Reading - 2 - LOS a, b: Q95-Q100

95、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 2 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 3 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 failing to indicate the number of times she took the Level 3 exam before passing.

C)   No.

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

The correct answer was C)

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.

96、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?

A)         Yes                        No

B)          No                        Yes

C)          Yes                             Yes

D)          No                              No

The correct answer was C)

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.

97、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 fulfilled her fiduciary duty to her clients by avoiding significant losses.

B)   No, because she used information that, although nonpublic, was not material to Breakthrough’s stock price.

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

D)   Yes.

The correct answer was D)

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.

98、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?

A)    Accept                                Reject

B)    Reject                    Accept

C)     Accept                  Accept

D)     Reject                                Reject

The correct answer was B)

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.

99、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?

A)      Yes                                     No

B)      Yes                                     Yes

C)      No                                      Yes

D)      No                                       No

The correct answer was B)

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).

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

A)   maintain the confidentiality of voting information on behalf of Ironclad’s clients.

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

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

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

The correct answer was D)

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.