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LOS a, b:

a. Demonstrate a thorough knowledge of the Code of Ethics and Standards of Professional Conduct by applying the Code and Standards to specific situations.

b. Recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.

Jack Stevens is employed by a company to provide investment advice to participants in the firm's 401(k) plan. One of the investment options is a stable value fund run by the company. Stevens' research indicates that the fund is far riskier and less liquid than the typical stable value fund and has a fundamental asset value lower than book value of the assets. He tells Jessica Cox, the head of employee benefits, about his research, and indicates that he will advise new employees to not invest in the fund and will advise employees who already own the fund to reduce their holdings in the fund. Cox points out that the fund is not in any current danger because there are very few redemptions requested of the fund. Cox also states that a sell recommendation may become a self fulfilling prophecy, causing investors to redeem their shares and forcing the fund to liquidate, which in turn will cause the remaining investors to receive less than their promised value. Stevens agrees with this assessment and feels his fiduciary duty is to all employees. Stevens should:

A)	tell investors he cannot give advice on the fund because of a conflict of interest.

B)	continue to recommend that new investors do not invest in the fund, but not advise existing investors to reduce their holdings.

C)	continue to recommend that new investors do not invest in the fund and existing investors reduce their holdings.

Travis Brown is a partner in a money management firm. He recently attended a seminar and learned about a quantitative model presented by Dixon. Upon returning to his office, Brown began testing the model and making a few minor alterations. He showed the model to his partners who were impressed and decided to promote the model as proof of the firm's value added. In the firm's next newsletter, Brown included a discussion of the model, the results, and financial data on several stocks selected by the model. These factual data were taken from Standard and Poor's publication. According to the CFA Institute Standards of Professional Conduct, which of the following actions is Brown required to take?

A)	Brown must credit S&, no need to credit Dixon.

B)	Brown must credit Dixon, no need to credit S&.

C)	Brown must credit both Dixon and S&.

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)	not violated the Standards.

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

Which of the following statements about a member's use of client brokerage commissions is NOT correct? Client brokerage commissions:

A)	may be directed to pay for the investment manager's operating expenses.

B)	should be commensurate with the value of the brokerage and research services received.

C)	should be used by the member to ensure that fairness to the client is maintained.

Anna Nichols is a research analyst preparing a report on Enterprise Company. In order to ensure accuracy in her report, she sends portions of the report to the Chief Financial Officer (CFO) of Enterprise to allow him to check for factual errors. The CFO makes some corrections, which Nichols checks and agrees with. The CFO also sends Nichols several pages of market analyses that appear favorable for Enterprise. Nichols checks the analyses for accuracy and includes a summary of them in her report, pointing out that the data came from Enterprise. Nichols has:

A)	violated the Standards of Professional Conduct by including the data from the CFO in the report.

B)	not violated the Standards of Professional Conduct but may have violated Research Objectivity Standards.

C)	violated the Standards of Professional Conduct by sending the report to the CFO before sending it to her clients.

It is acceptable to send the report to management to check for factual errors and to use careful judgment in including the data provided by Enterprise (note that this was disclosed). Although Nichols has not violated the Standards of Professional Conduct, the Research Objectivity Standards would prohibit Nichols from sending the full report to the CFO. To comply with the Research Objectivity Standards, Nichols should only send the sections of the report containing facts about the company for verification.

Scott Andrews, CFA, is a stockbroker selling an oversubscribed stock issue. Which of the following best describes Andrews' actions regarding this sale? Andrews:

A)	can offer this security on a prorated basis to all clients for which the security is appropriate.

B)	cannot offer an oversubscribed issue of stock to any clients.

C)	can only offer this security to clients for which it is appropriate on a first come first serve basis.

Standard III(B), Fair Dealing, applies. When new issues or secondary offerings are available or are being offered by the firm or if the firm is part of a selling syndicate, all clients for whom the security is appropriate are to be offered a chance to take part in the issue. If the issue is oversubscribed, then the issue is to be prorated to all subscribers.

Denise Weaver is a portfolio manager who manages a mutual fund and has pension clients. When Weaver receives a proxy for stock in the mutual fund, she gives it to Susan Griffith, her administrative assistant, to complete. When the proxy is for a stock owned in a pension plan, she asks Griffith to send the proxy on to the sponsor of the pension fund. Weaver has:

A)	violated the Standards by her policy on mutual fund and pension fund proxies.

B)	violated the Standards by her policy on mutual fund proxies, but not her policy on pension fund proxies.

C)	not violated the Standards.

Proxies should be taken seriously, and although it is likely that Griffith can understand some of the issues, it is likely that she is not capable of making responsible decisions on all potential proxy issues. Proxies for a pension plan should be voted in the best interests of the beneficiaries, not the plan sponsor. The sponsor's interests will not always be the same as the beneficiary's interest.

A company has a defined benefit plan that is currently under-funded. The plan sponsor has instructed the portfolio manager of the plan to invest more aggressively to bring the funding level up to an adequate amount. Which of the following statements best describes the course of action the portfolio manager should take? The portfolio manager should:

A)	not invest more aggressively because this is not the method used to increase the funding level of a plan.

B)	not invest more aggressively since this may expose the plan to too much risk and may not be in the best interest of the plan's beneficiaries.

C)	invest more aggressively because his fiduciary duties lie with the plan sponsor.

Standard III(A), Loyalty, Prudence, and Care, applies in this situation. According to this Standard, investment actions should be carried out for the sole benefit of the client and in a manner the manager believes to be in the best interest of the client. Here, the client is the plan beneficiaries, not the manager or the entity that hired the manager.

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)	I(C)—Misrepresentation.

B)	IV(C)—Responsibilities of Supervisors.

C)	IV(A)—Loyalty.

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.

Paul Drake is employed by a company to provide investment advice to participants in the firm's 401(k) plan. Company stock is one of the investment options in the plan. Drake feels that the stock is too risky for employees to own in their 401(k) plan and starts advising them to pull out of the stock. The Treasurer of the company calls Drake and tells him that he will be fired if he continues making such advice because he is violating his fiduciary duty to the company. Drake should:

A)	make sell recommendations but point out that the company Treasurer has a differing and valid point of view.

B)	tell employees that he cannot provide advice on company stock because of a conflict of interest.

C)	continue to advise employees to sell their stock.

Joan Platt, CFA, operates an investment firm in New York, but maintains an office in Xania. Platt’s firm invests on its clients’ behalf in both domestic and international stocks and bonds. Platt’s employees include two analysts, Paula Linstrom, CFA, and Hershel Wadel, a member of the CFA Institute. Both analysts report to Platt directly. Thorvald Knudsen, CFA, manages the international bond portfolio.

Xania recently established a stock market, which is not very efficient. None of the Xanian stocks trade in the U.S. market. Xania legally permits the use of material inside information. Platt believes that using inside information would help her compete against other Xanian investment advisers, and also help some of her Xanian clients reach their investment objectives.

Platt instructs Wadel to write a research report on Gamma Company. Wadel's wife inherited 500 shares of Gamma Company from her father when he died five years ago. Gamma stock currently sells for $35 a share. Wadel does not believe that informing Platt about his wife's inheritance is necessary.

Doris Black, one of Wadel's long-time clients, verbally promised Wadel that he could use her vacation home in Aspen, Colo., for a week during skiing season if the return on her portfolio exceeded its benchmark by two percentage points during the next year. Black also promised to reimburse Wadel for his travel expenses. Because Wadel is the sole manager of Black’s portfolio, he says nothing to Platt about his arrangement with Black.

Platt instructs Linstrom to write a research report on Delta Enterprises. Delta's stock is widely held by institutional and individual investors. Linstrom does not own any Delta shares, though one of her friends owns 100 shares of Delta. Linstrom does not believe that informing Platt about her friend's ownership of Delta shares is necessary.

Linstrom has a client, Mandy Miller, with a large account. Miller has set a return goal for her portfolio, promising Linstrom that if the portfolio exceeded the target return, she would let Linstrom use her time-share in St. Maarten in December. Linstrom sent an e-mail to Platt describing Miller’s promise to her. Platt promptly replied to her email granting her permission to enter the agreement.

In February, Linstrom was able to arrange for the purchase of Brady Company bonds at a significant discount to market value. The purchase was made in three blocks at 13%, 15%, and 12% discounts to market value. Linstrom allocated the 15% discount block to Miller’s account and the balance to her remaining clients.

Knudsen’s uncle, Gustaf Jensen, owns a construction firm that has extra cash. When Jensen saw Knudsen at a family event last November, he asked Knudsen to give him advice about purchasing domestic bonds for the construction firm. In exchange for the advice, the construction firm would pay Knudsen $5,000 per year. At the same event, Knudsen’s aunt, Hanna Jorgensen, approached Knudsen and asked if he would manage Jorgensen’s apartment building for a fee of 10% of the gross rents. Knudsen agreed to both Jensen’s and Jorgensen’s proposals. Knudsen informed Platt of Jensen’s request, but not about the Jorgensen arrangement.

Platt suspects that one of the firm’s unpaid interns has violated a federal securities regulation.

Regarding their research reports, which of the following statements about Linstrom and Wadel's conduct is CORRECT?

A)	Wadel violated Standard VI(A)—Disclosure of Conflicts, and Linstrom did not violate Standard VI(A).

B)	Wadel did not violate Standard VI(A)—Disclosure of Conflicts, and Linstrom did violate Standard VI(A).

C)	Both Linstrom and Wadel violated Standard VI(A)—Disclosure of Conflicts.

A)	Wadel need not disclose anything to his clients or to Platt because he is violating no fiduciary duty.

B)	Wadel must disclose the arrangement to Platt but is not required to disclose the arrangement to his other clients.

C)	Wadel must disclose the arrangements to his clients and to Platt only if he believes it will create a conflict with his responsibilities to other clients.

Wadel is required to disclose the arrangement between him and Black under Standard IV(B)—Additional Compensation Arrangements, regardless of whether or not the compensation is cash or noncash. Under Standard I(B)—Independence and Objectivity, members may accept bonuses or gifts from clients, so long as they disclose them to their employers, because gifts in a client relationship are deemed less likely to affect a member's objectivity and independence than gifts in other situations. Token gifts need not be disclosed. (Study Session 1, LOS 2.a,b)

A)	Standard IV(B)—Additional Compensation with relation to the Jensen deal, but did not violate the Standard with relation to the Jorgensen deal.

B)	Standard IV(B)—Additional Compensation with relation to the Jorgensen deal.

C)	no Standards with regard to both the Jensen and Jorgensen deals.

Notifying Platt about the Jensen deal is not enough. He needs permission in writing from both parties before accepting the work. Thus, Knudsen violated Standard IV(B) with relation to the Jensen matter. However, it does not appear that the work performed for Jorgensen is in competition with Platt’s employer, so this aspect is not in violation of Standard IV(B). (Study Session 1, LOS 2.a,b)

A)	did not violate the Code and Standards because the appropriate disclosures were made.

B)	violated Standard III(B)—Fair Dealing, but not Standard IV(B)—Additional Compensation Arrangements.

C)	violated Standard IV(B)—Additional Compensation Arrangements, Standard III(B)—Fair Dealing, and Standard IV(C)—Responsibilities of Supervisors.

A)	Report the intern’s behavior to the appropriate regulatory authority.

B)	Initiate an investigation and place limits on the intern’s activities pending the outcome.

C)	Tell the intern to stop the conduct.

Platt must initiate an investigation, and must also take steps to ensure that additional violations do not occur during the investigation. The investigation could be handled internally by the firm’s compliance officer, or could involve outside legal counsel. Simply instructing the intern to stop the conduct is not sufficient—the Standards require a more proactive response. Reporting the intern to the authorities is not appropriate because Platt is not sure the intern is violating the law. The fact that the intern is not paid does not absolve Platt or her company from liability for the intern’s actions. (Study Session 1, LOS 2.a,b)

A)	use material inside information when trading in Xania only if the information does not relate to a tender offer.

B)	not use material inside information when trading in Xania.

C)	not use material inside information unless trading Xanian stocks.

Standard II(A)—Material Nonpublic Information does not allow the use of material nonpublic information in investment decisions. Platt is bound by the law of the land if it is stricter than the Standards, and by the Standards if they are stricter than the law. Since the Standards are stricter than Xanian law, Platt’s Xanian operations are governed by the Standards. Thus, she cannot use material nonpublic information under any circumstances. (Study Session 1, LOS 2.a,b)

Mason Dixon is an investment advisor with Vicki Lynn as a client. Lynn has expressed an interest in socially responsible investing and has expressed a desire to replace her international and small company funds with socially responsible funds. Dixon has research that indicates the Alpha International Fund and the Beta Small Company Fund are the best socially responsible funds in their class. He believes the Alpha fund will likely have slightly lower performance than the current international fund, but the Beta fund will have significantly worse performance than the current small company fund. Moreover, Dixon has research that supports the contention that socially responsible funds as a group will underperform regular funds. Dixon:

A)	must explain the research to Lynn and tell her that he cannot as her advisor purchase either fund without violating his fiduciary duty.

B)	must explain the research to Lynn and tell her that he cannot as her advisor purchase the Beta fund without violating his fiduciary duty, but he can purchase the Alpha fund.

C)	must explain the research to Lynn, who can purchase the funds if she still feels comfortable with these investments.

A)	Soft dollars are assets of the client.

B)	Directed brokerage are soft dollars to be used for research that benefits the investment firm.

C)	Soft dollars are third party research arrangements.

Your manager, Nathan Green, is asking you about "fiduciary duty." Green asks you to give examples of this fundamental concept. You show him a series of statements that might be made by a CFA Institute member who is an investment manager for a pension plan operating under the provisions of ERISA, the Employee Retirement Income Security Act of 1974. This U.S. legislation established guidelines and requirements for fiduciary conduct and sets standards for many aspects of all private and some public pension plans in the United States. Together with the CFA Institute Code of Ethics and Standards of Practice, the ERISA prescriptions may serve as a model for appropriate fiduciary conduct worldwide.

Note: Respond to the following question from the viewpoint of a "plan fiduciary" whose conduct is governed by the CFA Institute Code and Standards. In addition, assume that the referenced individuals, as investment professionals, have full investment authority over the portion of the pension portfolio they manage.

Concerning an investment manager's responsibility to vote proxies, which of the following statements is CORRECT?

A)	The investment manager is only required to vote proxies in support of anti-management votes. When in agreement with management, no vote is required.

B)	The investment manager must vote all proxies unless there are bona fide reasons, consistent with the interests of the plan participants and beneficiaries, for not doing so.

C)	The investment manager must vote all proxies.

Plan fiduciaries cannot be passive shareholders. Proxy voting rights are considered assets of a pension plan, and as such, proxy voting involves the exercise of fiduciary responsibility. Votes must be cast in a way that the fiduciary believes will maximize the economic value of plan holdings. The fiduciary has a duty to make investment decisions solely in the interest of participants and beneficiaries and exclusively for the purpose of providing benefits to the participants and beneficiaries.

A)	Fiduciaries must invest so as to ensure they do not experience negative returns.

B)	Fiduciaries must consider the risk return tradeoff.

C)	Fiduciaries are required to conduct a thorough and diligent analysis.

Courts have based findings of imprudence less on the type of investment at issue than on the fiduciary's failure to undertake a thorough and diligent analysis of the merits of an investment that may have revealed its unsuitability or the existence of alternative investments offering a more favorable risk/return trade-off. The emphasis is on competence and process, not resulting investment performance. A key question might be, "Did the investment manager have a set of well-reasoned investment policies and were those guidelines followed?"

A)	the plan documents should be followed.

B)	the firm's compliance officer should determine which will govern plan administration.

C)	ERISA requirements should be followed.

Members and Candidates must be knowledgeable of the applicable laws. A plan must be administered according to the documents governing the plan. However, plan documents are to be followed only to the extent they are consistent with requirements of ERISA. An ERISA fiduciary must not comply with investment provisions or a plan document that contravenes the statutory standards under ERISA. ERISA, therefore, places on the fiduciary the additional burden of investigating whether the plan instrument and investment objectives are permissible under ERISA.

Mary Montpier, CFA, is an equity analyst located in the Malaysia office of World Class Advisers. The firm provides investment advice and financial-planning services globally to institutional and retail clients. The Malaysia office was opened last year to provide additional international investment opportunities for U.S. clients. Montpier covers small-cap stocks in the region. Montpier’s supervisor, Rick Reynolds, CFA, works in New York.

Jim Taylor is an analyst in New York who works at World Class Broker-Dealer, a sister company of World Class Advisers. Taylor covers healthcare and biotech stocks for the firm. Taylor recently completed Level I of the CFA examination and is registered for the Level II examination next year. Taylor works for John James, CFA.

Through her interaction with other analysts in Malaysia, Montpier learns that the use of material, nonpublic information is common practice in analyst research reports and recommendations, which is not prohibited by law in Malaysia. Montpier has acquired material, nonpublic information on the research pipeline of Circuit Secrets, a Malaysian semiconductor company. The nonpublic information makes the company seem like a fine investment. After extensive research through traditional means, Circuit Secrets appeared to be fully valued relative to its growth potential until Montpier found the nonpublic information.

In preparation for a client meeting, James asks Taylor to prepare a research report on attractive companies in the healthcare industry. Since Taylor is busy preparing for company conference calls, James tells him to “throw something together.” To meet James’ request, Taylor obtains reports on Immune Health Care and Remedy Corp., two companies that he likes, but has not researched in depth. Taylor takes the original reports, which were prepared by a small brokerage firm in the Netherlands, adds some general industry information, incorporates World Class’s proprietary earnings-growth model, and submits “strong buy” recommendations to James for the stocks. Although written procedures require James to review all analyst reports prior to release, time constraints consistently prevent him from reviewing the reports prior to distribution.

Montpier is proud of her CFA charter. In fact, she often boasts that she is one of the elite members of the CFA Institute that passed all three exams consecutively without failing. Taylor is also proud of the CFA program. He told his friends and family the CFA designation is globally recognized in the field of investment management and research. Furthermore, Taylor states that he believes the program will enhance his portfolio management skills and further his career development.

In her free time, Montpier has begun consultation for members of a local investment club. The club is in the process of developing an appropriate compensation package for her services, which to date have included financial-planning activities and investment research. Montpier informs the investment club that she has a full-time job at World Class Advisers, which offers similar services. The investment club gave Montpier written permission to consult for them despite her full-time work.

To gain insight on biotech stocks, Taylor registers for an upcoming asthma study conducted by Breakthrough Corp., through which he and others will be the subject of testing for the efficacy of several new drugs. On his application, longtime asthma sufferer Taylor indicates that he has the appropriate medical condition for the study and signs a confidentiality agreement. During the study, a researcher shows Taylor a spreadsheet detailing the progress of Breakthrough’s research pipeline. Two of the new drugs on which Breakthrough is awaiting regulatory approval have serious negative side effects in patient testing. This information confirms suspicions Taylor had developed after extensive research and conversations with company executives regarding nonmaterial, nonpublic information, though he was not certain about the names of the drugs until he saw the spreadsheet. At the conclusion of the study, Taylor releases a report detailing the drugs’ side effects and recommends that clients “sell” Breakthrough Corp.

Over the next two weeks, Breakthrough releases information that the drugs in question have been held up by a regulatory agency pending additional investigation. The stock plunges more than 30% on the news.

A)	Taylor sends out a resume referring to himself as a Level II CFA candidate and indicating his intention to take the Level II test in June.

B)	James has dinner with Taylor and promises to provide Taylor with three weeks off in May to study for the CFA exam and offer some test-taking tips.

C)	Reynolds approves Montpier’s report on Circuit Secrets immediately, but tells his traders to wait a week before buying the stock themselves.

An immediate approval of Montpier’s report implies that Reynolds did not check the facts or talk to Montpier about the recommendation, which was dependent on the use of insider information. Reynolds violated the Standard relating to supervisory responsibilities. Side work that is not in competition with the intern’s firm is not a violation unless the side job interferes with her work for World Class. The statement on Taylor’s resume is appropriate, and James’ plans to help Taylor are well within the requirements of the Standards. (Study Session 1, LOS 2.a,b)

A)	Montpier’s best course of action is to initiate coverage of Circuit Secrets as a “hold,” and attempt to get the company to disclose the nonpublic information.

B)	If Montpier prepares a research report for all World Class clients recommending Circuit Secrets as a "buy," but does not reveal the nonpublic information, she has still violated Standard II(A)—Material Nonpublic Information.

C)	Montpier could satisfy the requirements of Standard II(A)—Material Nonpublic Information by producing a research report on Circuit Secrets for Malaysian clients, but not making it available to U.S. clients.

Standard II(A) prohibits not only the revelation of nonpublic information, but also trading on the basis of that information. The buy rating itself is a product of the nonpublic information, and as such is a violation. Montpier must comply with the Code and Standards regardless of the laxness of regulations in her country. If Montpier believes the stock is a buy, initiating it as a hold would be inappropriate. Analysts cannot be expected to have a recommendation on every stock, so failing to recommend a potentially good stock is not a breach of fiduciary duty. (Study Session 1, LOS 2.a,b)

A)	both Montpier and Taylor are in compliance.

B)	only Taylor is in compliance.

C)	neither Montpier nor Taylor is in compliance.

A)	Just use excerpts from the original reports, rather than copying the whole reports.

B)	Initiate coverage of Immune Health Care and Remedy Corp. as holds, not strong buys, until he has time to do further research.

C)	Base his report on information from Value Line and Standard & Poor’s reports rather than research from rival analysts.

Value Line and Standard & Poor’s are “recognized financial or statistical reporting services,” and as such, can be used as the basis for reports without acknowledgment. Caveat: Those publications are copyrighted, and copying directly from them may be illegal in some circumstances, even if it does not technically violate the plagiarism Standard. Using excerpts is still plagiarism and changing the stock recommendation will not change that fact. It is unlikely that a Dutch research report would not be protected under U.S. copyright, and even if it were not, using the material without attribution still violates the Standard. (Study Session 1, LOS 2.a,b)

A)	Neither Taylor nor Montpier is in violation of the Standard.

B)	By accepting compensation for his role in the medical study, Taylor is violating the Standard.

C)	Despite getting written permission from her client to consult, Montpier is not in compliance with the Standard.

Montpier needs to get permission from both the client and her employer before she can begin to consult; since she has not received permission from World Class, she is not in compliance. Neither Taylor’s use of rivals’ research nor his participation in a medical study violate the Standard. Standard IV(A) addresses outside income, not research methods. And while the medical-study payment is certainly income, it is not in competition with his firm, and as such does not violate the Standard. (Study Session 1, LOS 2.a,b)

A)	violate Standard II(A)—Material Nonpublic Information because the information was not in the public domain.

B)	do not violate Standard II(A)—Material Nonpublic Information because he was only confirming what he already suspected.

C)	did not violate Standard I(D)—Misconduct because he did not misappropriate the information.

Taylor’s use of the material nonpublic information provided to him in confidence by a researcher is a clear violation of Standard II(A). The professional-misconduct Standard prohibits actions that reflect negative on "professional reputation, integrity, or competence." Since Taylor has signed a confidentiality agreement, his violation of the agreement definitely says something about his honesty. Thus, he is in violation of Standard I(D). Standard IV(A) only applies to work in competition with the employer. (Study Session 1, LOS 2.a,b)

In August 2005, the following events occurred related to Aggregate Opportunities, Inc.:

A)	violated none of the Standards.

B)	violated Standard V(A): Diligence and Reasonable Basis because she lacked sufficient reason to justify the downgrade.

C)	violated Standard V(B): Communication with Clients and Prospective Clients because she failed to distinguish between fact and opinion.

The information published in the Wall Street Journal was public information, so Henderson did not violate Standard II(A). While Henderson did not do any independent research, the Journal is a credible source, and even the hint of an accounting scandal can be enough to sink a stock. As such, using the story to justify a downgrade did not violate Standard V(A) or Standard V(B). (Study Session 1, LOS 2.a,b)

A)	did not violate Standard II(A): Material Nonpublic Information because the information did not involve a tender offer.

B)	violated Standard II(A): Material Nonpublic Information by taking investment action.

C)	did not violate Standard II(A): Material Nonpublic Information because there was no breach of duty.

Watkins violated the CFA Institute Standards because the information was both material and nonpublic. It does not matter if the information was not misappropriated, not received in a breach of duty or not related to a tender offer. Watkins still cannot trade or cause others to trade. CFA candidates are indeed subject to the CFA Institute Standards. While the misappropriated information did not involve a tender offer, Watkins’ use of it still violated the Standards simply because it was material nonpublic information. (Study Session 1, LOS 2.a,b)

A)	violated Standard V(A): Diligence and Reasonable Basis because he did not have sufficient information to spur investment action.

B)	violated Standard III(B): Fair Dealing because he did not take his own advice and sell the stock.

C)	did not violate Standard I(B): Independence and Objectivity, but his supervisor violated Standard IV(C): Responsibilities of Supervisors.

Black’s conduct does not violate Standard I(B), because a reasonable person would not call his independence into question, even though his ethics are suspect. Black’s supervisor should have asked Black where he got the information before the research report was circulated, and the failure to do so means that the supervisor violated Standard IV(C). Black is also clearly in violation of Standard II(A): Material Nonpublic Information, because he would clearly have known that the information received from his Brother was both material and nonpublic. However, Standard II(A) is not one of the choices. Black’s failure to follow his own advice does not violate Standard III(B). Ignoring all of the other details, knowledge that an earnings restatement is possible could certainly be considered a reasonable basis to dump a stock, so Black did not violate Standard V(A). Standard VI(A) pertains only when a relationship would impair investment judgment, and that is not the case here. (Study Session 1, LOS 2.a,b)

A)	violated Standard II(A): Material Nonpublic Information by taking investment action based on information not accessible to the public.

B)	violated Standard VI(B): Priority of Transactions by trading Aggregate from her own account.

C)	did not violate Standard II(A): Material Nonpublic Information because the information was disclosed to a select group of analysts.

The way in which Aggregate handled the conference call was an instance of selective dissemination, Members and Candidates must be aware that disclosure to selected analysts is not necessarily public disclosure. Thus, until the material information is made public, Sanders cannot trade or cause others to trade. Once the information is made public, Sanders must disseminate the information to her clients first, and give them adequate time to act on the recommendation before trading for her own account. In the absence of knowledge of any company policy with stricter requirements, 3 hours is probably sufficient, and we cannot assume she violated Standard VI(B). Standard III(B) does not require equal dissemination of information but rather fair dissemination. Nothing in the question indicated that Sanders disseminated the information unfairly. (Study Session 1, LOS 2.a,b)

A)	violated Standard II(A): Material Nonpublic Information by using information obtained from Watkins.

B)	violated no standards.

C)	violated Standard III(A): Loyalty, Prudence, and Care by using information obtained from Watkins.

Martinez was aware of how Watkins obtained the information; therefore, Martinez violated II(A) by trading on material nonpublic information. Martinez has no fiduciary duty to Watkins, and as such did not violate Standard III(A). It would be difficult to argue that Cho’s thorough research is not sufficient reason to trade Aggregate stock, so Martinez did not violate Standard V(A). (Study Session 1, LOS 2.a,b)

A)	Martinez did not violate the Standard regarding use of material nonpublic information and did not violate the fiduciary-duties standard.

B)	Henderson violated the reasonable-basis standard, but Sanders did not violate the Standard regarding use of material nonpublic information.

C)	Aggregate’s CFO violated the fair-dealing Standard, but Black did not violate the fiduciary-duties Standard.

Aggregate’s selective disclosure did violate the fair-dealing Standard, and while Black violated a number of Standards, his brother’s fiduciary duty cannot be imposed on him. Black did not violate the fiduciary-duties Standard. While Cho did not violate the insider-trading standard because he came to his conclusions through the mosaic method, Watkins certainly did because he misappropriated the information. Martinez violated the Standard on material nonpublic information. Henderson did not violate the reasonable-basis Standard. Sanders did violate the insider-trading Standard. (Study Session 1, LOS 2.a,b)

Scott Marsh is a research analyst for a brokerage firm following the computer industry. Joe Perry is Marsh's former college roommate and is the head of technology for Mercury, a large software company. Perry informs Marsh on Tuesday that in two days the company will be making an official announcement that its release of its newest version of its software will be moved up one month, from October 1 to September 1. The announcement will be surprising to the industry and will likely be met with skepticism because the company has had trouble meeting release dates in the past. Perry assures Marsh that he is certain that they will meet the September 1 date. Marsh considers Perry to be very honest and highly competent. Marsh should:

A)	wait until the public announcement is made, then release a report explaining that he believes the company will make the release date, disclosing that one of the reasons for his opinion is Perry is a friend of his.

B)	immediately put out a report recommending the stock, but waiting until the official announcement to state his reasons.

C)	produce his research report in two days based solely on the official announcement, not taking into consideration the information from Perry.

The research report cannot be released until the official announcement is made, otherwise he will be violating the Standard on prohibition against the use of material nonpublic information. Once it is made public, Marsh can disclose the nature of the conversation without violating that Standard because the information will now be public. However, he should disclose the relationship with Perry or he will be violating the Standard on communications with clients and prospective clients.

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& 500 by at least 15% in each of the last three years since the offering.

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)

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.

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)

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?

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)

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

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

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

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)

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 legal agreement, but cannot tell him why.

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

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

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 stating her candidate status using language that is inconsistent with the Standards.

No.

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)

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?

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)

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

Yes.

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

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)

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?

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)

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?

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).

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

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.

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).

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

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

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

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.

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 considering taxes.

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

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.)

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

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.

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.

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.

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

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

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

A)	encourage public dissemination of the information.

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

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

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

B)	develop criteria for identifying inside information.

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

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

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

C)	sell the shares before issuing the report.

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)

A)	conform to all relevant standards.

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

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

A)	report the situation to his supervisor.

B)	promptly initiate an investigation.

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

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)

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.

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)

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, nor do his actions regarding the investment-policy statements.

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

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)

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

B)	all Standards.

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

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)

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)	can publish his conclusion in a research report.

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

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

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.

Christopher Lance, CFA, Chuck Cunningham, and Lucy Hunt, CFA, went to graduate school together and have remained close friends ever since. Lance and Hunt earned their CFA charters this past June and Cunningham is a Level III candidate. Lance, Cunningham, and Hunt have dinner every month at Cunningham’s country club, one of the most prestigious in the metropolitan area where they live.

In his new position at IMed, Lance is the principal spokesperson on the company’s financial performance and is responsible for developing and maintaining good relationships with the company’s shareholders, especially large institutional investors, and with approximately 30 research analysts who issue research reports and make recommendations about publicly-traded equity and debt securities. It is April 12th and Lance is preparing to conduct the next conference call following the release on April 15th of IMed’s quarterly earnings. Participating in the call will be Lance’s former colleague and good friend, Cunningham, and the other analysts who cover IMed. In addition, Hunt, a portfolio manager at Primary Pensions, a major institutional investor, has told Lance she will also be on the call. Primary Pensions has accumulated the largest single holding in IMed equity.

Cunningham is a research analyst at Lance’s former employer and has taken over coverage of IMed following Lance’s resignation. Until his promotion to Lance’s former position, Cunningham was a junior analyst covering the oil and gas industry. Although knowledgeable about fundamental financial analysis and equity valuation, he is unfamiliar with IMed and the pharmaceutical industry. Cunningham has been reviewing the past 5 years of IMed’s financial statements and Lance’s research reports in preparation for participating in IMed’s quarterly conference call to discuss its quarterly earnings release. Cunningham is under considerable pressure from his employer to meet or exceed Lance’s reputation and be rated “top analyst” by Investment Professional. His firm’s currently rates IMed as a “strong buy” based on Lance’s last research report. Based on his own preliminary analysis, Cunningham has a hard time justifying a “hold” recommendation. He is puzzled by several of the earnings adjustments that Lance made to achieve his target share price for IMed. He plans to ask Lance about these adjustments at their dinner on April 14^th.

Lance, Cunningham, and Hunt met for their regular monthly dinner on April 14th. Cunningham opens the after dinner discussion by questioning Lance about his new job and asks him if he and Hunt should anticipate any surprises at tomorrow’s conference call. Cunningham specifically asks Lance if IMed will meet or beat analyst expectations and the consensus earnings forecast. Lance responds that, under current securities laws, he is unable to discuss details of IMed’s performance with Cunningham and Hunt and that they’ll both be briefed with the other analysts and shareholders on tomorrow’s call. Shortly thereafter, the three friends say their good-byes. Hunt and Cunningham wish Lance well on the next day’s conference call.

What Standard governs Lance’s response to Cunningham’s question and is he in compliance?

VII: Responsibilities as a CFA Institute Member or
CFA Candidate

Yes

III: Duties to Clients

I: Professionalism

Yes

Lance’s response to Cunningham’s question is covered under Standard I(A) which requires members to maintain knowledge of and comply with applicable laws and regulations (including the CFA Institute’s Code of Ethics and Standards of Professional Conduct). In this case, Lance specifically references the requirements of securities laws not to discuss IMed’s performance in advance of the quarterly conference call. If he had done so, he would have disclosed material nonpublic information, since he knows that information about the decline in sales of Mediplex will have an adverse affect on IMed’s share price. In addition, Standard I(A) prohibits Lance from knowingly participating or assisting in any violation of such laws. If Lance had responded in any other way to Cunningham’s question he would potentially have assisted Cunningham and Hunt in violating Standard II(A), Material Nonpublic Information. (Study Session 1, LOS 2.a,b)

Based on her conclusions from the dinner with Lance and Cunningham, which of the following best describes the actions Hunt should take regarding IMed?

A)	Hunt can both tell her mother to sell the investment club’s shares of IMed and sell the shares in the Primary Pensions’ portfolio.

B)	Hunt can sell the IMed shares in the Primary Pensions’ portfolio but cannot encourage her mother to sell the investment club’s shares.

C)	Hunt cannot sell IMed and cannot encourage others to sell IMed.

According to Standard V(A), Diligence and Reasonable Basis, Hunt is required to exercise diligence and thoroughness in taking investment actions and she is required to have a reasonable and adequate basis, supported by appropriate research and investigation, for such actions. Her conclusions about Lance’s response and actions during the dinner do not constitute a reasonable and adequate basis for selling IMed shares from Primary Pensions’ portfolio.

In addition, even if Hunt were to reach the same conclusion after developing a reasonable basis for selling IMed shares, she would be able to sell Primary Pensions’ share of IMed but would be prohibited under Standard VI(B), Priority of Transactions, from telling her mother and encouraging her to sell the investment club’s shares until after she sells the shares in the Primary Pensions portfolio. Members must ensure that transactions for clients and employers have priority over transactions in securities or other investments of which a member is a beneficial owner so that such personal transactions do not operate adversely to their clients’ or employer’s interests. Hunt’s relationship to her mother could reasonably be assumed to constitute an “indirect” interest in the investment club’s securities. (Study Session 1, LOS 2.a,b)

A)	Inform the appropriate regulatory authority that Lance had violated securities laws.

B)	Make reasonable efforts to achieve public dissemination of material nonpublic information disclosed in a breach of duty.

C)	Not trade in shares of IMed.

Unless required by law, the Code of Ethics and Standards of Professional Conduct do not require members to report legal violations to the appropriate governmental or regulatory authority. Such disclosure may be prudent in certain circumstances. Cunningham would be prohibited under Standard II(A), Material Nonpublic Information, from trading in the securities of IMed or causing others to trade by issuing a research report incorporating the material nonpublic information before that information is made public by IMed. Cunningham would also be required to make reasonable efforts to have Lance and IMed make public disclosure of the information. (Study Session 1, LOS 2.a,b)

Which Standard will Lance violate if he continues to allow Cunningham to pay for dinner?

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

B)	Standard IV(B), Additional Compensation Arrangements.

C)	Standard III(B), Fair Dealing.

Over the course of a year, Lance will have received gifts of more $2400 from Cunningham. Standard I(B), Independence and Objectivity, covers receipt of gifts from external parties that may try to influence members’ professional actions to the possible detriment of Lance’s employer, IMed, and the investing public. Even though Lance and Cunningham are long-time friends and former colleagues at Cunningham’s employer, the potential for undue influence exists. Lance should be particularly concerned given Cunningham’s inappropriate question regarding IMed’s earnings. In determining how best to comply with Standard I(B), Lance should no longer permit Cunningham to pay for his dinner and, given the prestigious nature of the country club, should also consider moving the monthly dinner to a different venue to avoid the appearance of impropriety. (Study Session 1, LOS 2.a,b)

In conducting his analysis and developing his recommendation, which of the following requirements of Standard V, Investment Analysis, Recommendations and Actions, would Cunningham least likely be concerned with?

A)	Clearly differentiate fact from opinion in making recommendations.

B)	Consider the appropriateness and suitability of investment recommendations for each client.

C)	Exercise diligence and thoroughness in making investment recommendations.

The research report and recommendation prepared by Cunningham is sent to all relevant clients of the broker-dealer and is not directed toward a particular client or portfolio. In simple terms, Cunningham’s responsibility is to develop a forecast of IMed’s share price and to make a general recommendation to buy, sell, or hold shares of IMed based on the difference between the current market price and his forecast. Cunningham does not interact with individual clients and is not making a specific recommendation to a client to take an investment action. He is not expected to have knowledge of the risk and return objectives, portfolio holdings or unique circumstances and constraints of individual clients. Therefore, he does not have a responsibility to consider the suitability of his recommendation for each client of the firm. Cunningham’s research report should contain sufficient information so that individual clients and their investment advisors can judge the appropriateness and suitability to the client’s particular situation. (Study Session 1, LOS 2.a,b)

During the call, Hunt asks Lance whether the rumors of the side effects of Mediplex are true and whether these rumors have negatively impacted sales. Lance assures Hunt that Mediplex sales are strong and that IMed is confident that sales will continue to rise for the remainder of the year.

Which of the following best describes Lance’s actions when he stated that sales of Mediplex were strong?

A)	Lance complied with Standard IV(A), Loyalty to Employer.

B)	Lance violated Standard I(D), Misconduct.

C)	Lance violated Standard III(B), Fair Dealing.

Lance violated Standards I(D), Misconduct, when he lied about the sales of Mediplex. Under Standard I(D), members are prohibited from engaging in any professional conduct involving dishonesty, fraud, deceit, or misrepresentation or commit any act that reflects adversely on their dishonesty, trustworthiness, or professional misconduct. Neither Standard IV(A), Loyalty to Employer, which relates to independent practice that could result in compensation or other benefit in competition with their employer and does not relate in this situation nor Standard III(B), Fair Dealing, which relates to dealing fairly and objectively when making recommendations to clients, are relevant or apply to this situation. Lance is also NOT in compliance with Standard I, Professionalism, because he violated Standard I(D), Misconduct. (Study Session 1, LOS 2.a,b)

Michael Smyth is Senior Vice President of equity investments at Systematic Investment Advisors, Inc. (SIA). He manages a team of analysts and portfolio managers and is responsible for maintaining and developing client relationships. SIA is located in a small European country and provides investment management services to high net worth individuals. Smyth is also a Level III Candidate for the CFA designation.

One of Smyth’s clients is the Muller-Durand family. He had a long relationship with Helmut Muller. Before Muller’s untimely death, he gave Smyth full discretion over his portfolio based on an investment policy statement that had been refined continuously over the years.

SIA has a soft dollar arrangement with a local brokerage firm, First Brokerage, owned by Smyth’s sister.

Smyth has an appointment to meet with Muller’s widow, Wilhelmina Durand, who, as an artist, left management of their financial assets to her husband. She is meeting with Smyth to better understand her financial position.

Which of the following Standards is most relevant regarding Smyth’s meeting with Durand?

A)	Standard III(C), Suitability.

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

C)	Standard III(E), Preservation of Confidentiality.

Standard III(C), Suitability, is most relevant for Smyth's meeting with Wilhelmina Durand. This Standard requires Smyth to make a reasonable inquiry into Durand’s financial situation, investment experience, and investment objectives prior to making any recommendations about her portfolio. Smyth must also consider the appropriateness of the existing portfolio and investment policy statement for Durand. Standard III(A) also has some relevance since Smyth is in a position of trust with respect to Durand, and Smyth must ensure that his and SIA’s goals do not conflict with Durand’s. (Study Session 1, LOS 2.a,b)

A)	Smyth played golf with Muller on a regular basis and developed client relationships.

B)	Smyth owns shares in Comax.

C)	SIA has a soft dollar arrangement with a brokerage firm owned by Smyth’s sister.

Smyth playing golf with Muller is not a conflict with respect to his relationship with Durand and he need not disclose to her that he played golf with Muller. Muller was his client at the time and there was full disclosure that Smyth developed new client relationships. All the other matters must be disclosed. Smyth must get Durand’s approval to continue to direct brokerage from her portfolio to his sister’s firm. As a director and shareowner of Comax, he has a potential conflict of interest when making a recommendation regarding Durand’s Comax shares. (Study Session 1, LOS 2.a,b)

A)	Purchase of research reports and attending the conference are allowable uses of client brokerage.

B)	Purchase of research reports is an allowable use of client brokerage.

C)	Purchase of both research reports and carpeting are allowable uses of client brokerage.

The primary principles regarding use of client brokerage are (1) brokerage is the property of the client and (2) the investment manager has an ongoing responsibility to seek to obtain best execution, minimize transaction costs, and use client brokerage to benefit clients. Consequently, contingent on disclosure of the soft dollar arrangement to clients whose portfolios might be affected, the CFA Institute Soft Dollar Standards permit client brokerage only to be used to purchase research; that is, goods and services, the primary use of which directly assists the investment manager in the investment decision-making process and not in the management of the firm. Therefore, the only allowable use of soft dollars by Smyth is purchase of the research reports. The purchase of the carpeting to create a more pleasant environment would, at best, only contribute indirectly to the investment manager and use of client brokerage is not permitted. Conferences may sometimes be considered research if their programs are designed to improve the investment decision-making process. In Smyth’s case, the conference he attended only had sessions on the management of the investment management firm, not the investment decision-making process. (Study Session 1, LOS 3.b)

A)	Smyth must clearly disclose that his duty as the investment manager is to continue to seek to obtain best execution.

B)	Smyth must clearly disclose, with specificity and in “plain language,” its policies with respect to all Soft Dollar Arrangements.

C)	Smyth must disclose that directed brokerage arrangements that require the investment manager to commit a certain percentage of brokerage might affect his ability to seek to obtain best execution.

Investment managers are required to clearly disclose, with specificity and in “plain language,” policies with respect to all Soft Dollar Arrangements. Because brokerage is an asset of the client, not the investment manager, the practice of client-directed brokerage does not violate the CFA Institute Soft Dollar Standards. However, directed brokerage arrangements have no required disclosures beyond those required for other soft dollar arrangements. Several disclosures are recommended. Because directed brokerage may impede the investment manager’s ability to seek to obtain best execution, which is one of the investment manager’s fundamental responsibilities, it is recommended that investment managers disclose his duty to seek to obtain best execution and that arrangements to commit a certain percentage of brokerage may affect his ability to do so. For all soft dollar arrangements, it is recommended, but not required, that, on request from the client, investment managers provide a description of the product or service obtained through brokerage generated from the client’s account. (Study Session 1, LOS 3.b)

Of the following Standards, determine which would least likely help Smyth decide what actions with respect to selling shares of Comax would be in compliance with the CFA Institute Standards of Practice.

A)	Standard III(B), Fair Dealing.

B)	Standard VI(A), Disclosure of Conflicts.

C)	Standard III(C), Suitability.

Standard III(C), Suitability, is the standard least likely to provide Smyth with guidance when he considers selling Durand’s holdings of Comax. This standard describes members’ responsibilities in developing appropriate recommendations and taking suitable actions. To reach the point where he has decided to sell Durand’s shares, Smyth would already have met these requirements. He has determined Durand’s and his other clients’ requirements and has recommended an appropriate and suitable investment action. His concern is how to implement his recommendation and be in compliance with the Standards of Professional Conduct.

Smyth has several problems with respect to selling shares of Comax from Durand’s portfolio and the portfolios of his other clients. First, he must comply with Standard III(B) and deal fairly and objectively with all clients and prospects when taking this investment action. Smyth must disclose his ownership of Comax to all affected clients according to Standard VI(A) and ensure that transactions for clients take precedence over transactions on his own behalf according to Standard VI(B). (Study Session 1, LOS 2.a,b)

A)	Standard VII, Responsibilities as a CFA Institute Member or CFA Candidate.

B)	Standard II, Integrity of Capital Markets.

C)	Standard IV, Duties to Employers.

As a director and member of Comax’s audit committee, Smyth possesses material nonpublic information about a tender offer. Therefore, Smyth must be particularly concerned about complying with Standard II(A), Material Nonpublic Information. Under this standard, Smyth may not trade nor cause others until the information becomes public. (Study Session 1, LOS 2.a,b)

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

B)	can publish his conclusion in a research report.

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

Jim Taylor works as a portfolio manager for Rose Capital and also serves as president of the Little League board of directors in his town. He receives no money from Little League, however the local golf club provides him with a free membership for volunteering his time on the Little League board. Taylor's involvement with Little League is in his company biography, but the club membership has not been disclosed to Rose or his clients. Taylor has:

A)	not violated the Standards.

B)	violated the Standards by not disclosing the club membership to Rose, but not by failing to disclose it to clients.

C)	violated the Standards by not disclosing the club membership to Rose and failing to disclose it to clients.

Brenda Simone is a money manager and the Blue Streets Pension Fund is one of her clients. The director of the pension fund calls Simone and asks her to use a particular broker so that the fund can obtain some research services with the soft dollars from that broker. Simone believes that the desired broker will provide the same price and execution as the normal broker that Simone uses. Simone does as the client wishes. Simone has:

A)	not violated the Standards as long as the research provided by the broker will benefit the plan beneficiaries.

B)	not violated the Standards as long as the research provided by the broker will benefit Blue Streets.

C)	violated the Standards.

Which of the following actions is least likely to prevent the misuse of insider information?

A)	Monitoring all the phone calls made by the brokers.

B)	Placing securities on a restricted list when the firm is in possession of material nonpublic information.

C)	Controlling relevant interdepartmental information.

Standard II(A), Material Nonpublic Information, applies in this situation. Standard II(A) suggests the use of "fire walls" to protect the firm and to conform to the Standards. A fire wall is an information barrier designed to prevent the communication of material nonpublic information between departments of a firm. Although the fire wall system should provide a means to review transactions, it is not feasible to monitor all communications into/out of departments. Placing sensitive securities/firms on "watch, "restricted," or "rumor" lists helps management target monitoring of transactions.

Scott LaRue is a portfolio manager for Washington Advisors. Washington has developed a proprietary model that has been thoroughly researched and is known throughout the industry as the Washington 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. La Rue feels the model would be improved by adding some factors but he has not fully tested this new version of the model. LaRue discloses his model to his own clients but not to his supervisor. LaRue is:

A)	violating the Standards by not having a reasonable and adequate basis for his investment recommendation.

B)	violating the Standards by not considering the appropriateness of the recommendations to clients.

C)	not violating the Standards.

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.

While having a conversation with a prospective client, John Henry states that his performance across all of his past clients over the past five years was over 20%, which was 200 basis points higher than his benchmark. He tells the client that while the benchmark may rise or fall over time, his excess performance will remain consistent. Henry violated the Standards of Professional Conduct because:

A)	he cannot discuss prospective future performance in any manner.

B)	the statement of excess performance is misleading with respect to its certainty.

C)	he cannot discuss performance without clearly stating that the composite does not conform to GIPS.

June Carter passed Level III of the CFA examination in June but will not complete her work experience requirement until August of next year. Carter can state on her resume that she:

A)	will be a CFA charterholder in August of next year as long as she is on track to complete her work experience.

B)	is a CFA in waiting.

C)	passed Levels I, II, and III of the CFA examination.

Kim Lee is a research analyst at Superior Investments and is researching a biotech firm specializing in the analysis of "mad cow" disease. While touring company facilities and meeting with management, she learns that they believe they may have found a way to reverse the disease. Moreover, one manager conjectured, "Suppose that we reversed the disease in someone who didn't even have it? We might then be able to boost that individual's IQ into the stratosphere!" After returning to her office, Lee issues a research report describing the compound as an "IQ booster with huge potential." This statement:

A)	is reasonable given the information she was provided by the company.

B)	lacks a reasonable and adequate basis in fact.

C)	is allowable but only if quoted verbatim from her conversations with management.

Standard V(A) requires that a member have a "reasonable and adequate basis" before making an investment recommendation. Extrapolating on the basis of the conjecture of one member of the management team, without independent corroboration, is clearly in violation of this Standard. She is also in violation of Standard V(B) concerning the use of reasonable judgment regarding what is included or excluded in a communication with a client or prospective client.

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 considering the appropriateness and suitability of the investment for his clients.

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

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

Judy Gonzales is a portfolio manager with Brenly Capital and works on Johnson Company's account. Brenly has a policy against accepting gifts over $25 from clients. The Johnson portfolio has a fantastic year, and in appreciation, the pension fund manager sent Gonzales a rare bottle of wine. Gonzales should:

A)	inform her supervisor in writing that she received additional compensation in the form of the wine.

B)	present the bottle of wine to her supervisor.

C)	return the bottle to the client explaining Brenly's policy.

In the course of reviewing the Corn Co., an analyst has received comments from management that, while not meaningful by themselves, when pieced together with data he has accumulated from outside sources, lead him to recommend placing Corn Co. on his firm's sell list. What should the analyst do?

A)	Show his report to his own manager and counsel for their review since this information has become material once it was combined with his analysis.

B)	Not issue the report until the comments are publicly announced.

C)	The comments are non material and the report can be issued as long as he maintains a file of the facts as supplied by management.

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 suitability.

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

C)	not violating the Standards.

Member compliance on issues relating to corporate governance or to soft dollars is primarily addressed by the Standard concerning:

A)	Disclosure of Referral Fees.

B)	Loyalty, Prudence, and Care.

C)	Disclosure of Conflicts to Clients and Prospects.

Ken James has been an independent financial advisor for 15 years. He received his CFA Charter in 1993, but did not feel it helped his business, so he let his dues lapse this year. He still has several hundred business cards with the CFA designation printed on them. His promotional materials state that he received his CFA designation in 1993. James:

A)	must cease distributing the cards with the CFA designation, but can continue to use the existing promotional materials.

B)	can continue to use the existing promotional materials, and can use the cards until his supply runs out—his new cards cannot have the designation.

C)	must cease distributing the cards with the CFA designation and the existing promotional materials.

Janice Melfi is a portfolio manager for Soprano Advisors. Soprano has developed a proprietary model that has been thoroughly researched and is known throughout the industry as the Soprano 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 use the model to assist them in making portfolio decisions, but, based on their own fundamental research, are allowed to purchase securities not recommended by the model. This fact is not disclosed to the clients, because the head of marketing does not think it is relevant. Which of the following statements regarding the portfolio manager’s investment decisions is CORRECT?

A)	There is no violation of the Standards.

B)	Melfi is violating the Standards by using two investment processes that are in conflict with each other.

C)	Soprano is violating the Standards by not disclosing the fundamental research aspect of the investment process.

Soprano is violating the Standard on portfolio investment recommendations and actions by excluding relevant factors of the investment process. The fundamental research aspect is highly relevant to the process and should be disclosed to clients. It is acceptable for Melfi to use two investment processes that may be in conflict with each other and to use a process that was not developed by her.

Jim Kent is an individual investment advisor in San Francisco with 300 clients. Kent uses open-ended mutual funds to implement his investment policy. For most of his clients, Kent has used the Baker fund, a small company growth fund based in Boston, for a portion of their portfolio. As a result he has become very friendly with Keith Dunston, the manager of the fund, whom Kent feels is mainly responsible for Baker's performance. One day Dunston calls Kent and tells him that he will be leaving the fund in four weeks and moving to San Francisco to work for a different money management company. Dunston is seeking suggestions on housing in the area. Baker has not yet announced Dunston's departure. Kent immediately finds a fund that is a suitable replacement for the Baker fund, and over the next two days he calls his 30 clients with the largest dollar investments in the funds and tells them he feels they should switch their holdings. Baker feels the remaining clients' positions are small enough to wait for their annual review to switch funds. Kent has:

A)	violated the Standards regarding nonpublic information but has not violated the Standards in failing to deal fairly with clients.

B)	violated the Standards by not dealing fairly with clients but has not violated the Standards regarding material nonpublic information.

C)	violated the Standards by not dealing fairly with clients and regarding material nonpublic information.

Victor Logan is a portfolio manager for McCoy Advisors, and Jack Brisco is the Director of Research for McCoy. Brisco has developed a proprietary model that has been thoroughly researched and is known throughout the industry as the McCoy 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. Brisco 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. Logan has conducted very thorough research on his own, using the same process that Brisco uses to validate his findings. Logan feels the model is missing some key elements that would further reduce the list of acceptable securities to purchase, however, Brisco has refused to look at Logan's research. Frustrated by this, Logan applies his own version of the model, with the justification that he is still only purchasing securities on the buy list. Because of the conflict with Brisco, he does not disclose the use of the model to anyone at McCoy or to clients. Which of the following statements regarding Logan and Brisco is CORRECT? Logan is:

A)	not violating the Standards by applying his version of the model, but is violating the Standards by not disclosing it to clients. Brisco is not violating the Standards.

B)	violating the Standards by applying his version of the model and by not disclosing it to clients. Brisco is violating the Standards by failing to consider Logan's research.

C)	violating the Standards by applying his version of the model and by not disclosing it to clients. Brisco is not violating the Standards.

Because the research is thoroughly conducted, and Logan has authority to make individual security selection decisions, Logan is not violating the Standards by applying his model. However, Logan is violating the Standard on communication with clients and prospective clients by excluding relevant factors of the investment process. The use of his model is an important aspect of the investment process and should be disclosed to clients. Brisco is not violating the Standards by not considering Logan’s research.