(A) because her first obligation is to her firm's clients. Standard VI(A) addresses precisely these kinds of situations regarding potential conflict of interest. Given this conflict of interest, Jackson also compromised her objectivity in violation of Standard I(B). Her fiduciary duty to her clients takes precedence over her fiduciary duty to AMD's stockholders under the CFA Institute Code and Standards. By not disclosing her relationship with AMD, she also violated Standard IV(B). Making past personal security transactions ahead of purchase of the same securities for her clients has put Jackson in violation of Standard VI(B). This standard clearly prohibits such actions.

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Marc Feldman, CFA, is manager of corporate investor relations for a high-tech startup, zippy.com, in Boise, Idaho. Feldman learns that Larry Smith, controller, is altering the accounting records. Feldman advises some of his personal friends to sell short zippy.com. This action:

A) constitutes a violation of the Standard concerning prohibition against misrepresentation.

B) constitutes professional misconduct but not the use of nonpublic information and is a violation of the Code and Standards.

C) constitutes the use of material nonpublic information and is a violation of the Code and Standards.

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The information is apparently nonpublic, and is clearly material since the valuation of securities in the market place is predicated upon financial data and other relevant information. Trading or inducing others to trade is a clear violation of Standard II(A).