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.

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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

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).

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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)

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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.

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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)

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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.

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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)

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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.

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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)

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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.

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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)

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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.

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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

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.

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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

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.

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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

A company has a defined benefit plan that is currently under-funded. The plan sponsor has instructed the portfolio manager of the plan to invest more aggressively to bring the funding level up to an adequate amount. Which of the following statements best describes the course of action the portfolio manager should take? The portfolio manager should:

A) not invest more aggressively because this is not the method used to increase the funding level of a plan.

B) not invest more aggressively since this may expose the plan to too much risk and may not be in the best interest of the plan's beneficiaries.

C) invest more aggressively because his fiduciary duties lie with the plan sponsor.

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Standard III(A), Loyalty, Prudence, and Care, applies in this situation. According to this Standard, investment actions should be carried out for the sole benefit of the client and in a manner the manager believes to be in the best interest of the client. Here, the client is the plan beneficiaries, not the manager or the entity that hired the manager.

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.

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

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

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

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.