Reading 2-II: Standards of Professional Conduct & Guida

cfaedu

CFA Institute Area 1-2: Ethical and Professional Standards
Session 1: Code of Ethics and Professional Standards
Reading 2-II: Standards of Professional Conduct & Guidance: Integrity of Capital Markets
LOS A.: Material Nonpublic Information.

cfaedu

According to CFA Institute Standards of Professional Conduct, which of the following statements about material nonpublic information is FALSE? Information is:

A) nonpublic until it has been disseminated to the marketplace in general.

B) material if its disclosure would be likely to have an impact on the price of a security.

C) nonpublic until it has been disseminated to a select group of investors.

D) material if reasonable investors would want to know the information before making an investment decision.

---

Answer and Explanation

Standard II(A), Material Nonpublic Information, states that information is nonpublic until it has been disseminated to the marketplace in general as opposed to a select group of investors.

cfaedu

A CFO who is a CFA Institute member is careful to make his press releasessome of them containing material and previously undisclosed informationclear and understandable to his readers. While writing a new release, he often has his current intern proofread rough drafts. He also sends electronic copies to his brother, an English teacher, to get suggestions concerning style and grammar. With respect to Standard II(A), Material Nonpublic Information, the CFO is:

A) not in violation of the Standard.

B) only in violation by showing the pre-release version to the intern but not to a relative such as his brother.

C) violating the standard by either showing the pre-release version to his intern or sending it to his brother.

D) only in violation by e-mailing the pre-release version to his brother but not the intern, because the intern is in essence an employee of the firm.

---

Answer and Explanation

Standard II(A), Material Nonpublic Information, says that a member must be careful about handling material non-public information. As a member of CFA Institute, the CFO must limit the people who see important information before it is released. It would not be appropriate to involve an intern or a relative in the process.

cfaedu

Which one of the following least accurately describes the CFA Institute Standard about using material nonpublic information?

A) An analyst may not use material nonpublic information secured from sources that misappropriated the information.

B) An analyst may use material nonpublic information as long as it has been developed under the Mosaic Theory.

C) An analyst may violate this Standard by passing information to others even when it has been obtained from outside the company.

D) An analyst using material nonpublic information may be fined by CFA Institute.

---

Answer and Explanation

Members may not use material nonpublic information for trading purposes unless, the information was developed under the Mosaic Theory. There is no provision for CFA Institute to issue fines to members.

cfaedu

Don Benjamin, CFA, is the compliance officer for a large brokerage firm. He wants to prevent the communication of material nonpublic information and other sensitive information from his firms investment banking and corporate finance departments to its sales and research departments. The most common and widespread approach that Benjamin can use to prevent insider trading by employees is the:

A) Wall Street Rule.

B) legal list.

C) fire wall.

D) mosaic approach.

---

Answer and Explanation

To comply with Standard II(A), a fire wall provides an information barrier that prevents communication of material nonpublic information and other sensitive information from one department to another within a firm.

cfaedu

A stockbroker who is a member of CFA Institute has a part-time housekeeper who also works for the CEO of Festival, Inc. One day the housekeeper mentions to the broker that she saw the CEO of Festival having a conversation at his home with John Tater, who is a nationally known corporate lawyer and consultant. The stockbroker is restricted from trading on this information:

A) only if the broker knows that the meeting is non-public information.

B) if the broker is friends with the CEO of Festival.

C) for all of the reasons listed here.

D) if the housekeeper says the meeting concerned a tender offer and the broker knows that it is non-public information.

---

Answer and Explanation

Standard II(A), Material Nonpublic Information, states a member cannot trade or cause others to trade in a security while the member possesses material nonpublic information A tender offer would certainly be material nonpublic information. Knowing that the meeting took place, and nothing else, does not restrict the broker. A reasonable investor would need to know more to determine if the information was material. Certainly being friends with the CEO is not an issue, so the answer all of the reasons is not correct.

cfaedu

An analyst provides services for a charitable organization and in return gets free membership in the organization. Part of her job is to manage the liquid assets of the organization, and those assets include stocks. Her supervisor in the organization calls her and tells her to buy a certain stock for the portfolio based upon insider information from a board member in the organization. The analyst objects, but the supervisor says this is what they have always done and sees no reason for changing now. The analyst complies with the request. With respect to Standards IV(A), Loyalty to Employer, and II(A), Material Nonpublic Information, the analyst violated:

A) only Standard II(A) that prohibits insider trading.

B) both Standards IV(A) and II(A).

C) only Standard IV(A) requiring duty of loyalty.

D) neither Standard since she is working for a charity.

---

Answer and Explanation

An employee/employer relationship does not necessarily mean monetary compensation for services. Complying with the request is a violation of II(A) which prohibits trading on insider information.  Standard IV(A) Loyalty deals with going into business for yourself, leaving an employer and continuing to act in the employer's best interest until their resignation becomes effective, and whistleblowing which means that the member's interests and their firm's interests are secondary to protecting the integrity of capital markets and the interests of the clients.

An employee/employer relationship does not necessarily mean monetary compensation for services. Complying with the request is a violation of II(A) which prohibits trading on insider information.  Standard IV(A) Loyalty deals with going into business for yourself, leaving an employer and continuing to act in the employer's best interest until their resignation becomes effective, and whistleblowing which means that the member's interests and their firm's interests are secondary to protecting the integrity of capital markets and the interests of the clients.

cfaedu

A CFA Institute member is a U.S. citizen living and working in a foreign country. That country has no laws against insider trading. Based on this information, the CFA Institute member may:

A) not trade using insider information based upon the CFA Institute Standards.

B) not trade using insider information based upon the rules of the SEC.

C) trade using insider information as long as it is not with a client with laws against insider trading.

D) trade using insider information.

---

Answer and Explanation

CFA Institute Standard II(A) prohibits trading using insider information. A member may not trade using such information regardless of the rules of the country where he/she lives.

cfaedu

Which one of the following constitutes the illegal use of material nonpublic information?

A) Trading based on your analytical review of the firm's future prospects.

B) Trading immediately after attending the firm's annual shareholders meeting.

C) Trading on information your sister, the firm's attorney, told you over dinner.

D) Trading on overheard remarks made by an unreliable source at a cocktail party.

---

Answer and Explanation

Members may not trade on material nonpublic information; therefore, the information conveyed by the firms attorney may not be used by a member for trading purposes.

cfaedu

A stockbroker who is a CFA Institute member is called on the telephone by the CEO of a large company. The CEO asks to buy shares of the CEOs company for the accounts of the CEOs children. In the course of the conversation, the CEO says this will really pay off when the upcoming takeover goes through. The stockbroker checks her sources and finds no information about the takeover. In this case the broker should:

A) do none of the actions listed here.

B) only execute the order in compliance with Standard III(A), Loyalty, Prudence, and Care. Since the client is buying the stock for the children, there is not a problem.

C) execute the order for all clients as required by Standard III(B), Fair Dealing.

D) first execute the trade for the children and then use public information to recommend the stock to other clients.

---

Answer and Explanation

Doing any of these actions would be a violation of Standard II(A), Material Nonpublic Information. Members and Candidates must not act or induce others to act on material nonpublic information.