1215

Kim Lee manages a variety of accounts at Superior Investments. Some are permitted to invest in tax-exempt issues only; others may not invest in a stock unless it pays dividends. Lee is researching a biotech firm specializing in the analysis of "mad cow" disease. While touring company facilities and meeting with management, she learns that they believe they may have found a way to reverse the disease. Moreover, one manager conjectured, "Suppose that we reversed the disease in someone who didn't even have it? We might then be able to boost that individual's IQ into the stratosphere!" Lee returns to her office and buys shares for all accounts under her supervision. This action is:

A) appropriate given the obvious potential of the therapy.

B) a violation of the Standard concerning appropriateness and suitability of investment actions.

C) a violation of the Standard concerning fiduciary duties.

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Given the variety of accounts under her supervision, it is not likely the shares of a speculative biotech firm would be suitable for all accounts. Placing such shares in all accounts indicates that she has failed to consider the appropriateness and suitability of the investment for each account, and this places her in violation of Standard III(C).

1215

What is the required frequency for updating information on each client’s financial situation, investment experiences, and investment objectives?

A) Regularly.

B) Only during the first meeting with the client.

C) Every year.

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Standard III(C) Suitability. Members shall make a reasonable inquiry into a client’s financial situation, investment experience, and investment objectives prior to making any investment recommendations and shall reassess and update this information regularly.

1215

If an analyst has a policy of making an inquiry into a client’s financial situation, investment experience, and investment objectives regularly, this is:

A) neither of these.

B) a violation of Standard III(E), concerning client confidentiality.

C) congruent with Standard III(C), Suitability.

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Standard III(C) explicitly says that an analyst should make such inquiries and update information regularly. Client confidentiality is addressed in Standard III(E) but that is with respect to how the analyst treats the information once it is obtained.

1215

An analyst thinks that a major change in the tax law will benefit holders of utility company stocks. She immediately begins calling all her clients and telling them of the upside potential of investing in such assets now. Based upon this information, this is most likely:

A) a violation of Standard V(A), Diligence and Reasonable Basis.

B) congruent with Standard V(A), Diligence and Reasonable Basis.

C) a violation of Standard III(C), Suitability.

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According to Standard III(C), the analyst needs to determine the suitability of an investment for each client. It is doubtful that all her clients are identical in their needs. According to the information, the analyst mentions the upside potential but does not mention the downside risk. Although the information says that she thinks that the change in the tax law will benefit holders of utility company stocks and says nothing of how she arrived at this conclusion, we do not know if she has or has not made her decision on a reasonable basis.

1215

Bob Hatfield, CFA, has his own money management firm with two clients. The accounts of the two clients are equal in value. One of the clients gets married and the assets of the new spouse and the client are combined. With the larger portfolio of the now married client, Hatfield determines that they can assume a higher level of risk and begins a change in the policy concerning that portfolio. Which of the following would violate Standard III(C), Suitability?

A) Implement a similar policy for the other client who did not just get married.

B) Assess the return objectives of the newly married client and his spouse.

C) Assess the time horizon of the newly married client and his spouse.

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According to Standard III(C), Suitability, the analyst must assess the time horizon, return objectives, tax considerations, and liquidity needs of a client before changing an investment policy. The analyst must notify the client of the new policy. Implementing the policy for the other client may be a violation of the Standard unless that client’s needs are totally reassessed and determined to be identical to the needs of the newly married client.

1215

Janet Reilly has just approached Betty Miller, CFA, about purchasing 10,000 shares of Brookshire Co., a newly incorporated real estate development firm. Reilly is a retired schoolteacher living off the income from her late husband's life insurance policy. This investment will represent a significant shift in her investment portfolio. Brookshire Co. is a local firm that has recently received a lot of press concerning some exciting, but speculative projects that they have undertaken in the region. Consistent with the Standards, Miller should:

A) not accept the order, because it is not a suitable investment for Reilly.

B) accept Reilly's order, but have her sign a disclaimer absolving Miller of any potential losses.

C) accept Reilly's order after she acquaints Reilly with the downside risks associated with a risky investment of this type.

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Members are required to consider the appropriateness and suitability of investment actions for their clients. The needs and circumstances of the client, and the characteristics of the investment and the portfolio must be taken into account. If Reilly understands the risks of this investment and the rest of her portfolio is adequate for her income needs, Miller can proceed to make the investment.

1215

The O’Douls (husband and wife) have decided to work with Jane Mack, CFA, to have her recommend an investment portfolio for them. The O’Douls are novice investors and Mack has determined their asset allocation model falls into the conservative category. After researching various investment options for the O’Douls, Mack has made a recommendation that they divide their account on a 25%/75% basis between shares of a computer peripherals manufacturing company her brokerage firm is underwriting and investment grade corporate bonds. The O’Douls are not aware that Mack’s firm is underwriting an offering of the company in question. Which CFA Institute Standard(s) has Mack violated given her actions?

A) Standard V(A), Diligence and Reasonable Basis, and I(D), Misconduct.

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

C) Standard VI(A), Disclosure of Conflicts, and III(C), Suitability.

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Mack is obliged to disclose the conflict of interest regarding her company’s IPO and to consider both the appropriateness and the suitability of the investment for her client. She has apparently failed in both respects.

1215

Carol Hull, CFA, is an investment advisor whose prospective client, Frank Peters, presents special requirements. To construct an investment policy statement for Peters, Hull inquires about Peters’ investment experience, risk and return objectives, and financial constraints. Peters states that he has a great deal of investment experience in the capital markets and does not wish to answer questions about his tolerance for risk or his other holdings. Under Standard III(C), Suitability, Hull:

A) may accept Peters’ account but may only manage his portfolio to a benchmark or index.

B) must decline to enter into an advisory relationship with Peters.

C) is permitted to manage Peters’ account without any knowledge of his risk preferences.

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Hull would not violate Standard III(C), Suitability, by managing Peters’ account without knowledge of his risk preferences. She made a reasonable inquiry into Peters’ investment experience, risk and return objectives, and financial constraints, as the Standard requires. If a client chooses not to provide some of this information, the member or candidate can only be responsible for assessing the suitability of investments based on the information the client does provide.

1215

Karen Jackson is a portfolio manager for Super Selection.  Jackson is friendly with David James, president of AMD, a rapidly growing biotech company. James has provided Jackson with recommendations in the biotech industry, which she buys for her own portfolio before buying them for her clients. For three years, Jackson has also served on AMD's board of directors. She has received options and fees as compensation.

Recently, the board of AMD decided to raise capital by voting to issue shares to the public. This was attractive to board members (including Jackson) who wanted to exercise their stock options and sell their shares to get cash. When the demand for initial public offerings (IPO) diminished, just before AMD's public offering, James asked Jackson to commit to a large purchase of the offering for her portfolios. Jackson had previously determined that AMD was a questionable investment but agreed to reconsider at James' request. Her reevaluation confirmed the stock to be overpriced, but she nevertheless decided to purchase AMD for her clients' portfolios.

Did Jackson violate Standard III(C) concerning Portfolio Recommendations and Actions?

A) Yes, she did not deal fairly with all clients.

B) No.

C) Yes, she did not consider the appropriateness and suitability of investment recommendations or actions for each portfolio or client.

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Jackson violated Standard III(C) because she did not consider her clients' financial situation, investment experience, and investment objectives. If the stock is questionable and overpriced, it is not suitable for any of her clients.

1215

According to CFA Institute Standards of Professional Conduct, when a client asks her portfolio manager to change the current investment strategy of the client’s portfolio, the manager should:

A) explain the implications of the new strategy after the member manager implements the strategy.

B) obey the client's request without question.

C) examine whether the strategy is appropriate for the client and explain the implications of the new strategy before implementing the strategy.

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According to Standard III(C), Suitability, the member manager must determine that an investment is suitable given the client’s objectives/constraints and within the context of the client’s total portfolio. In this case, the member manager must examine the new strategy to see if it is appropriate for the client, even if the client asked for the change. The member should also explain the implications of the strategy to avoid any misrepresentations that may result from omitting details.