Walex

Mike Johnson, who is sitting for Level III of the CFA exam this year, is a junior consultant at a small investment advisory firm. Julie Gowan, CFA, is Johnson’s supervisor and in the last three months had been letting Johnson develop a clientele. Johnson had met Mrs. Campbell two months earlier as a referral from an existing client: Mrs. Smith. Following his recent second visit with Mrs. Campbell, Johnson gave Campbell a personal data form to complete and return. The purpose of the form was to gather information about Campbell’s financial situation, investment experience, and investment objectives. Upon receiving the completed form in the mail, Johnson had his assistant, who is a CFA Level I candidate, type up the information. Johnson then reviewed the information and determined that he needed to call Campbell to clarify several items and to request more information.When Campbell answered the phone and Johnson identified himself, Campbell immediately asked if Johnson was still confident in the firm’s recommendation to buy shares of Brown Company, which Smith had purchased upon the firm’s recommendation three months earlier. The rapid rise of the stock of Brown Company after the recommendation, Campbell added, was the reason Campbell wanted to meet with a representative of Johnson’s firm. Johnson quickly did a search on his computer and found the buy recommendation on Brown Company that had been sent to Smith and other clients. Johnson then remembered that some of the clients, who were his friends, had been very happy with the stock’s performance. Johnson responded to Campbell by saying that purchasing the stock was a good idea.
Johnson then asked for a few details concerning Campbell’s situation, and Campbell answered some questions over the phone. Some of the information was not at her fingertips, so she promised to mail it to Johnson.During the phone conversation, Campbell stated that it is extremely important that the information she is providing to Johnson be considered confidential for several reasons. First, as a result of a lawsuit from a former neighbor, Campbell needs to hide some assets to avoid paying a judgment. Therefore, she wants to open up two separate accounts; a small one in her name, and a second account in the name of the company that Campbell owns. Second, Campbell told Johnson that she is about to file for divorce from her husband and does not want her husband to know about the accounts. After collecting all the information he needed, Johnson visited with Gowan to ask advice about opening the account in the name of Campbell’s company. Gowan told Johnson that Campbell should open the account in the name of a fictitious company instead of using the name of Campbell’s company. This would make it more difficult for the courts to find the assets. However, the supervisor stated, "You realize that opening an account in the name of a fictitious firm is illegal so I cannot suggest that you do it. I am only saying that, if you did this, it would help Campbell accomplish her objective."
Later that day, Johnson went to a restaurant and met his old college roommate, William Black, who is now a divorce attorney. Johnson told Black all about Campbell’s situation and suggested that, if Black needs a new client, he should contact Campbell who is about to divorce her husband. Black said he could not act on the information because Campbell’s husband had seen him already about a possible divorce. Johnson assured Black that, as they had agreed, he did not tell Campbell about the possibility of Johnson passing her name on to Black. Black thanked Johnson for the lead and said that, thanks to Johnson’s referrals, he currently had more clients than he could handle anyway. Despite that, Black paid for the dinner as he usually did when Johnson gave him a good lead. Did Johnson violate the Code and Standards by telling Black about Campbell’s impending divorce?

A) No, because Black is not going to act on the information.

B) No, because the impending divorce had nothing to do with Campbell’s financial situation.

C) Yes, he violated client-member confidentiality.

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Johnson violated Standard III(E), which states that all information about current and former clients and prospects must be kept confidential. The fact that Black does not act on the information, and that Black already knew that Campbell and her husband were having marital problems is irrelevant. Although the impending divorce had nothing to do with Campbell's financial situation, this information was clearly communicated to Johnson "within the scope of the client-member relationship." (Study Session 1, LOS 2.a,b)

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Did Johnson violate the Code and Standards by the way he gathered information from Campbell using the personal data form?

A) No, he did not violate the Code and Standards by the way he gathered information.

B) Yes, because he failed to collect the information during face-to-face contact.

C) Yes, because he permitted his assistant who does not hold the CFA designation to see this confidential information.

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There is no provision that would prohibit Johnson from gathering information through the mail,nor is there a provision prohibiting employees of an investing management firm from working with confidential client information. (Study Session 1, LOS 2.a,b)

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In his recommendation of Campbell buying the shares of Brown company, Johnson violates the Code and Standards concerning:

A) Standard III(C) Suitability but not Standard V(A) Diligence and Reasonable Basis.

B) both Standard III(C) Suitability as well as Standard V(A) Diligence and Reasonable Basis.

C) Standard V(A) Diligence and Reasonable Basis but not Standard III(C) Suitability.

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Although Johnson’s firm had made the recommendation three months earlier, he obviously had not been directly involved in the recommendation, nor did he check to see if any new information had been gathered on Brown Company. This is a violation of Standard V(A). Since the client profile was still incomplete at the time of the recommendation, Johnson did not know if Brown Company was suitable for Campbell. The stock had obviously gone up in value since the last recommendation and thus it may not have much capital gain potential left. This is a violation of Standard III(C). (Study Session 1, LOS 2.a,b)

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Did Johnson's supervisor violate the Code and Standards when she told Johnson about a more effective way to hide assets?

A) Yes, because the supervisor assisted in an apparent violation of law.

B) No, because the supervisor specifically stated that, "I cannot suggest" that you open an account in the name of a fictitious firm.

C) No, because the supervisor did not take specific action that violated the law.

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Johnson's supervisor violated the Code and Standards when she told Johnson about a more effective way to hide assets. Standard I(A), Knowledge of the Law, states that "members shall not knowingly participate or assist in any violation of such laws..."Giving information about which illegal act will most benefit Campbell falls into this category. Stating that "I cannot suggest doing this," does not avert blame from the supervisor. She has assisted in the violation of the law by suggesting how best to break the law. Also, there is no confidentiality relationship between investment professionals and their supervisor. (Study Session 1, LOS 2.a,b)

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Which of the following is a violation of the Code and Standards?

A) Johnson having the assistant type up Campbell’s information.

B) Black paying for the dinner with Johnson.

C) Johnson gathering information over the phone.

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Apparently Johnson has been referring many clients to Black, a practice Johnson hides from the clients, and the dinners Black has paid in return would qualify as a benefit received by the member or delivered to others for the recommendation. This violates Standard VI(C) Referral Fees and Standard III(E) Preservation of Confidentiality. None of the other circumstances listed violate the Code and Standards. (Study Session 1, LOS 2.a,b)

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Is Johnson in violation of the Code and Standards if he informs the legal authorities that Campbell is attempting to hide assets from the courts?

A) No, because Campbell has done something illegal.

B) Yes, because he would be violating client-member confidentiality.

C) Yes, because Johnson has only hearsay information about illegal activity and he would need written documentation to justify notifying the legal authorities.

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Johnson is not in violation of the Code and Standards if he informs the legal authorities that Campbell is attempting to hide assets from the courts, because Campbell has done something illegal. According to Standard III(E), the rules of confidentiality do not apply when a member receives information concerning illegal activities. (Study Session 1, LOS 2.a,b)

Walex

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

A) not use the information.

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

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

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

Walex

Lee Roth, who is an investment advisor, is riding in a taxi and finds a file of information labeled "Genco Valuation." The folder contains a great deal of financial data, projections and nonpublic information concerning the food products industry that lead Roth to believe that Genco will be worth 50% more than its current stock value. Roth also finds some correspondence that leads him to believe that the file belonged to Tom Hagan. Roth tries to find out where Hagan works so he can return the file. Roth can recommend Genco to his clients unless Hagan works for:

A) Roth cannot recommend Genco to his clients at this time.

B) the corporate finance department for Genco.

C) the equity research department for a brokerage firm.

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The information is material and nonpublic; therefore, Roth cannot act or cause others to act at this time.

Walex

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.

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The employees to whom Stephens owes fiduciary duty are the ones who are seeking his advice, even if acting on that advice hurts other employees who might eventually become clients.

Walex

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&P, no need to credit Dixon.

B) Brown must credit both Dixon and S&P.

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

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The Standards require members to acknowledge the author of a model, but members are not required to acknowledge information from a recognized statistical and reporting service.

Walex

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

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

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

C) not violated the Standards.

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

Walex

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

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

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

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

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Brokerage commissions are the property of the client and may only be used for client benefit

Walex

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.

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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.

Walex

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.

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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.

Walex

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 proxies, but not her policy on pension fund proxies.

B) not violated the Standards.

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

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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.