2020 Level lll - Vol 1 Ethical and Professional Standards
Reading 1: Code of Ethics and Standards of Professional Conduct
CFA Mission lead investment profession globally by promoting highest standards of ethics, education, and professional excellence for ultimate benefit of society.
ETHICS Set of moral principles/rules of conduct that provide guidance for our beh when it affects others (honesty, fairness, diligence, & care and respect for others)
• Ethical principles, like laws & reg, prescribe appropriate constraints on our natural tendency to pursue self-interest that could harm the interests of others.
o Laws & regulations do not cover all unethical behavior; legal beh = what is required and ethical beh = conduct that is morally correct.
o Ethical principles go beyond that which is legally sufficient and encompass what is the right thing to do.
The Code high-level aspirational ethical principles Standards practical ethical principles of conduct that members and candidates must follow
Handbook the primary resource for guidance in interpreting and implementing the Code and Standards.
The Code of Ethics Members and Candidates (M&C) must:
▪ Act with integrity, competence, diligence, and respect and in an ethical manner with the public, clients, prospective clients, employers, employees,
colleagues in the investment profession, and other participants in the global capital markets.
▪ Place the integrity of the investment profession and the interests of clients above their own personal interests.
▪ Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking
investment actions, and engaging in other professional activities.
▪ Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession.
▪ Promote the integrity and viability of the global capital markets for the ultimate benefit of society.
▪ Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.
Standards of Professional Conduct
I PROFESSIONALISM
A. Knowledge of the Law:M&C must understand and comply with all applicable laws, rules, and regulations (& CFA Institute COEthics & Standards of
PConduct) of any gov’t, regulatory org, licensing agency, or professional association governing their professional activities.
In the event of conflict, must comply with the more strict law, rule, or regulation; must not knowingly violate such laws/rules/regulations.
B. Independence and Objectivity: reasonable care & judgment to have independence and objectivity in their professional activities.
must not offer, solicit/accept any gift, benefit, $$ that reasonably could compromise their own /another’s independence & objectivity.
C. Misrepresentation: must x knowingly make any misrepresentations relating to inv analysis/recommends/actions, or other prof activities.
D. Misconduct: must x engage in any prof conduct w dishonesty/fraud/deceit/commit any act that reflects adversely on their prof rep, integrity, or competence.
II INTEGRITY OF CAPITAL MARKETS
A. Material Nonpublic Information: if possess material nonpublic info that could affect value of an inv; must x act or cause others to act on the information.
B. Market Manipulation: must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.
III DUTIES TO CLIENTS
A. Loyalty, Prudence, & Care: duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Must act for the benefit of
their clients and place their clients’ interests before their employer’s or their own interests.
B. Fair Dealing: must deal fairly & objectively with all clients when providing inv analysis/recommends/inv action/other professional activities.
C. Suitability
1. When Members and Candidates are in an advisory relationship with a client, they must:
a. reasonable inquiry into a client’s (or prospective) inv experience; risk&return obj; financial constraints first & must reassess & update regularly
b. Determine that an inv is suitable and consistent with the client’s written obj & constraints before making recommendation or taking inv action.
c. Judge the suitability of investments in the context of the client’s total portfolio.
2. When Members and Candidates are responsible for managing a portfolio to a specific mandate, strategy, or style, they must make only investment
recommendations or take only investment actions that are consistent with the stated objectives and constraints of the portfolio.
D. Performance Presentation: When communicating inv perf info, must make reasonable efforts to ensure that it is fair, accurate, and complete.
E. Preservation of Confidentiality Members and Candidates must keep information about current, former, and prospective clients confidential unless:
1 The info concerns illegal activities on the part of the client or prospective client, 2 Disclosure is required by law, or 3 client permits disclosure of the info
IV DUTIES TO EMPLOYERS
A. Loyalty: In matters related to their employment, must act for the benefit of their employer and not deprive their employer of the advantage of their skills
and abilities, divulge confidential information, or otherwise cause harm to their employer.
B. Additional Compensation Arrangements: must not accept gifts, benefits, compensation, or consideration that competes with or might reasonably be
expected to create a conflict of interest with their employer’s interest unless they obtain written consent from all parties involved.
C. Responsibilities of Supervisors: must make reasonable efforts to ensure anyone s.t their supervision complies w applicable laws/rules/reg & the Code&Standards.
V INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS
A. Diligence and Reasonable Basis: must
1. Exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions
2. Have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action.
B. Communication with Clients and Prospective Clients Members and Candidates must:
1. Disclose to clients (prospective) the basic format & general principles of the inv processes used to analyze inv, select sec/construct portf and changes
2. Disclose to clients and prospective client’s significant limitations and risks associated with the investment process.
3. Use reasonable judgment in identifying which factors are important to their analyses, recommends/actions and include communications with clients
4. Distinguish between fact and opinion in the presentation of investment analysis and recommendations.
C. Record Retention: must develop/maintain approp records to support their analyses, recommends, actions, & other inv-related communications w clients
VI CONFLICTS OF INTEREST
A. Disclosure of Conflicts: must make full & fair disclosure of all matters that could reasonably be expected to impair their independence & objectivity or
interfere with respective duties to their clients/prospective and employer; prominent, delivered in plain language, and communicate effectively.
Commented [MN1]: The disclosure of a conflict should be
B. Priority of Transactions inv transac for clients & employers must have priority over inv transactions in which a M or Candidate is the beneficial owner.
C. Referral Fees must disclose to their employer, clients/prospective any compensation, consideration, or benefit received from/paid to others for the made—prominently and in plain language—regardless of
recommendation of products or services.; must disclose nature, i.e.flat fee or % basis; a one-time or continuing benefit; or based on performance whether the member views the conflict as material so the cli
VII RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATE can determine the materiality of the conflic
A. Conduct as Participants in CFA Institute Programs: must not engage in any conduct that compromises the reputation or integrity of CFA Institute or the
CFA designation or the integrity, validity, or security of CFA Institute programs.
B. Reference to CFA Institute, the CFA Designation, and the CFA Program
When referring to CFA Institute, CFA Institute membership, the CFA designation, or candidacy in the CFA Program, Members and Candidates must not
misrepresent or exaggerate the meaning or implications of membership in CFA Institute, holding the CFA designation, or candidacy in the CFA Program.
,2020 Level lll - Vol 1 Ethical and Professional Standards
Reading 2: Guidance for Standards I–VII
I PROFESSIONALISM
Standard I(A) Knowledge of the Law
- The “more strict” law or regulation is the law or regulation that imposes greater restrictions on the action of the member or candidate or calls for the
member or candidate to exert a greater degree of action that protects the interests of investors
- If less strict laws & reg (LS or NS-no sec law/reg )applies, adhere to Code and Standards; if More Strict applies, adhere to MS
Commented [MN2]: Member resides in LS country, does
- Stay informed, review procedures, maintain current files; seek advice of compliance/legal department when need be; dissociate
- When in doubt about the appropriate action to undertake, it is recommended that a M/C seek the advice of compliance personnel or legal counsel business in MS country; LS law applies, but it states that law of
concerning legal requirements locality where business is conducted governs = adhere to MS law
Standard I(B). Independence and Objectivity: Member resides in MS country, does business in LS country; MS
- Gifts/undue pressure from co may → non independence in actions/research reports applies, but it states that law of locality where business is conduct
- Recommendations must convey the M/C’s true opinions, free of bias from internal or ext pressures, and be stated in clear and unambiguous language. governs. to Code and Standards.
- Need to be careful about the investment banking/research analysis department collab; firewalls when necessary Member resides in MS country, does business in LS country with
- The work of credit rating agencies also raises concerns similar to those inherent in investment banking relationships client who is a citizen of LS country; MS law applies, but it states
- Issuer paid research: must adhere to standard; and make proper disclosures i.e. nature of compensation, to avoid misleading investors
- Protect the integrity of opinions (unbiased); restricted lists; restrict special cost arrangements; gift limits; restrict inv/require preapproval; that the law of the client’s home country governs. to the Code a
Compensation arrangements should x link analyst remuneration directly to IB assignments in which the analysts may participate as a team member Standards.
Standard I(C) Misrepresentation:
- “knowingly” means that the member or candidate either knows or should have known that the misrepresentation was being made or that omitted
Commented [MN3]: The compensation arrangement will like
information could alter the investment decision-making process. to create a conflict of interest too
- prohibits members and candidates from guaranteeing clients any specific return on volatile investments.
- X misrepresent the success of performance record through presenting benchmarks that are not comparable to their strategies; if use reference, disclose
reasons to avoid misrepresentation of performance (i.e. HFs and nature of investments vs possible benchmark)
- X cherry picking—situations in which selected accounts are presented as representative of the firm’s abilities. The omission of any accounts
appropriate for the defined composite may misrepresent to clients the success of the manager’s implementation of its strategy
- Plagiarism - must not copy (or represent as their own) original ideas or material without permission and must acknowledge and identify the source of
ideas or material that is not their own
- Research and models developed while employed by a firm are the property of the firm. The firm retains the right to continue using the work
Commented [MN4]: most flagrant example is to take a
completed after a member or candidate has left the organization; may use in future reports w/o providing attribution to prior analysts research report or study done by another firm or person,
Standard I(D)Misconduct: change the names, and release the material as one’s own
- Encourage firms to have code of ethics, list of violations, reference checks
original analysis. This action is a clear violation of Standard I
- i.e excessive drinking at lunch and subseq intoxication at work constitute a violation of Standard I(D) bc raise qxs about professionalism/competence
- signing on behalf of clients Other practices include (1) using excerpts from articles or
reports prepared by others either verbatim or with only sligh
II INTEGRITY OF CAPITAL MARKETS changes in wording without acknowledgment, (2) citing spe
Standard II(A) Material Nonpublic Information quotations as attributable to “leading analysts” and
- Any trading based on material nonpublic information constitutes a violation of Standard II(A)
- Info “material” if its disclosure would probably have an impact on P of a sec or if reasonable investors would want to know it b4 making an inv decis “investment experts” without naming the specific references
- The less reliable a source, the less likely the information provided would be considered material. (3) presenting statistical estimates of forecasts prepared by
- Information is “nonpublic” until it has been disseminated/made known or is available to the marketplace in general others and identifying the sources but without including the
- Mosaic Theory: may use sign findings from analysis of public & nonmaterial non-public info as basis for recom/decs; x risk violation
- When a particularly well-known/respected analyst issues a report or makes ∆to their recomd, that info alone may have an effect on the market and
qualifying statements or caveats that may have been used, (
thus may be considered material; considered disseminated when distributed to clients. using charts and graphs without stating their sources, and (5
- An information barrier “firewall” is the most widely used approach for preventing the communication of material nonpublic information within firms copying proprietary computerized spreadsheets or algorithm
- Personal trading limits/restricted lists/transaction disclosures/watch lists
without seeking the cooperation or authorization of their
Standard II(B) Market Manipulation:
- Market manipulation includes (1) the dissemination of false or misleading information and (2) transactions that deceive or would be likely to mislead creators.
market participants by distorting the price-setting mechanism of financial instruments
- disseminating false information with the intent to mislead market participants. Commented [MN5]: should save and document all their
- Attempts to mislead participants about the actual liquidity of the market constitute a violation of Standard II(B) research [see Standard V(C)–Record Retention
III DUTIES TO CLIENTS
Standard III(A) Loyalty, Prudence, & Care:
- prudence requires following the investment parameters set forth by the client and balancing risk and return; contstraints/themes; total portfolio view
- Members & candidates should place the client’s interests first by disregarding any firm or personal interest in motivating a recommended transaction.
Commented [MN6]: seek best price and best execution
- The duty of loyalty is owed to the ultimate beneficiaries.
- When can’t avoid potential COI between their firm & clients’ interests, must provide clear and factual disclosures of the circumstances to the clients.
- A M&C who pays a higher brokerage commission than he or she would normally pay to allow for the purchase of goods or services, without
corresponding benefit to the client, violates the duty of loyalty to the client. Soft commissions
Standard III(B) Fair Dealing: Members and candidates must make every effort to treat all individual and institutional clients in a fair & impartial manner
- “fairly” implies that the M&C must take care not to discriminate against any clients when disseminating inv recommend/taking inv action.
- Not equally but fairly; may have diff level/fee structure for clients with differing services; disclose offerings; i.e. investment may x be suitable for all
➔ the selection process by which cx receive info should be based on suitability and known interest, not on any preferred or favored status.
- ensure that information is disseminated in such a manner that all clients have a fair opportunity to act on every recommendation
Commented [MN7]: treat all clients fairly in light of their
Standard III(C) Suitability investment objectives and circumstances; i.e. prorate
- IPS – client identification, objectives (return/risk tol), constraints (liq, horizon, tax, pref, etc), benchmarks; regular updates oversubscribed IPOs
- Beyond return, look at inv’s impact on diversification, compare the risk of it with client’s risk tol, and the fit of it w the inv strategy
- Not every investment opportunity will be suitable for every portfolio, regardless of the potential return being offered. Commented [MN8]: Under no circumstances should a
- Derivatives/synthetic inv vehicles: Such leverage & limited liq, bear directly on the issue of suitability for the client. manager take investment action that is inconsistent with the
- M&C who manage pooled assets & have to invest in manner consistent with the specific mandate, are not responsible for determining the suitability client’s IPS. B
of the fund as an investment for investors who may be purchasing shares in the fund (that is the advisor/m&c w advisory rel’s job).
Standard III(D) Performance Presentation: fair, accurate, and complete.
- Members and candidates should encourage their firms to comply with the GIPS standards. Global Investment Performance Standards
- Include terminated accounts, include disclosures, clearly identify simulated performance results, maintain records of calculations
Commented [MN9]: hould include disclosures that fully expl
Standard III(E) Preservation of Confidentiality
- members and candidates must continue to maintain the confidentiality of client records even after the client relationship has ended.
the performance results (for example, whether the performance is
gross of fees, net of fees, or after tax).
,2020 Level lll - Vol 1 Ethical and Professional Standards
IV DUTIES TO EMPLOYERS
Standard IV(A) Loyalty:
- must always place the interests of clients above the interests of their employer but should also consider the effects of their conduct on the
sustainability and integrity of the employer firm
- Employers are not obligated to adhere to the Code and Standards
- M&C must abstain from independent competitive activity that could conflict with the interests of their employer; receive consent
- solicitation of the employer’s clients prior to cessation of employment is a violation
- free to use public info after departing to contact former clients without violating Standard IV(A) as long as there is no specific agreement not to do so.
Commented [MN10]: M&C must not take records or files
- Except with the consent of their employer, departing members and candidates may not take employer property, even those the M/C prepared a new employer w/o the written permission of the previous
- Whistleblowing: A M/C’s personal interests, & interests of employer, are secondary to protecting integrity of capital mkts & interests of clients. employer.
Standard IV(B) Additional Compensation Arrangements:
- M&C must obtain permission for add’l compensation/benefits (4 services) bc may affect loyalties and objectivity & create potential COI
- Gain approval, disclose (i.e. like objectivity standard) Standard IV(A) prohibits employees from soliciting the clien
Standard IV(C) Responsibilities of Supervisors: of employers prior to, but not subsequent to, their departur
- make reasonable efforts to prevent and detect violations by ensuring the establishment of effective compliance systems
- should implement education and training programs on a recurring or regular basis for employees; incentive structure that rewards ethical conduct Commented [MN11]: members and candidates required
- When recognize wrongdoing, should initiate an investigation to ascertain the extent of wrongdoing; Relying on an employee’s statements about the obtain written permission from their employer before
extent of the violation or assurances that the wrongdoing will not reoccur is not enough
- Only when compensation and incentives are firmly tied to client interests and how outcomes are achieved, rather than how much is generated for the accepting any compensation or benefits from third parties t
firm, will employees work to achieve a culture of integrity. may create a conflict of interest.
V INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS Commented [MN12]: member or candidate should declin
Standard V(A) Diligence and Reasonable Basis: must in writing to accept supervisory responsibilities until the firm
- If rely on secondary or third-party research, must make reasonable and diligent efforts to determine whether such research is sound. adopts reasonable procedures to allow him to adequately
- must understand the assumptions and limitations inherent in any quant model; test the models
exercise such responsibility.
- also applies to the level of review necessary in selecting an external adviser or subadviser to manage a specifically mandated allocation
- If the m/c is confident in the process, (adeq basis) does not need to dissociate from recommend. report even if it does not reflect his or her opinion. Commented [MN13]: Secondary research is defined as
- Analysis of an investment that results in a reasonable basis for recommendation does not guarantee that the investment has no downside risk
Standard V(B) Communication with Clients and Prospective Clients Members and Candidates must:
research conducted by someone else in the member’s or candidate
- should communicate in a recommendation the factors that were instrumental in making the inv recommendation; opinion vs fact; communicate ∆s firm.
➔ describe properly the basic characteristics of the actual and implied risks of the investment strategy Third-party research is research conducted by entities outside th
- use of leverage constitutes a signt risk & should be disclosed; other also ctpy risk, country risk, sector/industry risk, sec-specif risk, credit risk, etc member’s or candidate’s firm
- limits: liquidity/ability to liquidate an inv on a timely basis at a reasonable cost, capacity/inv amt beyond which returns will be - affected by new inv
- . Members and candidates cannot be expected to disclose risks they are unaware of at the time recommendations or investment actions are made
Standard V(C) Record Retention:
- Record = firm property; M/C can’t take the property of the firm, including original forms or copies of supporting records of their work, to the new
employer w/o consent of the previous employer; must recreate supporting records at new firm with public/co sources, not from memory/old firm sources
- In the absence of regulatory guidance or firm policies, CFA Institute recommends maintaining records for at least 7 years.
VI CONFLICTS OF INTEREST
Standard VI(A) Disclosure of Conflicts:
- conflicts can occur between the interests of clients, the interests of employers, and the member’s or candidate’s own personal interests
- When conflicts cannot be reasonably avoided, clear and complete disclosure of their existence is necessary.
- If rel threatens independence and objectivity, must be disclosed
Standard VI(B) Priority of Transactions
- Client interests have priority
- M/C may undertake transactions in accounts for which they are a beneficial owner only after their clients and employers have had adequate
opportunity to act on a recommendation
- Family accounts that are client accounts should be treated like any other firm account and should neither be given special treatment nor be
disadvantaged because of the family rel
Standard VI(C) Referral Fees
- Consideration includes all fees, whether paid in cash, in soft dollars, or in kind; Referral Fees as “any compensation, consideration, or benefit
received from or paid to others for the recommendation of products or services;
Commented [MN14]: compensation paid to bring on clients t
➔ Disclosure will help the client evaluate any possible partiality shown in the recommendation of services.
➔ & allow clients and employers to evaluate the full cost of the services your own company are not referral fees (i.e. fee-sharing agreemen
VII RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATscu
Standard VII(A) Conduct as Participants in CFA Institute Programs
- Don’t cheat or violate testing rules; don’t provide confidential program/exam info; don’t improperly use an assoc w CFA
- Can’t discuss specific details/qx or even broad topical areas/formulas tested/not tested on the exam; applies to test takers and graders
- Free to express opinion, but can’t disclose content-specific info when doing so
Standard VII(B )Reference to CFA Institute, the CFA Designation, and the CFA Program
- statements referring to CFA Institute, the CFA designation, or the CFA Program that overstate the competency of an individual or imply, either
directly or indirectly, that superior performance can be expected from someone with the CFA designation are not allowed under the standard.
- Can refer to oneself as active member if abide by the standards annually and pay annual fees
Commented [MN15]: If a candidate passes each level of t
- Candidates cannot state they have achieved any partial designation as a result of passing 1 or more levels or cite an expected completion date of any exam in consecutive years and wants to state that he or she
level of the CFA Program; CORRECT: “I passed Level I of the CFA Program.” INCORRECT: “CFA, Level II” so, that is not a violation of Standard VII(B) because it is a
- Correct: “I passed all three levels of the CFA Program and may be eligible for the CFA charter upon completion of the required work experience.”
INCORRECT: “CFA, Expected 2011” “John Smith, Charter Pending”
statement of fact. If the candidate then goes on to claim or
imply superior ability by obtaining the designation in only
Reading 3 Application of the Code and Standards: Level III (encompassed in notes above^)
- High beta stocks are not low risk; are contrary to long-term risk profile three years, however, he or she is in violation of Standard
- The Code and Standards apply to individual members and candidates of CFA Institute, but firms are encouraged to adopt the Code and VII(B).
Standards as part of their firm code of ethics. The CFA Institute Asset Manager Code has been drafted specifically for firms.
, 2020 Level lll - Vol 1 Ethical and Professional Standards
Questions:
Magee manages pension accounts for Trust Assets, Inc., but has become frustrated with the working environment and has been offered a position with Fiduciary
Management. Before resigning from Trust Assets, Magee asks four big accounts to leave that firm and open accounts with Fiduciary. Magee also persuades several
prospective clients to sign agreements with Fiduciary Management. Magee had previously made presentations to these prospects on behalf of Trust Assets.
Comment: Magee violated the employee–employer principle requiring him to act solely for his employer’s benefit. Magee’s duty is to Trust Assets as long as he is
employed there. The solicitation of Trust Assets’ current clients and prospective clients is unethical and violates Standard IV(A).
Gary Carter is a representative with Bengal International, a registered broker/dealer. Carter is approached by a stock promoter for Badger Company, who offers to
pay Carter additional compensation for sales of Badger Company’s stock to Carter’s clients. Carter accepts the stock promoter’s offer but does not disclose the
arrangements to his clients or to his employer. Carter sells shares of the stock to his clients.
Comment: Carter has violated Standard VI(A) by failing to disclose to clients that he is receiving additional compensation for recommending and selling Badger
stock. Because he did not disclose the arrangement with Badger to his clients, the clients were unable to evaluate whether Carter’s recommendations to buy Badger
were affected by this arrangement. Carter’s conduct also violated Standard VI(A) by failing to disclose to his employer monetary compensation received in addition
to the compensation and benefits conferred by his employer. Carter was required by Standard VI(A) to disclose the arrangement with Badger to his employer so that
his employer could evaluate whether the arrangement affected Carter’s objectivity and loyalty.
Alex Burl is a portfolio manager at Helpful Investments, a local investment advisory firm. Burl is on the advisory board of his child’s school, which is looking for
ways to raise money to purchase new playground equipment for the school. Burl discusses a plan with his supervisor in which he will donate to the school a portion
of his service fee from new clients referred by the parents of students at the school. Upon getting the approval from Helpful, Burl presents the idea to the school’s
advisory board and directors. The school agrees to announce the program at the next parent event and asks Burl to provide the appropriate written materials to be
distributed. A week following the distribution of the flyers, Burl receives the first school-related referral. In establishing the client’s investment policy statement,
Burl clearly discusses the school’s referral and outlines the plans for distributing the donation back to the school.
Comment: Burl has not violated Standard VI(C) because he secured the permission of his employer, Helpful Investments, and the school prior to beginning the
program and because he discussed the arrangement with the client at the time the investment policy statement was designed.
Emma Madeline, a recent college graduate and a candidate in the CFA Program, spends her summer as an unpaid intern at Murdoch and Lowell. The senior
managers at Murdoch are attempting to bring the firm into compliance with the GIPS standards, and Madeline is assigned to assist in its efforts. Two months into her
internship, Madeline applies for a job at McMillan & Company, which has plans to become GIPS compliant. Madeline accepts the job with McMillan. Before
leaving Murdoch, she copies the firm’s software that she helped develop because she believes this software will assist her in her new position.
Comment: Even though Madeline does not receive monetary compensation for her services at Murdoch, she has used firm resources in creating the software and is
considered an employee because she receives compensation and benefits in the form of work experience and knowledge. By copying the software, Madeline violated
Standard IV(A) because she misappropriated Murdoch’s property without permission.
Carol Corky, a senior portfolio manager for Universal Management, recently became involved as a trustee with the Chelsea Foundation, a large not-for-profit
foundation in her hometown. Universal is a small money manager (with assets under management of approximately US$100 million) that caters to individual
investors. Chelsea has assets in excess of US$2 billion. Corky does not believe informing Universal of her involvement with Chelsea is necessary.
Comment: By failing to inform Universal of her involvement with Chelsea, Corky violated Standard VI(A). Given the large size of the endowment at Chelsea,
Corky’s new role as a trustee can reasonably be expected to be time consuming, to the possible detriment of Corky’s portfolio responsibilities with Universal. Also,
as a trustee, Corky may become involved in the investment decisions at Chelsea. Therefore, Standard VI(A) obligates Corky to discuss becoming a trustee at Chelsea
with her compliance officer or supervisor at Universal before accepting the position, and she should have disclosed the degree to which she would be involved in
investment decisions at Chelsea.
Erin Toffler, a portfolio manager at Esposito Investments, manages the retirement account established with the firm by her parents. Whenever
IPOs become available, she first allocates shares to all her other clients for whom the investment is appropriate; only then does she place any
remaining portion in her parents’ account, if the issue is appropriate for them. She has adopted this procedure so that no one can accuse her of
favoring her parents.
Comment: Toffler has violated Standard VI(B) by breaching her duty to her parents by treating them differently from her other accounts simply
because of the family relationship. As fee-paying clients of Esposito Investments, Toffler’s parents are entitled to the same treatment as any other
client of the firm. If Toffler has beneficial ownership in the account, however, and Esposito Investments has preclearance and reporting
requirements for personal transactions, she may have to preclear the trades and report the transactions to Esposito.
Alton Newbury is an investment adviser to high-net-worth clients. A client with an aggressive risk profile in his investment policy statement asks
about investing in the Top Shelf hedge fund. This fund, based in Calgary, Alberta, Canada, has reported 20% returns for the first three years. The
fund prospectus states that its strategy involves long and short positions in the energy sector and extensive leverage. Based on his analysis of the
fund’s track record, the principals involved in managing the fund, the fees charged, and the fund’s risk profile, Newbury recommends the fund to
the client and secures a position in it. The next week, the fund announces that it has suffered a loss of 60% of its value and is suspending
operations and redemptions until after a regulatory review. Newbury’s client calls him in a panic and asks for an explanation.
Comment: Newbury’s actions were consistent with Standard V(A). Analysis of an investment that results in a reasonable basis for
recommendation does not guarantee that the investment has no downside risk. Newbury should discuss the analysis process with the client while
reminding him or her that past performance does not lead to guaranteed future gains and that losses in an aggressive investment portfolio should
be expected.
Deion Miller is the research director for Jamestown Investment Programs. The portfolio managers have become critical of Miller and his staff because the Jamestown
portfolios do not include any stock that has been the subject of a merger or tender offer. Georgia Ginn, a member of Miller’s staff, tells Miller that she has been
studying a local company, Excelsior, Inc., and recommends its purchase. Ginn adds that the company has been widely rumored to be the subject of a merger study by
a well-known conglomerate and discussions between them are under way. At Miller’s request, Ginn prepares a memo recommending the stock. Miller passes along
Ginn’s memo to the portfolio managers prior to leaving for vacation, and he notes that he has not reviewed the memo. As a result of the memo, the portfolio
managers buy Excelsior stock immediately. The day Miller returns to the office, he learns that Ginn’s only sources for the report were her brother, who is an
acquisitions analyst with Acme Industries, the “well-known conglomerate,” and that the merger discussions were planned but not held.
Comment: Miller violated Standard IV(C) by not exercising reasonable supervision when he disseminated the memo without checking to ensure that Ginn had a
reasonable and adequate basis for her recommendations and that Ginn was not relying on material nonpublic information.
