Walex

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(A)—Loyalty.

C) IV(C)—Responsibilities of Supervisors.

---

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.

Walex

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.

---

Although Drake is paid by the company, his fiduciary duty is to the plan participants. His advice cannot be compromised by business considerations, otherwise he will be violating the Standard on loyalty, prudence, and care.

Walex

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

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

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

---

Wadel violated Standard VI(A) by not disclosing his wife’s holdings. Linstrom is not in violation of the Standard because a friend’s ownership of the shares should not be expected to impair her ability to make objective decisions. (Study Session 1, LOS 2.a,b)

---

What is the obligation, if any, to disclose Wadel’s arrangement with Black?

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

B) 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.

C) Wadel must disclose the arrangement to Platt but is not required to disclose the arrangement to his 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)

---

Knudsen violated:

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

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

---

The handling of the Miller account:

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

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

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

---

Linstrom did not violate Standard IV(B) because she disclosed Miller’s offer to Platt. However, her allocation of the best lot of bonds to Miller’s account violated Standard III(B). (Study Session 1, LOS 2.a,b)

---

According to the Standards, how must Platt deal with the intern’s alleged illegal activity?

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

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

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)

---

Platt is considering adopting local investment practices in Xania. According to the Standards, Platt may:

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)

Walex

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.

---

Lynn is in effect establishing a constraint that Dixon must respect in formulating her portfolio. As long as she has full knowledge of the economic consequences, Dixon can continue as her advisor

Walex

Which of the following statements about soft dollars is least accurate?

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

B) Soft dollars are assets of the client.

C) Soft dollars are third party research arrangements.

---

Directed brokerage are soft dollars directed by the client to the investment manager to pay for goods and services that benefits the client only and not the firm.

Walex

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.

---

Which of the following statements is least accurate with respect to the new prudent investor rule?

A) Fiduciaries must consider the risk return tradeoff.

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

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?"

---

To the extent that pension plan documents spelling out investment guidelines are inconsistent with the requirements of ERISA:

A) the plan documents should be followed.

B) ERISA requirements should be followed.

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

---

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.

Walex

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

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)

---

Which of the following statements about Montpier’s analysis of Circuit Secrets is CORRECT?

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)

---

With regard to Standard VII(B)—Reference to CFA Institute, the CFA Designation, and the CFA Program:

A) both Montpier and Taylor are in compliance.

B) neither Montpier nor Taylor is in compliance.

C) only Taylor is in compliance.

---

Both Montpier, as a CFA charterholder, and Taylor, as a CFA candidate, are subject to the Standards. Montpier violated Standard VII(B) by exaggerating the implications of passing the exam in three years. Taylor’s comments comply with the Standards. (Study Session 1, LOS 2.a,b)

---

Which of the following actions could Taylor take to ensure he is not in violation of Standard I(C)—Misrepresentation?

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

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

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

---

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)

---

Which of the following statements regarding Standard IV(A)—Loyalty to Employer is CORRECT?

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

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

C) By accepting compensation for his role in the medical study, Taylor is violating 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)

---

Taylor’s actions regarding Breakthrough Corp.:

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

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

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

---

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)

Walex

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

• Aug. 8: The Wall Street Journal reported that Aggregate Opportunities had inflated its 2004 earnings due to questionable accounting practices. The story was based on interviews with unnamed sources within Aggregate and its auditor, Millennium Partners. On that day the stock fell 42 percent to $12.50 from $21.55.
• Aug. 10: At 9 a.m., Aggregate revealed in a conference call to analysts a restatement of earnings for the previous three fiscal years that almost completely erased the reported net income for fiscal years 2002, 2003, and 2004. Aggregate’s chief financial officer personally selected the small group of analysts participating in this call. Company officers said the restatement resulted from questionable accounting practices for off-balance sheet limited partnerships. At 1 p.m., the company issued a news release containing the information provided in the conference call. By the end of the trading day the stock had fallen 74 percent to $3.25.
• Aug. 11: At 10 a.m., Aggregate’s Chief Financial Officer Buster Lockhart, CFA, publicly announced his resignation, and the Securities and Exchange Commission said it was pursuing an investigation.

During July and August of 2005, the following actions were taken:

• July 20: Michael Cho, CFA, a highly respected analyst with 25 years of experience covering Aggregate’s industry, had spent several days reading Aggregate’s 10-K and 10-Q documents and other analysis published by some of his competitors at major brokerage houses. Based on his reading and conversations with Aggregate management concerning nonmaterial, nonpublic information, Cho concluded that Aggregate had inflated its earnings. On July 20, Cho issued a detailed research report to his clients and concluded that Aggregate should be sold. He subsequently participated in the Aug. 10 conference call, although it only confirmed what he had already detailed in his July research report.
• Aug. 2: Equity analyst Harold Black, a CFA charterholder, received from his brother information that Aggregate might restate its earnings. Black’s brother is a senior partner at Millennium Partners. Based on this information, Black immediately prepared a new research report that advised his clients to sell Aggregate, but did not liquidate his personal holdings in the company.
• Aug. 4: Bob Watkins, a CFA Level II candidate and portfolio manager, was golfing at his club. Approaching the third tee, he heard the chief executive officer and chief financial officer of Aggregate discussing company finances. Concealing himself behind a tree, Watkins overheard them discussing the upcoming Wall Street Journal article and the earnings restatement. Based on this conversation, he immediately sold all Aggregate holdings in his clients’ portfolios. Later that day, Watkins told his friend Juan Martinez, CFA, what he learned about Aggregate and how he learned it. Martinez, a subscriber to Cho’s research, then read Cho’s report on Aggregate. Immediately after finishing Cho’s report, Martinez sold the fund’s entire stake in Aggregate. Watkins and Martinez were not participants in the Aug. 10 conference call.
• Aug. 8: Barb Henderson, a CFA charterholder, read the Wall Street Journal article in the morning and after going over her research papers, issued a sell recommendation for Aggregate. On Aug. 10, she participated in the conference call and heard the details of the earnings restatement.
• Aug. 10: Lisa Sanders, CFA, participated in the Aggregate conference call. At 10 a.m., she changed her recommendation on Aggregate from hold to sell and informed all of her clients. At 1 p.m., Sanders sold Aggregate from her personal account.

In issuing a sell recommendation for Aggregate, Henderson:

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). Henderson did check his research papers and relied on the Journal which is a credible source. 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)

---

In selling his clients' holdings in Aggregate, Watkins:

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

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

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

---

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)

---

In advising his clients to sell Aggregate, Black:

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

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

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

---

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)

---

After changing her recommendation on Aggregate, Sanders:

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)

---

In selling his fund's stake in Aggregate, Martinez:

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)

---

Which statement about violations of the Code and Standards is CORRECT?

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

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

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

---

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)

Walex

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

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

C) 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.

---

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.

JonnyKay

William Fleming is an investment advisor for GlobalBank, a large, multinational financial corporation. He is based in the New York office, and his client base consists of medium to large institutional accounts in the United States and Western Europe. Roughly three-quarters of his clients pay performance-based fees, while the remaining one-quarter pay fees based on assets. GlobalBank’s investment banking division is an industry leader, and Fleming is able to offer his clients the opportunity to participate in some of the hottest initial public offerings (IPOs) and secondary offerings brought to market. GlobalBank’s compliance department formulated and distributed to its employees and clients its policy on how to allocate trades among clients.
The policy states that in order to reward customer loyalty, customers that utilize the services of GlobalBank’s divisions other than investment advisory will receive allocations on all trades (including IPOs and secondary offerings) based on the relative size of their order, before clients that utilize only investment advisory services. After filling orders for multi-relationship clients, clients that only utilize investment advisory services will receive trade allocations on all trades, including IPOs and secondary offerings, based on the relative size of their order. This policy reflects GlobalBank’s long-term goal of being a full-service provider of financial products and services to all of its clients.
One of Fleming’s accounts, Waverly Capital Partners, has contacted him regarding an upcoming secondary offering by DCH Corp., for which GlobalBank will serve as lead underwriter. Waverly has already performed its due diligence on the offering and is interested in purchasing a substantial position in the secondary offering in order to employ the company’s current surplus of cash. Waverly’s representative tells Fleming over the phone that they would like to purchase 5,000 shares of the offering but gives no other details of its analysis of the offering. Fleming has not read the prospectus for the offering yet and is not familiar with the details, but because he has confidence in Waverly’s investment expertise, he tells them that he too believes they should participate in the offering. Because Waverly does a significant amount of business with GlobalBank’s other divisions, Fleming assures them that they will be able to obtain their desired allocation of the offering and takes the order.
After taking the purchase order for the Waverly account, Fleming thoroughly reads the prospectus and marketing materials for the offering, as well as past research reports on the issuing company. He determines that DCH shares would be a suitable investment for one of his other clients, The Crockett Foundation. He contacts the Chief Investment Officer (CIO) of the foundation, explains how an investment in DCH would fit with its current risk and return objectives as detailed in the foundation’s investment policy statement (IPS) and provides her with the prospectus for the offering. Fleming tells her that GlobalBank was the lead underwriter for DCH’s initial public offering three years ago and that since then, the stock has outperformed the S&P 500 by at least 15% every year. Fleming also states that the company’s financial position is now even stronger and that the shares will perform at least as well as the lowest return earned on the IPO shares in the last three years. He then proceeds to tell her, “If the foundation is interested in the offering, you should place an order immediately because the issue may be oversubscribed due to strong interest in the offering from Waverly Capital Partners and other clients.” This information is enough to motivate Crocket’s CIO to call a meeting with the foundation’s investment committee.
After a quick meeting with Crockett’s investment committee, the CIO calls Fleming to say that the foundation is interested in the offering and would like to place a purchase order. Crockett does not currently conduct any additional business through GlobalBank’s other divisions. Because of GlobalBank’s trade allocation policy, coupled with the high probability that the offering will be oversubscribed, Crockett is unlikely to be allocated as many shares of the offering as they would like to purchase. In order to obtain the desired number of shares for the client, Fleming devises a plan. He plans to add the Crockett Foundation’s order to Waverly’s order, and once the order is filled he will re-allocate the extra shares back to the foundation’s account at the end of the day. He feels that his action is justified because Crockett has maintained its account with Fleming and GlobalBank for over ten years. In addition, Fleming has traders at GlobalBank sell large blocks of DCH over several days in order to push the stock price lower. The drop in value causes smaller investors at GlobalBank, who are not Fleming’s clients, to withdraw their orders for shares of DCH’s secondary offering. Fleming determines that the fewer number of purchase orders and the plan to piggyback on Waverly’s order will allow Crocket to acquire its desired allocation of shares in DCH’s secondary offering. Having achieved his goal, Fleming allows GlobalBank’s traders to repurchase the firm’s shares of DCH.
Twelve months pass, and the shares of DCH’s secondary offering have declined in price by nearly 20%. The CIO of the Crockett Foundation calls a meeting with Fleming to discuss the poor performance of the security and to review the basis upon which Fleming recommended the investment. Fleming prepares Crockett’s file to take with him to the meeting. The file contains Crockett’s IPS, a detailed account of the purchase order and all conversations held between Fleming and the CIO. In accordance with his own established procedures, however, Fleming maintained the original analysis supporting the purchase of shares in DCH’s secondary offering for nine months after the investment was made.Did GlobalBank’s trade allocation policy violate the CFA Institute’s Standards of Professional Conduct?

A) No, because the firm fully disclosed its allocation policy to all clients and employees.

B) No, because the firm is allowed to offer different levels of service to its clients as long as they are disclosed and available to all clients.

C) Yes, because the policy favors one group of clients over another and will disadvantage those clients that do not have multiple relationships with the firm.

---

The actions of GlobalBank are covered under Standard III(B)—Fair Dealing. According to Standard III(B), members must deal fairly and objectively with all clients. Trade allocation procedures must be fair and equitable to ensure that investment opportunities are available to all clients. A firm may offer different levels of service to its clients, but a policy may not favor clients that have multiple relationships with the firm over those that do not. The Standards also recommend that a pro rata system, rather than an ad hoc system, be utilized in order to avoid conflict of interest. (Study Session 1, LOS 2.a,b)

---

According to the CFA Institute’s Standards of Professional Conduct, Fleming’s execution of Waverly’s trade order after confirming the appropriateness of the trade is most likely in violation of:

A) Standard V(B)—Communication with Clients and Prospective Clients for not separating fact from opinion, but is not in violation of Standard I(C)—Misrepresentation because his guarantee of future investment performance was not a written representation.

B) Standard I(C)—Misrepresentation for not disclosing to Waverly that he did not read the marketing materials, but is not in violation of Standard III(C)—Suitability because the client analyzed the investment thoroughly.

C) Standard V(A)—Diligence and Reasonable Basis for not exercising diligence and thoroughness in his analysis of the investment and Standard III(C)—Suitability for recommending an investment before determining if the investment was appropriate for the client.

---

Fleming violated Standard V(A)—Diligence and Reasonable Basis because he was not familiar with the specifics of the investment, but made an investment recommendation based upon his confidence in Waverly’s investment expertise. Fleming is also in violation of Standard III(C)—Suitability because his agreement with Waverly’s investment decision was not based upon the suitability of the offering within the context of Waverly’s total portfolio. Standard I(C)—Misrepresentation was also violated when Fleming confirmed that Waverly should purchase shares in DCH’s secondary offering, but failed to inform the client that he had not analyzed the investment in any way. Waverly would reasonably expect Fleming to analyze an investment prior to its recommendation and was therefore misled. (Study Session 1, LOS 2.a,b)

---

According to CFA Institute Standards of Professional Conduct, which of the following of Fleming’s actions is most likely a violation of Standard I(C)—Misrepresentation? Fleming:

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&P 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)

---

Which of the following statements most accurately assesses Fleming’s comment about Waverly during his conversation with the CIO of the Crockett Foundation? According to the Code and Standards, Fleming’s statement is:

A) not in violation of any standard because he only disclosed factual information, and he did not disclose the details of Waverly’s purchase.

B) in violation of Standard I(C)—Misrepresentation because his statement may be misleading with regard to future performance of the offering.

C) in violation of Standard III(E)—Preservation of Confidentiality because his failure to keep information about a client’s investment action confidential.

---

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?

Conversation with CIO [td=1,1,100]Sell decision

A) No Yes

B) Yes Yes

C) Yes No

---

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)

---

Is it most likely that Fleming violated any CFA Institute Standards of Professional Conduct related to his meeting with the CIO of the Crockett Foundation?

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)