1215

Rachel Young, CFA, is making preparations to start a competitive business before terminating her relationship with her employer, a large money management company. Young asks Dot Wiggins, CFA, to consider joining her. In subsequent discussions with Young, Wiggins learns that Young has not disclosed to her employer ownership of stocks that Young recommended. She also learns that Young has used excerpts from research reports by others with only a slight change in wording without acknowledging the source. Wiggins declines Young’s offer to join the new business but does not dissociate herself from the violations. According to CFA Institute Standards of Professional Conduct, which of the following statements is NOT correct?

A) Wiggins violated Standard I(A) Knowledge of the Law, because she did not dissociate herself from the violations.

B) Young violated Standard IV(A) Loyalty to Employer, because she was making preparations to start a competitive business before terminating her relationship with her employer.

C) Young violated Standard I(C) Misrepresentation, because she did not acknowledge the source of excepts that she used in research reports.

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Young did not violate Standard IV(A) Loyalty to Employer because such preparations are permitted provided that they do not breach Young’s duty of loyalty to her employer. Breaches that would violate Standard IV(A) include soliciting clients or taking records or files while still working for the current employer.

1215

Steve Jones is a portfolio manager for Gregg Advisors. Gregg has developed a proprietary model that has been thoroughly researched and is known throughout the industry as the Gregg model. The model is purely quantitative and screens stocks into buy, hold, and sell categories. The basic philosophy of the model is thoroughly explained to clients. The director of research frequently alters the model based on rigorous research—an aspect that is well explained to clients, although the specific alterations are not continually disclosed. Portfolio managers then make specific sector and security holding decisions, purchasing only securities that are indicated as "buys" by the model. Jones thoroughly understands the model and uses it with all of his clients. Jones is:

A) not violating the Standards either in purchasing stocks without a thorough research basis or in not disclosing all alterations of the model to clients.

B) violating the Standards in purchasing stocks without a thorough research basis and in not disclosing all alterations of the model to clients.

C) violating the Standards in not disclosing all alterations of the model to clients, but not in purchasing stocks without a thorough research basis.

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Jones and Gregg are using reasonable judgment in not continually disclosing all of the alterations of the model. It is acceptable to use a pure quantitative model as a sole basis for purchasing stocks, as long as it is thoroughly researched.

1215

Brenda Clark is an investment advisor. Two years ago Clark decided to stop calculating a return composite because of the time required to make those calculations. A prospective client asks Clark what she thinks her performance would have been over the past two years. Clark:

A) can answer the question orally but cannot state the numbers in writing.

B) cannot answer the question because it would be misleading.

C) cannot answer the question, nor can she discuss potential future market returns with the prospective client.

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Any discussion of past performance would imply that Clark had made some calculations, which would be misleading. However, Clark need not calculate historical performance to be an advisor. She can also talk about her view on the future of capital markets.

1215

Greg Allen is a security analyst and visits David Dawson, the Chief Financial Officer of Edmonds Company. Dawson reveals a great deal of nonmaterial financial data to Allen, data that Dawson routinely reveals to all security analysts who visit him. From this data and other industry information, Allen conjectures that Edmonds is likely to make a tender offer for another company in the industry, a fact that if true would be considered material to the value of the company. Allen:

A) should send a copy of the report to Dawson for verification before disseminating the report to clients.

B) must not disseminate the information or use it for trading purposes until the tender offer is announced.

C) can publish his conclusion in a research report.

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Releasing information to analysts does not constitute a public release of information. Dawson's information should be considered nonpublic until it is released to the public. Allen has used this information, along with other industry information, to come to his conclusion of a pending tender offer which he can use to trade upon based on the mosaic theory.

1215

Juan Lopez manages accounts for Street Capital. Lopez’s mother is a client of the firm. Lopez does not make trades in his mother’s accounts until all other clients of the firm have been given an opportunity to trade. Lopez has:

A) not violated CFA Institute Standards of Professional Conduct because transactions for clients should have priority over personal transactions and transactions for beneficial owners.

B) violated CFA Institute Standards of Professional Conduct because family accounts that are client accounts should be treated like any other firm accounts.

C) violated CFA Institute Standards of Professional Conduct because he is not allowed to trade in family accounts.

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Standard VI(B) Priority of Transactions. Family accounts that are client accounts should be treated like any other firm accounts. Lopez should refrain from exercising excess caution since his mother is a client of the firm like all other clients.

1215

Randy Wesson is a research analyst for a large brokerage company following the chemical industry. Wesson receives a phone call from his nephew who works part-time in an airport hospitality center for an airline while going to business school. Many meetings take place at the center on any given day. The nephew tells Wesson that while bringing some faxes into a conference room, he overheard executives of Hunt Chemical talking about the likely divestiture of one of their subsidiaries. His nephew wants to know whether that will be good for Hunt. Wesson should:

A) write a research report describing that he learned about the likely divestiture from his nephew who works at the hospitality center.

B) write a research report describing the possibility of a divestiture, but not mention how he learned about it.

C) not use the information.

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The information is material and nonpublic; therefore, Wesson cannot trade or cause others to trade on the information. Any action concerning the information would violate the Standard on material nonpublic information.

1215

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

C) constitutes professional misconduct but not the use of 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).

1215

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.

1215

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

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

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

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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.

1215

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

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

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

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