cfa level iii sp17 ss1_mharbour... · 2017-03-14 · 1 university of southern california cfa...

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University of Southern California

CFA Society of Los Angeles

CFA Review Program

CFA LEVEL III

Ethical and Professional Standards

Study Session 1

March 18, 2017

Mark Harbour [email protected]

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Ethical and Professional Standards

You must be able to demonstrate a thorough

knowledge of the:

CFA Institute Code of Ethics

Standards of Professional Conduct

Including - o The rules and sanctions relating to disciplinary

proceedings

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Reading Assignments

1. Code of Ethics and Standards of Professional

Conduct Standards of Practice Handbook,

Eleventh Edition

2. Guidance for Standards I-VII, Standards of

Practice Handbook, Eleventh Edition

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Learning Outcomes

Code of Ethics and Standards of Professional

Conduct: You should be able to –

Describe the structure of the CFA Institute

Professional Conduct Program and the disciplinary

review process for the enforcement of the Code of

Ethics and Standards of Professional Conduct;

Explain the ethical responsibilities required by the

Code of Ethics and the Standards of Professional

Conduct, including the subsections of each standard.

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Code of Ethics

Members and candidates must:

Act with integrity, competence, diligence, and respect, and in an ethical manner

Place integrity of the investment profession and interests of clients above their own personal interests

Use reasonable care and exercise independent professional judgment

Practice and encourage others to practice in a professional and ethical manner

Promote the integrity and viability of the global capital markets for the ultimate benefit of society

Maintain and improve professional competence and help others to do so as well

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Standard I: Professionalism

Standard II: Integrity of Capital Markets

Standard III: Duties to Clients

Standard IV: Duties to Employers

Standard V: Investment Analysis, Recommendations, and Actions

Standard VI: Conflicts of Interest

Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate

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General Comments

Look for multiple provisions

Code and Standards apply globally

Look for assisting/participation and/or supervisory

responsibility whenever several people are

involved

Disclosure frequently is a separate obligation, but

doesn’t always cure other violations

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Enforcement of

Code and Standards Rules of Procedure:

Fair Process

Confidentiality of proceedings

The CFA Institute’s Board of Governors

maintains oversight and responsibility

through the Disciplinary Review Committee

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Possible Sanctions for Violators:

Cautionary letter

Institution of proceedings to discipline

If disciplinary action is appropriate, the following

sanctions may be imposed in increasing order of

severity: o Private censure

o Public censure

o Suspension of membership

o Revocation of membership

o In the case of CFA charterholders, suspension or revocation of

CFA charter

Enforcement of

Code and Standards

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If member or candidate rejects a proposed

disciplinary sanction the matter is referred to a

hearing panel of CFA Institute members

Enforcement of

Code and Standards

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Guidance for Standards I-VII:

You should be able to

Demonstrate a thorough knowledge of the Code

of Ethics and Standards of Professional Conduct

by interpreting the Code and Standards in various

situations involving issues of professional

integrity;

Recommend practices and procedures designed to

prevent violations of the Code of Ethics and


Learning Outcomes

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Standard I Professionalism

(A) Knowledge of the law

Must understand and comply with all applicable laws,

rules and regulations (including CFA Institute Code of

Ethics and Standards of Professional Conduct) licensing

agency, or professional association governing activites

In the event of a conflict, comply with the more strict law,

rule or regulation

Must not knowingly participate or assist in and must

dissociate from any violation of such laws, rules, and

regulations

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(A) Knowledge of the law Recommended Procedures for Compliance

Members and Candidates

Stay informed

Review procedures

Maintain current files

Firms

Develop and/or adopt a code of ethics

Provide information on applicable laws

Establish procedures for reporting violations

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(B) Independence and Objectivity

Must use reasonable care and judgment to achieve and

maintain independence and objectivity in their

professional activities

Must not offer, solicit, or accept any gift, benefit,

compensation, or consideration that reasonably could

be expected to compromise their own or another’s

independence and objectivity

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(B)Independence and Objectivity Investment recommendations must reflect opinions that

free of bias – select guidance highlights are -

Buy-Side Clients –Respect and foster intellectual honesty of sell-side research

Investment-Banking Relationships –Firewalls can minimize conflicts of interest

Public Companies –Analyst is responsible for assessing a company’s prospects and stock

price performance in a factual manner

Issuer-Paid Research –Best practice is for analysts to accept only a flat fee, without regard to

conclusions or recommendations

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(B) Independence and Objectivity

Recommended Procedures for Compliance

Protect the integrity of opinions

Create a restricted list (disseminate factual

information)

Restrict special cost arrangements

Limit gifts

Restrict investments (for example, IPOs)

Implement review procedures

Establish formal written policies on independence

Appoint a senior officer for oversight

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(C) Misrepresentation – Must not knowingly make any misrepresentation

relating to investment analysis, recommendations,

actions, or other professional activities

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(C) Misrepresentation


Periodically review employee

correspondence/documents

Develop procedures to verify 3rd party information

Regularly monitor website postings

Maintain current files

o Copies of statutes/rules/regs/important cases

o Attribute quotations

o Attribute summaries

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(D) Misconduct

Must not engage in any professional conduct involving

dishonesty, fraud, or deceit or commit any act that

reflects adversely on professional reputation, integrity, or

competence

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(D) Misconduct


Develop or adopt a code of ethics

Disseminate to all employees a list of potential

violations and associated disciplinary sanctions

Check references of potential employees

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Standard II Integrity of Capital Markets

(A) Material Nonpublic Information

Members and candidates who possess material nonpublic

information that could affect investment value of an

investment must not act or cause others to act on the

information.

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Must be

Material (disclosure likely would affect price or

reasonable investor would want to know the

information before making an investment

decision) o look at specificity, extent of difference from public information,

nature and reliability

Non-public (not disseminated – defined as “made

known”)

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Materiality –Examples Earnings

Mergers, acquisitions, tender offers or joint ventures

Changes in assets or asset quality

Innovative, products, processes or discoveries

New licenses, patents, regulatory approvals

Developments regarding customers or suppliers

Changes in management

Changes in auditor’s reports or opinions reliance

Bankruptcies

Significant legal disputes

Events regarding issuer securities & debt rating changes

Large trade orders (before they are executed)

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Companies can’t disclose material, non-public

information to a “chosen few”

Information made available to analysts remains

non-public until it is made available to investors in

general

A company can’t discriminate among analysts in

the disclosure of information or blackball analysts

who have given negative reports on the company

in the past

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Mosaic Theory – An analyst may use significant

conclusions derived from the analysis of public and

non-material nonpublic information as the basis for

investment recommendations and decisions even if

those conclusions would have been material inside

information had they been communicated directly to

the analyst by the company.

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(A) Material Nonpublic Information


Make efforts for public dissemination (e.g. encourage

issuer to disseminate by press release)

“Firewalls” are the most widely used approach to

preventing the communication of material nonpublic

information within firms

Reporting system for interdepartment communication

Written compliance policies and guidelines should be

circulated to all employees of a firm

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(B) Market Manipulation

Must not engage in practices that distort prices or

artificially inflate trading volume with the intent to

mislead market participants

May be informational in nature (for example,

spreading false rumors), or

Transactional in nature (trading among various

accounts to artificially increase the bid price of a

stock)

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Standard III Duties to Clients

(A) Loyalty, Prudence, and Care

Members and candidates have a duty of loyalty

to their clients and must act with reasonable

care and exercise prudent judgment

Place client’s interest first, before their

employer’s or their own interests

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(A) Loyalty, Prudence, and Care


Submit statements to clients at least quarterly

Members/candidates should review investments periodically to ensure compliance with governing documents

Establish policies and procedures regarding proxy voting, use of client brokerage including soft dollars

Members/candidates should encourage firms to deal with the following topics in manuals:

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Follow all applicable rules and laws

Establish client investment objectives

Consider all information when taking actions

Diversify investments to reduce risk of loss

Carry out regular reviews

Deal fairly with all clients

Disclose conflicts of interest

Disclose compensation arrangements

Determine authorization for voting proxies

Maintain confidentiality

Seek best execution

Place client interests first


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(B) Fair Dealing

Must deal fairly and objectively with all clients when

providing investment analysis, making investment

recommendations, taking investment action, or

engaging in other professional activities

May not discriminate against any clients when

disseminating investment recommendations or taking

investment action

“Fair” treatment does not necessarily mean “equal”

treatment

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(B) Fair Dealing

Recommended Procedures for Compliance (page 1 of 2)

Develop firm policies to

limit the number of people involved

Shorten the time frame between decision and dissemination

Publish guidelines for pre-dissemination behavior

Simultaneous dissemination timing

Maintain a list of clients and their holdings

Develop/document trade allocation procedures

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(B) Fair Dealing

Recommended Procedures for Compliance (page 2 of 2)

With regard to trade allocation procedures -

Document and time stamp orders

Execute orders on a first-in, first-out basis

Develop policies to address prices for partial fill orders and group orders for block trades

Give all client accounts participating in block trades the same execution price and commission


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(C) Suitability (in advisory relationships w/ client)

Make reasonable inquiry into client/prospect financial situation, investment experience, risk and return objectives and financial constraints before actions

Must reassess and update information regularly

Consider suitability before making recommendation or taking action and consider it in the context of the client’s total portfolio

You are responsible for making only investment recommendations and taking actions that are consistent with stated objectives and constraints of the portfolio

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(C) Suitability

At the inception of a relationship, the client’s

needs, circumstances and investment objectives

should be outlined in a written “investment

policy statement” (IPS)

The IPS should be reviewed/updated annually

and prior to making a material change to any

investment recommendation or decisions on

behalf of the client

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(C) Suitability


Written investment policy statement:

Client identification

Investor objectives

Investor constraints

Performance measurement benchmarks

Compare the above with capital market

expectations to develop appropriate asset allocation

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(D) Performance Presentation

Make reasonable efforts to ensure that presentation of

performance is fair, accurate and complete

Inform employer (supervisor) about Global

Performance Standards (also known as “GIPS”) and

encourage use


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(D) Performance Presentation


Compliance in the absence of GIPS -

Consider knowledge/sophistication of audience

Present performance of a weighted composite of

similar portfolios (rather than using a single account)

Include terminated accounts as part of performance

history

Include disclosures explaining the results

Maintain data and records used for calculations


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(E) Preservation of Confidentiality

Must keep information about current, former, and

prospective clients confidential unless

The information concerns illegal activities on the part

of the client

Disclosure is required by law

The client or prospective client permits disclosure

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(E) Preservation of Confidentiality


Simplest, most conservative/effective way to comply is

to avoid disclosing any client information except to

authorized fellow employees working for the client

If considering making disclosure of client information

you should ask:

• What is the context (i.e., is the disclosure relevant to your work?)

• Will the disclosure enable improved client service?

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Standard IV Duties to Employers

(A) Loyalty

Must act for the benefit of employer and not

deprive employer of the advantage of their skills

and abilities, divulge confidential information or

otherwise cause harm to employer

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(A) Loyalty

Must disclose matters that could affect ability to perform duties or render unbiased advice

Must also comply with rules on disclosure of conflicts and any limits imposed to deal with conflict

Consider:

o Whether independent practice could create conflicts

o Whether plans to leave could create conflicts (can’t solicit clients, steal trade secrets, etc.)

o Whether “whistle blowing” is clearly aimed at protecting clients or the integrity of the market and not for personal gain

o Whether scope of responsibilities are clearly defined

o Firm approved social media is considered a firm asset


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(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 written consent is obtained

from all parties involved


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(B) Additional Compensation Arrangements


Members and candidates should make an immediate

written report to their supervisor and compliance

officer specifying any compensation they propose to

receive for services in addition to compensation and/or

benefits received from their employer

The report should specify all terms of any agreement

related to compensation (including nature, amount and

duration)

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(C) Responsibilities of Supervisors

Make reasonable efforts to ensure that anyone subject to

their supervision or authority complies with laws, rules,

regulations and Code/Standards

Develop/implement effective compliance tools including

A code of ethics

Compliance policies and procedures

Education and training programs

An incentive structure that rewards ethical conduct

Adoption of firm-wide best practice standard (e.g., the GIPS standards, the CFA Institute Asset Manager Code of Professional Conduct)

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(C) Responsibilities of Supervisors

Adopt a code of ethics and compliance procedures

Adequate compliance procedures should:

Be clearly written and accessible

Be easy to understand

Designate a compliance officer

Describe the hierarchy of supervision

Implement a system of checks and balances

Outline the scope of the procedures

Provide for monitoring/testing

Outline permissible conduct

Delineate procedures for reporting violations

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Standard V Investment Analysis, Recommendations, and Actions

(A) Diligence and Reasonable Basis

Members and candidates must –

Exercise diligence, independence, and thoroughness in

analyzing investments, making recommendations and

taking investment actions

Have a reasonable and adequate basis supported by

appropriate research/investigation

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(A) Diligence and Reasonable Basis


Members/Candidates should encourage firms to consider:

Establish a policy requiring research reports and recommendations have a basis that can be substantiated as reasonable and adequate

Develop detailed written guidance for analysts

Develop measurable criteria for assessing quality of research

Establish minimum levels of scenario testing

Establish measurable criteria for outside providers

Adopt standardized criteria for external advisers


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(B) Communication - Clients / Prospective Clients

Disclose basic format and general principles of the investment process and promptly disclose changes that might materially affect those processes

Disclose significant limitations and associated risks

Use reasonable judgment in identifying factors important to analyses, recommendations, or actions; include these factors in client communications

Distinguish between fact and opinion when presenting investment analysis and recommendations


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(C) Record Retention

Develop and maintain appropriate records supporting

investment analysis, recommendations, actions and

other investment-related communications with clients

and prospective clients

In the absence of regulatory guidance, CFA Institute

recommends maintaining records for at least 7 years.


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Standard VI Conflicts of Interest

(A) Disclosure of Conflicts

Make full and fair disclosure of all matters that could

reasonably be expected to impair independence and

objectivity or interfere with respective duties to their

clients, prospective clients, and their employer

Ensure that such disclosures are prominent, are delivered

in plain language, and communicate relevant information

effectively

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(A) Disclosure of Conflicts


Should disclose special compensation arrangements with

employer that might conflict with client interests (for

example, short-term bonuses, commissions, incentive

fees, performance fees, and referral fees)

Firms are encouraged to include information on

compensation packages in promotional literature

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(B) Priority of Transactions

Investment transactions for clients and employers must

have priority over investment transactions in which a

member or candidate is the beneficial owner

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(B) Priority of Transactions


Firms should adopt certain basic procedures to address conflict areas created by personal investing. These include:

Limited participation in equity IPOs

Restrictions on private placements

Establish blackout/restricted periods

Reporting requirements o Disclosure of holdings (of employee’s beneficial interest(

o Providing duplicate confirmations of transactions

o Pre-clearance procedures (prior to execution of trades)

Disclosure of firm policies (on request)

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(C) Referral Fees

Members and candidates must disclose to their employer,

clients, and prospective clients, as appropriate, any

compensation, consideration, or benefit received from, or

paid to, others for the recommendation of products or

services

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Standard VII Responsibilities as a CFA Institute Member or CFA Candidate

(A) Conduct as Participants in CFA Institute Programs (e.g. CIPM and Claritas)

Must not:

Engage in any conduct that compromises the reputation or integrity of the CFA Institute or the CFA designation or the integrity, validity or security of the CFA examinations

This includes:

o cheating on the CFA examination

o disregarding CFA program rules

o improperly using CFA designation

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(B) Reference to the CFA Institute, the CFA Designation, and the CFA Program

Must not misrepresent or exaggerate meanings or implications of membership in the CFA Institute, holding the CFA designation or candidacy in the CFA Program

Improper references: o CFA, Level II

o CFA, expected [year]

o CFA charterholders achieve better performance results

o As a CFA charterholder, I am the most qualified to manage investments


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Proper references: Completion of the CFA Program has enhanced my portfolio

management skills

I passed all three CFA examinations in three consecutive years

As a CFA charterholder I am committed to the highest ethical standards

I passed Level I of the CFA examination

I am a [year] Level III CFA candidate in the CFA Program

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cfa level iii sp17 ss1_mharbour... · 2017-03-14 · 1 university of southern california cfa...

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