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Lee Roth, who is an investment advisor, is riding in a taxi and finds a file of information labeled "Genco Valuation." The folder contains a great deal of financial data, projections and nonpublic information concerning the food products industry that lead Roth to believe that Genco will be worth 50 percent more than its current stock value. Roth also finds some correspondence that leads him to believe that the file belonged to Tom Hagan. Roth tries to find out where Hagan works so he can return the file. Roth can recommend Genco to his clients unless Hagan works for:

A) Roth cannot recommend Genco to his clients at this time.

B) the corporate finance department for Genco.

C) the equity research department for a brokerage firm.

D) an investment advisor that competes with Roth.

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Answer and Explanation

The information is material and nonpublic; therefore, Roth cannot act or cause others to act at this time.

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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) cease making sell recommendations because of the harm that can come to himself.

B) make sell recommendations but point out that the company Treasurer has a differing and valid point of view.

C) continue to advise employees to sell their stock.

D) tell employees that he cannot provide advice on company stock because of a conflict of interest.

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Answer and Explanation

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.

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Chuck Thomas is the trustee of a trust of which Jill Wyatt is the main beneficiary. Wyatt's husband is the president of a company. In emptying the recycling bin at home, Wyatt finds some papers that lead her to believe that her husbands company will make a tender offer to acquire another firm. Wyatt takes the information to Thomas, who uses it to purchase shares of the company for the trust, but does not further disclose the information. Thomas has:

A) violated the Standards concerning material nonpublic information.

B) violated the Standards concerning loyalty, prudence, and care.

C) violated the Standards concerning preservation of confidentiality.

D) not violated any Standards.

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Answer and Explanation

Thomas cannot act or cause others to act on material nonpublic information.

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Victor Logan is a portfolio manager for McCoy Advisors, and Jack Brisco is the Director of Research for McCoy. Brisco has developed a proprietary model that has been thoroughly researched and is known throughout the industry as the McCoy model. The model is purely quantitative and screens stocks into buy, hold, and sell categories. The basic philosophy of the model is thoroughly explained to clients. Brisco frequently alters the model based on rigorous researchan aspect that is well explained to clients, although the specific alterations are not continually disclosed. Portfolio managers then make specific sector and security holding decisions, purchasing only securities that are indicated as "buys" by the model. Logan has conducted very thorough research on his own, using the same process that Brisco uses to validate his findings. Logan feels the model is missing some key elements that would further reduce the list of acceptable securities to purchase, however, Brisco has refused to look at Logan's research. Frustrated by this, Logan applies his own version of the model, with the justification that he is still only purchasing securities on the buy list. Because of the conflict with Brisco, he does not disclose the use of the model to anyone at McCoy or to clients. Which of the following statements regarding Logan and Brisco is TRUE? Logan is:

A) violating the Standards by applying his version of the model and by not disclosing it to clients. Brisco is not violating the Standards.

B) violating the Standards by applying his version of the model, but not by failing to disclose it to clients. Brisco is not violating the Standards.

C) violating the Standards by applying his version of the model and by not disclosing it to clients. Brisco is violating the Standards by failing to consider Logan's research.

D) not violating the Standards by applying his version of the model, but is violating the Standards by not disclosing it to clients. Brisco is not violating the Standards.

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Answer and Explanation

Because the research is thoroughly conducted, and Logan has authority to make individual security selection decisions, Logan is not violating the Standards by applying his model. However, Logan is violating the Standard on communication with clients and prospective clients by excluding relevant factors of the investment process. The use of his model is an important aspect of the investment process and should be disclosed to clients. Brisco is not violating the Standards by not considering Logans research.

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Jim Kent is an individual investment advisor in San Francisco with 300 clients. Kent uses open-ended mutual funds to implement his investment policy. For most of his clients, Kent has used the Baker fund, a small company growth fund based in Boston, for a portion of their portfolio. As a result he has become very friendly with Keith Dunston, the manager of the fund, whom Kent feels is mainly responsible for Baker's performance. One day Dunston calls Kent and tells him that he will be leaving the fund in four weeks and moving to San Francisco to work for a different money management company. Dunston is seeking suggestions on housing in the area. Baker has not yet announced Dunston's departure. Kent immediately finds a fund that is a suitable replacement for the Baker fund, and over the next two days he calls his 30 clients with the largest dollar investments in the funds and tells them he feels they should switch their holdings. Baker feels the remaining clients' positions are small enough to wait for their annual review to switch funds. Kent has:

A) violated the Standards by not dealing fairly with clients but has not violated the Standards regarding material nonpublic information.

B) violated the Standards by not dealing fairly with clients and regarding material nonpublic information.

C) violated the Standards regarding nonpublic information but has not violated the Standards in failing to deal fairly with clients.

D) not violated the Standards.

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Answer and Explanation

Kent must treat all clients fairly in acting on the information, regardless of the size of the investment. The information concerning the fund managers departure is not material nonpublic information because its release would have no effect on individual security prices.

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Randy Wesson is a research analyst for a large brokerage company following the chemical industry. Wesson receives a phone call from his nephew who works part-time in an airport hospitality center for an airline while going to business school. Many meetings take place at the center on any given day. The nephew tells Wesson that while bringing some faxes into a conference room, he overheard executives of Hunt Chemical talking about the likely divestiture of one of their subsidiaries. His nephew wants to know whether that will be good for Hunt. Wesson should:

A) write a research report describing the possibility of a divestiture, but not mention how he learned about it.

B) not use the information.

C) manufacture a reason to upgrade the stock to a "buy" recommendation to protect his nephew's confidentiality.

D) write a research report describing that he learned about the likely divestiture from his nephew who works at the hospitality center.

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Answer and Explanation

The information is material and nonpublic; therefore, Wesson cannot trade or cause others to trade on the information. Any action concerning the information would violate the Standard on material nonpublic information.

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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) 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.

C) wait until the public announcement is made, then release a report stating that he is sure that the company will make his release date, but not disclose the relationship with Perry.

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

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Answer and Explanation

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.

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Lynne Jennings is a research analyst for a large brokerage company following the chemical industry. While flying through Chicago, Jennings visited her sister who works in the airport hospitality center for an airline. Many meetings take place at the center on any given day. At the center Jennings saw several senior officers who she knows are from the largest and fourth largest chemical companies walk into a conference room. She concluded that negotiations for an acquisition might be taking place. She told her sister this, and her sister asked her not to disclose how she got the information. Jennings should:

A) not write a research report disclosing the meeting.

B) write a research report describing that she witnessed the senior officers together in the hospitality center, and must mention in the report that her sister is an employee of the center.

C) write a research report mentioning the meeting but not disclose how she knew that the meeting occurred.

D) write a research report describing that she witnessed the senior officers together in the hospitality center, but need not mention in the report that her sister is an employee of the center.

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Answer and Explanation

The information is material and nonpublic, therefore, Jennings cannot trade or cause others to trade.

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Patricia Young is an individual investment advisor who uses a computer model to place her clients into an appropriate portfolio. The model takes the clients goals and a range of simulated returns and presents the probability of achieving their goals. The investor then chooses the portfolio that provides a satisfactory probability of achieving their goals. By using this process, Young is:

A) violating the Standard on suitability.

B) violating the Standard on misrepresenting the expected investment performance.

C) violating the Standard on reasonable basis and representations.

D) not violating the Standards.

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Answer and Explanation

The Standard on suitability calls for Young to assess risk tolerance, which is ignored by her process.

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Christopher Lance, CFA, Chuck Cunningham, and Lucy Hunt, CFA, went to graduate school together and have remained close friends ever since. Lance and Hunt earned their CFA charters this past June and Cunningham is a Level III candidate. Lance, Cunningham, and Hunt have dinner every month at Cunninghams country club, one of the most prestigious in the metropolitan area where they live.

Lance was a well-respected research analyst covering the pharmaceutical industry at an international broker-dealer before accepting a job as Vice President, Investor Relations, at IMed, a large multinational pharmaceutical company that he covered as an analyst. Since he started coverage of IMed, Lance had consistently been named top analyst of the pharmaceutical industry by Investment Professional, the leading journal of the investment industry.

In his new position at IMed, Lance is the principal spokesperson on the companys financial performance and is responsible for developing and maintaining good relationships with the companys shareholders, especially large institutional investors, and with approximately 30 research analysts who issue research reports and make recommendations about publicly-traded equity and debt securities. It is April 12th and Lance is preparing to conduct the next conference call following the release on April 15th of IMeds quarterly earnings. Participating in the call will be Lances former colleague and good friend, Cunningham, and the other analysts who cover IMed. In addition, Hunt, a portfolio manager at Primary Pensions, a major institutional investor, has told Lance she will also be on the call. Primary Pensions has accumulated the largest single holding in IMed equity.

Lance is concerned about this call because IMeds president, Bill Norton, has just told the management team that sales of Mediplex, its new cancer drug, have begun to sag after rumors of serious side effects, including death, have hit the press. Norton told Lance that if sales continue to fall that this years earnings would be considerably less than the current consensus forecast. Norton is also concerned that the regulatory agency that approves the sale of drugs will repeal IMeds license to market Mediplex.

Cunningham is a research analyst at Lances former employer and has taken over coverage of IMed following Lances resignation. Until his promotion to Lances former position, Cunningham was a junior analyst covering the oil and gas industry. Although knowledgeable about fundamental financial analysis and equity valuation, he is unfamiliar with IMed and the pharmaceutical industry. Cunningham has been reviewing the past 5 years of IMeds financial statements and Lances research reports in preparation for participating in IMeds quarterly conference call to discuss its quarterly earnings release. Cunningham is under considerable pressure from his employer to meet or exceed Lances reputation and be rated top analyst by Investment Professional. His firms currently rates IMed as a strong buy based on Lances last research report. Based on his own preliminary analysis, Cunningham has a hard time justifying a hold recommendation. He is puzzled by several of the earnings adjustments that Lance made to achieve his target share price for IMed. He plans to ask Lance about these adjustments at their dinner on April 14^th.

Hunt has been managing a large cap equity portfolio at Primary Pensions for 5 years. Based almost exclusively on Lances buy recommendations in his research report, she began purchasing IMed several years ago just before it made several major acquisitions that contributed to its phenomenal growth and to her portfolios performance over the last 5 years. Since Lance moved to IMed, Hunt has been doing some due diligence and has become concerned that the growth of IMeds earnings is overly dependent on sales of Mediplex. Based on her enthusiasm for IMed and her portfolios performance, other managers at Primary Pensions have also taken considerable positions in IMed to the extent that Primary Pensions is IMeds largest single stockholder. If she is right, Hunt knows that she will need to reduce her portfolios holdings. Since Primary Pensions prohibits its employees from owning individual equity securities, Hunt has no personal investment in IMed. However, she had boasted about IMeds performance to her mother and is aware that her mothers investment club invested 10 percent of the clubs assets in IMed. Hunt is preparing her questions for the upcoming conference call and her exit strategy if the answers confirm her fears.

Lance, Cunningham, and Hunt met for their regular monthly dinner on April 14th. Cunningham opens the after dinner discussion by questioning Lance about his new job and asks him if he and Hunt should anticipate any surprises at tomorrows conference call. Cunningham specifically asks Lance if IMed will meet or beat analyst expectations and the consensus earnings forecast. Lance responds that, under current securities laws, he is unable to discuss details of IMeds performance with Cunningham and Hunt and that theyll both be briefed with the other analysts and shareholders on tomorrows call. Shortly thereafter, the three friends say their good-byes. Hunt and Cunningham wish Lance well on the next days conference call.

What Standard governs Lances response to Cunninghams question and is he in compliance?

Standard

Compliance

A) VII: Responsibilities as a CFA Institute Member or CFA Candidate Yes

B) III: Duties to Clients No

C) V: Investment Analysis, Recommendations, and Action No

D) I: Professionalism Yes

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Answer and Explanation

Lances response to Cunninghams question is covered under Standard I(A) which requires members to maintain knowledge of and comply with applicable laws and regulations (including the CFA Institutes Code of Ethics and Standards of Professional Conduct). In this case, Lance specifically references the requirements of securities laws not to discuss IMeds performance in advance of the quarterly conference call. If he had done so, he would have disclosed material nonpublic information, since he knows that information about the decline in sales of Mediplex will have an adverse affect on IMeds share price. In addition, Standard I(A) prohibits Lance from knowingly participating or assisting in any violation of such laws. If Lance had responded in any other way to Cunninghams question he would potentially have assisted Cunningham and Hunt in violating Standard II(A), Material Nonpublic Information.