Ethical and Professional Standards 【Reading 4】 system, include, following, fiduciary, effective

prashantsahni

All of the following would be effective components of a formal compliance system EXCEPT:

A) the investor's objectives and constraints should be maintained and reviewed periodically to reflect any changes in the client's circumstances.

B) as a fiduciary under ERISA, the firm will strictly follow pension plan instructions and restrictions, which may include concentrating portfolios in a few securities or industries.

C) the firm prohibits analysts and portfolio managers from using material nonpublic information in making investment recommendations or taking investment action.

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According to Standard III(A) – Loyalty, Prudence, and Care, “members shall use particular care in determining applicable fiduciary duty.” Under ERISA, a fiduciary has the duty to diversify the plan’s investments in order to protect it from the risk of substantial loss. The firm must follow pension plan instructions and restrictions unless they conflict with ERISA or other applicable laws and regulations. Having concentrated portfolios does not constitute effective diversification. An appropriate policy statement would be: “ The firm will follow pension plan documents only to the extent that they are consistent with applicable laws and regulations. The firm will diversify plan assets to minimize the risk of loss.”

kim226

Benson & Company (BC) is a brokerage and investment advisory firm that specializes in venture capital. BC researches start-up companies for their clients and helps qualified startups raise money. BC often acts as a conduit for investors and firms needing start-up capital. Over the past ten years, of the venture capital opportunities for which BC has raised money, the proportion of successes is significantly higher than the average for BC’s peers. This fact appears in writing in most of BC’s promotional material. When approaching investors with venture capital deals, BC representatives have been instructed to say “we offer opportunities with a higher expected return than stocks without the extra risk.”Ron Thornton, CFA, has just been promoted to the role of supervisor of research, with a specific charge to reorganize his division. Thornton begins with a review of the files. He decides to throw out all files pertaining to companies that had applied to BC for financing, but had been refused by BC. He also decides to throw out files on those firms that have been researched, but were not being recommended by BC.
Thornton asks Sue Fosler, a level III CFA candidate, to look at Spanish Garden, which is a new concept family-restaurant chain that is seeking venture capital from BC. He gives her a coupon for a complementary meal that had been sent to BC by the owners of Spanish Garden. Fosler goes to a local branch of the restaurant for the meal. While she is there, she sees Fred Benson enjoying a meal at the restaurant. Fred Benson is one of the Benson and Company partners. Later, she asks him about the restaurant, and he says “I like the food.” He added jokingly that “the American public will benefit from the growth of Spanish Garden.” Fosler also learns that Fred Benson is on the board of directors of Spanish Garden and owns two-percent of the company. Fosler continues gathering data and, based on the data and her opinion regarding her dining experience at the restaurant, concludes that a “buy” recommendation is appropriate. After writing up her report, she gives it to Thornton who will be responsible for disseminating the report. The next day Fosler discovers that the Center for Disease Control (CDC) has ordered Spanish Garden to change some of its food handling procedures. She calls the CDC, and a CDC spokesman informs her that the restaurant could be closed down unless it complies with these requests immediately. Fosler calls the head quarters of Spanish Garden and is told “no comment” by a restaurant representative. Fosler relays this information to Thornton before he disseminates Fosler’s recommendation. He disseminates the recommendation without any changes. Upon learning this, Fosler made arrangements to speak with BC’s legal counsel. With regard to the written statement concerning the success of BC’s prior venture-capital investment offerings, and the verbal slogan concerning risk and return that BC’s representatives have been instructed to say to investors, which (if any) is a violation of the Code and Standards?

A) The written statement only.

B) Both statements are a violation.

C) The verbal statement only.

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According to Standard I(C), Misrepresentation, the firm and its representatives cannot make oral or written statements that misrepresent the firm’s record or what it can expect to achieve. It is not reasonable to believe that BC is capable of repealing the laws of risk and return. Therefore the verbal statement is in violation of the Standard. On the other hand, assuming that its record of success is correct as indicated, then it can publish that fact. However, some caution is warranted here as well, and, despite what BC has accomplished, past performance is not necessarily an indicator of future results. This statement should accompany the performance data. (Study Session 2, LOS 5.a,b)

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In preparing her report on Spanish Garden, Fosler violated the code and standards by:

A) accepting the meal coupon but not by eating at the restaurant before writing her report.

B) eating at the restaurant before writing her report but not by accepting the coupon.

C) no violation has occurred.

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The gift is not a violation of Standard I(B), Independence and Objectivity. Token gifts are not a violation. Eating at the restaurant would be part of the research process and congruent with Standard V(A), Diligence and Reasonable Basis. (Study Session 2, LOS 4.a,b)

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Of the two categories of files that Thornton has decided to throw away, for which will the discarding of the files be a violation of the Code and Standards?

A) Both categories of files.

B) The files on applicants for venture capital that were refused.

C) Neither category of files.

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According to Standard V(C), Record Retention, a firm must keep adequate records supporting actions taken and recommendations made. The Code and Standards do not require records for actions not taken and recommendations not made. (Study Session 2, LOS 4.a,b)

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Fred Benson’s comments concerning Spanish Garden would be considered:

A) material public information and Fosler would not be in violation of the Code and Standards by not including it in her report on Spanish Garden.

B) nonmaterial nonpublic information and Fosler would not be in violation of the Code and Standards by not including it in her report on Spanish Garden.

C) nonmaterial nonpublic information and Fosler would be in violation of the Code and Standards by not including it in her report on Spanish Garden.

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Fred Benson saying he likes the food is merely a personal opinion, and such an opinion would not be unexpected, given his relationship with Spanish Garden. His second comment says nothing about the quality of the restaurant as an investment. No reasonable investor would take such comments as a reason to purchase the company. Under Standard V(B), Communication with Clients and Prospective Clients, "members shall use reasonable judgment regarding the inclusion or exclusion of relevant factors in research reports." Clearly, the comment was just an opinion, and it should not be included in the report. (Study Session 2, LOS 4.a,b)

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When issuing the report on Spanish Garden, Fosler must disclose:

A) neither Fred Benson’s ownership interest nor the directorship.

B) Fred Bensons’ ownership and the directorship.

C) Fred Benson’s directorship, but not the ownership.

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Both the ownership interest and the directorship must be disclosed to be in compliance with Standard VI(A), Disclosure of Conflicts. The disclosure of such information will allow those acting on the basis of the research to judge for themselves whether, and to what degree, such a conflict of interest may bias the opinion contained in the report. (Study Session 2, LOS 4.a,b)

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With respect to Fosler’s report on Spanish Garden, the CDC order, and the subsequent actions taken by Fosler and Thornton:

A) Thornton is in violation of the Code and Standards, but Fosler is not.

B) neither Fosler nor Thornton are in violation of the Code and Standards.

C) both Fosler and Thornton are in violation of the Code and Standards.

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Fosler composed the report using appropriate information and judgment. She told her supervisor about the CDC order. When Thornton disseminated the report without the new information, he was in violation of Standard V(B), Communication with Clients and Prospective Clients because he did not use reasonable judgment regarding the inclusion or exclusion of relevant factors in the research report. Fosler acted correctly by seeking BC’s legal counsel after the dissemination. (Study Session 2, LOS 4.a,b)

kim226

Mary Hiller, CFA, is a senior analyst at a mutual fund. She is also a member of the Board of the Directors of her daughter’s Skating Club. She is often asked for advice about the management of the club budget and about possible short-term investments, but she is not paid for this advice. She does not undertake any research to answer these questions, providing information based only on the general practices of the mutual fund at that moment. The only benefit she receives is a free monthly membership for her daughter that would usually cost $182. What should she do before making any recommendations, in order to comply with the CFA Institute requirements?

A) Obtain prior permission from her employer.

B) Inform her current clients about her outside consulting.

C) Consult only on her free time and do not accept any benefit greater than $100.

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According to Standard IV(A) Loyalty to Employer, it is the employee’s duty to inform the employer about any type of outside consulting service, including duration and any compensation. Only after receiving permission from her employer, can she proceed.

kim226

Using as his universe all companies in the steel industry, Reynold Anderson analyses the performance of stock prices for the industry. He succeeds in developing a regression model with excellent statistical control measures. The extrapolation from the model shows low risk variance of the securities in this industry. Without the inclusion of non-steel stocks in the portfolio, Anderson concludes that, based on these results, every portfolio can use the steel industry securities to diversify and lower its risk. He persuades his clients to change their current portfolios. Anderson states that, as the model’s results show, some particular industries, such as car manufacturers, have underpriced stocks, and investors should take advantage of it. Anderson has violated the Standards because he:

A) does not consider the suitability of the investment.

B) is not clear enough about the model results.

C) does not distinguish the opinion, based on his model, from the fact.

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While any of the answers can be shown to violate CFA Institute Standards, this cannot be determined conclusively from the information given. However, the scenario clearly indicates that Anderson does not distinguish between opinion and fact in communicating to his clients. Therefore, he violates the Standards on this basis.

kim226

In order to comply with the CFA Institute Standards, an analyst should:

A) use only his own research in making investment recommendations, because anything else would violate Standard I(B), Independence and Objectivity.

B) use only his company's research when making investment recommendations and use outside research for reports and analysis on stocks.

C) use outside research only after verifying its accuracy.

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Standard I(B), Independence and Objectivity: the analyst is allowed to use outside research only after an insightful review. There are no restrictions regarding the exclusive use of outside information or in-house information.

kim226

Perley & Sons is an investment advisor company that just signed a contract with full discretionary power for the management of assets for Bright Future, a charitable fund. Without consultation, portfolio manager Martin Brown, CFA, decides to trade the funds’ assets through a brokerage firm that provides, as an additional benefit, research reports for companies in the microchip industry. These companies represent the main investment interest for most of the Perley & Sons clients. The Bright Future portfolio does not hold any equities in the microchip industry, and, because of its risk profile, is unlikely to ever do so. Which of the following activities represents a possible breach with the CFA Institute standards?

A) Exercising a selection principle that does not comply with the idea of best trade price and execution.

B) Accepting research reports from the brokerage firm that do not benefit client portfolios.

C) Lack of action in consulting with the client before choosing the brokerage firm.

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The problem refers to the fiduciary duties of the analyst and brokerage contracts involving soft money. Trades placed with a broker that provides the firm with research are implicitly paying for the research. In a competitive marketplace, it is probable that the trades could have been as effectively placed with a broker that was able to provide research that would apply to the holdings of Bright Future. According to Standard III(A) Loyalty, Prudence, and Care, it is permissible to direct trades of the client portfolio through a broker who provides research that does not directly benefit the client portfolio, but the client should be informed about the situation.

kim226

Marc Feldman, CFA, is manager of corporate investor relations for a high-tech startup, zippy.com, in Boise, Idaho. Feldman learns that Larry Smith, controller, is altering the accounting records. Feldman advises some of his personal friends to sell short zippy.com. This action:

A) constitutes a violation of the Standard concerning prohibition against misrepresentation.

B) constitutes the use of material nonpublic information and is a violation of the Code and Standards.

C) constitutes professional misconduct but not the use of nonpublic information and is a violation of the Code and Standards.

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The information is apparently nonpublic, and is clearly material since the valuation of securities in the market place is predicated upon financial data and other relevant information. Trading or inducing others to trade is a clear violation of Standard II(A).

kim226

Amanda Brad, CFA, is a security analyst at UpTrend, Inc. During a routine visit to a beauty salon, she learns that a major cosmetic company, Lorean, is expected to present a revolutionary formula for facial cream. Brad buys Lorean stock for her portfolio and prepares a special report on the company. Brad also makes a call to Hillary Lang, another security analyst at UpTrend, to inform her about the news. Lang starts trading on her clients’ portfolios. Brad’s report states that given the on-going research activity at Lorean within the last months, investors can expect some successful new products and a sharp increase in the price of the stock. Lang’s actions:

A) violate the Standard of Objectivity and Independence.

B) violate the Standard of Fair Dealing.

C) violate the Standards because she trades on inside information.

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Lang violates Standard III(B), Fair Dealing, which imposes the requirement to start trading on the clients’ portfolios only after the information is disseminated to all clients.

kim226

Milton Baker, CFA, prepares a research report on the dynamics of a stock price. In his study, he uses a considerable number of information sources, both outside sources and his company’s own research papers, prepared for both internal and public use. The report will first be distributed at the monthly department meeting and then later will be published on the company’s Internet site. He thinks that he may have neglected to mention some of his sources in his reference list but decides that he needs to be concerned about full disclosure of his sources only for the public version of the report, so he will wait to revise his work until after the monthly meeting but before it is published on the internet site. Which Standards does Baker NOT comply with?

A) Standard I(C), Misrepresentation, I(B), Independence and Objectivity, and I(A), Knowledge of the Law.

B) Standard I(C), Misrepresentation, only.

C) Standard I(C), Misrepresentation, and I(A), Knowledge of the Law.

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Baker has some doubts but does not initiate any action presuming they only apply to the publicly disclosed report. The lack of action is a violation of Standard I(A), Knowledge of the Law. He also violates Standard I(C), Misrepresentation, by failing to properly disclose the sources of his information, where necessary.

kim226

Which of the following is NOT considered plagiarism under CFA Institute Standards?

A) Using factual information from a recognized financial information agency without acknowledging the source of the information.

B) Improving an existing report and using it inside the company under a new title without acknowledging the source of the original report.

C) Adjusting an already published model and announcing it as a new model without acknowledging the source of the original model.

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Factual information that is already public and is obtained from a recognized information agency can be used without acknowledgment and is not considered plagiarism. All other options are considered plagiarism.