1215

Randal Brooks is the chief economist for a large brokerage firm. In the aftermath of a national tragedy, Brooks feels that it is very possible that the stock market will drop significantly and not recover for several years. However, he does not believe that this is the most likely scenario but merely that the risk of investing in equities has increased. He decides to write a market commentary to the brokerage clients that discusses the reasons why the market will remain stable and talks about why he, as a private citizen, feels patriotic. He does not mention the increase risk in equities. Brooks has:

A) violated the Standards by not including all of the relevant factors in the research report and making patriotic statements.

B) violated the Standards by not including all of the relevant factors in the research report, but not by making patriotic statements.

C) not violated the Standards.

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By not mentioning the increased risk of the market, Brooks has violated the Standard on using reasonable judgment in a research report. However, the patriotic statements do not violate the Standards.

1215

Steven Wade, CFA, writes an investment newsletter focusing on high-tech companies, which he distributes by e-mail to paid subscribers. Wade does not gather any information about his clients’ needs and circumstances. Wade has developed several complex valuation models that serve as the basis for his recommendations. Each month, his newsletter contains a list of “buy” and “sell” recommendations. He states that his recommendations are suitable for all types of portfolios and clients. Because of their proprietary nature, Wade does not disclose, except in general terms, the nature of his valuation models. He conducted numerous statistical tests of these models and they appear to have worked well in the past. In his newsletter, Wade claims that subscribers who follow his recommendations can expect to earn superior returns because of the past success of his models.

Wade violated all of the following CFA Institute Standards of Professional Conduct EXCEPT:

A) Standard III(B), Fair Dealing.

B) Standard I(C), Misrepresentation.

C) Standard V(B), Communication with Clients and Prospective Clients.

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Wade did not violate Standard III(B), Fair Dealing, because this situation does not indicate that he failed to deal fairly and objectively with all clients when disseminating his newsletter containing investment recommendations.

Wade violated Standard V(B), Communication with Clients and Prospective Clients, because he failed to include all relevant factors behind his recommendations. Without providing the basis for his recommendations, clients cannot evaluate the limitations or the risks inherent in his recommendations.

Wade violated Standard I(C), Misrepresentation, because his claims about gaining superior expected returns are misleading to potential investors.

1215

Jim Crockett is a portfolio manager for Miami Advisors and reports to Vicki Tubbs, the Chief Investment Officer. Miami has developed a proprietary model that has been thoroughly researched and is known throughout the industry as the Miami model. The model is purely quantitative and takes a given set of client characteristics and universe of potential securities and forms a portfolio for the investor. Individual portfolio managers are responsible for selecting securities to fit into the model based on recommendations from the firm's research department and the managers' own judgment. Because of the specific nature of the inputs to the model, each manager is responsible for applying the model on his or her own computer. The basic philosophy of the process is thoroughly explained to clients. Crockett does not understand the basics of the model, but feels that since it provides pure quantitative output, he does not need to understand it. However, he misapplies the model for several of his clients. In reviewing some of Crockett's portfolios, Tubbs finds the errors and points them out to Crockett. Which of the following statements regarding Tubbs and Crockett is CORRECT?

A) Crockett has violated the Standards by not exercising diligence and thoroughness in making investment recommendations.

B) Crockett has violated the Standards by not considering the appropriateness and suitability of the investment for his clients.

C) Tubbs has violated the Standards by failing to supervise adequately.

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Crockett had a responsibility to know the model well enough to detect the mistakes that could occur from misapplication, so he violated the Standard of diligence and reasonable basis.

1215

Cynthia Abbott, a CFA charterholder, is preparing a research report on Boswell Company for her employer, Capital Asset Management. Bob Carter, president of Boswell, invites Cummings and several other analysts to visit his company and offers to pay her transportation and lodging. Abbott declines Carter’s offer but, while visiting the company, accepts a gift from Carter valued at $75. Abbott fails to disclose the gift to her supervisor at Capital when she returns. In the course of the company visit, Abbott overhears a conversation between Carter and his chief financial officer that the company’s earnings per share (EPS) are expected to be $1.10 for the next quarter. Abbott was surprised that this EPS is substantially above her initial earnings estimate of $0.70 per share. Without further investigation, Abbott decides to include the $1.10 EPS in her research report on Boswell. Using the high EPS positively affects her recommendation of Boswell.

Which of the following statements about whether Abbott violated Standard V(A), Diligence and Reasonable Basis and Standard I(B), Independence and Objectivity is CORRECT? Abbott:

A) violated Standard V(A) but she did not violate Standard I(B).

B) did not violate Standard V(A) but she violated Standard I(B).

C) violated both Standard V(A) and Standard I(B).

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Abbott violated Standard V(A), Diligence and Reasonable Basis, because she did not have a reasonable and adequate basis to support the $1.10 EPS without further investigation. By including the $1.10 EPS in her report, she did not exercise diligence and thoroughness to ensure that any research report finding is accurate. If Abbott suspects that any information in a source is not accurate, she should refrain from relying on that information. Abbott did not violate Standard I(B), Independence and Objectivity, because the gift from Carter was merely a token item.

1215

Jessica French is an individual investment advisor with 200 clients and claims she conforms to Global Investment Performance Standards (GIPS). French includes all of the clients on her books. One of those clients is her father, to whom she charges no fee. However, she manages that portfolio using the same processes as she uses for her paying clients. Another client included in the composite is John Randolph, a wealthy entrepreneur. Randolph is the only client who does not give her discretion over the assets and makes every decision himself, getting suggestions from French and using her to implement decisions. French:

A) conforms to GIPS, if disclosures are made about the non-fee-paying account.

B) has violated GIPS because it includes her father's account, but not because it includes Randolph's account.

C) has violated GIPS because it includes Randolph's account, but not because it includes her father's account.

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Non-fee-paying clients can be included in the same composite as fee-paying clients as long as it is disclosed. Nondiscretionary clients should not be included in the composite as the clients would not adhere to the investment strategy used by the investment advisor.

1215

Patricia Cuff is the chief financial officer and compliance officer at Super Selection Investment Advisors that has incorporated the CFA Institute Code of Standards into the firm's compliance manual. Karen Trader is a portfolio manager for Super Selection. Trader is friendly with Josey James, president of AMD, a rapidly growing biotech company. Trader has served on AMD's board of directors for the last three years. James has asked Trader to commit to a large purchase of AMD stock for her portfolios. Trader had previously determined that AMD was a questionable investment but agreed to reconsider. Her reevaluation deemed the stock to be overpriced, but she nevertheless decides to purchase for her portfolios. Which standard was NOT broken?

A) IV(A)—Loyalty.

B) I(C)—Misrepresentation.

C) IV(C)—Responsibilities of Supervisors.

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IV(A) Loyalty was not broken because this standard involves going into a business that competes with your employer. IV(C) Responsibilities of Supervisors was breached because Trader broke several CFA Institute Standards which Cuff should have enforced. I(C) Misrepresentation was broken because Trader purchased stock for her clients even though she thought AMD was a questionable investment.

1215

Noah Johnson, CFA, is a broker with a money management company, Factor, Inc. In a conversation with Tom Williams, Johnson describes the activities of Factor and discusses the characteristics of portfolio construction. Which of the following statements would NOT, on its face, be considered a misrepresentation?

A) Factor guarantees the portfolio will achieve its goal return.

B) If Williams is not satisfied with the current target return, Johnson can always improve it by increasing his T-bills share.

C) The portfolio securities were carefully selected by Factor to minimize Williams' risk.

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Standard I(C), Misrepresentation, prohibits CFA charterholders from misrepresenting characteristics of the portfolio or the services that the company can provide. The only statement that can be accepted as plausible is that the securities were selected to minimize the risk.

1215

Williams and Fudd is a major London-based brokerage and investment banking firm. Heritage Group, a money management firm, is the first, second, or third largest holder of each of the securities listed on Williams & Fudd's "PrimeShare #10" equity security list.

On Tuesday morning, August 22, Williams & Fudd released a research report recommending the purchase of Skelmerdale Industries to the public and to its clients. On Wednesday afternoon, August 23, Heritage Group bought 1.5 million shares of Skelmerdale. This action is:

A) in accordance with the CFA Institute Code and Standards.

B) a violation of the Standard concerning fair dealing.

C) a violation of the Standard concerning disclosure of conflicts.

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These actions are in accordance with both Standards III(B), Fair Dealing, and VI(B), Priority of Transactions. There is no violation.

1215

Todd Gregory has been recently hired as the head of compliance for Speed Capital. He decides the firm should precisely follow the recommendations of the CFA Institute Standards of Professional Conduct to ensure integrity within the firm. Which of the following is NOT a compliance procedure that Speed should put in place?

A) A requirement that investment personnel should clear all personal investments to identify possible conflicts.

B) A requirement of disclosure of all investment holdings of friends and family members of employees on an annual basis.

C) A requirement that employees provide duplicate confirmations of personal investing transactions.

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Members and Candidates are not required to disclose investment holdings of friends unless those holdings create a conflict of interest.

1215

Patricia Young is an individual investment advisor who uses a computer model to place her clients into an appropriate portfolio. The model takes the clients’ goals and a range of simulated returns and presents the probability of achieving their goals. The investor then chooses the portfolio that provides a satisfactory probability of achieving their goals. By using this process, Young is:

A) violating the Standard on misrepresenting the expected investment performance.

B) not violating the Standards.

C) violating the Standard on suitability.

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The Standard on suitability calls for Young to assess risk tolerance, which is ignored by her process.