Reading 2-III: Standards of Professional Conduct & Guida applies, generated, investment, class, 2010

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Session 1: Ethical and Professional Standards
Reading 2-III: Standards of Professional Conduct & Guidance: Duties to Clients and Prospective Clients

LOS A.: Loyalty, Prudence, and Care.

 

 

 

Heidi Krueger, CFA, an investment advisor, applies soft dollars generated from client accounts to purchase a report on the economic impact of world events, and to purchase a new conference table for the office she uses to meet with clients and prospects. Do these purchases violate Standard III(A) Loyalty, Prudence, and Care?

A) Both of these purchases violate the Standard.

B) Only one of these purchases violates the Standard.

C) Neither of these purchases violates the Standard.

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Using soft dollars for the purchase of office furniture does not benefit clients and is a violation. Purchasing research reports with soft dollars is not a violation, but the advisor should ensure that research purchased with client brokerage will benefit her clients.

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According to Standard III(A) Loyalty, Prudence and Care, brokerage is an asset of the:

A) managing firm.

B) brokerage firm conducting the trades.

C) client.

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Brokerage is an asset of the client.

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Bertha Mader, CFA, received proxy material related to a hostile takeover attempt of Danube Industries by Balnet Company. She holds shares of Danube in most of her client accounts. Mader has a high opinion of Danube’s management because they have run the company successfully and have always responded directly and honestly to her inquiries. She is not acquainted with Balnet’s management team but knows they have a reputation for improving the bottom line at the companies they acquire, partly because they tend to replace upper management at their targets and assume their functions. Balnet's offer is 60% higher than the price of Danube shares before the announcement. Danube’s management has contacted Mader and requested that she vote the shares she controls against the takeover because the management is concerned for their jobs and for the welfare of the company. To comply with the Code and Standards, Mader should:

A) vote for the takeover if she can get assurance that Danube's management team will remain in place.

B) delegate her proxy vote to another member of her firm due to the conflict of interest created when she was contacted by management.

C) vote for the takeover if it is in the best interest of Danube's shareholders, regardless of the consequences to current management.

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Standard III(A), Loyalty, Prudence, and Care, requires that members act for the benefit of their clients. Mader’s duty is to her clients, who are shareholders of Danube. She has no duty to Danube’s management, nor to the company itself, and must vote the shares accordingly.

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Which of the following is least likely required of fiduciaries who are responsible for pension plans?

A) Judging investments in the context of the total portfolio.

B) Acting solely in the interest of plan participants.

C) Supporting the sponsor's management during proxy fights.

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Under Standard III(A) Loyalty, Prudence, and Care, fiduciaries must evaluate management’s proposals during proxy fights to see if they are in the best interest of the plan participants. If management’s ideas are justifiable and reasonably ensure plan participants’ betterment, then fiduciaries can support them. If management is only trying to further its own objectives, especially at the cost of plan participants, then fiduciaries must vote against management in proxy fights.

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All of the following are required by fiduciaries under Standard III(A), Loyalty, Prudence, and Care, EXCEPT:

A) act solely in the interest of the ultimate beneficiaries.

B) place the client’s interest before the employer’s interest.

C) support the sponsor's management during proxy fights.

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Members are required to act in the interest of their clients. In voting proxies, the client’s interest must prevail over management’s interest.

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Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. He places trades for the fund with River City Brokerage. River City provides Calaveccio with soft dollars to purchase research. River City also deals in municipal bonds, some of which Calaveccio holds in his personal portfolio. He periodically uses the soft dollars to request research reports on various small cap stocks and also on the status of the municipal bond market and issues that he holds. These actions are:

A) not in violation of the Code and Standards.

B) in violation of his fiduciary duties regarding the municipal bond research but not so regarding the research on the small cap issues.

C) in violation of his fiduciary duties regarding both the small cap research and the municipal bond research.

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The issue at hand is the member's fiduciary responsibilities in handling "soft dollars" which are technically the property of the client. Standard III(A), Loyalty, Prudence, and Care, delineates the member's fiduciary responsibilities with regards to soft dollars. Since municipal bond research is clearly not relevant to the Small Cap Fund holders, he is clearly using the soft dollars to obtain research for his personal benefit and is in violation of the Standard.

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Which of the following is a possible breach of fiduciary duties by a CFA Institute member who manages assets on behalf of a client?

A) Voting all proxies of stocks the client owns.

B) Using directed brokerage.

C) Neither of these breach fiduciary duties.

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Proxies have economic value to the client. To comply with Standard III(A), the analyst is obligated to vote proxies in an informed and responsible manner. A cost benefit analysis may show that voting all proxies may not benefit the client, so voting proxies may not be necessary in all instances. Directed brokerage occurs when the client requests that a portion of the client's brokerage be used to purchase services that directly benefit the client. Although, this may prevent best execution, it does not violate the Standards as it was directed by the client, not the brokerage firm.

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An analyst with his own money management firm trades on behalf of several large pension funds. The analyst now performs all trades through a particular brokerage firm because the brokerage provides his firm with a no-interest line of credit if paid within 60 days. The line of credit is available to all brokerage clients. The brokerage provides the analyst with personal account privileges that he would not otherwise be eligible for. The brokerage also provides the analyst with free research reports on many companies. Which of these benefits are violations of Standard III(A), Loyalty, Prudence, and Care?

A) Neither of these.

B) The research reports.

C) The personal account privileges.

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The personal account privileges are clearly a violation. The no-interest line of credit could be a violation if the analyst does not factor in the benefits when determining the fees of the clients, but it is not a per se violation. Research reports are least likely to be a violation.

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An independent analyst has only one client. One of the client’s largest holdings is a brokerage firm. Because of the large holding by his client, the brokerage firm recently began allowing the analyst to tap into the firm’s computer network to use the firm’s research facilities. This is allowable as long as the analyst:

A) uses the resources to help manage the client's account.

B) discloses the relationship to the client.

C) does both of the actions listed here.

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According to Standard III(A), Loyalty, Prudence, and Care, the analyst must put the client first and inform the client of any possible conflicts of interest. The analyst must channel any benefits derived from his service to the client, back to the client, and inform the client of the benefits

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Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. Calaveccio places a trade with Quantco Brokerage. While Calaveccio's part of the transaction was conveyed correctly to Quantco, there was a trading error made in Calaveccio's account due to a slip up within Quantco. Calaveccio realizes that the error has taken place, and informs his contact at Quantco. Calaveccio allows Quantco to cover the error, with no cost to TrustCo. This is:

A) a violation of Calaveccio's duty to his employer.

B) permissible under CFA Institute Standards since some trading errors are a fact of life in the securities industry.

C) a violation of Calaveccio's fiduciary duties.

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The issue is similar to an allocation of soft dollars. Clearly, if the broker absorbs the loss, they expect to make up the difference in some way. However, since the error was on the part of Quantco Brokerage, Calaveccio is under no obligation to cover the cost of the trading error. Moreover, no reasonable observer expects that there exists any implied future allocation of trades to Quantco in return for correcting their own mistake. There is no violation of Standard III(A), Loyalty, Prudence, and Care.