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.


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


Seven Standards of
3. Duties to clients
A. Loyalty, prudence and care
B. Fair dealing
C. Suitability
D. Performance presentation
E. Preservation of confidentiality

Seven Standards of

4. Duties to employers
A. Loyalty
B. Additional compensation arrangements
C. Responsibility of supervisors


Seven Standards of

5. Investment analysis, recommendations and actions
A. Diligence and reasonable basis
B. Communication with clients and prospective clients
C. Record Retention


Seven Standards of

6. Conflicts of Interest
A. Disclosure of conflicts
B. Priority of transactions
C. Referral fees


Seven Standards of
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.


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


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.

Information given to a select group of analysts is not public

information and acting upon such information is a violation of
the standard.

(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 pricesetting mechanism of
financial instruments.

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.

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.

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.


(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 received

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.


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.


Cases where Disclosure is required:
 providing banking services on a company the candidate reports
 involvement 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 trade
2) the investment professional does not benefit personally from
trades undertaken for clients
3) 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 CFA
Candidate (A. Conduct as Members and Candidates in the CFA
Program)
Violation:
 Breaking exam rules
 Compromising the exam integrity by divulging details of an exam
 Misrepresentation of any information to the CFA institute.


Candidate (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


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.


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


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.


(B. Market Manipulation)
Any action that is likely to affect price and volume artificially
(even with good intentions) must be full disclosed
Members should encourage their firms to have well drafted
policies regarding responsibilities to clients.

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.


(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.


(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.


Actions
Cover all pertinent issues when arriving at a recommendation.
Understand the parameters used in the model or quantitative

research.


Actions
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.

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.


Actions
(C. Record Retention)
Archive research notes and other documents that support
their current investment-related communications


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 shortterm 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


Candidate (A. Conduct as Members and Candidates in the CFA
Program)
Do not disclose details relating to the content of the exam.
Do not use the membership or CFA designation to further business

interests.


Candidate (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.


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

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


Qualifications of
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
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.


Qualifications of
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.


Qualifications of
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


Qualifications of
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


Qualifications of
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.


Qualifications of
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
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.

Qualifications of
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.

Qualifications of
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 DecisionMaking Process and not in the management of the investment
firm.


Qualifications of
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.


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.


Standards (cont.)
Requirements

Research 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.


Standards (cont.)
Requirements
Research 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.


Standards (cont.)
Requirements
Timeliness 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.

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.


Standards (cont.)
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.


Standards (cont.)
Relationships With Subject Companies: Firms should have policies

and procedures governing analyst relationships with subject
companies, specifically relating to material gifts, companysponsored trips, and so on.

Personal Investments and Trading: Always place interests of clients

ahead of personal and firm interests.


Standards (cont.)
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.


Standards (cont.)
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 Company
Violations 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.

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.)
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.)
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 Selection
The Super Selection case emphasizes the fiduciary duty that members have
to their clients.

 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.)
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))


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))


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 Disclosure
Trade 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.


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.


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.


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

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

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