l2 flash cards ethics ss 1

What is the CFA Institute Professional Conduct Program?

All CFA Members and Candidates are required to comply with

the Code of Ethics and Standards of Professional Conduct (the

“Code” and “Standards”).

The CFA Institute maintains responsibility for the Professional

Conduct Program.

Study Session 1, Reading 1

Enforcement of the CFA Institute Professional Conduct Program

The Disciplinary Review Committee of the CFA Institute Board

of Governors has overall responsibility for the Professional

Conduct Program and enforcement of the Code and

Standards.


Enforcement of the CFA Institute Professional Conduct Program (cont.)

The Rules of Procedure for Proceedings Related to Professional

Conduct are based on 2 principles:

1) fair process to the member and candidate

2) confidentiality of proceedings


Initiation of Inquiry

Enquires may arise because of:

1) members must self disclose on the annual Professional Conduct

Statement all matters that question their professional conduct

2) written complaints about a member

3) CFA Institute staff may become aware of questionable conduct

through the media or other sources.


After Initiation of Inquiry

The CFA Institute may:

1) request a written statement from the member/candidate

2) interview the member/candidate, complaining parties, or 3rd

parties

3) collect documents supporting evidence


After Collecting Evidence

After collecting evidence, the Designated Officer may

1) conclude the enquiry with no disciplinary sanction

2) continue proceedings to discipline the member/candidate


Disciplinary Sanctions

Sanctions imposed by CFA Institute for a breach may include:Members: public censure, suspension of

membership/designation, or revocation of CFA charter.

Candidates: suspended from further participation in the program.


Code of Ethics

The Code is a set of principles that define the

professional conduct that CFA Institute expects from

its members and candidates in the CFA Program.


Six Mandatory Principles in the Code of Ethics

1. All members must act with integrity, competence,

diligence, respect, and in an ethical manner with the

public, clients, prospective clients, employers,

employees, colleagues in the investment profession,

and other participants in global capital markets.


Six Mandatory Principles in the Code of Ethics (cont.)

2. All members must place the integrity of the

investment profession and the interests of clients

above their own personal interests.



3. All members must use reasonable care and exercise

independent professional judgment when

conducting investment analysis, making investment

recommendations, taking investment actions, and

engaging in other professional activities.



4. All members must practice and encourage others to practice

in a professional and ethical manner that will reflect credit

on themselves and the profession.

5. All members must promote the integrity of and uphold the

rules governing capital markets.



6. All members must maintain and improve their professional

competence and strive to maintain and improve the

competence of other investment professionals.


Standards of Professional Conduct

The standards of professional conduct outline fair and ethical

business practices.

While Code defines the conduct, Standards outline it in more

details

Violations may result in disciplinary sanctions


Seven Standards of Professional Conduct

1. Professionalism

A. Knowledge of the Law

B. Independence and Objectivity

C. Misrepresentation

D. Misconduct


Seven Standards of Professional Conduct (cont.)

2. Integrity of capital markets

A. Material non public information

B. Market manipulation



3. Duties to clients

A. Loyalty, prudence and care

B. Fair dealing

C. Suitability

D. Performance presentation

E. Preservation of confidentialityStudy Session 1, Reading 1


4. Duties to employers

A. Loyalty

B. Additional compensation arrangements

C. Responsibility of supervisors



5. Investment analysis, recommendations and actions

A. Diligence and reasonable basis

B. Communication with clients and prospective clients

C. Record Retention



6. Conflicts of Interest

A. Disclosure of conflicts

B. Priority of transactions

C. Referral fees



7. Responsibilities of a CFA institute member or CFA candidate

A. Conduct as members and candidates in the CFA program

B. Reference to the CFA institute, the CFA designation and

the CFA program


Ethics and CFA Institute

Through adherence to the codes and standards, each member

does his part in maintaining the integrity of the profession

The code outlines the high level of ethical conduct expected

from candidates

The standards are interwoven with the code forming a

tapestry of ethical requirements


Conduct that Conforms and Violates Standards

Standard 1 Professionalism (A. Knowledge of the Law)

When applicable law and the Code and Standards contradict,

members and candidates must follow the stricter of the

applicable law or the Code and Standards.


Conduct that Conforms and Violates Standards (cont.)


Ex. Applicable law may not require disclosure of referral fees for the recommendation of investment products or services. Because the Code and Standards impose this obligation, however, members and candidates must disclose the existence of such fees.




A member or candidate must dissociate, or separate, from any

form of unethical or illegal activity



Standard 1 Professionalism (B. Independence and Objectivity)

Gifts should not be accepted if it leads to a conflict of interest.

Participating in IPOs or private ownership/participation of

companies that the analyst himself is covering is

unacceptable.



Standard 1 Professionalism (C. Misrepresentation)

A misrepresentation is any untrue statement or omission of a

fact or any statement that is otherwise false or misleading.

Ex. Omitting negative scenarios from financial models/Orally

exaggerating your expertise or capabilities



Standard 1 Professionalism (C. Misrepresentation)

Misrepresentation through plagiarism in investment

management can take various forms.

Ex. Taking a research report/study of another firm or person,

change the names, and release the material as one's own

original analysis



Standard 1 Professionalism (D. Misconduct)

Otherwise legal actions are often construed as misconduct.

Example.

Excessive alcohol consumption during business hours – it

could have a detrimental effect on the member's/candidate's

ability to fulfil his or her professional responsibilities



Standard 2 Integrity of Capital Markets (A. Material Non Public Information)

Material information can have a bearing on the stock prices.

For information to be material it has to be from a reliable

source. Analysts must be wary of receiving information from

corporate insiders. Study Session 1, Reading 2



Information given to a select group of analysts is not public

information and acting upon such information is a violation of

the standard.



Standard 2 Integrity of Capital Markets (B. Market Manipulation)

1) dissemination of false or misleading information

2) transactions that deceive or would be likely to mislead mar ket

participants by distorting the price-setting mechanism of

financial instru ments.Study Session 1, Reading 2


Standard 3 Duties to Clients (A. Loyalty, Prudence and Care)

Duties to client exist beyond managing assets. The brokerage

commissions or soft dollars are the assets of the client and

must be used for their benefit.

Proxy voting is an economic benefit of the client. Voting

irresponsibly violates the duties towards the clients.



Standard 3 Duties to Clients (A. Loyalty, Prudence and Care)

Violation: Excessive trading (which benefits brokers) within a

portfolio of client securities, even if the securities themselves

are appropriately bought and sold.



Standard 3 Duties to Clients (B. Fair Dealing)Members/candidates should treat all clients fairly in light of

their investment objectives and circumstances.

Example. When making investments in new offerings or in secondary financings, members and candidates should distribute the issues to all customers for whom the investments are appropriate.



Standard 3 Duties to Clients (B. Fair Dealing)

Members and candidates should not take advantage of their

position in the industry to the detriment of clients.

For instance, in the context of IPOs, members and candidates

must make bona fide public distributions of "hot issue"

securities.



Standard 3 Duties to Clients (C. Suitability)

While deciding the suitability of a security for a client, the overall affect of the transaction of the risk return profile of the portfolio should be considered.

Violation: Evaluating a security in isolation/Recommending a single transaction for all the clients



Standard 3 Duties to Clients (D. Performance Presentation):Violation: Not including terminated accounts as part of

performance history with a clear indication of when the accounts were terminated

Past performance can be highlighted for marketing but must be clearly mentioned that the performance was achieved at another fund.



Standard 3 Duties to Clients (E. Preservation of Confidentiality):Confidentiality must be preserved, even if the person is no

longer a client.

However client confidentiality does not mean that potentially illegal activities are not to be revealed to the respective authorities.



Standard 4 Duties to Employers (A. Loyalty):Violation:

rendering independent services until they receive consent from their employer to all of the terms of the arrangement

Keeping a record of client details and intellectual property of previous employer, once they have decided to leave the company, unless with consent from the previous employer



Standard 4 Duties to Employers (A. Loyalty):Violation: Taking work done for the previous employer to the

new employer, even if the member has worked on it entirely on his own.

Example. A member cannot give software developed for GIPS compliance for a previous employer to the new employer who is seeking GIPS compliance, even though candidate has done the entire work to develop the software.



Standard 4 Duties to Employers (B. Additional Compensation Arrangement):

Candidate must obtain the consent of his employer to accept a supplemental benefit. Supplemental benefit can be a vacation trip paid by the client for good performance. Not disclosing such arrangement would be a violation of the standard.



Standard 4 Duties to Employers (C. Responsibilities of Supervisors):A member or candidate must adopt reasonable procedures

and taken steps to implement an effective compliance program

Violation: Knowledge that the procedures designed to detect and prevent violations are not being followed



Standard 5 Investment Analysis, Recommendations and Actions

(A. Diligence and Reasonable Basis)Violation: Drawing conclusions from non-reliable secondary or

third party research. Financial models must be rigorously tested for the

assumptions made. Violation: Not updating a research report when new

information is receivedStudy Session 1, Reading 2


Standard 5 Investment Analysis, Recommendations and Actions (B. Communication with Clients and Prospective Clients)Violation: Failure to identify the limits of statistically developed

projections

In communication with Clients, facts and opinions must be clearly distinguished. Violation: Treating estimates as actual numbers

Violation: Report fails to describe properly the basic characteristics of the actual and implied risks of the investment strategy.



Standard 5 Investment Analysis, Recommendations and Actions (C. Record Retention)

Violation: Failure to keep a document and copies of all the information that goes into his reports, including the secondary or third-party research of other analysts.



Standard 6 Conflicts of Interest (A. Disclosure of Conflict)Disclosure does not relieve the investment advisor or analyst

of their obligation of impartiality. It is an additional requirement.



Standard 6 Conflicts of Interest (A. Disclosure of Conflict)

Cases where Disclosure is required: providing banking services on a company the candidate reportsinvolvement in an IPO for a company the candidate report additional compensation arrangements or bonus schemes that

may cause the candidate to favour one client above another



Standard 6 Conflicts of Interest (B. Priority of Transactions)Individual managers, advisers, or mutual fund employees can

make money from personal investments as long as: 1) the client is not disadvantaged by the trade2) the investment professional does not benefit personally from

trades undertaken for clients3) the investment professional complies with applicable

regulatory requirements



Standard 6 Conflicts of Interest (C. Referral Fees)Non disclosure of any kind of referral fee can be a violation of

the standard. Even inter departmental referral fees should be disclosed.

A Quid pro quo relationship with another investment or brokerage firm should be disclosed, even if the relationship benefits the client.



Standard 7 Responsibilities as a CFA Institute Member and CFACandidate (A. Conduct as Members and Candidates in the CFAProgram)Violation:

Breaking exam rulesCompromising the exam integrity by divulging details of an examMisrepresentation of any information to the CFA institute.



Standard 7 Responsibilities as a CFA Institute Member and CFACandidate (B. Reference to CFA Institute, the CFA Designation,and the CFA Program)Violation: Exaggerating the meaning or implications of

membership in CFA Institute. For example passing three exams in consecutive years may be a statement of fact, but it cannot be used to claim superior abilities as an investment analyst.


Practices Designed to Prevent Code Violations

Standard 1 Professionalism (A. Knowledge of the law):Reporting potential violations of the Code and Standards

committed by fellow members and candidates.

Undertaking the necessary due diligence when transacting cross-border business to understand the multiple applicable laws and regulations

Providing written protocols for reporting suspected violations and provide information on applicable laws


Practices Designed to Prevent Code Violations (cont.)

Standard 1 Professionalism (B. Independence and Objectivity)When possible, prior to accepting "bonuses" or gifts from

clients, members and candidates should disclose to their employers such benefits offered by clients.

Establishment of a formal written policy on the independence and objectivity of research.



Standard 1 Professionalism (C. Misrepresentation)Provide guidance for employees who make written or oral

presentations to reduce the likelihood of misrepresentation.

Members and candidates should encourage their employers to develop procedures for verifying information of third-party firms.



Standard 1 Professionalism (D. Misconduct)Development and/or adoption of a code of ethics

Dissemination of a list of potential violations and associated disciplinary sanctions

Checking references of potential employees to ensure that they are of good character



Standard 2 Integrity of Capital Markets (A. Material Non Public Information)Public dissemination of the information that is material

If material non public information is disclosed for the first time in an analyst meeting or call, the analyst should encourage the company to promptly issue a press release or otherwise make the information publicly available.




Procedures concerning interdepartmental communication, the review of trading activity, and the investigation of possible violations should be compiled and formalized.



Standard 2 Integrity of Capital Markets (B. Market Manipulation)Any action that is likely to affect price and volume artificially

(even with good intentions) must be full disclosed

Standard 3 Duties to Clients (A. Loyalty, Prudence and Care)Members should encourage their firms to have well drafted

policies regarding responsibilities to clients.



Standard 3 Duties to Clients (B. Fair Dealing)Information should be disseminated in such a manner that all clients

have a fair opportunity to act.

Design an equitable system to prevent selective or discriminatory disclosure.

Limit the amount of time that elapses between the decision to make an investment recommendation and the time the actual recommendation is disseminated.



Standard 3 Duties to Clients (C. Suitability)A member or candidate should put the needs and

circumstances of each client and the client's investment objectives into a written investment policy statement.

The investor's objectives and constraints should be maintained and reviewed periodically to reflect any changes in the client's circumstances.



Standard 3 Duties to Clients (D. Performance Presentation)Include disclosures that fully explain the performance results

being reported.Maintain the data and records used to calculate the

performance being presented.Present the performance of the weighted composite of similar

portfolios rather than using a single representative account.



Standard 3 Duties to Clients (E. Preservation of Confidentiality)Avoid disclosing any information received from a client except

to the authorized fellow employees who are also working for the client.

Uand follow their firm's electronic information storage procedures.



Standard 4 Duties to Employers (A. Loyalty)Understand any restrictions placed by the employer on

offering similar services outside the firm.

Understand the termination policies of an employer.



Standard 4 Duties to Employers (B. Additional Compensation Arrangement)

Members and candidates should make an immediate written report to their employer specifying any compensation they propose to receive for services in addition to the compensation or benefits received from their employer.



Standard 4 Duties to Employers (C. Responsibilities of Supervisors)Understand what constitutes an adequate compliance system

and appropriate compliance procedures should be established, documented and communicated.

Members and candidates are encouraged to recommend that their employers adopt a code of ethics.




(A. Diligence and Reasonable Basis)Cover all pertinent issues when arriving at a recommendation.

Understand the parameters used in the model or quantitative research.




(A. Diligence and Reasonable Basis)Adopt a standardized set of criteria for evaluating the

adequacy of external advisers.

Due diligence of a portfolio manager must be applied more deeply than a review of a single security. It includes a review of outside managers and investment funds.



Standard 5 Investment Analysis, Recommendations and Actions(B. Communication with Clients and Prospective Clients)Describe to clients the manner in which the member or candidate

conducts the investment decision-making process.

Outline known limitations of the analysis and conclusions contained in their investment advice.

Maintain records to assist in the after-the-fact review of a report.




(C. Record Retention)Archive research notes and other documents that support

their current investment-related communications



Standard 6 Conflicts of Interest (A. Disclosure of Conflict)When conflicts cannot be reasonably avoided, clear and complete

disclosure of their existence is necessary.

Disclose special compensation arrangements with the employer that might conflict with client interests, such as bonuses based on short-term performance criteria, commissions, incentive fees, performance fees, and referral fees.



Standard 6 Conflicts of Interest (B. Priority of Transactions)Individual firms must decide who within the firm should be

required to comply with the trading restrictions.

Supervisors should establish reporting procedures for investment personnel, including disclosure of personal holdings/beneficial ownerships, confirmations of trades, and preclearance procedures.



Standard 6 Conflicts of Interest (C. Referral Fees)Inform their employer, clients, and prospective clients of any benefit

received for referrals of customers and clients. Such disclosures allow clients or employers to evaluate 1) the partiality shown in any recommendation of services and 2) the full cost of the services.

Disclose payment of a fee or compensation to others for referrals



Standard 7 Responsibilities as a CFA Institute Member and CFACandidate (A. Conduct as Members and Candidates in the CFAProgram)Do not disclose details relating to the content of the exam.

Do not use the membership or CFA designation to further business interests.



Standard 7 Responsibilities as a CFA Institute Member and CFACandidate (B. Reference to CFA Institute, the CFA Designation,and the CFA Program)

CFA institute has well defined rules for using the designations like charter holder, member or candidate. The rules must be strictly followed.


CFA Institute Soft Dollar Standards

Soft dollars refer to investment research given to the investment manager by brokers.

Soft dollar credit is the client’s asset because he or she pays the commission.

Soft dollars are not to be used for any purpose that does not benefit the client.

Only firms can claim compliance and it is voluntary.


CFA Institute Soft Dollar Standards (cont.)

General Principals

Brokerage is the property of the client.

Investment managers have a duty to obtain best execution, minimize transactions costs, and use client brokerage to benefit clients.


CFA Institute Soft Dollar Standards (cont.)Objectives of Soft Dollar Standards

Complete disclosure of the investment manager’s use of soft dollars and client brokerage.

Consistent presentation of data so all parties can clearly understand brokerage practices.

Uniform disclosure and record keeping


CFA Institute Soft Dollar Standards (cont.)Expected behaviour from managers

They must disclose all details relating to benefits received through a client’s brokerage

Third-party and proprietary research are to be treated similarly Any research purchased with client brokerage must directly assist

the investment manager in the investment process and not in the overall management of the firm.

If there is ever any question as to whether the research assists in the investment process, it should be paid for with investment manager assets.


Qualifications of "Permissible Research" Product

CFA Institute Soft Dollar Standards have provided a 3-level analysis to assist the investment manager in the determination of whether a product or service is permissible research that can be purchased with client brokerage.


Qualifications of "Permissible Research" Product (cont.)

Three-Levels Analysis:

Level I: Define a Product/Service

Level II: Determine Usage

Level III: Mixed Use Analysis




The purpose of soft dollar standards is to identify what is “allowable” research, establish standards for soft dollar use, create model disclosure guidelines, and provide guidance for client-directed brokerage arrangements.


Qualifications of "Permissible Research" Product (cont.)CFA Institute Soft Dollar Standards

CFA Institute Soft Dollar Standards are ethical principles intended to ensure:

Full and fair disclosure of an investment manager’s use of a client’s brokerage;

Consistent presentation of information so that the client, broker, and other applicable parties can clearly understand an investment manager’s brokerage practices;

Uniform disclosure and record keeping to enable an investment manager’s client to have a clear understanding of how the investment manager is using the client’s brokerage; and

High standards of ethical practices within the investment industry.




CFA Institute Soft Dollar Standards add guidance by requiring that the primary use of the Research must directly assist the Investment Manager in its Investment Decision-Making Process and not in the management of the investment firm.



Level I—Define the Product or Service

Well the first step for the Investment Manager is to define the product or service to be purchased with Client Brokerage. In most instances, the product or service is clearly defined Example: an industry report




However, there are many products and services which consist of different components that are related only to the ability of the product or service to assist the Investment Manager in its Investment Decision-Making Process Example: a computer work station that runs research software




For such multi component products or services, the Investment Manager must narrowly construe the component parts that are necessary for the products or services to directly assist the Investment Manager in the Investment Decision-Making Process.



Level II—Determine Usage

In the second step the Investment Manager determines that the primary use of the product or service, as defined by the Investment Manager in the Level I analysis, will directly assist the Investment Manager in its Investment Decision-Making Process.


Qualifications of "Permissible Research" Product (cont.)Level II—Determine Usage

For example, an Investment Manager subscribes to the Bloomberg Service and uses this service only to enable all persons visiting the Investment Manager’s offices to look up the price of securities and analyze market trends. Under the Level I analysis, the Investment Manager defines the service as the market data received from Bloomberg, plus the Bloomberg supplied terminal and the dedicated line necessary to receive the Bloomberg service in the Investment Manager’s offices. However, under the Level II analysis, the Investment Manager does not use the Bloomberg service to directly assist it in its Investment Decision- Making Process. To the contrary, the Investment Manager subscribes to the Bloomberg Service as a benefit to the firm. The Bloomberg Service, therefore, cannot be paid for with Client Brokerage.



Level III—Mixed-Use Analysis

The third step occurs only after the Investment Manager determines that the product or service is research by completing the Level I and Level II analysis above.

Then the Investment Manager determines what portion of the Research is used by the Investment Manager to directly assist it in the Investment Decision-Making Process. If less than 100% of the Research is used for assistance in its Investment Decision-Making Process, the Investment Manager must consider the Research as Mixed-Use Research.




With Mixed-Use Research, the Investment Manager can use Client Brokerage to pay for only that portion of the Research used by the Investment Manager in the Investment Decision-Making Process and not in the management of the investment firm.




For example, if the Bloomberg service discussed in the Level III analysis was actually used 50% of the time to determine market and industry trends as part of the Investment Manager’s Investment Decision-Making Process, the Investment Manager could pay for 50% of the Bloomberg service with Client Brokerage.


CFA Institute Research Objectivity Standards

Prepare research; make recommendations; take investment actions; and develop policies, procedures, and disclosures that put client interests before the interests of employees and the firm.

Facilitate full, fair, meaningful, and specific disclosures to clients and prospects of possible and actual conflicts of interest of the firm and its employees.


CFA Institute Research Objectivity Standards (cont.)

Promote the use of effective policies and procedures that minimize possible conflicts that may adversely affect the independence and objectivity of research.

Support self-regulation by adhering to specific, measurable standards to promote objective and independent research.

Provide a work environment conducive to ethical behaviour and adherence to the Code and Standards.


CFA Institute Research Objectivity Standards (cont.)RequirementsResearch Objectivity Policy: formal written independence and

objectivity of research policy.

Public Appearances: disclose any personal and firm conflicts of interest.

Reasonable and Adequate Basis: reports and investment recommendations must have a reasonable and adequate basis.

Investment Banking: separate research analysts from the investment banking.


CFA Institute Research Objectivity Standards (cont.)RequirementsResearch Analyst Compensation: Compensation for research

analysts should be directly related to the quality of the research and recommendations.

Relationships With Subject Companies: Analysts must not allow the subject company to see any part of the research report prior to publication.

Personal Investments and Trading: Ensure covered employees do not trade ahead (i.e., front running) of client or enable anyone else to do the same.


CFA Institute Research Objectivity Standards (cont.)RequirementsTimeliness of Research Reports and Recommendations: Regularly

issue research reports on subject companies on a timely basis.Compliance and Enforcement: Firms must enforce their policies and

compliance procedures.Disclosure: The firm must disclose conflicts of interests related to

covered employees or the firm as a whole.Rating System: The firm must have a rating system that investors

find useful for investment decisions.


CFA Institute Research Objectivity Standards (cont.)Recommended Compliance Procedures

Research Objectivity Policy: Any policy should clearly identify the factors on which research analysts compensation is based.

Public Appearances: Covered employees making public appearances should always be prepared to disclose all conflicts.

Reasonable and Adequate Basis: Firms must provide guidance on what constitutes reasonable and adequate basis for a specific recommendation.



Investment Banking: Investment banking/corporate finance personnel may review reports only to verify factual information or to identify possible conflicts of interest.

Research Analyst Compensation: Compensation systems should be based on measurable criteria consistently applied to all research analysts.



Relationships With Subject Companies: Firms should have policies and procedures governing analyst relationships with subject companies, specifically relating to material gifts, company-sponsored trips, and so on.

Personal Investments and Trading: Always place interests of clients ahead of personal and firm interests.



Timeliness of Research Reports and Recommendations: Firms are required to publish regular updates to research and recommendations. Quarterly updates are preferred.

Compliance and Enforcement: Firms should distribute to clients a list of activities which are violations and include disciplinary sanctions for such violations.



Disclosure: Firms should require regular updates to research and recommendations. Quarterly updates are preferred.

Rating System: Rating systems should include the recommendation and rating categories, time horizon categories, and risk categories.


The Glenarm CompanyViolations in the case

By taking confidential information, and soliciting clients and prospects to benefit Glenarm, Sherman has harmed his former employer, Pearl, and hence is in violation of his duty of loyalty. (Violations of Standard IV (A))

Sherman did not disclose his consulting arrangements to Glenarm.

The consulting arrangements had the potential to affect Sherman’s independence and objectivity. (Violations of Standard IV (B), VI (A), I(B))


The Glenarm Company (cont.)The Glenarm case introduces you to the obligations of CFA Institute

members.

Actions to prevent violations

Sherman should not solicit Pearls clients or prospects until he completes his employment at Pearls.

Sherman should not have taken Pearl property.Sherman should disclose his consulting arrangements to Glenarm.Sherman must disclose all details about outside compensation to

Glenarm and obtain written permission from Glenarm in advance of entering into any such arrangements.


Preston Partners The Preston Partners emphasizes the violations that can occur when

allocating block trades.

Violations in the case

Smithson should have considered clients’ individual risk tolerances, needs, circumstances, and goals; he should have also better matched clients with investments. (Violations of Standard III (C))

The firm had no clear procedures for allocating block trades to client accounts. Large accounts were favoured, disadvantaging smaller accounts. (Violations of Standard III (B))


Preston Partners (cont.)Violations in the case

The senior management at Preston Partners should have made reasonable efforts to identify and prevent violations of applicable laws, rules, and regulations. A compliance program should have been in place. (Violations of Standard IV (C))


Preston Partners (cont.)Actions to prevent violations

Smithson’s clients should have written investment objectives and policy statements.

Detailed guidelines covering block trades must be prepared, emphasizing fairness to clients, timely executions, and accuracy.

Preston must have proper procedures established that would have prevented violations such as those that occurred.


Super SelectionThe Super Selection case emphasizes the fiduciary duty that members have

to their clients.

Violations in the case

Cuff has the responsibility to take steps to prevent violations, and as a compliance officer, she should see that the firm’s compliance procedures are adhered to by employees. Any violations must be addressed. (Violations of Standard IV (C))

Trader failed to disclose ownership of AMD stock options and also the compensation she received as a director of AMD. (Violations of Standard VI (A))


Super Selection (cont.)Violations in the case

Trader determined AMD was not a suitable security for her clients. Trader was pressured by James and reversed positions; thus the AMD stock was purchased. (Violations of Standard V (A))

The fiduciary duty to clients was violated. The client interests should always come first. (Violations of Standard III (A))


Super Selection (cont.)Violations in the case

AMD stock was purchased for clients without considering client needs and circumstances. (Violations of Standard V (A))

Trader violated this Standard by trading personally prior to client trades. (Violations of Standard VI (B))


Super Selection (cont.)Actions to prevent violations

Cuff must take prompt action to correct violations by reporting the violations to the appropriate members of senior management.

As a supervisor, Cuff must take action to ensure disclosure and, if necessary, by limiting behaviour and imposing sanctions.



Trader should have conducted due diligence and thorough research before making an investment decision for clients’ accounts.

The compliance officer, Cuff, should review investment actions taken for clients at least annually.

Trader should have taken any investment action for the sole benefit of her clients.



Cuff must completely investigate Trader’s activities to determine other fiduciary breaches.

Trader should have considered clients needs and circumstances instead of taking actions that benefited her personally.

The compliance officer should establish at least an annual review to compare the suitability of investment actions with the investment policy statements.


Trade Allocation: Fair Dealing and DisclosureTrade Allocation Practices

The allocation of trades may be based on compensation arrangements. Alternatively, the allocation of trades may be based on client relationships with the firm.

An ad hoc allocation procedure gives rise to the temptation to allocate a disproportionate share of profitable trades

to performance-based fee accounts.


Trade Allocation: Fair Dealing and Disclosure (cont.)Trade Allocation Practices

Also, an ad hoc allocation procedure gives rise to the temptation to allocate a disproportionate share of profitable trades to favoured clients.


Trade Allocation: Fair Dealing and Disclosure (cont.)

Appropriate actions

Get an advance indication of client interest regarding any new issues.

Distribute new issues by client, not by portfolio manager.

Have in place a fair and objective method for trade allocation, such as pro rata or a similar system.


Trade Allocation: Fair Dealing and Disclosure (cont.)

Appropriate actions

Be fair to clients regarding both execution of trades and price.

Execute orders in a timely and efficient manner.

Keep records and periodically review them to ensure that all clients are being treated equitably.


Changing Investment Objectives

The investment manager must inquire about the clients investing experience and investment objectives.

The actions and recommendations must be suitable to the client’s situation.

Individual investment decisions must be judged in the context of the entire portfolio.


Changing Investment Objectives (cont.)

Disclosure of investment objectives

The security selection and portfolio construction processes are typically described in a fund’s prospectus.

These processes are the key elements upon which the determination of the appropriateness and suitability may be determined.



Disclosure of investment objectives

A material deviation from these processes, in the absence of approval from clients, constitutes a violation of CFA Institute Standard III(C) Duties to Clients Suitability.

The investment must fit within the mandate or within the realm of investments that are allowed according to the fund’s disclosures.



Appropriate actions

Determine the clients’ financial situation, investment objectives, and level of investing expertise.

Adequately disclose the basic security selection and portfolio construction processes.

Conduct regular internal checks for compliance with these processes.



Appropriate actions

Stick to the stated investment strategy if managing to a specific mandate or strategy.

Notify investors and potential investors of any potential change in the security selection and portfolio construction processes and secure documentation of authorization for proposed changes.


The Prudent Investor Rule

Basic principles

The new Prudent Investor Rule incorporates the principles of portfolio theory.

Diversification is expected of portfolio managers as a method of reducing risk.

Trustees must base an investment’s appropriateness on its risk/return profile in a portfolio context.


The Prudent Investor Rule (cont.)

Basic principles

Excessive trading (churning), as well as excessive fees and other transactions costs that are not warranted by the portfolio risk/return objectives should be avoided.

Current income for the trust must be balanced against the need for growth.

Trustees are allowed to delegate investment authority Study Session 1, Reading 10


General Fiduciary standards

The general fiduciary standards that a trustee must adhere to are care, skill, caution, loyalty, and impartiality.

The adherence to these standards is required of the trustee at the time of the investment decision.



Difference between new and old prudent investment rule

Total return is emphasized rather than the preservation of purchasing power.

Risk must be consistent with expected return objectives. Under the old rule, risk was avoided.

The investments are evaluated from a risk-return perspective in a portfolio context, not individually.



Difference between new and old prudent investment rule

No securities are“off limits”because they are risky on a stand-alone basis.

Delegation of duties is encouraged rather than prohibited.



Key factors to be considered by fiduciary

General economic conditions (including inflation and deflation)

Total expected return and the risk-return trade-off of the portfolio.

The unique needs of the beneficiary, including the tax situation, other resources available to the beneficiary, liquidity, income and capital preservation requirements, and unique assets with a special relationship to the beneficiary.


l2 flash cards ethics ss 1

Technology

evidence study session

misconduct study session

cfa members

membercandidatestudy

professional activities

cfa program

code of ethicsthe code

record retentionstudy