anshultongia

William Fleming is an investment advisor for GlobalBank, a large, multinational financial corporation. He is based in the New York office, and his client base consists of medium to large institutional accounts in the United States and Western Europe. Roughly three-quarters of his clients pay performance-based fees, while the remaining one-quarter pay fees based on assets. GlobalBank’s investment banking division is an industry leader, and Fleming is able to offer his clients the opportunity to participate in some of the hottest initial public offerings (IPOs) and secondary offerings brought to market. GlobalBank’s compliance department formulated and distributed to its employees and clients its policy on how to allocate trades among clients.
The policy states that in order to reward customer loyalty, customers that utilize the services of GlobalBank’s divisions other than investment advisory will receive allocations on all trades (including IPOs and secondary offerings) based on the relative size of their order, before clients that utilize only investment advisory services. After filling orders for multi-relationship clients, clients that only utilize investment advisory services will receive trade allocations on all trades, including IPOs and secondary offerings, based on the relative size of their order. This policy reflects GlobalBank’s long-term goal of being a full-service provider of financial products and services to all of its clients.
One of Fleming’s accounts, Waverly Capital Partners, has contacted him regarding an upcoming secondary offering by DCH Corp., for which GlobalBank will serve as lead underwriter. Waverly has already performed its due diligence on the offering and is interested in purchasing a substantial position in the secondary offering in order to employ the company’s current surplus of cash. Waverly’s representative tells Fleming over the phone that they would like to purchase 5,000 shares of the offering but gives no other details of its analysis of the offering. Fleming has not read the prospectus for the offering yet and is not familiar with the details, but because he has confidence in Waverly’s investment expertise, he tells them that he too believes they should participate in the offering. Because Waverly does a significant amount of business with GlobalBank’s other divisions, Fleming assures them that they will be able to obtain their desired allocation of the offering and takes the order.
After taking the purchase order for the Waverly account, Fleming thoroughly reads the prospectus and marketing materials for the offering, as well as past research reports on the issuing company. He determines that DCH shares would be a suitable investment for one of his other clients, The Crockett Foundation. He contacts the Chief Investment Officer (CIO) of the foundation, explains how an investment in DCH would fit with its current risk and return objectives as detailed in the foundation’s investment policy statement (IPS) and provides her with the prospectus for the offering. Fleming tells her that GlobalBank was the lead underwriter for DCH’s initial public offering three years ago and that since then, the stock has outperformed the S&P 500 by at least 15% every year. Fleming also states that the company’s financial position is now even stronger and that the shares will perform at least as well as the lowest return earned on the IPO shares in the last three years. He then proceeds to tell her, “If the foundation is interested in the offering, you should place an order immediately because the issue may be oversubscribed due to strong interest in the offering from Waverly Capital Partners and other clients.” This information is enough to motivate Crocket’s CIO to call a meeting with the foundation’s investment committee.
After a quick meeting with Crockett’s investment committee, the CIO calls Fleming to say that the foundation is interested in the offering and would like to place a purchase order. Crockett does not currently conduct any additional business through GlobalBank’s other divisions. Because of GlobalBank’s trade allocation policy, coupled with the high probability that the offering will be oversubscribed, Crockett is unlikely to be allocated as many shares of the offering as they would like to purchase. In order to obtain the desired number of shares for the client, Fleming devises a plan. He plans to add the Crockett Foundation’s order to Waverly’s order, and once the order is filled he will re-allocate the extra shares back to the foundation’s account at the end of the day. He feels that his action is justified because Crockett has maintained its account with Fleming and GlobalBank for over ten years. In addition, Fleming has traders at GlobalBank sell large blocks of DCH over several days in order to push the stock price lower. The drop in value causes smaller investors at GlobalBank, who are not Fleming’s clients, to withdraw their orders for shares of DCH’s secondary offering. Fleming determines that the fewer number of purchase orders and the plan to piggyback on Waverly’s order will allow Crocket to acquire its desired allocation of shares in DCH’s secondary offering. Having achieved his goal, Fleming allows GlobalBank’s traders to repurchase the firm’s shares of DCH.
Twelve months pass, and the shares of DCH’s secondary offering have declined in price by nearly 20%. The CIO of the Crockett Foundation calls a meeting with Fleming to discuss the poor performance of the security and to review the basis upon which Fleming recommended the investment. Fleming prepares Crockett’s file to take with him to the meeting. The file contains Crockett’s IPS, a detailed account of the purchase order and all conversations held between Fleming and the CIO. In accordance with his own established procedures, however, Fleming maintained the original analysis supporting the purchase of shares in DCH’s secondary offering for nine months after the investment was made.Did GlobalBank’s trade allocation policy violate the CFA Institute’s Standards of Professional Conduct?

A) Yes, because the policy favors one group of clients over another and will disadvantage those clients that do not have multiple relationships with the firm.

B) No, because the firm fully disclosed its allocation policy to all clients and employees.

C) No, because the firm is allowed to offer different levels of service to its clients as long as they are disclosed and available to all clients.

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The actions of GlobalBank are covered under Standard III(B)—Fair Dealing. According to Standard III(B), members must deal fairly and objectively with all clients. Trade allocation procedures must be fair and equitable to ensure that investment opportunities are available to all clients. A firm may offer different levels of service to its clients, but a policy may not favor clients that have multiple relationships with the firm over those that do not. The Standards also recommend that a pro rata system, rather than an ad hoc system, be utilized in order to avoid conflict of interest. (Study Session 1, LOS 2.a,b)

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According to the CFA Institute’s Standards of Professional Conduct, Fleming’s execution of Waverly’s trade order after confirming the appropriateness of the trade is most likely in violation of:

A) Standard V(A)—Diligence and Reasonable Basis for not exercising diligence and thoroughness in his analysis of the investment and Standard III(C)—Suitability for recommending an investment before determining if the investment was appropriate for the client.

B) Standard V(B)—Communication with Clients and Prospective Clients for not separating fact from opinion, but is not in violation of Standard I(C)—Misrepresentation because his guarantee of future investment performance was not a written representation.

C) Standard I(C)—Misrepresentation for not disclosing to Waverly that he did not read the marketing materials, but is not in violation of Standard III(C)—Suitability because the client analyzed the investment thoroughly.

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Fleming violated Standard V(A)—Diligence and Reasonable Basis because he was not familiar with the specifics of the investment, but made an investment recommendation based upon his confidence in Waverly’s investment expertise. Fleming is also in violation of Standard III(C)—Suitability because his agreement with Waverly’s investment decision was not based upon the suitability of the offering within the context of Waverly’s total portfolio. Standard I(C)—Misrepresentation was also violated when Fleming confirmed that Waverly should purchase shares in DCH’s secondary offering, but failed to inform the client that he had not analyzed the investment in any way. Waverly would reasonably expect Fleming to analyze an investment prior to its recommendation and was therefore misled. (Study Session 1, LOS 2.a,b)

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According to CFA Institute Standards of Professional Conduct, which of the following of Fleming’s actions is most likely a violation of Standard I(C)—Misrepresentation? Fleming:

A) executes the trades on DCH Corp. per Waverly’s instructions without first referring to Waverly’s IPS.

B) tells the CIO of the Crockett Foundation that DCH’s secondary offering will earn at least the lowest return earned on its IPO shares over the last three years.

C) tells the CIO of Crocket Foundation that shares of DCH’s IPO outperformed the S&P 500 by at least 15% in each of the last three years since the offering.

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Standard I(C)—Misrepresentation prohibits members and candidates from making any untrue statements or omissions of facts that may be false or misleading. Guaranteeing a particular rate of return on an investment is in direct violation of the standard. Fleming has essentially guaranteed a minimum rate of return on the secondary offering equal to the lowest rate of return earned on the IPO shares over the last three years. Even though a specific number isn’t mentioned in the question, it would be observable by the Crockett Foundation. The other statements might also be considered violations of the standards but are not specifically violations of I(C)—Misrepresentation as noted in the question. (Study Session 1, LOS 2.a,b)

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Which of the following statements most accurately assesses Fleming’s comment about Waverly during his conversation with the CIO of the Crockett Foundation? According to the Code and Standards, Fleming’s statement is:

A) in violation of Standard III(E)—Preservation of Confidentiality because his failure to keep information about a client’s investment action confidential.

B) not in violation of any standard because he only disclosed factual information, and he did not disclose the details of Waverly’s purchase.

C) in violation of Standard I(C)—Misrepresentation because his statement may be misleading with regard to future performance of the offering.

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According to Standard III(E)—Preservation of Confidentiality, members and candidates must keep information about current, former, and prospective clients confidential unless the information concerns illegal activities, disclosure is required by law, or the client permits disclosure. By telling other clients of Waverly’s investment actions, whether offering specific information on the trade or not, Fleming could adversely affect Waverly’s investment in the offering. (Study Session 1, LOS 2.a,b)

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According to CFA Institute Standards of Professional Conduct, did Fleming’s conversation with the CIO of the Crockett Foundation or his decision to sell GlobalBank’s position in DCH stock most likely violate Standard II(B)—Market Manipulation?

Conversation with CIO [td=1,1,100]Sell decision

A) No Yes

B) Yes Yes

C) Yes No

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Standard II(B)—Market Manipulation prohibits practices that distort prices or artificially inflate trading volume with the intent to mislead market participants, including the dissemination of false or misleading information. Although Fleming’s conversation included two prohibited comments (a guarantee of performance and an inappropriate disclosure of client information), he did not give the CIO of Crockett information in an attempt to manipulate prices or trading volume and thus did not violate Standard II(B). His decision to sell GlobalBank’s shares of DCH, however, was intended to manipulate the price of DCH stock in order to intimidate smaller investors into withdrawing their purchase order in the secondary offering, thereby freeing up shares for his client, the Crockett Foundation. This action is clearly a violation of Standard II(B). (Study Session 1, LOS 2.a,b)

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Is it most likely that Fleming violated any CFA Institute Standards of Professional Conduct related to his meeting with the CIO of the Crockett Foundation?

A) No—he does not have a duty to maintain client records, only his employer does.

B) No—he maintained an IPS and followed established procedures in maintaining client records and data.

C) Yes—he failed to maintain appropriate records to support his investment recommendation.

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Standard V(C)—Record Retention states that members and candidate must maintain appropriate records to support their investment recommendations and actions. Fleming maintained an IPS and records of conversations, but he is also required by the standard to keep research and other documentation supporting investment recommendations and actions, which Fleming did not do. When there are no regulatory requirements related to record retention, the Standard recommends that members and candidates keep client records for a minimum of seven years. (Study Session 1, LOS 2.a,b)

anshultongia

One year ago, Karen Jason left the employment as a portfolio manager of Howe Advisors. The departure was contentious and both parties threatened legal action. As a result, both parties signed a settlement in which Jason was paid a pro rated bonus, but agreed not to work on the portfolios of any existing Howe client for two years. The terms of the agreement were that both parties agreed to keep all aspects of the agreement confidential, including the fact that there was hostility surrounding the departure. Jason now works for Torre Advisors, who has the Stein Company as a new client. At the time Jason left Howe, Stein was a client of Howe, although Jason did not personally work on the Stein portfolio. Jason's supervisor at Torre wants Jason to work on the Stein portfolio. Jason should:

A) inform her supervisor that she cannot work on the portfolio because of a non-compete agreement.

B) inform her supervisor that she cannot work on the portfolio because of a legal agreement, but cannot tell him why.

C) work on the portfolio because she did not personally work on the portfolio when she was at Howe.

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Jason must inform her supervisor of the conflict, but she cannot violate the terms of the confidentiality agreement and she cannot work on the portfolio.

anshultongia

Hunter Harrison, CFA, has recently been promoted to Chief Investment Officer (CIO) of Ironclad Investments, an investment adviser and pension consultant for medium and large corporate pension clients. Ironclad recently hired a compliance officer to update its compliance manual, which is consistent with the CFA Institute Code and Standards. Harrison serves as a director on several non-profit and corporate boards of directors, some of which have their pension assets managed by Ironclad. As part of his new job duties, Harrison will oversee Ironclad’s research analysts and portfolio managers, including Michelle Myers, who passed the Level II CFA examination last year and is registered for the next exam. Myers is a portfolio manager who regularly meets with clients and prospects. Myers is also a partner in a software company that sells retirement and benefit administration services to institutional clients, some of which are also clients of Ironclad to whom Myers has recommended the software company. Myers has disclosed her partnership interest in the software company to Ironclad, including the potential for additional compensation and the possible conflicts of interest, but not to her clients.
In her correspondence with prospects and clients, Myers normally refers to her status as a candidate in the CFA Program. Her latest brochure includes a reference to her status as a “Level III CFA candidate” in her biographical background to increase her prominence in the industry. Her targeted marketing efforts using these brochures have led to several new accounts in the last few years.
One of Myers’ software clients, Breakthrough Pharmaceuticals (Breakthrough), is a publicly traded corporation that is also held in many of Ironclad’s client portfolios. In the course of their business relationship, Breakthrough’s CEO informs Myers that the company has been having difficulty making retirement benefit payments, and its pension plan has recently gone from “overfunded” to “significantly underfunded” as a result of market conditions. Breakthrough’s CEO indicates to Myers that he is attempting to source additional short-term financing to make retiree benefit payments and will disclose the significant “underfunded status” of the pension plan in the upcoming financial statements. Myers, concerned that Breakthrough’s current pension troubles and short-term liquidity issues will negatively affect its earnings and consequently the performance of the company’s stock, informs Harrison of the impending disclosure. Harrison allows Myers to sell 1,800,000 shares of Breakthrough stock for clients, causing the price to drop by 5%. When the pension troubles are later disclosed in the company’s financial statements, Breakthrough’s stock price drops an additional 18%.
As part of Ironclad’s portfolio management activities on behalf of its clients, Harrison and Myers maintain relationships with third-party soft dollar providers and commission recapture brokers. Better Trading Brokerage (BTB), one of Ironclad’s top ten brokers and soft dollar providers, has offered Harrison two round-trip airline tickets anywhere in the U.S. in appreciation for its 2-year relationship with Ironclad. One of Harrison’s pension clients, Worldwind Travel Inc. (WTI), participates in commission recapture and has offered Harrison two roundtrip airline tickets anywhere in the U.S. or Europe in appreciation for its 2-year relationship with Ironclad. Harrison has disclosed both offers to Ironclad in writing but has not yet responded to either offer because he has been busy with proxy voting duties.
Harrison, as CIO, is chairman of Ironclad’s proxy voting committee. Myers is also a member of the committee. Ironclad, as a discretionary investment manager, votes proxies through the proxy voting committee on behalf of clients. Ironclad is currently reviewing proxies for several companies covered in research, including technology companies Advanced DSL (Advanced), InterConnect Inc. (InterConnect), Speedy Chip Technology (Speedy Chip), and Wavelength Digital (Wavelength). Each company’s current proxy contains voting proposals pertaining to employee stock option expensing methods. This issue is particularly important to Ironclad because several of its investment personnel recently participated in an industry forum that supported increased disclosure for company stock options. The panel concluded that such disclosure will provide investors with a more complete estimate of corporate earnings. Ironclad, through its clients, owns approximately 4% of the outstanding shares of Advanced and InterConnect and approximately 6% of the outstanding shares of Speedy Chip and Wavelength.
Harrison serves on the board of directors for InterConnect and Wavelength, while Myers provides consulting services for Speedy Chip. Harrison receives cash compensation and stock options for his services, while Myers receives restricted stock and stock options. The investment bank that led the public offering of InterConnect and Speedy Chip and seven of nine sell-side analysts covering the companies have “sell” ratings on the stocks. Ironclad’s analysts have also issued “sell” recommendations on the companies due to, among other issues, lack of earnings transparency and low earnings quality. Contrary to committee consensus, Harrison and Myers vote client proxies “against” the expensing of employee stock options for InterConnect, Wavelength, and Speedy Chip. Harrison increases his clients’ positions in both InterConnect and Wavelength, citing “growth opportunities” and “consensus opinion.” Neither Harrison nor Myers has disclosed these compensation arrangements to Ironclad.Is it likely that Myers violated any CFA Institute Standards of Professional Conduct in her reference to her candidacy in the CFA program?

A) Yes, by inappropriately using her candidate status to recruit new clients.

B) Yes, by stating her candidate status using language that is inconsistent with the Standards.

C) No.

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The actions of Myers are consistent with Standard VII(B), which requires that candidates appropriately reference their participation in the CFA Program, clearly stating their candidate status and not implying the achievement of any type of partial designation. Additionally, to be considered a candidate, an individual must be registered to take the next scheduled exam. Since Myers completed Level II last year and has registered for the next exam, she is in compliance with the Standard. There is also no indication that she has exaggerated the meaning of implications of her candidacy in the CFA program in the promotional brochure by, for example, over promising her competency or future investment results. (Study Session 1, LOS 2.a,b)

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Is it likely that Myers violated any CFA Institute Standards of Professional Conduct with respect to her disclosure of the partnership interest in the software company or did Harrison violate any standards with respect to the sale of Breakthrough stock?

Partnership interest

Breakthrough sale

A) Yes No

B) No Yes

C) Yes Yes

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Standard VI(A) – Disclosure of Conflicts, is applicable since Myers is a portfolio manager with fiduciary responsibility for institutional clients of Ironclad who may also be clients of her software company, thereby potentially compromising her ability to make unbiased and objective investment recommendations. Myers should disclose the potential conflict to her clients and to Ironclad and abide by any restrictions imposed by the firm. Myers has not disclosed the conflict to clients and has therefore violated the Standard. Harrison has violated Standard IV(C) – Responsibilities of Supervisors by failing to prevent Myers from trading on material nonpublic information. He has a responsibility as a supervisor to make reasonable efforts to detect and prevent violations of the Standards by his employees. (Study Session 1, LOS 2.a,b)

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Is it likely that Myers violated any CFA Institute Standards of Professional Conduct by selling the Breakthrough stock for her clients’ accounts?

A) No, because she first made her supervisor aware of the information upon which the trade was based and received approval for the trade.

B) No, because she fulfilled her fiduciary duty to her clients by avoiding significant losses.

C) Yes.

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Although the information shared by Myers may have helped Ironclad’s clients avoid losses in shares of Breakthrough, the information was material nonpublic information. Information is “material” if its disclosure would have an impact on the stock or if a reasonable investor would want to know the information prior to making an investment decision. Information is “nonpublic” until it has been generally disseminated to the marketplace and investors have had an opportunity to react to the information. The information about Breakthrough’s pension difficulties was both material and nonpublic, as the stock dropped significantly upon disclosure of the information in the market. Therefore, Myers had a duty to keep the information confidential and not to trade or cause others to trade on the information. By sharing the information with Harrison and trading on that information, Myers violated Standard II(A) – Material Nonpublic Information. (Study Session 1, LOS 2.a,b)

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In order to maintain compliance with CFA Institute Standards of Professional Conduct, is it appropriate for Harrison to accept, or is he required to reject, the offers of appreciation from BTB and WTI, assuming Ironclad consents to both?

BTB

WTI

A) Reject Accept

B) Reject Reject

C) Accept Reject

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Harrison can accept the offer from Worldwind but cannot accept the offer from Better Trading. Harrison’s actions are covered by Standard I(B) – Independence and Objectivity and Standard IV (B) – Additional Compensation Arrangements. Under Standard I(B), members shall use reasonable care and judgment to achieve and maintain independence and objectivity in making investment recommendations or taking investment actions. Harrison, as a fiduciary to his investment clients, has an obligation to act in their best interest and must maintain his independence and objectivity when making investment decisions. Harrison’s relationship with Better Trading is, among other things, to execute trades in return for soft dollar services for Ironclad. Soft dollars involve the use of client brokerage by an investment manager to obtain products and services that aid the manager in the research and investment decision-making process. As such, Harrison’s acceptance of the offer from Better Trading could be perceived to compromise his independence and objectivity on behalf of his clients, as the broker may be trying to influence Harrison to increase the amount of trading that Ironclad executes on behalf of clients. The offer from Worldwind, who is one of Ironclad’s clients, if accepted, does not cause Harrison to violate Standard I(B). Gifts from clients are distinguishable from gifts from third parties seeking to influence the activities of an investment manager. Worldwind’s offer to Harrison may be accepted, provided it is disclosed to Ironclad. Standard IV(B) – Additional Compensation Arrangements, requires members to disclose in writing any additional compensation or other benefits received for their services in addition to those provided by their employer. (Study Session 1, LOS 2.a,b)

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With respect to Harrison’s directorships with InterConnect and Wavelength and Myers’ consulting arrangement with Speedy Chip, is it likely that any CFA Institute Standards of Professional Conduct have been violated?

Harrison's directorships

Myers' consulting arrangements

A) Yes Yes

B) No No

C) Yes No

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Standard IV(B) – Additional Compensation Arrangements, applies to both Harrison and Myers, as they both receive compensation for their respective outside services in the form of cash, stock, and stock options. There is no indication that either of them have disclosed their compensation arrangements to Ironclad, which constitutes a violation of Standard IV(B). Standard I(B) – Independence and Objectivity also applies to this situation, as both Harrison and Myers have outside activities that have the appearance of compromising their independence and objectivity regarding Ironclad’s clients. Harrison’s role on the boards of directors for InterConnect and Wavelength and Myers’ role as a consultant for Speedy Chip appear to drive their proxy voting decisions, on behalf of Ironclad’s clients, regarding the expensing of stock options. Thus both Harrison and Myers have also violated Standard I(B). Harrison and Myers may have also violated Statement VI(A) – Disclosure of Conflict by failing to disclose the conflicts of interest that exist as a result of Harrison’s directorships with Interconnect and Wavelength and Myers’ consulting arrangement with Speedy Chip. Such conflicts (whether actual or potential) are required to be disclosed prominently and in clear language to clients, prospects, and employers according to Standard VI(A) (Study Session 1, LOS 2.a,b).

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Which of the following least accurately describes Harrison’s actions necessary for compliance with the Code and Standards regarding proxy voting? Harrison should:

A) abstain from voting on matters affecting Internet and Wavelength to avoid conflicts of interest.

B) discard all proxies on behalf of Ironclad’s clients when there is a conflict of interest.

C) disclose all proxy voting policies to Ironclad’s clients including the treatment of routine and nonroutine issues.

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According to Standard III(A) – Loyalty, Prudence, and Care, Ironclad, as a discretionary investment manager, is responsible (unless otherwise stipulated in the client guidelines or agreement) for making informed and reasonable decisions regarding proxy voting on behalf of clients. Among other things, Ironclad should have a proxy voting policy and a process for identifying and reviewing major proxy issues for appropriate clients. Ironclad and Harrison also have an obligation to avoid conflicts of interest when voting proxies. Although Harrison has a conflict of interest in voting issues on behalf of InterConnect and Wavelength due to his role on their board of directors, proxies on non-routine matters should not be discarded under any circumstances, as such action would constitute a breach of fiduciary duty. Harrison should abstain from voting on matters affecting InterConnect and Wavelength to avoid the appearance of a conflict of interest. Harrison should also ensure proper treatment of any confidential information received in his role on the respective boards of directors. Harrison should maintain confidentiality of voting information on behalf of clients and follow Ironclad’s proxy voting policy. Clients must be made aware of the firm’s policies on voting routine and non-routine proxy issues. (Study Session 1, LOS 2.a,b).

anshultongia

Dan Jeffries is a portfolio manager who is being sued by one of his clients for inappropriate investment advice. The Professional Conduct Program of CFA Institute is investigating Jeffries for the same offense. Jeffries settles the lawsuit with the client while the Professional Conduct Program investigation is ongoing. When the Professional Conduct Program staff questions Jeffries about the problematic investment advice, Jeffries claims he cannot talk about it because doing so would violate the confidentiality of his client. Jeffries has:

A) not violated the Standards by executing the settlement agreement or by refusing to talk about the case with the Professional Conduct Program.

B) violated the Standards by executing the settlement agreement, but not by refusing to talk about the case with the Professional Conduct Program.

C) violated the Standards by refusing to talk about the case with the Professional Conduct Program, but not by executing the settlement agreement.

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Because the Professional Conduct Program will maintain client confidentiality, Standard III(E) Preservation of Confidentiality does not permit members to refuse to cooperate with a PCP investigation because of confidentiality concerns. The Standards do not require members to delay dealing with related legal matters while a PCP investigation is in progress.

anshultongia

Steve Wynn, CFA, is an investment advisor and Jennifer Carey has been a client of his for three years. Carey has shown an interest in international stocks, so they agree to consider putting a portion of Carey's portfolio in foreign stocks. Wynn makes sure that Carey is aware of the currency and political risks inherent in foreign investing before proceeding. They jointly agree to purchase a small portfolio of stocks in the country of Bellagio because one of the brokerage houses that Wynn uses has a great deal of fundamental research on companies domiciled there. Six months later it is revealed in the news media that Bellagio has had severe insider trading problems which have contributed to the loss on the portfolio. Wynn has:

A) violated the Standards by not informing Carey about the insider trading risks and contributing to the problem of insider trading.

B) not violated the Standards.

C) violated the Standards by not informing Carey about the insider trading risks, but not by contributing to the problem of insider trading.

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Wynn should have known about the risks and should have informed Carey of the risks. However, merely investing in a market in which insider trading is prevalent is not a violation of the Standards.

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anshultongia

Jordan Conomos is the new trustee for the Grant Trust, which has both current beneficiaries and remaindermen. Up until now, the trust has been entirely invested in long-term tax-free municipal bonds. Conomos decides to put 30 percent of the assets in common stocks, with the justification that taxes should be the concern of the trust beneficiaries and not the trust, and the trust needs some diversification and growth. Conomos is:

A) not violating his fiduciary duty.

B) violating his fiduciary duty by not investing solely for the purposes of the current beneficiaries.

C) violating his fiduciary duty by not considering taxes.

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The trustee must consider tax liabilities of beneficiaries. However, he should also provide diversification and be concerned with the desires of the remaindermen. (Remaindermen refers to the group that is to receive the remainder of the trust once its term is complete. Of course, some trusts never expire so not every trust has remaindermen.)

anshultongia

The following information pertains to the Galaxy Trust, a trust established by Stephen P. House and managed by Gamma Investment LLC:

• At the time the trust was established House provided $5 million in cash to fund the trust, but Gamma was aware that 93% of his personal assets were in the form of Oracle stock.
• Gamma has been asked to view his funds and the trust as a single entity for planning purposes, since House’s will stipulates that all of his estate will pass to the trust upon his death.
• The investment policy statement, developed in September 1996, stipulates that the trust should maintain a short position in Oracle stock and use the proceeds to diversify the trust more adequately.
• House was able to sell all of his Oracle shares back to the corporation in January 1999 for cash.
• The policy statement redrawn in September 1999 continues to stipulate that the trust hold a short position in Oracle stock.
• House has given the portfolio manager in charge of the trust an all expenses paid vacation package anywhere in the world each year at Christmas. The portfolio manager has reported this fact in writing to his immediate supervisor at Gamma.

Which of the following is most correct? The investment manager is:

A) in violation of the Code and Standards by not properly updating the investment policy statement in light of the change in the circumstances but is not in violation with regard to the acceptance of the gift from House.

B) in violation of the Code and Standards by not properly updating the investment policy statement in light of the change in the circumstances and is in violation with regard to the acceptance of the gift from House.

C) not in violation of the Code and Standards for not properly updating the investment policy statement in light of the change in the circumstances and is not in violation with regard to the acceptance of the gift from House.

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The investment manager is in violation of the Standard requiring him to make a reasonable inquiry into the client’s financial situation and update the investment policy statement since such a dramatic change in the client’s circumstances would undoubtedly alter the investment policy statement and would probably eliminate the need to hold a short position in Oracle. The investment manager is not in violation of the Standard concerning additional compensation, since the gift has been reported to his supervisor and has come from a client. If there was a failure to report such a gift, if the firm had a rule in place against the acceptance of gifts from clients, or if the gift had come from a non-client, there would be a violation of the standard.

anshultongia

June Bird is a pension consultant asked to advise on the Backwater County Pension Plan. Bird notices that 20 percent of the plan's assets are invested in privately held local businesses. Bird is concerned about the lack of liquidity and diversification caused by such an investment. She learns that state law allows investing in local businesses and county law requires at least one-fifth of the plan's assets to be dedicated to investing in local businesses. Bird:

A) should file a written complaint to the Department of Labor pointing out that the law is in conflict with the Employee Retirement Income Security Act (ERISA).

B) should recommend that the trustees resign or risk being sued for violating the Prudent Expert Rule.

C) can continue to advise the pension plan as best she can with the restrictions.

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According to Standard III(A), Loyalty, Prudence, and Care, Bird can continue to serve as a consultant to the plan, but must follow the applicable law.

anshultongia

Lon Smith is an analyst in the Research Department of Lincoln & Co., a large investment firm. He has just completed a temporary assignment in Lincoln's Corporate Finance Department related to FinSoft, a computer software company whose recent operating record has reflected lagging sales volume and heavy product development expenses. Smith has marked his FinSoft notes and work sheets "CONFIDENTIAL / CORPORATE FINANCE DEPARTMENT" and sent them to the company file in the Research Department. This material reveals that FinSoft is about to receive a major contract for an innovative software program that will have a very significant positive impact on earnings as well as on the company's visibility and stature in the industry.
Jay Jones, a CFA candidate and a portfolio manager for Lincoln, has come upon these notes and work sheets while reviewing the FinSoft research file. Jones had been considering sale of the stock from the accounts under his management, but realizes after reading the file material that the recent weakness in operating results is about to be reversed and that the company's prospects are actually quite favorable. Perhaps, he thinks, he should add to his clients' FinSoft positions instead of considering their sale.
Jones briefly reflects on the matter of "inside information" in relation to perhaps buying more of the stock instead of selling it, but his recollection is hazy and Lincoln has no formal guidelines on the subject to which he can refer. Based on the circumstances, Jones believes he is free to use this new knowledge for the benefit of Lincoln's clients.
Based on CFA Institute Standards of Professional Conduct, which of the following is NOT correct?

A) There is misappropriation of information by Jones because the file is marked "Confidential / Corporate Finance Department."

B) There is no breach of duty if traded on because Jones did not conduct the research that produced the information.

C) The information is material because the new software is likely to significantly increase FinSoft's future earnings.

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Jones has a derivative duty not to trade or cause others to trade on material nonpublic information. It does not matter that he did not conduct the research.

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Based on the information presented in this situation, Jones has an obligation to do all of the following EXCEPT:

A) wait to trade on the information until after a reasonable period has passed.

B) encourage public dissemination of the information.

C) encourage his employer to review the compliance procedures as they relate to material nonpublic information issues.

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Jones has an obligation to not trade on the information until after he is sure the information has been made public.

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Based on the information presented, Lincoln should adopt a set of guidelines on inside information that include each of the following EXCEPT:

A) develop criteria for identifying inside information.

B) have in place a supervisor or compliance officer who has the authority and responsibility to decide whether information is material and nonpublic.

C) prohibit exchange of personnel, even temporary, between investment banking and institutional money management departments.

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There is no need to avoid transfer of personnel as long as proper safeguards and procedures are observed.

anshultongia

Greg Hartsburg, a CFA charterholder, is a leading health-care industry analyst for Reynolds and Co., a New York-based brokerage firm. He has ten years of industry experience and has appeared on the Wall Street Journal’s roster of all-star analysts for four straight years.
Hartsburg initiates coverage on Northern Lights Medical Equipment, a Minnesota-based company that designs medical equipment. Hartsburg owns shares of Northern Lights in his personal trading account, a stake of which his company is aware.
Maria Voltaire, a junior analyst working under Hartsburg, has asked the senior analyst to help her prepare for the 2009 Level III CFA exam. He makes himself available to answer her questions on specific topics during the course of her study and gives her two days off, with pay, to study during the week before the exam. He also discusses with her in detail his recollection of the topical areas covered on the 2007 Level III exam, which he took and passed.
One of Reynolds’ traders tells Hartsburg that he believes Voltaire is trading in her own account based on information she gathers from research reports written by analysts in the office before the reports are publicly released.
Hartsburg attends an analysts’ conference in Toronto. At dinner he is seated close to a table that includes a number of leading analysts in the health-care industry. Hartsburg overhears parts of the conversation, in which the group discusses new trends in the health-care industry as a result of the changing political climate in Washington. The consensus at the table is that trends in the industry are favorable over the next four or five years.
Hartsburg has been in the process of preparing his own detailed industry analysis in which he reaches similar conclusions. The conversation he overhears confirms his own analysis, though one of the analysts, Phil Houston, makes some points about competition in the medical-device area that Hartsburg had not considered. On the plane home that evening, Hartsburg rereads the financial statements of two companies he covers, then concludes that Houston’s points about competition are correct.
When he returns home, Hartsburg completes his industry report. In the report he wants to use Houston’s ideas. But Houston works for a rival firm, and as a matter of policy, Reynolds does not refer to rival companies in its reports. So Hartsburg pulls some numbers from 10-K reports for context, starts with Houston’s premise, and makes a similar point in his own words.
Hartsburg is planning to leave Reynolds at the end of the month to take a position as a portfolio manager at Lone Pine Investments. He has disclosed to Reynolds, in the form of an e-mail message to his supervisor, his intention to take with him to his new position a fundamental factor model that he developed before coming to Reynolds and further refined during his time at Reynolds.
He also discloses plans to take with him three sample client investment policy statements (with the client names eliminated) to use as templates in the development of policy statements for his new clients at Lone Pine. In the e-mail to his supervisor, Hartsburg promises he will not solicit the business of these three clients.
Reynolds hires an outside firm to create a company website. Hartsburg is featured in promotional materials touting the firm’s performance. The material reads, in part, “Greg Hartsburg is a Chartered Financial Analyst (CFA) with 10 years of experience in the investment industry. He has appeared on the Wall Street Journal’s roster of all-star analysts for four years in a row.”In order to conform to the Code and Standards with relation to Northern Lights stock, Hartsburg MUST:

A) ask the company to assign another analyst to cover the stock in an effort to avoid the conflict of interest.

B) directly disclose his holdings or have his company issue a generic disclaimer about analyst stock ownership.

C) sell the shares before issuing the report.

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If the brokerage uses language related to the analysts’ potential stock ownership, that should satisfy the requirements of Standard VI(A): Disclosure of Conflicts. The other answers would satisfy the Standard, but are not REQUIRED. Requiring the selling of shares or requesting another analyst is overkill, as analysts are not prohibited from owning stocks they cover. (Study Session 1, LOS 2.a,b)

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Hartsburg’s efforts to help Voltaire pass the CFA exam:

A) violate both Standard I(D): Misconduct and Standard VII(A): Conduct as Members and Candidates in the CFA Program.

B) conform to all relevant standards.

C) conform to Standard I(D): Misconduct, but violate Standard VII(A): Conduct as Members and Candidates in the CFA Program.

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Hartsburg violated Standard VII(A) when he discussed with Voltaire in detail his recollection of the topical areas covered on the 2007 Level III exam. (Study Session 1, LOS 2.a,b)

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With respect to the allegation that Voltaire is front-running research recommendations, Hartsburg’s first priority, under CFA Institute Standard IV(C) concerning supervisory responsibilities, should be to:

A) report the situation to his supervisor.

B) freeze Voltaire’s trading account and begin documenting her conduct as a precursor to possible termination.

C) promptly initiate an investigation.

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Standard IV(C) calls for supervisors to “prevent any violation of applicable statutes, regulation, or provisions of the Code and Standards.” While reporting the situation to a superior and discussing the situation with Voltaire are good ideas, he should first investigate the situation to see if these actions are warranted. Freezing Voltaire’s trading account is premature, as Hartsburg has not yet investigated the situation to find out whether a violation is actually taking place. (Study Session 1, LOS 2.a,b)

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Regarding Hartsburg’s report on the health-care industry, his actions:

A) conform to Standard I(C) concerning misrepresentation; and conform to Standard II(A) concerning the use of nonpublic information.

B) fail to conform to Standard II(A) concerning the use of nonpublic information; and conform to Standard V(A) concerning diligence and reasonable basis.

C) fail to conform to Standard I(C) concerning misrepresentation; but conform to Standard V(A) concerning diligence and reasonable basis.

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While Hartsburg used Houston’s ideas in his report, he did not quote or paraphrase Houston. That is not a violation of the plagiarism standard. Houston’s statement was innocently overheard in a public place, and as such is not material nonpublic information. Hartsburg has a reasonable basis for his research, and the conversation he overheard merely confirmed his own analysis. The independence standard does not apply in this situation. (Study Session 1, LOS 2.a,b)

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Which statement about Hartsburg’s actions prior to his leaving Reynolds is most accurate? His actions regarding the factor model:

A) conform to Standard IV(A): Loyalty to Employer, as do his actions regarding the investment-policy statements.

B) do not conform to Standard IV(A): Loyalty to Employer, but his actions regarding the investment-policy statements do.

C) do not conform to Standard IV(A): Loyalty to Employer, nor do his actions regarding the investment-policy statements.

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According to Standard IV(A): Loyalty to Employer, Hartsburg cannot, without the consent of Reynolds, his current employer, take with him any property that rightfully belongs to Reynolds. Merely disclosing to his supervisor his intention to take the model and the investment policy statements with him does not constitute consent on the part of Reynolds, and as such could be considered misappropriation. Therefore his actions regarding both the model and the policy statements fail to conform to Standard IV(A). (Study Session 1, LOS 2.a,b)

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Reynolds’ promotional material conforms to:

A) Standard I(C) regarding misrepresentation, but not Standard III(D) concerning performance presentation.

B) Standard I(C) regarding misrepresentation and Standard III(D) concerning performance presentation, but violates at least one other standard.

C) all Standards.

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The material fails to conform to Standard VII(B), Reference to CFA Institute, the CFA Designation, and the CFA Program. The Chartered Financial Analyst designation should always be used as an adjective, never as a noun. It would be proper, for instance, to print, “Greg Hartsburg is a CFA charterholder.” The statements about industry experience and the all-star analyst list are statements of fact. Reynolds has not misrepresented the services the company or Hartsburg is capable of performing, its qualifications, or Hartsburg’s professional credentials. Hence they conform to Standard I(C). The statement also does not contradict Standard III(D) concerning performance presentation in any way. (Study Session 1, LOS 2.a,b)